More on Last Week’s Grant in No. 06-1413, MeadWestvaco Corporation v. Illinois Department of Revenue, et al.

The following entry was written by Susan Ruge, a tax associate at the Akin Gump office in Washington, DC.

Last Tuesday, the Court agreed to consider whether the standard applied by an Illinois appellate court to determine whether Illinois may tax the sale of a business by a non-domiciliary is in conflict with the Court’s own rulings and the Due Process and Commerce Clauses of the Constitution.

Mead Corporation was organized and maintained its principal corporate offices in Ohio during all of the relevant years. Mead was and remains in the business of producing and selling forest products, including paper and office supplies. In 1968, Mead acquired Data Corporation for $6 million. Data Corporation was involved in the development of ink jet printing technologies and a full-text information retrieval technology that eventually became Lexis/Nexis. Mead made subsequent capital contributions to Lexis/Nexis to support the business until it finally became profitable in the 1970s. In the 1980s and 1990s, Mead alternated between treating Lexis/Nexis as a corporate division and a subsidiary; at the time of the sale, it was a division.

Between 1988 and 1993, Mead included Lexis/Nexis’ financial information in its Illinois combined income tax returns and in 1994 included Lexis/Nexis’ sales in its report of Mead’s Illinois sales. In 1994, Mead sold all of the assets of Lexis/Nexis for $1.5 billion. It did not include such proceeds in its apportionable business income in its Illinois return for 1994. In 2002, long after the transaction in question, MeadWestvaco Corporation was formed as the holding company for Mead and Westvaco Corporation. MeadWestvaco is the successor in interest to Mead in this case.

Whether a state may tax a non-domiciliary on the gain from the sale of a business depends on whether the interest in the business is considered to perform an operational function or an investment function. The Illinois Department of Revenue seeks to tax $1 billion from the sale as nonapportionable business income. Mead contests this assessment, arguing that this gain is nonbusiness investment income from the sale of an intangible asset (goodwill).

The trial court held that while Mead and Lexis/Nexis did not operate a unitary business, Mead’s interest in Lexis/Nexis did serve an operational function, rather than constituting a mere investment, so that a portion of the gain was properly apportioned to and taxed by Illinois. On appeal, the appellate court agreed with this determination, relying upon the following factors: Mead made capital investments in Lexis/Nexis during its early, unprofitable years; Mead received certain tax benefits when it used its discretion to treat Lexis/Nexis as a division or as a subsidiary; Mead controlled the investment of Lexis/Nexis’ excess for the benefit of Lexis/Nexis; Mead’s board approved of major debt and major capital expenditures; and Mead included Lexis/Nexis in its description of business activities in its annual report and its Forms 10-K.

The basis of MeadWestvaco’s position is that the appellate court’s decision utilized a standard different from that enunciated by the Supreme Court in Allied-Signal, Inc. v. Director, Div. of Taxation (1992), and prior cases to determine whether it was appropriate to apportion part of the income from the disposal of Lexis/Nexis to Illinois. MeadWestvaco contends that the factors considered by the appellate court not only are contrary to the legal standard set forth by the Supreme Court and in conflict with the decisions of high courts in other states, but would eviscerate the distinction between operational and investment functions, permitting any state to tax any multi-state non-domiciliary corporation on the sale of any such business.

The Illinois Department of Revenue argued that there is no conflict between the appellate court’s decision and the Supreme Court’s rulings because the Illinois court applied the legal standard as articulated by the Supreme Court in Allied-Signal, but simply found that MeadWestvaco failed to meet its burden of proof that the state had overreached its constitutional boundaries. Therefore, MeadWestvaco is simply contesting how the appellate court weighed the facts and applied the law to its circumstances, making review by the Court unwarranted. Illinois also disputed the assertion that the Illinois appellate court opinion is in conflict with those from high courts in other states, contending that the apparent divergent results between the state courts are “the inevitable result of applying a fact-sensitive rule to factually distinct transactions.”

MeadWestvaco’s brief is due Nov. 5 and the Illinois Department of Revenue’s brief is due on Dec. 3. The case is expected to be argued in January.