Corporate Close-Up: Multistate Taxpayers Beware -- Maryland’s Blend of Unitary Business, Economic Substance Doctrines Could Be a Trap for the Unwary


Maryland has been using its own house blend of the unitary business and economic substance doctrines to serve up a strong brew of nexus for out-of-state businesses, including major multistate corporations like Staplesnext hit, Conagra Brands and Gore Enterprises. This approach, while confined to Maryland, could give the jitters to businesses that have structured their operations to limit their Maryland tax liabilities but nonetheless later end up on the hook for state income taxes, several practitioner’s recently told Bloomberg BNA Weekly Tax Report’s Radha Mohan

Most recently, following the Maryland high court's 2014 decision in Gore Enterprise Holdings, the Maryland Tax Court affirmed a tax assessment against the parent of the Staples group and a wholly owned subsidiary, finding sufficient contacts with Maryland to require them to file returns and pay income taxes for years 1999 through 2004.  [Staples, Inc., Staples the Office Superstore, Inc. v. Maryland Comp. of the Treas., Nos. 09-IN-OO-0148, 09-IN-OO-0149 (Md. Tax Ct. May 28, 2015, released July 2015)]

The Staples ruling continues trend in Maryland Tax Court of pulling into the state's tax net multistate corporations based on an unusual analysis of a company's ties with the state that relies upon certain aspects of the unitary business and economic substance doctrines. As a result, Maryland's approach to “nexus” determinations has made it an outlier among states.

In Staples, the tax court determined the two petitioners did not have real economic substance as separate business entities.  Instead, their income was produced by the activities of their affiliates in Maryland, and the unitary nature of the business established nexus between Staples and Superstore and the state.

After a reorganization in 1998, Staples, the parent company, provided managerial and administrative services, including cash pooling and management, credit support, and legal, accounting and payroll services for three subsidiaries, Superstore, Staples East and Staples C&C.  Superstore and Staples C&C were wholly owned subsidiaries of Staples, and Staples East was wholly owned by Superstore.  

Superstore provided the franchise system services to Staples East and Staples C&C, including centralized purchasing, inventory control, lease and contract negotiation, and advertising and marketing.  According to the court, Staples East and Staples C&C relied on Superstore for these services, as well as for licenses to use the Staples trademarks and other intellectual property.  

Because the activities of Staples and Superstore "permeate the activities" of each other and the other two subsidiaries, the court concluded the petitioners could not operate independently.  The court, therefore, upheld the Comptroller's position that enterprise dependency existed between them and their affiliates.  In other words, the petitioners did not generate their own value as "discrete business enterprises," but relied on the activities of unitary affiliates for that value, including activities in Maryland.  As a result, Staples and Superstore had nexus with Maryland.

Superstore received royalty income and Staples received interest income, both recognized as expenses by Staples C&C and Staples East.  Citing Gore for upholding the constitutionality and fairness of applying the apportionment factor of the licensee/in-state retailer to affiliated entities that receive royalty and interest payments, the court concluded that the Comptroller's apportionment of petitioners' income to Maryland reasonably reflected how the income was generated and fairly represented the amount attributable to Maryland.

The Tax Court had to find that Staples and Superstore lacked economic substance in order to subject the two out-of-state companies to Maryland's taxing jurisdiction.  The Gore court clarified that the unitary business principle cannot be used as a basis to assert nexus over an out-of-state entity engaged in a unitary business with another entity with a presence in Maryland.  When evaluating intercompany transactions with intangible holding company affiliates, the test to be applied, according to Gore, is whether the entities in question have “real economic substance as separate business entities."  The court concluded the petitioners in this case, as in Gore, lacked economic substance because of their dependence on affiliates for income.

Although the Gore decision rejected the unitary nexus theory, it noted that there’s no reason that factors that indicate a unitary business cannot also be relevant in determining whether subsidiaries have no real economic substance.

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: is the Staples case an indication that Maryland courts will continue to conflate the “unitary nexus” and “economic substance” theories to impose tax on the intangible income of out-of-state affiliates?

Additional discussion of the unitary basis for attributional nexus can be found in Bloomberg BNA's State Tax Portfolio: 1430-2nd T.M., Jurisdictional Limitations: Attributional Nexus.

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