Corrigan v. Testa (Slip Opinion)

[Until this opinion appears in the Ohio Official Reports advance sheets, it may be cited as

Corrigan v. Testa, Slip Opinion No. 2016-Ohio-2805.]

NOTICE

This slip opinion is subject to formal revision before it is published in an

advance sheet of the Ohio Official Reports. Readers are requested to

promptly notify the Reporter of Decisions, Supreme Court of Ohio, 65

South Front Street, Columbus, Ohio 43215, of any typographical or other

formal errors in the opinion, in order that corrections may be made before

the opinion is published.

SLIP OPINION NO. 2016-OHIO-2805

CORRIGAN, APPELLANT, v. TESTA, TAX COMMR., APPELLEE.

[Until this opinion appears in the Ohio Official Reports advance sheets, it

may be cited as Corrigan v. Testa, Slip Opinion No. 2016-Ohio-2805.]

Income taxation—R.C. 5747.212—Statute violates Due Process Clause of

Fourteenth Amendment as applied to nonresident taxpayer’s capital gain

from sale of ownership in limited-liability company that conducted business

in Ohio—Board of Tax Appeals’ decision reversed and matter remanded to

tax commissioner for grant of refund.

(No. 2014-1836—Submitted February 23, 2016—Decided May 4, 2016.)

APPEAL from the Board of Tax Appeals, No. 2012-3244.

____________________

O’CONNOR, C.J.

{¶ 1} A 2002 amendment to R.C. 5747.212 broadly imposed Ohio’s income

tax on a capital gain realized by an out-of-state investor in a pass-through entity if

that investor held a 20 percent or greater interest in the entity during a three-year

period including the taxable year. The new statute apportioned the capital gain to

SUPREME COURT OF OHIO

Ohio based on the percentage of the entity’s business conducted in this state during

the three-year period. In this appeal, appellant, Patton R. Corrigan, a nonresident

taxpayer, contests R.C. 5747.212’s imposition of income tax on a portion of the

capital gain that he realized in 2004 when he sold his ownership interest in

Mansfield Plumbing, L.L.C., a producer of sanitary supplies.

{¶ 2} The resolution of Corrigan’s challenge turns on a crucial distinction:

Ohio’s taxation of Mansfield Plumbing’s income to Corrigan and Ohio’s taxation

of Corrigan’s capital gain from the sale of Mansfield Plumbing. It is undisputed

that because Mansfield Plumbing constituted a pass-through entity for tax purposes,

Ohio was able to tax Corrigan’s distributive share of the entity’s income (or in this

case, loss) based on Mansfield Plumbing’s own business activity in Ohio. The issue

before us is whether Ohio may also levy income tax on Corrigan’s capital gain as

if it were income from the business itself.

{¶ 3} If R.C. 5747.212 were not the law, Corrigan would be subject to the

ordinary treatment of capital gains derived from intangible property: he would

allocate the entire amount of the gain outside Ohio because he was not domiciled

in Ohio. See R.C. 5747.20(B)(2)(c). Corrigan asserts that applying R.C. 5747.212

to him is unconstitutional and that he should therefore be permitted to allocate the

gain entirely outside Ohio.

{¶ 4} In defending the imposition of R.C. 5747.212 on Corrigan, the tax

commissioner does not contend that Corrigan himself was operating or managing

the business of Mansfield Plumbing. Instead, the state’s theory is that Ohio enjoys

the constitutional prerogative of taxing the proceeds of a nonresident’s out-of-state

sale of intangible property, based on nothing more than the fact that the entity being

sold conducted some of its business in Ohio. We disagree with the state’s

contention.

{¶ 5} We hold that R.C. 5747.212, as applied to Corrigan, violates the Due

Process Clause of the Fourteenth Amendment to the United States Constitution.

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We therefore reverse the decision of the Board of Tax Appeals (“BTA”) and

remand to the tax commissioner to grant Corrigan a refund.

RELEVANT BACKGROUND

FACTS

{¶ 6} In 2000, Mansfield Plumbing was an established enterprise engaged

in producing sanitary ware, with plants in Texas and California. It did business in

Ohio—in fact in all 50 states—as well as in other countries.

{¶ 7} In 2000, Corrigan, then a resident of Connecticut, acted in concert

with business associates to acquire the assets of Mansfield Plumbing, including the

right to use that entity’s name. More specifically, the record demonstrates that the

consent to use the name “Mansfield Plumbing, L.L.C.” is dated November 2000

and that Corrigan’s share of the entity—his “membership” interest in the limited-

liability company—was 79.29 percent.

{¶ 8} Corrigan became the main co-owner and a “manager,” i.e., a member

of the board of managers of Mansfield Plumbing. The day-to-day operations of the

company were overseen by officers and managers employed by the company.

According to Corrigan’s brief before the tax commissioner, as a manager, Corrigan

visited the company headquarters in Perrysville, Ohio, “for board meetings and

management presentations regarding operations, labor, finance, strategic

positioning and other matters important to the goal of growing Mansfield’s market

share.” Corrigan testified that that involvement was “easily a hundred hours” per

year. According to Corrigan, his role and capacity was as an “investo[r] who

bought companies with the intention of providing financing and strategic expertise

to grow the company for an eventual exit via a sale to a third party.” Corrigan

specifically argued to the tax department that his role in the entity involved

“stewardship” rather than active management of the business.

