Opposition Brief — Lanco, Inc. v. Director, Division of Taxation, 127 S. Ct. 2974 (2007) (No. 06-1236)

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FILED

(A MAY 1 4 2007

OFFICE OF THE CLERK

No. 06-1236 SUPREME COURT, U.S.

In the

Supreme Court of the United States

LANCO, INC.,

Petitioner,

¥.

DIRECTOR, DIVISION OF TAXATION,

Respondent.

On Petition for a Writ of Certiorari to the

Supreme Court of New Jersey

BRIEF IN OPPOSITION TO

PETITION FOR A WRIT OF CERTIORARI

STUART RABNER

ATTORNEY GENERAL OF NEW JERSEY

PATRICK DEALMEIDA

Assistant Attorney General*

MARLENE G. BROWN

Deputy Attorney General

R.J. Hughes Justice Complex

25 Market Street

P.O.Box 112

Trenton, New Jersey 08625-0112

(609) 292-8576

* Counsel of Record

TABLE OF CONTENTS

TABLE OF AUTHORITIES ...............0-0e0ee. iii

Pog eee ee ee

POINT I

CERTIORARI IS NOT WARRANTED BECAUSE

THE STATES ARE IN ACCORD ON THE

QUESTION OF WHETHER THE COMMERCE

CLAUSE PERMITS THE ASSESSMENT OF

INCOME TAX ON REVENUE GENERATED BY A

CORPORATE TAXPAYER FROM THE USE OF

INTANGIBLE PROPERTY IN THE STATE, BUT

TRANSFERRED THROUGH A TAX AVOIDANCE

MECHANISM TO A RELATED COMPANY IN A

STATE THAT SHELTERS THAT INCOME FROM

TARA RI ee eG ss hace ccs ecees.

A. State Courts Are In Agreement In

Holding That States May Impose

Income Tax On Revenue Generated’ -

Through The Use of Intangible

Property Where Taxpayers Attempt

To Export That Revenue To A Tax-

WEN re eee bccs ccc ree eses

B. State Legislatures, In The Absence Of

Congressional Action, Have Largely

Eliminated The Tax Avoidance

Potential Of Intangible Holding

Companies Through Legislation,

Greatly Reducing the Significance Of

The Issue Addressed By The Lower

Court And Militating Against Review

POINT II

THE DECISION BELOW DOES NOT LEAVE

MATTERS IN AN UNPRINCIPLED OR

CONFUSED STATE BECAUSE THE NEW

JERSEY SUPREME COURT’S DECISION IS

CONSISTENT WITH, AND REFLECTIVE OF, THE

COMMERCE CLAUSE JURISPRUDENCE OF

es re nando epee oP eoer 12

A. This Court’s Precedents Have Not

Required A Single, Wooden

Application Of The Commerce Clause

To All Types Of State Taxes ............. 12

B. New Jersey And Other States That

Impose Income Or Franchise Taxes .

