MeadWestvaco Corp. v. Illinois Department of Revenue - Oral Argument

Argument of Beth S. Brinkmann

Chief Justice Roberts: We will hear argument next in Case 06-1413, Mead Westvaco v. The Illinois Department of Revenue.

Ms. Brinkmann.

Mr. Brinkmann: Mr. Chief Justice, and may it please the Court: The ruling of the Illinois Appellate Court in this case radically expanded the Court's operational function test.

The State tax at issue violates the principles of constitutional limitations on state taxing authority for at least two reasons.

First, the factors relied on by the appellate court here for functional... for operational function would mean that ownership and investment would meet that standard.

But that's what this Court rejected in Allied-Signal.

A State does not have the authority to reach out to tax all investments owned by a company that does business in the State.

The operational function demands more.

It applies--

Justice Ginsburg: You are saying to me, Ms. Brinkmann... we talk about an asset, an investment.

This was one company.

This... it's strange to talk about unitary basis or investment.

This is a division of one company.

And we are talking about a sale of assets.

Not the sale of stock of a subsidiary.

So what more is there than this is one company, it sells some of its assets?

Mr. Brinkmann: --Well, Your Honor, the fact that it's a division does not mean that it meets either the operational function test or the unitary business test.

A long line of cases from this Court tell us that.

It--

Justice Ginsburg: Do we have any cases... do we have any decisions that go against the state taxing authority that involve divisions as opposed to subsidiaries?

Mr. Brinkmann: --No, but the Exxon case involved divisions, and it went in favor of the state taxing authority.

But the Court applied a straightforward, unitary business analysis to that.

And, Your Honor, this dates back to the Adams Express case of 1897.

The Court in that case said it's not ownership.

It's about the use, the unitariness of use, not of ownership.

Mobile followed on that.

Mobile talked about the fact that it's not the corporate form that matters.

It pointed out that that could have little to do with the underlying determination of apportionment, which depends upon whether it's a discrete business enterprise.

And then following on the heels of that analysis in Mobil, the Court applied it to the Exxon case that involved divisions.

That was a vertically integrated corporation.

It's very different from the facts of this case, and it reached a different result.

Moreover, the Woolworth case involved subsidiaries.

Three out of the four of them were 100 percent wholly owned.

Justice Stevens: Can I go back to sort of a fundamental question I'm not quite sure I know the answer to.

Supposing we don't have corporations here, but an individual resident of New York owned this whole business and a big bunch of it was activities in Illinois, and he sold the business.

Would Illinois have the authority to impose any tax on that transaction?

Mr. Brinkmann: If it was a capital gain, Your Honor, on the sale of investment, the Court's longstanding cases teach that it is the domicile that taxes that commercial gain.

Justice Stevens: I'm assuming it's not the domicile.

The owner lives in New York.

The business is all over the country, but does millions of dollars of business in Illinois.

And they sell the whole business.

Would the owner be subject to any tax of any kind in Illinois on that transaction?

Could he constitutionally be subjected to any tax?

Mr. Brinkmann: If there was... the domiciliary State generally is the State which has the authority to tax an income on a capital gain--

Justice Stevens: --Assume it's not the domiciliary State.

Mr. Brinkmann: But what the Court explained in Mobil, for example, if it is under the unitary business principle, then the State in which--

Justice Stevens: Could we get an answer without reference to cases?

Do you think Illinois would have the authority to impose a tax on that transaction?

Mr. Brinkmann: --If the... there was sufficient nexus to the company doing business--

Justice Stevens: Millions of dollars of business in Illinois, that's my assumption.

Mr. Brinkmann: --Yes, they would be able to tax the ongoing business activity in that State.

Justice Kennedy: No.

Justice Stevens: Could they tax the sale of the business?

Justice Kennedy: I have the same--

Mr. Brinkmann: The sale of the business would be to the domicile of the seller.

They would be able to--

Justice Stevens: You're saying only the domicile could impose a tax?

Mr. Brinkmann: --Yes, unless, as the Court recognized in Mobil, there is this unitary business exception, because the State's ability to tax begins at the starting point at the territorial limitations of the State.

And the Court has--

Justice Stevens: But if they owned a truck instead of a business, they could tax that transaction, I suppose?

Justice Scalia: You can't have a unitary business... a person who is a unitary business.

I mean, a person can't be unitary with Exxon.

I mean, when you speak of a unitary business you're talking about a corporation which, you know, is unitary with another corporation.

Mr. Brinkmann: --That's the area--

Justice Scalia: Once you put it into a personal taxation scheme, it seems to me the whole unitary business notion has no application at all.

Mr. Brinkmann: --Well, I agree with you, Your Honor.

But it does come back to the taxing, the right of the domicile State to tax on a sale--

Justice Ginsburg: What is... what does the domicile State... we have Ohio.

But you say as a matter of constitutional law, not State tax policy, as a matter of constitutional law, the only State that has authority to tax the capital gain is Ohio?

Mr. Brinkmann: --That's right, Your Honor, unless--

Justice Ginsburg: Does Ohio... would Ohio give credit for the tax that its sister State thinks is due?

What is, in fact, Ohio's tax law in this respect?

Does Ohio give credit to taxes paid by other States... to other States?

Mr. Brinkmann: --Ohio would allocate the entire gain as a capital gain on an intangible that was sold in the State of Ohio.

That would be allocated in its entirety to Illinois.

Now, what the Court has recognized is that default principle sometimes gives way when that gain has had enough connection to business activity in another jurisdiction.

That's where these issues arise, because there are States taxing multi state activities.

And that's--

Justice Ginsburg: Can I have an answer to a very simple question?

If Illinois claimed the tax, would Ohio give credit for the tax paid in Illinois?

Mr. Brinkmann: --Not if Ohio had the constitutional right to allocate that tax to Ohio, as it does.

Justice Ginsburg: Do we know what... what Ohio does in these situations?

Mr. Brinkmann: Yes.

It allocates it to the State of Ohio.

The only exception for that would be in a situation, not the facts here, but if that capital gain either served an operational function to the business activities that were conducted in another State, then that State would have a right to apportion it and tax its portion of that or if the operational function applied.

And that is because the activity now has transformed from just a capital gain that's connected to the domiciliary State of the seller to a business income because it is part of this unitary business.

That's why the other State has a right to apportion.

Justice Alito: What has Ohio done--

Mr. Brinkmann: That's not the situation here.

