State developments in intangible property.

• Author: Huizenga, David L.

Recent court and administrative decisions in Maryland, Massachusetts and New Mexico have asserted issues related to unitary and economic nexus, "phantom corporation" claims and modification of the traditional apportionment formula for companies receiving related-party income from intangibles.

Maryland

The Maryland Circuit Court affirmed three taxpayer victories on March 17, 2000: MCI Int'l Telecommunications Corp., Crown Cork & Seal, and SYL, Inc. In affirming the Maryland Tax Court, it was determined that the affiliated entities, with no physical presence in the state, do not have unitary or economic nexus in Maryland.

MCI, in the business of providing international telecommunications to its affiliates and other customers, was receiving and paying service and management fees; it had no physical presence (i.e., payroll, property or switches) in Maryland. The comptroller argued that MCI was not a substantial entity and its existence was only a means by which the in-state affiliate (parent) could divert taxable income to an out-of-state entity. The court concluded that, under the unitary nexus theory, the comptroller could not assert that an out-of-state entity (MCI) had nexus based on the in-state presence of an affiliate, because the entity was not a "phantom corporation" (i.e., it had economic substance and was established for valid business purposes). In addressing the economic substance and business purpose issues, the court noted that, "in this technologically advanced era, ... [i]t is conceivable that, for legitimate business purposes, a seemingly insignificant affiliate (i.e., one employee and/or one computer) can exist which generates substantial income yet have little or no expense." The court also affirmed that MCI had no direct nexus with the state and that the in-state affiliate's factors could not be attributed to the entity for apportionment purposes.

In SYL and Crown Cork & Seal, the entities were formed as Delaware holding companies, to hold and manage intangible assets (including trademarks, tradenames and patents), which were licensed back to Maryland-affiliated entities for an agreed-on royalty fee. The comptroller determined in both SYL and Crown Cork & Seal, that the tax-paying entities were shell or "phantom corporations" with no economic substance. The comptroller asserted nexus, based on the unitary, in-state activity of an affiliate (parent), which would permit the state to attribute the parent's nexus and...