Comptroller of the Treasury v. SYL

• Decision Date: 09 June 2003
• Docket Number: No. 76 | 80
• Parties: COMPTROLLER OF THE TREASURY v. SYL, INC. Comptroller of the Treasury v. Crown Cork & Seal Company (Delaware), Inc.
• Court: Maryland Court of Appeals

825 A.2d 399

375 Md. 78

COMPTROLLER OF THE TREASURY v. SYL, INC. Comptroller of the Treasury v. Crown Cork & Seal Company (Delaware), Inc.

Nos. , Sept. Term, 2000.

Court of Appeals of Maryland.

June 9, 2003.

Gerald Langbaum, Asst. Atty. Gen. (J. Joseph Curran, Jr., Atty. Gen., John K. Barry, Asst. Atty. Gen., on brief), Annapolis, for appellant.

Robert J. Carson (Robert J. Carson, P.A., on brief), Daryl J. Sidle (Baxter, Baker, Sidle & Conn, P.A., on brief), Baltimore, for appellee.

Argued before BELL, C.J., ELDRIDGE, RAKER, WILNER, CATHELL, HARRELL and LAWRENCE F. RODOWSKY, (Retired, specially assigned), JJ.

ELDRIDGE, J.

These cases concern the liability for Maryland income taxes of two corporations that do no business in Maryland, and own no tangible property in Maryland, but are subsidiaries of parents that do business in Maryland. The dispositive issue is whether there is a sufficient nexus between the State of Maryland and each subsidiary corporation so that the imposition of Maryland income tax does not violate either the Commerce Clause of the United States Constitution, Art. 1, Section 8, cl. 3, or principles of due process.

I.

This opinion encompasses two cases; consequently, we shall set forth the facts of each case separately.

A. No. 76, Comptroller of the Treasury v. SYL

SYL, Inc. is a Delaware corporation and a wholly owned subsidiary of Syms, Inc. SYL owns intellectual property assets used by Syms, specifically trademarks, trade names and advertising slogans.¹ SYL's primary function is to manage and control these intellectual property assets. Syms is a New Jersey corporation that sells men's, women's and children's clothing in numerous states, including Maryland.

Syms incorporated SYL in December 1986, and upon its formation, Syms assigned the above-described intellectual property assets to SYL. In return, SYL granted to Syms a license to manufacture, use and sell the products covered by the trade names and trademarks in its business throughout the United States. In consideration for these intellectual property rights, Syms agreed to pay SYL a royalty based on the parent corporation's sales. At the same time that Syms created SYL, it also created another wholly owned subsidiary named SYI, Inc., the purpose of which was to give SYL investment advice.

For the tax years 1986 through 1993, SYL did not file corporate income tax returns in Maryland. Throughout this period, SYL did not own or lease tangible property in Maryland, had no employees in Maryland, and maintained no bank accounts in Maryland. Nor did SYL directly sell or lease goods or services in Maryland through advertising, mailings, or in-person solicitations. Syms, however, did have extensive business contacts in Maryland during this time period through its ownership and operation of retail stores in Maryland. Syms regularly filed Maryland corporate income tax returns.

In 1996, the Comptroller issued a Notice of Assessment to SYL, indicating that SYL owed for the years 1986 through 1993 an amount of $637,362 in corporate income taxes, including interest and penalties. SYL timely protested the Comptroller's Notice of Assessment. After a hearing, the Comptroller, by a hearing officer, issued a Notice of Final Determination that sustained the Notice of Assessment. The hearing officer, inter alia, found as follows:

"In general, the Comptroller's Office assessed SYL, Inc., a tax-haven entity earning substantial related party income, based on the position that SYL, Inc. (`SYL') was a phantom entity that did not have substantial economic substance. The Comptroller's audit section concluded that SYL's lack of substantial substance and its dependence on Syms Corporation (`Syms') for its earnings required SYL to file returns with Maryland based on the apportionment factor of its parent company Syms. The Comptroller's audit section relied upon Comptroller v. Armco, 82 Md.App. 429, 572 A.2d 562 (1990) (cert.denied); Comptroller v. Atlantic Supply Co., 294 Md. 213, 448 A.2d 955 (1982). The Comptroller's Office believes these decisions are consistent with Tax-General Article, Section 10-402 which generally requires that the income reasonably and fairly attributable to carrying on business in Maryland be taxable by Maryland. In short, the Comptroller's section found SYL to be a phantom or bookkeeping entity and taxed it based on economic reality and the true source of its income."

