Reed Smith Client Alert

Authors: Stephen J. Blazick

In a case decided late last month, Comptroller of the Treasury v. Gore Enterprise Holdings, Inc. and Future Value, Inc., Nos. 1696 and 1697 (January 24, 2013), the Maryland Court of Special Appeals held that patent royalties and interest income claimed as expenses in Maryland and paid to wholly owned, out-of-state subsidiaries are taxable as part of a unitary business.

The court’s decision reversed a taxpayer favorable circuit court ruling that many taxpayers hoped would serve as a break in the Comptroller’s winning streak in cases involving intangible holding company issues. The court’s decision, which appears to adopt the unitary business principle (although Maryland is a separate filing state), could influence the outcome in a number of intangible holding company cases pending at the Maryland Tax Court and circulating at the Comptroller’s office at audit or in administrative review.


W.L. Gore & Associates, Inc. ("Gore") is a Delaware corporation that uses certain patented material in the manufacture of various products. Gore operates in Maryland and is the parent to two wholly owned, out-of-state subsidiaries – Gore Enterprises Holdings, Inc. (GEH) and Future Value, Inc. ("FVI"). GEH holds all of Gore’s patents and granted Gore an exclusive license to use the patents. In exchange for this right, Gore paid a royalty fee to GEH. FVI holds all of Gore’s financial assets and makes loans to Gore. In return, Gore pays interest to FVI. Gore deducts its royalty payments to GEH and its interest payments to FVI from its taxable income.

In 2006, the Comptroller audited Gore and issued its typical "pick your poison" alternative assessments. The Comptroller issued assessments to GEH and FVI, asserting that the entities had nexus with Maryland, and apportioning their income to the state using Gore’s apportionment factor. The Comptroller also issued an alternative assessment to Gore, disallowing Gore’s royalty and interest expense deductions for its payments to GEH and FVI. Upon the Comptroller’s Notice of Final Determination, which upheld the audit assessment, the entities appealed the matter to the Maryland Tax Court.

The Tax Court affirmed the assessments against GEH and FVI, explaining that because it was Gore’s business in Maryland that produced the income of GEH and FVI, the subsidiaries did not have real economic substance as business entities separate from Gore, and were engaged in a unitary business in Maryland with Gore. The taxpayers then appealed to the Circuit Court for Cecil County, which reversed the Tax Court decision. The Comptroller appealed to the Maryland Court of Special Appeals. The Maryland Court of Special Appeals reversed the decision of the circuit court, stating that GEH and FVI had nexus with Maryland because they were engaged in a unitary business with Gore, and Gore had nexus with Maryland.

The taxpayers are expected to appeal the Court of Special Appeals decision to the Maryland Court of Appeals, the highest court in Maryland, before the March 12 deadline.1 If the Court of Appeals accepts the case, we could see a decision by the end of 2013.

And the Tangled Web of Tax Principles Continue

The conflation of various tax principles (sham transaction, economic substance, unitary business) has long plagued Maryland court decisions regarding intercompany transactions. However, the Gore decision takes this confusion to a new level by applying the unitary business principle to decide a case involving a nexus issue. The unitary business principle has no place in the analysis of a corporation’s nexus with a state that has not adopted unitary combined reporting. The Court of Special Appeals cited the U.S. Supreme Court decision in MeadWestvaco Corp. v. Ill. Dep’t of Revenue, 553 U.S. 16 (2008) to support its application of the unitary business principle. However, the court failed to acknowledge that the application of the unitary business principle in MeadWestvaco was to an entity that already had established nexus with Illinois (it filed tax returns in Illinois). GEH and FVI, however, have no connection to Maryland other than the receipt of income from Gore. Thus, the court’s use of the unitary business principle as a tool to establish or prove that the out-of-state entities had nexus with Maryland is both incorrect and unprecedented.

The only instance in which such an analysis would be plausible is if Maryland was a combined reporting state. However, Maryland law mandates separate filing. The Gore decision, if upheld, may be interpreted by the Comptroller as support for a move to unitary combined reporting in Maryland while bypassing the legislature. However, such a move would be highly controversial, given the numerous failed attempts in recent years to adopt unitary combined reporting through the legislative process.

Impact on Pending Tax Court Cases and Comptroller Audits

The Gore decision will likely impact other cases involving similar issues currently pending at the Maryland Tax Court. For instance, ConAgra Brands, Inc. v. Comptroller of the Treasury, No. 09-IN-OO-0150, involving intercompany royalty payments, was heard by the Tax Court in October 2010.2 The Tax Court also heard arguments in August 2011 in Staples, Inc. v. Comptroller, No. 09-IN-OO-0148, and Staples the Office Superstore, Inc. v. Comptroller, No. 09-IN-OO-0149 ("Staples"), involving intercompany royalty and interest payments. The Tax Court previously signaled that it was awaiting a decision in the Gore case before ruling. Now that Gore has been decided, we may see a ruling from the Tax Court in these cases, regardless of whether the Maryland Court of Appeals grants certiorari in Gore.

In addition to ConAgra Brands and Staples, there are more than a half-dozen other cases involving intercompany royalty and interest payments pending before the Tax Court. However, hearing dates have yet to be scheduled in these other cases.

The decision will also impact the standard applied in audits conducted by the Comptroller’s Office and appeals heard by the Comptroller’s Office of Hearings and Appeals. Although the Comptroller’s Office is happy with the Gore win, it is still grappling with the correct post-Gore standard to be applied to cases involving intercompany transactions. For instance, at the Hearings and Appeals level, an economic substance test is applied in ruling on cases. The Gore decision would appear to broaden the test hearing officers could apply. Only time will tell how the Comptroller’s staff will apply the Gore decision.

This alert is a part of a series of periodic updates on recent judicial, legislative and policy developments in the State of Maryland. For more information on the Gore decision, or the Maryland tax treatment of payments to affiliated entities, please contact one of the authors, or the Reed Smith attorney with whom you regularly work. For more information on Reed Smith’s Maryland tax practice, visit

About Reed Smith State Tax Reed Smith’s state and local tax practice is comprised of lawyers across seven offices nationwide. The practice focuses on state and local audit defense and refund appeals (from the administrative level through the appellate courts), as well as planning and transactional matters involving income, franchise, unclaimed property, sales and use, and property tax issues. Click here to view our State Tax team

1. In Maryland, a party has 15 days from the date of the Court of Special Appeals’ mandate to file a petition for writ of certiorari to the Maryland Court of Appeals. Although the Court of Special Appeals issued its opinion January 24, 2013, the mandate (final judgment) is scheduled to be issued February 25. Absent the filing, and grant, of a motion for reconsideration, the 15-day clock begins to run from February 25, and a petition for writ of certiorari would be due by March 12.
2. Taxpayers should be keeping an eye on the ConAgra Brands case. It is arguably distinguishable from the other intangible holding company cases that have been litigated to decision in Maryland because the taxpayer at issue has quite a bit of facts supporting a finding of economic substance for its intangible holding company. Prior to the Court of Special Appeals ruling in Gore, it appeared that the Tax Court might distinguish ConAgra Brands from its other intangible holding company cases, and could result in a taxpayer win. However, the unitary business analysis used by the Court of Special Appeals in Gore could render the evidence of economic substance produced by ConAgra Brands meaningless.



Client Alert 2013-039