United States: Maryland Appeal Court Rules Intangible Holding Companies Have Nexus

Maryland Court of Special Appeals Holds Intangible Holding Companies Have Corporate Income Tax Nexus

On January 24, the Maryland Court of Special Appeals held that two out-of-state intangible holding companies had corporate income tax nexus with Maryland because they were in a “unitary business” relationship with their Maryland parent company.1 In reaching this determination, the Court particularly emphasized the fact that the parent company deducted its payments which were treated as income by its intangible holding companies. The Court of Special Appeals reversed a circuit court decision that had cancelled the tax assessments against the taxpayers, and in doing so, endorsed the Maryland Tax Court’s original decision that upheld the Maryland Comptroller’s assessment against the intangible holding companies.


The parent company (P), a manufacturer with a physical presence in Maryland, created two intangible holding companies (IHC1, a royalty company, and IHC2, an investment company) that were incorporated in Delaware and lacked a physical presence in Maryland. IHC1 granted P the exclusive license to make, use and sell any of its patented inventions in exchange for a “reasonable fee” or royalty payments. IHC2 earned interest income by investing in and managing P’s excess cash and capital according to a long-term investment plan. P deducted both its royalty payments to IHC1 and its interest payments to IHC2 from its taxable income.

IHC1 and IHC2 did not file Maryland corporate income tax returns and as Delaware entities, their intangible and interest income derived from their transactions with P fell under Delaware’s exemption of passive income. Moreover, the intangible and interest income were not taxable in separate reporting states (in which P was doing business) that lacked related-party expense addback rules.

In 2006, the Comptroller audited P, IHC1 and IHC2 for tax periods from 1983 to 2003, determining that the subsidiaries were required to apportion income to Maryland. The Comptroller used P’s ratio to apportion its Maryland income and expenses and applied it to IHC1 and IHC2’s federal taxable income derived from P, excluding any income that did not originate from P.2 As a result, based on its position that the two holding companies had substantial connections and nexus with Maryland under unitary business principles, the Comptroller assessed over $26 million against IHC1 and over $2.6 million against IHC2. The Comptroller also made an alternative assessment of tax3 against P based on the denial of the deduction for royalty and interest payments, on the grounds that P had not sufficiently established these amounts as ordinary and necessary business expenses.

A hearing officer in the Comptroller’s office upheld the assessments and upon appeal, the Maryland Tax Court affirmed the tax assessments based on its conclusion that the two holding companies had nexus with Maryland because they lacked real economic substance as business entities separate from their parent company.4 The holding companies subsequently appealed to the Cecil County Circuit Court, which found that P and IHC1 were not in a unitary business and that P and IHC2 conducted transactions at arm’s length, reversing the Tax Court’s decision and cancelling the assessments against both IHC1 and IHC2. The Comptroller appealed the matter to the Court of Special Appeals.

Out-of-State Intangible Holding Companies Subject to Maryland Tax

Unitary Business Analysis

In reversing the circuit court, the Court of Special Appeals noted that Maryland law permits the state to tax multistate corporations doing business in Maryland to the fullest extent permitted by the U.S. Constitution.5 The Due Process Clause of the U.S. Constitution requires minimal contacts with the state in order to subject the entity to taxation within the state,6 while the Commerce Clause requires that an entity have substantial nexus before it may be taxed by a state.7 A state may tax an apportioned sum of a corporation’s multistate business if the business is deemed “unitary” and the state is not seeking to tax values derived from unrelated out-of-state business activities of a discrete business enterprise.

The Court then acknowledged that it had previously ruled that there is sufficient nexus to justify a state’s taxation of an out-of-state subsidiary when the economic reality is that the parent’s business in Maryland produced the subsidiary’s income.8 Applying this prior ruling to the present case, the Court determined that P, IHC1 and IHC2 operated as a unified business since P generated income in Maryland and deducted its payments to its subsidiaries, and the subsidiaries recognized the payments as income.

In addition, the “hallmarks” of a unitary business relationship under constitutional law were present: “functional integration, centralized management, and economies of scale.”9 The holding companies were not only dependent upon P for their core business functions, but were also controlled by P. Where the parent’s expense in the taxing state is its subsidiaries’ income, the Court concluded that such control establishes a unitary business. Moreover, the Court rejected the argument that case precedent addressing trademark holding companies does not apply to scenarios involving patent holding companies, stating that a distinction in type of intellectual property “does not affect how or where they are ‘used’ for purposes of state income taxation.”

Furthermore, P’s deduction of its payments to IHC1 and IHC2 in Maryland were treated as “gains to assets on its own balance sheets,” gains to IHC1 and IHC2. Therefore, the expenses were incurred in Maryland and the corresponding gains were also realized in Maryland.

Statute of Limitations and Prior Audits

The Court also disagreed with the holding companies’ contentions that the Comptroller was barred from recovery by the statute of limitations and by its failure to assess the taxes at issue in its prior audits of P. First, with respect to the statute of limitations, Maryland law permits income tax to be assessed at any time if a return is not filed as required. Since both holding companies failed to file returns as required by law, an assessment was permitted “at any time.” Next, the holding companies were responsible for their own deprivation of the opportunity to timely address the issues underlying the assessments. They were the ones who could have sought the Comptroller’s opinion. The Comptroller was not commanded to investigate each and every expense payment made by P when it was “on notice” of them during its audits.

