Opinion
Dkt No. 010589-2010
05-01-2014
Re: Elan Pharmaceuticals, Inc. v. Director, Division of Taxation
BY ELECTRONIC MAIL Charles J. Moll, Esq. Jeffrey P. Catenacci, Esq. Winston & Strawn, L.L.P. Michael J. Duffy Deputy Attorney General
NOT FOR PUBLICATION WITHOUT APPROVAL OF
THE TAX COURT COMMITTEE ON OPINIONS
Mala Sundar
JUDGE
BY ELECTRONIC MAIL
Charles J. Moll, Esq.
Jeffrey P. Catenacci, Esq.
Winston & Strawn, L.L.P.
Michael J. Duffy
Deputy Attorney General
Dear Counsel:
This letter constitutes the court's opinion as to the parties' partial summary judgment motions. The issue is whether the gain of about $360 million from the sale of the U.S. and Canadian markets for a pharmaceutical drug called ABELCET, administered primarily to cancer patients, along with the drug's New Jersey manufacturing facility, is operational income subject to apportionment and to corporation business tax ("CBT") in New Jersey. Plaintiff, a Delaware company headquartered in California and doing pharmaceutical business in New Jersey that is unitary with its world-wide corporate family, argues that the sale was a liquidation of its corporate family's oncology business in a geographical segment, thus, results in nonoperational income that is not subject to apportionment pursuant to McKesson Water Prods. Co. v. Director, Div. of Taxation, 23 N.J. Tax 449 (Tax 2007), aff'd, 408 N.J. Super, 213 (App. Div.), certif. denied, 200 N.J. 506 (2009). Defendant ("Taxation") maintains that McKesson does not apply because Plaintiff retained its foreign business rights and assets of the ABELCET product line, continued to operate its business as to other medical drugs, some of which were oncology related, and further because Plaintiff retained a portion of the sale proceeds. Taxation alternatively argues that Plaintiff's operation of the ABELCET business was conducted in and from New Jersey, therefore, even if the income was deemed nonoperational, New Jersey can tax it under N.J.S.A. 54:10A-6.1(a).
For the reasons explained below the court finds that Taxation's arguments of the inapplicability of McKesson as persuasive, and supported by the facts on the record. Therefore, its assessment in this respect is proper. FACTS
(A) Background
Elan Corporation, PLC, ("Parent") is an Irish public limited company headquartered in Ireland. It is a worldwide pharmaceutical company with its research and development ("R&D"), manufacturing, and marketing facilities in Ireland, and other countries including the U.S. Its 1999 annual report notes that it "has had a strategy of investing in biotechnology, drug delivery and genomics companies."
Parent conducted operations through two primary business units. One unit was Elan Pharmaceuticals, which was "engaged in the discovery, development and marketing of products in the therapeutic areas of neurology, pain management, oncology, infectious diseases and dermatology." It was also involved in clinical development programs in "the fields of," among others, oncology. The other business unit was Elan Pharmaceutical Technologies, which was engaged in the "development, licensing and marketing of drug delivery products, technologies and services to pharmaceutical industry clients on a worldwide basis."
Plaintiff was incorporated in Delaware and during 2002, the audit period at issue here, it was headquartered in California. Plaintiff became licensed to do business in New Jersey in 1999. It used to be Parent's subsidiary but at some point became wholly owned by Athena Neurosciences, Inc. ("Athena"), a company located in California. Parent had acquired Athena and its subsidiaries sometime in 1996. In 1999, Athena became the wholly owned subsidiary of Elan Holdings, Ltd., an Irish company, which was wholly owned by Parent.
(B) Acquisition of Liposome Company Inc.
Starting in 1996, Parent acquired a series of biotechnology companies so it could grow into a world-wide fully integrated pharmaceutical company. One such acquisition was the Liposome Company, Inc. ("Liposome"), a Delaware biotechnology corporation, listed on the NASDAQ, and qualified to do business in New Jersey since 1981. Liposome's R&D facility was in New Jersey ("Princeton facility"). Its manufacturing facility was in Indianapolis ("Indianapolis facility"), operated by its wholly-owned subsidiary, the Liposome Manufacturing Company, Inc., which was headquartered in Indiana.
Liposome was in the business of developing, manufacturing and marketing therapeutic drugs to treat diseases incurring in among others, cancer patients. One such proprietary (i.e., patented) drug that was the major source of Liposome's revenue was ABELCET, which was commercially marketed world-wide for treating severe, systemic fungal infections in cancer, AIDS or transplant patients who were intolerant to conventional therapy. It was approved for sale nationally by the FDA and commercially marketed mostly to hospital-based oncologists. Liposome's staff marketed and distributed ABELCET in the U.S. and Canada, while it partnered with other companies for sales in other countries. One of Liposome's foreign subsidiaries was Liposome Canada, Inc., which held the license from the Canadian government to sell ABELCET in Canada, and operated the stand alone Canadian ABELCET business. Liposome also owned or held several intellectual property rights to, and in, clinical studies/research as to ABELCET and other products in the pipeline.
Liposome developed or was in the processing of developing several other therapeutic products. One such drug, MYOCET, used in patients with metastatic breast cancer, was only approved abroad.
On March 16, 2000, Parent issued a "Notification" of its intent to acquire Liposome. The proposed acquisition was to be accomplished by merging Liposome into Lithium Acquisition Corporation, a wholly owned subsidiary of Parent (created only for purposes of acquiring Liposome), and by issuing Parent's stock as consideration for purchase of Liposome's shares.
