Geoffrey, Inc. v. Commissioner of Revenue

• Decision Date: 08 January 2009
• Docket Number: SJC-10106
• Citation: 453 Mass. 17,899 N.E.2d 87
• Parties: GEOFFREY, INC. v. COMMISSIONER OF REVENUE.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

899 N.E.2d 87

453 Mass. 17

GEOFFREY, INC. v. COMMISSIONER OF REVENUE.

SJC-10106

Supreme Judicial Court of Massachusetts, Suffolk.

Argued October 7, 2008.

Decided January 8, 2009.

Paul H. Frankel, New York (Maxwell D. Solet, Boston, with him) for the taxpayer.

Thomas A. Barnico, Assistant Attorney General, for Commissioner of Revenue.

Present: MARSHALL, C.J., IRELAND, SPINA, COWIN, CORDY, & BOTSFORD, JJ.

SPINA, J.

The present appeal is from a decision of the Appellate Tax Board (board) affirming the denial by the Commissioner of Revenue (commissioner) of an application by the taxpayer, Geoffrey, Inc. (Geoffrey), for the abatement of corporate excises assessed for the tax years ending January 31, 1997 through January 31, 2001. We granted Geoffrey's application for direct appellate review. At issue is whether, consistent with the commerce clause, art 1, § 8, of the United States Constitution,¹ the Commonwealth can impose a corporate excise tax, pursuant to G.L. c. 63, § 39, on a foreign corporation² that does not have a physical presence in Massachusetts. In our decision in Capital One Bank v. Commissioner of Revenue, 452 Mass. 1, 15, 890 N.E.2d 819 (2008) (Capital One), released today, we concluded that the constitutionality, under the commerce clause, of the Commonwealth's imposition of an income-based excise on an out-of-State entity is not determined by the "physical presence" test articulated in Quill Corp. v. North Dakota, 504 U.S. 298, 317-318, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992) (Quill), but by the "substantial nexus" test articulated in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279, 97 S.Ct. 1076, 51 L.Ed.2d 326 (1977) (Complete Auto). Our holding in Capital One is controlling with respect to Geoffrey's constitutional claim. For the reasons that follow, we now affirm the decision of the board.

The board found the following facts, based on the parties' stipulations of facts and the testimony and exhibits introduced at the hearing. See G.L. c. 58A, § 13 ("The decision of the board shall be final as to findings of fact"); United Church of Religious Science v. Assessors of Attleboro, 372 Mass. 280, 281, 361 N.E.2d 1254 (1977).

On January 24, 1984, Geoffrey was incorporated in Delaware as a wholly owned subsidiary of Toys "R" Us, Inc. (Toys Inc.), a Delaware corporation.³ Effective August 1, 1984, Toys Inc. transferred trademarks, trade names, and service marks (collectively, trademarks) to Geoffrey in exchange for stock. Included in this transfer were the "Toys `R' Us" and "Kids `R' Us" trademarks and the "Geoffrey" giraffe character logo. A 1991 appraisal by Arthur Andersen & Co. determined that the fair market value of the intellectual property owned by Geoffrey was $1.5 billion. Geoffrey's business activities consisted of licensing the trademarks to various Toys Inc. subsidiaries and affiliates for use in their retail operations throughout the United States. Geoffrey had no employees or offices in Massachusetts, and it owned no tangible property, real or personal, in this Commonwealth. The trademarks were registered with the United States Patent and Trademark Office.

Toys "R" Us-Mass, Inc. (TRUMI), was another subsidiary of Toys Inc. During the tax years at issue, TRUMI operated twenty-six Toys "R" Us and Kids "R" Us retail stores in the Commonwealth. Pursuant to a licensing agreement dated May 3, 1992, Geoffrey permitted TRUMI to use the "Toys `R' Us" and "Kids `R' Us" trademarks solely in Massachusetts in exchange for royalty payments to Geoffrey at a rate of three per cent of TRUMI's net sales at Toys "R" Us stores, and two per cent of its net sales at Kids "R" Us stores. This agreement was made subject to the laws of Delaware. TRUMI filed Massachusetts corporate excise tax returns on a separate company basis, and it claimed a deduction for a portion of the royalties paid to Geoffrey.

In February, 1997, Geoffrey entered into a similar licensing agreement with Babies "R" Us, a division of Baby Superstore, Inc. (Baby Superstore), which was an affiliate of TRUMI, for the use of Geoffrey's "Babies `R' Us" trademark. During the tax years at issue, Babies "R" Us operated three retail stores in the Commonwealth. Pursuant to this licensing agreement, Babies "R" Us paid Geoffrey royalties at a rate of one per cent of its net sales for the 1996 fiscal year, one and one-half per cent of its net sales for the 1997 fiscal year, and two per cent of its net sales for the remaining years of the agreement.