Justice Alito: --What has Ohio done up to this point with respect to this transaction?

Mr. Brinkmann: Under Ohio's laws this would be allocated to that State.

Chief Justice Roberts: To Ohio?

Mr. Brinkmann: Yes, because it's a capital gain on a sale of an investment.

Chief Justice Roberts: Ms. Brinkmann, you begin your brief by saying this, a paper company, that happens to own a data processing company.

Why couldn't you equally say this is a data processing company that happens to own a paper company?

Mr. Brinkmann: No, Your Honor.

This has been a paper company since 1846.

Chief Justice Roberts: Well, and Lexis/Nexis has been a data processing company since whenever.

Mr. Brinkmann: But under the Court's unitary--

Chief Justice Roberts: It's not the oldest... whichever is oldest isn't the one that gets to be regarded as the dominant partner, is it?

Mr. Brinkmann: --No.

But when you do the analysis, you're looking at the taxpayer, which is Mead Corporation.

And it clearly has a--

Chief Justice Roberts: Is General Electric a light bulb company or, since it owns NBC, a media company.

Mr. Brinkmann: --I would have to know many more facts in order to answer that question, Your Honor.

But I... and I don't mean to be evasive--

Justice Ginsburg: Why isn't the answer both?

Why isn't the answer both, just as here it is both a paper or office supply company and a Lexis/Nexis, electronic data company?

Mr. Brinkmann: --It's an analytical construct that we're doing here.

We're looking at the taxpayer who is being taxed, the Mead Corporation.

So you look at its business that's being conducted in Illinois.

They have a unitary paper company that's vertically integrated that's doing business activities in Illinois.

Chief Justice Roberts: Well, that's because they sell paper in Illinois?

Mr. Brinkmann: Yes.

Chief Justice Roberts: Well, Lexis sells data services in Illinois, too.

Mr. Brinkmann: Yes.

But when you're looking... and for both purposes, Your Honor, for State tax on the operating income of both of those businesses, Illinois does have a right to apportion those taxes.

And those taxes were paid without objection by both of those businesses.

We're talking about a tax on a different event, on a capital gain on a sale of the business in Ohio.

Chief Justice Roberts: Well, why doesn't... I mean, you just said, as I understand it, Illinois has the right to tax Lexis under business activities in Illinois.

Illinois would argue the reason it has a capital gain is partly because they were doing business in Illinois and so we should be entitled to part of that capital gain.

Almost... I mean, it seems to me it would be pretty easy if they get to tax 2 percent of Lexis's business, well then maybe they should get 2 percent of the capital gain when it's sold or tax 2 percent.

Mr. Brinkmann: Your Honor, that is a belated argument that the State of Illinois has raised in this Court.

It did not present an argument to the Illinois appellate court based on Lexis/Nexis's connection to Illinois.

It raises a host of jurisdictional, procedural and substantive bars.

Under the rules of Illinois, as we point out in our reply brief, that argument is waived.

This comes to the Court from a State court, not a Federal court of appeals.

Because of that waiver, it's an independent and adequate state ground.

Moreover, that argument wasn't raised in the brief in opposition, either.

Justice Ginsburg: They're raising it in... in support of the judgment.

So if it's novel, but it supports the judgment, then at least shouldn't the Illinois courts have a chance to look at it and say, oh, that's what we really meant, we just got... explained it the wrong way?

Mr. Brinkmann: Well, that would certainly be a matter for the Illinois court rather than for this Court, Your Honor.

But in addition, I think any disposition on the merits of that issue would be a ruling by this Court that would be trumping that independent and adequate State ground waiver.

Moreover, this argument wasn't raised in the brief in opposition, either.

And the Court's precedent, of course, and practice would not be to address that.

Particularly in this case, it denied notice to the amici who would be affected by this argument.

But turning to the substance of it--

Justice Kennedy: --I think this is part of the substance.

I thought that as part of one of your answers you said that Ohio is free to allocate part of this capital gains tax to Illinois?

Did I hear you say that, because I don't understand that?

Mr. Brinkmann: --No, Your Honor, I'm sorry.

I apologize if I misspoke.

Ohio would allocate, I mean, take the entire gain for itself as the domicile State of the seller--

Justice Kennedy: I see.

Mr. Brinkmann: --of the investment.

In other factual scenarios, if it turns out that that asset actually was not an investment and in fact had enough connection to the business activities in Illinois because it was really the supplier of the raw materials, or the two examples that this Court has given as operational functions is the interest on the bank account, which is the working capital, or the... the futures hedging against the raw material of corn.

Chief Justice Roberts: Well, isn't it kind of like futures hedging?

I mean, you've got a paper company and then you've got something that is sort of the paperless aspect, and they can look at it and say, well, we're kind of hedging our paper business by investing heavily in something that's supposedly going to take away the need for paper.

Mr. Brinkmann: No, Your Honor.

Under the operational function test, it has to be a much closer nexus to the operating, the operations of the paper company; and short of that operational function... or if it were part of the unitary business, the domiciliary State would allocate.

And if I could turn--

Justice Kennedy: Are you saying this is a passive investment?

Mr. Brinkmann: --Yes, Your Honor.

Justice Souter: How can you call it a passive investment, not only when there was... I think undisputedly... as... as much interest and activity in Nexis's business planning by the Mead people?

But to my mind even more importantly, when in fact Mead, I think a couple of times, merged with... with Nexis... with Lexis... when that provided a tax advantage, by... by giving them loss carryforwards that reduced their taxes.

Why isn't it fair to... to say under the operational function test that if... if the company is... if Nexis is... is mergeable with Mead when it produces a tax advantage and is certainly in a very operational sense functional then, because it's saving them a lot of money... and that's, that has nothing to do with passive investment.

If it's usable in a merger scenario there, it ought when the... when the tide turns be... be regarded as close enough in operational function to be taxable when the gain comes in.

Mr. Brinkmann: Your Honor, that's contrary to the Court's long standing recognition that something that enriches the taxpayer is not necessarily part of the unitary business's operational function.

Justice Souter: That's... that's right.

But weren't the enrichment cases in which income was being generated by an investment?

The investor, of course, was the... was the taxpayer company, and it simply reaped the benefits of a profitable investment.

That's something very different from merging corporations, then unmerging them, and then merging them again to provide not merely enrichment, but great tax savings; and if they are operationally close enough to produce great tax savings, why shouldn't they be treated as operationally close enough when in fact they... they produce a capital gain?

