Top court upholds Md. income tax against Nordstrom subsidiary

A Nordstrom subsidiary can’t use its own error to avoid a Maryland tax bill of more than $2 million, the state’s highest court has held.

The subsidiary, one of several Nordstrom Inc. created to minimize its tax obligations in the mid-1990s, said it erred in declaring deferred income for 2002 and 2003. It argued that, under Maryland law, it should have filed a separate Maryland tax return for fiscal 1999 and declared the entire amount as a gain at that time.

Had the error occurred in 1999, it would have been outside the statute of limitations, the Court of Appeals noted.

“The fact that NIHC may have made a series of mistakes in the preparation of its Maryland tax returns, as a result of transactions apparently devised to avoid state taxation, does not entitle it to escape its tax liability on that income,” Judge Robert N. McDonald wrote Monday for the Court of Appeals.

Attorneys for both sides agreed Monday that the court is following a line of cases that stretches back to its landmark 2003 ruling, Comptroller v. SYL, which dealt with the taxation of income-sheltering subsidiaries.

“The court has been fairly consistent in its analysis of these cases and how [SYL] applies to these multistate companies…,” said Assistant Attorney General Brian L. Oliner, counsel to the Comptroller of Maryland. “As additional cases come up, you get new fact scenarios to see how that plays into its prior decision.”

NIHC’s lawyer, though, saw it as something more like the closing of a door.

“The takeaway is that if you have a company that lacks economic substance — which was the case here — the court is not going to listen to any other defenses, but is going to affirm the comptroller’s assessment,” said tax attorney Harry D. Shapiro, of Saul Ewing LLP.

“If you have a company that lacks economic substance, you are D-E-A-D,” Shapiro added.

Like the subsidiary in SYL, NIHC was created to shift income from licensing of corporate trademarks away from its parent company (which does business in Maryland and therefore can be taxed here) to the subsidiary, which has no independent connection to the state.

Such arrangements were popular prior to 2003, when the Court of Appeals issued its decision in SYL.

“Much as the shot clock led to the demise of the four corners offense, judicial decisions during the past two decades have limited the utility of this tax avoidance strategy,” McDonald wrote, referring to SYL and a 1993 decision from South Carolina, Geoffrey Inc. v. South Carolina Tax Commission. The Supreme Court refused to hear both those cases.

Section 311(b) gain

In Monday’s opinion, the income in question stemmed from a trademark licensing agreement that NIHC had shifted to another Nordstrom subsidiary, N2HC.

Nordstrom’s tax consultant determined that, under the federal tax code, the transfer was “distribution of appreciated property that would be recognized as a gain to NIHC under §311(b) of the Internal Revenue Code,” according to the opinion.

On its consolidated federal return, Nordstrom amortized the 311(b) gain over 15 years. For the years in question — 2002 and 2003 — it reported deferred income from the arrangement of more than $186 million in 2002 and again in 2003, but apportioned none of it to Maryland.

Nordstrom said it concluded in 2005 that it had misunderstood Maryland reporting requirements, and should have filed a separate Maryland return in 1999 to report the entire 311(b) gain at the time. (However, it never sought to amend its return, the Court of Appeals noted.)

In 2007, the comptroller determined that NIHC owed a total of about $2 million, including a 25 percent penalty, for the 2002 and 2003 tax years.

The Maryland Tax Court upheld that award, but the Baltimore City Circuit Court agreed with the taxpayer, based on the state law requiring corporate affiliates to file separate returns.

The Court of Special Appeals, however, ruled for the comptroller, and the Court of Appeals affirmed.

“On the facts of this case, the separate reporting requirement does not eliminate the tax liability for the income reported, properly subject to tax, and not previously taxed,” the top court concluded. “We hold that, on the record before the Tax Court, NIHC did not carry its burden of showing that the Comptroller’s assessment was wrong.”

Oliner, the comptroller’s lawyer, said his client has not calculated a new total yet but that interest and penalties would have continued to accrue during the litigation.

Faster turnarounds

Shapiro, a tax lawyer of 50 years’ standing, was one of the attorneys who argued the SYL case in the Maryland Tax Court. He noted that Tax Court ruled in the taxpayer’s favor and that the Court of Appeals reversed that ruling “27 months to the day after it heard argument in the case.”

On taking the helm of the court last year, Chief Judge Mary Ellen Barbera vowed to end such lengthy waits, promising that all cases heard in one term would be decided before the beginning of the next term the following August.

The NIHC case was heard on March 7. With Monday’s decision, the court has four opinions to go to make good on the chief judge’s pledge.

WHAT THE COURT HELD

Case:

NIHC v. Comptroller, CA No. 63, Sept. Term 2013. Reported. Opinion by McDonald, J. Argued March 7, 2014. Filed Aug. 18, 2014.

Issue:

Did the Maryland Tax Court properly uphold an assessment on a subsidiary for income that should have been declared as a 311(b) gain on a separate Maryland tax return in 1999?

Holding:

Yes; the separate reporting requirement does not eliminate the tax liability for the income reported, properly subject to tax, and not previously taxed.

Counsel:

Harry Shapiro for petitioner; Assistant Attorney General Brian Oliner for respondent.