Maryland Tax Court adopts economic substance doctrine.

• Author: Yesnowitz, Jamie C.

Two recent decisions highlight the Maryland Tax Court's creation and use of the economic substance doctrine in cases involving the use of intangible holding companies (IHCs). The Tax Court ruled in The Classics Chicago, Inc. v. Comptroller and The Talbots, Inc. v. Comptroller, Nos. 06-IN-OO-0226 and 06-IN-OO-0227 (Md. Tax Ct. 4/11/08), that deductions relating to transactions between a parent company with Maryland nexus and a subsidiary can be revoked if the subsidiary does not have sufficient "economic substance."

Further, the court held that the subsidiary, which had not previously filed corporation income taxes in Maryland, had constitutional nexus with Maryland and was subject to a Maryland filing requirement. The Tax Court reached a similar result in Nordstrom, Inc. v. Comptroller, Nos. 07-IN-OO-0317, 07-IN-OO-0318, and 07-IN-OO-0319 (Md. Tax Ct. 10/24/08), where two IHCs belonging to a parent company that did business in Maryland both had nexus with the state because they lacked real economic substance as separate business entities.

Talbots

In Talbots, the Maryland comptroller's assessments stemmed from the effect of several intercompany transactions. In 1988, Talbots, Inc. (Talbots), a national retailer with locations in Maryland, transferred its intellectual property (including the Talbots trademarks) to Jusco BV, a related foreign holding company. Talbots and Jusco BV then entered into a licensing arrangement whereby in exchange for the right to use the Talbots trademarks, Talbots paid Jusco BV a royalty fee based on a percentage of Talbots' net sales. In 1993, Jusco BV sold the intangible assets to The Classics Chicago (Classics), a new Talbots subsidiary. Classics and Talbots entered into a new licensing agreement under which Classics held the Talbots trademarks and licensed them to Talbots in exchange for royalty payments representing a percentage of Talbots' sales.

Talbots filed Maryland corporation income tax returns and deducted the royalty payments from its Maryland taxable income. Classics did not file Maryland corporation income tax returns because it had no property, bank accounts, or employees in Maryland. Maryland imposed an assessment on Talbots for tax years 2001 and 2002 and on Classics for tax years 1993-2003. The assessments resulted from the comptroller's disallowance of Talbots' royalty and interest deductions because such payments were not considered "ordinary and necessary" business expenses and because the...