Is the unitary business principle the sole test for determining whether a state can tax an apportioned share of a non-domiciliary’s capital gains under the U.S. Supreme Court’s Due Process Clause and Commerce Clause jurisprudence? Jaye A. Calhoun, Bruce P. Ely, and Kelvin M. Lawrence believe so, and discuss its relevance in the last of a two-part series focusing on a closely watched case currently on appeal before the Massachusetts Supreme Judicial Court.
As Part I of our Insight warns, a case before the Massachusetts Supreme Judicial Court, VAS Holdings & Investments LLC v. Commissioner of Revenue, No. SJC-13139 (“VASHI”), has brought the unitary business principle front and center. But the competing amicus briefs filed in that case, as eminent tax professor Rick Pomp noted, sail past each other like “two ships passing in the night.” How is it that the Multistate Tax Commission (the “MTC”), an organization of member states seeking uniformity and avoidance of double taxation, and the American College of Tax Counsel (“the College”), an organization of prominent private, academic and government tax attorneys, can view the same facts and the applicable law in such irreconcilable ways?
We refer our readers to the first installment of this Insight for the critical facts and the procedural posture of the case. In short, VASHI sold its entire 50% membership interest in Cloud5, LLC, in 2013 to an unrelated third party and excluded the resulting capital gain from its and its shareholders’ Massachusetts income tax bases. The Massachusetts Commissioner of Revenue assessed tax on 100% of this capital gain, and VASHI appealed on Due Process Clause and Commerce Clause grounds, among others. Understandably, VASHI argued that a non-domiciliary seller’s gain must be derived from a “unitary” business conducted by the seller and its subsidiary in the state. Only then can that gain be included in apportionable income and subject to that state’s tax. The commissioner, on the other hand, sought to tax 100% of VASHI’s capital gain on the basis of “investee apportionment.” Under that theory, the commissioner argued that a unitary business relationship is not needed as long as the business sold—here, Cloud5—had sufficient connection with the state of Massachusetts.
While that position would seem directly at odds with the Supreme Court’s holdings, the Appellate Tax Board (“ATB”) nonetheless upheld the commissioner’s assessment in VAS Holdings & Investments, LLC v. Comm’r of Revenue, Mass., finding VASHI’s “almost singular focus on the unitary business principle was too narrow.” Through its interest in Cloud5, the ATB concluded, VASHI had “avail[ed] itself of the protections and benefits afforded by the commonwealth.” Despite VASHI’s lack of Massachusetts contacts, and what the authors thought was a crucial stipulation that VASHI was not engaged in a unitary business with Cloud5, the assessment was affirmed.
Against that backdrop, it’s no surprise this case has attracted national attention. What is surprising, however, is the way in which the commissioner and the MTC simply jettisoned relevant Supreme Court precedent in this most recent attempt to run the blockade set up by the Supreme Court to protect nonresidents from overreach by states with which they have no contact. In MeadWestvaco Corp. v. Ill. Dep’t of Revenue, the Supreme Court reaffirmed that the unitary business principle is “the linchpin of apportionability"—the rationale for apportioning the income of a nonresident owner falls apart without a unitary business relationship between the business enterprise conducted by the nonresident in the state and the business being sold.
In MeadWestvaco, the taxpayer, an Ohio company, was engaged in the paper products business in Illinois and elsewhere. Mead sold a division, Lexis, which was also engaged in business in Illinois. Because the Court found that Lexis’s business was not unitary with Mead’s paper products business, Illinois could not include Mead’s gain on the sale in its apportionable tax base. Any other rule runs the risk of sinking the national economy under the weight of excessive extraterritorial taxation. Ironically, neither the commissioner in its filings nor the ATB in its decision relied on MeadWestvaco.
The Amicus Brief of the H.M.S. Multistate Tax Commission
As its most recent salvo in the war on the unitary business principle, the MTC filed an amicus brief in support of the ATB’s decision, asserting a novel interpretation of the principle: that the principle simply doesn’t apply where the subsidiary being sold does business in the taxing state. Although this interpretation is “novel,” in that it’s contrary to at least three Supreme Court precedents, it is not novel to the MTC. In fact, it’s the same position the MTC took in several amicus briefs filed in earlier cases before the Supreme Court—and other courts—which position the Supreme Court declined to adopt in each instance. In their previous amicus efforts, as well as this one, the MTC argued that a state’s furnishing benefits and protections to the entity doing business in that state—here, Cloud5, a pass-through entity—gives the state the constitutional authority to tax the entity’s nonresident owners on all their income derived from the business—both its operating income and their capital gains from the sale of ownership interests.