Mr. Brinkmann: Because that isn't the operational connection that justifies a State--

Justice Souter: The gain alone certainly is not.

If they had absolutely done nothing but make their investment and wait to see whether the ship came in, I would understand your argument.

But between the investment and the return of the ship, they were merging these corporations back and forth for... for their... for Mead's tax advantage.

And that seems to me to take it out... take the facts of this case out of the sort of the paradigm of the... the operational or the nonoperational function cases.

Mr. Brinkmann: --Your Honor, I think not, if we look at Allied-Signal, we look at Woolworth, and we look at ASARCO.

Allied-Signal was a sales and investment... and getting back to the point about the argument really was waived about the connection with Lexis/Nexis in Illinois, those were the same facts in Allied-Signal.

The investment there was--

Justice Ginsburg: It was a sale of stock in that case, wasn't it?

Mr. Brinkmann: --Yes.

Justice Ginsburg: It was the sale of a subsidiary.

And here we have a sale of assets of one company, and that's why it's so hard for me to see this, as, why are we talking about unitary or not?

There is only one company; it's Mead.

Mr. Brinkmann: In Allied-Signal, the investment there was also doing business within the State.

In the Exxon case, there were divisions to which this Court applied the entire unitary business principle, because what the Court has said repeatedly in Mobil, in Exxon, in all these cases, it's not the corporate form; it is whether there is a discrete business enterprise; and ASARCO speaks to this.

Justice Ginsburg: You told me that there was no case that the tax... taxing authority lost that involved divisions of a single company and sale of assets, rather than the sale of stock.

Mr. Brinkmann: That's correct.

We have four or five cases here.

One of them does involve divisions, Exxon, but in that case it was a vertically integrated corporation, and the State prevailed in that case, but it did not change the analysis that applied.

Justice Ginsburg: Well, we're talking about what Due Process permits States to do, and you're asking us to declare a restriction that, as far as I know, has never been declared in any case.

Mr. Brinkmann: It has, Your Honor.

It goes back to principles that ownership do... does not determine; simply because there is a business operating in the State, the State does not have the right to tax every investment that's owned by that.

That dates back to 1897.

Justice Ginsburg: It's not just that it's an investment, it's not just that it's holding on to the shares in another company.

It's both of these are ongoing businesses, Lexis/Nexis and Mead, and they are both generating income, and all along Illinois has been taxing the income of both of them, right?

Mr. Brinkmann: Yes, the operating income within the State's apportioned.

But if you look to the business activity of the taxpayer Mead, operating in Illinois, it is that nexus on which Illinois is claiming that they have a right to tax here.

And if we look at the Woolworth case, for example, I think that is also instructive.

Those were four subsidiaries.

Three of them were 100 percent wholly owned, and the Court expressly said we recognize they are wholly owned subsidiaries.

These could be integrated divisions, and they said, that is not significant, if they are independent, different business enterprises.

Justice Ginsburg: Weren't those foreign corporations?

Mr. Brinkmann: Yes, Your Honor.

Justice Ginsburg: So running them as... as a single company would have been a little harder.

Mr. Brinkmann: Well, no, in fact there were also some foreign subsidiaries, I believe, involved in the ASARCO case, for example, Your Honor, and the same analysis applied... you know, whether it was vertically integrated and whether or not it met... the unitary business test goes back to three core principles, and this Court has said at least four if not five times that the unitary business principle is the linchpin of apportionment.

That is whether or not there is functional integration.

Justice Souter: Don't we start... I don't mean to cut off your argument, but don't we start with the assumption that this is not a unitary business?

Wasn't that the finding of the trial court which was not disturbed on appeal?

Mr. Brinkmann: That's right, Your Honor.

That's right.

Justice Souter: You can say it if you want, but I wanted to make sure--

Mr. Brinkmann: There is no virtual integration; there is no sharing of centralized management; there's no economies of scale.

We think this is unassailable in the stipular record--

Justice Breyer: Am I thinking about that part correctly?

I... I found this difficult.

I go back to the railroad; that seems the easiest case.

You have a railroad in 50 States, and Illinois finds it very hard to evaluate its... evaluate its value, its railroad property in Illinois, because the value of that depends on service everywhere.

So the court says that's the unitary principle; and really what you're supposed to look at is whether when you look at the supposedly separate part of the business, does that separate part of the business contribute to the whole thing?

So that if you were in fact trying to say what is Illinois doing without considering that separate part, it would be tough to do.

I mean, that's the underlying theme.

Mr. Brinkmann: --We would--

Justice Breyer: And if that's so, there is no second test.

I mean, I grant you there is language, but really what people have done is they've said, we are here in a special situation because we have an interest in another company, and that's a special part of our business, and has nothing to do with the rest of the business.

And then the argument is no, it does have something to do with the rest of the business.

And if it does, like it provides you with working capital, it's just like the railroad track in California vis a vis Illinois.

Mr. Brinkmann: --It's contributing to the business.

Justice Breyer: And if it doesn't, it doesn't.

So now, if that's right, then it's the form of analysis rather than the result that's wrong in the court below.

Because they start talking about two separate tests and then people argue whether the second should swallow up the first, and at that point I get totally lost.

It's fairly long, but I'd appreciate your evaluating what I've just said.

Mr. Brinkmann: Well, Your Honor, there... on this record, there's no question that the Lexis/Nexis cannot meet the unitary business test.

Justice Ginsburg: Yes, there is, Ms. Brinkmann.

The Illinois appellate court never got to that question.

Illinois argued all along this is a unitary business.

The only one who said it wasn't was this trial court, and the Illinois intermediate appellate court says, well, we don't have to deal with that because if you use the other label, operational function, that comes out all right, too.

But this argument was certainly the number one argument that Illinois was making.

It lost only in the trial court on... on it.

And the appellate court said we don't have to get to it.

So I think your answer to Justice Souter really wasn't accurate because it isn't--

Mr. Brinkmann: Well, our position is on the record here, Your Honor, the stipulated record, that it's unassailable.

But we do--

Justice Ginsburg: --All we know is that a trial judge said that was so.

Mr. Brinkmann: --And then that's our position, obviously, on the record, Your Honor; but we agreed this was properly raised in the appellate court, as opposed to the other argument which was not.

And this also was mentioned in the brief in opposition, as opposed to their other argument, which was not.

