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Corporate Executive Board Company v. Virginia Department of Taxation, 297 Va. 57, 822 S.E.2d 918

Facts

CEB is a corporation headquartered in Arlington, Virginia, primarily generating revenue from a subscription service and professional services, with over 95% of its sales occurring outside Virginia. For the years in question, CEB earned $1.76 billion in total sales, with Virginia accounting for about $66 million. The majority of CEB's employees responsible for developing its products were located in Virginia, and the content was stored on servers in the state. Virginia employs a formula to determine the portion of a corporation's income that can be taxed, which CEB argued was unconstitutional as applied to its situation.

CEB is a corporation that is headquartered in Arlington, Virginia. CEB describes itself as “the premier ‘best practices’ advisory firm in the world.” Most of CEB’s revenue comes from an annual fixed fee subscription service of its “Core Product.” This subscription service provides “online access to best practices research, executive education and networking events, and tools used by executives to analyze business functions and processes.” In addition, CEB sells professional services, or “Solutions,” that include employee education and performance analytics. It also conducts executive education seminars. CEB’s customers include 97% of the Fortune 100 companies and more than 10,000 additional organizations in more than 50 countries.

Issue

Did the income tax assessments against CEB violate the Commerce and Due Process Clauses of the United States Constitution?

CEB argues that the Tax Department unconstitutionally apportioned its income in 2011, 2012, and 2013, in violation of the “dormant” Commerce Clause and the Due Process Clause of the Fourteenth Amendment.

Rule

A state income tax must be fairly apportioned, which requires both internal and external consistency, ensuring that the tax reflects a reasonable sense of how income is generated within the state.

A tax does not infringe the dormant Commerce Clause if it: (1) applies to an activity with a substantial nexus to the taxing state; (2) is fairly apportioned; (3) does not discriminate against interstate commerce; and (4) is fairly related to services or benefits provided by the state.

Analysis

The court applied the external consistency test to determine if Virginia's apportionment method taxed only that portion of CEB's revenues that reasonably reflected the in-state component of the activity being taxed. The court found that the content for CEB's Core Product was developed by Virginia employees and stored on Virginia servers, thus justifying the state's claim to tax the income generated from these activities.

The external consistency test “asks whether the State has taxed only that portion of the revenues from the interstate activity which reasonably reflects the in-state component of the activity being taxed.” The stipulated facts establish that the content for CEB’s Core Product was developed by CEB employees working in Virginia. The servers on which the product resides are located in Virginia. Each time a customer uses CEB’s Core Product, the customer reaches into Virginia to consult materials developed in Virginia and stored in Virginia.

Conclusion

The Supreme Court affirmed the Tax Commissioner's decision, concluding that CEB did not suffer from an unconstitutional apportionment of its income and that Virginia's apportionment method satisfied constitutional standards.

We conclude that CEB did not suffer from an unconstitutional apportionment of its income. We can find nothing in the precedent of the United States Supreme Court interpreting the dormant Commerce Clause or the Due Process Clause that requires one of two taxing States to “recede simply because both have lawful tax regimes reaching the same income.”

Who won?

Virginia Department of Taxation prevailed in the case, as the court upheld the constitutionality of the state's income tax assessments against CEB.

The Tax Commissioner has issued a regulation, 23 VAC § 10-120-280, that specifies when a method of allocation and apportionment is inapplicable or inequitable. This regulation specifies that a method will be found “inapplicable” only if it “produces an unconstitutional result under the particular facts and circumstances of the taxpayer’s situation.”

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