Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
MeadWestco Corp. v. Illinois Department of Revenue:
A States-Based Approach to Establishing Consistency in the Apportionment of Liquidation Income
Colin Douglas Campbell, Jr.*
In forging our republic from a loose confederation of individual sovereign states, the Founding Fathers sought to lay the foundation for a unified national economy to harness the vast and diverse holdings of the United States and generate streams of commerce and revenue that could transcend state borders. Roughly two-and-a-half centuries later, the economic landscape of the United States continues to evolve in accordance with their original design as national conglomerates, which enjoy constitutional protections designed to reduce state interference with national economic development, have all but replaced the once vibrant population of local businesses of every state. As a result of this expansion, however, powerful corporate entities such as Wal-Mart generate staggering amounts of income from business activities carried out in several states, each of which is constitutionally authorized to tax an amount not more than that which correlates to the magnitude of the interstate corporation’s activities within the state’s borders. In stark contrast to the numerous restrictions placed on the states’ abilities to preserve local businesses and ultimately their intrastate economies, the Founding Fathers left untouched the states’ essential power to raise revenue for the governance of their citizens.
As could be imagined, the interactions between our nation’s vital interest in preserving economic unity and the unassailable power of the states to carry a tension in the realm of state and local taxation. Indeed, within that field, those competing interests have forged a landscape that is dominated by a multitude of state approaches to the taxation of business income that are often difficult to reconcile and pose significant threats of double taxation to interstate businesses that fail to invest substantial resources into tax planning activities. Those operators of well planned interstate businesses who do proceed with caution, however, also understand that this landscape of hodgepodge state tax regimes often presents opportunities to create “nowhere income” through the manipulation of competing state statutes. States...in reaction to such manipulation, states, unable to risk the loss of millions of dollars in much-needed revenues, have recently begun to amend their business-income statutes to reach even greater shares of liquidation gains, which in turn has further muddied the path that interstate corporations must follow to avoid multiple taxation. The reach of many of these statutes has yet to be established and could potentially lead to unconstitutional applications.
To demonstrate that the key to the establishment of consistent state apportionment of liquidation income lies at the intersection between the states’ evolving reach of such income and the enforcement of constitutional limits by the Supreme Court, this Article first highlights the failures of previous attempts to achieve uniformity through a national apportionment standard against the more recent progress made by the states toward achieving that goal. Starting with an examination of the Uniform Division of Income for Tax Purposes Act (UDITPA), Part II observes that the drafters of the voluntary apportionment standard faced the same landscape that exists today, yet produced a framework that, when applied by the states, produced numerous competing interpretations based on hyper-technical linguistic exercises, almost none of which allowed the states to reach a maximum amount of constitutionally permissible liquidation income. Beyond revealing the inherent failures of a voluntary national apportionment standard, Part II provides a backdrop against which one may observe the natural inclination of the states to strive to reach greater amounts of liquidation income. Part III magnifies that observation by demonstrating that the efforts of the State of Illinois to expand the scope of the unitary business principle and the operational function test succeeded in providing the Court with an excellent opportunity to establish comprehensive limits for each of the theories. Part III also explores the state’s attempt to proceed into uncharted territory through the introduction of a tax regime that not only bypasses the unitary business principle and the operational function test, but also threatens to render obsolete those tools for the determination of apportionability—a proposal that nonetheless afforded the Court an opportunity to drastically redefine the state tax landscape to improve its consistency and fairness. Against the progress made through the Court’s examination of the state’s arguments in Part III, Part IV weighs the possible merits and practical deficiencies of a federal apportionment standard. As demonstrated in Parts II and III, Part IV lends credence to the proposition that the establishment of acceptably consistent treatment of income arising from the liquidation of discrete business segments will most likely occur naturally as the states continue to test the limits provided under the Constitution.
*Colin Campbell is an Assistant Counsel at the Office of the Legislative Counsel of the United States Senate. The views expressed in this Article are those of the author and do not reflect the views of the Office of the Legislative Counsel.