Supreme Court Denies Review in Taxpayer Apportionment Win

The BR State + Local Tax Spotlight

In a case involving whether a nondomiciliary state can apportion a gain earned by a passive holding company on the sale of an interest in a limited liability company (“LLC”), the Idaho Supreme Court found the gain was not apportionable, and the U.S. Supreme Court denied review. Noell Indus. Inc. v. Idaho State Tax Comm’n, 470 P. 3d 1176 (Idaho filed May 22, 2020), cert. denied, 209 L. Ed. 2d 130 (2021). This case is significant in that it adds clarity to the question—never addressed by the U.S. Supreme Court—of whether a passive holding company is unitary with the investment it holds. The careful analysis in Noell—examining the lack of operational connection between a passive holding company and an operating business, and the lack of any traditional indicia of a unitary relationship—should help support arguments by holding companies that gain on the sale of companies in which they had no active role should not be apportioned to nondomiciliary states.

Facts: Noell Industries Inc. (“Noell”) was incorporated in Virginia in 1993 to develop and sell combat and tactical gear. Its assets were transferred in 2003 to Blackhawk Industries Products Group Unlimited LLC (“Blackhawk”), a Virginia LLC, in exchange for a 78.54 percent interest. Thereafter, Noell’s activities were limited to owning the investment in Blackhawk and one other business. After 2003, Noell had no employees, shared no assets or expenses with Blackhawk, and provided no financing or services to Blackhawk.

Noell sold its remaining interest in Blackhawk in 2010, reporting and paying taxes on the gain to Virginia, its commercial domicile, and excluding the gain from its income apportionable to Idaho. The Idaho Tax Commission sustained an audit adjustment including the gain in apportionable income, but the district court struck the assessment and the Idaho Supreme Court agreed.

The Decision: The Idaho Supreme Court analyzed the relationship between Noell and Blackhawk under Idaho Code Section 63-3027(a)(1), which incorporates the Uniform Division of Income for Tax Purposes Act (“UDITPA”) two-part test for business income, applying both the “transactional” test (examining whether the income arose from a transaction in the regular course of the taxpayer’s trade or business) and the “functional” test (examining whether the income arose from property, the “acquisition, management, or disposition” of which constitutes “integral or necessary parts of the taxpayer’s trade or business”). The court also applied the constitutional unitary business test, finding that the Idaho Tax Administrative Rules incorporated the unitary test as one method to determine whether income was apportionable business income.

The court found that neither the statutory nor constitutional test was met, since Noell did not regularly engage in buying or selling subsidiaries, and the interest in Blackhawk was a passive investment, and not a part of Noell’s business operation. It determined that Noell was merely a parent holding company, and that the “high-level separation of the companies,” and Noell’s role as a shell holding company, demonstrated “substantial independence rather than the level [of] interdependence required to manifest unity.” Noell, 470 P. 3d at 1187.

This article is one in a series of articles written for the April 2021 edition of The BR State + Local Tax Spotlight.