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Tax Law

Maryland Court Says Unitary Relationship Creates Nexus

The Maryland Court of Special Appeals held that a company that lacks physical presence in Maryland has sufficient nexus to justify corporate income taxes based on its unitary relationship with an affiliate operating in the state. [Comptroller of the Treasury v. Gore Enter. Holdings, Inc., 2013 Md. App. LEXIS 7 (Md. Ct. Spec. App. Jan. 24, 2013).]


W.L. Gore &Associates, Inc. (Parent), a Delaware corporation, patented materials used in its manufacturing business. Parent filed corporate income tax returns in Maryland and apportioned income to Maryland based on its local product sales and on its Maryland manufacturing facilities. Parent formed Gore Enterprise Holdings, Inc. (Subsidiary), a wholly owned subsidiary formed under Delaware law to hold all Parent patents. Subsidiary was governed by a board of directors comprised of Parent employees. Parent provided various administrative services to Subsidiary, including accounting, payroll, employee benefits, and general services. Subsidiary granted Parent an exclusive license to use all US patents presently owned or thereafter acquired. In exchange, Parent paid Subsidiary a reasonable fee. Subsidiary recognized these royalty payments as taxable income. Parent also formed Future Value, Inc. (Finance Sub), a wholly-owned subsidiary to hold all of Parent's financial assets. Finance Sub made loans to Parent, and Parent deducted the interest payments made to Finance Sub.  Neither of the subsidiaries filed corporate income tax returns in Maryland, and upon audit, the Maryland Comptroller determined that the subsidiaries were subject to tax and were required to apportion income to Maryland. The assessments were affirmed by the Maryland Tax Court, but on appeal, the Circuit Court of Cecil County reversed the Maryland Tax Court decision and canceled the assessments. The Comptroller's appeal of that decision was the subject of the current decision.

Nexus Established in Maryland Through Unitary Relationship

Based on Parent's nexus with Maryland due to its instate activities, the Court found that if the subsidiaries partake in Parent's unitary business, then they inherit Parents nexus in Maryland. The Court determined that sufficient nexus to justify taxation arises if a parent's in-state business produces a subsidiary's income. Accordingly, the Court found that "Gore generated income in Maryland and deducted payments to GEH and FVI, which recognized those payments as their income - an accounting identity that reflects their unified business." The Court noted that, as a practical matter, Parent's expenses paid to the subsidiaries result in "gains to assets on its own balance sheet" and that it would "defy logic" to argue that the subsidiaries' gains are somehow not realized in Maryland as part of a unitary business. The Court found that the entities demonstrated the 'hallmarks' of a unitary business relationship:

  1. functional integration;
  2. centralized management; and
  3. economies of scale.

For example, the subsidiaries were dependent upon Parent and had common directors, executives and employees. While the Court noted that control is not dispositive of a unitary business, in this case it was sufficient because Parent's deductible expense in Maryland constituted the Maryland income of the subsidiaries.

Lessons to be Learned

This decision significantly expands the previous scope of the Maryland corporate income tax, which focused on overall business purpose in addition to unitary considerations. Basically, the Court has granted the Comptroller the power to tax an entity without its own Maryland presence if it operates as part of a unitary business with an affiliate operating in Maryland. Despite the fact that Maryland is still, at least based on Maryland statute, a separate return filing state for corporate income tax purposes, the Court has effectively sanctioned taxation on a combined reporting basis. Taxpayers should be cautioned that the Court has disregarded traditional constitutional principles of nexus and substituted unitary concepts as a surrogate for nexus. The Court explains that the "distinction that appellees draw between the "constitutional nexus' and the 'unitary business principle' is relevant where there is some question as to whether any part of a unitary business has a sufficient nexus with the taxing state. But where, as here, a parent company undoubtedly has a requisite nexus, the only question is whether the subsidiary partakes in the parent's unitary business; if so, it inherits the parent's nexus and the tests are effectively merged." In describing the entities' unitary relationship, the Court appears to have been strongly influenced by Parent's expenses and the subsidiaries' income. It would be a major expansion of unitary tax principles if mere accounting entries are sufficient to raise a business relationship to the level of creating nexus for out-of-state companies.

While it is unclear at this time whether any further appeals will be forthcoming, out-of state taxpayers with Maryland affiliates should be concerned with the Court's application of unitary and accounting principles to establish nexus with the state and would be wise to revisit their economic relationships.


RELATED LINKS: For additional information about nexus and state income apportionment principles, see:

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