{¶ 9} In 2004, Corrigan and his fellow investors sold their interests in

Mansfield Plumbing to a third party, Ceramicorp, Inc., a unit of a Colombian entity

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in the sanitary-wares business that wanted a foothold in North America. As a result

of the sale, Corrigan realized a capital gain of $27,563,977 from his share of

Mansfield Plumbing. In filing his returns for tax year 2004, Corrigan treated the

entire amount of the gain as allocable outside Ohio, apparently because Corrigan

was not domiciled in Ohio.

PROCEDURAL HISTORY

{¶ 10} In 2009, Ohio issued an assessment for an unpaid 2004 tax liability

of $674,924.58, which, with interest, amounted to a total assessment of

$847,085.19. Corrigan paid $100,000 of the assessment, then filed a refund claim

for that amount on March 8, 2010. See former R.C. 5747.11(A)(3), Am.Sub.H.B.

No. 530, 151 Ohio Laws, Part IV, 6700 (requiring the tax commissioner to refund

amounts more than $1 “paid on an illegal, erroneous, or excessive assessment”).

These proceedings arise from that claim.

{¶ 11} The tax commissioner denied the refund claim through a final

determination issued on August 20, 2012. The final determination applied a

straightforward reading of R.C. 5747.212 and concluded that the assessment and

payment complied with the statute. The final determination also rejected

Corrigan’s constitutional arguments.

{¶ 12} Corrigan appealed to the BTA, which held a hearing on January 15,

2014. Corrigan testified at the hearing.

{¶ 13} The BTA issued its decision on September 24, 2014. Noting the

presumption favoring the tax commissioner’s findings and its own lack of

jurisdiction to declare a statute unconstitutional, the BTA “acknowledge[d]”

Corrigan’s constitutional claims but made “no findings in relation thereto.” 2014

Ohio Tax LEXIS 4415, BTA No. 2012-3244, at 4 (Sept. 24, 2014). The BTA also

noted that Corrigan raised a statutory argument in his BTA brief but held that it

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January Term, 2016

lacked jurisdiction to entertain that contention because Corrigan had not specified

that claim in his notice of appeal to the BTA.1 Id.

{¶ 14} The BTA affirmed the tax commissioner’s final determination, and

Corrigan appealed to this court.

ANALYSIS

THE DUE PROCESS AND COMMERCE CLAUSES

SET LIMITS ON OHIO’S TAXING AUTHORITY

{¶ 15} “It is a venerable if trite observation that seizure of property by the

State under pretext of taxation when there is no jurisdiction or power to tax is simple

confiscation and a denial of due process of law. ‘* * * Jurisdiction is as necessary

to valid legislative as to valid judicial action.’ ” Miller Bros. Co. v. Maryland, 347

U.S. 340, 342, 74 S.Ct. 535, 98 L.Ed. 744 (1954), quoting St. Louis v. Wiggins

Ferry Co., 78 U.S. 423, 430, 20 L.Ed. 192 (1870). And “[g]overnmental

jurisdiction in matters of taxation * * * depends upon the power to enforce the

mandate of the state by action taken within its borders, either in personam or in

rem.” Shaffer v. Carter, 252 U.S. 37, 49, 40 S.Ct. 221, 64 L.Ed. 445 (1920). These

precepts point to the importance of the Due Process Clause of the Fourteenth

Amendment as a means of “guarding against extraterritorial taxation” by defining

the limits of state taxing authority. Hillenmeyer v. Cleveland Bd. of Rev., 144 Ohio

St.3d 165, 2015-Ohio-1623, 41 N.E.3d 1164, ¶ 40. Additionally, the United States

Supreme Court has held that under the Due Process Clause, “the States * * * are

subject to limitations on their taxation powers that do not apply to the Federal

Government.” F.W. Woolworth Co. v. New Mexico Taxation and Revenue Dept.,

458 U.S. 354, 363, 102 S.Ct. 3128, 73 L.Ed.2d 819 (1982).

1

Corrigan contended that the commissioner’s determination significantly overstated the amount of

the capital gain based on intricacies of the Internal Revenue Code. Corrigan has not raised this

contention before this court.

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{¶ 16} Similarly, the dormant Commerce Clause imposes its own

restrictions upon state taxing power. “By prohibiting States from discriminating

against or imposing excessive burdens on interstate commerce without

congressional approval, [the dormant Commerce Clause] strikes at one of the chief

evils that led to the adoption of the Constitution, namely, state tariffs and other laws

that burdened interstate commerce.” Maryland Comptroller of Treasury v. Wynne,

___ U.S. ___, 135 S.Ct. 1787, 1794, 191 L.Ed.2d 813 (2015).

{¶ 17} “Due process centrally concerns the fundamental fairness of

government activity,” while the Commerce Clause reflects “structural concerns

about the effects of state regulation on the national economy.” Quill Corp. v. North

Dakota, 504 U.S. 298, 312, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992). Although the

constraints imposed by the Due Process Clause and the Commerce Clause are

distinct, they partially overlap. Commerce Clause restrictions may run parallel to

Due Process Clause restrictions or be imposed in addition to Due Process Clause

constraints. That said, under both the Due Process Clause and the Commerce

Clause, the bedrock principle is “that a State may not tax value earned outside its

borders.” Allied-Signal, Inc. v. Dir., Div. of Taxation, 504 U.S. 768, 777, 784, 112

S.Ct. 2251, 119 L.Ed.2d 533 (1992). “ ‘No principle is better settled,’ ” the high

court has stated, “ ‘than that the power of a state, even its power of taxation, in

respect to property, is limited to such as is within its jurisdiction.’ ” Miller Bros. at

342, quoting New York, Lake Erie & W. RR. Co. v. Pennsylvania, 153 U.S. 628,

646, 14 S.Ct. 952, 38 L.Ed. 846 (1894).

