Sherwin-Williams can deduct intercompany royalties and interest.

• Author: Ochsenschlager, Thomas P.
• Position: Massachusetts

On Oct. 30, 2002, the Massachusetts Supreme Judicial Court (SJC) determined that The Sherwin-Williams Co. (SW) can deduct royalty and interest payments made to an affiliated company, as they were expenses "necessary to the conduct of its business"; see The Sherwin-Williams Company v. Comm'r of Rev., MA Sup. Jud'l Ct., No. SJC-08516 (10-31-02).

The SJC reversed a ruling of the Appellate Tax Board (ATB) that disallowed royalty and interest payments made by SW to two of its wholly owned subsidiaries, Sherwin-Williams Investment Management Company, Inc. (SWIMC) and Dupli-Color Investment Management Company, Inc. (DIMC). The disallowed payments were for the use of certain intangible properties that SW had transferred to the subsidiaries and licensed back as part of a corporate reorganization. The disallowed interest payments were made in connection with a loan from SWIMC.

Background

SW is an Ohio corporation, headquartered in Cleveland, and is engaged in the manufacture, distribution and sale of paints and paint-related products. In 1991, it formed SWIMC and DIMC under Delaware law to hold certain tradenames, trademarks and service marks that it had developed. After the formation of these subsidiaries, an appraisal of the value of the marks, the establishment of a royalty rate based on the appraisals, and the transfer of the intangibles, SW and the subsidiaries entered into nonexclusive licensing agreements for the right to use these various intangibles.

In filing its 1991 state income tax return, SW deducted all royalty and interest expenses accrued under the agreement, in computing taxable income. On audit, the Department of Revenue (DOR) disallowed the deductions and assessed additional tax, because the (1) transfer and license back of the marks was a "sham" disallowed under the "sham-transaction doctrine," (2) royalty payments were not deductible, because the transactions had no valid business purpose and (3) transactions were not at "arm's-length."

ATB

The ATB sustained the DOR's determination, finding that the transactions lacked any economic substance other than tax avoidance. Further, the expenses were not ordinary and necessary and the transactions were not at arm's length.

SJC

Sham-transaction doctrine. In quoting from its decision in Syms Corp., 436 Mass. 505 (2002), the SJC stated that the sham-transaction doctrine gives the commissioner the authority to "disregard, for taxing purposes, transactions that have no economic substance or...