The Sale of a US Business

The Sale of a US Business

June 01, 2008

The sale of a US business may trigger a tax in more than one US state or in just the state where the US parent company is located under a US Supreme Court decision in April.

MeadWestvaco Corp. sold its Lexis-Nexis data research service in 1994 for $1.5 billion. It had a $1 billion gain on the sale. The business was organized as a division rather than a separate subsidiary. Lexis-Nexis is like Google for lawyers; it is a search engine for legal research.

Lexis-Nexis was headquartered in Illinois. The parent company, MeadWestvaco, has its headquarters in Ohio. Illinois insisted that the company had to pay taxes in Illinois on the gain from the sale.

Illinois distinguishes between “business income” and “nonbusiness income.” The former is income from “transactions and activity in the regular course” of the taxpayer’s business.

If the gain was nonbusiness income, then Illinois would allocate it entirely to Ohio where the parent company that received the income is based. None of it would be taxed in Illinois. However, if the gain was business income, then the state would treat part of it as earned in Illinois.

The US constitution places limits on the ability of a state to tax companies. A company must have a sufficient link to the state to justify a tax. In today’s economy where large conglomerates of affiliated companies operate across many states, each state ends up apportioning the income of the entire group, including subsidiaries, partly to the state under a formula. Most states use some combination of property, payroll and sales in the state as a percentage of total property, payroll and sales of the larger “unitary business” — or conglomerate — to apportion income. States moved to this approach after the rise of railroad, telegraph and other multistate businesses made it too hard to trace actual dollars to the state. State tax departments are also too small and no match for the complicated internal accounting of large multinational corporations.

MeadWestvaco argued that the gain from the sale of Lexis-Nexis was nonbusiness income that should be taxed only in Ohio. It also argued that Lexis-Nexis was not part of a larger unitary business with the parent since it operated as a standalone company with its own management team and with oversight by the parent, but no involvement by the parent or headquarters staff in its day-to-day affairs.

The Illinois courts concluded that Lexis-Nexis was separate enough that it was not part of a unitary business, but nevertheless said the state could apportion part of the gain to Illinois because Lexis-Nexis served an “operational purpose” in the larger company. It was considered in the strategic planning and allocations of resources by the parent company.

The US Supreme Court added its two cents in April.

The court said two things and then sent the case back to Illinois for the Illinois courts to reconsider.

First, either the business sold is part of a unitary business or it is not. If it is not part of a unitary business, then none of the income can be apportioned to Illinois. However, the fact that an asset serves an “operational as opposed to purely an investment function” can make it part of a unitary business. Thus, for example, a state like Illinois can tax a share of interest earned on a bank account that the parent company in Ohio has in a third state if the bank deposit is part of the working capital of the larger unitary business. Second, in order for two companies or divisions to be linked together in a unitary business, they must have “functional integration, centralized management, and economies of scale.” The trial court in Illinois said Lexis-Nexis and the Ohio parent company had none of these things. The state appeals court failed to address the question.

The case is MeadWestvaco Corp. v. Illinois.


Keith Martin