So we do think the Court could reach this argument, and we maintain that on this record the linchpin of apportionment giving the right of a State... and this is a right to extend beyond its territory.

The Court has already let it go beyond its territory to get to something outside the State if it's part of the unitary business... the railroad case, the express case.

And in that situation there are three factors, none of which can be met on this record.

There was no shared, centralized management, none.

There was no integrated functions, none.

And there were no economies of scale.

Lexis/Nexis did not even get a discount on any paper they bought from Mead.

They were, you know, minor customers of each other.

Justice Ginsburg: Maybe when we're talking about Due Process and Commerce Clause limitations on what States can tax, we ought to ask ourselves if those three... is that it?

If we're trying to measure, is there a sufficient relationship between Lexis/Nexis, Mead, and the State of Illinois to make it fair for them to tax?

And you say, oh, yes.

Each year when they're making income, when they are a going concern, Illinois can get a piece of it.

But when the assets are sold, assets that would have generated income for Illinois year after year, but when those assets are sold, Illinois can get nothing to represent... to substitute for that stream of income that it would have gotten.

Mr. Brinkmann: No.

It will continue to get income tax on an apportioned basis before and after.

Justice Ginsburg: But Lexis/Nexis is gone.

Mr. Brinkmann: Well, Lexis/Nexis continues to operate.

It's now owned by Reed Elsevier.

So it would continue to pay an apportioned income tax.

It's a different event here, Your Honor.

It is the sale of an investment that occurred in Ohio.

And as the domicile State, Ohio has provided benefits to the corporate headquarters, to management--

Justice Ginsburg: Suppose it had been Delaware, and there was nothing there in Delaware except it was a Delaware corporation.

Mr. Brinkmann: --That's not the commercial domicile, Your Honor.

There is a distinction in all of these cases between the State of incorporation and the commercial domicile.

The commercial domicile--

Chief Justice Roberts: Ms. Brinkmann, one thing that concerns me is how this will complicate the process.

I think, with respect to ordinary income, the States work this out, and they figure we get 5 percent because we have 5 percent of the presence or business, whatever.

Now, they're going to have that, and they're going to have an overlay on that.

They're going to say, well, it's 5 percent; but, you know, we sold this asset that doesn't have any connection to Illinois; and that's part of the income we've got.

So you don't get quite 5 percent of all.

And another... Illinois is going to come back and say, well, yes, but you sold this other one; and, as to that one, you've got sufficient connection with Illinois.

It seems to me it's going to be impossible to sort this out.

Mr. Brinkmann: --Your Honor, this has been going on since at least 1992 in the Allied-Signal case.

The lower courts, the State courts, except for the court in this case, have been able to apply that easily.

In order to take the expansive view of Illinois here, you would be undermining Allied-Signal, which had the same facts as in this case, not to mention ASARCO, Woolworth.

And I would just say, before I could reserve the remainder of my time, Allied-Signal was the case in which this Court was faced with new arguments raised by the States, at argument.

You went back and had resupplemental briefing and reargument, and questioned in your questions to those parties whether or not ASARCO and Woolworth should be revisited and overruled.

So the Allied-Signal case took into account all of these concerns and came back with a ringing affirmation of the linchpin of an apportionability for state taxation being the unitary business test with the operational function aspect.

Justice Kennedy: I don't like to intrude on the white light, but if I could just ask one question.

If the unitary tax argument has been preserved and is met and if there's a finding that they are unitary, does Illinois have the right to tax the sale, or to... to a portion of it?

Mr. Brinkmann: We think that the finding is that it is not unitary.

Justice Kennedy: No, no.

Assume... assume it is unitary.

Can Illinois then, in your view, have a part of... tax part of the gain on the sale?

Mr. Brinkmann: Yes, if it were unitary, but we think there's no way this record could meet the standards compared to Woolworth, ASARCO.

In all those cases, they were much closer.

Thank you.

Argument of Brian F. Barov

Chief Justice Roberts: Thank you, Ms. Brinkmann.

Mr. Barov.

Mr. Barov: Mr. Chief Justice, and may it please the Court: Illinois is not attempting to tax income earned outside its borders.

To the contrary, the income it seeks to tax here is income earned by Mead on its electronic publishing business, Lexis, which conducted substantial business in Illinois.

Mead paid taxes on the income that the electronic publishing business earned.

Yet, it now contends that the Constitution bars it from taxing any of the gains it realized on the sale of Lexis, even though Illinois undeniably contributed--

Justice Kennedy: Well, if you did not proceed on the unitary business there, let's take that off the table.

It seems to me that Lexis's presence in Illinois is quite irrelevant.

Mr. Barov: --No, Your Honor.

It's--

Justice Kennedy: It seems to me that, under your theory, you could tax the sale, even if Lexis were not in Illinois at all, just because Mead is.

Mr. Barov: --If this... if they were unitary, yes, then Lexis's presence in Illinois would be irrelevant to this case, if they met the unitary business doctrine.

Justice Breyer: That's not the question.

I thought that the... I agree with the same question Justice Kennedy had.

Suppose that I'm a Massachusetts company that sells tables, and I sell some tables in Illinois.

And one day I take some of the money, and I buy an iron mine in New Mexico.

And then I sell the iron mine.

And Illinois, not Massachusetts, wants to impose a tax.

And suppose there is no connection whatsoever between the iron mine and anything else but for four, which are the four listed on page 13a: One, that I have contributed capital support to the iron mine.

Two, I approve the major capital expenditures of the iron mine, sitting in my office in Massachusetts.

Three, sometimes... and this is a tougher one... I call the iron mine a division of my table company.

And, four, I sometimes retain tax benefits and control over the extra cash of the iron mine, but I'm not using it in my day to day work.

Now, are those four things alone sufficient for Illinois to tax the sale of my iron mine?

That, it seems to me, is the way they presented it.

Maybe it is a unitary business really, but I guess we have to send it back for that.

Mr. Barov: Under... under those bare facts, probably there would be not a sufficient connection.

Justice Breyer: All right.

Then why isn't that the end of this case?

That's what they said it was.

That's what they said, perhaps wrongly, that this isn't a unitary business.

And, therefore, we are left with those four facts, and why not send it back and say you haven't reached the unitary business question; go reach it?

Mr. Barov: Because, Your Honor--

Justice Kennedy: And if I can just add on to that same question: If you're going to have the unitary tax theory, that's... that's very helpful.

