In an order released in July 2021, the Illinois Tax Tribunal denied a taxpayer’s motion for summary judgment in a “unitary business” case, finding that there were disputed issues of fact as to whether the taxpayer was engaged in a unitary business with a company that the taxpayer sold. See Christopher v. Illinois Dep’t of Rev., 19 TT 131 (Ill. Tax Trib. Nov. 24, 2020, released July 2021). The taxpayer, T. Christopher Holding Company (“Holding Company”), claimed that it was not unitary with Vogue International, LLC (“Operating Company”), and thus its gain from the sale of Operating Company could not be included in Holding Company’s Illinois business income under U.S. constitutional principles and Illinois law. However, the Tribunal found that the Illinois Department of Revenue (“Department”) had presented sufficient evidence to establish a disputed issue of material fact that rendered summary judgment on this issue inappropriate.
In an affidavit accompanying the summary judgment motion, Todd Christopher, president and majority owner of Holding Company, averred that Holding Company was a “passive” entity that served solely to hold equity interests in Operating Company, a nationwide developer, distributer and marketer of hair and skin care products that was also founded by Mr. Christopher. Operating Company, which was treated as a partnership for federal and Illinois tax purposes, was headquartered in and operated out of Florida. Other than the equity interest in Operating Company and a brokerage account, Holding Company had no property, and it also had no employees and no active trade or business.
Before 2014, Holding Company held a majority interest in Operating Company and was its managing partner. In February 2014, Holding Company sold a 49% interest in Operating Company to an unrelated investment company, and later sold its remaining 50% interest to a different third party in 2016. Both sales resulted in a gain to Holding Company. In the instant case, Operating Company reported its gain from the 2014 sale as “nonbusiness income” under Illinois law, and allocated the gain entirely to Florida for Illinois replacement tax purposes. The Department issued a notice of deficiency, asserting that the gain should have been included in Holding Company’s business income base and apportioned in part to Illinois.
The Illinois replacement tax, which is effectively an income tax surcharge, applies to the “net income” of a corporation, partnership or trust “earning or receiving income in” Illinois. See 35 ILCS § 5/201(c). Under the Illinois Income Tax Act (“IITA”), for both income tax and replacement tax purposes, a taxpayer’s “net income” must, as an initial matter, be divided into “business income” and “nonbusiness income.” “Business income,” defined as “all income that may be treated as apportionable business income under the Constitution of the United States,” is apportioned to Illinois by multiplying such business income by the taxpayer’s sales factor. 35 ILCS §§ 5/304(a), (h)(3); 5/1501(a)(1). “Nonbusiness income,” which is defined as “all income other than business income,” is not apportioned, but is allocated entirely to a single state according to the IITA’s allocation rules. See 35 ILCS §§ 5/303; 5/1501(a)(13).
Under these definitions, whether or not the gain from the sale of Operating Company can be included in Holding Company’s “business income” in Illinois depends on whether that gain constitutes “apportionable” income under the U.S. Constitution. As the United States Supreme Court has repeatedly held, “the linchpin of apportionability in the field of state income taxation is the unitary business principle.” Mobil Oil Corp. v. Comm’r of Taxes, 445 U.S. 425, 439 (1980). Therefore, including the gain in Operating Company’s apportionable income would be permissible under the U.S. Constitution only if the gain was derived from a business operation or asset that was unitary with Holding Company’s in-state business. MeadWestvaco Corp. v. Ill. Dep’t of Rev., 553 U.S. 16, 29 (2008).
Before the Tribunal, Holding Company moved for summary judgment on the grounds that, because it was a passive holding company with no business operations, it was not unitary with Operating Company as a matter of law, and therefore the gain from the sale of its interest in Operating Company could not be considered business income in Illinois. In ruling for the Department, the Tribunal first looked to the definition of a “unitary business” under Illinois law. Under the IITA, a “unitary business group” is defined as “a group of persons related through common ownership whose business activities are integrated with, dependent upon and contribute to each other.” 35 ILCS 5/1501 (a)(27). The Tribunal also explained that, “under the Constitution, whether the gain from the sale of a business is apportionable to Illinois turns on the unitary relationship between the seller and asset sold.” Christopher, supra, citing MeadWestvaco Corp., 553 U.S. at 29-30 and A.B. Dick Co. v. McGraw, 287 Ill. App. 3d 230, 231-32 (4th Dist. 1997).
