Indiana Law Review


Indiana Laiiv Revieiv

Volume 16 1983 Number 4

Constitutional Considerations of State Taxation of
Multinational Corporate Income: Before and After

Container Corporation ofAmerica v. Franchise Tax Board

William W. Stuart*
Michael K. Williams**

I. Introduction

Domestic law has been applied to the multinational corporation

through operation of the federal securities laws, the federal antitrust

laws, and the federal tax laws.^ Over the last two decades much critical
commentary has been directed to identifying the extent to which the
national tax laws apply to multinational corporations.^ More recently
consideration has been given to whether state governments can in-
clude foreign-source income in determining taxable corporate income.^

The crux of the question is whether the states should be limited in
taxing such income, which primarily consists of dividends, interest,

and capital gains derived from foreign subsidiaries and affiliates/

Professor of Law, De Paul University. A.B., Stanford University, 1965; LL.B.,
Washington and Lee University, 1969.

**B.A., Villanova University, 1977; J.D., Villanova University, 1980; LL.M., De
Paul University, 1983.

^See generally, C. Bergsten. T. Horst & T. Moran, American Multinationals and

American Interests (1978); R. Tindall, Multinational Enterprises: Legal and
Management Structures and Interrelationship With Ownership, Control, Antitrust,
Labor, Taxation and Disclosure (1975).

'See generally, L. Krause & K. Dam, Federal Tax Treatment of Foreign Income
(1964).

^See General Accounting Office, Report to the Chairman, House Committee on
Ways and Means: Key Issues Affecting State Taxation of Multijurisdictional Cor-
porate Income Need Resolving (1982) (GA1.13 GGD-82-38) [hereinafter cited as G.A.O.
Report-1982]. The General Accounting Office, in a long-anticipated report, concluded that
congressional action is required to resolve controversies and complexities in the State

taxation of multijurisdictional corporations. For purposes of this article, a multijurisdic-

tional corporation may be defined as a corporation or a group of related corporations
operating in several states or of diverse nationality joined together by common owner-
ship and management. The taxation of international investments has become impor-
tant in recent years because of the growth in the international economy.

Tor purposes of this article, a foreign subsidiary or affiliate is a non-United
States corporation in which a corporation based in the United States has a substantial

783



784 INDIANA LAW REVIEW [Vol. 16:783

In ASARCO Inc. v. Idaho State Tax Commission^ and F. W.
Woolworth Co. v. Taxation & Revenue De'partmenU^ the United States
Supreme Court severely restricted the ability of the states to tax
a domestic parent corporation on foreign-source income on the grounds

that due process considerations prevented state taxation of subsidiaries

which did not have a unitary business relationship with the parent

corporation. Although consistent with the reasoning of ASARCO and
Woolworth, the Supreme Court recently endorsed the state taxation
of the worldwide combined income generated by a domestic parent

corporation and its foreign subsidiaries which were found to constitute

a unitary business in Container Corp. of America v. Franchise Tax
BoardJ

The purpose of this article is to examine the due process con-
siderations with regard to the state taxation of corporate foreign-

source income as developed by the Supreme Court, and to analyze
the Court's commitment to the unitary business concept. First, the
constitutional and statutory principles underlying current methods of

state taxation of multijurisdictional corporations need to be identified.

Secondly, the historical development of the unitary business princi-

ple will be discussed along with an overview of recent legislative ac-

tivity and judicial decisions in this area. Finally, an examination will

be made of recent United States Supreme Court decisions recogniz-
ing constitutional considerations regarding the state taxation of the

income of multinational corporations based in the United States.

Attention will be directed at Mobil Oil Corp. v. Commissioner of
Taxes,^ in which the Supreme Court held that it is permissible for
a state to include foreign-source dividends in taxable income, assum-

ing there is a unitary relationship between the payor foreign corpora-

tion and the recipient domestic corporation. The analysis developed
in the Mohil decision provides the foundation for the Court's subse-

quent decisions placing limits on state taxation of foreign-source in-

come. An examination of the factual situations and constitutional prin-
ciples contained in ASARCO and Woolworth reveals that there con-
tinues to be a number of unresolved issues related to the power of
the states to tax foreign-source income. Container seems to be the

ownership interest. Unlike a multistate corporation which conducts business within

a domestic context, a multinational corporation has the capacity to create markets

for its products and services on a global scale in an international context. For a report

on the growth of multinational corporations, see General Accounting Office. Report
TO THE Chairman. House Committee on Ways and Means: IRS Could Better Protect
U.S. Tax Interests in Determining the Income of Multinational Corporations 4 (1981)
(GA1.13 GGD-81-81) [hereinafter cited as G.A.O. ReportIRS].

^02 S. Ct. 3103 (1982).
«102 S. Ct. 3128 (1982).

^103 S. Ct. 2933 (1983).

«445 U.S. 425 (1980).



1983] TAXING MULTINATIONAL CORPORATIONS 785

Court's valedictory opinion on these due process matters for the deci-

sion serves to defer the further resolution of these issues to the judg-

ment of the state courts.

II. The Sources of the Constitutional Limitations

The states have the general power to tax the income of
corporations.^ The United States Constitution, however, imposes
several restrictions on the states' taxing power. ^° Among these," the
most significant restrictions are imposed by the commerce clause^^
and the due process clause.^^

A. Commerce Clause Limitations

The commerce clause restrains a state from promoting taxation
which discriminates against interstate commerce^* by providing a

direct commercial advantage to local business,^^ or which places an

undue burden of multiple taxation^^ on interstate commerce.^^ Under
the four-pronged standard announced by the Supreme Court in Com-
plete Auto Transit, Inc. v. Brady,^^ a tax will pass review under the

^As of December 31, 1981, 44 states and the District of Columbia had some type
of corporate income tax. See 1 [All States Unit] St. & Loc. Tax Serv. (P-H) t 101; see
also Moorman Mfg. Co. v. Bair, 437 U.S. 267, 278-80 (1978); Corrigan & Dexter, States'
Latitude in Taxing Multistate Businesses, 11 Urb. Law. 505 (1979).

^°See P. Hartman, Federal Limitations on State and Local Taxation 6 (1981).
"The equal protection clause of the fourteenth amendment is such a restriction

which provides, in pertinent part, that no state shall "deny to any person within its

jurisdiction the equal protection of the Laws." U.S. Const, amend. XIV, § l.See Western

& S. Life Ins. Co. v. State Bd. of Equalization, 451 U.S. 648 (1981) (upholding the con-
stitutionality of retaliatory state tax imposed upon foreign insurance companies); Note,

Taxing Out-of-State Corporations After Western & Southern: An Equal Protection
Analysis, 34 Stan. L. Rev. 877 (1982).

^^U.S. Const, art. I, § 8: "The Congress shall have Power ... To regulate Commerce
with foreign Nations, and among the several States, and with the Indian Tribes."

^^U.S. Const, amend. XIV, § 1: "[N]or shall any State deprive any person of life,

liberty, or property, without due process of law."

"State taxes that "discriminate against interstate commerce" are strictly scru-
tinized under the commerce clause. Complete Auto Transit, Inc. v. Brady, 430 U.S. 274,
279, 288-89 n.l5 (1977); see also Memphis Steam Laundry Cleaner, Inc. v. Stone, 342
U.S. 389, 394-95 (1952); Nippert v. City of Richmond, 327 U.S. 416 (1946).

^^See Maryland v. Louisiana, 451 U.S. 725 (1981); Boston Stock Exch. v. State Tax
Comm'n, 429 U.S. 318 (1977).

^^Multiple taxation is the taxation of the same income by more than one taxing
jurisdiction. See Mobil Oil Corp. v. Comm'r of Taxes, 445 U.S. 425, 442-46 (1980).

'Tor general discussions with regard to commerce clause restrictions on the power
of states to tax, see Hellerstein, State Taxation Under the Commerce Clause: An Historical
Perspective, 29 Vand. L. Rev. 335 (1976); Hellerstein, State Taxation and the Supreme
Court: Toward a More Unified Approach to Constitutional Adjudication?, 75 Mich. L.
Rev. 1426 (1977); Tushnet, Rethinking the Dormant Commerce Clause, 1979 Wis. L. Rev. 125.

>«430 U.S. 274 (1977).



786 INDIANA LAW REVIEW [Vol. 16:783

commerce clause so long as the tax "[1] is applied to an [interstate]
activity with a substantial nexus with the taxing State, [2] is fairly

apportioned, [3] does not discriminate against interstate commerce,
and [4] is fairly related to services provided by the State."^^ When
the instrumentalities of foreign commerce are involved, however, the
state tax may be unconstitutional under the commerce clause if it
violates either of two standards articulated in Japan Line, Ltd. v.
County of Los Angeles,^^ namely, if the tax (1) creates a substantial
risk of multiple taxation at the international level, or (2) interferes

with the federal regulation of foreign commercial relations.^21

B. Due Process Clause Limitations

It is a well established principle of constitutional law that the due

process clause precludes a state from taxing value earned outside of

its borders.^^ When imposing a tax which is geared to income, the

^^d. at 279. See also Commonwealth Edison Co. v. Montana, 453 U.S. 609 (1981)
(focusing on the "fair relation" prong of the Complete Auto Transit test which is satisfied

if the measure of the tax is reasonably related to the extent of the taxpayer's contact

with the taxing state).

^''441 U.S. 434 (1979).

''Id. at 450-51. But see Mobil Oil Corp. v. Comm'r of Taxes, 445 U.S. 425, 446 (1980).
In Japan Line, the Court considered whether a property tax was unconstitutional

if the tax was assessed against shipping containers owned and registered in another
nation and used exclusively in foreign commerce. The Court explained why some multi-
ple taxation may be acceptable with respect to the state taxation of interstate com-
merce, but not acceptable with respect to the state taxation of foreign commerce.

Due to the absence of an authoritative tribunal capable of ensuring that the
aggregation of taxes is computed on no more than one full value, a state
tax, even though "fairly apportioned" to reflect an instrumentality's presence

within the State, may subject foreign commerce " 'to the risk of a double tax
burden to which [domestic] commerce is not exposed, and which the com-

merce clause forbids.'
"

441 U.S. at 447-48 (quoting Evco v. Jones, 409 U.S. 91, 94 (1972) (quoting J.D. Adams
Mfg. Co. V. Storen, 304 U.S. 307, 311 (1938))). The Court analyzed the potentially harm-
ful effect that such a state tax may have on foreign commerce:

A state tax on instrumentalities of foreign commerce may frustrate the
achievement of federal uniformity in several ways. If the State imposes an

apportioned tax, international disputes over reconciling apportionment for-

mulae may arise. If a novel state tax creates an asymmetry in the interna-
tional tax structure, foreign nations disadvantaged by the levy may retaliate
against American-owned instrumentalities present in their jurisdictions. Such

retaliation of necessity would be directed at American transportation equip-

ment in general, not just that of the taxing State, so that the Nation as
a whole would suffer. If other States followed the taxing State's example,

various instrumentalities of commerce could be subjected to varying degrees
of multiple taxation, a result that would plainly prevent this Nation from

"speaking with one voice" in regulating foreign commerce.

441 U.S. at 450-51.

''See ASARCO, Inc. v. Idaho State Tax Comm'n, 102 S. Ct. 3103, 3109 (1982).



1983] TAXING MULTINATIONAL CORPORATIONS 787

taxing power asserted by a state must bear a fair and substantial
financial relationship to the protections, opportunities, and benefits

conferred by that state. In these instances the controlling question

is whether the taxing state has given anything to the corporation for
which it can ask a return.^^ In Moorman Manufacturing Co. v. Bair,^^
the Court refined this question by combining prior decisions into the

following test:^^ (1) a minimal connection must exist between the cor-

poration's activities and the taxing state,^^ and (2) there must be a
rational relationship between the income attributed to the state for

taxing purposes and the values connected with the state.^27

III. Principles and Methods of State Taxation of
Income of Multinational Corporations

In complying with the constitutional limitations, the states have

developed certain methods and adopted certain principles with regard

to the taxation of corporate net income. These principles and methods

are related to the composition of taxable income, a state's jurisdic-

tion to tax, and the division of such net income among the taxing
jurisdictions. Because most of these concepts may be applicable to
multinational corporations as well as to multistate corporations, it is

appropriate to briefly review them.

A, Composition of the Tax Base: Determining Taxable Income

The majority of the states make reference to the federal taxable
income of a multinational corporation for the initial determination of

the composition of the income taxable by the state.^^ Those states,
however, make certain adjustments to federal taxable income in order
to later determine what portion of a multinational corporation's in-
come they can tax. With respect to such adjustments, an important
issue is whether and to what extent intercorporate dividends are to

^^Wisconsin v. J.C. Penney Co., 311 U.S. 435, 444 (1940).
^"437 U.S. 267 (1978).

''Id. at 272-73.

^^The Court has stated that this is the "time-honored concept: that due process

requires some definite link, some minimum connection, between a state and the per-
son, property, or transaction it seeks to tax." Miller Bros. Co. v. Maryland, 347 U.S.

340, 344-45 (1954). The nexus is established if a corporation avails itself of the "substan-

tial privilege of carrying on business" within the taxing state. Wisconsin v. J.C. Pen-

ney, 311 U.S. 435, 444-45 (1940).

"Butler Bros. v. McColgan, 315 U.S. 501, 506 (1942).

^Tor a discussion of this method and a listing of the states using it, see G.A.O.

Report 1982, supra note 3, at 13, 60-61. The remaining states which tax corporate net
income generally start with the gross income of the multijurisdictional corporation

and deduct certain items. L. Hale & R. Kramer, State Tax Liability and Compliance
Manual 28-29 (1981) [hereinafter cited as Hale & Kramer].



788 INDIANA LAW REVIEW [Vol. 16:783

be included in the taxable income.^® Similar issues arise with respect
to other types and forms of income, such as interest and royalties^"
or capital gains from the sale of assets in a state other than the tax-
ing state.^^ These issues are often resolved by focusing on an even
more fundamental analysis — whether the taxing state has the ap-
propriate jurisdiction to tax the income.

B. Jurisdiction to Tax

The states use various criteria to establish jurisdiction to tax;^^
however, the appropriate criteria will vary depending on the type of
tax.^^ With respect to net income taxes, two of the most significant
concepts are commercial domicile^^ and nexus.^^ States have the power
to tax their domiciliaries on income earned in other states.^^ In Mem-
phis Natural Gas Co. v. Beeler,^'^ the Court upheld a tax on the net

^The federal tax system permits corporations within a controlled group to deduct

85% to 100% of the dividends received from other corporations to the extent that
the dividends received represent income that has already been subject to federal in-

come taxation in order to avoid multiple taxation of the income prior to the distribu-

tion of the income to shareholders. See I.R.C. §§ 243-247 (West 1978 & West Supp.
1983), § 882 (West 1982 & West Supp. 1983); B. Bittker & J. Eustice. Federal In-
come Taxation of Corporations and Shareholders f 5.06 (4th ed. 1979). In the case
of an affiliated group of corporations which files a consolidated return under I.R.C.

sections 1501-1505, dividends paid by one member of the affiliated group to another
member of the affiliated group are eliminated from taxable income. See Treas. Reg.
§ 1.1502-14(a)(l) (1972). Dividend income, however, is generally subject to state tax even

though it may be deductible for federal income tax purposes. The majority of the
states do not acknowledge these deductions. See Hale & Kramer, supra note 28, at 45.

^'See, e.g., Quails v. Montgomery Ward & Co., 266 Ark. 207, 585 S.W.2d 18 (1979)
(interest).

''See, e.g., Atlantic Richfield Co. v. State, 198 Colo. 413, 601 P.2d 628 (1979).

'^For a general listing of the various jurisdiction to tax criteria which are used

by the states which tax multijurisdictional corporations, see G.A.O. Report-1982, swpra

note 3, at 59-60. States tax corporations: (1) doing business in the state; (2) deriving

income from sources or activities in the state; (3) owning, leasing, or deriving income

from property in the state; (4) or maintaining an office in the state. Id.

"^See, e.g.. Standard Pressed Steel Co. v. Washington, 419 U.S. 560 (1975) (presence

of agents in the state is sufficient contact to justify imposition of sales or gross receipts

taxes); National Geographic Soc'y v. Franchise Tax Bd., 430 U.S. 551 (1977) (any type
of permanent office or employees imposes duty to collect use taxes on sales).

'^"Commercial domicile" is the state in which the operations and activities of a

corporation are managed. Wheeling Steel Corp. v. Fox, 298 U.S. 193, 211-12 (1936);

see also Developments in the Law—Federal Limitations on State Taxation of Interstate
Business, 75 Harv. L. Rev. 953, 1005 (1962) (courts have relied on Wheeling Steel to sus-

tain net income taxes on the basis of commercial domicile).

^^See supra note 26 and accompanying text.

'*New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937) (rent from out-of-state

land); Lawrence v. State Tax Comm'r, 286 U.S. 276 (1932) (compensation for personal
services rendered outside taxing state).

'^315 U.S. 649 (1942).