But if we take the unitary tax theory off the table, it seems to me that you are confusing the law by having some midway test.

I don't know what your theory is, that... in relation to this part of Justice Breyer's question.

Mr. Barov: --There's a two part answer to that question... those questions, Your Honor.

First, there's a second avenue of State taxation that's been well recognized by this Court for at least 80 years, which is that if a business conducts business in a State, a State has a tax... has the right to tax a share of that business.

And that's all Illinois did here.

When it apportioned the income in this case, it apportioned the income only based on Lexis's in State Illinois presence.

So under that avenue alone, the tax is constitutional.

The second--

Justice Kennedy: But Mead didn't receive... pardon me... Lexis didn't receive the money for the sale, Mead did.

Mr. Barov: --Right.

Justice Kennedy: Unless, again, if Mead's presence or nonpresence is simply irrelevant to what happened here, absent a unitary theory.

Mr. Barov: No, Your Honor.

Mead received the tax... the gain for the sale because Lexis was a division of Mead, and the only tax paying... the only... there is no... there was no legal entity known as "Lexis" at the time that Lexis was sold.

It was assets... it was assets owned by the Mead Corporation.

Now, Mead received the benefit... the gain on the sale because Mead was the only tax paying entity in this case.

So Mead was conducting a business in Illinois called "Lexis", and, therefore, Illinois could tax at least--

Justice Kennedy: Do you think that if there had been a separate corporation and that Lexis was a subsidiary corporation and the subsidiary was... it was sold, that, again, absent a finding of unitary, Illinois then could have had a tax?

Mr. Barov: --Yes.

Illinois could have taxed based on the--

Justice Kennedy: All right.

So, then, the asset stock doesn't make any difference?

Mr. Barov: --But the... but the point, Your Honor, is that Lexis had a presence in Illinois.

It was conducting business in Illinois.

That, alone, gave Illinois the power to tax a share of the income--

Justice Kennedy: That gets back to Justice Stevens's initial hypothetical.

If you live in New York and you have an investment in a company that does a lot of business in Illinois and you in New York, a resident individual, sell that stock, under your theory Illinois could tax it.

Mr. Barov: --No.

Illinois can't tax that State because there is no relationship... there has to be some relationship, you know, between Illinois and the tax paying activity and the taxpayer.

In Justice Breyer's hypothetical there was none.

But there is a... but let me, if I can, address that prong of the analysis, also.

Here there was a much closer connection between Lexis and Mead than simply that of a passive investment.

It wasn't just that Mead helped Lexis buy, make, handle acquisitions.

They were involved in the actual acquisitions themselves, in purchasing and contracting to make those acquisitions.

Mead was involved in many of the... in controlling lots of their capital investment, its... and its... it was also involved in manipulating excess... in their excess cash.

And there is a whole... there was a host of facts that supported a closer relationship between Mead and Lexis than simply that, that passive investment.

So whether... even if you are looking at it from the operational function point of view, there was... there was a... a sufficient connection between Lexis and Mead beyond that of Justice Breyer's hypothetical.

Justice Alito: If you traded places with Ohio, how would you have treated this transaction under your tax laws?

Mr. Barov: Under our tax laws--

Justice Alito: Say that Mead was domiciled in Illinois but Lexis/Nexis operated in Ohio, would you have just taken... would you have allocated or would you have claimed that... the right to tax the entire capital gain?

Mr. Barov: --This would have probably, I think, Your Honor... I believe this would have been apportioned as business income under Illinois law.

Justice Ginsburg: Do you know what... or did you know what Ohio did in the--

Mr. Barov: I don't know what Ohio did.

They... Mead has never cited anything in the record to support the contention that it has been... that it was allocated all to Ohio.

My understanding of Ohio law at the time was they... they have the same business income test, basically, that Illinois does.

Justice Ginsburg: --Well, what would you say... I mean, we talk about apportioning income and allocating income, allocating to the commercial headquarters.

What in an enterprise like this would you say is allocated to the commercial headquarters as opposed to being apportioned among all the States?

Mr. Barov: Different States have different rules, Your Honor, and these are State-law rules, not constitutional rules, about allocation and apportionment.

Some States will allocate an intangible capital gain like this to their own domicile State.

Other States will apportion it based on the share of income that is done in the State.

Again, I don't know what Ohio did.

But the point is that's a rule... that's a State-law rule of choice, not a rule of... a constitutional rule.

I think this Court has been pretty clear in the Mobil Oil case that these... those... that doesn't have a constitutional significance.

That when a State, a domicile State, and a State where a source... which is the source of income, when those conflict, in fact, this Court has signaled that apportionment is the default rule.

And that the source State actually would have... the source State would win that confrontation.

Justice Souter: Mr. Barov, I just want to go back to an earlier answer to see how far you would go with the position that you took.

Assume that, exclusive of Nexis, Mead is the same kind of unitary corporation as under... under everybody's understanding now.

Assume, also, as you suggested in a hypo, that Lexis was doing business in Illinois.

So that at least a... a portion of its own activity could be taxed in Illinois.

And assume, third, that the relationship between Mead and Lexis is simply one of passive investment.

Mead simply bought a lot of stock, maybe 100 percent of the stock at the right time; and, otherwise, it kept hands off.

And at this point Mead now... now sells.

On... on your theory, would... would the State of Illinois be able to tax a portion of the capital gain?

Mr. Barov: Yes, they would, Your Honor.

But they would be limited in how much of that capital gain they could apportion.

They would apportion it limited to the amount of income that arose in Illinois.

And that's what the auditor did in this case.

Justice Souter: Well, but that would be, in effect, the portion of the Nexis business, total business that took place in Illinois, total sales, total payroll, however you do it.

Mr. Barov: Right, and then that would be put... that would be put into--

Justice Souter: Okay.

But the only point I wanted to be clear on to understand your position is that purely passive investment would be enough to trigger your theory?

Mr. Barov: --Yes, it would be.

Justice Souter: Okay.

Mr. Barov: It is, Your Honor.

Chief Justice Roberts: Counsel, why isn't your friend correct that you have waived any argument based on the presence of Lexis in Illinois?

Mr. Barov: Your Honor, two reasons: First, under the... they have cited basically two basis grounds for waiver, one under Illinois law and under this Court's rules.

But they misstate Illinois law in the... on the waiver regard.