{¶ 18} In considering this case, we are persuaded that the assessment of a

tax on Corrigan’s capital gain cannot be sustained under the basic due-process test

for the exercise of proper tax jurisdiction. Our disposition of the appeal on those

grounds obviates the need for any separate analysis under the Commerce Clause.

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January Term, 2016

THE OPERATION OF THE TAX STATUTES AS APPLIED TO CORRIGAN

{¶ 19} As a general matter, Ohio imposes individual income tax on “every

individual * * * residing in or earning or receiving income in this state.” R.C.

5747.02(A); Cunningham v. Testa, 144 Ohio St.3d 40, 2015-Ohio-2744, 40 N.E.3d

1096, ¶ 9. Corrigan is a nonresident, nondomiciliary of Ohio; as such, he is subject

to Ohio income tax only with respect to his income earned or received in this state.

Id.

During his majority ownership, Corrigan was subject to Ohio income tax on a

portion of his distributive share of Mansfield Plumbing’s “business income”

{¶ 20} R.C. Chapter 5747 puts flesh on the bones of the concept of “earning

or receiving income in this state.” In acquiring his controlling interest in Mansfield

Plumbing in 2000, Corrigan subjected himself to Ohio income taxation because of

the pass-through nature of the entity in which he invested and by which he sought

to profit.

{¶ 21} Ohio’s income tax distinguishes between “business income” and

“nonbusiness income.” As a general matter, business income is defined as income

from “the regular course of a trade or business” and is apportioned to Ohio

according to the percentage of the business’s property, payroll, and receipts located

in Ohio. See R.C. 5747.01(B) (definition of business income) and 5747.21(B)

(providing for apportionment of business income by reference to apportionment

statutes of the former corporate franchise tax, R.C. Chapter 5733).

{¶ 22} By contrast, nonbusiness income includes compensation, rents,

royalties, and capital gains and is specifically allocated to a situs. R.C. 5747.02(C)

and 5747.20. Compensation, for example, is specifically allocated to the place

where the services were performed; rents are specially allocated to the place where

the rental property is located. R.C. 5747.20(B)(1) and (3). In the case of capital

gains from the sale of intangible personal property, the tax situs is the domicile of

the taxpayer. R.C. 5747.20(B)(2)(c).

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{¶ 23} As majority owner of Mansfield Plumbing for tax years 2000

through 2004 and as a result of that entity being organized and treated as a pass-

through entity for tax purposes, Corrigan realized his distributive share of the

income or loss that was generated by Mansfield Plumbing’s business. Because that

income or loss qualified under the business-income definition as business income

or loss to the entity itself, it was deemed to be business income as to Corrigan as

the pass-through taxpayer who included it on his return. See Agley v. Tracy, 87

Ohio St.3d 265, 268, 719 N.E.2d 951 (1999) (income derived from an S

corporation’s business activity that passed through the individual taxpayer’s tax

return was business income as to the individual taxpayer); R.C. 5747.231.

{¶ 24} The appearance of any income from Mansfield Plumbing as part of

Corrigan’s federal adjusted gross income would mean that the same income would

have been included in Corrigan’s Ohio adjusted gross income. To eliminate Ohio

tax on income generated by business conducted outside Ohio, Corrigan would have

had recourse to the nonresident credit, R.C. 5747.05(A); that credit would offset

the Ohio tax on his distributive share that related to business that Mansfield

Plumbing conducted outside Ohio.

{¶ 25} In actuality, however, Mansfield Plumbing realized losses rather

than profits during the years of Corrigan’s ownership, and those losses were

reported on a composite return filed by Mansfield Plumbing on behalf of its

members. Corrigan personally filed Form IT 1040s in Ohio for those years,

claiming a 100 percent nonresident credit.

{¶ 26} Although bereft of profits from his Mansfield Plumbing investment,

Corrigan apparently realized a different kind of financial benefit from his

ownership of the business: he apparently was able to use his Mansfield Plumbing

losses to offset other income and reduce the taxes he owed to other jurisdictions.2

2

Both the audit remarks and Corrigan’s testimony at the BTA indicate that the hours Corrigan spent

managing Mansfield Plumbing and other businesses that he owned satisfied a standard of

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January Term, 2016

But for R.C. 5747.212, Corrigan would pay no Ohio tax on his capital gain

because that gain would have its tax situs outside Ohio

{¶ 27} In 2004, Corrigan and his fellow investors sold 100 percent of their

membership interests in Mansfield Plumbing. They realized capital gain from the

transaction, and in the ordinary course, Corrigan’s capital gain would not have been

allocated to Ohio because Ohio was not Corrigan’s residence and domicile.