On IHCs Do Not Reach Beyond Their

Borders And Lanco Follows This

Court’s Commerce Clause Analysis

Which Is Manageable By The

Judiciary And Taxpayers Alike ........... 17

RANGE a 5 80045 Fei Eun en Niece eee 19

ill

TABLE OF AUTHORITIES

CASES CITED

A & F Trademarks, Inc. v. Tolson,

605 S.E. 2d 187 (N.C. Ct. App. 2004),

certif. denied, 611 S.E.2d 168 (N.C.),

cert. denied, 126 S. Ct. 353 (2005) ............. 5, 6

America Online, Inc. v. Johnson,

2002 WL 1751434 (Tenn. Ct. App. 2002) .......... 8

Borden Chemicals and Plastics, L.P. v. Zehnder,

726 N.E.2d 73, 80 (Ill. App. Ct.),

app. denied, 731 N.E.2d 762 (Ill. 2000) ........... 7

C & A Carbone, Inc. v. Town of Clarkstown,

Ee AR Eo ose 5 d55 0 oboe ee eee cies 3

City of Philadelphia v. New Jersey,

ee 6 eT OEE oo cee bcases head caewess oe

Complete Auto Transit, Inc. v. Brady,

es Ti gs eae ee ee passim

Couchot v. State Lottery Comm'n,

659 S.E.2d 1225 (Ohio’),

cert. denied, 519 U.S. 810 (1996) ............. cn

Fulton Corp. v. Faulkner,

gk BD rrr ner ee nea re 3

Geoffrey, Inc. v. So. Carolina Tax Comm’n,

437 S.E.2d 13 (S.C.), cert. denied,

See as I EE 2s odors s ek eed eaarhaceu 4,5

Guardian Indus. Corp. v. Dep’t of Treasury,

499 N.W.2d 349 (Mich. App. 1993),

app. denied sub nom,

512 N.W.2d 846 (Mich. 1994) ................. 8,9

Kassel v. Consol. Freightways Corp.,

450 U.S. 662 (1981) ....... PE PO NCMrny hater 13

J.C. Penney Nat'l Bank v. Johnson,

19 S.W.3d 831 (Tenn. Ct. App. 1999),

cert. denied, 531 U.S. 927 (2000)... 2... cece eee 8

National Bellas Hess, Inc. v. Department of Revenue,

a. POUCHES 6 Fo Nas vee has eikeea passim

Orvis Co., Inc., v. Tax Appeals Tribunal,

654 N.E.2d 954, 960 (N.Y.), cert. denied

sub nom, 516 U.S. 989 (1995) ......... ce ceceees 14

Quill Corp. v. North Dakota,

POPE AE BATU ED 65 9 bso bs 6b 00 5n eS s¥a 54 es passim

Rylander v. Bandag Licensing Corp.,

18 S.W.3d 296 (Tex. App. 2000) ................. 8

Secretary, Dep’t of Revenue v. Gap (Apparel), Inc.,

886 So.2d 459 (La. Ct. App. 2004) ............... 6

Tax Comm’r v. MBNA Am. Bank,

OO Be BAC. VR UE vole i vad ne oeans bowen 7

CONSTITUTIONAL, STATUTORY, AND

REGULATORY PROVISIONS CITED

Se I CUE, OF cs bo wc wdc a4 9c kaw caeuane 3

Se en oeW dwn ah cc Cen eewsevenans 1]

OIE 535 iy ssa ie bio Wath ne eae On 10

Perr ey err Pre ree 10

PARI GORE: GAS. BOT INO) oc vce vcccccccccsncsiven 1]

Ariz. Rev. Stat. Ann. §43-947 .............. inde 1]

Ark. Code Ann. §26-51-423(g)(1),.............0..005. 10

ee ye Ro LS: nee 1]

eR ee Ss ere 11

COU, S50M. BU. SES-ZIGOR) occ ccc ces esercesecess 10

D.C. Code Ann. 47-1803.03(a)(19) ..............005. 10

Ga. Code Amn. $46-7-28.3(6) .. occ cece cece nesnes 10

Sy. Te, UE, SUD ES OMAOMS cass cesses sceisevess 11

BE SOI wins vnc ecisecveecessvnsenes 11

IED 3s 5. oe oid hue Few Se deh sad eae 10°

Kan. Stat. Ann. §79-32,142(a) ...... tines abe ean od 11

Ky. Rev. Stat. Ann. §141.205(2) .............eeeeees 10

Ky. Rev. Stat. Ann. §141.205(4) .........0.cc cee eees 10

Mass. Gen. Laws ch. 63, §311 (a) .........2....00058. 10

Mass. Gen. Laws ch. 63, §31I1(b) ................... 10

Md. Code Ann. Tax-Gen.§10-306.1(b)(2) ............. 10

pee. Rev. Stat, Arm. $5200.64 .. nse cccverccsevccencs 11

8 Fe FR Pre en re eee 1]

Pe, An SOME Sn. av kasaunendedvnoerusen 11

Miss. Code Ann. §27-7-17(2)(b) «00... cee eee ee eee 10

Mont. Code Ann. §15-31-141(1) ............ aagat 11°

Mont. Code Ann. §15-31-141(2) «2.2... 0.0... eee. 11

Neb. Rev. Stat. §77-2734.01 ........... adeceeteee - 41

eR ge. ere 11

Pues, OY. ONE, AD STRADG once cc cccccescctes ere |

IOS. Adm: Coe Gt FPG SS oo uno vee hcevecctecesas 9

N.J. Stat. Ann. $54:10A-4.4(%) ...... 0. cee cc eee eee 9

Pets Ws SU PEE ined aye raven vane euaes 15

Ds BO OE hc th b nv ect havesar utes 10

seg kb) ree eer 10

eee CE SC en bcs baie seks we bores 1]

