The Unitary Business Principle Applies To More Than Corporate Net Income Taxes: Reynolds Metals Company V. Department Of Treasury

Recently, in Reynolds Metals Company v. Department of Treasury, the Michigan Court of Appeals held that the unitary business principle applies to Michigan's Single Business Tax (the "SBT").1 Although the court's decision comes as no surprise, it is significant inasmuch as it reinforces the fact that the unitary business principle applies to more than corporate net income taxes, i.e., it applies to gross receipts taxes or value-added taxes ("VAT") as well. Long before corporate net income taxes were commonly used by states, the U.S. Supreme Court developed the rationale of a unitary business to ensure that a state did not tax value or activity occurring outside of the state. That rationale applies equally to VATs, gross receipts taxes, net worth taxes or other business activity taxes. In the following pages, we review and analyze the court's decision in Reynolds Metals and discuss its application to taxes other than the SBT.

The Michigan Court of Appeals Holds That Michigan May Not Tax the Gain on the Sale of a Non-Unitary Entity

The SBT, which was repealed for years after 2007, is a VAT that uses the federal income tax system as its starting point.2 A taxpayer then makes various required additions and subtractions to federal taxable income to convert the base into a consumption-type VAT base (the "SBT tax base").3

Reynolds Metals Company ("Reynolds Metals") is a manufacturer, distributor and marketer of aluminum products. At issue in Reynolds Metals was the Michigan Court of Claims' decision that precluded the Department of Treasury ("Department") from including in the SBT tax base capital gains recognized by Reynolds Metals from the sale of an interest in a foreign joint venture that was based in Australia.4 The foreign joint venture was established by Reynolds Metals and three other aluminum companies for the mining and refining of alumina, a product used to produce aluminum.

The Michigan Court of Appeals sustained the lower court's decision that held that the capital gains were not includable in the SBT tax base. The evidence showed that no functional integration existed inasmuch as there was no sharing of managerial or operational resources between Reynolds Metals and the joint venture, no sharing of research and development, Reynolds Metals was unable to control the joint venture and transactions and agreements between Reynolds Metals and the joint venture were negotiated at arm's-length. Reynolds Metals and the foreign joint venture did not have centralized management inasmuch as Reynolds Metals had less than a majority control of the foreign joint venture's executive committee (comparable to a board of directors) and day-to-day operations were run by an independent management company that had its own facilities, resources, employees and accounts and that reported to the executive committee. Finally, no economies of scale were present because no joint purchasing or production occurred and any alumina produced by the joint venture and sold to Reynolds Metals was sold at arm'slength terms.

The Michigan Court of Appeals Affirms That the Unitary Business Principle Applies to Michigan's SBT

In sustaining the lower court's decision, the Michigan Court of Appeals rejected the Department's argument that the unitary business principle does not apply to the SBT. The Department based its argument on two premises: (1) "the unitary business principal[sic] is not...