Per the Notification, Parent had no "share" in the oncology market in Ireland although it had several oncology related products which it had "licensed to Ligand for the U.S. and Canada." Whereas Liposome had about 20%-30% market share of ABELCET in Ireland. The "proposed acquisition involve[d]" Parent's entry "into the oncology (cancer drug) market," which was "its next therapeutic area of interest," and the acquisition would allow it to develop its oncology business "through product and strategic acquisitions." The Notification also stated that Liposome "will complement [Parent's] existing activities in oncology and oncology-related fields in the [Parent's] drug-delivery business and alliances" and benefit Parent's "marketing of ziconotide in the treatment of severe chronic cancer pain" by use of Liposome's sales force.
Parent's 2000 Annual Report listed ziconotide as one of its products in the area of "pain management" for cancer and AIDS patients, which drug had received FDA approval in June of 2000.
An internal corporate bulletin of March 6, 2000 echoed these statements. Liposome's representative added that the "combination of Liposome's experience in the oncology field with [Parent's] extensive resources in oncology and related activities" favored the merger.
On May 12, 2000, Parent completed acquisition of Liposome and Liposome's subsidiaries for about $731 million, the price being primarily allocated to goodwill, patents and licenses. Within two weeks, on May 24, 2000, Parent transferred ownership of Liposome and its subsidiaries to Elan Holdings, Ltd., its Irish subsidiary. On the same day, Elan Holdings, Ltd. transferred ownership of Liposome to Athena, its California subsidiary, and Plaintiff's parent.
Although the dates of transfers are somewhat confusing chronology-wise, Liposome Canada, Inc. became Plaintiff's subsidiary with the name Elan Canada, Inc. on December 11, 2001. On December 28, 2001 Liposome's Indianapolis subsidiary became Plaintiff's subsidiary renamed as Elan Operations, Inc. Three days later, at midnight of December 31, 2001, Parent merged Liposome into Plaintiff.
The corporate structure as of December 31, 2002 showed Plaintiff as parent of foreign subsidiaries in Canada (Elan Canada, Inc.); U.K.; France (Laboratories Liposome); Switzerland; and Japan (Nychiyu Liposome Co., Ltd.). It was unclear when and how these subsidiaries (other than Elan Canada, Inc.) were created but it is undisputed that most of them were created to be able to market/sell ABELCET in these foreign countries, along with the other drug products such as MYOCET. Plaintiff's subsidiary, Elan Operations, Inc., had a "division" within it also named "Elan Operations, Inc.," which was a business unit that held title to the Princeton facility after sale of the Indianapolis facility.
According to the certification of Parent's employee, sometime after the Liposome acquisition, the European ABELCET business and distribution rights; the MYOCET distribution rights in Europe; and the Asian rights in ABELCET were transferred to and held by Elan Pharma International, Ltd. ("EPIL"), an Irish based subsidiary of Parent which did not do business in the U.S. These distribution rights did not require EPIL to own title to the intellectual property (i.e., of ABELCET's patents, trademarks, or licenses), and the same remained with Plaintiff as cost/time saving efficiency measures. The distribution rights "were the essential assets" used by EPIL "to run this business" and per the employee, Plaintiff never participated in EPIL's "operation of the [ABELCET and MYOCET] . . . business" in Europe.
Presumably, there was some inter-corporate arrangement whereby Plaintiff as owner of all rights to ABELCET and MYOCET, granted distribution rights to these products to EPIL. No details in this regard were provided.
Per the employee, Parent created subsidiaries in France (Elan Pharma Sarl); Germany (Elan Pharma GmBH); Italy (Elan Pharma Italia S.p.A.); and Spain (Elan Pharma S.A.U.) for marketing ABELCET and MYOCET in these countries since European laws required a localized corporation. EPIL sold ABELCET and MYOCET to these subsidiaries (presumably through inter-corporate arrangements), which in turn sold those products to the local health care providers in the respective countries.
Parent's 2001 annual report represented that Parent had achieved its goal to become an integrated biopharmaceutical company through a "corporate development" program of acquiring corporate entities such as Liposome, in addition to other measures of investments, cost/risk sharing in R&D areas, and forming business ventures to leverage the group's portfolio of intellectual property as a revenue raising measure.
Over the course of a year following the acquisition, Liposome's senior management departed Plaintiff's employ and were replaced with the management personnel from Parent and Plaintiff, and located in Ireland and California, respectively. Parent's chairman and CEO in Ireland was responsible for, and directly involved in the overall management of ABELCET business, and Parent's president in Ireland assumed management over ABELCET general business operations following the resignation of Liposome's former CEO in mid-2001. While Plaintiff claimed that all the management aspects of the running of ABELCET business was, in and out of, California, Taxation points out that there were several key personnel located in New Jersey as evidenced by excerpts from the corporate telephone book.
(C) Disposition of the U.S. and Canadian markets for ABELCET
Sometime in 2001, Parent started to experience financial difficulties. It then proposed a recovery plan by which it would divest the group of non-strategic businesses, assets and investments. It identified intellectual property (patents and trademarks) as its "vital asset" and revenue source, with ABELCET being one such product/asset.
In early 2002, the financial situation worsened for the Elan group. This was due to, among others, increased competition from other drug companies, loss of patent protection for some of its largest selling products, and setbacks in certain R&D areas. Competition and loss of Liposome's experienced sales personnel also caused decrease in revenues from sales of ABELCET although this was not the primary reason for Parent's financial problems. Parent's share prices dropped from $40 to about $1 per share.
Around July 2002, Parent decided to sell the group's most profitable business lines with their attendant assets. This would raise money to pay a large portion of the group's debt to lenders but still retain Parent's business in "three core therapeutic areas: neurology, pain management, and autoimmune diseases." One of the products identified as being more profitable, thus, easier to sell, was ABELCET. Apparently, Parent was advised to sell the U.S. and Canadian businesses separately from the European market for ABELCET since the former was more profitable thus, allowed for a quicker sale and speedier revenue.
