Gore Decided: Unitary Nexus Rejected; Economic Substance Test Clarified

Today, the Maryland Court of Appeals issued its highly anticipated decision in Gore Enterprise Holdings, Inc. v. Comptroller of the Treasury; Future Value, Inc. v. Comptroller of the Treasury.1 The court held that under the Due Process and Commerce Clauses, Maryland had the authority to tax the income of two out-of-state subsidiaries that did not have economic substance as separate business entities apart from their Maryland parent. The court also clarified that the unitary business principle cannot be used as a basis to assert nexus over an out-of-state entity engaged in a unitary business with another entity with a presence in Maryland. A copy of the opinion can be accessed here.

Background

W.L. Gore & Associates, Inc. ("Gore") is a Delaware corporation that uses certain patented material in the manufacture of various products. Gore operates in Maryland and is the parent to two wholly owned, out-of-state subsidiaries - Gore Enterprises Holdings, Inc. (GEH) and Future Value, Inc. ("FVI"). GEH holds all of Gore's patents and granted Gore an exclusive license to use the patents. In exchange for this license, Gore paid a royalty fee to GEH. FVI holds all of Gore's financial assets and makes loans to Gore. In return, Gore pays interest to FVI. Gore deducts its royalty payments to GEH and its interest payments to FVI from its taxable income.

In 2006, the Comptroller audited Gore and issued its typical "pick your poison" alternative assessments. The Comptroller issued assessments to GEH and FVI, asserting that the entities had nexus with Maryland, and apportioning their income to the state using Gore's apportionment factor. The Comptroller also issued an alternative assessment to Gore, disallowing Gore's royalty and interest expense deductions for its payments to GEH and FVI. Upon the Comptroller's Notice of Final Determination, which upheld the audit assessment, the entities appealed the matter to the Maryland Tax Court.

The Tax Court affirmed the assessments against GEH and FVI, explaining that because it was Gore's business in Maryland that produced the income of GEH and FVI, the subsidiaries did not have real economic substance as business entities separate from Gore, and were engaged in a unitary business in Maryland with Gore. The taxpayers then appealed to the Circuit Court for Cecil County, which reversed the Tax Court decision. The Comptroller appealed to the Maryland Court of Special Appeals. The Maryland Court of Special Appeals...