The cases and rules they cite to stand for a simple proposition that a point not raised in a brief before a particular court can't be raised on oral argument.

But what the Illinois Supreme Court has been clear on "otherwise" is that an argument, even if it's not raised in the appellate court, as long as it's raised in the trial court in support of a judgment, may be raised in a reviewing court on further review.

I can provide a couple of cites, Your Honor.

Justice Ginsburg: And... and I'm not following your argument, because I thought that the argument that this was a unitary enterprise was made in the Illinois appellate court, and the appellate court recognizes that it was made, and said we are not going to reach it because we have this operational function test?

Mr. Barov: Yes, Your Honor.

That's... that's correct.

Chief Justice Roberts: Well, but that's... they are very different from your current argument, which you emphasize that whether they are unitary or not, Lexis/Nexis was in Illinois.

Mr. Barov: That's correct, Your Honor.

Chief Justice Roberts: Okay.

Now, as to that argument, at least I am very reluctant to overturn a State court on an argument that they didn't have an opportunity to consider.

And whether it's technically waived because you raised it in the trial court or not, it certainly was not an argument you made to the Illinois appellate courts.

Mr. Barov: That's correct, Your Honor.

And... but I think, as this Court set forth in Caterpillar v. Lewis, it is a predicate to the intelligent resolution of this case.

Chief Justice Roberts: Well, it wasn't in Allied-Signal.

In Allied-Signal the asset that was sold was in New Jersey, and that was totally irrelevant to how we treated the issue in that case.

Mr. Barov: Certainly, Your Honor.

But New Jersey was taking a very different position in that case.

They were making a much broader argument than we are making here.

They were trying to overturn the entire unitary doctrine.

And so they may have... they may have chosen not to make that argument.

It may very well have been in that case that ASARCO's apportionment factors in that case were so minimal that it wasn't worth their making that argument.

But, for whatever reason, they weren't interested in taxing based on the source alone.

But here, as the facts show, Illinois did tax.

We taxed Lexis, or the gain on Lexis, pursuant to Lexis' in state apportionment factors.

Justice Stevens: May I ask this question just... it shows my ignorance, but if the unitary business approach to taxation was not applied in this case, how did you compute the amount of the tax?

Mr. Barov: It was computed... what the department did in this case is it... it took the entire gain that put... that went into Mead's apportionable tax base.

But, then, in order to find the Illinois-Lexis share of the gain, he looked at the... he looked at Lexis's Illinois sales and Illinois's... Lexis's Illinois payroll and pulled that amount out, which was about four percent of the gain, and put that into Mead's--

Justice Stevens: So you use a different formula from the normal three factor formula to compute the tax?

Mr. Barov: --Right.

You use a different formula.

You use a two factor formula, but it was just related to Mead's sales, not to--

Justice Kennedy: But it seems to me that those factors are wholly irrelevant to the fact of sale.

It's just whimsical.

It has nothing to do with the sale.

The reason we use apportionment in other cases is, just as in Justice Breyer's railroad example, there is no other way to tell, and so forth.

But here the presence of Lexis in Illinois is wholly accidental with reference to what went on in the sale.

Mr. Barov: --No, Your Honor, it wasn't.

I mean Lexis did considerable business in Illinois, and the auditor was isolating Illinois's business in attempting to accurately value the amount of gain that should be attributable to Mead based on Lexis's Illinois presence.

Chief Justice Roberts: Well, that's why it's even more dramatic to me that you didn't raise the argument based on the Lexis connection to Illinois.

That's the basis on which your auditor is claiming these taxes; and, yet, you don't even raise it before the Illinois appellate court as a ground for being able to reach the Lexis/Nexis income.

Mr. Barov: --the trial court... actually the appellate court ruled on whether the State law tests had been met at the time.

And when it went up on appeal we... we prevailed in the appellate court based on operational... I'm sorry, in the trial court, based on the court's finding the operational function had been met.

That's how the appellant framed the issue, and the case sort of turned on really Illinois State law's interpretation of Allied-Signal.

But, you know, at this point the... the facts and the law are clear and a decision--

Justice Stevens: In the Illinois courts, they did argue that as a matter of Federal constitutional law the tax is impermissible, didn't they?

Mr. Barov: --Correct, yes.

Yes, they did.

At this point, Your Honor, I mean, to render a decision that doesn't take into account the facts of the case, the economic reality, accordingly would be artificial.

Chief Justice Roberts: We couldn't do anything more if we said you haven't waived it, we couldn't do anything more than send it back.

You're telling us Lexis has this presence in Illinois, but we have nothing in the record about that.

Mr. Barov: Yes, it is in the record.

The auditor's... I mean, the stipulation itself shows that Lexis was in Illinois.

And the Illinois appellate court made a finding that the presence of Lexis... Mead to tax Nexis with Illinois was undisputed.

So the Illinois appellate court recognized that Lexis had a taxing... adequate taxing connection with Illinois.

Chief Justice Roberts: Where is that?

Mr. Barov: That is... I don't have the page cite handy, Your Honor, but the appellate court did make a finding that it was undisputed that the--

Chief Justice Roberts: I just... usually appellate courts don't make findings.

That's why I'm curious--

Mr. Barov: --I'm sorry.

Made a statement.

Justice Ginsburg: Was there any sort of stipulation between the parties to say what each, what Lexis/Nexis was doing in Illinois, what Mead was doing in Illinois?

Mr. Barov: There was, there was a long stipulation, yes, Your Honor, and plus there was exhibits attached to the stipulation, which are reflected in our briefs, that discuss in detail what Mead and Lexis were both doing, at least their relationship to each other.

Justice Ginsburg: Let me ask you about the theory that both the trial court and the intermediate appellate court went on, this operational function test, which has been brought up in a few of our cases, but I don't know any that was decided.

Did we ever have any case that turned on the operational function test to hold for the State taxing authority?

Mr. Barov: No, Your Honor.

But in Allied-Signal there was... examples were given of certain--

Justice Ginsburg: Yes.

But one of the problems with applying it as you urge here is that that would just override... why would anyone go to the trouble of making a case under the so called unitary business test, because the operational function test would be much easier to meet?

So--

Mr. Barov: --I guess on that point I would disagree with you a bit, Your Honor.

I think there are very... they're different types that look at different relationships.

So one doesn't... while the same facts can support them in instances, you can have situations where a business is unitary but not operational or... I'm sorry, an asset is operational, but isn't necessarily--

Justice Breyer: What?

