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In brief

The Idaho Supreme Court recently affirmed a District Court’s judgment that the gain from the sale of a 78.54% membership interest in a limited liability company did not constitute ‘business income’ under Idaho Code section 63-3027.  In Noell Indus. Inc. v. Idaho State Tax Comm’n, Docket No. 46941 (Idaho 2020), the court determined that “this type of gain does not meet the definition of ‘business income’ under either the transactional test or functional test (including the unitary business test),” and was therefore not apportionable income.


Noell Industries, Inc. (“Noell Industries”), incorporated in 1993 in Virginia by Mike Noell, was created to develop and sell combat and tactical gear.  Noell Industries manufactured and sold tactical gear until 2003, when it transferred its business assets to a new company, Blackhawk Industries Products Group Unlimited LLC (“Blackhawk”), in exchange for a 78.54% membership interest (the remaining membership interests were held by third parties).  Mike Noell was the President and Chief Executive Officer of Blackhawk.  Blackhawk, a Virginia limited liability company, established a physical presence in Idaho in 2004, and by 2010, held approximately $20 million of real and personal property in Idaho.

Upon selling its majority interest in Blackhawk for a net gain of $120 million in 2010, Noell Industries reported the gain on its Idaho tax return, but did not apportion any of the gain to Idaho, instead allocating the gain entirely to its state of commercial domicile, Virginia (where Noell included the gain as apportionable income and paid taxes thereon).  After conducting an audit, the Idaho Tax Commission concluded that the gain from the sale of the membership interests in Blackhawk was ‘business income’ under Idaho Code section 63-3027 and assessed a tax deficiency of $1.4 million.  The Idaho District Court found in favor of Noell Industries, determining that the gain was not ‘business income’ and, therefore, was not apportionable to the state.  The Idaho Tax Commission appealed.

In affirming the District Court’s determination, the majority rejected the Idaho Tax Commission’s argument that Noell Industries’ gain from the Blackhawk sale constituted business income “because the ‘acquisition and management of Blackhawk LLC constituted a necessary part of its business operations.’”

Idaho Code section 63-3027(a)(1) adopts the Uniform Division of Income for Tax Purposes Act definition of  ‘business income’, which Idaho has interpreted as providing for both a transactional and functional test.  Under the transactional test, ‘business income’ is “income arising from transactions and activity in the regular course of the taxpayer’s trade or business.”  Under the functional test, ‘business income’ is “income from the acquisition, management, or disposition of tangible and intangible property when such acquisition, management, or disposition constitute integral or necessary parts of the taxpayer’s trade or business operations.”  In reviewing the application of both tests de novo, the majority concluded that the District Court did not err in ruling that Noell Industries’ gain from the Blackhawk sale was nonbusiness income.

In applying the transactional test, the court relied on case law from other jurisdictions that use a similar definition of ‘business income’ for the general principle that “the gain arising from a holding company’s sale of a subsidiary can qualify as business income if the holding company regularly engages in the buying and selling of subsidiaries; however, a one-time sale does not qualify.”  See e.g., E.I. DuPont De Nemours & Co. v. Indiana Dep’t of State Revenue, 79 N.E.3d 1016, 1023 (Ind. T.C. 2017), with PPG Indus., Inc. v. Dep’t of Revenue, 765 N.E.2d 34, 45 (Ill. App. 2002).  Here, the court determined that Noell Industries’ primary business was investing and holding interests in subsidiary companies.  The court further concluded that Noell Industries, in holding its investments, did not appear to have regularly engaged in the trade or business of buying and selling subsidiary companies.  Thus, “a one-time sale over a seven-year span does not constitute a ‘regular’ trade or business,” and the gain from the sale of Blackhawk did not satisfy the transactional test.

With respect to the functional test, the court noted that Idaho Income Tax Administrative Rule 333.08 provides two methods for meeting the functional test: (a) by finding that the intangible interest serves an operational function, rather than a passive investment, or (b) by meeting the unitary business test.  Importantly, the court noted that even though these appear to be two independent methods, the U.S. Supreme Court has rejected the notion that the operational function test and unitary business test are separate principles.  MeadWestvaco Corp. ex rel. Mead Corp. v. Illinois Dep’t of Rev., 553 U.S. 16, 29–32 (2008).