In September 2002, Parent, through Morgan Stanley & Co., made a written offer for the sale of the U.S. and Canadian rights to ABELCET along with the associated assets such as intellectual property, clinical studies, personnel, and the Indianapolis facility (including a third-party contract through which Parent or Plaintiff was "processing and packaging" a different drug at the facility for another company), but excluding the rights to MYOCET, the drug patented and sold in Europe. The offering noted that ABELCET enjoyed a strong intellectual property position world-wide with market exclusivity until 2014, and addressed a much-needed medical need because of the increased number of patients with impaired immune systems due to ageing population, growing use of chemotherapy, bone marrow/organ transplant, and prevalence of AIDS. It also stated that the primary customers for ABELCET in the U.S. were physicians such as oncologists treating cancer of a "solid" organ (about 6,000); hematologists treating blood cancer or leukemia patients (about 6,000); bone marrow transplant specialists treating cancer patients; pulmonologists treating lung disease or lung cancer (about 9,000); and infectious disease specialists (about 5,000).
On October 1, 2002, Enzon, Inc. ("Enzon"), a Delaware corporation headquartered in New Jersey, entered into an Asset Purchase Agreement with Parent, Plaintiff, and Plaintiff's two subsidiaries, Elan Canada, Inc. (which marketed Liposome in Canada), and Elan Operations, Inc. (which owned and operated the Indianapolis facility). Pursuant to the agreement, on November 22, 2002, Enzon purchased all assets and rights, tangible and intangible, to the U.S. and Canadian markets for ABELCET. The purchase included assignment of any and all third-party contracts such as for distribution of ABELCET in U.S. and Canada.
Although not part of the bid, Enzon demanded and the Elan group agreed to transfer the rights/assets to and in the ABELCET business in Japan, provided doing so would not cause them to be in breach with any third party and incur material/adverse costs.
The sale did not include the tangible and intangible assets related to any other drug or product, such as MYOCET, the drug patented and sold by the Elan group outside the U.S. to treat patients with metastatic breast cancer. Further, Parent, Plaintiff and its subsidiaries retained all rights and assets, tangible and intangible, to ABELCET business outside U.S. and Canada. Enzon and Parent (with their respective affiliates) agreed not to sell, market, or distribute ABELCET outside of their respective permitted geographical regions for a 10-year period.
The Asset Purchase Agreement defined the term "Business" as the "research, development, manufacture, distribution, marketing, sale and promotion" of ABELCET as it existed or improved/altered/extended in the future.
On the same date of November 22, 2002, Plaintiff entered into a License Agreement with Enzon whereby Plaintiff granted Enzon an exclusive license in the U.S., Canadian, and Japanese markets to ABELCET-related intellectual property as was necessary to make, develop, sell, market, and use ABELCET and related improvements. Plaintiff retained the "exclusive right and license under" ABELCET-related intellectual property (know-how and patents) within and outside the U.S., Canadian, and Japanese markets "for all other purposes." Enzon was able to use ABELCET or its improvements outside these markets in connection with clinical trials or R&D conducted by Enzon, and Elan had the same rights within the U.S. and Canada.
On the same date, Enzon entered into two long-term "Manufacturing and Supply" agreements with EPIL. The agreements required Enzon to manufacture and supply ABELCET and MYOCET to EPIL for a term of nine and seven years respectively, with automatic annual renewals thereafter unless terminated. The agreements were to be governed by Delaware laws. The agreements were so Elan group could comply with their multi-year contractual obligations for the sale/use and/or grant of concomitant licensing of these drugs in European countries.
In addition, on the same date, Plaintiff and Elan Canada, Inc. entered into an Interim Services Agreement with Enzon. Under this, Plaintiff and Elan Canada, Inc. agreed to perform certain remunerated transitional services for Enzon (in connection with transferring contracts, negotiations, licenses, and transitioning/directing the U.S. and Canadian sales forces). Enzon allowed Plaintiff and Elan Canada, Inc. to sell and handle returns of ABELCET in Canada on Enzon's behalf for a one-year period after the closing of the Asset Purchase Agreement on the same terms and conditions as prior to Enzon's purchase, except Enzon was to be liable for issues regarding the sale/marketing of ABELCET. Enzon was to receive 50% of the net sales revenue in this regard. After the one-year period, Enzon undertook to market and sell MYOCET in Canada on behalf of Plaintiff and Elan Canada, Inc., in return for 40% of the net sales revenue.
This contradicts Parent's employee's certification that the Interim Service agreement was for a "limited time" and that neither Plaintiff nor Elan Canada received any benefit "from such appointment."
Enzon paid about $360 million (adjusted) in cash for the purchase of the ABELCET product line. For purposes of tax reporting (IRS Form 8594, "Asset Acquisition Statement" under I.R.C. §1060), $338 million was allocated to Plaintiff representing payments for intellectual property and personnel and $22 million was allocated to Elan Operations, Inc., representing payments for real/personal property including inventory. No portion of the proceeds was allocated to Elan Canada, Inc.
Despite the Interim Services Agreement whereby Plaintiff was permitted to sell ABELCET in Canada for a year for 50% net sale proceeds as the remuneration, Athena indicated "No" to the tax form's question whether the buyer entered into a management, employment, or similar contract with the seller.