Geoffrey's trademarks appeared on signage, store displays, and product packaging at Massachusetts stores operated by TRUMI and Baby Superstore. The trademarks were intended to demonstrate to consumers that goods and services sold by licensees were of high quality and good value. Pursuant to the licensing agreements, Geoffrey had the right to review product samples and specifications, signs, labels, tags, packaging materials, advertising and sales promotion materials, catalogues, and pamphlets that displayed the trademarks. TRUMI and Baby Superstore agreed to comply with Geoffrey's instructions to ensure that the trademarks did not become generic, which could adversely affect Geoffrey's interests in them. Geoffrey received over $33 million in royalty income from retail stores located in Massachusetts during the tax years at issue.⁴

Under a quality control, legal and treasury service Agreement dated February 3, 1996, Toys Inc. provided advice and assistance to Geoffrey with respect to investment opportunities, accounting matters, and licensing issues. In particular, Toys Inc. dedicated the services of an intellectual property specialist to the task of protecting Geoffrey's assets. Toys Inc. also employed regional and district managers with responsibilities for Massachusetts stores who could monitor the use of the trademarks in the Commonwealth and would bring store problems to the attention of appropriate officials. Reports from Toys Inc. explaining the results of its quality control activities were provided to Geoffrey. For its services, Toys Inc. was paid $300,000 annually. In addition, Geoffrey had access to State and Federal courts in Massachusetts to protect its interests in its trademarks and its entitlement to royalty payments under the licensing agreements.

During an audit of TRUMI in 2002, the Department of Revenue (department) discovered that Geoffrey had been receiving royalty income under the licensing agreement with TRUMI, but had not been filing corporate excise returns in Massachusetts.⁵ On October 2, 2002, the department issued to Geoffrey a notice of failure to file corporate excise returns for the tax years at issue. In response, Geoffrey provided the department with unsigned, pro forma returns for the relevant years. On December 14, 2002, the department issued to Geoffrey a notice of intent to assess, which was subsequently revised on December 23, 2002. Approximately one month later, the department sent Geoffrey a notice of assessment for the tax years at issue in the amount of $3,143,445, consisting of $1,692,568 in corporate excise taxes $645,008 in accrued interest, and $805,865 in penalties.⁶ Geoffrey filed a timely application for abatement, claiming that it was not obligated to pay such taxes because it had no nexus with the Commonwealth. See G.L. c. 62C, § 37. On September 19, 2003, the commissioner denied the application, and Geoffrey appealed to the board pursuant to G.L. c. 62C, § 39.

In affirming the commissioner's denial of the abatement, the board stated that Geoffrey's business activities in Massachusetts constituted a "substantial nexus" with the Commonwealth that justified imposition of the corporate excises for the tax years at issue. In particular, the board based its determination on Geoffrey's purposeful efforts to reap economic benefits from the Commonwealth's retail marketplace by licensing the trademarks for use by TRUMI and Baby Superstore. The trademarks, the board pointed out, were used extensively by Toys "R" Us, Kids "R" Us, and Babies "R" Us stores in Massachusetts, and such use resulted in Geoffrey's receipt of substantial royalty income. The board also noted that Geoffrey retained the right to regulate use of the trademarks, and was afforded access to State and Federal courts in Massachusetts to protect its interests.⁷ Consequently, the board concluded that the Commonwealth's assessment of corporate excise taxes on Geoffrey was constitutional under the Federal commerce clause. The board further stated that Geoffrey did not demonstrate that it had acted with reasonable cause in failing to file returns or pay corporate excises for the tax years at issue, and therefore, Geoffrey was not entitled to abatement of the penalties assessed pursuant to G.L. c. 62C, § 33.⁸

A decision by the board will not be modified or reversed if the decision "is based on both substantial evidence and a correct application of the law." Boston Professional Hockey Ass'n v. Commissioner of Revenue, 443 Mass. 276, 285, 820 N.E.2d 792 (2005). We presume that a tax is constitutionally valid unless the party challenging it establishes its invalidity "beyond a rational doubt." Andover Sav. Bank v. Commissioner of Revenue, 387 Mass. 229, 235, 439 N.E.2d 282 (1982). While we give deference to the board's expertise in interpreting the tax laws of the Commonwealth, see French v. Assessors of Boston, 383 Mass. 481, 482, 419 N.E.2d 1372 (1981), we apply our independent judgment as to both the law and the facts on constitutional issues. See Opinion of the Justices, 328 Mass. 679, 687, 106 N.E.2d 259 (1952).

Pursuant to G.L. c. 63, § 39, "every foreign corporation, exercising its charter, or qualified to do business or actually doing business in the commonwealth, or owning or using any part or all of its capital, plant or any other property in the commonwealth, shall pay, on account of each taxable year, the [specified] excise." The Legislature has stated that the purpose...