{¶ 28} Corrigan claimed a nonresident credit that eliminated all Ohio

liability in 2004. But in 2009, the tax department issued its assessment based on

former R.C. 5747.212. The operative part of the version of the statute in effect

during tax year 2004 read as follows:

A pass-through entity investor that owns, directly or

indirectly, at least twenty per cent of the pass-through entity at any

time during the current taxable year or either of the two preceding

taxable years shall apportion any income, including gain or loss,

realized from the sale, exchange, or other disposition of a debt or

equity interest in the entity as prescribed in this section. For such

purposes, in lieu of using the method prescribed by sections 5747.20

and 5747.21 of the Revised Code, the investor shall apportion the

income using the average of the pass-through entity’s apportionment

fractions otherwise applicable under section 5747.21 of the Revised

Code for the current and two preceding taxable years. If the pass-

through entity was not in business for one or more of those years,

each year that the entity was not in business shall be excluded in

determining the average.

participation under the Internal Revenue Code. Consequently, the Mansfield losses qualified as

nonpassive, thereby permitting Corrigan to use those losses more broadly as an offset against his

income.

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Am.Sub.S.B. No. 261, 149 Ohio Laws, Part I, 1793, 1870.3

{¶ 29} Corrigan’s situation came within R.C. 5747.212 because he owned

over 79 percent of Mansfield Plumbing, thereby clearing the 20 percent threshold,

and because he realized a gain from selling his equity interest in Mansfield

Plumbing during 2004.

DUE PROCESS PREDICATES TAXATION OF A NONRESIDENT’S INCOME ON

OHIO’S CONNECTION TO BOTH THE TAXPAYER AND THE TRANSACTION

{¶ 30} Due process “ ‘requires some definite link, some minimum

connection, between a state and the person, property or transaction it seeks to tax.’

” Quill, 504 U.S. at 306, 112 S.Ct. 1904, 119 L.Ed.2d 91, quoting Miller Bros.,

347 U.S. at 344-345, 74 S.Ct. 535, 98 L.Ed.2d 744.

{¶ 31} A state’s taxing jurisdiction may be exercised over all of a resident’s

income based upon the state’s in personam jurisdiction over that person.

Hillenmeyer, 144 Ohio St.3d 165, 2015-Ohio-1623, 41 N.E.3d 1164, at ¶ 41, citing

Shaffer, 252 U.S. at 52, 40 S.Ct. 221, 64 L.Ed. 445. By contrast, the power to tax

nonresidents reflects the state’s in rem jurisdiction over the income-producing

activities conducted within the state:

“[J]ust as a State may impose general income taxes upon its own

citizens and residents whose persons are subject to its control it may,

as a necessary consequence, levy a duty of like character, and not

more onerous in its effect, upon incomes accruing to non-residents

3

This was the original version of the statute, which was enacted in 2002. The version quoted by

the tax commissioner in his final determination reflected amendments to the statute made in 2005

that were not in effect at the time Corrigan incurred his tax liabilities for tax year 2004. See

Am.Sub.H.B. No. 66, 151 Ohio Laws, Part III, 4674.

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January Term, 2016

from their property or business within the State, or their occupations

carried on therein.”

(Emphasis deleted.) Hillenmeyer at ¶ 42, quoting Shaffer at 52.

{¶ 32} Inherent in the Supreme Court’s pronouncement in Shaffer is the

need for a link between the state and the person being taxed as well as between the

state and the activity being taxed. The former is expressed in terms of the

minimum-contacts test that is familiar in the context of determining the personal

jurisdiction that may be exercised by a court sitting in one state and issuing process

to a person in another state. See Quill at 307, citing Internatl. Shoe Co. v.

Washington, 326 U.S. 310, 66 S.Ct. 154, 90 L.Ed. 95 (1945), and Shaffer v. Heitner,

433 U.S. 186, 97 S.Ct. 2569, 53 L.Ed.2d 683 (1977). Applying principles from this

area of the law, due process requires that a person whom a state proposes to tax

have “purposefully availed” himself of benefits within the taxing state. Id.

{¶ 33} In addition to the state’s connection with the person to be taxed, “in

the case of a tax on an activity, there must be a connection to the activity itself,

rather than a connection only to the actor the State seeks to tax.” Allied-Signal, 504

U.S. at 778, 112 S.Ct. 2251, 119 L.Ed.2d 533. In Allied-Signal, New Jersey

attempted to tax one corporation’s gain from selling its shares in another

corporation, and the court clarified that the mere fact that the taxpayer performed

some of its business within the taxing state did not by itself permit the taxation of

that taxpayer’s gain from the sale of shares of another corporation. Instead, the

high court enforced its earlier pronouncement that “[a] State may not tax a

nondomiciliary corporation’s income * * * if it is ‘derived from “unrelated business

activity” which constitutes a “discrete business enterprise.” ’ ” Id. at 773, quoting

Exxon Corp. v. Wisconsin Dept. of Revenue, 447 U.S. 207, 224, 100 S.Ct. 2109, 65

L.Ed.2d 66 (1980), quoting Mobil Oil Corp. v. Vermont Commr. of Taxes, 445 U.S.

425, 442, 439, 100 S.Ct. 1223, 63 L.Ed.2d 510 (1980).

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Ohio-derived income may be taxed to the person

whose business activity generated the income

{¶ 34} Shaffer demonstrates that the direct conduct of business subjects the

nonresident person conducting the business to a tax on the proportionate share of

business conducted within the taxing state. Under Shaffer, this scenario relies on

the state’s in rem jurisdiction over the income generated by in-state activity. But

the situation also entails the taxpayer’s purposeful availment of the protections and

benefits of the state’s laws by conducting a portion of the business within that state.