Plaintiff claims that it did not retain any portion of the sale proceeds or use the same for payment of its business operations. It maintains that it paid Athena, its parent, $155 million on December 31, 2002; $183 million in June 2003; and $22 million in November 2003. As to the $155 million, the minutes of a December 2002 Board meeting notes that after a "discussion" of Plaintiff's consolidated balance sheet as of November 29, 2002, "to determine" the existence of "adequate cash reserves from surplus or current earnings as a source for the dividend payment," the Board "resolved" to pay $155 million as dividends to its "sole stockholder." Per Plaintiff, the $360 million was distributed in installments so cash reserves would be available to meet Plaintiff's potential indemnification obligations under the Asset Purchase Agreement. Plaintiff maintains that Athena, in turn, transferred payments to Parent for use in reducing Parent's/Elan group's business indebtedness to outside lenders.
Taxation points to an undated work paper titled "[ABELCET] Proceeds received November 22, 2002," provided by Plaintiff during discovery, as evidence that Plaintiff retained a portion of the proceeds and distributed a portion to the group's affiliates other than Athena. The sheet shows the proceeds of $338,208,000 being reduced by (i) several "intercompany payments" (payments to Parent's affiliates including EPIL, EIS (Elan International Services) and one on "behalf of" Athena); (ii) three payments for "retrospective reimbursement of [Plaintiff's] qualifying reinvestments;" and (iii) intercompany loan repayment to Athena/ EPIL. Additions include certain intercompany receipts including one from EPIL of about $96 million "out of" ABELCET proceeds. The "summary of spending" shows $88,815,599 as being spent by Plaintiff "directly" and $249,392,401 as being "amounts paid to other group companies," leaving a zero balance of "[ABELCET] cash left in" Plaintiff as of December 31, 2003.
Per Plaintiff, however, the document is irrelevant because it did not rely upon the same in its partial summary judgment motion, and in any event, does not prove that Plaintiff did anything other than distribute the ABELCET sale proceeds. Parent's employee certified that the "reimbursement" amounts were actually repayments by Plaintiff to Athena "of periodic intercompany contributions to" made by Athena to Plaintiff, and that the intercompany payments to Parent's affiliates would, if they were, have been made at Athena's direction, and if so paid, would have been "re-transferred" by those affiliates to EIS, an international finance company organized by Parent, for Parent's use of those monies.
Per the employee this sheet still showed the distribution of ABELCET proceeds as follows: (1) the $155 million being comprised of three December 2002 "intercompany payments," one to "ETT" (Elan Transdermal Technologies), shown on the corporate chart as a subsidiary of Athena; one to EPIL; and one to EPIL "on behalf of" Athena; (ii) the $183 million being comprised of two payments, $149 million to Athena/EPIL as "intercompany loan repayment" and $33 million as "retrospective reimbursement of [Plaintiff] for qualifying reinvestment;" (iii) the $22 million being a single payment for "reimbursement of qualifying reinvestment expenditure."
(D) Disposition of ABELCET & MYOCET Business and Assets in Europe
In 2003, Parent and/or its affiliates earned about $16 million in Europe and Asia, attributable to ABELCET. This was in addition to income from the sale/marketing/licensing of MYOCET.
However, Parent was continuing with its recovery plan. Its 2002 annual statement noted that as part of such plan, the Elan group was reorganized into two new units: Core Elan and Elan Enterprises. The description of these units appeared to be the same as the former two primary business units, Elan Pharmaceuticals and Elan Pharmaceutical Technologies, except that Core Elan was to engage in commercial activities in the therapeutic areas of neurology, pain management, and infectious diseases; and Elan Enterprises would attempt to dispose of many of the drug delivery businesses, business ventures, and non-core pharmaceutical products. In this connection, Plaintiff's employee certified that Plaintiff's three "core" business operations of neurology, autoimmune diseases, and severe pain management, constituted a distinct business segment, with little interaction between each operationally and medically.
The annual statement also listed several of the business lines sold, many of which were in the U.S. Included was a description of the Enzon transaction. ABELCET was listed as one of the "divested" products in its continued therapeutic area of "infectious diseases" such as "fungal infections." Also included was the sale of Athena Diagnostics, Inc., one of Plaintiff's subsidiaries, a stand-alone diagnostics entity focused on neurological diagnostics.
On December 23, 2003, Parent with "asset vendors" (Plaintiff, Athena, EPIL, among others) and "share selling companies" (which included Parent's foreign subsidiaries in France, Germany, Italy, and Spain), entered into an "Agreement For the Sale and Purchase of the European Specialities Pharmaceutical Business of Elan" with Medeus UK Ltd. Included in the list of "Products" sold were ABELCET and MYOCET. Also included were the intellectual property rights with license agreements and contracts acquired by Plaintiff when Parent purchased Liposome; the October 2002 ABELCET purchase agreement; the November 2002 Supply Agreements; and the November 2002 License Agreement. The assignment of the trade marks for ABELCET was however subject to a license back to the Elan group to continue labeling and packaging of that drug. Plaintiff was identified as the "proprietor" of the intellectual property in ABELCET and MYOCET, accompanied with a list of the several foreign countries in which those drugs were patented. Plaintiff was also separately listed as proprietor of other drugs, clinical methods and processes.
(E) Taxation's Audit
On its 2002 CBT return, Plaintiff reduced its reported federal entire net income, which included the gain from the Enzon sale, by $340,332,168, as being the nonoperational income attributable to the same. However, on its 2002 California consolidated corporate income tax return, Athena, as parent, reported about 26% of this amount as apportionable, operational income. Thus, no amount was reported to California as non-business income.
Schedule R-4 of the California return required reporting of any gain or loss from sale of nonbusiness assets, which included sales of "intangible personal property if the corporation's commercial domicile is in California or the income is otherwise allocable to California."
Taxation's audit determined that the gain on the Enzon transaction was apportionable income, thus, subject to CBT not only because Plaintiff did not allocate the entire income to California but also because the transaction did not "meet the criteria allowing for the business liquidation exception." The final determination upholding the audit noted that should a court decide the gain from the Enzon transaction was nonoperational income, then pursuant to law, Taxation would assess Plaintiff, for among others, "recapture prior expenses on disposed assets."
