Maryland Tax Court Again Subjects Affiliated Taxpayers To Corporate Income Tax With 'Fair' Apportionment

The Maryland Tax Court has determined that a multistate retailer and its subsidiary engaged in substantial intercompany transactions with each other, as well as other members of an affiliated group, were subject to Maryland corporation income taxes. Following several precedential decisions of Maryland courts based on similar fact patterns, the Court ruled that the retailer and subsidiary had nexus with the state, and the Maryland Comptroller fairly apportioned income to the retailer and subsidiary based on incomeproducing activities that occurred in Maryland.1

Background

The taxpayer, Staples, Inc. (Staples) is a multistate retailer of office products. Prior to 1998, Staples and a wholly-owned subsidiary, Staples Properties, Inc. (SPI), engaged in substantial intercompany transactions involving intellectual property. SPI held the intellectual property and licensed the property to Staples. SPI was audited by the Maryland Comptroller for the 1993-1997 tax years, and ultimately paid over $4 million in tax, penalties and interest to the state.

Staples engaged in an internal reorganization in 1998. Staples formed Staples the Office Superstore, Inc. (Superstore) as a wholly-owned subsidiary of Staples, along with several other affiliated entities. Staples provided managerial and administrative services on behalf of Superstore and the other affiliated entities, and Superstore provided franchise system services to the other affiliated entities. Superstore and the other affiliated entities relied on Staples for a variety of corporate necessities.

Following an audit of the 1999-2004 tax years, in 2008, the Comptroller assessed Staples and Superstore over $14 million in tax, interest and penalties. In doing so, the Comptroller contended that Staples and Superstore had no economic substance as separate entities. In response, Staples and Superstore argued that both Staples and Superstore had economic substance, as both companies employed thousands of individuals and owned substantial amounts of property. In addition, fees for intercompany transactions involving the provision of services by one company to another were charged at arm's length.

Nexus Determination

The Court began its analysis by reviewing the basic constitutional principles required to be met to impose the Maryland income tax. In addition to citing the relevant and oft-cited Due Process and Commerce Clause requirements for taxation,2 the Court pointed to the unitary business principle...