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Two subsidiary corporations that did not do business in Maryland and did not own tangible property in Maryland, but were subsidiaries of an out-of-state parent company that did business in Maryland, were liable for Maryland corporate income tax because they lacked real economic substance as separate business entities and constitutional nexus existed.
Licensing Agreements
The parent company incorporated one of the subsidiary companies in 1996 and entered into a license agreement authorizing the subsidiary to license the use of the parent trademarks in exchange for 100% of the subsidiary's stock. In 1997, the parent company transferred its stock in the first subsidiary to a second subsidiary in exchange for cash. In 1999, the first subsidiary distributed the license agreement, as a dividend, to the second subsidiary. Later that year, the second subsidiary entered into a license agreement with the parent company which granted the parent company a license to the trademarks in exchange for royalty payments.
The Maryland returns filed for the parent company's affiliates, including the two subsidiaries, for the years in question listed the income reported on the federal consolidated return for each affiliate with a zero Maryland apportionment factor. The Maryland Comptroller's office disagreed and assessed the subsidiaries Maryland corporate income taxes.
The subsidiaries both relied on
Comptroller of the Treasury v. SYL, Inc., 375 Md. 78, cert. denied (2003), in arguing that they were not liable for Maryland corporate income tax. One of the subsidiaries argued that it did not lack real economic substance because it was actively engaged in maintaining, managing, enforcing, and protecting the trademarks. The other subsidiary contended that the Court was bound by Syl, to look to the underlying source of its income and that the parent's activity in Maryland had nothing to do with the gain derived by the subsidiary. The second subsidiary further argued that nexus did not exist and that the "federal sham doctrine" applied, based on SYL. All of the subsidiaries' arguments were rejected.
Lack of Economic Substance
The Court noted that the parent company paid royalties to the second subsidiary for the years in question and the subsidiary loaned back approximately two thirds of the sums back to the parent. The Court determined these were not arm's length market transactions. Neither of the subsidiaries had substantial operating expenses and the Court determined that the subsidiaries did not act independently. Therefore, the subsidiaries lacked real economic substance as a separate business entities and the activities of the subsidiaries had to be viewed through the activities of its operating parent. As such, there were substantial activities of the subsidiary within Maryland.
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Nordstrom, Inc. v. Comptroller of the Treasury, Maryland Tax Court, Appeal Nos. 07-IN-OO-0226; 06-IN-OO-00317, 07-IN-OO-0226; 06-IN-OO-00318, 07-IN-OO-0226; 06-IN-OO-00319 October 24, 2008.
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