The assessment at issue is $3,062,795.15 (tax $1,560,546.50; penalty $156,054.66; and interest $1,346,193.99). A portion of the assessment relates to inclusion of income which Plaintiff claims is not includable under the throw-out rule. The instant motions however address the inclusion of income from the Enzon transaction. ANALYSIS
(A) Appropriateness of Summary Judgment
Summary judgment will be granted "if the pleadings, depositions, answers to interrogatories and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact challenged and that the moving party is entitled to a judgment or order as a matter of law." R. 4:46-2(c); Brill v. Guardian Life Ins. Co. of Am., 142 N.J. 520, 523 (1995).
The issue is whether the sale proceeds from the Enzon transaction constitute operational income, thus, apportionable income subject to CBT. The material facts as to the acquisition and disposition of the U.S. and Canadian ABELCET business lines are undisputed. What remains is the application of law to the transaction. Therefore, summary judgment is appropriate.
(B) Income Subject to CBT
Prior to 2002, N.J.S.A. 54:10A-6.1(a) provided as follows:
"Operational income" subject to allocation to New Jersey means income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations and includes investment income serving an operational function. Income that a taxpayer demonstrates with clear and cogent evidence is not operational income is classified as nonoperational income, and the nonoperational income of taxpayers, other than those that have their principal place from which the trade or business of the taxpayer is directed or managed in this State, is not subject to allocation.The above statute was amended effective January 1, 2002 by requiring the standard of evidence for claiming income as non-operational to be "clear and convincing" and by replacing the language as to nonoperational income as follows:
. . . Income that a taxpayer demonstrates with clear and convincing evidence is not operational income is classified as nonoperational income, and the nonoperational income of taxpayers is not subject to allocation but shall be specifically assigned; provided, that 100% of the nonoperational income of a taxpayer that has its principal place from which the trade or business of the taxpayer is directed or managed in this State shall be specifically assigned to this State to the extent permitted under the Constitution and statutes of the . . . United States.The above addition was to avoid "a significant part of the nonoperational income of New Jersey headquartered companies to escape taxation." Assembly Budget Comm. Statement to Assembly No. 2501 (June 27, 2002).
(C) Liquidation Exception to N.J.S.A. 54:10A-6.1(a)
In McKesson, supra, the issue was whether income from the sale of stock of a subsidiary, a non-domiciliary which did business in New Jersey, was nonoperational income not subject to CBT. The subsidiary, which was wholly-owned by its parent, sold bottled drinking water nationally, whereas parent sold "health-related, primarily pharmaceutical-type, products." 23 N.J. Tax at 451. Parent sold the subsidiary to another non-domestic entity. Ibid. Since the stock sale was treated as a deemed asset sale under I.R.C. §338(h)(10), the subsidiary was deemed to have liquidated and paid the purchase price for its stock as a liquidating distribution to its shareholders, here, its parent. Id. at 451-52.
The court first concluded that the "source of N.J.S.A. 54:10A-6.1(a) was the "functional test" found in the second part of the definition of "business income" in the Uniform Division of Income for Tax Purposes Act ("UDIPTA"). McKesson, supra, 23 N.J. Tax at 454-56. It then surveyed the various cases interpreting the UDIPTA definitions and found that "where the sales have constituted liquidations or partial liquidations of a business, and the sale proceeds have not been reinvested in the business, courts (with the exception of the California courts) uniformly have held . . . that the sale proceeds were nonbusiness income." Id. at 457. The court then concluded:
Under the judicial interpretations discussed above, the deemed sale of assets by, and liquidation of [subsidiary] did not constitute the acquisition, management and disposition of property as an integral part of the [subsidiary's] regular trade or business operations. The result of the transaction, under the Section 338(h)(10) election made by Parent, as seller, and [the] . . . buyer, was a cessation of [subsidiary's] business with a complete liquidation and distribution to Parent of the proceeds of the sale of [subsidiary's] assets. This was an extraordinary event in the company's history, resulting in the deemed termination of its operations and existence. The gain resulting from the sale was neither operational income nor investment income serving an operational function because no operational function of [subsidiary] continued after the deemed sale ofThe court did not decide the issue of whether the subsidiary and the parent conducted a unitary business since it was not ripe for decision by summary judgment. Id. at 465, n.5.
assets and liquidation, and Parent did not invest the proceeds of the sale in a business similar to that conducted by [subsidiary].
[Therefore] . . . income resulting from its deemed sale of assets was nonoperational income under N.J.S.A. 54:10A-6.1(a). As a result, the income is not allocable to New Jersey and must be assigned to California, the location of [subsidiary's] principal place of business.
[23 N.J. Tax at 465]
The Appellate Division affirmed. 408 N.J. Super. at 221. It noted that the Supreme Court's ruling in MeadWestvaco Corp. v. Ill. Dep't of Revenue, 553 U.S. 16, 19 (2008), a case decided after the Tax Court's holding, did not require a different result. This is because in that case the Court had held that income from the sale of a foreign company's "division" was operational income apportionable to Illinois "under the unitary business principle," whereas in McKesson the decision was based on statutory grounds. 408 N.J. Super. at 220-21. This distinction, namely, the "thorough[]" resolution of the issue on "purely statutory grounds" did not require the court to "to reach the constitutional issues implicated in the unitary business principle." Id. at 221 (citations omitted). Cf. Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 794 (1992) (no dispute or contention that the gains from the sale of stock held by taxpayer in another company "was not intended to benefit a unitary business, part of which operated in New Jersey) (O'Connor, J., dissenting).