1983] TAXING MULTINATIONAL CORPORATIONS 789

income of a foreign corporation over commerce clause objections on
the ground that the corporation's establishment of a commercial

domicile in the state provided the necessary jurisdiction to tax.^®

The due process clause requires sufficient activities or connections
between the corporation and the taxing state to provide the state
with the jurisdiction to tax.^^ In the past, the Supreme Court has not
imposed a very demanding test for determining what minimum con-
nections are necessary to satisfy the due process requirement. In

Northwestern States Portland Cement Co. v. Minnesota,'^^ the Court sus-
tained the power of a state to levy a net income tax on an out-of-
state corporation doing an exclusively interstate business in the state/^

The Court concluded that the states could tax the entire net income
of a multijurisdictional corporation generated by interstate as well

as intrastate activities provided that the income was fairly divided
among the taxing states and that the tax was not discriminatory/^
Shortly thereafter, Congress enacted legislation on the states' jurisdic-

tion to tax."

C. Division of Income Among Jurisdictions

In general, the due process clause provides that a state may only
tax net income arising from sources within the state.'^* Because a state

may not tax value earned outside of its borders, the states have
devised three methods to determine the portion of a multijurisdic-
tional corporation's income which is deemed to be earned within their
borders: separate accounting, specific allocation, and formulary

apportionment.'*^

''Id. at 652, 656-67.

'^See supra notes 22-27 and accompanying text.
*<'358 U.S. 450 (1959).

*The systematic sales solicitation activities in the state subjected the corpora-

tion to the state net income tax even though all orders taken were subject to the

final approval of out-of-state offices. Id. at 454.

«/d. at 452.

*^Act of Sept. 14, 1959, Pub. L. No. 86-272, tit. I, §§ 101-104, 73 Stat. 555-56 (codified

at 15 U.S.C. §§ 381-384 (1976)). Even though this law placed restrictions on a state's
jurisdiction to tax, it is of little importance to the multijurisdictional corporation because

its scope includes only small merchandising businesses. See Hellerstein, State Taxation

Under the Commerce Clause: An Historical Perspective, 29 Vand. L. Rev. 335, 339 (1976).
For an analysis of Pub. L. No. 86-272 and a treatment of the case law thereunder,

see Hartman, "Solicitation" and "Delivery" Under Public Law 86-272: An Uncharted
Course, 29 Vand. L. Rev. 353 (1976); Developments in the Law—Federal Limitations on
State Taxation of Interstate Business, 75 Harv. L. Rev. 953 (1962).

**See Rudolph, State Taxation of Interstate Business: The Unitary Business Con-

cept and Affiliated Corporate Groups, 25 Tax L. Rev. 171, 181 (1970) (cited in ASARCO,
102 S. Ct. at 3109 n.ll); see also Northwestern States Portland Cement Co., 358 U.S. at 464.

*^See Dexter, The Unitary Concept in State Income Taxation of Multistate-

Multinational Businesses, 10 Urb. Law. 181, 181 (1978); H.R. Rep. No. 1480, 88th Cong.,



790 INDIANA LAW REVIEW [Vol. 16:783

Separate accounting is used when a corporation can separate with
accuracy the net income, if any, generated or derived within a par-

ticular state from income generated or derived within other states
or geographic areas. Specific allocation involves determining the source

of particular items of income, such as interest, dividends, and capital

gains, which the states may allocate to the commercial domicile of
the corporation. Specific allocation is sometimes used in conjunction

with formulary apportionment.

In contrast to this formal geographical or transactional account-

ing, formulary apportionment does not trace the source of the income

or assign income-generating activities to certain states; rather, the

formulary apportionment method divides the income of a corpora-
tion in accordance with a mathematical formula which quantifies

income-generating factors and roughly approximates the income con-

nected with the taxing state.'*^ The Court has given the states wide
latitude in selecting apportionment formulas and has said that it will

not invalidate an assessment resulting from such a formula unless a

corporation proves '"by clear and cogent evidence' that the income

attributed to the State is in fact 'out of all appropriate proportions'"

to the income-generating activities in that state or is a gross

distortion."*^

D. Legislative Development and Statutory Application

All states which have a corporate income tax use formulary

apportionment."** The mathematical formula attributes the total income
of a multijurisdictional corporation to the states on the basis of cer-

tain income-generating factors. The three factors most generally used
in the apportionment formula are property, payroll, and sales."^ Most
of the taxing states have statutes which apportion income by com-

paring the average of the three factors of the formula within the tax-

ing state to the total of such factors both within and without the

2d Sess. 160-217 (1964) [hereinafter cited as Special Subcommittee Report]; G. Altman
& F. Keesling. Allocation of Income in State Taxation 67-168 (1950); Hale & Kramer,
supra note 28, at 30-36; J. Hellerstein & W. Hellerstein, State and Local Taxa-
tion 432-37 (4th ed. 1978) (separate accounting) [hereinafter cited as State and Local
Taxation]; Boren, Specific Allocation of Corporate Income in California: Some Problems
in the Uniform Division of Income for Tax Purposes, 30 Tax. L. Rev. 607 (1975) (specific
allocation); Hartman, State Taxation of Corporate Income from a Multistate Business,
13 Vand. L. Rev. 21, 64-74 (1959) (formula apportionment).

*'See Moorman Mfg. Co. v. W. Bair, 437 U.S. 267, 273 (1978).
"Id. at 274 (quoting Hans Rees' Sons, Inc. v. North Carolina ex rel. Maxwell,

283 U.S. 123, 135 (1931)). The burden of proving that a state tax is unconstitutional
traditionally has been on the taxpayer. Dexter, supra note 45, at 187.

*^See Dexter, supra note 45, at 182 & n.l.
*^See General Motors Corp. v. District of Columbia, 380 U.S. 553, 559 (1965); Special

Subcommittee Report, supra note 45, at 168-70 (providing a description of formula ap-
portionment and illustrations of the mechanics of the use of different formulas).



1983] TAXING MULTINATIONAL CORPORATIONS 791

state.^" There have been two significant state statutory developments

addressing the problem of dividing the income of a multijurisdictional

corporation among those states having the jurisdiction to tax some
portion of that income: (1) the Uniform Division of Income for Tax
Purposes Act (UDITPAP and (2) the Multistate Tax Compact
(Compact).^

The UDITPA sets forth principles of allocation and apportionment
of the income of a multijurisdictional corporation which are designed

to ensure that the states avoid both multiple taxation and under

taxation.^^ These principles split corporate income into business in-

come and non-business income.^'' Business income arises from transac-
tions and activities in the regular course of business.^^ Non-business

income is all income other than business income.^ Items of non-business

income, such as dividends, interest, and capital gains, are allocated

to the particular state according to the principles set out in the

UDITPA,^^ which usually permit a tax to be imposed where the cor-
poration is commercially domiciled.^* Business income is apportioned

on the basis of an equally weighted three-factor formula^^ which in-

cludes property, payroll, and sales.^°

^"The three-factor formula is:

In-State property + In-State payro l' + In-State sales

Total property Total payroll Total sales
Total Income

X corporate = taxable by

income the State
o

See 1 [All States Unit] St. & Loc. Tax Serv. (P-H) 1 1046; Special Subcommittee Report,
supra note 45, at 170.

^^Uniform Division of Income for Tax Purposes Act, 7A U.L.A. 91 (1957)
[hereinafter cited as UDITPA]. The UDITPA is also reproduced as Article IV of the
Multistate Tax Compact [hereinafter cited as Compact] in 1 [All States Unit] St. &
Loc. Tax Serv. (P-H) If 6315-6332. For a list of the states which have adopted substan-
tially all of the UDITPA to date, see 7A U.L.A. 11 (Supp. 1983).

^Tor the text of the Compact, see 1 [All States Unit] St. & Loc. Tax Serv. (P-H)
1 6310. For a list of the Compact members and associate members, see id. If 5150.

^^See generally Lynn, Formula Apportionment of Corporate Income for State Tax
Purposes: Natura Non Facit Solium, 18 Ohio St. L.J. 84 (1957); Lynn, The Uniform. Divi-
sion of Income for Tax Purposes Act, 19 Ohio St. L.J. 41 (1958); Pierce, The Uniform

Division of Income for State Tax Purposes, 35 Taxes 747 (1957) (a discussion of the basic

components by the drafter of the UDITPA).
^This "income-splitting" is not a simple process. See State and Local Taxation,

supra note 45, at 490-504.

''UDITPA, supra note 51, § 1(a).

""Id. at § 1(e).

"/d. at §§ 4-8; see Dexter, Taxation of Income from Intangibles of Multistate-

Multinational Corporations, 29 Vand. L. Rev. 401, 406-07 (1976) (a detailed description

of the specific allocation of non-business income as well as criticism of the income-

splitting as lacking a reasonable basis).

'^UDITPA, supra note 51, § 7.

'Vd at §§ 9-17. See supra note 50.

*°If this formula does not result in a fair reflection of the taxpayer's state ac-



792 INDIANA LAW REVIEW [Vol. 16:783

The Compact^^ is an interstate taxation agreement with regard
to the taxation of multijurisdictional corporations which has adopted

the UDITPA provisions.^^ The Compact established the Multistate Tax
Commission (Commission)^^ and, pursuant to the Compact, any member
state may request that the Commission perform an audit on its behalf/*
The Compact was sustained in United States Steel Corp. v. Multistate

Tax Commissions^ against a facial attack on the ground that it violated

the compact clause of the United States Constitution.^^

There is a third state development of importance with regard to

the division of a multijurisdictional corporation— combined reporting.^'

Under combined reporting, a state determines its proportionate share
of the combined income which, with respect to the members of an
affiliated group of corporations, is taxable by the state. It then ap-
plies its apportionment formula to the combined income.^* A combined

tivities, relief may be sought under UDITPA § 18.
®Tor a succinct summary of the origins and the nature of the Compact, see Heller-

stein, State Taxation Under the Commerce Clause: An Historical Perspective, 29 Vand.
L. Rev. 335, 341 (1976).

^^See supra note 51.

^Composed of one member from each member state, the Commission is the govern-
ing and administrative body of the Compact. The Commission is empowered to for-
mulate regulations which address allocation and apportionment of income for income

tax purposes. The regulations are merely advisory and not binding on any state unless
it adopts them. See State and Local Taxation, supra note 45, at 544.

'*See article VI of the Compact in 1 [All States Unit] St. & Loc. Tax Serv. (P-H)
1 6310.

'^434 U.S. 452 (1978). See Dexter, An Analysis of the Supreme Court's U.S. Steel
Decision Upholding Multistate Tax Compact, 48 J. Tax'N 368 (1978).

^M34 U.S. at 472-78. The Court concluded that the existence of the Commission

did not enhance the political power of the member states so as to encroach upon the
supremacy of the United States. Id. at 472. The Court also upheld the Compact over

challenges based on commerce clause and fourteenth amendment grounds. Id. at 478-79.
For the text of the compact clause, see U.S. Const, art. I, § 10, cl. 3.

^Teters, Use of Combined Reporting Required by Increasing Number of States, 41
J. Tax'n 375 (1974). The Commisson has been advocating the use of combined reporting.
See Corrigan, Interstate Corporate Income Taxation—Recent Revolutions and a Modem
Response, 29 Vand. L. Rev. 423, 439-41 (1976). For a general introduction to combined

apportionment and allocation with regard to multicorporate enterprises, see State

AND Local Taxation, supra note 45, at 438-43, 520-26. For the background with respect
to the development of combined reporting and its relationship to separate accounting

and formulary apportionment, see Hale & Kramer, supra note 28, at 60-79.
^^Rudolph, supra note 44, at 197-201. In this sense, a prerequisite to combined

reporting is that the affiliated group be a unitary business. The income of separate
but related corporations determined to be engaged in a unitary business is combined

to calculate the tax liability of the members of the related corporate group. After
the elimination of certain intercorporate transactions, such as dividends, the net in-

come is that of the combined group and the apportionment formula includes the fac-
tors of the members of the combined group. For a discussion of combined reporting,
see Keesling, A Current Look at the Combirved Report and Uniformity in Allocation
Practices, 42 J. Taxn 106 (1975). The combined report usually includes only related cor-
porations in which the parent corporation owns, directly or indirectly, more than 50%



1983] TAXING MULTINATIONAL CORPORATIONS 793

report is not a consolidated tax return; rather, it has the qualities

of an information return.^® Combined reporting is applied by some
states to multijurisdictional corporations which are operating within

the United States, outside of the United States, or both.^" When for-
mulary apportionment is applied to the combined income of an af-

filiated group of corporations consisting of both foreign corporations

operating outside of the United States and one or more corporations
doing business within the taxing state, the method is commonly re-
ferred to as worldwide combined reporting.^^

Congress has not fully exercised its power to legislate in the area

of state taxation.^^ The application of any legislation which has been
enacted has, in every instance, been very narrow in scope.^^ The
Supreme Court has acknowledged both the limitations of any judicial
resolution of state taxation controversies^* and the appropriateness

of congressional action.^^ Proposed legislation placing limitations on

the states' power to tax the income of multijurisdictional corporations
has been considered in recent years.^^ For example, bills have been

proposed to limit the taxation of foreign-source income of multina-

tional corporations.^^ The most recent legislative efforts with regard
to the taxation of foreign-source income have been concerned with

prohibiting the states from using worldwide combined reporting and

restricting the states in the taxation of foreign-source dividends.^* The

of the stock. See Buresh & Weinstein, Combined Reporting: The Approach and Its Prob-
lems, 1 J. State Tax'n 5, 8 (1982).

^^See Buresh & Weinstein, supra note 68, at 6-7.
^"The application of combined reporting is based either on statutory provisions

relating to such reports or on judicial or administrative decisions construing combined

reporting statutory provisions. See, e.g., F. W. Woolworth Co. v. Director of Div. of
Taxation, 45 N.J. 466, 213 A.2d 1 (1965).

"5ee Hellerstein, State Income Taxation ofMultijurisdictional Corporations: Reflec-

tions on Mobil, Exxon, and H.R. 5076, 79 MiCH. L. Rev. 113, 156 (1980); G.A.O.

Report-1982, supra note 3, at 31.

^Tub. L. No. 86-272, see supra note 43, was the first time that Congress passed
legislation concerning the power of the states to tax the income of corporations engaged

in interstate commerce. Except for this legislation, the power of Congress to regulate
state taxation of the income of interstate corporations has been virtually unexercised.

"Since the enactment of Pub. L. No. 86-272, Congress has passed other legisla-

tion limiting the power of the state to tax in certain well-defined areas. See, e.g., 15
U.S.C. § 78bb(d) (1976) (stock transfer taxes); 49 U.S.C. § 11503 (Supp. V 1981) (railroad
property); 49 U.S.C.A. § 11503a (West 1983) (motor carrier property).

'"Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450, 457 (1959).
''Moorman Mfg. Co. v. Bair, 437 U.S. 267, 280 (1978).

^'^See Madere, State Taxation After Mobil and Exxon, 33 Tax Exec. 103, 127-31
(1981).

"For a thorough summary and analysis of this legislation, see Hellerstein, supra
note 71, at 154.

'«S. 655, 97th Cong., 1st Sess. (1981); H.R. 1983, 97th Cong., 1st Sess. (1981).

No final action was taken on these bills. For a discussion of their constitutional



794 INDIANA LAW REVIEW [Vol. 16:783

issue of whether and how to include the income from foreign corpora-
tions in a taxpayer's apportionable income has not only been treated
extensively in congressional hearings, but has also been of central

importance in recent tax treaty negotiations.^79

IV. The Unitary Business Principle

A significant area in which substantial uniformity exists among
all of the states which tax multijurisdictional corporations, then, is

the use of formulary apportionment.^" The application of formulas to
apportion the income of a multijurisdictional corporation, however, is

permitted only in the case of a unitary business.*^ The Supreme Court
has recently reaffirmed that an essential prerequisite of apportionabil-

ity for state taxation of a multijurisdictional enterprise is adherence

to the unitary business principle.^^ The unitary business principle is
a historical concept which has been developed throughout this cen-

tury by the Supreme Court. While this principle has been the sub-
ject of much commentary,^ the determination of whether a business
satisfies the unitary business principle is no easy task. The difficulty
stems from the definitional criteria for determining whether a cor-

porate enterprise should be characterized as a single unitary enter-

prise for tax purposes.^"

ity, see Dexter, State Taxation of Multinationals: Are the Mathias and Conable Bills
Constitutional?, 14 Tax Notes 715 (1982).

^Tor example, the United States-United Kingdom Income Tax Treaty originally
contained a provision which substantially restricted the ability of the states to use

combined reporting and formulary apportionment with regard to United States cor-

porations which are subsidiaries of United Kingdom corporations. The provision was
eventually deleted from the treaty. See Hellerstein, supra note 71, at 161.

^°See supra notes 46-50 and accompanying text.

^^"Formulary apportionment, which takes into account the entire business income

of a multistate business in determining the income taxable by a particular state, is

constitutionally permissible only in the case of a unitary business." ASARCO Inc. v.
Idaho State Tax Comm'n, 102 S. Ct. 3103, 3111 n.l4 (1982) (quoting Rudolph, supra note
44, at 183-84).

