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Levi Bennett

Abstract

The unitary business principle permits a state to tax a percentage of the total income of an out-of-state business operating within the state’s borders, as opposed to only taxing income derived from in-state activities. The goal of the principal is to allow states to tax value created by out-of-state activities that promote the generation of in-state revenue. In order to tax an enterprise under the principle, that enterprise must be a “unitary business.” Courts have traditionally looked for three key factors in determining if a unitary business exists: functional integration, centralization of management, and economies of scale. Many observers had interpreted recent Supreme Court cases on the issue as creating a second test, permitting states to tax an out-of-state business when an in-state asset serves an operational function within the business as opposed to merely being an investment. In MeadWestvaco Corp. v. Illinois Department of Revenue the United States Supreme Court declared that this “operational function” test is not a separate route to taxing out-of-state businesses, requiring states to tax under the unitary business principle. This casenote explores the implications of the Court’s decision and ultimately concludes that MeadWestvaco was correctly decided. While the Supreme Court denies use of the operational function test as a separate ground for taxation, the Court’s use of the test to permit taxation based on an in-state intangible asset suggests that it has a place within the unitary business principal as the test to be applied to such assets. The use of the traditional factors was required in MeadWestvaco because the asset at issue there was a business instead of an intangible asset. This casenote also discusses possibilities for corporate tax avoidance created by the Court’s holding and suggests that a test based on direct connections between the state and the asset to be taxed could prevent such avoidance from occurring

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