* * *

"In December, 1986, Syms incorporated SYL in Delaware and putatively assigned to SYL its ownership in trademarks. As part of an overall plan, SYL licensed back to Syms the trademarks and ostensibly assumed (at least on paper) all obligations for management and administration of the marks. Just as before the assignment and simultaneous license back of the marks, Syms continued to utilize the marks in its retail clothes stores in Maryland and other states. SYL charged Syms a 4% royalty pursuant to a license agreement which was apparently entered into on December 18, 1986 (though dated July 1986). The 4% royalties were charged from October 1, 1986 even though the formal assignment of the intangibles was not effectuated until December 19, 1986. Moreover, the valuation of the arm's length royalty rate was provided by a company which was engaged by a consultant (Coventry Financial Corp.) which apparently was provided a financial stake in the tax savings obtained.

"At least one significant objective of forming SYL was to generate state income tax benefits. See memorandum of Karen Artz Ash dated July 22, 1986 at p. 6. See also Rosen, `Use of a Delaware Holding Company To Save State Income Taxes', 20 Tax Advisor 180 (1989). Significant state income tax savings were generated from SYL in Maryland and other separate return states because (a) Syms deducted the substantial royalty payments of roughly $12 million each year to SYL and (b) SYL did not report its royalty income as taxable in Maryland or other separate return states other than Delaware. Since Delaware does not generally tax income from intangibles, SYL generated very substantial state income tax benefits. It appears from one document (finally obtained after repeated requests) that Syms paid a third party—Coventry Financial Corp.—a percentage of the early year state tax savings for its consulting efforts in setting up SYL. See the Richard Diamond to Sy Syms memorandum dated December 12, 1986 entitled `State Income Tax Savings—Coventry Financial Corp.'"

* * *

"While by no means exhaustive, I find some of the salient and controlling facts as follows:

"(1) SYL was a thinly constituted entity with very little if any true economic or operational activity in that:

"(a) It paid out very little in wages and the $1,200 or so of yearly wages paid were to employees of third party `nexus service providers' which are in the business of providing tax-haven entities with `apparent substance'. SYL contracted with one such `nexus service provider' which provides mail forwarding, shared office space and shared employees for numerous other taxpayers. At least some nexus service providers promote their services to potential clients at tax seminars, and it is understood that hundreds, if not thousands, of taxpayers enter into arrangements with these nexus service providers.

"(b) SYL had no separate office or employees other than the shared space and purported employees of nexus service providers and the officers of Syms who were compensated solely by Syms.

"(c) SYL had no phone listing, phone service or office signage.

"(d) SYL apparently did not license its marks (or attempt to license) to third parties.

"(e) SYL officers did not have business cards, job descriptions, job evaluations or other indicia of a true employment relationship.

"(f) Though requested, SYL could not produce invoices issued to Syms pursuant to the royalty agreement (beyond the initial billing period).

"(g) Though requested, SYL could not produce travel reports showing business activity in Delaware.

"(h) Though requested, SYL failed to produce a person at the informal hearing who could speak to any activities being conducted by SYL."

* * *

"From a legal standpoint, it is difficult to find fault in the Comptroller's assessment. As in Armco, the Comptroller's Office appropriately determined that the factors and attributes of Syms should determine how SYL's income should be taxed. Since SYL was found to be a phantom, it was clearly appropriate to look to the true underlying source of its income. SYL's booked income was in reality generated from Syms' sales, property and payroll.

"It was Syms' use of the marks, its goodwill and its efforts in Maryland and elsewhere which gave the marks value and generated the income `booked' in SYL."

SYL appealed the assessments to the Maryland Tax Court, with its "Petition of Appeal" headed "SYL, INC. c/o Syms Corporation[,] Syms Way[,] Secaucus, New Jersey 07094 v. Comptroller of the Treasury." SYL's petition alleged, inter alia, that it was a Delaware corporation "organized in 1986 by its parent, Syms Corp.... to hold certain registered trademarks and trade names," that SYL had "as a valid business purpose the protection, maintenance and management of valuable intangible assets," that SYL maintains an office in Delaware, a separate bank account, and has its own corporate officers and board of directors who meet regularly, that SYL "is a bona fide corporation with substantial corporate substance" and with "a valid business purpose," that the taxation of SYL's income is not authorized by Maryland Code (1988, 1997 Repl.Vol., 2002 Supp.), § 10-402 of the Tax-General Article, or by any other Maryland statute, and that the Comptroller's assessments violate the Fourteenth Amendment's Due Process Clause and the Commerce Clause of the United States Constitution. The Comptroller's answer denied SYL's allegations concerning its viability, valid business purpose, substance, etc., as well as SYL's legal conclusions under the...