Meadwestvaco v. IL Dep't of Revenue

This tax law case gives us an insight into how the State of Illinois, and states in general, are able to tax the sale of a business when the business was 100% owned by another, out-of-state business. We have big numbers here--that is probably why the case made it to the Supreme Court--and we have the sale of one of the two most prevalent providers of online legal materials for judges and lawyers, Lexis/Nexis ("L/N"). In a nutshell, the Meadwestvaco Co. ("Mead"), which is the successor company to the one that sold L/N to its current owner (Reed Elsevier) in the early 1990s, lost in lower courts but contends before the Supreme Court that the sale of L/N should be reported on their IL corporate income tax return as a nontaxable event in Illinois. In the technical language of tax law, MW contends that L/N was an "investment asset" and not "operational asset" of the company, and therefore the State of IL ought not to be able to tax the $1.5 billion sale of L/N. (IL would like to tax about $1 billion of the $1.5 billion sale, the "gain" which Mead realized). The resulting savings for MW would be over $4,000,000 if the Supreme Court agrees with their argument. Let's talk about a few facts:

Background Facts

In the late 1960s, when Mead was an Ohio company producing paper, packaging and school/office supplies, it purchased Data Corp. for $6,000,000. Data was involved at the time in ink-jet technologices but what made it attractive for Mead was its entrepreneurial work in computerized full text information retrieval systems. By 1973 Data was known as L/N, which became profitable in the late 1970s. It became very profitable in the 1980s. When it sold L/N to Reed Elsevier in 1994 for $1.5 billion, Mead had to make a decision on how to report this "income" on its tax returns. Mead actually used the money to pay down some of its short and long-term debt and to buy back some company stock.

In its 1994 tax return, Mead reported the $1.5 billion in gain of sale as a gain on "goodwill" and listed it as nonbusiness income. If it is nonbusiness investment income, then the amount realized by the sale does not have to be "apportioned," which in tax law is a term that means that the income doesn't have to be "divided" and reported as business income among the various taxing jurisdictions where it operated its business.

The Law of this Case

Two lower courts, both in IL, got a crack at this case, even though the IL Supreme Court refused to deal with the issue. The lower court ruled that the relationship between Mead and L/N was not "unitary" (another concept in tax law) but that the sale was the sale of an "operational" asset. In making this determination, the lower courts considered the relationship of Mead with L/N and concluded that even though the businesses were separate in a number of ways, Mead was in operational control of L/N. Here were some of the factors the court used: (1) Mead owned 100% of L/N; (2) It infused capital into L/N in the early years; (3) Mead invested L/N's excess cash for the benefit of L/N; (4) Mead approved major debt and major capital expenditures of L/N; (5) Mead changed L/N from a division of Mead to a subsidiary; (6) Mead included L/N in describing the company's business in annual reports and Forms 10-K. Therefore, since Mead exercised this operational control, in the court's mind, its sale became business income.

But Mead argues in its petition for certiorari that if these factors are allowed by the Supreme Court to determine a "functional" or "operational" rather than "investment" control of a subsidiary, then the "investment" category will be completely "eviscerated" (their word--and a favorite word of retired Justice Sandra Day O'Connor). In addition, it points primarily to a 1992 case decided in the Supreme Court, Allied-Signal v. Director, 504 US 768 (1992), which it says contradicts the analysis of the Illinois courts. Mead's central point is that the mere ownership of one business by another and the intervention in the subsidiary's affairs through loaning money, sweeping its daily cash-on-hand, and approving significant capital expenditures, says nothing about whether a business is functionally in charge of its subsidiary.

In fact, Mead contends that L/N was simply an investment. L/N ran itself. Once a year L/N management would present a business plan to Mead; that was the extent of Mead's involvement in the operations of L/N.

Conclusion

If the Court concludes that L/N was primarily owned as an "investment" by Mead, then the IL Dep't of Revenue has no business apportioning the proceeds of the 1994 sale of L/N and considering it to be business income for Mead for that year. The case has dramatic implications for businesses which completely own (and then sell) subsidiary businesses. And, it takes the rest of us on a journey that we may never have been on previously.....

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