United States: Maryland Tax Court Again Subjects Affiliated Taxpayers To Corporate Income Tax With "Fair" Apportionment

The Maryland Tax Court has determined that a multistate retailer and its subsidiary engaged in substantial intercompany transactions with each other, as well as other members of an affiliated group, were subject to Maryland corporation income taxes. Following several precedential decisions of Maryland courts based on similar fact patterns, the Court ruled that the retailer and subsidiary had nexus with the state, and the Maryland Comptroller fairly apportioned income to the retailer and subsidiary based on incomeproducing activities that occurred in Maryland.1


The taxpayer, Staples, Inc. (Staples) is a multistate retailer of office products. Prior to 1998, Staples and a wholly-owned subsidiary, Staples Properties, Inc. (SPI), engaged in substantial intercompany transactions involving intellectual property. SPI held the intellectual property and licensed the property to Staples. SPI was audited by the Maryland Comptroller for the 1993-1997 tax years, and ultimately paid over $4 million in tax, penalties and interest to the state.

Staples engaged in an internal reorganization in 1998. Staples formed Staples the Office Superstore, Inc. (Superstore) as a wholly-owned subsidiary of Staples, along with several other affiliated entities. Staples provided managerial and administrative services on behalf of Superstore and the other affiliated entities, and Superstore provided franchise system services to the other affiliated entities. Superstore and the other affiliated entities relied on Staples for a variety of corporate necessities.

Following an audit of the 1999-2004 tax years, in 2008, the Comptroller assessed Staples and Superstore over $14 million in tax, interest and penalties. In doing so, the Comptroller contended that Staples and Superstore had no economic substance as separate entities. In response, Staples and Superstore argued that both Staples and Superstore had economic substance, as both companies employed thousands of individuals and owned substantial amounts of property. In addition, fees for intercompany transactions involving the provision of services by one company to another were charged at arm's length.

Nexus Determination

The Court began its analysis by reviewing the basic constitutional principles required to be met to impose the Maryland income tax. In addition to citing the relevant and oft-cited Due Process and Commerce Clause requirements for taxation,2 the Court pointed to the unitary business principle, under which according to the Court, "enables taxation by apportionment when . . . 'functional integration, centralized management and economies of scale' are present." The Court then pointed to Maryland's recent line of cases in which nexus could be achieved on the basis of an economic reality test, where the parent's business in Maryland produced the income of the subsidiary.3 The Court looked to Staples' structure and audit result from 1993-1997 to show that the reorganization that Staples undertook in 1998 was done to shift income from Maryland using transactions involving intercompany royalty and interest expense arrangements.

Following a review of Staples' post-1997 structure and intercompany arrangements, the Court determined that Staples and Superstore had sufficient contacts with Maryland to require both companies to file. The Court went to great lengths to show that since Staples and Superstore were not separate business entities, and were part of a unitary business enterprise, these entities had nexus with the state of Maryland for corporation income tax purposes. Specifically, the Court determined that Staples and Superstore could not operate independently and along with the affiliated corporations, exhibited enterprise dependency.

Fair Apportionment

Following the nexus determination, the Court approved the Comptroller's distinctive method of apportionment in an affiliated entity context. Citing the method endorsed in the Gore4 decision issued by the Maryland Court of Appeals, the Court stated that applying the apportionment factor of an in-state retailer acting as a licensee to affiliates that are receiving royalty and interest payments associated with the intellectual property used in the state was proper. In this matter, Superstore received royalty income and Staples received interest income which was reported as expenses by Staples' other affiliated entities. Again, the Court looked back to Staples' 1993-1997 structure and audit results to prove that the Comptroller's assessment was reasonable. The Court summarily rejected testimony from Staples' expert witness that the Comptroller's computation was distortive, in part because such testimony was premised on the assumption that Staples operated as a single entity prior to 1998.

