Opinion ID: 1057560
Heading Depth: 3
Heading Rank: 2

Heading: Constitutionality of Tax Assessment

Text: Taxpayer contends, in the alternative, that the Department's tax was unconstitutional. The Due Process Clause of the Fourteenth Amendment to the United States Constitution imposes two requirements on a state's taxing power over a multistate business enterprise. Exxon Corp., 447 U.S. at 219-20, 100 S.Ct. 2109. First, the taxing state must have some minimum connection with the business entity it seeks to tax. Allied-Signal, Inc. v. Dir., Div. of Taxation, 504 U.S. 768, 777, 112 S.Ct. 2251, 119 L.Ed.2d 533 (1992) (quoting Miller Bros. Co. v. Maryland, 347 U.S. 340, 344-45, 74 S.Ct. 535, 98 L.Ed. 744 (1954)). Taxpayer conducts business in Tennessee. The Department therefore may tax Taxpayer. The second requirement of the Due Process Clause is that there must be a rational relationship between the income attributed to the taxing state and the intrastate value of the business being taxed. Allied-Signal, Inc., 504 U.S. at 772, 112 S.Ct. 2251. A state may not tax income from an activity or property to which the state does not have a connection, even if the state has a minimum connection to the actor or owner. Id. at 778, 112 S.Ct. 2251 (stating that in the case of a tax on an activity, there must be a connection to the activity itself, rather than a connection only to the actor). The Commerce Clause imposes a parallel limitation that forbids states from levying taxes that discriminate against or burden interstate commerce by subjecting activities to multiple or unfairly apportioned taxation. MeadWestvaco Corp. v. Ill. Dep't of Revenue, 553 U.S. 16, 24, 128 S.Ct. 1498, 170 L.Ed.2d 404 (2008). These constitutional limitations prohibit states from taxing value that is generated without any protection, opportunities and benefits from the taxing state. Id. at 24-25, 128 S.Ct. 1498 (stating that the broad inquiry is `whether the state has given anything for which it can ask return' (quoting ASARCO Inc. v. Idaho Tax Comm'n, 458 U.S. 307, 315, 102 S.Ct. 3103, 73 L.Ed.2d 787 (1982))). Because the income of a multistate business enterprise like Taxpayer may be generated from a myriad of assets and activities across state lines, the United States Supreme Court has set forth guidance to assist taxing states in complying with the Due Process and Commerce Clauses. The United States Supreme Court has recognized that the value of a multistate business enterprise often cannot be fairly apportioned based solely on the business's activities or property within the borders of the taxing state. See MeadWestvaco Corp., 553 U.S. at 26, 128 S.Ct. 1498. Accordingly, the United States Supreme Court permits states to tax an apportionable share of a multistate business enterprise rather than taxing only that part of the multistate business enterprise that is within the taxing state. Allied-Signal, Inc., 504 U.S. at 778, 112 S.Ct. 2251. To ensure that a taxing state taxes its fair share of the value of a multistate business enterprise within the limitations imposed by the Due Process and Commerce Clauses, the United States Supreme Court adopted the unitary business principle. See id. The unitary business principle provides that a state may tax an apportioned share of the income from a multistate business enterprise's unitary business if the unitary business is conducted in part in the taxing state. See MeadWestvaco Corp., 553 U.S. at 25, 128 S.Ct. 1498. The operation of the unitary business in the taxing state creates a sufficient nexus between the taxing state and the unitary business's out-of-state activities or assets to satisfy Due Process and Commerce Clause concerns. Taxpayer operates the Blue Bell ice cream business in Tennessee. Pursuant to the unitary business principle, the Department therefore may constitutionally tax Tennessee's fair portion of the Blue Bell ice cream business, including any income from out-of-state activities, assets, or business entities that are unitary with the ice cream business in Tennessee. The income at issue in Taxpayer's challenge is Taxpayer's capital gains from its acquisition and sale of stock during the reorganization. We must determine, therefore, whether the Stock Transaction and reorganization are unitary with