What?

What could it be?

That is... as I read this, I thought, well, there is no separate test.

It's just there's a certain situation that comes up fairly commonly where someone claims that an asset of a company was really quite separate, and therefore when they get income from it or they sell it it has nothing to do with my business.

And the answer is: It did have something to do with your business, you used the working capital and so forth, in which case it's part of the business.

So how... how is it... how is it different from that?

Mr. Barov: --I agree, Your Honor.

Justice Breyer: Well, if you agree with that, do you really agree, because if you agree with that there's no such separate test, this court was wrong to consider it separately, the lower court, and they should have reached the question they didn't reach, which was is this whole thing one single business, which is normally called the unitary business test?

Mr. Barov: Your Honor, on that point I disagree.

Justice Breyer: Good.

All right.

Mr. Barov: I think there is... I mean, they're both ways of reaching the overall unitary principle, whether you can show the intangible flow of assets... of value between a company... I can give you an example, say, of a company that would be unitary but where the operational function analysis wouldn't apply is the Container Corp. Type fact pattern, where you have a domestic... a domestic parent providing value out to the foreign subsidiaries, but there is nothing sort of flowing back to the domestic parent.

They're not really using those subsidiaries in the domestic business.

But nevertheless, there is enough value being thrown out that it passed the unitary threshold.

The unitary... the unitary... I'm sorry.

The operational function analysis or test or principle, whatever you want to call it, arises in the examples given in Allied-Signal.

As you said, you've got something which isn't really part of the rest of your business, but you're using it in that business to support it way beyond just a passive investment.

And this... in this case, that's how Mead was using Lexis.

They were using it to support their, the value of their multiple, their multi state business, by manipulating... by making capital contributions, manipulating corporate structures, and bringing back that tax and net loss carryforwards, which increased the value, which increased their business activities.

So this case actually is that... is that... falls within that paradigm also.

It's not unlike any... like either of those hypotheticals in Allied-Signal, not unlike the use of working... investment of working capital.

So, yes, both... the test, while there are facts that overlap them, they can show that there are different relationships.

Justice Ginsburg: --So say you... but you would be asking us, if you were going to go on that operational function, to take two examples that were given in Allied-Signal that are quite different from what's involved here, and to make that a doctrine when you recognize that we have never used that theory to hold for a State taxing authority in the context of a multi state enterprise?

Mr. Barov: Your Honor, I don't think you have to create a separate doctrine again.

I think these are both considered different ways of showing the intangible flow of value, the significant links between a business that give rise to constitutional apportionment.

And whether they're considered separate analyses... they have been described by some academics as corollaries of each other.

It's certainly, given this Court's signals in Allied-Signal, I think it's certainly appropriate where the facts arise to make the constitutional finding based on the operational function that an asset serves in a business.

Justice Stevens: May I ask this question.

Does the record tell us whether other States have sought to tax the capital gain on this transaction?

Mr. Barov: No, it does not, Your Honor.

Justice Stevens: As far as we know, Illinois is out on its own here?

Mr. Barov: I don't know, Your... I don't know the answer to that, Your Honor.

I hope not.

In any event, Your Honor--

Justice Scalia: You'd not wager, however, right?

Mr. Barov: --In any case, Your Honor, as you said, as I've said, there are two possible ways that... two different constitutional paths or theories that we can go down in this case to meet the... that allows Illinois to apportion.

Independent of the operational links, Mead can tax the gain on Lexis simply because Lexis conducted business in Illinois.

A state may tax a nonresident's investment income based on its investment in a separate business, and that's exactly what Illinois... that's another way to uphold the Illinois appellate court's decision.

Justice Ginsburg: If Illinois... if Ohio is, in fact, taxing the whole gain at its full rate on the theory that this entire income should be allocated to Ohio, then you do have an element of double taxation, right?

Mr. Barov: That's possible, Your Honor, but it's... first, there is no... there's no evidence that Ohio in fact did that.

But I think the Mobil Oil case should have disposed of that, that contention, because this Court rejected a similar argument that the mere possibility of taxation by a domiciliary State foreclosed taxation by a State where the business was present.

And under Mobil Oil, when a resident State's claim and a source State's claim conflict, this Court indicated that the resident State's claim must yield to that of the source State.

So there should be no issue of multiple taxation in this case.

Just... Chief Justice Roberts, just to go back to your question, it's page 11A of the pet.

app. where the appellate court said:

"Mead does not dispute that Lexis/Nexis had the requisite connection or nexus with Illinois. "

Chief Justice Roberts: --I thought... I've been looking, too.

I thought 18A does say that they had $46 million of sales attributable to Lexis/Nexis.

Mr. Barov: Right.

Certainly.

There was hundreds of millions of dollars of sales in Illinois.

So that's really not an issue in this case.

Chief Justice Roberts: No, only 46 million.

Mr. Barov: I'm sorry.

Chief Justice Roberts: It said 46, not hundreds of millions.

Mr. Barov: I'm sorry.

In 1994, yes, that's correct.

The... and again there's... both Mead and Lexis... as both Mead and Lexis had adequate constitutional connection here, there is no basis not to sustain--

Justice Scalia: You're taxing Mead, not Nexis/Lexis?

Mr. Barov: --Correct.

That's correct.

Justice Scalia: So what relevance is it that Nexis/Lexis has business in Illinois?

Mr. Barov: It's--

Justice Scalia: I mean that's fine if that's who you're taxing.

Mr. Barov: --Well, it's relevant if, only if, this Court finds that there was no operational relationship between Lexis and Mead.

Then Lexis's presence in Illinois becomes relevant because in that case, whether you look at this as a separate business conducted by Mead or whether it was even a passive investment of Mead's, Illinois can still tax it in the manner that it did by... by isolating the values of Lexis's... that Lexis earned in Illinois.

Justice Kennedy: And that is different--

Justice Scalia: I might say that I don't follow that.

It seems to me what you can establish from the fact that it did a lot of business in Illinois is that can you tax it and... but I don't see how.

Justice Ginsburg: There was no "it" to tax, right?

Mr. Barov: That 's correct.

There was no J.C. Penney, a State can tax a nonresident on an investment in that State as well as the tax is properly prorated to the amount of income that rose within that State.

Justice Ginsburg: At the time of this sale of Lexis/Nexis assets, there was only one taxpayer; it was Mead.

Mr. Barov: That's correct, Your Honor.