Apportionment Factor

Finally, the Court addressed the holding companies’ position that their income should have been apportioned according to P’s sales alone and not based on P’s apportionment factor, which takes into account P’s property or payroll. The Court found that because P’s apportionment factor reasonably reflected its expenses in Maryland, which were equivalent to the holding companies’ income, the same factor reasonably shows the amount of income attributable to Maryland as part of P’s unitary business. Therefore, the use of P’s apportionment factor to determine the holding companies’ Maryland income was not erroneous, and the Comptroller’s assessments were upheld.


This decision is consistent with Maryland’s continuing attempt to thwart businesses from using intangible holding companies that result in a state tax benefit. Accordingly, businesses with a physical presence in Maryland must be prudent when they create an “out-of-state” intangible holding company. The Comptroller may very well take the position that the company falls within the state’s taxing jurisdiction based upon a “unitary business” relationship resulting from substantial intercompany transactions between the in-state parent (which generates deductions in the home state) and the subsidiary (which generates income in tax-free or tax-favored jurisdictions).

However, the Tax Court’s use of a unitary analysis in a separate reporting jurisdiction like Maryland, and the finding that two entities which have no independent economic substance from their parent have to be treated as separate taxpayers subject to tax in Maryland using its parent’s apportionment factor is particularly controversial and untested in other jurisdictions. The unitary theory directly addresses the issue of apportionment, not nexus.10 Without the ability to require statutory combined reporting for unitary businesses in Maryland, passive investment holding companies that solely hold investments and intangible holding companies that hold patents and other intangible items arguably should not be forced to file in Maryland on the basis of economic nexus principles alone.

Even though Maryland requires separate returns,11 this decision indicates that the state is moving toward an acceptance of unitary business principles. Though combined reporting was not specifically endorsed in this decision, the requirement that both out-of-state subsidiaries file as Maryland taxpayers and share the same apportionment factor as their parent effectively caused a result not unlike combined reporting on a unitary basis as required in numerous states. Also, this decision may affect other cases concerning intercompany payments that are pending before the Tax Court.12

Finally, the Comptroller’s assessments extend back to 1983, many years preceding the Geoffrey13 decision in South Carolina. It is interesting that a state would make an assessment based on a theory that had not been judicially adopted for many of the periods under assessment. Considering that this case has been reversed twice, there does not seem to be a consensus among the Maryland courts concerning this issue. Therefore, it is probable that the taxpayers will seek review by the Maryland Court of Appeals, the state’s highest court.


1 Comptroller of the Treasury v. Gore Enterprise Holdings, Inc.; Comptroller of the Treasury v. Future Value, Inc., Maryland Court of Special Appeals, Nos. 1696, 1697, Jan. 24, 2013.

2 IHC1’s tax liability was calculated by multiplying royalties from P by P’s apportionment factor, and IHC2’s tax liability was calculated by multiplying interest from P by P’s apportionment factor.

3 The alternative assessment against P was in the amount of $193,718, including interest and penalties. This amount reflects the fact that P filed tax returns, which triggered the statute of limitations.

4 W.L. Gore & Assoc., Inc. v. Comptroller of the Treasury, Maryland Tax Court, Nos. 07-IN-OO-0084,

07-IN-OO-0085, 07-IN-00-0086, Nov. 9, 2010.

5 MD. CODE ANN., TAX-GEN § 10-402.

6 In Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the U.S. Supreme Court explained that the “Due Process Clause ‘requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax,’ and that the ‘income attributed to the State for tax purposes must be rationally related to values connected with the taxing State.’” (citations omitted)

7 In Complete Auto Transit Inc. v. Brady, 430 U.S. 274 (1977), the U.S. Supreme Court developed a four-part test to determine whether a state’s imposition of a tax satisfies the Commerce Clause. To meet the test, the tax must (1) be applied to an activity with a substantial nexus with the taxing state, (2) be fairly apportioned, (3) not discriminate against interstate commerce and (4) be fairly related to the services provided by the state.

8 The Classics Chicago, Inc. v. Comptroller of the Treasury, 985 A.2d 593 (Md. Ct. Spec. App. 2010).

9 MeadWestvaco v. Ill. Dep’t of Revenue, 553 U.S. 16 (2008).

10 For example, the U.S. Supreme Court has characterized the unitary business principle as the “linchpin of apportionability.” See ASARCO, Inc. v. Idaho State Tax Commission, 458 U.S. 307 (1982). It should be noted that Maryland strictly prohibits combined filings, and so the Comptroller and the Tax Court could not simply decide to combine the three entities on the basis of unity. MD. CODE ANN., TAX-GEN § 10-811.

11 Note that Maryland has been considering a change to combined reporting for years. In an effort to obtain information to assist the state in evaluating the potential impact of combined reporting on state revenue, Maryland required pro forma combined reports to be filed for the 2006 through 2010 tax years. MD. CODE ANN., TAX- GEN § 10-804.1; MD. REGS. CODE § Also, combined reporting legislation has been introduced during prior legislative sessions (for example, H.B. 941 was introduced in February 2012) and the current legislative session (H.B. 1158 was introduced on February 8, 2013).

12 For example, cases involving ConAgra Brands (No. 09-IN-OO-0150) and Staples (Nos. 09-INOO- 0148, 09-IN-OO-0149) are being considered by the Tax Court.

13 Geoffrey, Inc. v. South Carolina Tax Commission, 437 S.E. 2d 13 (S.C. 1993).

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