The West Virginia Supreme Court of Appeals has held that an out of state company licensing intellectual property to out of state licensees did not have corporation net income tax or business franchise tax nexus.1 The Court based its determination on the following facts of the case: (i) the licensor lacked a physical presence in the state and did not sell products or services within the state; (ii) the licensees manufactured the products bearing the trademarks and trade names outside the state; (iii) the licensor did not direct or dictate how the licensees distributed the products; and (iv) the licensees did not operate any stores in the state and only sold the products to wholesalers and retailers in the state.
Background
ConAgra Brands, a Nebraska corporation, was established by ConAgra Foods to centralize the management and protection of intellectual property. ConAgra Foods, which wholly owned ConAgra Brands, transferred the intellectual property, consisting of trademarks and trade names that appeared on food products distributed throughout the United States, including West Virginia, to ConAgra Brands. ConAgra Brands also acquired intellectual property from other unrelated entities.
Pursuant to its licensing agreements, ConAgra Brands collected royalties based on the licensees' sales of the food products bearing the intellectual property. However, ConAgra Brands operated its business of licensing and protecting the intellectual property entirely outside West Virginia. Moreover, its licensees manufactured the products outside the state as well, and merely sold or distributed the products to in state wholesalers and retailers. ConAgra Brands did not direct or dictate how the licensees distributed the products, although ConAgra Brands paid all expenses in defending its intellectual property against infringement and in overseeing national marketing efforts.
In July 2006, after conducting a field audit, the Director of the Auditing Division of the West Virginia State Tax Division issued two notices of assessment against ConAgra Brands for the period June 1, 2000 to May 31, 2003 for failure to pay corporation net income tax and business franchise tax as apportioned to West Virginia.
The West Virginia Office of Tax Appeals upheld the assessments, concluding that the assessments were consistent with the requirements under the Due Process and Commerce Clauses of the U.S. Constitution. On appeal, a circuit court ruled in favor of ConAgra Brands, setting aside the decision of the Office of Tax Appeals. The circuit court found that the imposition of the taxes on ConAgra Brands did not, in fact, pass constitutional muster, stressing the fact that all manufacturing processes occurred outside West Virginia. As a result, the West Virginia State Tax Commission appealed the matter to the West Virginia Supreme Court of Appeals.
Intangible Holding Company Did Not Have Nexus
The West Virginia Supreme Court of Appeals determined that ConAgra Brand's licensing agreements with its licensees did not create nexus with West Virginia for corporation net income tax or business franchise tax purposes. In reaching its decision, the Court first analyzed U.S. Supreme Court case precedent, which highlighted potential Due Process and Commerce Clause concerns with a state's imposition of tax on foreign entities.2 Under the Due Process Clause analysis, the "requirement of some minimum connection between the state and the activity sought to be taxed" must be met, while the Commerce Clause analysis examines "whether a state_imposed tax unduly burdens interstate commerce."
The Court then addressed its decision in Tax Commissioner v. MBNA America Bank,3 which also dealt with the constitutional issues of imposing a tax on an out_of_state entity without physical presence in the state. In MBNA, the Court determined that a Delaware corporation that issued and serviced credit cards was subject to the state's corporation net income and business franchise taxes. The Court held that the corporation "purposefully directed" its activities toward the state by promoting its business, in the state, via mail and telephone solicitation, satisfying the Due Process Clause. The Court then determined that despite a lack of physical presence in the state, the corporation's "significant economic presence" in the state was enough to satisfy the Commerce Clause, as the corporation's solicitation was both "continuous and systematic."
The Court distinguished MBNA from the present case based on the fact that ConAgra Brands did not direct or dictate how the licensees distributed the products bearing the intellectual property. Unlike the taxpayer in MBNA, ConAgra Brands did not purposefully direct its activities toward West Virginia in a continuous or systematic fashion.