^'ASARCO Inc. v. Idaho State Tax Comm'n, 102 S. Ct. 3103, 3110 (1982).
^^See Hellerstein, Recent Developments in State Tax Apportionment and the Cir-

cumscription of Unitary Business, 21 Nat. Tax J. 487 (1968); Rudolph, supra note 44;
Dexter, supra note 45. For other scholarly discussions of the unitary business con-

cept, see Altman & Keesling, supra note 45, at 97-102; State and Local Taxation,
supra note 45, at 504-56; Dexter, Taxation of Income from Intangibles of Multistate-
Multinational Corporations, 29 Vand. L. Rev. 401 (1976); Keesling, A Current Look at
the Combined Report and Uniformity in Allocation Practices, 42 J. Tax'n 106 (1975);
Keesling & Warren, The Unitary Concept in the Allocation of Income, 12 Hastings L.J.
42 (1960).

®Tor a discussion of the Supreme Court's unwillingness to settle upon a single
definition of the scope of a unitary business, see Hellerstein, supra note 71, at 148-51.



1983] TAXING MULTINATIONAL CORPORATIONS 795

A. Origins

The origin of the unitary business principle lies in state ad valorem
property tax cases.^^ At the turn of the century, a so-called unit rule
was designed to apply ad valorem taxes to interstate utility systems^^
and was also applied in early railroad cases.®^ This tax concept assumed
that the value of a railroad was a function of the rail system as a
whole; therefore, a formula was developed to divide the value of the
rail system as a unit among all of the jurisdictions within which it
operated.** These cases provide the basis for the contemporary pro-

position that all of the properties of a unitary business utilized in

the operations of the business, whether it conducts the business in

a single or multiple corporate form, are subject to a reasonable ap-

portionment formula.*^ Subsequently, the unit rule was incorporated
into the field of income taxation.

B. Developments: Corporate Income Tax Cases

The seminal case on formulary apportionment is Underwood
Typewriter Co. v. Chamberlain^ decided by the United States Supreme
Court in 1920. This case involved the imposition of a net income tax

on a manufacturing and sales corporation operating in different states.

The corporation had its manufacturing plants and substantial prop-
erty located within the taxing state while a greater portion of its sales

were made in other states.^^ The taxing state apportioned income on
the basis of a single-factor property formula.^^ The corporation argued
that the formula taxed "income arising from business conducted

beyond the boundaries of the State" in violation of the due process

clause.^^ The Court rejected the due process objection and concluded
that the formula resulted in a fair apportionment reaching only profits

generated in the state.^'' Underwood, then, sanctioned formulary ap-

*^Dexter, supra note 43, at 184.

''Id. See Isaacs, The Unit Rule, 34 Yale L.J. 838 (1926).
''See, e.g., Union Pacific Ry. v. Cheyenne, 113 U.S. 516 (1884).

**The Supreme Court summarized its holdings in this regard and considered what
constituted a unitary business in Adams Express Co. v. Ohio State Auditor, 165 U.S.
194, 220-23 (1897).

^^Dexter, supra note 45, at 191.
^"254 U.S. 113 (1920).

^^Id. at 117-19. The corporation earned income through a "series of transactions"
beginning with manufacturing in the state and ending with sales outside of the state.

Id. at 120-21.

^^The single-factor formula using property as a basis computes the ratio of real
and tangible personal property values within the state to the value of that same prop-
erty owned in total by the corporation so as to determine the state's proportionate
share of income. Id. ait 118.

''Id. at 120.

'Vd at 121. The Court acknowledged the difficulty of determining the state's
fair proportionate share of taxable income by accounting only for the manufacturing



796 INDIANA LAW REVIEW [Vol. 16:783

portionment as a proper method of dividing the net income of a cor-
poration derived from the interstate operations of a vertically in-

tegrated business among nondomiciliary states.
In 1924, the Court extended the Underwood reasoning to permit

a taxing state to impose taxes based on apportionment of net income

earned by a foreign corporation in Bass, Ratcliff & Gretton, Ltd. v.
State Tax Commission.^^ This case involved a vertically integrated
operation across national boundaries. The unitary business was a
British corporation which manufactured its product in England and

sold it in the United States as well as in England.®^ The taxing state
used a single-factor property formula similar to that used in the Under-

wood case and included the foreign income in the total taxable in-
come to be apportioned.^' Even though the corporation had showed
a loss from United States operations on its federal income tax return,

the use of the formula resulted in income taxable by the state.^® The
Supreme Court sustained the tax over due process objections basing
its holding on a finding that the corporation was carried on as a
unitary business.®^

In 1931, in Hans Rees' Sons, Inc. v. North Carolina ex rel.
MaxwelU^^^ a case involving facts strikingly similar to those at issue

in Underwood and Bass, the Supreme Court upheld the corporation's
challenge to a state tax based on apportionment.^"^ The corporation
manufactured its product in the taxing state, but its principal offices

within the state. Id. at 120-21. See also Moorman Mfg. Co. v. Bair, 437 U.S. 267, 278-80
(1978) (formulary apportionment is used as a rough approximation of the net income

of a corporation attributable to the taxing jurisdiction).
'^266 U.S. 271 (1924). The Bass case involved a franchise tax measured by net

income attributable to the taxing state. Id. at 277. A franchise tax is an assessment
for the privilege of doing busines in the taxing jurisdiction. The significance of this
case lies in the inclusion of foreign-source income into preapportionment taxable in-

come. Id. at 282. In this regard, foreign-source income refers to income generated out-

side of the United States.

""Id. at 278-79.

®^The single-factor formula using property in this case is different from that used

in Underwood. In the instant case the state deterniined that the property owned in
total by the corporation contributed to generating dividend income. Id. at 277-80.

''Id. at 279^0.

''Id. at 282. Although the term "unitary business" is not used in Underwood, the

Court upheld the tax in Bass by citing Underwood. Id. at 280-82. One may infer that
the corporation described in Underwood was a unitary business.

^'"'283 U.S. 123 (1931).

"^M at 136. It is interesting to note that a taxpayer has not often successfully
prevailed in challenging the results of a taxing state's formulary apportionment of

net income. Some of the successful taxpayer cases have been the following: Colonial
Pipeline Co. v. Traigle, 421 U.S. 100 (1975); Standard Pressed Steel Co. v. Dep't of

Revenue, 419 U.S. 560 (1975); Norfolk & W. Ry. Co. v. Missouri State Tax Comm'n,
390 U.S. 317 (1968); Memphis Natural Gas Co. v. Stone, 335 U.S. 80 (1948).



1983] TAXING MULTINATIONAL CORPORATIONS 797

and storage facilities were in another state/"^ Its worldwide net in-
come resulted from sales in the United States, Canada, and Europe.^"^
The taxing state utilized a single-factor property formula and attemp-
ted to tax from sixty-six to eighty-five per cent of the corporation's

net income, while the corporation offered strong evidence derived from

a separate accounting procedure which showed that at most twenty-
three per cent of its profit was attributable to its manufacturing in
the taxing state/"^ The Court characterized a manufacturing and
marketing enterprise in several jurisdictions as unitary^"^ and did not

question whether the corporation was in fact a unitary business. The
Court simply held that the formula based on a single-factor analysis

was invalid because the result in this case was unreasonable/"^ The
precedential value of this opinion is of limited significance because

the majority of the states presently have a three-factor apportion-

ment formula which has survived judicial scrutiny/"^
In the 1942 decision of Butler Brothers v. McColgan,^^^ the Court

approved the use of the three-factor apportionment formula and ex-

tended the application of the unitary business concept from manufac-
turing enterprises to a wholly mercantile operation. In this case, a

single corporation used a central office in one state to purchase all

of the goods and inventory for branch wholesale distribution centers

in several states, including the taxing state.^"^ The central office also
provided resources such as advertising, accounting, and management
for the branches. The central office allocated the costs of its opera-
tions among the branch offices and, by means of separate accounting,
accurately determined a loss for the taxing state."" The state applied
the three-factor formula which resulted in a tax liability."^ The cor-
poration, however, maintained that the application of the formula in

this case resulted in the taxation of extraterritorial values in viola-

tion of the due process clause."^

^"2283 U.S. at 126-27.

'"'Id. at 127.

"Yd. at 128-34.

'''Id. at 133.

"*The statute was applied unreasonably and arbitrarily by attributing to the tax-

ing state a percentage of income "out of all appropriate proportion to the business

transacted by the [corporation] in that state." Id. at 135-36. The Court distinguished

Underwood and Bass on the ground that the corporations in those cases failed to

establish that the amount of net income with which the corporations were charged
in the taxing states under the apportionment method was not reasonably attributable

to the processes conducted within the borders of those states. Id. at 133.

'°''See supra notes 48-50 and accompanying text.
"«315 U.S. 501 (1942).

'''Id. at 504.

""/d. at 504-05.

"Yd
"Yd at 506-07.



798 INDIANA LAW REVIEW [Vol. 16:783

The Court determined that the state properly characterized the
.corporation as a unitary business, focusing on the centralized manage-

ment and functional integration of the interstate operations/^^ In so
doing, the Court relied on a test developed by the state court,"'' the

so-called three-unities test, which consists of (1) unity of ownership,

(2) unity of use, and (3) unity of operation and management."^ The
Court held that the reasonableness of a particular apportionment form-

ula may not be contested by the corporation by means of a separate
accounting once the corporate enterprise has been properly
characterized as a unitary business."^

V. State Taxation of Multinational Corporate
Foreign-Source Dividends: Mobil

The key precedent regarding state taxation of foreign-source in-
come is the United States Supreme Court decision in Mobil Oil Corp.
V. Commissioner of Taxes}^'^ In this 1980 decision, the Supreme Court
addressed the constitutional limitations on a nondomiciliary state's tax-

ation of a domestic corporation's dividend income received from foreign

subsidiaries and affiliates."* The Court rejected both due process and
commerce clause objections and held that it is permissible for a state
to include foreign-source dividends in a multinational corporation's ap-

portionable tax base so long as there is a unitary relationship between

the payor foreign corporation and the recipient domestic corporation."^

The reasoning of the Court in arriving at its holding has generated
considerable commentary.^^"

''Ud. at 508.

""Butler Bros. v. McColgan, 17 Cal.2d 664, 111 P.2d 334 (1941), affd, 315 U.S. 501

(1942).

"^315 U.S. at 508-09. See Boren, Separate Accounting in California and Uniformity
in Apportioning Corporate Income, 18 U.C.L.A. L. Rev. 478, 490-94 (1971) (discussing

the development of the three-unities test together with modifications made by the
California courts). Commentators have been critical of the many ambiguities of the
three-unities test and its modifications. See Dexter, supra note 45, at 192-98. For ex-

ample, the test gives no significance to the distinction between in-state business and

out-of-state business.

"®315 U.S. at 508-09. Even though it was not decided on constitutional grounds,
General Motors v. District of Columbia, 380 U.S. 553 (1965), stands as the Supreme
Court's endorsement of the three-factor formula noting its prevalence among the tax-
ing states and its justification as a rough practical approximation of the distribution

of a corporation's sources of income and the social cost for which the corporation is

responsible.

"^445 U.S. 425 (1980).

"«M at 427.
"Tor an excellent analysis of the Mobil decision together with an analysis of pro-

posed federal legislation for the restriction on state taxation of foreign-source income,

see Hellerstein, supra note 71.

^^"Many articles have been written which are mostly critical of the Mobil decision.

See, e.g., Chisum, State Taxation of Interstate Corporate Income from Intangible Prop-



1983] TAXING MULTINATIONAL CORPORATIONS 799

Mobil, a New York corporation authorized to do business in Ver-
mont, was engaged in an integrated, worldwide business which in-

volved the production, refinement, distribution, and sale of petroleum

products.^^^ Mobil's foreign business was conducted through wholly and

partly owned subsidiaries and affiliates, none of which was incor-
porated in or conducted business in Vermont. ^^^ Mobil's activities in

Vermont were limited to the marketing of petroleum products and
formed only a small part of its worldwide business. ^^^

This dispute involved Mobil's tax liability to Vermont for the years

1970, 1971, and 1972. Vermont imposed a net income tax on every
corporation doing business in the state. ^^^ Net income was composed
of taxable income as defined by the Internal Revenue Code.^^^ Because

Mobil was engaged in business both within and without the state,
Vermont used the three-factor apportionment formula to determine

a fair and equitable portion of the net income attributable to Mobil's

commercial activities in Vermont.^^^ On its federal income tax returns,
Mobil's net income included substantial dividends received from its

erty: Due Process and Commerce Clause Limitations, 13 Tex. Tech. L. Rev. 1 (1982); Cor-
rigan, How Multistate Tax Commission Conducts Joint Audits and Controls Income Alloca-
tions, 25 Tax'N For Acct. 108 (1980); Corrigan, Toward Uniformity in Interstate Taxa-
tion, 11 Tax Notes 507 (1980); Corrigan, MohW-izing Interstate Taxation, 13 Tax Notes
803 (1981); Dexter, Tax Apportionment of the Income of a Unitary Business: An Ex-
amination of Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 1981 B.Y.U. L.
Rev. 107; Feinschreiber, State Taxation ofForeign Dividends After Mobil v. Vermont: Ad-
justing the Apportionment Formula, 6 Int'L Tax J. 267 (1980); Hellerstein, Allocation
and Apportionment of Dividends and the Delineation of the Unitary Bum.ness, 14 Tax
Notes 155 (1982); Keesling, The Impact ofthe Mobil Case on Apportionment ofIncome, 1981
B.Y.U. L. Rev. 87; Killefer, State Taxation ofCommerce: Mobil Oil Corporation v. Com-
missioner of Taxes of Vermont, 8 J. Corp. Tax'n 3 (1981); Nackenson, The Impact of
Mobil V. Vermont on Interstate Taxation, 6 Int'l Tax J. 323 (1980); Peters, Supreme
Court's Mobil Decision on Multistate Income Apportionment Raises New Questions, 53
J. Tax'N 36 (1980); Comment, State Taxation of Foreign Source Corporate Dividends:
Another Conqu£st of the Expanded Unitary Business Doctrine, 22 Urb. L. Ann. 229 (1981).

'^'445 U.S. at 427-28.

'^Ud. at 428.

''Ud.

''*Id. at 429. Vt. Stat. Ann. tit 32, §§ 5811(15), 5832 (1981).
^^^445 U.S. at 429. Under the Vermont state taxation system, net income is defined

as the taxable income of the taxpayer "under the laws of the United States." Vt.

Stat. Ann. tit. 32, § 5811(19) (1981).
^^M45 U.S. at 429. Vermont's formula multiplied the corporation's net income "by

a fraction representing the arithmetic average of the ratios of sales, payroll, and prop-

erty values within Vermont to those of the corporation as a whole." Id. See Vt. Stat.
Ann. tit. 32, § 5833(a) (1981). For the taxable year 1972, the ratios of Mobil's Vermont
sales, payroll, and property to those factors "everywhere" were approximately .24%,
.06%, and .25%, respectively. 445 U.S. at 429 n.2. Vermont applied the fraction pro-
duced by the formula to the corporation's federal taxable income with minor modifica-
tions which, for example, excluded income exempt from state taxation under federal
law. Id. at 429. Vt. Stat. Ann. tit. 32, § 5811(18) (1981).



800 INDIANA LAW REVIEW [Vol. 16:783

foreign subsidiaries and affiliates/" On its Vermont returns, Mobil
subtracted from federal taxable income its foreign-source dividend in-

come, which resulted in losses for 1971 and 1972.^^ The Vermont
Department of Taxes restored the items to the preapportionment tax
base and assessed accordingly.^^®

Mobil argued that the restoration of the foreign-source income

to its preapportionment tax base violated the due process clause as

well as the commerce clause.^^" In addition, Mobil petitioned for
modification of the apportionment.^^^ The Supreme Court of Vermont
sustained the tax on the foreign-source dividends,^^^ and on appeal,

the United States Supreme Court affirmed the judgment.^^^
Mobil proposed three principal arguments for exclusion of its

foreign-source dividends from income subject to formulary
apportionment.^^ First, the corporation argued that the lack of a nexus

between the taxing State and either the parent corporation's manage-

ment of its investments in the subsidiaries or the business activities
of the subsidiaries precluded taxation of its dividend income.^^^ Thus,

the state tax on this foreign income violated due process. In consider-

ing this due process clause argument, the Court determined that a

sufficient nexus existed between the parent corporation's activities

and the taxing state to permit the assessment of the tax. The Court
found that there was nothing unique about foreign-source dividends
so as to prohibit their taxation.^^^ To the extent that a multinational
corporation operates as a functionally integrated enterprise and earns

dividends from subsidiaries or affiliates which reflect profits derived

from such an enterprise, those dividends are treated as income which

is to be appropriately included in the parent corporation's appor-

tionable tax base pursuant to the unitary business principle.^^^ The
Court reasoned that it would be misleading to characterize the

^"Mobil's federal income tax returns for 1970-72 showed taxable income of ap-

proximately $220 million, $308 million, and $233 million, respectively. 445 U.S. at 430.

