Sherwin-Williams Co. v. State

• Decision Date: 28 October 2004
• Docket Number: 94107.
• Citation: 2004 NY Slip Op 07737,784 N.Y.S.2d 178,12 A.D.3d 112
• Parties: In the Matter of SHERWIN-WILLIAMS COMPANY, Petitioner, v. TAX APPEALS TRIBUNAL OF THE DEPARTMENT OF TAXATION AND FINANCE OF THE STATE OF NEW YORK et al., Respondents.
• Court: New York Supreme Court — Appellate Division

12 A.D.3d 112

784 N.Y.S.2d 178

2004 NY Slip Op 07737

In the Matter of SHERWIN-WILLIAMS COMPANY, Petitioner, v. TAX APPEALS TRIBUNAL OF THE DEPARTMENT OF TAXATION AND FINANCE OF THE STATE OF NEW YORK et al., Respondents.

94107.

Appellate Division of the Supreme Court of the State of New York, Third Department.

October 28, 2004.

Proceeding pursuant to CPLR article 78 (initiated in the Appellate Division of the Supreme Court in the Third Judicial Department pursuant to Tax Law § 2016) to review a determination of respondent Tax Appeals Tribunal which sustained a notice of deficiency.

Morrison & Foerster L.L.P., New York City (Paul H. Frankel of counsel), for petitioner.

Eliot Spitzer, Attorney General, Albany (Robert M. Goldfarb of counsel), for Commissioner of Taxation and Finance, respondent.

Michael A. Cardozo, Corporation Counsel, New York City (Robert J. Firestone of counsel), for City of New York, amicus curiae.

OPINION OF THE COURT

LAHTINEN, J.

Petitioner contends that respondents erred in requiring it to file a combined corporate franchise tax report in 1991 with two of its subsidiaries pursuant to Tax Law § 211. Petitioner is an Ohio corporation that does business in New York. Its activities include, among others, the manufacture and sale of various coatings under a variety of brand names, such as "Sherwin-Williams," "Dutch-Boy," "Martin-Senour," "Dupli-Color" and "Krylon." As part of its business, petitioner uses a host of trademarks, trade names and service marks (hereinafter collectively referred to as trademarks). In January 1991, petitioner created two wholly-owned Delaware corporations, Sherwin-Williams Investment Management Company, Inc. (hereinafter SWIMC) and Dupli-Color Investment Management Company, Inc. (hereinafter DIMC), to hold and manage its trademarks.¹ Petitioner transferred over 400 domestic trademarks associated with its nonaerosol products to SWIMC in exchange for all that company's common stock and entered into a like arrangement with DIMC regarding over 100 of its aerosol-related trademarks. All of the trademarks transferred to the subsidiaries were then licensed back to petitioner in exchange for the payment of royalties based on a specific percentage of net sales.²

In its 1991 corporate franchise tax return, petitioner deducted the trademark royalty payments it made to the subsidiaries. Respondent Commissioner of Taxation and Finance determined that petitioner should file its tax return on a combined basis with SWIMC and DIMC and, thus, a deduction for royalties paid to those subsidiaries was not permitted. The Division of Taxation (hereinafter Division) assessed, in 1997, a deficiency of $196,536 for 1991. Petitioner requested a conciliation conference, which resulted in a conciliation order sustaining the tax. Petitioner then filed a petition with the Division of Tax Appeals protesting the notice of deficiency. Following an extensive hearing that included testimony from numerous expert witnesses and the submission of approximately 150 exhibits, the Administrative Law Judge (hereinafter ALJ) concluded in a June 2001 determination that petitioner was not required to file a combined corporation franchise tax report with its two subsidiaries. The Division filed an exception. Thereafter, respondent Tax Appeals Tribunal issued a lengthy written decision in which it reversed the ALJ's determination and sustained the notice of deficiency. This CPLR article 78 proceeding by petitioner ensued.

