ANALYSIS OF FEBRUARY 7, 2019 SUPREME COURT OPINION
(Posted February 7, 2019) Corporate income taxation is the milieu for today’s published opinion in Corporate Executive Board Co. v. Dep’t of Taxation. CEB is an Arlington business that provides what I’ll loosely call business-management services to major corporations around the world. Some of those services include the management of an online database of resources and analytical tools. It also provides company-specific education and analysis.
Here‘s an early paragraph from today’s opinion that sets the table for today’s dispute:
The vast majority of CEB’s sales of its Core Product and Solutions, over 95%, occur outside of Virginia. The Commonwealth accounts for less than 5% of CEB’s gross revenue. For the three years at issue, CEB earned $1.76 billion in total sales. Of that total, Virginia accounted for about $66 million.
Hence the problem: Can Virginia tax all of that $1.7B of income when the customers are elsewhere? It’s more complex than you might think; numerous states have adopted tax-allocation formulas that tax such income in their states, where a customer in one of those states buys services from a Virginia company like CEB.
Virginia has for 60 years used a formula that fully (indeed, doubly) weighs sales for taxation where the “income-producing activity is performed in the Commonwealth …” A trial court considered the matter and ruled that all of the sales, even those to remote locations, counted toward Virginia taxable income.
I’ve done the math on this three times, because the result is so staggering: The difference between a business-friendly interpretation and a tax-man-friendly interpretation is on the order of $300 million, for this one company alone. That many zeroes make for a judgment well worth appealing, so CEB went to Richmond and got a writ.
Today the justices unanimously affirm. The court analyzes constitutional challenges under the Commerce Clause and the Due Process Clause, concluding that SCOTUS precedent lines up with the trial court’s ruling. It may surprise you that double taxation – where the identical income from the identical transaction is taxed by two different states – isn’t unconstitutional. The Supreme Court today finds that Virginia’s tax scheme isn’t externally inconsistent. And citing language from the Notorious RBG, the Supreme Court agrees that the Constitution doesn’t require one state to “recede simply because both have lawful tax regimes reaching the same income.” The court finds that Virginia’s method of apportionment doesn’t extend beyond the value fairly attributed to activity here.
That doesn’t end the matter, because Virginia has a savings statute, and CEB sought relief there, too. That act allows relief where the allocation method is inequitable. That, in turn, requires proof of two elements, under a tax regulation. The first is double taxation, which definitely applies here. The second criterion is that “the inequity is attributable to Virginia, rather than to the fact that some other state has a unique method of allocation and apportionment.”
It’s this second one that trips up the taxpayer here. Justice McCullough’s opinion for the court analyzes several other states’ apportionment methods, finding it impossible to describe them as “unique.” More fundamentally, the inequity is attributable to the other states’ more recent taxation changes. Virginia uses an approach based on a 1957 uniform model act. Today’s opinion notes that that approach “has faced mounting criticism” as the American economy shifts from manufacturing to service and information. But the Commonwealth has resisted efforts to change.
The changes, instead, have come from other states’ efforts to modernize their tax codes. Using the common definition of attribute, the justices today hold that any inequity is attributable to those states’ amendments.
This opinion notes that the few legislative proposals to move Virginia’s allocation model toward a “market-based sourcing approach” have failed in the past eight years. This ruling will no doubt spur pro-business legislators to try again next year, lest the Commonwealth be viewed as an unfavorable state for business taxation. Of course, our 6% tax rate, one of the lowest in the nation, may offset that; but I do expect Corporate Virginia to try.