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McKesson Water Products Co. v. Director

July 16, 2009


On appeal from the Tax Court of New Jersey, Docket No. 0156-04, whose decision is reported at 23 N.J. Tax 449 (Tax 2007).

The opinion of the court was delivered by: Fuentes, J.A.D.



Argued January 27, 2009

Before Judges Winkelstein, Fuentes and Chambers.

In this appeal, we are required to decide whether the Tax Court correctly construed the term "nonoperational income," as used in N.J.S.A. 54:10A-6.1(a), to determine whether plaintiff's gain from a deemed asset sale under Internal Revenue Code § 338(h)(10) is subject to the New Jersey Corporation Business Tax (CBT). As a corollary to this issue, the Director of Taxation also asks us to remand this matter for the Tax Court to consider the applicability of the "unitary business" principle, in light of the United States Supreme Court's decision in Meadwestvaco Corp. v. Illinois Department of Revenue, 553 U.S. ___, 128 S.Ct. 1498, 170 L.Ed. 2d 404 (2008).

After carefully reviewing the record developed before the Tax Court, and considering prevailing legal standards, we affirm Judge Kuskin's well-reasoned opinion, as reported in McKesson Water Products Co., v. Director, Division of Taxation, 23 N.J. Tax 449 (Tax 2007). Because the Tax Court decided this case on cross-motions for summary judgment, we will rely on the core material facts that informed the Tax Court's decision.*fn1


At all times relevant to this case, McKesson Water Products Company (McKesson-Water) was a Delaware corporation with its principal place of business located in the State of California. McKesson-Water was a wholly-owned subsidiary of McKesson Corporation (McKesson-Parent); McKesson-Water was in the business of processing and selling bottled drinking water across the country by direct delivery and at retail establishments. McKesson-Parent was a Delaware Corporation with its commercial domicile in California. It sold and distributed pharmaceuticals and other healthcare-related products.

On January 10, 2000, McKesson-Parent entered into a Stock Purchase Agreement with Danone International Brands, Inc. and Groupe Danone, S.A. (Danone), under which McKesson-Parent agreed to sell all of its stock in McKesson-Water to Danone. The sale took place on February 29, 2000. The parties to the Stock Purchase Agreement made an election under I.R.C. 338(h)(10). The Tax Court gave the following explanation of the tax benefits derived from such an election.

A Section 338(h)(10) election permits a sale of stock to be treated, for federal income tax purposes, as a sale of assets by the entity whose stock is being sold (the "target corporation") to a hypothetical new corporation of the same name. The target corporation is deemed to have received a purchase price equal to the amount that was in fact paid by the purchaser to the parent corporation as consideration for the purchase of the target corporation's stock.

The target corporation is then deemed to have made a liquidating distribution to its shareholder(s). As a result of the deemed sale, the assets of the target corporation receive a stepped-up basis for purposes of depreciation under the Internal Revenue Code. See Treas. Reg. 1.338-1(a) and (d) (describing a deemed sale of assets transaction). [McKesson, supra, 23 N.J. Tax at 451.]

Thus, McKesson-Parent's sale of McKesson-Water's stock to Danone was treated, for federal income tax purposes, as if McKesson-Water had sold its assets to a new company of the same name. Under this fictional sale, [t]he new company was deemed to have paid to [McKesson-Water], as the purchase price of the assets, an amount equal to the purchase price Danone paid [McKesson-Parent] for [McKesson-Water's] stock. [McKesson-Water] was then deemed to have liquidated and to have distributed to [McKesson-Parent] the proceeds of the hypothetical sale of its assets. [Id. at 452.]

McKesson-Parent filed a consolidated federal income tax return for the period April 1, 1999, through March 31, 2000, that recognized no gain or loss from the sale of McKesson-Water stock. McKesson-Water filed a New Jersey CBT return for the period, between April 1, 1999, and February 29, 2000, reporting a tax due in the amount of $244,990. William J. Peeters, the Director of Tax Audits for McKesson-Parent, submitted a detailed affidavit explaining the accounting methods he used to determine the CBT due. Based on this analysis, McKesson-Water sought to ...

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