Ohio Rev. Code Ann. §5733.042(C) ......... eat 10

te Rea, earn aererer fe aoe 1]

BO, FOG ET EINOES boc bbe wisdsyanvcustosceves

Utah Code Anm. $59-7-402 on cc ccccsevccccccvvcees

Va. Code Ann. §58.1-446 ........ PETC CET REP Cees

es i Pe NE 4 5k cd cedes ko Chee

oe . EE Oe re os cv on 0 bre ode ee

OTHER AUTHORITIES CITED

Congressional Research Service, State Corporate

Income Tax: A Description and

Amabyeis (June 30,2006)... ccc ccc ccc er eccces

Institute on Taxation and Economic

Policy, Combined Reporting: How ;

Does Your State Stack Up? (Apr. 2007) ...........

J. Hellerstein & W. Hellerstein, State Taxation

Warren, Gorham & Lamont (3d ed. 1998) .........

M. Mazerov, Center on Budget and Policy

Priorities, Growing Number of States

Considering a Key Corporate Tax

FRG Fi TE 8 ook ka tan ere eee

Ruling of Comm’r, P.D. 05-29, Va. Dep’t

of Taxation (Mar. 2, 2008) «0.0.0.0. cece ccccnecs

Ruling of Comm’r, P.D. 05-28, Va. Dep’t

Oe SOOO: 7, Oe hae vue res beeen

]

BRIEF IN OPPOSITION TO

PETITION FOR A WRIT OF CERTIORARI

ARGUMENT

I. CERTIORARI IS NOT WARRANTED BECAUSE

THE STATES ARE IN ACCORD ON THE

QUESTION OF WHETHER THE COMMERCE

CLAUSE PERMITS THE ASSESSMENT OF

INCOME TAX ON REVENUE GENERATED BY A

CORPORATE TAXPAYER FROM THE USE OF

INTANGIBLE PROPERTY IN THE STATE, BUT

TRANSFERRED THROUGH A TAX AVOIDANCE

MECHANISM TO A RELATED COMPANY IN A

STATE THAT SHELTERS THAT INCOME FROM

TAXATION.

Petitioner seeks to draw this Court into a field where

judicial precedent has firmly developed in a uniform fashion

and where State legislative action has largely eliminated the

continuing validity of the tax avoidance mechanism -- the

intangible property holding company (IHC) — that is the subject

of this appeal. Intervention by this Court is not warranted

because the pér curiam decision below is in accord with the

decisions of other State courts that have addressed the issue and

conforms with legislative developments in a vast majority of

States, including New Jersey, that eliminate the ability of

related entities to escape taxation through the use of an IHC.

An IHC is a corporate entity created by a parent or

operating company to hold intangible assets, usually the

trademarks, service marks, and good will of a related company.

IHCs are physically located in a State, Nevada and Delaware

are two popular examples, that does not impose income tax on

revenue generated by intangible property. The IHC has no

employees, property or bank accounts outside of the tax-haven

State. The parent company transfers the intangible assets to the

IHC, which enters into an agreement with the parent to permit

the use of the intangible property for retail or other purposes by

the parent company or its related entities in various States. The

parent or related company agrees to pay a royalty to the IHC,

generally based on a percentage of the gross income earned by

the related company through the use of the intangible assets,

and deducts that royalty from the parent or related company’s

State income as a business expense. The IHC pays no tax on

the royalty payments to its home tax-haven State, and resists

attempts at taxation by the State in which the IHC’s intangible

property is used to generate revenue by arguing that the

Commerce Clause precludes taxation because the IHC has no

physical presence in the taxing State.