Of that, net dividend income accounted for approximately $174 million, $283 million,

and $280 million. Id.

^^^Id. Mobil subtracted amounts representing interest and foreign taxes as well

as dividends. Id. at 430 n.6.

^^^Id. at 431-32. Mobil's aggregate tax liability for the three years was calculated

by Vermont at over $76,000. Id. at 432.

'''Id. at 432,

'^'Id. Vermont allows a corporation to petition for relief where the three-factor

formula results in an unfair apportionment.

^^^Mobil Oil Corp. v. Comm'r of Taxes, 136 Vt. 545, 394 A.2d 1147 (1978).
^3^445 U.S. at 449.

''*Id. at 436.

'''Id.

''^Id. at 438-39. Mobil had claimed that foreign-source dividends by their very nature

are not apportionable income. Id. at 434.

''Ud. at 440.



1983] TAXING MULTINATIONAL CORPORATIONS 801

dividends received in a unitary business as proceeding from a separate

identifiable source because separate accounting may fail to account
for contributions to profitability, such as integrated functions, cen-

tralized management, and economies of scale which arise from the
operation of the business as a whole/^®

Therefore, the nondomiciliary corporation must show that foreign-
source income was earned in the course of activities unrelated to its
activities in the taxing state in order to establish that the income

is not subject to formulary apportionment/^^ The Court found that
Mobil failed to demonstrate that the activities of its foreign sub-

sidiaries were distinct from its marketing activities in the taxing

state.^^° The unitary business principle remains the linchpin of the
Court's decision with regard to the due process analysis of state tax-

ation of foreign-source income/"^ A multinational corporation must
prove that there is not an underlying unitary business involving the

operations producing the foreign-source income in order to exclude

such income from a state's apportionable tax base/"^

Second, Mobil argued that it was subject to an unconstitutional
burden of multiple taxation because the foreign-source dividends would

be potentially taxable in full in the state of its commercial domicile

by means of specific allocation.^"^ On this commerce clause issue, the
Court decided that where the foreign-source income bears relation
to benefits conferred by several states, formulary apportionment,

rather than specific allocation, is ordinarily the acceptable means of

'''Id. at 438.

^'^Id. at 439. Because Mobil failed to sustain its burden of proving any unrelated

business activity on the part of its subsidiaries and affiliates, the Court did not have

to decide whether the foreign-source dividends would be apportionable in the absence

of a unitary business relationship. The Court added a critical qualification to its holding

that the foreign-source dividends were not shown to be exempt, as a matter of due
process, from apportionment in this instance:

We do not mean to suggest that all dividend income received by cor-
porations operating in interstate commerce is necessarily taxable in each State

where that corporation does business. Where the business activities of the
dividend payor have nothing to do with the activities of the recipient in the

taxing State, due process considerations might well preclude apportionability,

because there would be no underlying unitary business.

Id. at 441-42.

'^'Id. at 439.

'''Id.

"^The corporate form of a business may have nothing to do with the underlying
economic realities of the business enterprise and transforming operating income into

dividends ought not impair the apportionability of income. Id. at 440-41. It is interesting

to note how the Court framed the issue and confined its opinion to the issue of "whether
there is something about the character of income earned from investments in affiliates

and subsidiaries operating abroad that precludes, as a constitutional matter, state tax-

ation of that income by the apportionment method." Id. at 435.

'*'Id. at 436.



802 ' INDIANA LAW REVIEW [Vol. 16:783

taxation/^^ The Court acknowledged that the state of commercial
domicile may have the authority to impose some tax on the dividend
income;^^^ however, the Court concluded that there is no reason to

find the taxing authority of the domiciliary state exclusive in cases

in which the dividend income proceeds from a unitary enterprise where

some part of that business operates in states other than the state
of the corporation's commercial domicile.^*^ The Court ruled the
domicile analysis based on property tax principles carries little force

in the context of income taxation.^^^ The Court determined that a non-
domiciliary state's interest in taxing its proportionate share of a

multinational corporation's dividend income was not preempted by any
interest of the state of commercial domicile/^®

Third, Mobil argued that the foreign-source of the dividends sub-

jected the corporation to a risk of multiple taxation at the interna-

tional level/''^ The corporation did not broadly propose that foreign-
source income is totally sheltered from state taxation; rather, Mobil

maintained that federal tax policies against double taxation of foreign-

source income required that the income must be specifically allocated
to the state of commercial domicile for imposition of state taxation. ^^°

Mobil asserted that the Court's decision in Japan Line, Ltd. v. County

of Los Angeles^^^ required the allocation of the tax to the state of the

corporation's domicile, because apportionment's inherent inaccuracy

would create a risk of multiple taxation which the Court would be

unable to correct/^^ The Supreme Court found that the tax did not
impose an undue burden on foreign commerce/^^ The Court distin-

'''Id. at 446.

'''Id. at 445.

'''Id. at 445-46.

''Ud. at 445. The Court noted that cases upholding allocation to a single situs
for property tax purposes have distinguished income tax situations involving formulary

apportionment. See Wheeling Steel Corp. v. Fox, 298 U.S. 193, 212 (1936).

^*M45 U.S. at 445-46. The constitutionality of a state tax assessed pursuant to
formulary apportionment should not depend on the vagaries of the tax policies of the

state of commercial domicile of a corporation. Id. at 444. The commercial domicile in
this case did not tax the dividend income in question and the Court noted that "actual

multiple taxation is not demonstrated on this record." Id.

'''Id. at 436.

'''Id. at 446.

15144]^ U.S. 434 (1979). See supra notes 20-21 and accompanying text.

"H45 U.S. at 446.
"Ud. at 449. The Court rejected Mobil's argument on several grounds. First, the

argument focused on the effect of foreign taxation when the important issue was the
effect of domestic taxation. Id. at 447. Second, the argument extended to any income

arguably earned in foreign commerce which would force the states to determine whether
the income has a foreign source. Id. Third, the argument underestimated the Court's
ability to correct discriminatory taxation of foreign commerce resulting from multiple



1983] TAXING MULTINATIONAL CORPORATIONS 803

guished the Japan Line decision on the ground that it involved a state

property tax and that the analysis of that opinion did not apply to

an income tax.^^* The Court did not provide any analysis supporting
this distinction. In addition, the Court noted that both federal and

state taxation of income is the norm and that federal and state treat-
ment of foreign-source income for tax purposes need not be similar,

absent some congressional directive. ^^^

In summary, the Court held that neither the due process clause

nor the commerce clause requires a preference for specific allocation,

rather than formulary apportionment, of foreign-source dividend

income. ^^^ The decision affirms formulary apportionment of foreign-
source dividends where there is a unitary business relationship among
the payor foreign subsidiaries or affiliates and the recipient parent

corporation; however, it does not require that the states employ this

method. Even though the holding in Mobil is limited as such, the
analysis of this decision remains at the center of the issues concern-

ing the state taxation of foreign-source income.

The most important issue unanswered by the Mobil opinion is the
criteria for a fair apportionment formula to be used in the context

of foreign-source income. The Court did not address a second due pro-

cess clause requirement which necessitates a rational relationship be-

tween the income taxed and the activities of the corporation within

the state.^^^ Arguably Vermont's apportionment formula violated this

second requirement because it failed to reflect the foreign sales, prop-

erty, and payroll values of the subsidiary corporations.^^*

taxation. Id. Fourth, specific allocation would not necessarily entail less of a tax on

foreign-source income. Id. at 447-48.

^^"The Court properly rejected the corporation's reliance upon Japan Line, which
was concerned with property taxation of instrumentalities of foreign commerce. Japan
Line dealt with multiple taxation on a purely international level, not on an interstate

level as in Mobil. Federal interests necessitate that any state taxation of foreign com-

merce must meet stricter standards of review than like taxation imposed solely on
interstate commerce.

1^^445 U.S. at 448.

'''Id. at 449.

^"The Court avoided this issue when it explained that Mobil's "election to attack
the tax base rather than the formula substantially narrows the issues before us. In

deciding this appeal, we do not consider whether application of Vermont's formula
produced a fair attribution of [Mobil's] dividend income to that State." Id. at 434.

'^*In his dissenting opinion. Justice Stevens expressed the view that Vermont's

formula was indefensible because, "Unless the sales, payroll, and property values con-
nected with the production of income by the payor corporations are added to the

denominator of the apportionment formula, the inclusion of earnings attributable to

those corporations in the apportionable tax base will inevitably cause Mobil's Ver-

mont income to be overstated." Id. at 461 (Stevens, J., dissenting). For the position
that apportionment formula factors should be adjusted by taking into account the prop-



804 INDIANA LAW REVIEW [Vol. 16:783

VI. ASARCO AND Woolworth: Due Process Limitations on the
State Taxation of Foreign-Source Income

The concept of a unitary business has expanded from single cor-
porations or an affiliated group of corporations doing business in

several states to include the income of a nondomiciliary corporation

derived from subsidiaries and affiliates operating outside of the United

States. Mobil endorsed the application of formulary apportionment to

such foreign-source income.^^^ The principal basis for finding any limita-

tion on the power of a state to impose formulary apportionment on
multinational enterprises is a successful demonstration that members
of a group of affiliated corporations are in fact engaged in discrete

business enterprises unrelated to their activities in the state.^^° For

the first time since the 1931 decision in Hans Rees' Sons, Inc. v. North
Carolina ex rel. MaxwelU^^^ the corporate taxpayers in the companion

cases of ASARCO Inc. v. Idaho State Tax Commission^^^ and F. W.
Woolworth Co. v. Taxation and Revenue Department^^^ succeeded in

obtaining a ruling from the Supreme Court that a state tax on foreign-
source income was unconstitutional by showing that certain income

had been derived from discrete business enterprises.^**

erty, payroll, and sales of the payor subsidiaries, when dividend income is included
in a corporation's tax base, see Feinschreiber, State Taxation of Foreign Dividends

After Mobil v. Vermont: Adjusting the Apportionment Formula, 6 Int'l Tax J. 267 (1980);
Nackenson, The Impact o/ Mobil v. Vermont on Interstate Taxation, 6 Int'L Tax J. 323
(1980). For a more thorough discussion of the unitary business principle in a purely
interstate context, see Exxon Corp. v. Dep't of Revenue, 447 U.S. 207 (1980).

The analysis developed in Mobil was subsequently applied by the Supreme Court
in Exxon to income earned from the domestic operations of a vertically integrated
petroleum products corporation. The Court reviewed the record analyzing the actual

business operations of the corporation which disclosed a centi'alized management pro-
viding the means to operate an optimum short-term operational program. 447 U.S.

at 224. The marketing activities in the taxing state were found to be interdependent
with the integrated operations of the corporation as a whole. Centralized purchasing

contributed to overall profits, centralized coordination achieved operating efficiencies,

and overall product distribution was enhanced by administration from the national

headquarters. Id. The Court concluded that the corporation was a "highly integrated
business which benefits from an umbrella of centralized management and controlled
interaction." Id.

^^'445 U.S. at 449.

''°Id. at 439.

'*'283 U.S. 123 (1931). See supra notes 100-07 and accompanying text.

"^02 S. Ct. 3103 (1982).
"n02 S. Ct. 3128 (1982).
'®^For a discussion oi ASARCO and Woodworth, see Floyd, The "Unitary" Business

in State Taxation: Confusion at the Supreme Court? 1982 B.Y.U. L. Rev. 465; Peters,
Supreme Court Requires Unitary Relationship Before States Can Tax Investment Income,
57 J. Tax'n 314 (1982); Seago, The Revitalization of the Unitary Business Principle—

ASARCO and Woolworth, 1 J. State Taxn 101 (1982).



1983] TAXING MULTINATIONAL CORPORATIONS 805

A. Reaffirmation of the Unitary Business Limitation: ASARCO

In ASARCO,^^^ a domestic corporation challenged a nondomiciliary

state's taxation of income received in the form of dividends, interest,

and capital gains from subsidiaries on both due process and commerce
clause grounds. The Supreme Court decided the case under due pro-
cess clause considerations only^^^ and found that the nondomiciliary

state exceeded its jurisdiction to tax this income where the business
activities of the payor subsidiaries had nothing to do with the reci-

pient parent corporation's activities in the taxing state/^^ The Court
also found the due process requirement of a rational relationship be-

tween the income attributed to the taxing state and the values at-

tributable to the state was not met.^^*
1. Facts and Lower Court Developments.—ASARCO, the parent

corporation, mined, smelted, and refined nonferrous metals in several

states. Its commercial domicile was in New York.^^^ ASARCO's primary
activity in Idaho was the operation of a silver mine, but it mined and
marketed other nonferrous metals and maintained a managerial of-

fice for the operations of its regional mining division in Idaho."" The
Court examined the taxability of income ASARCO received from
dividends, interest, and capital gains"^ from five corporations in which

it held substantial ownership interests."^

Idaho had adopted a version of the UDITPA."^ Consequently,
Idaho split corporate net income into either business income or non-

business income."* Under the Idaho statute, business income included
income from intangible property, such as interest, dividends, and

^«n02 S. Ct. 3103.

"^Id. at 3115 n.23.

"Yd at 3115. For an explanation of the two requirements to be satisfied under
the due process clause, see supra notes 24-27 and accompanying text.

"n02 S. Ct. at 3115.

"«M at 3105.
'™M Idaho calculated that approximately 2.5% of ASARCO's total business ac-

tivities took place within the state. Id.

^^^ASARCO had received other forms of intangible income during the applicable

period, but the appropriate treatment of that income for tax purposes was not at issue
before the Supreme Court. Id. at 3105 n.l. The issue was before the Idaho Supreme
Court, however, and it ruled that ASARCO's receipt of certain rents and royalties,
as well as its receipt of other dividends from another subsidiary, constituted appor-

tionable income. See American Smelting & Ref. Co. v. Idaho State Tax Comm'n, 99
Idaho 924, 935-37. 592 P.2d 39, 50-52 (1979).

^^^102 S. Ct. at 3106. During the applicable period, ASARCO owned approximately
34% to 53% of the stock in the corporations. Id. at 3106 n.2.

^''^Id. at 3106. For a discussion of the UDITPA, see supra notes 51, 55-60 and
accompanying text.

^^n02 S. Ct. at 3106.



806 INDIANA LAW REVIEW [Vol. 16:783

capital gains, when the acquisition, management, or disposition of that
property was an integral or necessary component of the corporation's
business operations."^ Idaho apportioned business income by means
of an equally weighted three-factor formula and included its propor-

tionate share of the corporation's business income in the state's tax-

able income."^ Nonbusiness income was allocated to the corporation's
commercial domicile."^

Idaho, a member of the Multistate Tax Compact, requested the
Multistate Tax Commission to audit ASARCO."^ The Commission
determined that the dividends, interest, and capital gains received

by ASARCO from its five subsidiaries constituted business income
and consequently added the amounts to ASARCO's income to be ap-
portioned, even though it also determined that the relationships of

these subsidiaries with the parent corporation were insufficient to

justify unitary treatment under a combined report."^ The state tax
commission adopted the Commission's adjustments and upheld its con-

clusions with respect to the characterization of the dividends, interest,

and capital gains of the five subsidiaries as business income. ^*°

After an adverse lower court decision, ^^^ the state tax commis-

sion appealed to the Idaho Supreme Court.^^^ In rejecting due process
and commerce clause challenges, the court reaffirmed the characteriza-
tion of the dividends, interest, and capital gains from the five sub-
sidiaries as apportionable business income of the parent corporation. ^^^

The United States Supreme Court subsequently reversed this
decision.^®'*

'''Id.

'''Id.

"Ud. "Nonbusiness" income was defined as "all income other than business in-

come." Id.

''Ud. at 3107. For a discussion of the Multistate Tax Compact and the Commis-

sion, see supra notes 61-66 and accompanying text.
^^^102 S. Ct. at 3108. For a discussion of the principles and uses of combined report-

ing, see supra notes 67-71 and accompanying text. The Commission recommended that

ASARCO and six other of its subsidiaries which it wholly owned be characterized
as a single corporation. The Commission combined ASARCO's income with the income
of the six subsidiaries and disregarded the six subsidiaries' dividend payments to the

parent corporation as intracompany accounting transfers. 102 ,S. Ct. at 3107. The pro-

priety of this treatment of the six subsidiaries was not an issue before the Supreme

Court. Id. at 3108.

'''Id. 102 S. Ct. at 3108.

^"ASARCO petitioned for review, and the state district court, in an unpublished
opinion, overruled the state tax commission's determination that the dividends, in-

terest, and capital gains of the five subsidiaries constituted business income. Id.

'^'American Smelting & Ref. Co. v. Idaho State Tax Comm'n, 99 Idaho 924, 592
P.2d 39 (1979).

''Ud. at 935-37, 592 P.2d at 50-52.

