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October Term, 2007 

April 15, 2008

Today the Supreme Court issued two decisions, described below, of interest to the business community.

United States v. Clintwood Elkhorn Mining  Co., No. 07-308 (previously discussed in the December 3, 2007 Docket Report).  Under 26 U.S.C. 7422(a), a taxpayer who sues the United States to recoup erroneously or unlawfully assessed or collected taxes must first file a claim for a refund with the Internal Revenue Service (IRS).  The Court today held that taxpayers seeking reimbursement of taxes levied in violation of the Export Clause of the Constitution are not exempt from that requirement.

After the taxing of coal exports under 26 U.S.C. 4121(a)(1) was held to be unconstitutional as a violation of the Export Clause (U.S. Const. art. I, 9, cl. 5), three coal companies sought refunds for the taxes they had paid on such exports for the years 1994 through 1999.  The companies filed claims for refunds with the IRS for the years 1997 through 1999 (and subsequently received their refunds plus interest). But because 26 U.S.C. 6511(a) imposes a three-year limitation period for seeking such refunds, the companies sued the United States in the Court of Federal Claims for refunds for the years 1994 through 1996.  Seeking to take advantage of the Tucker Act's six-year limitation period, see 28 U.S.C. 2501, the companies sued directly under the Export Clause, with jurisdiction premised on the Tucker Act.  The Court of Federal Claims allowed the suit to go forward, and the Court of Appeals for the Federal Circuit affirmed in relevant part.

In a unanimous opinion by Chief Justice Roberts, the Supreme Court reversed.  Relying on the "plain language" of  Sections 7422(a) and 6511(a) (slip op. 12), the Court held that the coal companies' suit in the Court of Federal Claims was subject to the requirement that taxpayers avail themselves of the IRS refund scheme before suing.  Having so held, the Court found that the lawsuit could not proceed because the companies had failed to exhaust administrative remedies.  The Court rejected the companies' argument that a different result was required because the tax at issue was assessed in violation of the Export Clause.  The Court explained that "Congress has the authority to require administrative exhaustion before allowing a suit against the Government, even for a constitutional violation" (id. at 7), and that it is "within Congress's authority to assure that allegations of taxes unlawfully assessed--whether the asserted illegality is based upon the Export Clause or any other provision of law--are processed in an orderly and timely manner, and that costly litigation is avoided when possible (id. at 10).  The Court also rejected the companies' narrower argument that Section 7422(a) does not apply to suits seeking relief from the specific coal-export tax at issue because the tax was facially unconstitutional.  The Court reasoned that Section 7422(a) applies to "any sum * * * in any manner wrongfully collected," and thus covers even a facially unconstitutional tax.

The Court's decision is important to all taxpayers seeking to determine what recourse they have against the federal government for taxes that were improperly assessed or collected.  The decision makes clear that the Court is unwilling to read exceptions into the statutory requirement that taxpayers file a timely refund claim with the IRS before filing suit.

Meadwestvaco Corp. v. Illinois Department of Revenue, No. 06-1413 (previously discussed in the September 25, 2007 Docket Report).  Under the Supreme Court's decisions applying the Due Process and Commerce Clauses of the Constitution, a State may not tax "extraterritorial" activities of a business.  Under the Court's decisions, however, a State may tax an apportioned share of the activities of a multi-state business to the extent that the activities form part of a "unitary business."  The Court today reaffirmed the principles it has developed for determining whether a multi-state business is "unitary."

Mead Corporation (Mead) owned Lexis/Nexis (Lexis).  Mead did not participate in Lexis's daily affairs, and the two entities maintained separate facilities and separate accounting, legal, marketing, and human-resources departments.  Mead's involvement was generally limited to approving Lexis' business plans and significant corporate transactions (e.g., financings and mergers).  After Mead sold Lexis, Illinois sought to tax more than $1 billion in gain from the transaction.  Mead paid the tax under protest and then filed suit in Illinois state court.  The trial court ruled that Mead and Lexis did not form a "unitary business" but that the State could nevertheless tax an apportioned share of the capital gain, because Lexis served an "operational purpose" in Mead's business.  The Appellate Court of Illinois affirmed.  Without reaching the question whether the two entities formed a unitary business, the appellate court held that the tax was permissible because Lexis served an "operational function" in Mead's business.

In a unanimous opinion by Justice Alito, the U.S. Supreme Court vacated the appellate court's decision, finding that the state courts had made a "fundamental error" in considering whether Lexis served an "operational purpose" in Mead's business.  Slip op. 6.  After tracing the history of the "unitary business" principle (id. at 8-11), the Court explained that its use of the term "operational function" in cases like Container Corp. of America v. Franchise Tax Board, 463 U.S. 159 (1983), and Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992), was "not intended to modify the unitary business principle by adding a new ground for apportionment."  Slip op. 11.  Instead, the Court said, the conclusion that an asset serves an "operational function" is "merely instrumental to the constitutionally relevant conclusion that the asset [i]s a unitary part of the business being conducted in the taxing State rather than a discrete asset to which the State ha[s] no claim."  Id. at 12.  The Court reiterated that, when the asset in question is another business, the "hallmarks" of a "unitary relationship" are "functional integration, centralized management, and economies of scale."  Id.  The Court held that the Appellate Court of Illinois had erred because it relied on an "operational function" test without deciding whether Mead and Lexis formed a "unitary business."  Id. at 13.  The Court remanded the case for a decision on that issue.

Justice Thomas filed a concurring opinion, in which he expressed "serious doubt" that the Constitution permits the Court to adjudicate cases of this type under either the Commerce Clause or the Due Process Clause.  Slip op. 1.

The Court's decision is important to the business community.  It confirms that the "unitary business" test is the only standard for determining whether a State may constitutionally tax an apportioned share of the activities of a multi-state business.  And the decision rejects an approach under which nearly every sale of a subsidiary by a parent corporation would give rise to apportionable "operational" income.

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