The Court noted that any judicial actions relating to the protection of ConAgra Brand's intellectual property, and arising out of West Virginia, would be brought "exclusively in the courts of the United States under the provisions of the laws of the United States protecting such intellectual property," and not in any state courts. In other words, ConAgra Brand's responsibility to pay the expenses of any litigation in defense of its intellectual property would not result in ConAgra Brand's availing itself of the benefits of West Virginia.
The Court also maintained that, unlike its prior decision in Hill v. Showa Denko, K.K.,4 the taxpayer did not create a "shell corporation" for tax avoidance purposes. In Hill, the Court held that West Virginia had jurisdiction over a Japanese manufacturer selling medications in the state because its American distributor_subsidiary was a "shell corporation," subject to the control of the Japanese manufacturer. In contrast, ConAgra Brands was established to address the lack of uniformity in brand image and to put an end to "inconsistent, disjointed, and inefficient trademark management." Moreover, ConAgra Brands not only earned royalty payments from affiliates, but it also earned payments from unrelated entities.
The Court also distinguished decisions from other jurisdictions from the present case. Both the Supreme Courts of South Carolina and Iowa held that out of state licensors were subject to their taxing jurisdictions.5 However, the South Carolina Supreme Court did not consider a fact pattern in which a foreign manufacturer manufactured, assembled and packaged the products out of state. It also did not address a licensor entering into agreements with both affiliates and unrelated entities. The Iowa Supreme Court also dealt with a different fact pattern than the one at hand. In the Iowa case, the licensor was licensing directly to in state franchisees that were subject to certain standards imposed by the licensor, whereas ConAgra Brands was licensing to out of state licensees that were not subject to ConAgra Brands' control.
As a result, the Court concluded that neither the "purposeful direction" test under the Due Process Clause nor the "significant economic presence" test under the Commerce Clause was satisfied. Thus, the Court invalidated the assessments issued against ConAgra Brands.
Commentary
This case follows the recent Oklahoma Supreme Court decision holding that an out of state intangible holding company likewise did not have nexus with the state.6 In the Oklahoma decision, an out of state licensor licensed intellectual property to an affiliate and the affiliate sub-licensed the intellectual property to in state entities. The decisions by the Oklahoma and West Virginia high courts may have started a trend away from the broad application of an "economic nexus" standard in favor of performing a detailed, fact specific, case by case analysis. Both these jurisdictions, however, addressed out of state licensors who directly licensed their intellectual property to other out of state licensees, rather than licensors who directly licensed their intellectual property to in state licensees.
Interestingly, in examining the West Virginia corporation net income tax imposition statute, which states: "the West Virginia taxable income of every domestic or foreign corporation engaging in business in this state or deriving income from property, activity or other sources in this state,"7 the West Virginia Supreme Court of Appeals only discussed the meaning of "engaging in business" in reaching its conclusion that the net income tax, as applied, was unconstitutional. The Court did not analyze the meaning of the phrase "deriving income from ... sources in this state" from a constitutional perspective. Arguably, deriving income from sources in a state may be consistent with a finding of economic nexus, which the Court rejected in this instance.
Footnotes
1 Tax Commissioner v. ConAgra Brands, Inc., West Virginia Supreme Court of Appeals, No. 11_0252, May 24, 2012.
2 Specifically, the Court summarized rules of law contained in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
3 640 S.E.2d 226 (W. Va. 2006), cert. denied, 551 U.S. 1141 (2007).
4 425 S.E.2d 609 (W. Va. 1992), cert. denied, 508 U.S. 908 (1993).
5 Geoffrey, Inc. v. South Carolina Tax Commission, 437 S.E.2d 13 (S.C. 1993), cert. denied, 510 U.S. 992 (1993); KFC Corp. v. Iowa Department of Revenue, 792 N.W.2d 308 (Iowa 2010), cert. denied, 132 S.Ct. 97 (2011).
6 In re Scioto Insurance Co., Oklahoma Supreme Court, No. 108943, May 1, 2012.
7 The Court cited W. VA. CODE § 11_24_4(3) (emphasis added).
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