Indiana nexus for intellectual property.

• Author: Dederyan, Karen

As various states continue to look for ways to increase and maximize their tax revenues, they frequently focus on nexus. At the same time, businesses with significant intangible assets try to minimize their state tax costs through the use of out-of-state subsidiaries that hold intellectual properties (IPs).

In Letter of Finding No. 95-0401, issued June 1, 2002, Indiana joined the ranks of those states broadening their definition of nexus, when it found that an out-of-state company had nexus with the state and was subject to adjusted gross income (AGO and gross income taxes on IP royalty income.

The taxpayer was a wholly owned subsidiary of an Indiana parent that manufactured parts and owned patents, trademarks and other IP. The taxpayer was a Delaware holding company and maintained an office in that state. It had no office, employees or tangible personal property in Indiana.

After its incorporation, the parent assigned all its IP to the taxpayer in exchange for all the taxpayer's stock. The decision was made "to insulate and protect [the intellectual property] from the day-to-day operational and financial risks of the [ parent's] business."

The parent paid the taxpayer $500,000 for the exclusive right to use the IP, and agreed to fees of 5% of the annual gross sales of certain products. The taxpayer paid a $500,000 dividend to the parent on the day it received the $500,000 fee from the parent; the taxpayer also routinely loaned to the parent the same amounts as the parent paid it in royalties.

On audit, the Indiana Department of Revenue (DOR) held the taxpayer subject to AGI and gross income taxes. In support of its findings, the DOR cited Geoffrey, Inc. v. South Carolina Tax Comm'n, 313 SC 15 (1993), noting "[i]t is well settled that the taxpayer need not have a tangible, physical presence in a state for income to be taxable there. The presence of intangible property is sufficient alone to establish nexus." The DOR concluded that Indiana was the business situs of the intangible property and that all of the taxpayer's income was Indiana income, because it was derived from that IP.

In addition, the DOR cited the following facts:

1. The taxpayer's income-producing assets consisted solely of the parent's IP.

2. The taxpayer licensed the property exclusively to the in-state parent.

3. All of the taxpayer's income consisted of royalties from the parent and interest on that royalty income and from...