Current corporate income tax developments.

• Author: Boucher, Karen J.
• Position: Part 1

This two-part article discusses a myriad of recent state tax activity in the corporate income tax area. Part I addresses nexus, tax base, business/nonbusiness income and trademark/tradename cases and determinations.

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During 2003, numerous state statutes were added, deleted or modified; court cases were decided; regulations were proposed, issued and modifed; and bulletins and rulings were issued, released and withdrawn. This two-part article focuses on some of the more interesting items in the following corporate income tax areas: nexus; tax base; business/nonbusiness income; trademark/tradename cases and determinations; apportionment formulas; and filing methods/unitary groups and administration; it also includes several other significant state tax developments. The first four areas are covered in Part I, below; the remaining areas will be covered in Part II of this article, in the April 2004 issue.

Nexus

* Alabama

The chief administrative law judge (ALJ) held (1) that Alabama did not have Constitutional jurisdiction over a nonresident limited partner whose only contact with the state was the ownership of a limited interest in an Alabama limited partnership. This holding was based on Alabama's adoption of the entity theory of partnerships, effective Jan. 1, 1997. Under that theory, "the presence and activities of a partnership in Alabama cannot be attributed to its nonresident partners for nexus purposes." For years after 2000, Alabama law (2) requires nonresident partners to consent to jurisdiction or be taxed through entity withholding.

* Massachusetts

In Alcoa Building Products, Inc., (3) the Massachusetts Supreme Court affirmed that Alcoa's district sales managers exceeded P.L. 86-272 nexus protections for their nonancillary in state warranty claim activities. The sales managers visited the state an average 1.5 times annually, as part of their perceived job function of initiating and investigating warranty claims to maintain customers and remain competitive in the marketplace.

In another case, (4) the Appellate Tax Board (ATB) ruled sales should not have been thrown back to Massachusetts, because certain product demonstrations, "in service" advice and troubleshooting activities in other jurisdictions were not ancillary to solicitation, and exceeded EL. 86-272's nexus protections.

* Michigan

In Acco Brands, Inc., (5) the Michigan Court of Appeals held that the tax authority's delay in changing guiding bulletins did not bar a nexus assessment through the "doctrine of laches." The court first noted that Acco clearly had Michigan nexus through the presence of two resident sales personnel that solicited sales from in state accounts. For laches to apply, Acco had to prove that the Department of Treasury (Department) lacked diligence and that the delay was prejudicial. According to the court, the Department's more-than-three year delay to audit Acco reflected the backlog of cases following the Gillette (6) nexus decision, but not a lack of diligence. The delay in issuing a new bulletin was not prejudicial to Acco, as the Gillette decision put Acco on notice that the previous bulletins were not determinative of nexus.

* New York

The Department of Taxation and Finance ruled (7) office space rented for the personal convenience of a president, chief executive officer and chairman of the board, and a listed telephone number for the corporation at that address, qualified as "doing business" nexus for the state corporate franchise tax.

* North Carolina

A Superior Court ruled (8) that the presence of reined educational videos in the state did not create nexus. The state Attorney General's office emphatically states that this case does not establish precedent, and has appealed.

* Ohio

Reversing the Board of Tax Appeals, file Ohio Supreme Court held (9) the business activities that occur during the tax (accounting) year, not the business activities that occurred as of January 1 of the report year, are used to determine whether activities are subject to P.L. 86-272.

* South Carolina

The Department of Revenue (DOR) issued Rev. Rul. 03-4, (10) which lists a number of" activities and indicates whether they create nexus for corporate income tax purposes.

* Tennessee

The DOR found (11) that a mortgage banker without physical presence in the state does not have nexus, but must still file a franchise and excise tax return and pay the minimum tax, because it is registered to do business.

In another ruling, (12) the aggregate of the taxpayer's employees' infrequent presence and the parent's activities performed for the taxpayer by its instate headquarters, created sufficient franchise and excise tax nexus. A regional manager employed by, arid based in, the parent's Tennessee headquarters offices, performed a majority of his services on the subsidiary's behalf, specifically as direct supervisor for the taxpayer's business managers, with responsibility for implementing and maintaining set-standard high-quality performance and profitability. In addition, certain subsidiary officers and directors outlined and implemented strategy while in Tennessee; the subsidiary's business managers attended annual corporate three day training sessions; and the subsidiary's accounting, tax, business and insurance records, as well as payroll processing, were kept with the parent company in the state.

* Texas

The mere holding of a lien on real property does not subject a corporation to the franchise tax; however, foreclosure on any loan related to a property lien that results in obtaining title to real property in the state creates franchise tax nexus. (13)

* Virginia

Financing subsidiaries having no office, employees or tangible assets in the state, but having their affairs conducted primarily by officers of an affiliated taxpayer's in-state headquarters, had commercial combine in Virginia and could, thus, be included in the taxpayer's combined report. (14)

Trademarks/Tradenames

* Indiana

The DOR again denied (15) a corporation's royalty expense deductions for payments to a Delaware holding company (DHC). On rehearing, the corporation argued that the previous ruling referred to a two-party transaction, but there really was a three party arrangement: the intangible was contributed to the DHC; the DHC collected royalties from related subsidiaries and provided arm's-length loans to the parent. According to the DOK, this structure still reflects no business or economic justification and, despite the arm's-length pricing, it can properly disallow the related deduction as not fairly representing the income derived from sources ill the state.

The DOR also upheld (16) an audit finding requiring a corporate group to file on a unitary basis, because the trademark/royalty relationships among the group were "entirely illusory." The DOR found the group's business purpose and economic substance arguments unsupported, concluding (1) trademarks have no value once severed from the business, (2) business operations were not affected by the creation of the transactions and (3) the holding companies did not manage or enhance the trademarks' value. The DOR, also noted that the holding companies simply "loaned" back the royalty money received or invested the money on the payer's behalf.

* Maryland

In a joint decision, (17) the Maryland Court of Appeals reversed the Maryland Tax Court to hold that income from affiliated intellectual property DHCs is subject to tax based on the parent's in-state business. The court explained that the subsidiaries did not have real economic substance as separate business entities, only a touch of "window dressing"...