Quill, 504 U.S. at 307, 112 S.Ct. 1904, 119 L.Ed.2d 91, citing Shaffer, 433 U.S. at

212, 97 S.Ct. 2569, 53 L.Ed.2d 683.

Distributive share may be taxed because the income taxed is generated by Ohio

business activity and the pass-through establishes “purposeful availment”

{¶ 35} Do due-process protections permit Ohio to impose its individual

income tax on the distributive-share income of a nonresident who realizes pass-

through income? We answered affirmatively in Agley, 87 Ohio St.3d 265, 719

N.E.2d 951:

Appellants have admitted that their S corporations

conducted business in Ohio. Thus, it is evident that the S

corporations have utilized the protections and benefits of Ohio by

carrying on business here. This income was then passed through to

the appellants as personal income. Thus, the appellants, through

their S corporations, have also availed themselves of Ohio’s

benefits, protections, and opportunities by earning income in Ohio

through their respective S corporations. We find that this provides

Ohio the “minimum contacts” with the appellants to justify taxing

appellants on their distributive share of income.

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Id. at 267. Simply stated, even though the taxpayers in Agley were nonresidents

who did not themselves conduct business in Ohio, we determined that their decision

to invest using corporate structures in Ohio and making federal pass-through

elections satisfied the purposeful-availment criterion for imposing the tax

obligation on them personally.

Capital gain is generated by the sale of intangible property

rather than by Ohio business activity,

and thus selling the shares does not involve purposeful availment

{¶ 36} The tax at issue here differs, however, with respect to Ohio’s

connection both to the activity and to the taxpayer. In this case, the activity at issue

is a transfer of intangible property by a nonresident. Thus, Ohio’s connection is an

indirect one, whereas in Agley the activity being taxed was the very income derived

from business activity in Ohio. Moreover, although Corrigan’s availment of Ohio’s

protections and benefits is clear with respect to the pass-through of Mansfield

Plumbing’s income to him, Corrigan’s sale of his interest in Mansfield Plumbing

did not avail him of Ohio’s protections and benefits in any direct way.

{¶ 37} For these reasons, we conclude that Agley does not extend to

Corrigan’s capital gain.

THE UNITED STATES SUPREME COURT’S PRECEDENTS DO NOT ESTABLISH

THE CONSTITUTIONALITY OF APPLYING R.C. 5747.212 TO CORRIGAN

{¶ 38} Corrigan and the tax commissioner rely on competing United States

Supreme Court cases.

{¶ 39} Corrigan emphasizes more recent cases in which the U.S. Supreme

Court has established that a state may not tax the dividends received by a

nonresident corporation from another corporation, or the capital gain realized from

selling shares in another corporation, absent a unitary business relationship between

the taxpayer and the other corporation. See MeadWestvaco Corp. v. Illinois Dept.

of Revenue, 553 U.S. 16, 128 S.Ct. 1498, 170 L.Ed.2d 404 (2008); Allied-Signal,

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504 U.S. 768, 112 S.Ct. 2251, 119 L.Ed.2d 533; ASARCO, Inc. v. Idaho State Tax

Comm., 458 U.S. 307, 102 S.Ct. 3103, 73 L.Ed.2d 787 (1982); F.W. Woolworth,

458 U.S. at 363, 102 S.Ct. 3128, 73 L.Ed.2d 819. By extension, Corrigan contends

that Ohio may not tax his capital gain unless Corrigan himself has engaged in a

business that is unitary with that of Mansfield Plumbing. As supplemental

authority, Corrigan points out that we have already applied ASARCO in a corporate

franchise tax case to bar the apportionment of investment income as business

income of the taxpayer. See Am. Home Prods. Corp. v. Limbach, 49 Ohio St.3d

158, 160-161, 551 N.E.2d 201 (1990), citing ASARCO.

{¶ 40} The tax commissioner relies on a pair of older Supreme Court

decisions addressing and upholding the imposition of Wisconsin’s “privilege

dividend tax.” See Internatl. Harvester, 322 U.S. 435, 64 S.Ct. 1060, 88 L.Ed.

1373; Wisconsin v. J.C. Penney Co., 311 U.S. 435, 61 S.Ct. 246, 85 L.Ed. 267

(1940). Instead of being imposed directly on corporate income, the privilege

dividend tax was imposed on the privilege of declaring and receiving dividends; in

practical operation, the tax required corporations to withhold from the payment of

a dividend the amount of the tax and remit the tax to the state. See J.C. Penney at

440, fn. 1 (quoting the underlying statute).

{¶ 41} In both older cases, the Supreme Court upheld the measure.

{¶ 42} In J.C. Penney, the high court hypothesized that a “supplementary

tax on the Wisconsin earnings of [foreign] corporations” that simply “postponed

liability for the tax until such earnings were to be paid out in dividends” was

consistent with due process and that the characterization of the tax as being levied

on the privilege of declaring and receiving dividends should not change the result.

Id. at 442-444. The court therefore reversed the Wisconsin Supreme Court’s

holding that the privilege dividend tax was unconstitutional.