Taxpayer's ice cream business. The United States Supreme Court has used the operational-function concept to determine whether income derived from assets such as stock is part of the Taxpayer's unitary business. Allied-Signal, Inc., 504 U.S. at 787, 112 S.Ct. 2251; accord MeadWestvaco Corp., 553 U.S. at 29, 128 S.Ct. 1498 (The concept of operational function simply recognizes that an asset can be part of a taxpayer's unitary business even if what we may term a `unitary relationship' does not exist between the `payor and payee.'); see Walter Hellerstein, MeadWestvaco and the Scope of the Unitary Business Principle, 108 J. Tax'n 261, 263 (May 2008) ([T]he Court explicitly embraced the `operational-function' concept as a basis for apportionability of income from assets.  (emphasis in original)). The United States Supreme Court has held that income from a capital transaction such as the Stock Transaction and the reorganization is part of a taxpayer's unitary business if the capital transaction serves an operational function rather than an investment function. Allied-Signal, Inc., 504 U.S. at 787, 112 S.Ct. 2251. An asset serves an operational function if the asset helps the taxpayer make better use of the taxpayer's existing business-related resources. Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159, 178, 103 S.Ct. 2933, 77 L.Ed.2d 545 (1983). The United States Supreme Court has stated that an investment function serves to diversify the entity and reduce the risks associated with being tied to one industry's business cycle. Id. For the Department to be entitled to judgment as a matter of law as to this constitutional issue, therefore, the uncontested facts must show that the Stock Transaction and reorganization served an operational function. Applying the United States Supreme Court's distinction between operational and investment functions to the present case, we hold that the Stock Transaction served an operational function rather than an investment function for the Blue Bell ice cream business. Taxpayer acquired and sold the 1,131 shares of stock solely as part of the reorganization of the entities profiting from the business. The Stock Transaction neither diversified the business nor reduced risks associated with the ice cream business. To the contrary, the Stock Transaction and reorganization served to increase net gain from the ice cream business. Because the capital transaction served an operational function for Taxpayer's business, Taxpayer's income from the stock is unitary with Taxpayer's ice cream business. Taxpayer contends, however, that the Stock Transaction and reorganization were BBC USA's activities. In support, it points to the uncontested fact that BBC USA implemented and controlled the reorganization, including the Stock Transaction. Although the reorganization resulted in Taxpayer's formation, Taxpayer states that it was a passive participant in the reorganization and Stock Transaction. Taxpayer further asserts that BBC USA is not unitary with Taxpayer's ice cream business in Tennessee. The operational-function concept is limited to determining when earnings from assets are part of the taxpayer's unitary business. Assuming arguendo that the Stock Transaction and reorganization were exclusively BBC USA's activities, the United States Constitution would prohibit the Department from taxing Taxpayer for capital gains from the Stock Transaction unless it first determined that BBC USA was unitary with Taxpayer's ice cream business. See MeadWestvaco Corp., 553 U.S. at 29-30, 128 S.Ct. 1498. We therefore consider whether BBC USA and Taxpayer are unitary pursuant to the unitary business principle. It is uncontested that BBC USA is a separate business entity from Taxpayer. To determine whether two separate business entities form a unitary business, we must look beyond the superficial divisions between parent corporations and their subsidiaries to the underlying activity generating the income. See Mobil Oil Corp. v. Comm'r of Taxes, 445 U.S. 425, 440-41, 100 S.Ct. 1223, 63 L.Ed.2d 510 (1980). To be an unrelated business activity, the separate business entity must constitute a discrete business enterprise from the taxpayer. Exxon Corp., 447 U.S. at 223-24, 100 S.Ct. 2109. For Taxpayer and BBC USA, the only