^"The Supreme Court first vacated and remanded the case for reconsideraton in
light of its decision in Mobil. ASARCO Inc. v. Idaho State Tax Comm'n, 445 U.S. 939



1983] TAXING MULTINATIONAL CORPORATIONS 807

2. The Majority Opinion. —After reaffirming the unitary business
criteria developed in Mobil,^^^ the Court examined "the way in which
the corporate enterprise is structured and operates, and . . . the rela-

tionship with the taxing state."^®^ The most likely foreign subsidiary
to be found part of a unitary business was the one in which ASARCO
owned about fifty-two per cent of the stock and which sold about
thirty-five per cent of its smelted but unrefined copper to ASARCO/^^
Idaho did not dispute, however, that a management agreement with
the other shareholders assured that ASARCO was unable to control
the subsidiary

/^^

The Court concluded that the business of the subsidiary and
ASARCO's silver mining in Idaho were inadequately connected to per-
mit unitary characterization/^^ Further, the Court found that the re-

maining four subsidiaries fell far short of meeting the criteria

necessary for unitary treatment.^^ In summary, all of those subsidiaries

were engaged in similar or related lines of business, but they were

unconnected with the taxing state. The parent corporation held
substantial minority or borderline majority capital stock interests in

the subsidiaries. The parent corporation provided some corporate ser-
vices for some of the subsidiaries and engaged in minimal business
transactions with all of them.

The state did not dispute any of the facts, but merely proposed
an expansion of the unitary business concept by arguing that corporate

purpose should be the controlling criterion for the unitary business

relationship. Thus, intangible income would be deemed a part of a
unitary business when that income related to or furthered the cor-
poration's trade or business. ^^^ The Court considered this definition
of a unitary business too broad and unacceptable because it would

transform the unitary business principle into no limitation at all.^^^

The Court found that the five subsidiaries were distinct business enter-

(1980). On remand, the Idaho Supreme Court reinstated its previous opinion. American
Smelting & Ref. Co. v. Idaho State Tax Comm'n. 102 Idaho 38, 624 P.2d 946 (1981).
The Supreme Court reversed that decision. 102 S. Ct. 3103 (1982).

i«n02 S. Ct. at 3109-11.

'''Id. at 3115 n.22.

^'Ud. at 3111-12. Another 20-30% of the subsidiary's output was sold to a similarly

owned corporation. Id. at 3111-12, 3112 n.l6.

'''Id. at 3112.

'''Id.

"'Id.

'^'Id. at 3114. The state relied upon the definition of business income in the

UDITPA, supra note 51, at § 1(a). The argument was that a relationship exists be-
tween investments and the business of the owner of the investments which, without

more, is sufficient to justify the apportionment of any income derived from the in-

vestments. See Dexter, Tax Apportionment of the Income of a Unitary Business: An
Examination o/ Mobil Oil Corp. v. Commissioner of Taxes, 1981 B.Y.U. L. Rev. 107, 119.

^^^102 S. Ct. at 3114.



808 INDIANA LAW REVIEW [Vol. 16:783

prises which had nothing to do with ASARCO's activities in Idaho/®^
Because there was no rational relationship between the dividends, in-
terest, and capital gains which had been attributed to the state and

the intrastate values of the business enterprise, the Court held that

Idaho violated the due process clause by taxing that income.^®*

3. The Dissenting Opinion. — In a strong dissent, Justice O'Connor^®^
argued that business and economic sense dictated a contrary result.

Justice O'Connor asserted that the Court erred in its finding that

ASARCO's investments were not part of a unitary business because
ASARCO failed to carry its burden of proof in at least three ways.^^^
First, ASARCO did not demonstrate that its investment decision mak-
ing was separate and apart from its expertise in the nonferrous metals
business.^®^ Second, ASARCO failed to show that its holdings in the
subsidiaries were separate and apart from its management of the finan-
cial requirements of its nonferrous metals business since ASARCO
presumptively used the foreign-source income as part of its working

capital/^® Third, the dissent argued that ASARCO's capital interest
in the subsidiaries contributed to its nonferrous metals business ad-

vantages, maintaining that ASARCO had effective operational con-
trol of at least three of the five subsidiaries. The multinational cor-
porate format provided greater stability to profits and the vertically

integrated relationship provided assured supplies of materials and
stable outlets for products.^^^

''Ud. at 3115.

''*Id. at 3115-16.

^'^Both ASARCO and Woolworth were 6-3 decisions in which Justice Blackmun
and Justice Rehnquist twice joined Justice O'Connor in the dissenting opinions. The

dissenting opinion in Woolworth, however, is quite brief in that it incorporates by

reference the rationale set forth in the dissenting opinion in ASARCO, Chief Justice
Burger filed a concurring opinion in both cases, 102 S. Ct. 3140 (1982), joining the

majority opinion written in both cases by Justice Powell in reliance on the majority's

express statement that the Court's holdings do not preclude congressional action in

this area. See 102 S. Ct. 3103, 3114 n.23.

'«n02 S. Ct. at 3119 (O'Connor, J., dissenting).

^^Yd at 3119-20. The flaw in this argument is the explanation of hoAv the parent

corporation's expertise with respect to the investments in the subsidiaries had anything

to do with the activities of the parent corporation in the taxing state.

^^^Id. at 3120-21. The dissent's perception of the facts differed from the undisputed

facts in the record. ASARCO's stock investments were not an integral part of its
business operations in Idaho. 102 S. Ct. at 3113-14 n.21.

^'n02 S. Ct. at 3121-23 (O'Connor, J., dissenting). The description of the five sub-

sidiaries as providing assured supplies and outlets is at variance with the undisputed

facts. Id. at 3114 n.21. As to the dissent's "business advantage" argument, the Court

responded in Woolworth:

Income, from whatever source, always is a "business advantage" to a cor-

poration. Our cases demand more. In particular, they specify that the proper
inquiry looks to "the underlying unity or diversity of business enterprise,"



1983] TAXING MULTINATIONAL CORPORATIONS 809

After challenging the reasoning of the majority opinion, the dis-

sent discussed what it judged to be the adverse consequences of the
majority decision. First, the dissent suggested that perhaps no state

would be able to meet due process requirements in order to include
ASARCO's investment income as such in its apportionable tax base.^°°
Second, the dissent detected a suggestion in the majority opinion that

only a domiciliary state might enjoy a constitutional preference to

tax such income.^"^ Third, the dissent argued that it was possible that
only those states in which the investment activities were conducted
could tax the income resulting from those activities.^"^ As a result,
the dissent concluded that the majority opinion had "straightjacketed"

the ability of the states to develop fair systems of apportionment

and had curtailed the state statutory developments pursuant to the

UDITPA.^"^ Finally, the dissent argued that the majority's reliance

on the due process clause, as opposed to the commerce clause, may
preempt possible congressional action.^®^

The majority opinion acknowledged the dissenting opinion's
criticism of the unitary business principle but asserted that the

analysis of the dissent relies on considerations different from those

identified as controlling in Mobil. According to the majority, Mobil

held that the income was determined to be apportionable by the states
because it was apparent that those corporations were engaged in

Mobil, 445 U.S. at 440, not to whether the nondomiciliary parent derives some
economic benefit — as it virtually always will — from its ownership of stock
in another corporation.

102 S. Ct. 3128. 3135 (citing ASARCO, 102 S. Ct. at 3113-15).
^102 S. Ct. at 3124 (O'Connor, J., dissenting). See Dexter, Taxation ofIncome From

Intangibles of Multistate-Mvltinational Corporations, 29 Vand. L. Rev. 401, 403 (1976);

McClure, Toward Uniformity in Interstate Taxation: A Further Analysis, 13 Tax Notes
51, 53 (1981). This conclusion does not necessarily follow. The business of managing

investments in the state of commercial domicile may be separate and apart from the
activities in a nondomiciliary state. The domiciliary state may have contributed to
the investment activities while the nondomiciliary state may have contributed nothing
to the investment activities. See Seago, supra note 164, at 113-14.

^''102 S. Ct. at 3124-25 (O'Connor, J., dissenting).

''Hd. at 3125-26.

^^^Id. A review of the UDITPA and the Commission's interpretation of the Act
may bear out this declaration, but it does not lend support to the implication that
the interpretation of the UDITPA which was advocated in ASARCO and Woolworth
by the states was either desirable or logical. See Peters, supra note 164, at 316.

=^°n02 S. Ct. at 3126-28 (O'Connor, J., dissenting). The majority opinion did not

address this concern: "The question of federal authority to legislate in this area—
whether to lay taxes or to delegate such power — is not presented in this case, and
we imply to view as to it." Id. at 3115 n.23. "In any event, it is difficult to understand
how the limitations placed on state taxation of income having no connection with the
taxing state could impede the Congress in the exercise of its power to regulate in-
terstate commerce." Peters, supra note 164, at 316. This can be done provided that

legislation is consistent with the ASARCO-Woolworth due process considerations.



810 INDIANA LAW REVIEW [Vol. 16:783

unitary businesses with a continuous flow and interchange of com-
mon products. These essential factors were demonstrated to be wholly
absent in this case.^°^ The majority concluded that it properly applied
the principles of Mobil but reached a wholly different result because

the facts differed in these critical ways.^°^

B. Limitations on the State Taxation of Foreign-Source

Income: Woolworth

F. W. Woolworth Co. v. Taxation and Revenue Department^'' reap-
plied the principles developed in ASARCO, but elaborated on the
parameters of the unitary business relationship and therefore provides

needed additional guidance for subsequent cases. The issues raised
in Woolworth were resolved solely by reference to due process clause
considerations. The Court held that a nondomiciliary state's taxation
of a portion of the dividend income received by a domestic corpora-

tion from foreign subsidiaries which constitute discrete business enter-

prises and which do no business in the taxing state fails to meet
established due process standards.^"*

1. Facts and Lower Court Developments. — Woolworth is engaged
in the retail merchandising business. It has chain stores located

throughout the United States and has its commercial domicile in New
York.^°^ Of relevance to this case, Woolworth received dividends from
four foreign subsidiaries, all of which are similarly engaged in chain

store retail merchandising.^^" Three of the payors are wholly-owned

and the fourth is a publicly held British corporation in which

Woolworth has a 52.7% interest.^" Woolworth elected all of- the direc-
tors of the wholly owned subsidiaries.^^^

The taxing state, New Mexico, adopted the UDITPA^^^ and is a
member of the Compact.^^^ Pursuant to its statute, the state divided
corporate income between business income,^^^ to which it applied its

2°n02 S. Ct. at 3116 n.24.

'''Id. at 3114 n.22.
'°'102 S. Ct. 3128 (1982).

'"'Id. at 3139.

'°'Id. at 3131.

'^°Id. Together, the four foreign subsidiaries paid Woolworth approximately $39.9
million in dividends.

'''Id.

'"Id. at 3134.

^^Tor a discussion of the UDITPA, see supra notes 51, 55-60 and accompanying text.
"*102 S. Ct. at 3134. For a discussion of the Multistate Tax Compact, see supra

notes 61-66 and accompanying text.
^^^"

'[BJusiness income' means income arising from transactions and activity in the
regular course of the taxpayer's trade or business and includes income from tangible

and intangible property if the acquisition, management and disposition of the prop-
erty constitute integral parts of the taxpayer's regular trade or business operations."

N.M. Stat. Ann. § 7-4-2(A) (1981).



1983] TAXING MULTINATIONAL CORPORATIONS 811

apportionment formula, and nonbusiness income,^^® which was generally
allocated on the basis of commercial domicile to a single state.^^^

Woolworth reported its foreign-source dividend income as nonbusiness

income, none of which was allocated to New Mexico.^^®
On audit, the state determined that Woolworth should have in-

eluded its foreign-source dividend income as apportionable business

income.^^^ The New Mexico Supreme Court found that the dividend
income from the subsidiaries met the statutory test for inclusion as
apportionable income^^" and held that the dividends were income

earned in a unitary business.^^^ The United States Supreme Court
reversed.^^

2. The Unitary Business Limitation on the State Taxation of
Foreign-Source Dividend Income. — The United States Supreme Court
acknowledged that Woolworth had the potential to operate its sub-
sidiaries as a single, unitary business; however, the Court found that

the New Mexico Supreme Court wrongfully resolved the constitutional
issue before it by relying too heavily on the potential ability to operate

the foreign subsidiaries as part of a unitary relationship, rather than

making its determination with reference to the actual operation of

the corporation. The Court made it clear that the potential ability
to operate a corporation as part of a unitary business is not the con-

trolling criterion when the dividend income is in fact derived from
a discrete business enterprise.^^^ For a state properly to impose a tax

on the foreign income, the Supreme Court held that the corporation
must be operated as an integrated enterprise in fact.^^^ The Court
then emphasized the factors which produce substantial mutual in-

terdependence, enumerated in Mobil, as relevant to the state taxa-

tion of foreign-source dividend income, namely: whether the activities

in the taxing state contributed to the income of the subsidiaries as

a result of functional integration, centralization of management, and

the achievement of other economies of scale arising from the opera-

tion of the business as a whole. If these factors do exist, then this

evidence of a unitary business may provide the state with the jurisdic-
tion of foreign-source dividend income, namely: whether the activities

other connections with that state.^^^

"®'"[N]onbusiness income' means all income other than business income." Id. at

§ 7-4-2(D).

^"102 S. Ct. at 3131-32.

'''Id. at 3132.

'''Id.

'''Id. at 3133. See Taxation & Revenue Dep't v. F. W. Woolworth Co., 95 N.M.
519, 624 P.2d 28 (1981).

^'^102 S. Ct. at 3133.

'"Id. at 3140.

'"Id. at 3134.

"*Id.

'"Id. at 3135.



812 INDIANA LAW REVIEW [Vol. 16:783

The Court turned to a consideration of the extent to which these
factors were present in the case and made the threshold determina-
tion that there existed little in the way of functional integration.^^®
The Court distinguished the business of retail merchandising from
the integrated multinational business of producing, processing, and

marketing a resource on a worldwide basis which involves a flow of

international trade, exchanges of personnel, and substantial mutual

interdependence.^" The Court referred to this as a ''critical
distinction"^^® and consistent with this distinction the evidence in the

case was found to show that no phase of any subsidiary's business
was an integrated operation together with the parent corporation.^^^
Each subsidiary performed independently of the parent corporation
in its ordinary course of business.^^° The parent corporation neither
provided essential corporate services for the subsidiaries nor engag-

ed in any centralized purchasing, manufacturing, or warehousing of

merchandise.^^^ Each subsidiary obtained financing from sources other
than the parent. The record persuaded the Court that, in fact, there
existed no functional integration.^^^

Next, the Court considered the extent to which there was cen-
tralized management or economies of scale. Management decentraliza-
tion was reflected in the fact that there was no interchange of per-
sonnel, no central training program, and each subsidiary was indepen-
dent and autonomous in operations and policies with regard to

retailing.^^^ The management of the foreign subsidiaries had complete
control over the business decisions affecting their operations. The
Court deemed it important that none of the parent corporation's
departments was devoted to overseeing the operations of the

""'Id.

^Id. at 3135. 3139.

"*The Court explained:

There is a critical distinction between a retail merchandising business
as conducted by Woolworth and the type of multinational business — now so
familiar — in which refined, processed, or manufactured products (or parts
thereof) may be produced in one or more countries and marketed in various
countries, often worldwide. In operations of this character there is a flow

of international trade, often an interchange of personnel, and substantial

mutual interdependence. The uncontradicted evidence demonstrates that
Woolworth's international retail business is not comparable. There is no flow
of international business. Nor is there any integration or unitary operation
in the sense in which our cases consistently have used these terms.

Id. at 3138-39 (footnote omitted).

"^Id. at 3135.

'''Id.

^'Ud. at 3135-36.

"^Ud. at 3136.

^M at 3136-37.



1983] TAXING MULTINATIONAL CORPORATIONS 813

subsidiaries.^^^ The personnel departments of Woolworth's foreign sub-
sidiaries were fully independent operations, dedicated to recruiting
and training nationals to fill positions at every level of the business.

In sum, it appeared to the Court that each subsidiary operated as

a distinct business enterprise at the level of full-time management.^^^

The Court did find that there was some centralizaton of manage-
ment. The parent corporation maintained common directors with some
of the subsidiaries.^^® There were frequent contacts in upper
management.^^^ Major financial decisions, such as the distribution of
dividends and the creation of substantial indebtedness, were subject
to the parent corporation's approval.^^® Woolworth published con-
solidated financial statements other than for tax purposes.^^ However,

the operations of the parent company were so unrelated to the opera-
tions of its subsidiaries that the stable operation of one corporation

was not important to another's full utilization of capacity.^*"
The Court, therefore, emphasized that the overriding finding of

fact was that "[e]xcept for the type of occasional oversight — with
respect to capital structure, major debt, and dividends — that any
parent gives to an investment in a subsidiary, there [was] little or

no integration of the business activities or centralization of the

management of [the subsidiaries]."^^^ On the basis of these facts, the
Court concluded that the corporations involved in Woolworth were
not part of a unitary business.^*^ Moreover, the apportionment of the

foreign-source dividend income did not bear the necessary relation-

ship to benefits afforded by the taxing state because New Mexico
attempted to reach extraterritorial values wholly unrelated to the

business of the parent corporation's retailing activities within that

state.'^^

3. Federal Tax Policy and the State Taxation of Foreign-Source

Dividends Deemed Received: Gross-Up. — The rationale and analysis
used by the Court in the resolution of the first issue carried over

to determine a similar result with respect to a second issue in

Woolworth by which the state had attempted to broaden the income

base subject to state taxation. The Court's decision on the second issue

''*Id. at 3137.

