The Classics Chicago, Inc. v. Comptroller of the Treasury (Ct. of Special Appeals)

Filed: January 4, 2010.
Opinion by Judge James Eyler.

Held: When a parent company does business in Maryland, its subsidiary which does not do business in the State may be constitutionally required to pay State income taxes. Such taxation is constitutional if the subsidiary’s income is generated by the parent’s business in the State.

Facts: A subsidiary held its parent’s trademarks and licensed to the parent the right to use the trademarks in exchange for royalty payments. During a several year period, the parent, which did business in Maryland, filed State income tax returns that deducted royalty payments made to the subsidiary. The subsidiary, which did not do business in Maryland, did not file State income tax returns and received a tax assessment from the Comptroller for the royalty payments. The issue on appeal was whether the assessment against the subsidiary is constitutional.

Analysis: The court stated that the constitutionality of the tax is governed by the Commerce Clause to the U.S. Constitution and principles of due process. The analysis turns on whether there is a substantial nexus between the state and the person it seeks to tax. Both parties’ arguments addressed their differing interpretation of Comptroller of the Treasury v. SYL, Inc., 375 Md. 78, cert. denied, 540 U.S. 984 and 540 U.S. 1090 (2003).

As in the case at hand, SYL involved a subsidiary that licensed intellectual property rights to its parent in exchange for royalties. The SYL court held that a tax on the subsidiary was constitutional. In the matter at hand, the subsidiary argued that SYL adopted the “sham doctrine,” which examines whether an entity’s motivation behind a corporate structure was to obtain tax benefits. Because the subsidiary was not formed for tax-related reasons, it allegedly should not have been taxed. The Comptroller argued that SYL did not adopt the “sham doctrine,” and, accordingly, an entity’s motivation is not dispositive.

The court accepted the Comptroller’s argument, holding that SYL did not adopt the “sham doctrine.” Rather, the constitutional analysis simply turns on whether the parent’s business in the taxing state is what produced the subsidiary’s income. Because the subsidiary’s income was generated solely by the parent, the court held that the tax was constitutional.

The full opinion is available in PDF. The opinion in SYL is also available in PDF.

State of Maryland, Comptroller of Maryland v. Ciotti (Maryland U.S.D.C.)

Filed: December 16, 2009.

Opinion by Judge Frederick Motz.

Held: A debtor that owes additional Maryland State taxes after a federal determination of additional income cannot discharge such debt in bankruptcy if it did not report the federal determination to the State.

Facts: The IRS audited the debtor’s prior tax returns and found additional taxable income. Maryland law requires that taxpayers file a report of federal adjustment with the State upon such an IRS determination. The debtor did not do so, but the IRS itself reported the adjustment to Maryland tax authorities. As a result, the Comptroller of Maryland made adjustments to the debtor’s tax returns that resulted in increased tax liability. The debtor subsequently filed for Chapter 7 bankruptcy and sought a declaration that her additional State tax liability as a result of the upward adjustment was discharged. The bankruptcy court granted the discharge, and the State appealed to the district court.

Analysis: Whether the debtor’s additional State tax liability can be discharged turns on the meaning of the words “or equivalent report or notice” added to 11 U.S.C. § 523(a)(1)(b) by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”). Section 523(a)(1) provides that a debtor shall not be discharged from any debt for a tax “with respect to which a return, or equivalent report or notice, if required – (i) was not filed or given” (emphasis added). Accordingly, the issue is whether the debtor’s failure to report the federal adjustment to the State amounts to an “equivalent report or notice” that was “not given.”

Reversing the bankruptcy court, the district court held that the failure to report was indeed a failure to provide an equivalent report. In so holding, the district court looked to legislative history provided by a House of Representatives report which addresses the changes made to section 523(a)(1). The district court also expressly rejected the bankruptcy court’s reasoning that the report required under Maryland law is not a “return” – and thus cannot be deemed to be the “equivalent of a return.” The court stated that to equate “return” and “equivalent report or notice” would render the latter phrase redundant. In addition, the inclusion of “or given” provides further evidence that Congress contemplated something less formal than a “return.”

The district court opinion is available in PDF. The bankruptcy court opinion, which was reversed by the district court, is also available in PDF.

Posey v. Comptroller (Maryland Tax Ct.)

Filed: October 29, 2009
Opinion by Chief Judge Walter C. Martz, II

Held: A physician severed his domicile in Maryland for tax purposes when he closed his professional practice in Maryland and manifested a subjective intent to be domiciled elsewhere.

Analysis: The Comptroller attempted to assess taxes against the plaintiff as if he were domiciled in Maryland. The plaintiff disputed the assessment, claiming he had severed his domicile in Maryland and established a domicile in Maine.

The court applied the two-pronged test for determining a change in domicile articulated in Shenton v. Abbot, 178 Md. 526 (1940):

1. It must be shown that a new residence was acquired with the intent of remaining there;
2. The abandonment of the old domicile must be so permanent as to exclude the existence of an intent to return.

To make a decision, the court examined the circumstantial evidence particular to the case. The court found several things material: the plaintiff acquired a new home in Maine, it was designed to be permanent, he signed a two year contract with a practice group in Maine, and he closed his Maryland practice and referred its patients to other doctors.

On that basis, the court concluded that the plaintiff clearly intended to abandon his domicile in Maryland. Accordingly, the Comptroller's assessments were reversed.

The full opinion is available in PDF.