This scenario is precisely what transpired here. The parent

company of Lane Bryant, a retailer of women’s clothing,

formed Lanco, a Delaware IHC. 52a. The parent transferred to

Lanco the trademarks, service marks and good will associated

with Lane Bryant stores, some of which are located in New

Jersey. 53a. Lane Bryant and Lanco entered into an agreement

through which Lane Bryant pays a monthly royalty in the form

of a percentage of Lane Bryant’s gross sales in New Jersey in

exchange for the use of Lanco’s intangible property. /d. Lane

Bryant deducts the payments from its New Jersey income as a

business expense, thereby significantly reducing its tax

obligation to the State. Lanco pays no tax on the royalties to

Delaware and takes the position that it may not be taxed by

New Jersey because it has no physical presence in the State.

Although Lanco seeks to pay no tax to New Jersey on the

income that it earns from the exploitation of the State’s

marketplace, Lanco derives numerous benefits from the use of

its property in New Jersey. As the Tax Court of New Jersey

found after hearing expert testimony, “Lancoclearly enjoys the

same benefits provided to Lane Bryant” by New Jersey. 36a.

In addition, among the expert testimony heard by the trial court

was that “Lanco’s licensure of intangibles for use in New

Jersey imposes costs on the state because it generates economic

activity that increases the demand for public services... .”

36a-37a. The expert opined that “Lanco benefits from this

activity, since it receives fees that increase with sales.” 37a.

Because Delaware does not tax income earned from the use of

Lanco’s intangibles, if petitioner prevails in its erroneous view

of the Commerce Clause and escapes taxation by New Jersey,

Lanco will pay no State income tax on its considerable earnings

and a significant percentage of the income generated by retail

sales in New Jersey will have been shielded from taxation by

any State.

" A. State Courts Are In Agreement In Holding That

States May Impose Income Tax On Revenue

Generated Through The Use of Intangible

Property Where Taxpayers Attempt To Export

That Revenue To A Tax-Haven State.

The Commerce Clause authorizes Congress to “regulate = -

Commerce . .. among the several States... .”” U.S. Const. art.

1, § 8, cl. 3. The dormant Commerce Clause is a “judicial

creation” that presumes that the Clause “not only empowers

Congress to regulate interstate commerce, but also imposes

limitations on the States in the absence of congressional action

...» C&A Carbone, Inc. v. Town of Clarkstown, 511 U.S.

383, 401 (1994)(O’Connor, J., concurring). The essence of the

Clause is that one State, in its dealings with other States, may

“not place itself in a position of economic isolation... .” City

of Philadelphia v. New Jersey, 437 U.S. 617, 623 (1978)

(quotations omitted). Nor may a State enforce economic

protectionism by penalizing interstate commerce for the benefit

of similar intrastate economic activity. Fulton Corp. v.

Faulkner, 516 U.S. 325, 330 (1996).

It has long been settled that in the area of State taxation a

tax on interstate economic activity does not offend the

Commerce Clause if it "is applied to an activity with a

substantial nexus with the taxing State, is fairly apportioned,

does not discriminate against interstate commerce, and is fairly

related to the services provided by the State." Complete Auto

Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977). It is the

substantial nexus prong, and the question of whether an IHC

must be physically present in a State where its trademarks or

other intangible property generate profits through retail sales by

an affiliated or related corporation to satisfy the Complete Auto

Transit test, that is presented by this petition.

The Supreme Court below, in deciding that question,

reached the same result as every other court that has issued a

published opinion on the subject: the physical presence test set

forth by this Court in National Bellas Hess, Inc. v. Department

of Revenue, 386 U.S. 753 €1967), for establishing substantial

nexus in the context of requiring a mail-order catalogue vendor

to collect and remit sales and use tax does not apply outside of

that limited area. This test, affirmed on the basis of stare

decisis in Quill Corp. v. North Dakota, 504 U.S. 298, 312

(1992), has consistently been found not to apply to IHCs that

attempt to shield from State taxation revenues generated by the

use of their intangible property by related entities with a

physical presence in the taxing State. Contrary to the

arguments posited by petitioner, the State court decisions in this

area are uniform and do not require clarification by this Court.