Consistent with U.S. Constitutional principles, the Tribunal noted that “the purpose of . . . the unitary business doctrine is to permit states to recapture the ‘many subtle and largely unquantifiable transfers of value that take place among the components of a single enterprise.’” Christopher, supra, citing A.B. Dick Co., 287 Ill. App. 3d at 239. Furthermore, the Tribunal pointed out that “[t]he question of whether the Holding Company and Operating Company comprised a unitary business group is a fact question.” Id. (emphasis added). Although the taxpayer alleged that Holding Company’s passive ownership of Operating Company and its lack of any other business operations established that Holding Company and Operating Company were not unitary as a matter of law, the Tribunal cited to precedent establishing that passive holding companies can be engaged in a unitary business with operating companies that they own. Id., citing A.B. Dick Co., 287 Ill. App. 3d at 232; Security Life of Denver Ins. Co. v. Ill. Dep’t of Rev., 14TT89 (Jun. 27, 2016). Furthermore, the Tribunal found that the Department had presented evidence of common ownership of Holding Company and Operating Company and evidence that the common owner (Mr. Christopher) had participated in the negotiation of Operating Company’s sale. Ultimately, because consideration of a summary judgment motion requires all evidence to be construed most strongly in favor of the non-moving party, the Tribunal found that the taxpayer’s assertions did not “not render the lack of a unitary relationship between the Holding Company and the Operating Company ‘clear and free from doubt’” and the evidence presented did not “rule out ‘the largely unquantifiable transfers of value’ indicative of the unitary business relationship.” Id., citing A.B. Dick Co., 287 Ill. App. 3d at 239 and Adams v. Northern Ill. Gas Co., 211 Ill. 2d 32, 43 (2004). The Tribunal therefore denied the taxpayer’s motion for summary judgment, and determined that “[t]he nature of the relationship between the Holding Company and Operating Company . . . requires the development of additional facts.”
The Tribunal’s decision highlights the general notion that the existence of a unitary relationship between two business enterprises, or between a business enterprise and an asset, is a highly fact-intensive inquiry. Whether two enterprises share what have been described by the Supreme Court as the “hallmarks” of unity—i.e., functional integration, centralized management and economies of scale—is ordinarily something that can only be determined after significant scrutiny and factual development. Likewise, the manner in which an asset was used in a taxpayer’s business and whether or not that asset was treated as an operational asset or a passive investment—the relevant decision points in an asset unity case—is a similarly fact-intensive analysis. Thus, it is not altogether surprising that the Tribunal chose not to decide this issue on a motion for summary judgment, where all evidence must be viewed in the most favorable light to the non-movant.
It is noteworthy, however, that the Tribunal found that a passive holding company could be—but is not per se—engaged in a unitary business with an operating company that it owns; in other words, the Tribunal’s order confirms that the same unitary analysis should be undertaken whether a holding company or an operating company is the taxpayer at issue. Other states, such as California, have issued legal rulings that treat holding companies differently than operating companies in the context of a unitary business analysis. For example, in FTB Legal Ruling 95-7, the FTB concluded that when a passive parent holding company holds one or more operating company subsidiaries that are engaged in a single unitary business with each other, the holding company’s “primary function” is as a “conduit” between the shareholders and the single unitary business operations they indirectly own, and thus the holding company and the operating companies must constitute a single unitary business. FTB Legal Ruling 95-8 addresses “intermediate” passive holding companies and comes to a similar conclusion. This “per se” unity viewpoint is problematic and fails to recognize that an operating company can be held and treated as a passive investment by a holding company—in which case the holding company and the operating company may not be unitary. For example, another state court has concluded that a parent holding company and its operating subsidiary engaged in a tobacco business were not unitary with an investment in a wine and spirits business. R.J. Reynolds Tobacco Co. v. Comptr. of Treas., Md. Tax Ct., Income Tax No. 4962, (January 21, 1994). In R.J. Reynolds, the Maryland Tax Court concluded that the taxpayer was not subject to the state corporate income tax on capital gain from the sale of all stock in Heublein, Inc. (a corporation engaged in the wine and spirits business), because there was no unitary business relationship between Heublein and either the taxpayer or the taxpayer’s parent (a holding company) and the investment in Heublein was a “discrete non-operational investment.” The Court found that the taxpayer bought stock of Heublein as an investment and it was treated as such by the taxpayer and its parent. The Court noted that Heublein was subject to certain controls by the parent holding company but that such controls did not constitute management. Additionally, there were minor joint activities such as advertising, insurance, pension services, and the maintenance of a corporate aircraft fleet that were found to be de minimis in nature and not controlling. Id.
Therefore, as the Illinois Tribunal in Christopher and the Maryland Tax Court in R.J. Reynolds have both recognized, the existence of a unitary relationship—the “linchpin” of apportionability—must be established regardless of whether one of the business enterprises at issue is a holding company, and treating all passive holding companies as “de facto” unitary with their owned subsidiaries raises concerns under the U.S. Constitution.
We will continue to monitor the Christopher case as it proceeds through the Tribunal, and will publish an update if a decision on the merits is issued.
 The treatment of the 2016 gain is the subject of a separate matter also pending before the Illinois Tax Tribunal.