WASHINGTON -- States that house corporations also doing business in a number of other states do not have a carte blanche to tax all of the firm's operations, the Supreme Court ruled yesterday.

The court's 5-to-4 ruling in Allied-Signal Inc. v. Director of Taxation defeated an attempt by New Jersey to collect close to $2 million in taxes arising from Bendix Corp.'s sale of shares inn Asarco Inc.

The court's opinion protects earnings of multistate corporations and appears to require states to document a direct link between a firm's earnings and activities within the states before being allowed to tax them.

The majority opinion was delivered by Justice Anthony Kennedy, who said the case record failed to support New Jersey's contention that the stock sale by Bendix, which is now a unit of Allied-Signal, was an integral part of the company's multistate business operations.

In so ruling, the justices reaffirmed their reliance on what is known as the "unitary business principle," under which a state may tax an apportionable share of a multistate corporation's business only if there is a sufficient connection between the firm's out-of-state and in-state activities.

To determine whether a unitary business exists, the court examines whether the firm's activities are functionally integrated, whether its management is centralized, and whether economies of scale exist.

Paul Mines, counsel for the Multistate Tax Commission, said a "disappointing aspect" of the court's ruling was that the issue of taxing multistate firms "remains such a factually intensive inquiry."

By the same token, Mr. Mines said, "The court is not telling states that they can't tax this kind of income. But they said you better have a factual record to back it up."

But Ferdinand P. Schoettle, a law professor at the University of Minnesota, said documentation "has always been open to the state." He said the ruling "provides much-needed protection for American business" and the flows of funds between parent companies and their subsidiaries.

In 1981, Bendix -- a corporation involved in the automotive, aerospace, energy, and forest products industries -- realized a $211.5 million gain when it sold its 20.6% stock interest in Asarco, a producer of nonferrous metals.

New Jersey taxed the gain, a decision backed up by the state's tax and supreme courts. The courts concluded the tax was constitutional in large part because Bendix intended to use the proceeds the fund operations.

But the U.S. Supreme Court yesterday reversed the lower courts, holding that the Constitution's commerce and due process clauses require a clear link between the taxing state and the transaction it is trying to tax.

"To be sure, our cases give states wide latitude to fashion formulae designed to approximate the instate portion of value produced by a corporation's truly multistate activity," Justice Kennedy said. "But that is far removed from New Jersey's theory that any business in the state, no matter how small or unprofitable, subjects all of a corporation's out-of-state income, no matter how discrete, to apportionment."

In essence, the Allied-Signal case was an issue of whether Bendix's Asarco investment was for purely investment purposes or actually served an operational purpose.

"A state may include within the apportionable income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another state if that income forms part of the working capital of the corporation's unitary business, notwithstanding the absence of a unitary relationship between the corporation and the bank," Justice Kennedy wrote.

But, he added, "That circumstance, of course, is not at all presented here." According to Justice Kennedy, the Asarco investment was not similar to a "short-term investment of working capital analogous to a bank account or certificate of deposit."

The court majority's rationale drew a rebuke from Justice Sandra Day O'Connor, who wrote, "Any distinction between short-term and long-term investments cannot be of constitutional dimension. Whether an investment is short-term or long-term, what matters for due process purposes is whether the investment is operationally related to the in-state business."

Concluding that the investment was operationally related, Justice O'Connor said New Jersey should have been allowed to tax the stock sale.

The court's unitary business principle and the concept of apportioning revenues arose during the late 1800s, when states were grappling with how to tax railroad and telegraph companies.

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