The Virginia Court of Appeals has held that the Department of Taxation (“Department”) cannot require a corporation to include the income and factors of a 17% owned limited liability company with its own income and factors, demonstrating that entities taxed as partnerships are not always unitary regardless of a taxing agency’s position. Dep’t of Tax’n v. FJ Management, Inc., d/b/a FJI, Inc., Record No. 0701-23-2 (Nov. 12, 2024).

Facts: Prior to 2008, FJ Management, Inc. (“FJM”) operated “Flying J” interstate travel centers which provided various services to long-distance truckers. It also operated, through subsidiaries, oil refineries in Utah and California, an oil pipeline in Texas, and a bank. It filed for Chapter 11 bankruptcy in 2008.

During the bankruptcy process, FJM effectively sold all of its travel centers to Pilot Travel Centers, LLC (“Pilot”), carried out as an exchange for a 17% membership interest in Pilot and $1.8 billion in cash to satisfy its creditors. FJM also entered into an agreement to sell fuel from the Utah refinery to Pilot for a period of 20 years. As part of the bankruptcy process, FJM also disposed of its oil refinery in California and the oil pipeline in Texas. Thus, after exiting bankruptcy, FJM retained only the oil refinery in Utah, the bank, and its minority interest in Pilot. Pilot then owned 550 interstate travel centers operating in multiple states, including Virginia.

FJM originally filed its Virginia corporate tax returns for 2013 through 2015 by including its distributive share of Pilot’s income and apportionment factors in its own tax base and apportionment factors. FJM subsequently filed amended returns treating the income from Pilot as allocable non-unitary business income and removing Pilot’s factors from FJM’s apportionment factors. These returns claimed a net refund.

The Department denied the refund claims and FJM pursued the matter first administratively and, then, into the courts.

The Decision: The Court of Appeals had little difficulty finding that FJM was not engaged in a unitary business with Pilot. It first found that the two were not functionally integrated as each was engaged in separate and discrete lines of business. Pilot was engaged in operating interstate travel centers whereas FJM was primarily engaged in operating a refinery in Utah and a bank. FJM and Pilot did not share any business functions, nor did they share any financial or human resource functions. While the two had entered into a fuel supply agreement, FJM sold the fuel to Pilot according to pricing terms used for all its other fuel purchasers based on spot prices set by an independent fuel-pricing service.

FJM and Pilot were also not centrally managed. Two other owners of Pilot were related to each other, owned 77.58% of Pilot and exercised control over all of Pilot’s significant management decisions. By contrast, FJM could appoint only two of the between nine and eleven members of Pilot’s board of managers.

The companies also did not derive any economies of scale. Indeed, they did not share any business activities that could have potentially enabled them to obtain cost efficiencies that they would not have otherwise been able to obtain on their own.

Based on the foregoing, the Court held that FJM and Pilot were not engaged in a unitary business. The Court found support from the testimony of a Department tax analyst who testified that FJM’s responses on a Department questionnaire indicated that functional integration, centralized management, and economies of scale did not exist between FJM and PTC.

Finally, the Court rejected the Department’s other arguments including that the Department could constitutionally treat FJM and Pilot as a unitary business because FJM’s ownership interest in Pilot, a pass-through entity, was not passive, and that FJM took on an operational role in Pilot’s management.

Accordingly, the Department’s actions violated the Due Process and Commerce Clauses of the U.S. Constitution and FJM was entitled to the refunds. This case is a good reminder not to accept a taxing agency’s position that a flow-through entity will always be unitary with a corporation that owns the entity.