Shortly after issuance of the Quill decision, the South

Carolina Supreme Court recognized the limited scope of the

physical presence requirement applicable in the sales and use

tax collection context. Geoffrey, Inc. v. So. Carolina Tax

Comm'n, 437 S.E.2d 13 (S.C.), cert. denied, 510 U.S. 992

(1993). There, the South Carolina Court upheld the application

of that State’s corporate income tax in circumstances strikingly

similar to those before the New Jersey court below. Geoffrey

was a Delaware holding corporation with no employees,

officers, or tangible property in South Carolina. /d. at 15. The

company owned several valuable trademarks and trade names,

including "Toys ‘R’ Us," a trademark that matched the name of

its parent corporation. Jd. Through a licensing agreement with

its related company, Geoffrey permitted the use of its

trademarks by Toys “R” Us in South Carolina. Geoffrey

received as consideration a percentage of the parent's net sales

of merchandise in that State. /d. As is the case with Lanco, the

effect of the corporate relationship between Geoffrey, Toys “R”

Us and their licensing agreement was the creation of "nowhere"

income that escaped State taxation entirely. Jd. at15n.1. In

fact, in 1990, Geoffrey, without any full-time employees, had

income of approximately $55 million and paid no State income

tax at all. Jd.

South Carolina ultimately made a determination that

Geoffrey was subject to that State's corporate income tax. Jd.

at 15. Geoffrey claimed that the Commerce Clause allowed it

to shield all of the profits that it made in South Carolina from

State taxation because the company did not have a physical

presence in that State. Jd. at 16. Thus, the taxpayer in Geoffrey

raised the identical argument Lanco makes in the case before

this Court in an attempt to escape paying its fair share of tax to

New Jersey.

The South Carolina Court, like the court below, found that

the Commerce Clause was not offended by application of South

Carolina's tax to the IHC. The Court found that reliance on the

Bellas Hess physical-presence test by the taxpayer was

"misplaced." /d. at 18. The court began its analysis by

remarking that this Court in Quill, while reaffirming Bellas

Hess for sales and use tax purposes, "noted that the physical

presence requirement had not been extended to other types of

taxes." Jd. at 18n.4. Recognizing legal precedents that permit

the imposition of taxes other than sales and use tax in the

absence of physical presence, the Court held "that by licensing

intangibles for use in this State and deriving income from their

use here, Geoffrey has a ‘substantial nexus’ with South

Carolina" for Commerce Clause purposes. /d. at 18.

Similarly, in A & F Trademarks, Inc. v. Tolson, 605 S.E.

2d 187 (N.C. Ct. App. 2004), certif: denied, 611 S.E.2d 168

(N.C.), cert. denied, 126 S. Ct. 353 (2005), the North Carolina

Court of Appeals upheld the imposition of corporate taxes

against corporations, including Lanco, the petitioner here, that

had no physical presence in that State, but which licensed the

use of their trademarks to North Carolina retailers. That court

properly rejected the notion that Quill created an immutable

bright-line rule requiring physical presence before any

corporate tax can be assessed against an entity conducting

business in a State. /d. at 194. The A & F court adopted the

themes that underlie the consistent line of precedent permitting

the taxation of IHCs: (1) that significant differences exist

between the sales and use taxes examined in Quill and the

corporate business taxes assessed against IHCs, (2) that IHCs

could not reasonably rely on a supposed bnght-line rule

requiring physical presence for the assessment of corporate

taxes, and (3) that_this Court begrudgingly affirmed the

physical presence rule for sales and use taxes in Quill because

of the powerful doctrine of stare decisis, but carefully limited

its holding to the tax at issue in that case. /d. at 194-96. See

also Secretary, Dep't of Revenue v. Gap (Apparel), Inc., 886

So. 2d 459, 461-62 (La. Ct. App. 2004) (holding, without

discussion of Quill, that Louisiana could impose a corporate

income tax on a trademark holding company under facts almost

identical to those presented here).