{¶ 43} In Internatl. Harvester, the high court considered the privilege

dividend tax anew in light of the Wisconsin Supreme Court’s clarifications that for

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January Term, 2016

state constitutional purposes, the tax was a privilege rather than an income tax and

that the corporation was not entitled to deduct the privilege dividend tax because

the burden of the tax fell upon stockholders. Internatl. Harvester at 438-439. The

United States Supreme Court affirmed, adhering to its holding in J.C. Penney.

{¶ 44} In arguing that J.C. Penney and Internatl. Harvester control here, the

tax commissioner points to the fact that the present case involves using the

business-income factors of Mansfield Plumbing, whereas the MeadWestvaco and

Allied-Signal line of cases involved state taxes that attempted to use the taxpayer’s

business-income factors to apportion the dividend or capital-gain income. This

distinction is one that can be characterized as the difference between the “investor

apportionment” analysis, in which the courts look at the nexus between the

taxpayer/investor (like Corrigan) and the jurisdiction, see, e.g., MeadWestvaco and

Allied-Signal, and the “investee apportionment” analysis, in which the courts look

at the nexus between the investee (like Mansfield Plumbing) and the taxing

jurisdiction, see, e.g., J.C. Penney and Internatl. Harvester.

{¶ 45} Seizing on this distinction, the tax commissioner asserts that the

unitary-business doctrine, which defined the limits of constitutionality in the

MeadWestvaco and Allied-Signal cases, is irrelevant here. The tax commissioner

contends that the taxpayer’s liability is determined by the business done by the

entity in which the taxpayer has invested and that the investment income realized—

whether that income is a dividend, a capital gain from the sale of the investment, or

the payment of a debt—may be taxed to the nonresident investor. In this manner,

the tax commissioner attempts to justify apportioning both the capital gain and the

debt interest pursuant to R.C. 5747.212.

{¶ 46} We disagree.

{¶ 47} First and foremost, J.C. Penney and Internatl. Harvester address a

tax law that, unlike R.C. 5747.212, never imposes tax liability on the investor. To

be sure, in upholding the tax, the high court accepted the proposition that the

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economic burden of Wisconsin’s privilege dividend tax fell upon nonresident

investors, even though it was actually paid by the corporation that declared and paid

the dividend. But the propriety of imposing the economic burden of a tax on a

nonresident does not necessarily require the conclusion that the tax liability itself

can be imposed on those nonresident investors. The Wisconsin statute at issue did

not do so, and the decisions upholding that statute should not be construed to

authorize other statutes that were not under review by the high court at that time.

{¶ 48} Second, even if J.C. Penney and Internatl. Harvester were construed

to extend to the imposition of a state income tax on the nonresident recipient of a

dividend, that would still not require the conclusion that the same reasoning extends

to a capital gain from the sale of corporate ownership. It is self-evident that the

dividend has a more direct relationship to corporate earnings, out of which the

dividend is paid, than does the capital gain from the sale of corporate ownership.

Indeed, it is possible in a given situation that the purchaser of a business may be

more interested in acquiring specific business assets than in the profits generated

by the ongoing business. That could, in fact, be true here inasmuch as Mansfield

Plumbing realized losses in the years immediately preceding the sale.

{¶ 49} Third, our reluctance to accept the tax commissioner’s expansive

interpretation of J.C. Penney and Internatl. Harvester is consistent with

MeadWestvaco.

{¶ 50} In MeadWestvaco, the taxpayer had sold its Lexis-Nexis division,

booking an intangible “goodwill” gain of about $1 billion, which the taxpayer

treated as nonbusiness income allocable to its domicile outside Illinois. See 371

Ill.App.3d 108, 113, 861 N.E.2d 1131 (2007), reversed, 553 U.S. 16, 128 S.Ct.

1498, 170 L.Ed.2d 404. The state revenue department recharacterized the income

as apportionable business income of the taxpayer, and the Illinois courts affirmed.

But the United States Supreme Court reversed on the basis of the Allied-Signal line

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of cases and the unitary-business doctrine. 553 U.S. at 29-30, 128 S.Ct. 1498, 170

L.Ed.2d 404.

{¶ 51} Of special relevance here is the question that the high court declined

to address. As a fallback position, the state in MeadWestvaco had argued that

Lexis-Nexis’s own business in Illinois justified the imposition of the additional tax

on its former parent’s gain. The Supreme Court characterized this argument as “a

new ground for the constitutional apportionment of intangibles based on the taxing

State’s contacts with the capital asset rather than the taxpayer.” Id. at 30. (Using

the terminology we have employed in this opinion, Illinois was arguing for investee

apportionment as an alternative to investor apportionment.) The court then

declined to address the “new ground” for apportionment for two reasons. First, it

noted that the argument had not previously been raised and passed upon. Second,

it recognized that the states that relied on investee apportionment, including Ohio,

had not been notified that the constitutionality of their statutes would be

determined. Id. at 31.4 In other words, the United States Supreme Court regards

the imposition of an investee-apportioned tax on the gain realized by an investor as

an unsettled question. Because the high court has not answered that question, we

cannot properly regard it as settled by J.C. Penney and Internatl. Harvester.