Here, neither party contends that there are factual issues as to whether the Elan group, including Plaintiff, was engaged in a unitary business. Neither party has argued that the U.S. and Canadian ABELCET business line is not unitary. Thus, the "property" sold, here the tangible and intangible assets associated with the ABELCET product line, is the property or assets employed in a unitary business, part of which was operating in New Jersey.
(D) Application of McKesson
McKesson is binding on this court. See Badische (BASF) Corp. v. Township of Kearny, 17 N.J. Tax 594, 599 (App. Div. 1998) ("[a] trial judge has the responsibility to comply with the pronouncements of the Appellate Division"). Therefore, unless this matter is either factually distinguishable or there is subsequent binding new law, this court must follow McKesson.
Taxation argues that (i) Mckesson misapplied UDIPTA because the Multistate Tax Commission's ("MTC") regulations interpreting the functional test specifically includes income from asset sales due to liquidation as business income; and (ii) the instant case is factually distinguishable because there was no liquidation, and, in any event, the sale proceeds, were used for operational purposes.
(i) MTC Regulations
Taxation is correct that the MTC regulations interpreting the UDIPTA provisions of business/nonbusiness income under the functional test provide that income from "isolated sales . . . and other infrequently occurring dispositions . . . including transactions made in liquidation or winding-up of business, is business income." MTC Reg. IV.1(a)(5)(B). The problem with Taxation's reliance on the MTC regulations, however, is two-fold. First, the regulation appears to have been adopted in 1973 and revised in August 2003. Thus, it was in place when McKesson was decided in 2007, and affirmed in 2009. Consequently, this court is hard-pressed to find that the MTC regulations are "new law" which may suffice to permit a re-interpretation of the liquidation exception to the functional test.
Second, the MTC regulations do not have the force of law. The preface of the regulations itself states that those rules "are subject to adoption by each member state in accordance with its own laws and procedures." Similarly, Walter Hellerstein, State Taxation ¶9.05 (3d ed. 1998), the treatise relied upon by Taxation, notes that "the MTC regulations are extremely influential in the construction of the UDIPTA" but has no legal effect "unless" a State "adopts the regulations in accordance with its own rulemaking procedures." Cf. AccuZIP, Inc. v. Director, Div. of Taxation, 25 N.J. Tax 158, 180-81 (Tax 2009) (for purposes of a nexus analysis, Taxation cannot "informally adopt the MTC's rules" without following the required rule-making procedures, where New Jersey "is only a Sovereignty Member of the MTC and is not bound by the group's position as would be required for a Compact Member."). This court was not provided with any CBT regulations promulgated by Taxation which either adopted the MTC regulations or provided similar rules interpreting the functional test.
Therefore, the MTC regulations and precedents from other States, while educational of the growing unpopularity of incorporating a liquidation exception to the functional test, does not provide grounds to deem McKesson as non-binding upon this court. Any reconsideration of, or remedy for, the liquidation exception to the application of N.J.S.A. 54:10A-6.1(a) should come from the higher courts or from our Legislature.
Several courts have ruled that income from liquidating sales is not an exception to application of the functional tests and is thus apportionable income. See, e.g., First Data Corp et al. v. Ariz. Dept. of Revenue, 313 P.3d 548 (Ariz. Ct. App. 2013) and citations therein (declining to follow a liquidation exception to the functional test, whether or not, there was an I.R.C. §338(h)(1) election, and finding unpersuasive cases, including McKesson, supra, which have held otherwise). See also Harris Corp. v. Ariz. Dep't of Revenue, 312 R3d 1143, 1151 (Ariz. Ct. App. 2013) where one of the reasons for the rejection of the liquidation test was a resultant "lack of symmetry" because during operation of the business, the income producing asset would "be depreciated and expenses deducted" which provides lesser "business income" however, "upon sale any gain would become nonbusiness income under a liquidation exception." Thus, the State which is apportioned the pre-sale reduced business income would "shoulder the deductions" whereas a "a single state" which is allocated the sale income under the liquidation exception to the functional test "might capture all the income" at no expense to it at all.
The above conclusion also disposes Taxation's argument that because Plaintiff treated the gain from sale of the U.S. and Canadian ABELCET markets as operational or business income in California where it is headquartered, it follows that Plaintiff cannot treat it as non-operational income elsewhere. While this is appealing under pure common sense, and in light of the purpose of the UDIPTA, it does not mean that Plaintiff is barred from seeking application of New Jersey law when challenging a New Jersey tax assessment. It is unclear whether McKesson, which acknowledged but disagreed with California's non-recognition of the liquidation exception, deemed this alleged inconsistent income-reporting to be of any consequence when it concluded that the income from liquidation of the subsidiary should be "assigned to California, the location of [subsidiary's] principal place of business." 23 N.J. Tax at 465. Nonetheless, this court should be guided by N.J.S.A. 54:10A-6.1(a), New Jersey's basis for taxing operational income, and the binding law construing that statute, not the consequent result of such treatment in another State.
See Jim Beam Brands Co. v. Franchise Tax Bd., 133 Cal App. 4th 514 (Cal. Ct. App. 2005) (holding that a company's gain from the sale of stock of a wholly owned subsidiary constituted business income), review denied, 2006 Cal. LEXIS 94, *1 (Cal. 2006).
(ii) Factual Distinction
The court can however distinguish McKesson. The immediately apparent factual distinctions are that (i) this case does not involve an I.R.C. §338(h)(10) sale; (ii) in McKesson, Parent was involved in one business line (pharmaceutical) and its subsidiary was involved in a completely distinct business (selling bottled water); (iii) the issue of unitary nature of the parent's and subsidiary's business was unresolved. However, since McKesson relied upon cases which were not factually identical, this court will examine the facts on the record before it.
