Trademark licensing companies have always been a difficult inquiry for courts to analyze from a constitutional perspective in the state and local tax arena. At its very basic level, the trademark licensing company cases involve a holding company (almost always a Delaware company) with no physical assets or employees in the taxing state. The holding company holds a valuable intangible asset, a trademark for example, and charges another company a fee to use that intangible asset to sell goods in a taxing state. The question then arises – does the taxing state have the power to tax the out-of-state holding company based on other company’s use of its trademarks within that state?
The only Supreme Court case that attempts to address this issue is Quill Corp. v. North Dakota, in 1992. In Quill, the Court held that in order for a state to have the power to tax a company within that state, the company must have some “physical presence” within that state. To add another wrinkle, Quill dealt with the ability for a state to force a company to collect its use tax. Does this “physical presence” apply to sales tax? What about corporate income tax?
Commentators and courts seem to agree that the “physical presence” test applies to both a sales and a use tax. However, courts and SALT professionals alike cannot seem to agree as to whether the “physical presence,” test applies to state corporate income tax.
The lead case for decades has been Geoffrey v. South Carolina, 437 S.E. 2d 13 (S.C. 1993). In Geoffrey, Toys R Us, Inc. set up a Delaware subsidiary named Geoffrey Inc. and transferred a valuable giraffe and the name “Toys R Us” to it. Geoffrey in turn allowed Toys R Us to use the trademark in just about every state in exchange for 1% of the sales made by Toys R Us. This tax planning strategy resulted in Geoffrey having income of $55 million in 1990 and no state corporate income tax due to any state. On the flip side, the transaction also siphoned off $55 million of reportable income by Toys R Us. The South Carolina Supreme Court found that Geoffrey had “nexus” with South Carolina, despite physical presence in South Carolina because the trademarks were used in South Carolina to sell toys in the state. Whether this is in line with Quill remains unanswered because the U.S. Supreme Court denied Geoffrey’s appeal.
As I will address in the parts to come are Geoffrey type cases and the courts’ recent trends to rule in favor of the taxpayers. After all how can intangible trademarks in a state (even though courts use this terminology, how can one determine where an intangible is located anyway) satisfy the physical presence test?
About the author: Mr. Donnini is a multi-state sales and use tax attorney and an associate in the law firm Moffa, Gainor, & Sutton, PA, based in Fort Lauderdale, Florida. Mr. Donnini’s primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, and Florida probate. Mr. Donnini is currently pursuing his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email or phone listed on this page. Firm Website