A corollary to the MTC’s argument is that there is no constitutionally significant distinction between operating income and capital gain. Is the MTC misdirecting the course of the discussion when it cites to the Supreme Court’s observation in ASARCO v. Idaho State Tax Comm’n, that dividends and capital gain should be subject to the same apportionability standard? After all, how similar are dividends and distributive share? But even if the Court follows that rubric today—and that’s debatable—any income can only be taxed by a state if that income is derived from a business activity that is unitary with the taxpayer’s business activity in that state.
Surprisingly, the MTC argues the unitary business principle applies only when determining the extent to which a state has nexus over income from extraterritorial sources and has no application when the income is derived—albeit indirectly—from an entity with a connection to the taxing state. The MTC contends the unitary business cases cited by VASHI all address whether income from businesses outside the taxing state were sufficiently related to a taxpayer’s in-state activity to subject the income to tax. Because this case involves taxing capital gain from a business that has a relationship to the taxing state, the MTC contends the state’s power to tax does not require a unitary relationship between the taxpayer/investor and the entity whose sale generated the income.
This unique argument ignores the Supreme Court’s more recent decisions in Allied-Signal, Inc. v. Dir., Div. of Taxation, and MeadWestvaco Corp. v. Ill. Dep’t of Revenue, which both applied the unitary business principle in voiding assessments, and both involved the sale of subsidiaries doing business in the taxing state. Notably, the MTC’s brief purports to limit its arguments to those under the Due Process Clause, thus bypassing the Commerce Clause.
The Amicus Brief of the Good Ship ACTC
Sailing in more well-charted waters, the amicus brief filed by the College explains that the ATB’s holding runs counter to well-settled Supreme Court jurisprudence relating to the sale of a business interest and clearly limiting a state’s ability to tax extraterritorial values. The Supreme Court has held that if a unitary relationship is established between the enterprise being sold, whether in-state or not, and the seller’s business in the state, the U.S. Constitution does not prohibit taxing an apportioned share of the gain on the sale of the interest in that enterprise. The extraterritorial values that can be brought into the tax base are those that are part of one business conducted within the taxing state. On the other hand, the Court has made clear that the Due Process and Commerce Clauses preclude a state from taxing even an apportioned share of the capital gain realized by a non-domiciliary investor on the sale of a business interest unconnected with the investor’s in-state business—if any.
The College’s brief explains the treacherous waters into which the MTC’s rudderless position would lead us. If the Massachusetts Supreme Judicial Court is persuaded to disregard MeadWestvaco and related cases and uphold the ATB’s opinion, other states will surely follow. After all, many legislatures would prefer not to have limits imposed on their state’s ability to tax and, better yet, their state’s ability to tax nonresidents—who cannot vote in the state. Massachusetts residents could find themselves taxed by some states on the entire capital gain realized on the sale of their own non-unitary investments, while other states may apply the “traditional” unitary business principle and ask for their “just share” of the gain. The College’s brief makes these important points, both for the benefit of non-domiciliaries but also for the benefit of Massachusetts residents. If “investee apportionment” were sanctioned and adopted, it “would expose Massachusetts businesses and residents to other states’ taxes when investing in out-of-state companies.” For example, if a Massachusetts business or resident invests in General Motors stock, then pursuant to the investee apportionment methodology, gain upon the sale of that stock would be taxable by Michigan, or perhaps any other state in which General Motors does business, even if the seller never engaged in any activities outside of Massachusetts.” Brief of College, at 25, footnote 6.
At the oral argument held virtually on Jan. 5, 2022, the justices of the Supreme Judicial Court questioned the commissioner’s attorney at length about what “limiting principle” would apply to protect owners of, for example, General Motors stock from finding themselves taxable in any state where GM does business. The answers provided by counsel appeared less than satisfactory to the justices. The commissioner’s counsel suggested the Department of Revenue would only pursue wealthy individuals and large businesses but was unable to articulate any standard for how “wealthy” or “large” would be determined, seemingly saying, “trust us, we’re the government,” as one justice remarked. Another justice cautioned the commissioner about the risk of creating “chaos” if this theory is adopted while other states continue to apply different theories of nonresident taxation.
Two Ships Passing in the Night
So the amici sailed off in different directions, and now it’s up to the Massachusetts Supreme Judicial Court to decide whether the Supreme Court’s requirement of a unitary business relationship under the circumstances was misguided, is open to interpretation, or simply should be followed as the law of the land.
Republished with permission. This article, "Full Speed Ahead: Competing Amicus Briefs in the VAS Holdings Case" was published by Bloomberg Tax on January 28, 2022.