In applying the operational function test, the court focused on the fact that Noell Industries was merely a holding company, and therefore, “[t]he sale of its interests in Blackhawk was a passive investment because the sale was not ‘an integral, functional, or operative component to the taxpayer’s trade or business operations.’”

The court noted that by selling Blackhawk, Noell Industries lost its primary source of income in exchange for the financial betterment of $120 million.  Therefore, the sale was not conducted in furtherance of Noell Industries’ trade or business of holding interests; rather, the sale discontinued it. The court also applied the unitary business test and determined that no unitary business existed primarily because Noell Industries was merely a parent holding company with no shared control or operations with Blackhawk.  The court determined that Noell Industries did not share centralized management, oversight, or headquarters with Blackhawk, nor did it share resources or employees, with the exception of utilizing the same accounting and legal firms.  Although Mike Noell acted as Blackhawk’s president and CEO, and served on a six-member management team, the court was persuaded by the fact that he did not manage Blackhawk’s day-to-day operations.  The court noted that “his presence at both companies alone does not suggest the level of oversight that the unitary principle requires for functional integration, centralized management, and economies of scale.”  Importantly, this conclusion regarding management and control further amplifies the conclusions of the U.S. Supreme Court that actual control, as opposed to the potential to control through majority ownership, is the critical inquiry for a unitary business analysis.  Here, Noell Industries held a 78.54% membership interest in Blackhawk (and Mike Noell was the sole owner of Noell Industries), an interest that arguably gave Noell Industries (and Mike Noell) the potential to control Blackhawk; however, because the court found that the actual day-to-day management of the company was not controlled by Noell Industries (or, Mike Noell), it concluded that centralized management did not exist.

Finally, the court handed the taxpayer an additional win by rejecting the Idaho Tax Commission’s argument that the decision would open a tax loophole to companies by “permitting them to dodge taxes through the creation of sham shell entities.”  On the contrary, the majority noted that Noel Industries paid taxes to Virginia (albeit on an apportioned share of the gain) because that was its commercial domicile, and therefore, “[t]here has been no fraud or subterfuge.”

In sum, the court here concluded that despite the fact that the seller owned an almost 80% membership interest in a subsidiary that it originally formed (using its own operating assets), and because the seller’s sole activity was investing, the gain derived from sale of the membership interests was non-business income.  This case is an important win for taxpayers and provides much needed guidance regarding the application of the unitary business principle, including the operational function test, to gains derived from sales made by passive holding companies.


Maria P. Eberle is a member of the Firm’s Tax Group in New York and she also serves as chair of the SALT subpractice group. She advises multinational companies on a full range of state and local tax matters, including tax controversy and litigation. Before joining Baker McKenzie, Ms. Eberle was a partner at an international law firm, where she concentrated on state and local tax matters. In addition, she was previously a manager of multistate tax services at a Big Four accounting firm where she advised individual and corporate clients on a variety of state and local tax issues. Ms. Eberle has also served as an adjunct professor of law at Quinnipiac University School of Law, where she taught a course on state and local tax. In 2019 Maria was recognized by Law360 as a Rising Star in the field of Tax. Chambers USA has also named Maria as a Leading Lawyer (State and Local Tax: New York, 2019) and International Tax Review recognizes Maria in their annual Women in Tax Leaders Guide (2016-2019).


Lindsay M. LaCava is a partner of the Firm’s Tax Practice Group in New York and advises individual and business clients on a full range of state and local tax issues. She was named a “Rising Star” in Tax Law in 2015 by Law360, and was selected by Super Lawyers as a New York-Metro "Rising Star" for Tax in 2013-2015. Prior to joining Baker McKenzie, Ms. LaCava was a partner in the state and local tax group of an international law firm. In addition, she previously worked at a Big Four accounting firm, where her practice focused exclusively on state and local tax. Ms. LaCava speaks on a variety of state tax topics at events around the country and also frequently writes about state and local tax issues.


Kelsey Muraoka is an associate in the New York office of Baker McKenzie and a member of the Tax Practice Group. Prior to joining the Firm, Kelsey provided multistate tax services at a Big Four accounting firm where she advised clients on a variety of state and local tax issues.