underlying activity generating income is the production, sale, and distribution of Blue Bell ice cream. BBC USA may be a separate business entity, but it is uncontested that BBC USA does not conduct any business operations of its own. Furthermore, BBC USA exists as a separate business entity to channel income from Taxpayer to BBC USA's stockholders without incurring a Texas franchise tax, according to William Rankin, the Chief Financial Officer of Taxpayer's general partner. Mr. Rankin also characterized BBC USA and BBC USA's subsidiaries as part of the singular ice cream business and characterized the stockholders of BBC USA as investors in the ice cream business. Because both entities derive their income from a single underlying activity, we hold that BBC USA is unitary with Taxpayer's Blue Bell ice cream business. Taxpayer contends, however, that it and BBC USA are not unitary pursuant to the tests that the United States Supreme Court has described for determining whether two businesses are unitary. Following the hallmarks of a unitary relationship test, for example, two separate business entities form a unitary business if their business operations are functionally integrated, have centralized management, and obtain economies of scale from their relationship. MeadWestvaco Corp., 553 U.S. at 30, 128 S.Ct. 1498. The three unities test similarly provides that two separate business entities form a unitary business if there is (1) unity of ownership; (2) unity of operation as evidenced by central purchasing, advertising, accounting and management divisions; and (3) unity of use of its centralized executive force and general system of operation. Barclays Bank PLC v. Franchise Tax Bd., 512 U.S. 298, 304 n. 1, 114 S.Ct. 2268, 129 L.Ed.2d 244 (1994) (quoting Butler Bros. v. McColgan, 17 Cal.2d 664, 111 P.2d 334, 341 (1941), aff'd, 315 U.S. 501, 62 S.Ct. 701, 86 L.Ed. 991 (1942) (internal quotation marks omitted)). Finally, two separate business entities are unitary pursuant to the dependency and contribution test used by other states if the taxpayer's business operations in the taxing state are dependent on or contribute to the operation of the separate business entity outside the state. In re Nat'l Coop. Refinery Ass'n, 273 Kan. 500, 44 P.3d 398, 404 (2002); see generally Louis Dreyfus Corp., 933 S.W.2d at 468 (citing courts that have used the dependency and contribution test). These tests are ill-suited for assessing Taxpayer and BBC USA's relationship because all three tests require a comparison of the relationship of the separate business entities' business operations. Taxpayer admits that BBC USA does not conduct any business operations. BBC USA therefore has no business operations that we can compare to Taxpayer's business operations. Furthermore, the United States Supreme Court has placed the burden on the taxpayer challenging the tax assessment to demonstrate that the tax is unconstitutional. Butler Bros. v. McColgan, 315 U.S. 501, 507, 62 S.Ct. 701, 86 L.Ed. 991 (1942). Regardless of the analysis we use, it is Taxpayer's burden to identify clear and cogent evidence demonstrating that Taxpayer and BBC USA are discrete business enterprises. See Exxon Corp., 447 U.S. at 221, 100 S.Ct. 2109; Mobil Oil Corp., 445 U.S. at 453-54, 100 S.Ct. 1223. Our review of the record reveals no clear and cogent evidence showing that BBC USA operates a business enterprise that is discrete from that of Taxpayer. We therefore consider Taxpayer and BBC USA unitary. See Mobil Oil Corp., 445 U.S. at 439-40, 100 S.Ct. 1223. Because the uncontested facts show that the Department's tax was constitutional, the Department is entitled to judgment as a matter of law. We cannot determine from the record, however, whether Taxpayer is nevertheless entitled to a refund for any overpayment of taxes. The Department asserts that Taxpayer's excise tax for the capital gains was $120,676.61, relying on an affidavit by an auditor at the Department. Taxpayer, however, sought a refund of $128,407, which Taxpayer described as the amount of all excise tax, interest, and penalties paid by Taxpayer for the excise tax assessment on the capital gains. We therefore remand this matter to the trial court to determine the amount of excise tax related to the Stock Transaction.