STATE COURT CASES DO NOT SUPPORT APPLYING R.C. 5747.212

TO CORRIGAN’S CAPITAL GAIN

{¶ 52} The tax commissioner also relies on state court decisions as support

for applying R.C. 5747.212 to Corrigan’s capital gain. Most notably, in his brief

and at oral argument, the commissioner relied heavily on the Louisiana Supreme

4

The Supreme Court recognized that the Ohio corporation franchise tax contained investee-

apportionment provisions at R.C. 5733.051(E) and (F). MeadWestvaco at 31. Division (E) calls for

investee apportionment of a corporate taxpayer’s capital gains, and division (F) calls for investee

apportionment of a corporate taxpayer’s dividend income. With the phase-out of the franchise tax

for most businesses pursuant to the 2005 tax-reform legislation, these provisions have a greatly

diminished significance. See Navistar, Inc. v. Testa, 143 Ohio St.3d 460, 2015-Ohio-3283, 39

N.E.3d 509, ¶ 1 (discussing 2005 tax-reform legislation).

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SUPREME COURT OF OHIO

Court’s decision in Johnson v. Collector of Revenue, 246 La. 540, 165 So.2d 466

(1964).

{¶ 53} In Johnson, a corporation held as its sole asset certain lands in

Louisiana on which oil and gas production activities were conducted. Those

activities had led to an appreciation in the value of the land, and accordingly, when

the corporation liquidated itself by exchanging shares for interests in the direct

ownership of the land, the state assessed a tax on the pro rata capital gain of the

shareholders. As in the present case, the intangible stock-share interests were held

and sold outside the taxing state, and the shareholders were nonresidents.

{¶ 54} The statute decisive to the decision upholding Louisiana’s taxation

of the capital gain read as follows:

“In cases where property located in Louisiana is received by

a shareholder in the liquidation of a corporation, the stock cancelled

or redeemed in the liquidation shall, for purposes of determining

taxable gain under this chapter, be deemed to have its taxable situs

in this state to the extent that the property of the corporation

distributed in liquidation is located in Louisiana. If only a portion

of the property distributed in liquidation is located in Louisiana,

only a corresponding portion of the gain realized by a shareholder

shall be considered to be derived from Louisiana sources.”

Id. at 567, quoting La.Rev.Stat. 47:159(H).

{¶ 55} The lower court had determined that the corporation had conducted

no Louisiana business and that the assignment of Louisiana situs was “wholly

fictitious and arbitrary, rendering the statute unconstitutional.” Id. at 570. But the

Louisiana Supreme Court reversed, observing that had the corporation itself sold

the lands to a third party, the corporation would have paid Louisiana tax on that

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January Term, 2016

gain from the disposition of in-state property. Id. at 572. The court explained that

the statute quoted above was intended to prevent the use of a corporate liquidation

and conveyance of Louisiana assets to avoid the imposition of tax on the gain

associated with such property. “Clearly, such a gain from oil-producing lands in

Louisiana reflects the protection and opportunities that the state has afforded,” the

court observed. Id. at 573.

{¶ 56} Counsel for the state characterizes the Louisiana statute as

“identical” to R.C. 5747.212 and its application in this case. We are persuaded,

however, not only that there are differences between the two schemes but also that

those differences are of decisive import here.

{¶ 57} Far from broadly subjecting a nonresident’s capital gain to in-state

apportionment as R.C. 5747.212 does, the Louisiana statute applies only when

nonresidents receive property with a Louisiana situs in conjunction with

redemption of their corporate shares. Moreover, the Louisiana statute allocates the

nonresident’s gain to Louisiana only to the extent of the gain on those Louisiana

assets.

{¶ 58} Quite simply, rather than broadly extending state taxing power to a

nonresident’s capital gain, the Louisiana statute does nothing more than prevent

avoidance of the Louisiana tax on a capital gain from the sale of a Louisiana asset

through a manipulation of corporate forms. We conclude that the Louisiana

statute’s limited purpose and effect bears no resemblance to the broad scope and

expansive purpose of R.C. 5747.212 and is of limited value in addressing the

constitutional question before us.

{¶ 59} One state court decision that genuinely adopts investee

apportionment comes from the New York Court of Appeals. In Allied-Signal, Inc.

v. Commr. of Fin., 79 N.Y.2d 73, 580 N.Y.S.2d 696, 588 N.E.2d 731 (1991), New

York’s highest court upheld New York City’s imposition of a tax on a nonresident

parent corporation’s capital gain from the sale of its interest in a subsidiary, where

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SUPREME COURT OF OHIO

the gain was apportioned to the city based on the subsidiary’s business-income

apportionment rather than the parent’s. Based on its reading of the United States

Supreme Court’s decision in Internatl. Harvester, the New York Court of Appeals

determined that New York City could assert a nexus with the investor’s capital gain.

Allied-Signal at 82-84.

{¶ 60} As already discussed, however, we decline to read Internatl.

Harvester as authorizing the imposition of a tax on the nonresident dividend

recipient, given that the statute at issue in that case imposed tax only on the

corporation that paid the dividends. In this regard, we find one of the dissenting

opinions in Allied-Signal persuasive. Namely, in his dissent, Judge Hancock

faulted the majority for a leap of logic, asserting that the mere fact that the burden

of the tax in J.C. Penney and Internatl. Harvester fell on the out-of-state

shareholders did not mean that the state had a nexus to tax those shareholders

directly. Allied-Signal at 102 (Hancock, J., dissenting).