""'Id. at 3139.

""'Id. at 3137.

""Ud.

''"Id.

^^Id. at 3137-38. Neither the parent corporation nor any of the foreign subsidiaries

consolidated its federal tax return with any of the other corporations. Id. at 3137.

^'Id. at 3138.

'*'Id.

^Ud.

'*Ud. at 3139.



814 INDIANA LAW REVIEW [Vol. 16:783

spanned a mere paragraph of the opinion, but the approach taken is
illustrative of the importance to be attached to the unitary business

limitation as the primary hurdle which any state must surpass in order

to include vast amounts of other forms of foreign-source income within

apportionable income. New Mexico had reached out to include within
Woolworth's apportionable income an amount known as "gross-up,"
which attempt, for the reasons already expressed, the Court summarily

held to contravene the due process clause.^^* In order to better ap-

preciate this result, it is helpful to briefly and generally describe the

federal tax concept of "gross-up" and its characterization for state tax

purposes by both the corporation and the state.

In the allocation of income of a multinational group of corpora-

tions, the posture of the federal tax system is unlike that of the states

in its recognition of the separate source of income earned in the United

States as distinguished from income earned in foreign nations.^"^ A
member of a multinational group of related corporations is treated
as if it were an independent corporation, the income of which is sub-

ject to taxation in the nations in which it has its operations. The tax-
able income of a domestic corporation, which is a member of such
an affiliated group, is determined on the basis of elaborate separate

geographical and transactional accounting rules, that is, by means of

separately determining the income realized and the expenses incur-

red on the books of that corporation.^^^

Pursuant to this method, if the parent corporation of such a related

group of multinational corporations is a domestic corporation, the tax-

able income of the parent corporation is for most purposes determined

without regard to the income of its foreign affiliates and subsidiaries.^^^

"*3 B. BiTTKER, Federal Taxation of Income. Estates and Gifts 1 70.1 (1981); P.
POSTLEWAITE, INTERNATIONAL CORPORATE TAXATION §§ 1.01, 1.03 (1980).

'^^^B. BiTTKER & J. EUSTICE, FEDERAL INCOME TAXATION OF CORPORATION AND
Shareholders t 15.06 (4th ed. 1979). The United States Internal Revenue Service is
authorized to monitor transactions and to reallocate any income, deduction, or other

item which affects taxable income among domestic corporations and their foreign sub-
sidiaries and affiliates and, if reallocation is required, to determine the taxable income

of each corporation. See I.R.C. § 482 (1976). Thus, the federal tax system is based on

a separate accounting approach. See generally, G.A.O. Report-IRS, supra note 4; Note,

Multinational Corporations and Income Allocation Under Section 4^2 of the Internal
Revenue Code, 89 Harv. L. Rev. 1202 (1976).

^"In conjunction with the separate acounting rules are the source rules for the

determination of the extent to which items of income are to be characterized as derived

from domestic sources or from foreign sources. P. Postlewaite, supra note 245, at

§§ 2.01-2.27. Another mechanism exists for calculating the amount of foreign-source in-

come. I.R.C. §§ 861-864 (1976 & West Supp. V 1981). The qualified separate accounting
approach is incorporated in the model convention proposed by the Organization for

Economic Cooperation and Development (OECD) of which there are 24 members, in-

cluding the United States. See OECD Model Convention, 1 Tax Treaties (CCH) 1 151.
The United States Treasury Department's Model Income Tax Treaty also adopts the



1983] TAXING MULTINATIONAL CORPORATIONS 815

Federal taxation of the income of the foreign subsidiaries is deferred

until the parent corporation receives a dividend or is deemed to
receive a dividend from the subsidiaries.^*® Double taxation is avoided

by granting to domestic corporations credits against income taxes paid

to foreign governments on the earnings which constitute the dividends

from the subsidiaries to the parent corporations.^^ The qualified

separate accounting approach, domestic income tax deferral, and

credits against other income taxes may be the three basic principles
of the federal system with respect to the taxation of the income of

related corporations.^^"

The allowance of a tax credit for inter-corporate dividends among
such related corporations is an important mechanism in the federal

tax system. In some cases, foreign tax credits may be the combina-
tion of foreign income taxes actually paid by the domestic corpora-

tion and those taxes which are deemed paid by statutory formula as
well.^^^ Under the statutory scheme of the Internal Revenue Code,
section 901 authorizes the election to take a credit for foreign income

qualified separate accounting approach and resembles the OECD Model Convention.
See Model Income Tax Treaty, 1 Tax Treaties (CCH) If 158 (June 16, 1981).

^"G. HuFBAUER & D. Foster, U.S. Taxation of the U>fDisTRiBUTED Income of Con-
trolled Foreign Corporations 1-63 (Tax Policy Research Study No. 3, Essays in Inter-

national Taxation: 1976, 1976). Exceptions to deferral are found in I.R.C. §§ 951-964

(West 1982 & West Supp. 1983) (shareholders currently taxed on income of a controlled
foreign corporation in certain situations), and in I.R.C. §§ 551-558 (1976) (foreign

personal holding companies).

^'^^I.R.C. §§ 901-904 (West 1982 & West Supp. 1983). For a lengthy analysis of the
foreign tax credit, see E. Owens, The Foreign Tax Credit (1961). For a more concise
explanation, see Dale, The Reformed Foreign ToCx Credit: A Path Through the Maze,
33 Tax L. Rev. 175 (1978). See also Ad Hoc Committee on Foreign Tax Credit, ABA Tax
Section, Comments Regarding Proposed Foreign Tax Credit Regulations, 33 Tax Law.
35 (1979). The rationale of the foreign tax credit was explained as follows:

[The] foreign tax credit system embodies the principle that the country in

which a business activity is conducted (or in which any income is earned)

has the first right to tax the income arising from activities in that country,

even though the activities are conducted by corporations or individuals resi-

dent in other countries. Under this principle, the home country of the in-
dividual or corporation has a residual right to tax income arising from these

activities, but recognizes the obligation to insure that double taxation does

not result. Some countries avoid double taxation by exempting foreign source
income from tax altogether. For U.S. taxpayers, however, the foreign tax-

credit system, providing a dollar-for-dollar credit against U.S. tax liability

for income taxes paid to a foreign country, is the mechanism by which double

taxation is avoided.

Joint Committee on Taxation 234, 1976-3 C.B. 246; see Surrey, Current Issues in the
Taxation of Corporate Foreign Investment, 56 Colum. L. Rev. 815 (1956).

^^Surrey, Reflections on the Allocation of Income and Expenses Among National
Tax Jurisdictions, 10 Law & Pol'y in Int'l Bus. 409, 415-16 (1978); see also G.A.O.
Report-1982, supra note 3, at 32; Hellerstein, supra note 71, at 162-63.

^"B. BiTTKER, Federal Taxation of Income, Estates and Gifts t 69.2.1 (1981).



816 INDIANA LAW REVIEW [Vol. 16:783

taxes.^^^ Section 901(a) provides for a credit for taxes deemed to have
been paid pursuant to section 902. Under section 902(a), a domestic
corporation which has received a dividend from a foreign subsidiary

will be deemed to have paid any foreign taxes paid by the foreign
subsidiary with respect to the earnings from which the dividend is

distributed.^^ This credit may be computed by multiplying the foreign
taxes of the subsidiary by a fraction which consists of dividends

received over the after-tax profits of the foreign subsidiary
.^^*

If a domestic corporation elects to take advantage of this foreign

tax credit, then Internal Revenue Code section 78 requires that the

domestic corporation include in gross income an amount equal to the
deemed-paid tax credit computed pursuant to section 902(a), which

amount is to be treated as a dividend received by the domestic cor-
poration in addition to the amount of the dividend actually received
from the foreign subsidiary.^^^ This procedure with respect to the

augmentation of foreign-source dividend income is commonly refer-
red to as "gross-up".®* Although the amount of gross-up is never ac-

^^^Geen & Schreyer, Foreign Tax Credit-Qualification and Computation, 5-4th Tax
Mgmt. A-3 (1979).

^^^See generally, R. Rhoades, Income Taxation of Foreign Related Transactions

§ 5.06[2] (1982); E. Owens & G. Ball, The Indirect Credit (1976). The amount of taxes
deemed paid by the domestic corporation is the proportion of the foreign taxes on
accumulated profits which the amount of the dividend bears to the accumulated pro-
fits in excess of the foreign taxes. Geen & Schreyer, supra note 252, at A-31 to A-32.
The "accumulated profits" of the foreign subsidiary are the pre-tax profits without
reduction for the foreign taxes. I.R.C. § 902(c)(1) (1976); Treas. Regs. §§ 1.902-l(e), 1.902-l(f)

(1980). See Schoenfeld, Some Definitional Problems in the Deemed Paid Foreign Tax
Credit of Section 902: "Dividends" and "Accumulated Profits", 18 Tax L. Rev. 401 (1963);
see also Rev. Rul. 71-65, 1971-1 C.B. 212 (treatment of dividends in kind for purposes

of the § 902 credit computations).

"^B. Bittker & J. Eustice, supra note 246, at 1 17.11. See Geen & Schrever, supra
note 252, at A-32. In American Chicle Co. v. United States, 316 U.S. 450 (1942), the
Court held that for purposes of computing the credit, "accumulated profits" of the

foreign subsidiary were to be defined as the foreign subsidiary's total pre-tax profits

less the foreign income taxes. For a description of this outdated approach, see R.

Rhoades, supra note 253, at §§ 5.06[4]-[5]. The American Chicle rule was criticized because

it did not avoid the allowance of what would otherwise amount to both a deduction
and a credit for the foreign taxes. This led to the enactment of the gross-up provision.

See I.R.C. § 78 (1976); Geen & Schreyer, supra note 252, at A-31 to A-32.
^^^The tax base for the domestic corporation is the actual dividend plus the divi-

dend deemed received under I.R.C. § 78 (1976). See R. Rhoades, supra note 253, § 5.06[7],
at 5-142 & n.86. Under Proposed Regulations § 1.902-3(d)(l)(ii), the dividend deemed
received is treated as being received by the parent corporation from the same foreign
subsidiary as was the actual dividend. Id. The § 78 dividend is treated as a dividend
for practically all purposes of the Internal Revenue Code. Id. § 5.06[7].

^^For a thorough description of the concept of "gross-up," see R. Rhoades, supra

note 53, at § 5.06[7], together with other related sections contained in the text in con-

nection therewith; see also B. Bittker, supra note 251, at f 69.2. Woolworth provided



1983] TAXING MULTINATIONAL CORPORATIONS 817

tually received, it is deemed as having been received by the domestic
corporation from the foreign subsidiaries for purposes of claiming the

foreign tax credit.^^^

The second issue raised in Woolworth concerned the apportion-
ment of the gross-up dividend income deemed received by the parent
corporation from its foreign subsidiaries.^^® Woolworth did not report
the federal gross-up amount as New Mexico business income.^^® On
audit, the state took the position that gross-up is business income sub-

ject to apportionment.^*" The state court of appeals disagreed with
the characterization of gross-up as business income and excluded the

amount from apportionable income.^^^ The New Mexico Supreme Court
rejected the corporation's constitutional challenges to the inclusion

of the gross-up amount in apportionable income^*^ and also rejected
the corporation's contention that the apportionment formula should

be adjusted if the dividend income were found to be apportionable.^*^

The United States Supreme Court determined that the foreign
tax credit of Woolworth related to the taxation by foreign countries

the following example illustrating the foregoing methods:

"If a foreign subsidary of a United States parent earns $100, pays foreign

tax of $40, and pays a dividend of $30 out of its after-tax profits of $60 the

deemed paid foreign tax credit of the parent under section 902(a) is 30/60

X $40, or $20. The parent includes $50 in dividend income (i.e., the actual
dividend of $30 plus $20 of "gross-up") and claims a foreign tax credit of

$20 against the federal income tax on this income."

Woolworth, 102 S. Ct. at 3132 n.6. Another good example may be found at Geen &
Schreyer, supra note 252, at A-32.

'^''Woolworth, 102 S. Ct. at 3132. The Court reasoned that the "gross-up computa-

tion is a figure that the Federal Government 'deems' Woolworth to have received

for purposes of part of Woolworth's federal foreign tax credit calculation." Id. at 3139.

The Court looked to the legislative intent in its analysis. Id. A possible inference from
this reasoning is that gross-up may not be construed to be a dividend for state tax
purposes in any event.

^^®This issue had been raised earlier in Vermont by Woolworth. F. W. Woolworth

Co. V. Comm'r of Taxes, 133 Vt. 93, 328 A.2d 402 (1974); F. W. Woolworth Co. v. Comm'r
of Taxes, 130 Vt. 544, 298 A.2d 839 (1972); see also, Mobil, 445 U.S. at 433 n.9 (the

gross-up issue was not considered by the Court).

^^^The magnitude of the item of gross-up and the substantial effect of its inclusion

in apportionable income is illustrated by this case. Woolworth calculated $25.5 million

of gross-up. This figure, together with the $39.9 million in actual dividends from

Woolworth's four subsidiaries and a $1.6 million foreign exchange gain, increased the

parent corporation's apportionable income from $86,622 to $401,518. 102 S. Ct. at 3132.

^^°Id. The State of New Mexico does not permit a deemed paid tax credit or other
credit similar to the federal tax credit. In fact, no states grant a credit similar to

the federal tax credit and most states do not allow a deduction so as to avoid any

resultant double taxation. See G.A.O. Report-1982, supra note 3, at 41.

2"^. W. Woolworth Co. v. Bureau of Revenue, 95 N.M. 542, 543-44, 624 P.2d 51,
52-53 (N.M. Ct. App. 1979), rev'd, 95 N.M. 519, 624 P.2d 28 (N.M. 1981).

=^"='102 S. Ct. at 3133-34.

'•^M at 3134 n.9.



818 INDIANA LAW REVIEW [Vol. 16:783

of the parent corporation's foreign subsidiaries, each of which operated

a discrete business enterprise. Therefore, the attempt by the state
to tax this gross-up was unconstitutional, especially since New Mex-
ico contributed nothing to the activities of the foreign subsidiaries.^®*

Nevertheless, it remains somewhat uncertain whether gross-up income
deemed received for federal foreign tax credit purposes may be ap-
portionable income for state tax purposes in the case of a unitary
business relationship where a state has a deemed-paid foreign tax

credit similar to the federal rules. Further, a question may still re-
main as to whether the parent corporation's state of commercial

domicile may treat the entire gross-up figure as dividends deemed
received for its state tax purposes.

C. Summary Comment on ASARCO and Woolworth

The contribution of Woolworth and ASARCO is the recognition
of the extent to which the existence of a substantial mutual in-

terdependence between the parent corporation and its foreign sub-
sidiaries plays in determining whether due process considerations pro-
hibit the state taxation of foreign-source income. The Supreme Court,
in ASARCO and Woolworth, examined the way in which the corporate
enterprises were structured and operated, employed sound economic
analysis in discerning the relationship of the enterprise with the tax-

ing state, and adopted identifiable criteria for the determination of

whether an enterprise is unitary. The Court has established the rule
that a nondomiciliary taxing state cannot subject foreign-source in-

come to an apportionment formula unless the parent corporation and
its foreign subsidiaries foster such substantial mutual interdependence

that they constitute a unitary business under the criteria reiterated

by the Court. It would not be fair to render the application of for-

mula apportionment to the receipt of income arising out of mere
passive investments, such as those in ASARCO, or in connection with
distinct business operations, such as those in Woolworth. Nevertheless,

there remain questions as to the relative importance of each of the

constituent criteria used to define the unitary business relationship

and as to the importance of the matrix of facts and assumptions which

may relate to these criteria.
ASARCO had argued that functional integration between a payor

subsidiary and a recipient parent corporation should be the "bright

line" criteria for a nondomicilary state's application of formula appor-

tionment to the income received by that parent corporation from the

subsidiary .^^^ In the past, however, the Court had upheld the applica-

''*Id. at 3139.

'''See Brief for Appellant at 13, ASARCO, 102 S. Ct. 3103.