Tax Law article 9-A imposes a corporate franchise tax on corporations doing business in New York (see Tax Law § 209 [1]). The Commissioner is afforded discretion to permit or require a corporation paying the New York tax to file a combined report with other corporations that the taxpayer controls (see Tax Law § 211 [4]; Matter of Campbell Sales Co. v New York State Tax Commn., 68 NY2d 617, 619-620 [1986], cert denied 479 US 1088 [1987]; Matter of Wurlitzer Co. v State Tax Commn., 35 NY2d 100, 105 [1974]; Matter of Standard Mfg. Co. v Tax Commn. of State of N.Y., 114 AD2d 138, 140 [1986], affd 69 NY2d 635 [1986], appeal dismissed 481 US 1044 [1987]). Requirements that must undergird a decision permitting or mandating a combined report include: (1) the taxpayer owns or controls substantially all the stock of the other corporations; (2) the group of corporations are engaged in a unitary business; and (3) a distortion of income would result if the corporations reported separately (see 20 NYCRR subpart 6-2). For purposes of these proceedings, petitioner has not contested that the first two conditions were satisfied.

With respect to the third condition, a presumption of distortion arises "when the taxpayer reports on a separate basis if there are substantial intercorporate transactions among the corporations" (20 NYCRR 6-2.3 [a], [b]; see 20 NYCRR 6-2.5). The Tribunal found that petitioner had substantial intercorporate transactions with the subsidiaries and, therefore, the presumption of distortion applied. The Tribunal further found that petitioner failed to rebut the presumption because petitioner's assignment and license-back transactions with the subsidiaries lacked a business purpose or economic substance apart from tax avoidance and the royalties paid by petitioner were not at arm's length rates. Petitioner disputes each of these findings, contending that its transactions with SWIMC and DIMC did not constitute substantial intercorporate transactions (and thus that the presumption of distortion should not have been used), its transactions were for viable business purposes and the royalty rates were within the range acceptable in the market.

We turn first to petitioner's argument that the intercorporate transactions that are a predicate to the presumption of distortion should be analyzed solely from its perspective as the taxpayer and not include the perspective of SWIMC and DIMC. Reviewing the transaction solely from petitioner's vantage point reveals that its transactions with the subsidiaries were a relatively small part of petitioner's overall corporate transactions. However, the regulations do not require such a constricted analysis (see 20 NYCRR 6-2.3 [a], [c]), and the Tribunal's interpretation of the pertinent statute and regulations is reasonable (see Matter of Upstate Farms Coop. v Tax Appeals Trib. of State of N.Y., 290 AD2d 896, 900-901 [2002]; Matter of Clinton Hill Equities Group v Tax Appeals Trib. of State of N.Y., 240 AD2d 992, 993 [1997], lv denied 90 NY2d 808 [1997]). The narrow application urged by petitioner would severely restrict an apparent purpose of the underlying statute (see Tax Law § 211 [4]) and, indeed, would essentially foreclose combined reporting whenever a taxpayer was a large corporation. Here, the subsidiaries received the overwhelming majority of their income from petitioner. The record amply supports the Tribunal's determination that sufficient intercorporate transactions occurred among the corporations to implicate the rebuttable presumption of distortion.

Next, we consider whether substantial evidence supports the Tribunal's determination that petitioner failed to rebut the presumption of distortion. In such regard, "the ultimate question [is] whether, under all of the circumstances of the intercompany relationship in this case, combined reporting fulfills the statutory purpose of avoiding distortion of and more realistically portraying true income" (Matter of Standard Mfg. Co. v Tax Commn. of State of N.Y., supra at 141). This is a fact-driven analysis and, to rebut the presumption of distortion, consideration is given to whether petitioner established a "transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached" (Frank Lyon Co. v United States, 435 US 561, 583-584 [1978]).

Reasons set forth by petitioner for forming the subsidiaries included improving quality control oversight of the trademarks, providing flexibility in preventing hostile takeovers, increasing investment return, affording liability protection, and taking advantage of Delaware's corporate tax exemption for investment management and trademark holding companies. Petitioner presented evidence that it had been a target of an unsuccessful hostile takeover and it had also lost one of its trademarks ostensibly due, in part, to the decentralized monitoring of the trademarks. The Division, on the other hand, drew attention to facts establishing that both subsidiaries were run on a part-time basis by Donald Puglisi³ (a professor in Delaware who had no background in trademark management), management of the trademarks had been contracted by the subsidiaries back to petitioner, and the subsidiaries had recycled most of the royalty payments back to petitioner as loans.

Petitioner's experts included Richard Pomp, a professor at the University of Connecticut Law School who testified as a...