{¶ 61} And contrary to the tax commissioner’s argument, we find that our

own decision in Couchot v. State Lottery Comm., 74 Ohio St.3d 417, 659 N.E.2d

1225 (1996), is inapposite here. In that case, we examined the imposition of Ohio’s

income tax on the incremental payments to a nonresident winner of the Ohio lottery

in light of constitutional challenges based on due-process, Commerce Clause, and

retroactivity grounds. With respect to the basic due-process claim, we observed

that “[i]t is difficult to imagine a more fundamental exertion of a state’s taxing

power than where the state taxes income on winnings from its lottery.” Id. at 422.

Indeed, the winning of the lottery game and the payments that ensued clearly

constituted the enjoyment of Ohio-created benefits and protections that justified the

imposition of the tax. That taxpayer’s scenario, however, is quite different from

Corrigan’s—in law and in fact.

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January Term, 2016

ENFORCING DUE-PROCESS RESTRAINTS ON STATE TAXATION

DOES NOT ELEVATE FORM OVER SUBSTANCE

{¶ 62} The tax commissioner argues that Ohio can tax a share of Corrigan’s

capital gain because the sale of the ownership interest is merely one form in which

the business could be sold and the same gain would be taxable if the business had

been sold through an asset sale instead. In his words, the tax commissioner

contends that because taxation would be proper under “that economically

equivalent situation,” it must be proper in the context with which we are presented.

{¶ 63} This argument relies on R.C. 5747.01(B), which includes in the

definition of business income the “gain or loss, from a partial or complete

liquidation of a business, including, but not limited to, gain or loss from the sale or

other disposition of goodwill.” Thus, if Mansfield Plumbing had made a bulk

transfer of its business assets rather than having the business transferred through a

sale of the L.L.C. ownership itself, then the gain from the sale would have been

realized at the L.L.C. level, and the Ohio-apportioned share would have been taxed

to Corrigan on a pass-through basis. The commissioner argues that because the

gain could be taxed to Corrigan in an asset sale, it may also be taxed in the form of

Corrigan’s individual capital gain.

{¶ 64} Although this argument may appear plausible, the jurisdictional

question before us presents more than merely a matter of form.

{¶ 65} We recognize that an asset sale and a sale of ownership interest may

be different forms involving the same economic substance to the parties, but that

does not mean that the jurisdictional limits on Ohio’s taxing powers lack their own

substantive importance. Nor is it unusual that two different methods of achieving

the same economic result could have drastically different tax implications.

{¶ 66} Moreover, the commissioner’s “form over substance” argument can

cut both ways. The commissioner argues that taxing Corrigan’s personal capital

gain is justified because Ohio law would apportion the gain from an asset sale as

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SUPREME COURT OF OHIO

business income. But one could, with equal logical force, assert that because the

sale of assets in liquidation of the business is in substance the same as the sale of

the corporate ownership, Ohio cannot constitutionally treat the gain from the asset

sale as apportionable “business income.”

{¶ 67} We decline to accept the form-over-substance argument as militating

against our conclusion, which is based on other grounds, i.e., that Corrigan’s capital

gain may not be taxed.

R.C. 5747.212 IS NOT FACIALLY UNCONSTITUTIONAL

{¶ 68} Corrigan has advanced both an as-applied and a facial challenge to

R.C. 5747.212. Our holding of unconstitutionality today is limited to R.C.

5747.212 as applied to Corrigan, in light of the absence of any assertion or finding

that Corrigan’s own activities amounted to a unitary business with that of Mansfield

Plumbing.

{¶ 69} Conceivably, an individual taxpayer might engage in the conduct of

a business with or through a corporate entity, and under the MeadWestvaco and

Allied-Signal line of cases, the imposition of tax under R.C. 5747.212 could be

sustained. We therefore decline to hold that R.C. 5747.212 is facially

unconstitutional because Corrigan has not demonstrated, as he must, that “there

exists no set of circumstances under which the statute would be valid.” Harrold v.

Collier, 107 Ohio St.3d 44, 2005-Ohio-5334, 836 N.E.2d 1165, ¶ 37. Because there

is at least a possibility that the statute could be applied when the unitary-business

situation is present,5 we reject the facial challenge.

5

Perhaps recognizing this possibility, Corrigan has made a distinct effort to establish that he has not

engaged in active management here, distinguishing his efforts as merely the “stewardship” of a

corporate director. For his part, the tax commissioner has consistently argued that the unitary-business

doctrine is irrelevant rather than contend that the unitary-business relationship might be present.

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January Term, 2016

{¶ 70} In light of our disposition of this appeal on due-process grounds, we

need not and do not address Corrigan’s claim that R.C. 5747.212 violates the

Commerce Clause.

CONCLUSION

{¶ 71} For the foregoing reasons, we reverse the decision of the BTA, and

we remand to the tax commissioner with instructions to grant a refund to Corrigan.

Decision reversed

and cause remanded.

PFEIFER, O’DONNELL, LANZINGER, KENNEDY, FRENCH, and O’NEILL, JJ.,

concur.

_________________

Taft, Stettinius & Hollister, L.L.P., and J. Donald Mottley, for appellant.

Michael DeWine, Attorney General, and Barton A. Hubbard, David D.

Ebersole, and Raina M. Nahra, Assistant Attorneys General, for appellee.

Baker & Hostetler, L.L.P., Edward J. Bernert, Elizabeth A. McNellie, and

Christopher J. Swift, urging reversal for amicus curiae, Ohio Chamber of

Commerce.

_________________

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