On January 24, 2013, the Maryland Court of Special Appeals reversed a circuit court’s withdrawal of assessments and affirmed the Tax Court’s ruling that out-of-state subsidiaries of a company operating in Maryland are subject to Maryland’s corporate income tax because the subsidiaries are engaged in a unitary business with and under the complete control of the Maryland parent company (Comptroller v. Gore Enterprise Holdings, Inc., Md. Ct. Spec. App., Dkt. Nos. 1696; 1697, 01/24/2013). The ultimate conclusion in this case is consistent with prior appellate and Tax Court case law in Maryland; however, some of the language in the opinion reflects a very expansive jurisdiction on multi-state businesses that could have unintended consequences for other out-of-state corporate taxpayers.
The in-state parent company in Gore had established two out-of-state subsidiaries, to which the parent paid intercompany royalty and interest expenses. The court held that Maryland could constitutionally tax an apportioned amount of the income of the subsidiaries because the subsidiaries had a unitary relationship with the parent.
States can tax an apportioned amount of income of a unitary business conducted by a corporation in more than one state, but typically can only do so with respect to affiliated entities when the state has adopted combined reporting requirements for related entities. Here, the appellate court allowed the taxation of the out-of-state companies despite Maryland not having adopted combined reporting for corporate income tax purposes. Prior cases in Maryland reaching similar decisions are somewhat clearer in that the conclusions were largely based on the subsidiaries being disregarded as separate entities because they lacked economic substance. Certain language in the Gore opinion suggests that its holding was similarly premised on a lack economic substance in the taxpayer’s structure, but this is not made explicit by the court.
The decision in this case is arguably correct in that the taxpayer admitted to its structure being implemented for tax avoidance reasons. However, the opinion could be interpreted as expanding Maryland’s authority to tax out-of-state affiliates so long as those entities are conducting a unitary business with an in-state affiliate.
Taxpayers considering implementing certain structures involving intercompany transactions should consider the state tax consequences in the jurisdictions where they do business. Although the legal analysis in Gore may be questionable, Maryland and other states have adopted other methods allowing for the taxation of income earned under similar arrangements. For example, many states, including Maryland, disallow certain related party expenses, such as interest on loans and royalty payments for the use of licensed intangibles.
If there are any questions please contact your Aronson tax advisor, Michael L. Colavito, or Henry Chiwaya at 301.231.6200.