1983] TAXING MULTINATIONAL CORPORATIONS 819

tion of the unitary business/formula apportionment method not only

to vertically integrated enterprises but also to a series of vertically

integrated enterprises which operated separately in several different

jurisdictions and which were linked by managerial or operational

resources that resulted in a sharing or exchange of value and other

economies of scale among the enterprises.^^^ Substantial mutual in-
terdependence, then, may exist among related corporations in the
absence of a vertically integrated enterprise and, as such, render the

related corporate group a unitary business. In ASARCO and
Woolworthy the Court determined that a unitary business relationship

did not exist where there was neither functional integration nor
substantial mutual interdependence among related corporations.
Although the ASARCO and Woolworth decisions set forth anii reaf-
firm some important taxation principles, their holdings are necessar-
ily limited to the Court's rigorous examination of the facts presented

in each case. The decisions seemed to be decided primarily upon the
factual record rather than upon innovations in the legal principles of

state corporate income taxation.

A description of the relationship between Woolworth and its
foreign subsidiaries provides a useful factual paradigm with respect

to which a corporate taxpayer may look for guidance to determine
whether dividend income or other types or forms of income from its

subsidiaries are derived from unrelated business activities. The fact
that the foreign subsidiaries engaged in essentially the same business
as the parent corporation, that major financial decisions of the sub-

sidiaries were subject to the approval of the parent corporation, that
there existed interlocking directorates, and that there were exchanges
of information and the potential for control in which all of these fac-

tors may result did not by themselves warrant characterization as
a unitary business. The operations of the foreign subsidiaries were
decentralized to such an extent that the activities of each within each

particular country were so integrated and self-sustaining as to be
separate and apart from the operations of the parent corporation.^^^

There was seemingly no transfer of products between the parent cor-
poration and its subsidiaries, and the personnel departments of the

foreign subsidiaries were independent operations.^*® Thus, "no phase
of any subsidiary's business was integrated with the parent's."^*^

Woolworth and ASARCO could have been read to stand for the

'^'Butler Bros. v. McColgan, 315 U.S. 501 (1942). See supra notes 108-16 and ac-
companying text, See Container Corp. of America v. Franchise Tax Board, 103 S.
Ct. 2933, 2941 (1983).

'''Woolworth, 102 S. Ct. at 3135-36.

'''Id.

'''Id. at 3135.



820 INDIANA LAW REVIEW [Vol. 16:783

proposition that, in the case of a group of related domestic and foreign
corporations which is not vertically integrated, a finding of a unitary
business would be impermissible without a flow of international trade
among the related corporations. As we have seen, prior decisions of
the Court which involved unitary apportionment within the domestic
context had been cases in which there had been a substantial flow
of goods and services among vertically integrated entities."" In the
most recent decision of the Supreme Court, however, this point was
further clarified by stating that the degree of substantial mutual in-
terdependence necessary to justify taxation can arise in a number
of different ways. The important criteria is that there be a sharing
or exchange of value, not simply a flow of trade.

VII. State Taxation of the Worldwide Combined Income of
A Multinational Enterprise: Container

Container Corp. of America v. Franchise Tax Board^'^^ is the first
decision of the United States Supreme Court to address the constitu-
tional considerations arising out of the application of worldwide com-

bined reporting to the income of a domestic corporation and its foreign

subsidiaries. As we have already noted,"^ however, the concepts of
"unitary business" and ''formulary apportionment" play a central role

in the combined reporting scenario. So in this fundamental sense the

application of combined apportionment to a worldwide enterprise does

not differ radically from the approach taken by the states in previous

cases before the Court; rather, it is logically consistent with the

unitary business/formula apportionment approach."^ One of the
distinguishing features of this form of apportionment is the composi-

tion of taxable income. Generally speaking, instead of including foreign-

source income such as dividends from the subsidiaries in the parent

corporation's apportionable tax base, combined reporting includes the

income realized from the operations of the foreign subsidiaries

themselves, and excludes intercorporate dividends so as to avoid

double inclusion of that income in the corporation's tax base."^ Another

distinguishing characteristic of combined reporting, which necessari-

ly parallels the composition of taxable income, is in the taxing state's

calculation of its apportionable share of the net income of the related

""See, e.g., Exxon Corp. v. Dep't of Revenue. 447 U.S. 207 (1980) (continuous pro-
duct flow in domestic context constituted unitary enterprise where it was a highly
integrated business); Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978) (integrated manufac-
turing and distribution of feeds).

"'103 S. Ct. 2933 (1983).

^^See supra notes 67-71 and accompanying text.
""103 S. Ct. at 2941.

"Vd at 2942 n.5.



1983] TAXING MULTINATIONAL CORPORATIONS 821

domestic and foreign corporations. The standard three-factor appor-
tionment formula includes the property, payroll, and sales of the

foreign subsidiaries. Irrespective of these formal variations, one might

easily infer that the due process and foreign commerce clauses were
once again invoked and applied to the facts of this case.

A. Background of the Case

Container was engaged in the production and distribution of paper-
board packaging. The operation of the corporation was vertically in-
tegrated and largely domestic."^ Container controlled several wholly-

owned and partially-owned overseas subsidiaries.^^^ In most instances,
the subsidiaries were fully integrated and were engaged in essentially
the same line of business as the domestic corporation in their local
markets. The subsidiaries purchased only small amounts of materials
from the domestic corporation.^'^ Although day-to-day management and
personnel matters were handled by the subsidiaries, the domestic cor-
poration had five persons assigned to overseeing the subsidiaries'

operations.^'® Those officers addressed long-term decisions and pre-
scribed profitability and ethical standards.^'® Container held or

guaranteed much of the long-term debt of the subsidiaries, provided
advice in several areas, and occasionally aided in the acquisition of

equipment.^*"

Container was doing business in California which had a corporate
franchise tax geared to income.^®^ The corporation initially calculated
its tax liability to the state based on an apportioned share of its net

income without regard to any income attributable to the foreign

subsidiaries.^®^ The state insisted that the corporation should have
characterized its foreign subsidiaries as part of a unitary enterprise

"7d. at 2943.

"'Container's ownership interest in the subsidiaries ranged between 66.7% and

100%. Id.

"^Such transactions amounted to approximately one percent of the subsidiaries'
total purchases. Id.

'''Id. at 2943-44.

'''Id. at 2944.

'""Id.

*"The California tax statute at issue was in large measure similar to most of the

statutes discussed earlier in this article. The statute derived most of its relevant pro-
visions from the UDITPA. See supra notes 51-60 and accompanying text. The appor-
tionment formula which California adopted was the standard three-factor formula. See

supra note 50. California's corporate franchise tax was measured by net income. The

California method of apportionment is explained in Keesling & Warren, The Unitary
Concept in the Allocation of Income, 12 Hastings L.J. 42, 43 (1960).

"^103 S. Ct. at 2944. Container also deducted all dividends and other non-business

income as authorized by state law. Id. at 2945.



822 INDIANA LAW REVIEW [Vol. 16:783

and not merely as passive investments.^^^ The state's calculations in-
creased the corporation's tax liability .^^* Container commenced a re-
fund action, the parties submitted the case to the trial court on

stipulated facts, and the court upheld the additional assessment. The
state court of appeals affirmed, finding that Container and its overseas

subsidiaries constituted a unitary enterprise, and the California

Supreme Court declined review.^®^
In the United States Supreme Court, Container challenged the tax-

ation of the worldwide combined income of the multinational corporate

group on three major grounds.^^^ First, the nondomiciliary state was
precluded from the application of combined apportionment because

the domestic corporation and its subsidiaries and affiliates operating

abroad do not constitute a unitary enterprise for tax purposes. Sec-

ond, the three-factor combined apportionment formula used by the

state misapportions income to the domestic corporation thereby

resulting in extraterritorial taxation in contravention of the due pro-

cess requirement of fair apportionment. Third, worldwide combined

reporting is inconsistent with the qualified separate accounting ap-

proach used by the federal government and other foreign governments

and results in multiple taxation which impairs federal uniformity

thereby violating the foreign commerce clause.

B. Due Process Considerations

1. The Propriety of the Unitary Business Determination. —On the
threshold issue, the Court concluded that the state properly applied

the unitary business principle to the multinational corporate group.

In reaching this conclusion, the Court stated that it would, "if

reasonably possible, defer to the judgment of the state courts in

deciding whether a particular set of activities constitutes a 'unitary

business.' "^*^ The Court declared that since the constitutional limita-
tions on the unitary business principle are well-established and the

factual records in the cases tend to be long and complex, the role

of the Court is not to engage in de novo adjudications, but rather

"to determine whether the state court applied the correct standards
to the case; and if it did, whether its judgment 'was within the realm
of permissible judgment.'

"^**

^^Id. at 2945. California's unitary treatment of multi-corporate enterprises is dis-

cussed in Keesling & Warren, supra note 281, at 57.
^^'See 103 S. Ct. at 2945 n.ll for a detailed accounting and explanation of the

net effect of the adjustments on the corporation's tax liability.

^''Ud. at 2945.

^"'/d at 2939.

^'Ud. at 2945.

'«*M at 2946 (quoting Norton Co. v. Dep't of Revenue, 340 U.S. 534, 538 (1951)).

The Court noted that the approach which it previously used in ASARCO and Woolworth
is consistent with this standard of review. 103 S. Ct. at 2946 n.l5. In ASARCO the



1983] TAXING MULTINATIONAL CORPORATIONS 823

Container made three claims that the state court was incorrect
in its particular application of the legal principles. First, Container

claimed that the state court, like the state court in Woolworth, erred

in its reliance upon the corporation's potential ability to control the

operations of the foreign subsidiaries.^®^ The Supreme Court disagreed,
finding that the state court had relied principally on the fact that

certain officers of the parent corporation established standards of com-

pliance for the subsidiaries.^^" The Court noted that even though the
potential ability to control a subsidiary is not a dispositive factor in

finding a unitary business, it is a relevant factor.^^^ Second, Container

argued that the state court incorrectly relied on a presumption that

related corporations engaged in the same business are unitary. Because
this presumption was only one factor among many considered by the
state court, the Supreme Court found its limited use reasonable. The
Court reasoned that when related corporations are engaged in essen-
tially the same line of business, these activities increase the probability

of better utilization of existing business resources through operational

integration or economies of scale.^®^ Third, Container argued that a

substantial flow of goods between the parent corporation and its sub-
sidiaries should be a prerequisite to a determination of a unitary

business. While such a test may be sensible as an administrative policy
matter, the Court could perceive of no reason to impose the test on

the states as a constitutional requirement.^^^ The Court stated that
the constitutional requirement for finding a unitary business is not

a substantial flow of goods, but a more wide-ranging flow of value
which results from "functional integration, centralization of manage-
ment, and economies of scale.*'^** Although a substantial flow of goods
is one of the means in which substantial mutual interdependence
among related corporations can result, it is not the sole means.^®^

The state court's judgment that the multinational corporate group
constituted a worldwide unitary enterprise was guided by several
factors.^^ Two of those factors were given special attention by the
Court.^^^ First, there existed a flow of capital resources through

substantial loans and guarantees from the parent corporation to the

Court relied on factual findings made by the state courts that a unitary business find-

ing was impermissible. Id. The Court in Woolworth examined the evidence and con-

cluded that the state court made critical errors in both the conclusions it drew and

the legal principles it applied. Id.

"'See supra text accompanying note 223.
'««103 S. Ct. at 2946.

""'Id. at 2946 n.l6.

^7d at 2947.
"»/d at 2947 n.l7.

^Id. at 2947 (quoting Woolworth, 102 S. Q. at 3135 (quoting Mobil, 445 U.S. at 438)).

"n03 S. Ct. at 2947.

^Id. at 2947-48.

^•Vd at 2948 n.l9.



824 INDIANA LAW REVIEW [Vol. 16:783

subsidiaries which resulted in a flow of value.^^* The Court pointed
out that those capital transactions served an operational function and

not merely an investment function.^^® Second, the parent corporation

played a managerial role in the affairs of its subsidiaries which was
"grounded in its own operational expertise and its overall operational
strategy."*'" Even though day-to-day management of the subsidiaries
was handled by local executives,^"^ the Court noted that merely decen-
tralizing the everyday management responsibilities would not prevent
the finding of unitary business.^"^ Based on these factors, the Court

found that Container came closer to presenting a functionally in-
tegrated enterprise than either ASARCO or Woolworth.^^^ These fac-
tors, taken in combination, convinced the Supreme Court that the state
court reached a conclusion within the realm of permissible judgment,

and, therefore, the state was entitled to tax the multinational cor-
porate group as a single unitary entity .^°^

2. The Fairness of the Apportionment Formula. — The Constitu-
tion requires that the state apply a fair formula which apportions the

income of the business, if the state determines that a particular set

of activities produces a unitary enterprise.^'^^ Container challenged the

application of the standard three-factor apportionment formula to the

foreign operations of its subsidiaries, claiming that a disproportionate

result occurred because the foreign operations were significantly more
profitable than the domestic operations of the parent corporation.^"^

This, claimed Container, resulted in the allocation of an inflated amount

of income to its apportionable tax base.^"^ Container maintained that

this result was compounded by the fact that wage rates, one of the
three factors of the formula, were substantially lower in their foreign

2^*Approximately half of the long term debt of the subsidiaries was either held

directly or guaranteed by the parent corporation. Id. at 2944. There was no indication

that the loans and guarantees were conducted at arm's length and it is likely that

they were part of an effort to ensure multinational corporate expansion and integra-

tion. Id. at 2948 n.l9. Also, capital expenditures of the subsidiaries were subject to

the approval of the parent corporation. Id. at 2944.

^^Id. at 2948 n.l9. Cf. Hellerstein, State Income Taxation ofMultijurisdictional Cor-

porations, Part II: Reflections on ASARCO and Woolworth, 81 Mich. L. Rev. 157, 180-83
(1982) (income from transactions in capital investments which are integrally related

to the taxpayer's business activities in the taxing state should be appropriate for in-

clusion in the recipient's apportionable tax base).

^'"'103 S. Ct. at 2948 n.l9.

'''Id. at 2943-44.

'"^Id. at 2948 n.l9 (citing Exxon Corp. v. Dep't of Revenue, 447 U.S. 207, 224 (1980)).

^"n03 S. Ct. at 2947-48.

'''Id. at 2948.

'°^Id. at 2942. See supra text accompanying notes 24-27, 44, 47.

'nOS S. Ct. at 2948.

''Ud. at 2949.



1983] TAXING MULTINATIONAL CORPORATIONS 825

operations.^°® As a result, the income earned on the books of foreign
subsidiaries which have lower production costs and greater profitabil-

ity is apportioned to the taxable income of domestic corporations which

have higher production costs or lesser profitability.^"* As evidence in
support of this argument, Container presented various statistical data

comparing wage rates, productivity, and profitability in domestic
operations with foreign operations in the multinational corporate

group.^^°

The Supreme Court held that the application of the standard three-
factor apportionment formula to the combined income of the multina-

tional corporate group was fair because Container had failed to
demonstrate that the income attributed to the taxing state was "out
of all appropriate proportion to the business transacted in that State."^"

Container's argument and its supporting evidence were predicated on

a variation of separate geographical accounting. The Court restated
that separate geographical accounting suffers from weaknesses that

justify the use of formula apportionment, including the potential failure

to "account for contributions to income resulting from functional in-

tegration, centralization of management, and economies of scale."^^^

Although the three-factor formula is necessarily imperfect, the

Court found it consistent in the sense that the payroll, property, and

sales factors taken in combination appear to reflect a large share of

income-generating activities.^^^ There is a substantial margin of error

inherent in any method which attributes income among the components
of a unitary enterprise. The Court concluded that Container had failed
to demonstrate that the margin of error inherent in the three-factor

apportionment formula was significantly greater than the margin of
error inherent in the formal geographical or transactional accounting

method.^^*

'°'Id.

^"^This effect of combined reporting is illustrated by the following simplified ex-
ample. P corporation has a domestic operation solely within the taxing state. Its foreign
subsidiary, 5 corporation, operates solely in another country. Assuming that both cor-
porations have equal payroll, property, and sales, combined apportionment would com-

bine the total income of both corporations and apportion 50% of the combined income
to each corporation. The same analysis would apply where S corporation realized earn-
ings of $10 million and P corporation incurred an operating loss of $5 million. In this
situation the taxing state would apportion $2,500,000 of income to P corporation and
impose a tax on that income.

'^"103 S. Ct. at 2949.

^"/d. at 2948 (quoting Hans Rees' Sons, Inc. v. North Carolina ex rel. Maxwell,
283 U.S. 123, 135 (1931)).

'^'103 S. Ct. at 2948-49 (quoting Mobil, 445 U.S. at 438).

^^n03 S. Ct. at 2949.

^"M at 2949-50. The statistical evidence presented by Container demonstrated
that the income taxable under the separate accounting method was 14% less than the
combined apportionment method, a "far cry" from the 250% difference present in Hans
Rees* Sons, Inc. v. North Carolina ex rel. Maxwell, 283 U.S. 123 (1931). 103 S. Ct. at 2950.



826 INDIANA LAW REVIEW [Vol. 16:783

C. Foreign Commerce Considerations

The separate accounting method for taxing domestic owned enter-
prises operating abroad is the method used by the federal govern-
ment and is the internationally accepted standard.^^^ Under this
method, related foreign and domestic corporations are treated as if

they are separate and independent entities dealing with each other

at arm's length.^^® Container argued that the commerce clause com-
pelled California to utilize that separate accounting, arm's-length

method in determining the corporation's tax obligations.^^^ Because the

domestic corporation and its subsidiaries formed an international

unitary business, the Court analyzed the state tax under the two ad-
ditional commerce clause considerations announced in Japan Line, Ltd.

