Syms Corp. v. Comm'r of Revenue
| Decision Date | 10 April 2002 |
| Docket Number | SJC-08513 |
| Citation | 436 Mass. 505 |
| Parties | SYMS CORP. vs. COMMISSIONER OF REVENUE. Docket No.:MASSACHUSETTS SUPREME COURT County: Suffolk |
| Court | United States State Supreme Judicial Court of Massachusetts Supreme Court |
Summary: Taxation, Corporate excise; Appellate Tax Board: findings. Administrative Law, Substantial evidence. Constitutional Law, Taxation.
Appeal from a decision of the Appellate Tax Board.
The Supreme Judicial Court on its own initiative transferred the case from the Appeals Court.
Paul H. Frankel, of New York, for the taxpayer.
Edward J. DeAngelo, Special Assistant Attorney General, for Commissioner of Revenue.
Present: Marshall, C.J., Greaney, Ireland, Spina, Cowin, Sosman, & Cordy, JJ.
Syms Corp. (Syms) appeals from a decision of the Appellate Tax Board (board) affirming the refusal by the Commissioner of Revenue (commissioner) to abate $291,571 in corporate excise taxes assessed against it for the tax years 1986, 1987, 1989, 1990, and 1991. The assessments resulted from the commissioner's disallowance of deductions Syms had taken for royalty payments it had made to its wholly owned subsidiary, SYL, Inc. (SYL). The royalties were paid to SYL for the use of certain trade names, trademarks, and service marks (marks), which Syms had transferred to SYL in December, 1986.
After an evidentiary hearing, the board found that Syms had not sustained its burden of establishing its entitlement to an abatement, and that the commissioner had properly disallowed the deductions on three alternative grounds: (1) the transfer and leaseback of the marks was a sham and could be disregarded under the "sham transaction doctrine";1 (2) the royalty payments were not deductible as ordinary and necessary business expenses where there was no valid business purpose justifying the expense and SYL added little or no value to the marks; and (3) G. L. c. 63, § 39A, permitted the commissioner to eliminate the royalty payments from the calculation of net income because they were made between affiliated corporations and were in excess of fair value.
On appeal, Syms claims that the board's findings are not supported by the record, that G. L. c. 63, § 39A, only permits the elimination of payments between subsidiaries and not from a parent corporation to its subsidiary, and that the disallowance of the deductions violates the due process and commerce clauses of the United States Constitution. Syms also challenges the board's refusal to abate the penalties assessed against it by the commissioner. We conclude that the board's findings are supported by substantial evidence in the record and that the disallowances do not violate the United States Constitution. We need not and therefore do not reach the question of the applicability of G. L. c. 63, § 39A, to the payments in this case.
1. Background. Syms is a New Jersey corporation engaged in "off-price" retailing, which is the retail sale of brand name clothing at prices lower than those in department stores. It was founded in 1959 by Sy Syms. It operates two stores in the Commonwealth and therefore is subject to Massachusetts corporate excise tax.
During the years in question, Sy Syms was the chairman of the board of directors and the dominant shareholder, owning fifty-six per cent of the stock and controlling the votes for another twenty-four per cent held in trust for family members. His daughter, Marcy Syms, was the president of the company.
Syms used several marks in its business, including the "Syms" name, a "multiple's' logo" that it placed on its own brands of clothing, and the slogan, "An Educated Consumer is Our Best Customer." Prior to December, 1986, Syms owned these marks.
The idea of a trademark holding subsidiary was first brought to the attention of Syms in early 1986 by Irv Yacht, a consultant with a company called Coventry Financial Corporation. Yacht broached this idea in a letter to Syms's chief financial officer, Richard Diamond, in which he promised that he "had a method of saving state taxes." Immediately after their first meeting in the spring of 1986, Yacht and Diamond signed an agreement, which recited that Coventry "has developed a program... for reducing [Syms's] income taxes by reorganizing the business activities of [Syms] in certain areas." Yacht's proposal was for Syms to form a Delaware subsidiary, transfer the marks to that subsidiary, and then execute a license agreement under which Syms would continue to use the marks as it had before the transfer (Coventry plan).