The undisputed facts are that ABELCET (i) was a pharmaceutical drug; (ii) was one of the several tangible products sold by the Elan group; (iii) had attendant several intellectual property rights which were valuable intangible assets for Plaintiff and for the Elan group; and (iv) was managed/employed/sold/marketed world-wide by Plaintiff and Parent's subsidiaries pursuant to licenses and/or distribution rights (also valuable intellectual property rights).
It is also undisputed that the Elan corporate family was involved in a world-wide pharmaceutical and biotechnology business whereby the source of income was from the sale of various drugs in the medical field, and from the licensing, use, or distribution of the intellectual property rights attendant to those drugs. It is further agreed that Parent's method of achieving its goal of becoming a globally renowned pharmaceutical company was by acquisition of profitable, viable companies in this field. Acquisition of Liposome and its subsidiaries by Parent was one of the many corporate acquisitions in furtherance of the goal, and Plaintiff was the corporate mechanism to aid and continue the growth of this endeavor.
The court thus finds that for purposes of the functional test in N.J.S.A. 54:10A-6.1(a), ABELCET and its intellectual property rights were tangible and intangible property; the same were acquired, managed, employed by, and integral to, Plaintiff's and the corporate group's regular trade or business of being a world-wide fully integrated pharmaceutical company; and the same earned significant income in the course of Plaintiff's and Elan group's regular trade or business as a world-wide fully integrated pharmaceutical corporation.
It would logically follow that the disposition of the tangible property (inventory of ABELCET and its raw materials; the machinery/equipment in Indiana which made ABELCET) and intangible property (patents, know-how, trade-marks, distribution rights, licenses, all of which were treated as income generating capital assets) should produce operational income. This is especially true where it is undisputed that the reason for the sale of ABELCET was so that the Elan group would reduce its debt, thus, allow it to continue to remain in business which was facing a downturn. ABELCET, as the most profitable drug in the most viable commercial market (the U.S.), with an assured market due to increasing number of patients with compromised or weakened immune systems (such as AIDS or cancer patients), would raise the maximal and quickest revenue. Thus, the sale of the U.S. and Canadian ABELCET markets was clearly for the benefit of the Elan group, including Plaintiff, and for their continuance, in and of, their unitary business.
However, as held by Mckesson, supra, income from disposition of a capital asset is not apportionable if it was earned in a liquidation context. This is because a complete "cessation of" the subsidiary's business due to the sale of all of its stock/assets is an "extraordinary event," thus, the resultant income is not operational especially where the sale proceeds were not re-invested in a "similar business." 23 N.J. Tax at 465. This court views this finding as requiring a narrow construction of the liquidation exception, thus, to be carefully scrutinized when being applied to the sale of capital assets which were unquestionably acquired and employed by the taxpayer such that the asset were "integral parts of the taxpayer's regular trade or business operations." A narrow construction will adhere to the language and intent of N.J.S.A. 54:10A-61.(a), the holding in Allied-Signal, supra, and general intent of UDIPTA, the latter two being the sources for the statute. It will also circumscribe the exception from swallowing the rule.
The court finds that neither Plaintiff nor the Elan group completely ceased doing its pharmaceutical business after the November 2002 sale of the U.S./Canadian markets for the ABELCET product line. Neither Plaintiff nor any of its or Parent's subsidiaries closed their respective shutters. Indeed, they continued as before, except that as to the ABELCET product line, their world-wide pharmaceutical business continued outside of the geographical areas of U.S. and Canada. However, even as to these two geographical areas, Plaintiff retained the rights to use ABELCET or its improvements in connection with any R&D activities conducted by Plaintiff or its affiliates under a license agreement with Enzon. Although Plaintiff claims that it had nothing to do with EPIL's sales of ABELCET abroad, the undisputed fact is that Plaintiff continued to be the legal owner of the drug and the intellectual property rights in the drug. The business reasons (cost/time savings) for providing only distribution rights to EPIL cannot subvert the fact, and thus, the conclusion, that Plaintiff continued to operate its pharmaceutical business, including the ABELCET product line outside the U.S. and in a restricted manner within the U.S.
Further, several agreements were effectuated with Enzon which allowed Plaintiff and the Elan group to continue to benefit from, and use, the ABELCET product and assets. This was in contrast to another 2002 divested product line, Permax, which Plaintiff sold to an unrelated company as part of its recovery plan, and as to which there were no supply agreements or other business arrangements since the group "divested . . . interest completely and retained no role or interest in the drug going forward," per Parent's employee's deposition.
Although the supply agreements included MYOCET, the product line which was not sold to Enzon, Parent's employee's statement that Plaintiff would not have earned monies from this drug business because "that product would have never been approved in the U.S.," is questionable in light of the December 2003 sale agreement with Medeus, where MYOCET was listed as having been issued a patent in the U.S. with an expiry date of May 13, 2014.
The above reasons also render unpersuasive Plaintiff's arguments that it was liquidating its and Parent's (or Parent's group's) "oncology" line of business. While ABELCET was directed to a market comprising of physicians or surgeons, and/or hospitals for ultimate use by mostly cancer patients, it was also targeted to similarly vulnerable patients such as those with AIDS. ABELCET was also viewed as used in the therapeutic areas of "infectious diseases" such as "fungal infections" as described in Parent's 2003 annual report. Nonetheless, whether ABELCET was viewed as a cancer or oncology drug or an anti-fungal medication, the above facts show that the sale of its U.S. and Canadian market was not a final closure or liquidation of Plaintiff or Parent's "oncology business." Plaintiff and Parent's affiliates continued to research develop, manufacture, market, license, and/or distribute MYOCET, which had as its target audience, patients with metastatic breast cancer. The group also continued to enter into joint ventures with other corporate entities in the cancer treatment area, such as for example, with Chemagenix Therapeutics, Inc.