Imposition of Interest and Penalties

Interestingly, given the above analysis and the focus on perceived lack of economic substance, one would have expected the Comptroller to impose interest and penalties under the Maryland Tax Code.5 Instead, the Court held that Staples and Superstore satisfied the reasonable cause exception since there was a good-faith reasonable basis to challenge the law. Accordingly, the Court abated interest from February 20, 2009, the date on which Staples and Superstore filed its Maryland Tax Court appeal, to May 28, 2015, the date the Court issued its decision in this matter. In addition, the Court did not impose penalties on Staples and Superstore.


The Court's decision, while not surprising given the decisions handed down by Maryland courts over the last several years, is somewhat disappointing and confusing in places. Specifically, the Court relied on the unitary business principle in part to determine that Staples and Superstore had corporation income tax nexus with Maryland. Traditionally, the use of the unitary business principle has been confined to determining whether affiliated corporations should be required to file on a combined basis. Use of the unitary business principle to conclude that nexus exists was a concept thought to be explicitly rejected by the Maryland Court of Appeals in Gore.6

The Court also claimed that the structure of Staples and Superstore following the reorganization lacked economic substance, even though Staples and Superstore argued that intercompany transactions were performed at an arm's length basis. The Court did not engage in a detailed review of the transactions to determine whether such arm's length standard was met, but simply rejected the arrangements made by Staples, Superstore and their affiliates out of hand. Compared to the fact patterns in Gore as well as the recent decision by the Court in ConAgra Brands,7 Staples and Superstores each had far more substantial payroll and property, but this fact ultimately did not interrupt the Court's conceptual association of enterprise dependency, non-economic substance, unity, nexus and the apportionment approximation that resulted in millions in additional Maryland corporation income tax liability.

The Court's decision not to require the payment of interest during the pendency of Staples' and Superstore's appeal to the Court is somewhat intriguing, and may be considered a tacit admission that the companies' position was not wholly meritless. Unfortunately, the Court's analysis still does not provide a taxpayer with an adequate roadmap to determine when a structure will pass the economic substance test, and how far the economic substance test can be taken in areas outside the fact pattern addressed in this matter. Given the overall stance of the Maryland courts in this area, it is unlikely that taxpayer-favorable decisions relating to related-party enterprises for tax years prior to the creation of the state's related-party addback statute8 are in the offing any time soon.


Staples, Inc. v. Comptroller of the Treasury; Staples The Office Superstore, Inc. v. Comptroller of the Treasury, Maryland Tax Court, Nos. 09-IN-OO-0148; 09-IN-OO-0149, May 28, 2015.

2  This analysis included references to prohibitions on taxing value earned outside a state's borders, and that there must be a definite link or minimum connection between a state and the person, property or transaction it seeks to tax. See Container Corp. of America v. Franchise Tax Bd., 463 U.S. 159 (1983); Allied-Signal, Inc. v. Dir., Div. of Taxation, 504 U.S. 768 (1992). In addition, the Court noted that if the substantial nexus test was achieved, the tax to be imposed "must be fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State." Trinova Corp. v. Michigan Dep't of Treasury, 498 U.S. 358 (1991).

3 For example, see The Classics Chicago, Inc., et al v. Comptroller of the Treasury, 189 Md. App. 593 (2010); Comptroller of the Treasury v. SYL, Inc., 825 A.2d 399 (Md. 2003).

4 Gore Enterprise Holdings, Inc. v. Comptroller of the Treasury and Future Value, Inc. v. Comptroller of the Treasury, 87 A. 3d 1263 (Md. 2014).

5 Pursuant to MD. CODE ANN., TAX-GEN §§ 13-606, 13-714.

6 As quoted in Gore, the "principle does not confer nexus to allow a state to directly tax a subsidiary based on the fact that the parent company is taxable and that the parent and subsidiary are unitary." [emphasis in original]

7 ConAgra Brands, Inc. v. Comptroller of the Treasury, Maryland Tax Court, No. 09-IN-00-0150, Feb. 24, 2015.

8  Pursuant to MD. CODE ANN., TAX-GEN § 10-306.1, the advent of Maryland's related-party intangible and interest expense addback rules after the tax years at issue in this case likely served to eliminate much of the Maryland corporation income tax benefits derived by the corporate structure created by Staples and other large multistate corporations. .

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