Under the license agreement, Syms would pay a large royalty to the subsidiary, thereby generating a deduction for Syms on its State excise taxes.2 The subsidiary, however, would not pay any State tax on the royalty income because, under Delaware law, corporations that hold intangible assets are exempt from income tax. Syms was to pay Coventry twenty-five per cent of the tax savings realized in the first year, with a declining percentage for the next four years.
In considering whether to engage in the Coventry plan, Syms recognized the risk of a tax audit. In a memorandum to Sy Syms, Diamond wrote, As a precaution, Syms held part of Coventry's compensation in escrow in case the hoped-for tax savings were disallowed in an audit.
Syms also consulted its trademark attorneys about risks attendant to the transfer of the marks under trademark law,3 and was advised that the transfer would be valid as a matter of trademark law because
Syms decided to proceed with the Coventry plan and SYL was incorporated in Delaware on December 4, 1986, as Syms's wholly owned trademark holding company. Its board of directors and officers were Sy Syms, Marcy Syms, Richard Diamond, and Edward Jones, a partner in a Delaware accounting firm.4 SYL and Syms executed a license agreement on December 18, 1986. SYL, acting as the owner of the marks, granted to Syms the right to use the marks nationally for a royalty equal to four per cent of Syms's annual net sales. The marks were transferred from Syms to SYL the next day, December 19, 1986.
For the calendar year 1986, Syms paid SYL a royalty for the marks that constituted four per cent of its annual net sales from October 1, 1986, until the end of December. The 1986 royalty was approximately $2.8 million. In subsequent years, the royalty amount increased from nearly $10 million in 1987 to $12.7 million in 1991. In each of these years SYL received one annual royalty payment from Syms, which it held in Delaware for a few weeks before paying it back to Syms, with interest (minus expenses) as a tax-free dividend.5 SYL's only income came from Syms's annual royalty payments, and its expenses amounted to approximately one-tenth of one per cent of its income.
SYL's corporate "office" consisted of an address rented from Jones's Delaware accounting firm, for an annual fee of $1,200.6 The accounting firm provided this same service to "a couple of hundred" other corporations that used Delaware subsidiary corporations to hold their intangible assets. Jones was not only a partner of the accounting firm, he was SYL's only employee, serving in a part-time capacity for which he was paid $1,200 per year.
The business operations of Syms did not change after the transfer and license-back of the marks. All of the work necessary to maintain and protect the marks continued to be done by the same New York City trademark law firm that had previously performed those services, and Syms (not SYL) continued to pay all the expenses attendant thereto. All efforts to maintain the good will and thus to preserve the value of the marks were undertaken by Syms, and all advertising using the marks was controlled and paid for by Syms or by a wholly owned Syms subsidiary formed solely to do advertising. The choice of which products would be sold under the marks, as well as the quality control of those products, remained the responsibility of the same persons who had done that work before the transfer -- Sy Syms himself, and the Syms staff of buyers.
2. Sham transaction. Syms does not contest the validity of the "sham transaction doctrine" and the commissioner's authority under that doctrine to disregard, for taxing purposes, transactions that have no economic substance or business purpose other than tax avoidance.7 It is a doctrine long established in State and Federal tax jurisprudence dating back to the seminal case of Gregory v. Helvering, 293 U.S. 465 (1935). It works to prevent taxpayers from claiming the tax benefits of transactions that, although within the language of the tax code, are not the type of transactions the law intended to favor with the benefit. Horn v. Commissioner of Internal Revenue, 968 F.2d 1229, 1236-1237 (D.C. Cir. 1992). "Usually, transactions that are invalidated by the doctrine are those motivated by nothing other than the taxpayer's desire to secure the attached tax benefit," and are structured to completely avoid economic risk. Id. at 1236.8
Syms contends that the doctrine does not apply in this case because it had business purposes, other than tax avoidance, for incorporating SYL and then transferring to it and licensing back the marks which it previously owned. It complains that the board ignored the "uncontroverted" evidence of these other business purposes, and based its decision on the record in another case litigated shortly after this one,9 and on an across-the-board policy of the "disallowance of deductions for all related trademark...
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