There was one taxpayer and it was Mead.

That was the only party that could have been taxed.

That's correct.

So here, in this case, Mead is taking an all or nothing approach to taxation but this could... this disregards the connections between Mead's electronic publishing business in Illinois.

And the Court should decline to rule in their favor.

In fact--

Justice Scalia: Do you have any case like that where your ability to tax a surviving corporation has to do with, not whether the surviving corporation itself has sufficient contacts with the State, but whether some other corporation that has disappeared now but that merged into it had sufficient... it seems to me you have to establish connection with the taxpayer.

Not... not with somebody from whom the taxpayer made some money.

Mr. Barov: --You have to establish a connection with the taxpayer's activities in the taxing State.

That's the constitutional touchstone.

So if Mead... whether Mead was running a business in Illinois or investing in Illinois or had a unitary business that operated in Illinois, those... that's the... that provides a sufficient link.

Justice Scalia: That's fine.

Mr. Barov: So that provides the taxing... the ability--

Justice Scalia: But that isn't established by the mere fact that Lexis/Nexis did business there.

Ultimately you have to come down to connecting it to Mead, either by your unitary business doctrine or by this functional doctrine that you're relying on.

Mr. Barov: --No, Your Honor.

Under International Harvester, I think that the Court made it very clear that even a passive investment can be taxed by a State.

If Mead... Mead can be taxed... even if LEXIS was a passive investor and Mead was only investing in Illinois, Illinois could still tax Mead on the value of its investment that arose in Illinois.

And so Mead realized the gain.

Mead is the taxpayer.

Mead can be taxed as long as the tax is properly prorated to the Illinois presence, which it was in this case.

Justice Kennedy: --But the proration, it seems to me... that should have nothing to do with the extent of Lexis in Illinois--

Mr. Barov: Exactly.

Justice Kennedy: --nor does it have to do with the extent of Mead in Illinois.

Mr. Barov: Well, no, Your Honor.

It's... under this... then under this Court's precedent, that you're looking for the source State, the activity of the business was conducted in the source State.

Now, in this case it happened that the amounts are fairly close to each other.

So if there is any question about it, there's no... you know, there is no constitutional problem that arises out of that.

But clearly this... I mean it's settled precedent that a State can tax based on income... the income that arose in that State and that's what happened here.

Indeed, to accept Mead's contention which also would create a constitutional loophole that for income in ae State's marketplace helped create but which a State cannot recover, the Illinois court's decision permitting Illinois to tax a fraction of the gain should be affirmed.

And if the Court has no other questions--

Justice Scalia: Can you tax me on stock... on stock that I own on companies that do business in Illinois?

Mr. Barov: --In the abstract, yes, you could, Your Honor.

Justice Scalia: Do you know any State that tries to do it.

Mr. Barov: No, Your Honor, but again, Your Honor--

Justice Scalia: That's extraordinary.

I don't know of any tax that a State could possibly impose, that no State has imposed.

[Laughter]

Mr. Barov: --Your Honor, this is... but Your Honor, International Harvester is the perfectly precise fact pattern where this Court upheld a tax on a... on investors, on the shareholder's investment in a State in which they were not present, so... but in this case Mead had an independent tax presence also in Illinois.

So that issue just doesn't arise in this case.

Rebuttal of Beth S. Brinkmann

Chief Justice Roberts: Thank you, Counsel.

Ms. Brinkmann, you have three minutes.

Mr. Brinkmann: I have four very quick points, Your Honor.

Two go into this new, very breathtaking argument that the State is making based on Lexis/Nexis's presence to the State.

Concerning Illinois law, if you look Repondents' brief in opposition, on page 12 at note 4, they cite the same Illinois law we do, trying to argue that we had waived arguments in the brief in op, so we are on pretty solid ground there.

I think it's their cert page, they were agreeing with us on what the Illinois law meant.

On the substance of it, I think Justice Scalia and Justice Kennedy brought out the weaknesses.

Their position would lead to taxes on all stock sales.

Any State where an investment was doing business could then reach out and apportion the gain on that.

And as far as International Harvester and J.C. Penney, those were tax on the investment, not the investor.

And the dissent... that was the dispute... the majority.

It was the incident of the tax fell on the invest... the investment that was doing business in the State.

The State concedes, Your Honor, on Justice Ginsburg's, the distinction between... the sale of assets and the sale of stocks that you were concerned about.

On page 43, they concede and I think it's very well recognized through Mobil and Exxon and Woolworth that

"apportionment has nothing to do with the form a business organization takes. "

Chief Justice Roberts: Ms. Brinkmann, your final point.

Mr. Brinkmann: Finally I would point out, on the question you asked... I think it was Justice Ginsburg... what Illinois would do in this.

Interestingly--

Justice Ginsburg: Ohio.

Mr. Brinkmann: --the record in this case at... it's not in the joint appendix, but it's at C-851.

It's Exhibit 1, to the stipulation of facts.

It indicates that interest and dividends allocable are allocable to Illinois if the commercial domicile is in Illinois.

Justice Scalia: Illinois or Ohio, were you talking about?

Mr. Brinkmann: This is the Illinois return, and the question was what Illinois would do?

And they say commercial domicile, we get your interest and dividends.

Chief Justice Roberts: Ms. Brinkmann, on the waiver point... I'm looking at page 18a... it not only says that Lexis/Nexis contributed $46 million from its presence in Illinois; it begins the sentence by saying

"as the Department notes, $46 million of Mead's income came from Lexis/Nexis activities in Illinois. "

So that doesn't sound like a waiver of that point to me.

Mr. Brinkmann: At one point, after they got through the unitary business and operational functional analysis, there was an argument about whether it was grossly disproportionate, and that's where some of that information came.

It was never in the context of this legal--

Chief Justice Roberts: Initially, it's about the context in which... what I regard as an important fact... was raised, whether it was raised in the context of an argument on unitary business or whether or not they went too far, but the stubborn fact is still there.

Mr. Brinkmann: --There are facts, Your Honor, but the Illinois law is very clear; it's rule 341(h)(7) and (i) which applies to applee.

If you don't raise a point in the appellate court, it is waived.

That's an independent and adequate State ground.

And it's a very breathtaking argument, as Justice Scalia pointed out, that also wasn't brought forth in the brief in opposition.

Thank you, Your Honor.

Chief Justice Roberts: Thank you.

The case is submitted.