Parent's selection of ABELCET, the drug aimed at the cancer market, as being the most profitable revenue source for reduction of the group's debt, or as its employee stated, "the valuable bit of the total oncology business," does not require a conclusion that the group ended its oncology business for purposes of applying the liquidation exception of the functional test. The annual reports show that the Parent's divestiture program included several business lines or corporations which was not identified as focused on oncology, such as for example, Plaintiff's subsidiary, Athena Diagnostics, Inc., which had been involved in neurological diagnostics.
The court is also not persuaded by Plaintiff's claims that because Parent separated its business activities into two distinct groups, and further identified three or four distinct therapeutic areas, each area was a distinct business division or segment for purposes of applying the liquidation exception. That each drug has its own characteristics, thus, its own scientific procedure for its creation (and patent protection), and targets different areas of a human body, thus, different areas of medical attention/expertise, does not alter the fact that Parent with its group held itself out to be a fully integrated, world-wide pharmaceutical company in the business of providing various medications, whether through its own R&D efforts, or by acquisition of other similar companies with established medical drug products and markets for the same.
Plaintiff argues that regardless, McKesson applies because it is undisputed that Plaintiff sold a geographic segment of a product line (ABELCET), and such sale qualified for liquidation pursuant to cases approved and adopted in McKesson. Such cases were McVean & Barlow, Inc. v. New Mexico Bureau of Revenue, 543 P.2d 489 (N.M. Ct. App. 1975) and Laurel Pipeline Co. v. Commonwealth of Pennsylvania, 642 A.2d 472 (Pa. 1994). The court finds that neither of these cases have similar facts to Plaintiff.
Cf. Harris Corp., supra, 312 P.3d at 1150-51 (noting that the McVean case is "distinguishable because it applied a transactional test without considering the functional test").
Neither involved the sale of valuable intangible intellectual property rights in addition to tangible property. Neither case involved reservation to the seller of the post-sale use of/ability to use the intangible property sold, as Plaintiff and other affiliates did here within and without the geographical areas under the license agreement. Even if the reservation for use was for R&D purposes, it cannot be doubted that this was to benefit from the economic value attached to the development or improvements to ABELCET pursuant to such R&D activities. Further, the sale involved an anti-competition undertaking whereby the Elan group (including Plaintiff) and buyer agreed not to sell, market, or distribute ABELCET outside of their respective permitted geographical regions for a 10-year period. Such clause would appear to acknowledge that Plaintiff, Parent and the Elan group continued in the same competitive pharmaceutical market with ABELCET as one of the primary products over, and as to which the Elan group still had rights, thus, belying a "complete" liquidation of Plaintiff, Parent's or the Elan group's trade or business. The above cases cited by Plaintiff do not allude to similar facts, and whether these facts, if present, would make a difference in their holdings.
As to the issue of whether the sale proceeds were fully distributed by Plaintiff to Athena, its sole shareholder, the court notes that Plaintiff's 2002 CBT return does not show any such distribution, or even the $155 million approved to be paid as dividends. Schedule C-1 showing the unappropriated retained earnings showed zero distributions. There is a line item showing a "decrease" of $179 million, however, the explanatory statement was not attached to the return for the court to understand the nature or source of this amount. Plaintiff's claim that it made installment distributions so that it would have adequate cash reserves to any potential indemnification obligations to Enzon is belied by the absence of any amounts reflected as appropriated retained earnings on the 2002 CBT return.
Plaintiff's claim that it used the sale proceeds to pay monies on behalf of Athena is not persuasive. EPIL, one of the recipients of the ABELCET sale proceeds, was neither Plaintiff's nor Athena's subsidiary or stockholder. EPIL was not a party to the October 2002 Asset Agreement yet paid Plaintiff about $96 million "out of the ABELCET" proceeds." Even if there was some inter-corporate arrangement, it is more likely between Plaintiff and EPIL directly (as opposed as through Athena as Plaintiff claims) because it was Plaintiff which, as proprietor, provided EPIL the distribution rights for ABELCET, not Athena. Plaintiff did not designate the payment of about $15 million to EPIL as being made "on behalf of" Athena. There was no explanation for payments of amounts designated as "partial [amount] designated out of [ABELCET] proceeds." Therefore, the court is not persuaded that Plaintiff made "liquidating" distributions to its sole shareholder, Athena, as contemplated by McKesson, supra.
In sum, the internal reorganization of Elan group's business strategy so as to increase revenue through, among others, reducing the group's debt by selling a portion of the ABELCET business line, which had been integral to, and regularly employed in Plaintiff's and the Elan group's trade or business, but with retention of some economically valuable intangible rights, thus ensuring continued income to, and corporate presence of, the Elan group, does not require a liberal interpretation of the liquidation exception carved out by McKesson, supra, in N.J.S.A. 54:10A-6.1(a). The court finds that based on the facts and the record, Taxation properly determined that Plaintiff did not prove by clear and cogent evidence that the sale of the U.S. and Canadian markets for ABELCET was nonoperational income. Therefore, Taxation's assessment as to this issue is affirmed. CONCLUSION
In light of the conclusion, the court does not analyze Taxation's alternative argument that because New Jersey was the "principal place from which" Plaintiff's business was "directed or managed," 100% of the income should be allocated to this State under the last sentence of N.J.S.A. 54:10A-6.1(a).
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A final Order and Judgment granting Taxation's motion for partial summary judgment will accompany this memorandum opinion.
Very truly yours,
Mala Sundar, J.T.C.