Recent Amendments to Laws Affecting Maryland Corporations

By James Winn, Tracy Bacigalupo and Barbara Nep

Changes in the Taxation of Related Parties and Amendments to the Maryland General Corporation Law

The 2004 session of the Maryland General Assembly yielded several changes to Maryland law that we believe will be of particular interest to our corporate clients. Chapters 556 and 557 of the 2004 Maryland Laws (House Bill 297 and Senate Bill 187, respectively) address the taxation of transactions with related non-Maryland parties. Chapter 516 (House Bill 737) effects several changes to the Maryland General Corporation Law (MGCL). Governor Ehrlich permitted Chapters 556 and 557 to become law without his signature; both go into effect on July 1, 2004. Chapter 516 was signed into law on May 26 and went into effect on June 1, 2004. This article summarizes the principal effects of Chapters 556, 557 and 516 and recommends steps all Maryland corporations should take in response to this recent legislation.

Chapters 556 and 557 derive from companion bills adopted in an attempt to address the so-called. Delaware holding company tax loophole. This refers to transactions in which a Maryland corporation seeks to lower its Maryland corporate income tax by, for example, transferring "intangible assets" to a related non-Maryland entity that is exempt from tax in its home jurisdiction, such as a Delaware holding company (DHC), and paying that entity for the use of the assets. Chapter 556 requires that Maryland corporations, in determining Maryland taxable income, add back deductions allowed for federal income tax purposes for interest expenses and "intangible expenses" paid to related non-Maryland entities or persons. .Intangible expenses. are defined in Chapter 556 to include, among other things, expenses, losses or costs related to patents, trade names, trademarks, service marks, copyrights, and similar intangible assets. The Maryland corporation will not be required to add back deductions related to transactions that satisfy complex safe harbor provisions. These provisions require, among other things, that the transaction be at "arms-length" rates and that tax avoidance not be "a" principal purpose of the transaction. Chapter 556 also confers upon the Maryland Comptroller authority to reallocate gross income, deductions and credits among two or more related parties, that parallels the authority of the IRS to do the same under Section 482 of the Internal Revenue Code. Chapter 556 will be effective for tax years beginning after December 31, 2003.

Chapter 557, commonly referred to as the amnesty provision, requires the Maryland Comptroller to administer a settlement period from July 1 through November 1, 2004, relating to the taxation of transactions between Maryland corporations and related non-Maryland persons or entities such as DHCs. If, on or before November 1, 2004, a corporation (whether or not it has already been assessed) pays tax that the State claims is due on such transactions for all tax years beginning on or after January 1, 1995, and ending on or before December 31, 2003, no penalty will be imposed, and the maximum interest charge will be 6.5% instead of the normal 13% rate. In addition, corporations that participate in the settlement will not be subject to assessment on such transactions for any taxable year beginning before January 1, 1995. In settling, the corporation can choose to pay either (a) the income tax that would have been payable by the related non-Maryland party if it had been subject to the Maryland corporate income tax, or (b) the increased tax on its own Maryland income that results from adding back federal deductions taken for interest and intangible expenses as provided in Chapter 556. Failure to take advantage of this amnesty period will expose the corporation or the related party to possible assessment for all past years during which the related-party structure was used and, if the assessment is upheld, to the full 25% penalty and interest at 13%. When considering this amnesty period, note that the Maryland Court of Appeals upheld income tax assessments for taxable years prior to the effective date of Chapter 556 against two DHCs that had been used in the manner described in the paragraph above.

• Contact your Maryland tax advisor as soon as possible, preferably prior to July 1, 2004, to discuss whether settlement during the amnesty period is appropriate.

• Consult with your Maryland tax advisor regarding current and proposed transactions with related parties, particularly those that do not do business in Maryland and do not file Maryland income tax returns. These transactions may need to be restructured in response to the recent legislation.

• If you have already entered into a settlement regarding transactions with related non-Maryland parties, on the terms originally offered by the Comptroller, you should consult with your Maryland tax advisor to determine whether you are entitled to modify your settlement to take advantage of the amnesty terms. If you are entitled to modification, you may be eligible for a refund of any taxes (and interest thereon) paid for years beginning before January 1, 1995, one-half of the interest paid on tax assessed for years beginning on and after January 1, 1995, and all of the penalty paid with respect to the assessed tax.

• Reverse Stock Split without Stockholder Action. Chapter 516 amends MGCL Sections 2-309 and 2- 604 to provide that unless its charter states otherwise, a Maryland corporation may accomplish a reverse stock split without stockholder action. The reverse split must be approved by a majority of the board of directors, and written notice of the reverse split must be given to record holders within 20 days after the effective date. This special authority is available only to Maryland corporations with a class of equity securities registered under the Securities Exchange Act of 1934, or registered as an open-end investment company under the Investment Company Act of 1940. In addition, a corporation may not effect reverse stock splits under this provision that would result in a combination of shares at a ratio of more than 10-to-1 in any 12-month period.

• Common Stockholder Action by Non-Unanimous Written Consent. Prior to the recent amendments, Section 2-505 of the MGCL permitted common stockholders to act by written consent only if unanimity were achieved. After June 1, 2004, if authorized by the corporation.s charter, holders of common stock entitled to vote in the election of directors will be entitled to act by written consents (including by electronic transmission) signed by stockholders entitled to cast the number of votes that would be required to act on the matter at a meeting. The corporation must give notice of such action to each common stockholder within 10 days after the effective date of the action. The board of directors may adopt reasonable procedures for delivering consents in lieu of holding a meeting.

• Execution of Stock Certificates. Prior to Chapter 516, Section 2-212 of the MGCL required that stock certificates be signed by the president, a vice president, or the chairman of the board of directors. This legislation expands the list of persons authorized to sign stock certificates to include the chief executive officer, chief operating officer, chief financial officer, and vice chairman of the board of directors.

• Board Authority upon Voluntary Dissolution. Before the recent amendments, Section 3-410 of the MGCL provided that the directors of a Maryland corporation undergoing voluntary dissolution became "director-trustees" of the corporation.s assets for the purposes of liquidation. As amended by Chapter 516, the MGCL directs the board of directors, as a board of directors and not as trustees, to manage corporate affairs for the purposes of the liquidation. The amended statute also specifically provides that dissolution of a corporation does not subject the board of directors to a standard of conduct other than the general standard of care imposed by MGCL Section 2-405.1, which is Maryland.s version of the so-called "business judgment rule".

• Reverse Stock Split without Stockholder Action. Review your charter to determine whether it denies the board of directors authority to effect a reverse stock split without stockholder approval. If so, consider whether it would be appropriate to amend the charter. If the charter is amended, conform the bylaws accordingly.

• Common Stockholder Action by Non-Unanimous Written Consent. Common stockholders will not have the authority to act by non-unanimous written consent unless the charter specifically authorizes such power. Maryland corporations should weigh the costs and benefits of allowing common stockholders to act by non-unanimous written consent, since this could give large stockholders a significant amount of power. If the charter is amended, confirm that the bylaws conform to the new charter provisions.

• Execution of Stock Certificates. Review your charter and bylaws to determine whether they specify which officers are authorized to sign stock certificates. If they do, consider amending the list to correspond more closely to the new MGCL provisions or, in the alternative, to simply crossreference MGCL Section 2-212.

• Board Authority upon Voluntary Dissolution. Review your charter and bylaws to confirm whether they specifically address this matter. If they conflict with the recent amendments, consider making conforming revisions.

This article is intended to provide information on recent legal developments. It should not be construed as legal advice or legal opinion on specific facts. Pursuant to applicable Rules of Professional Conduct, it may constitute advertising.