V. County of Los Angeles.^^^ The Court examined, first, whether the
tax increases the risk of multiple taxation and, second, whether the
tax interferes with needed federal uniformity.

The Court acknowledged that actual double taxation resulted
under the facts in Container, but found that double taxation is not

inevitable in all cases involving the simultaneous use of worldwide

unitary apportionment and arm's-length allocation.^^^ Furthermore,

because there are substantial differences among the allocation rules
applied by the various taxing jursidictions which have adopted the

arm's-length approach, compelling the state to adopt that approach

would not necessarily avoid double taxation.^^" The Court was unwill-
ing to require the state to adopt one allocation method over another
where double taxation was a possibility under both.^^^

On the second commerce clause consideration, the Court found
that the state tax did not impair federal uniformity for it neither im-

plicated foreign policy issues nor violated a clear federal directive.

Although a finding that the state tax might lead to foreign retalia-

tion would raise foreign policy issues,^^^ the Court identified three fac-

tors that weighed strongly against such an implication.^^^ First, the

^^^03 S. Ct. at 2950.

^'^Id. at 2952.

''Ud. at 2939.

'^*441 U.S. 439 (1979). See supra notes 20-21 and accompanying text.
^^^03 S. Ct. at 2954.

''°Id. at 2953-55.

^^^Id. at 2954-55. The Court distinguished Japan Line on several grounds. First,
it involved a property tax instead of an income tax. Id. at 2952. Second, the state

tax at issue in that case inevitably resulted in double taxation. Id. Finally, the in-

cidence of the property tax fell on foreign rather than domestic corporations. Id. The
Court recognized the difficulty of avoiding double taxation when allocating income
among various taxing jurisdictions and called the task similar "to slicing a shadow."
Id. at 2954.

''Ud. at 2955.

'''Id. at 2955-56.



1983] TAXING MULTINATIONAL CORPORATIONS 827

tax did not automatically result in international double taxation. Sec-

ond, the legal incidence of the tax fell on a domestic corporation and

not a foreign corporation.^^^ Third, the amount of tax paid by the cor-
poration was more a function of the state's rate of taxation than it
was of its allocation method. Finally, the Court refused to find that
the state tax was preempted by federal statutes, or inconsistent with
federal policy.^^^

D. Summary Comment on Container

One might argue that there are some endeavors in which a careful
disorderliness is the best method. One such endeavor is the applica-
tion of formula apportionment to purported unitary enterprises. The
endeavor is careful not to step upon the limits of a constitutionally
acceptable application. There is also a certain disorderliness to this

endeavor because the states have adopted various apportionment for-

mulas which strive to reach as much of the corporate income as possi-
ble. Container will cause apprehension among some corporate tax-
payers in regard to both their compliance with a variety of state tax

statutes and the possible multiple taxation of the same income. After
Container^ a state may elect two ways to tax the foreign-source in-

^^^The Court acknowledged that the imposition of a tax on a corporation with

a domestic domicile may lead to less significant foreign retaliation than in the case
of a domestic corporation owned by foreign interests. The Court did not decide whether
such a case would require it to alter its analysis. Id. at 2956 n.32.

^^^Id. at 2957, The dissent in this 5-3 decision did not consider whether in Con-

tainer the taxpayer and its subsidiaries constituted a unitary business or whether

the apportionment formula was fair because they found the California tax unconstitu-

tional on foreign commerce clause grounds. Justice Powell was joined by Chief Justice

Burger and Justice O'Connor in a dissenting opinion which viewed the state tax as

clearly violating the foreign commerce clause. The principles which were enunciated

in Japan Line, the dissent argued, should be controlling in this case because the facts
in Japan Line were identical on the issues of double taxation and federal uniformity.

Id. See supra notes 20-21 and accompanying text. The dissent maintained that double

taxation is inherently inevitable because California had rejected the international norm

in favor of a system which was fundamentally different in its basic assumptions. The
risk of double taxation under the separate accounting, arm's length approach was said

to be the result of disagreements in application only and not of structural differences

as with unitary apportionment. 103 S. Ct. at 2958-59. On the issue of federal uniform-
ity, the dissent maintained that the California tax is flatly inconsistent with federal

policy. Id. at 2961. Therefore, the dissent concluded that the California tax violated

the foreign commerce clause on both requirements under Japan Line and should be

declared unconstitutional. Id. The dissent pointed out that the majority opinion did

concede that the California tax had resulted in double taxation and that its decision

ran contrary to the federal government's preference for the arm's length method adopted

by the international community. Id. at 2957. As such, the dissent claimed that the
majority failed to meet the requirements which a standard of review of close scrutiny

demands in such a case under the foreign commerce clause. Id.



828 INDIANA LAW REVIEW [Vol. 16:783

come of a domestic corporation. First, it may tax the dividends, in-
terest, or capital gains received by a corporation doing business in
the taxing state from its overseas affiliates. Second, it may tax the
income of the overseas affiliates as a portion of the total combined

income of a multinational corporate group, provided that the state

properly determines the scope of the unitary enterprise and fairly

apportions the income. With either approach, the income of the foreign
corporation is indistinguishable from any other income of the domestic

corporation when subjected to formula apportionment.
The equally weighted three-factor formula widely used by the

states was not only approved by the Court in Container, but has
become "something of a benchmark against which other apportionment
formulas are judged."^^^ Because an apportionment formula must bear
a reasonable relation to all of the activities generating the income

of a multinational enterprise, foreign property, payroll, and sales should

be included in the equally weighted three-factor formula when
calculating the state's share of the income of a multinational enter-

prise. The formula used in Container included property, payroll, and
sales of the foreign subsidiaries, but the absence of those factors may
lead to the inherent unfairness and difficulties which were the sub-

ject of the strong dissent in Mobil.^'^

Despite endorsing the application of the standard three-factor for-

mula to the worldwide combined income of a multinational group of
corporations, the Court in Container acknowledged the imperfections

which are necessarily inherent in the formula.^^* The equal weight
given to each of the three factors is arbitrary, and the formula does

not reflect all of the factors which are material to the generation of

income. The formula is based on the economic assumption that rates
of return on property and payroll are roughly equal in various taxing

jurisdictions. This assumption has clear weaknesses when made in the
context of worldwide operations. Although variations in the cost of

payroll and property in an interstate or a domestic context result in

a margin of error in the apportionment of income, this margin of er-

ror is constitutionally acceptable because it is reasonable to assume

that the rate of return on an investment in one state will roughly

approximate the rate of return on an investment in another state.

In an international context, however, the cost of payroll and proper-

ty and the rates of return with respect to those factors vary so

significantly from those in a domestic context that the economic

assumption may no longer be valid. The application of the equally
weighted three-factor formula to foreign operations, therefore, may

''n03 S. Ct. at 2943.

'"See supra notes 157-58 and accompanying text.

'''n03 S. Ct. at 2949-50 & n.20.



1983] TAXING MULTINATIONAL CORPORATIONS 829

be inherently arbitrary and entail unreasonable distortions in
apportionment.

The result of the Court's opinion in. Container is an endorsement
of a substantial margin of error resulting from the application of the
three-factor formula to the combined income of a global enterprise.^^^
Formula apportionment divides the income of a multinational enter-
prise on the basis of a mathematical generalization.^^" If this approach

was applied by all taxing jurisdictions, it should result in no double
taxation of the income of a multinational unitary enterprise.^^^ In order

to eliminate double taxation, the Court would have to establish a single

method of taxation among the taxing jurisdictions, a task which it
considers to be a federal legislative responsibility .^^^ Therefore, it is

likely that multinational corporations will continue to be subjected

to inconsistent formulas in the apportionment of income by many
states. This marked lack of consistency among the formulas adopted
by the states, compounded by the fundamental differences between
formula apportionment and the international norm of a qualified
separate accounting approach, will likely result in the taxation of more
than all of the income of the multinational unitary enterprise.

Aside from the apportionment formulas themselves, many of the
most significant issues in the state taxation of multinational corpora-

tions have arisen in relation to the determination of the existence

of a unitary business and in the definition of the scope of the com-

ponents which constitute the unitary enterprise. In the resolution of

these issues, the Court has expressed a willingness to defer to the

judgment of the state courts.^^^ Given this fact, one can expect the

state courts to continue to make crucial errors in determining the
existence and scope of the unitary enterprise. Because of the Court's

decision in Container, confusion and misunderstanding may also con-
tinue to exist with respect to the criteria used in establishing the

extent of a unitary business.

Before the Container decision, it could have been argued that the

Supreme Court had implicitly adopted a standard for finding a horizon-
tally integrated business to be unitary: Was there a substantial flow
of goods within the enterprise? The express adoption of a substantial

flow of goods requirement as the predominant criterion for a unitary

business relationship may have appropriately reflected the economic
logic behind the development of formulary apportionment.^^^ Coupled

'""Id. at 2950.

^Yd. at 2952.

'''Id. at 2942.

'''Id. at 2943.

""Id. at 2945.

'^*The use of formulary apportionment has its origins in cases evidencing such

complete functional integration through the interchange of products and services, that



830 INDIANA LAW REVIEW [Vol. 16:783

with the other unitary business criteria adopted by the Court, that
standard would have provided additional certainty for the state tax

administrators, state courts, and multinational corporations.^^^ In Con-

tainer, however, the Supreme Court specifically rejected the narrow
"flow of goods" test, finding it an inappropriate constitutional require-

ment to impose upon the states.^^^ Although finding that the test for
a unitary enterprise may be satisfied by a substantial flow of goods
between a parent corporation and its subsidiaries, the Court stated
that "[t]he prerequisite to a constitutionally acceptable finding of

unitary business is a flow of value, not a flow of goods."^^^ The Court
rightfully adopted a flow of value standard in lieu of the taxpayer's

proposed flow of goods test in Container.^^^ What is problematic with
the Court's pronounced prerequisite is that the concept of "value" is

difficult to define. One may assume that a flow of value means a
substantial interchange of products, markets, management services,
technologies, capital resources, or other contributions to income which,

in combination or degree, are relevant to substantial mutual in-

terdependence among related corporations. In this context, the
substantial flow of value requirement has the advantage of providing

a controlling factor in an otherwise largely complex determination as

to whether a business is unitary. The other essential factors such as
functional integration, centralized management and operations, or other
economies of scale gain greater meaning and become more deter-
minative as useful criteria when used in conjunction with the fun-
damental requirement of a flow of value. Although reasonable minds

may differ as to what constitutes a flow of value, the Container opin-
ion has added much to our understanding of the delineation of a
unitary business.

"[t]he legislature in attempting to put upon this business its fair share of the burden

of taxation was faced with the impossibility of allocating specifically the profits earned

by the processes conducted within its borders." Bass, Ratcliff & Gretton, Ltd. v. State
Tax Comm'n, 266 U.S. 271, 281 (1924). See supra notes 95-99 and accompanying text.

For enterprises that manufactured products in one taxing jurisdiction and distributed

them in others, formulary apportionment became a logically consistent and meaningful

method for the division of the net income of a multijurisdictional corporation. In the

absence of substantial mutual interdependence, as evidenced by such a substantial

flow of trade, a coherent justification for apportionment may be lacking. See Heller-
stein, supra note 83, at 501-02.

^^^This approach has been advocated by a leading commentator. See Hellerstein,

supra note 83, at 501-02.

''nOS S. Ct. at 2947 n.l7.

''Ud. at 2947.

^^*From an economic point of view, it is easy to demonstrate the existence of a

unitary business where there is no significant flow of goods. See McClure, Operational

Interdependence is not the Appropriate 'Bright Line Test' of a Unitary Business—at

Least Not Now, 18 Tax Notes 107 (1983).



1983] TAXING MULTINATIONAL CORPORATIONS 831

VIII. Conclusion

This article has considered only the principal features of the

unitary business/formula apportionment concepts. The important con-
stitutional problems which are presented when a taxing state applies
its particular version of formula apportionment to the income of related

domestic and foreign corporations which are purportedly engaged in

a multinational unitary enterprise have been described. The challenges
to the application of the unitary business/formula apportionment con-

cepts have been advanced by corporate taxpayers primarily under the

due process and commerce clauses. Although commerce clause con-
siderations bear directly upon the issues associated with fair appor-

tionment, especially in the international context, due process considera-

tions have been more important, or at least more fundamental, as a
means for resolving the problems.

The first step toward resolution of the problems raised by the
unitary business/formula apportionment concepts can be understood

only by reference to actual business practices. The unitary business/for-
mula apportionment approach is not to be perceived as a counter-

movement by any level of government against the formal geographical
or transactional accounting approach for determining a state's ap-

propriate share of the income of an integrated corporate group; rather,

it is the logical consequence of both revenue objectives of govern-

ment and accounting techniques used by corporations. Some corpora-
tions prefer unitary apportionment over separate accounting because

it may result in undertaxations or a more reasonable tax liability.
Originally, the separate accounting approach was preferred by the
states for the determination of the income tax of a corporation doing

business largely within the state. As the activities of corporations
spread across interstate boundaries, however, the application of some
variation of formula apportionment became a practical necessity for
the purpose of the fair division of the corporation's income among
several taxing jurisdictions. The interstate businesses of corporations
have become so functionally integrated that separate accounting is
no longer practical. The next logical development of the unitary ap-
portionment approach was its application to the interstate operations
of affiliated corporations deemed to be a single unitary enterprise.
Finally, whether a state is taxing an affiliated group of domestic cor-
porations engaged in activities generating income in an interstate con-

text, or an affiliated group of domestic and foreign corporations

engaged in activities generating income both in an interstate and an
international context does not appear to amount to a logically or con-
stitutionally significant difference. The application of formula appor-
tionment seems proper when a particular set of activities of a related
group of corporations as a practical necessity renders the application

of separate accounting improper. Worldwide combined reporting of



832 INDIANA LAW REVIEW [Vol. 16:783

multinational corporate income, then, is the logical conclusion of an

apportionment technique applied to regional railroad property a cen-

tury ago.

In four recent cases, the United States Supreme Court has con-
sidered the constitutional implications of the state taxation of the in-

come of a multinational group of corporations. In these decisions, a
searching inquiry has been made into the understanding of the unitary
business principle. Much guidance is made available through the study
of these opinions. They establish that related domestic and foreign
corporations may be treated as a unitary business to the extent that
there is a sharing or an exchange of value throughout the multina-

tional corporate group as evidenced by substantial mutual in-

terdependence. As a necessary corollary to determining the scope of
the unitary enterprise, the cases also establish that the apportion-

ment of the income of the unitary business between the taxing state
and the rest of the world must take into account a reasonable measure

of the income generating activities of the unitary business, conducted

as a whole, and its concrete relationship to activities within the state.

In Mobily the Court approved the state taxation of foreign-source

dividends as part of the domestic recipient's apportionable income,

but only because the Court assumed that the payor subsidiaries were
engaged in a unitary business relationship with the parent corpora-

tions. In ASARCO and Woolworth, the court confined its analyses to
due process considerations, and, as in Mobil, the unitary business prin-

ciple formed the linchpin of its decision. The Court determined that
a state cannot include foreign-source income in the apportionable in-

come of a nondomiciliary corporation doing business in a taxing state
when it can be demonstrated that the payor subsidiaries are discrete
business enterprises apart from the parent corporation and have no

other connection with the taxing state. In Container, the Court held

that the worldwide combined income of a domestic corporation and

its foreign subsidiaries is subject to unitary apportionment without

contravention of the due process clause as long as the unitary business

test has been properly applied and the apportionment formula is fair.

In so holding, the Court declined to endorse the proposition that it

was necessary to a finding of a unitary business that there be a con-
tinuous and signficant product flow between the domestic parent cor-

poration and its foreign subsidiaries in the absence of vertical integra-

tion among the corporations. Instead, the Court chose to establish the
unitary business relationship in the totality of the circumstances which

necessitates a case by case determination of whether there exists

substantial mutual interdependence sufficient to justify the finding

of a unitary business.

The attitude taken by the Court to the taxing power of the states
in these four cases is quite consistent with that which the Court has



1983] TAXING MULTINATIONAL CORPORATIONS 833

followed in previous state tax cases— an attitude of judicial restraint

or nonintervention. The constitution places limited restrictions on the
taxing power of the states and the Court is unlikely to alter its tradi-
tionally limited function with respect to the adjudication of these mat-

ters. The Court declines to intervene into the complexities of state
finance and impose general legal formulations upon the taxing power
of the states where those principles are not constitutionally required.
In the absence of congressional action, the Court has developed ob-

jective standards which are not intended to extend beyond the con-

crete circumstances to which they are applied. These standards reflect

the Court's generalizations with respect to the practical operation of

state corporate income taxes. In these cases, the Court has affirmed

the latitude which the states have in taxing the income of multina-

tional corporations.