The intermediate appellate decision below, adopted by a

per curiam decision of the Supreme Court of New Jersey,

follows that rationale and the holdings in Geoffrey and A & F.

See 20a (“We are satisfied that the physical presence

requirement applicable to use and sales taxes is not applicable

to income tax and the New Jersey Business Corporation Tax

may be constitutionally applied to income derived by plaintiff

from licensing fees attributable to New Jersey’’). No published

judicial opinion takes the opposite view. Under each existing

precedent examining an IHC and its receipt of royalties from an

affiliated corporation for use of the intangible assets, the facts

of this case would have resulted in the same outcome: a holding

that the Commerce Clause permits State taxation in these

circumstances without the need to establish that the IHC had a

physical presence in the taxing State. Simply put, there is no

divergence of authority on the subject of this petition and no

conflict for this Court to resolve.

State court decisions in other tax-related contexts have

rejected the notion that the Commerce Clause requires a

physical presence for the imposition of an income tax. The

Supreme Court of Appeals of West Virginia in Tax Comm'’r v.

MBNA Am. Bank, 640 S.E.2d 226 (W. Va. 2006), petition for

certiorari filed, when examining a factual complex distinct

from that presented by the IHC paradigm, held that the

Complete Auto Transit substantial nexus prong does not require

physical presence for the State to collect an income tax from a

bank that earns money in West Virginia through its extension

of credit to West Virginia consumers. This opinion, which

rejected the argument that Quill ’s physical presence test applies

beyond sales and use tax collection obligations, is consistent

with the decision below and with each State court decision

addressing State taxation of IHCs.'

In addition, courts have recognized that the Commerce

Clause does not require a taxpayer’s physical presence in a

variety of other contexts. See Borden Chemicals and Plastics,

L.P. v. Zehnder, 726 N.E.2d 73, 80 (Ill. App. Ct.)(holding

application of personal property tax replacement income tax to

an out-of-state corporation to be permissible because the “Quill

court merely carved out a narrow exception in the area of use

tax collection duties”), app. denied, 731 N.E.2d 762 (Ill. 2000);

Couchot v. State Lottery Comm'n, 659 S.E.2d 1225, 1230

(Ohio)(holding that non-resident with no physical presence in

State is subject to income tax on Ohio lottery winnings), cert.

denied, 519 U.S. 810 (1996).

To support its suggestion of a conflict among the State

courts, petitioner relies primarily on the holding of an

‘Petitioner pleads with this Court to hold this petition,

should certiorari be granted in MBNA. Petition for Certiorari

at 30. There is simply no reason for the Court take this

approach. The unique circumstances presented by the IHCs

and the overwhelming response of the States to eliminate the

IHCs tax- avoidance scheme set this case apart from MBNA.

Review is not warranted in this petition whether or not

certiorari is granted in MBNA.

intermediate appellate court faced with facts significantly

different from the THC scenario. J.C. Penney Nat'l Bank v.

Johnson, 19 §.W.3d 831 (Tenn. Ct. App. 1999), cert. denied,

531 U.S. 927 (2000). This decision reflects a wooden

application of the Quill physical presence test with no

meaningful analysis. /d. at 839 (“Any constitutional

distinctions between the franchise and excise taxes presented

here and the use taxes contemplated in Bellas Hess and Quill

are nof within the purview of this court to discern”). One

decision of an intermediate appellate court, contrary to all other

published opinions on the topic, does not constitute a conflict.

Moreover, the continued validity of the J.C. Penney opinion

has been called into doubt by subsequent judicial

developments. See e.g., America Online, Inc. v. Johnson, 2002

WL 1751434 (Tenn. Ct. App. 2002)(rejecting a reading of /.C.

Penney that “would simply substitute ‘physical presence’ for

‘nexus.””). Standing alone and undercut by subsequent

precedent, the J.C. Penney holding is an insufficient basis for

review by this Court.

Two other cases relied upon by petitioner, Guardian Indus.

Corp. v. Dep't of Treasury, 499 N.W.2d 349 (Mich. App.

1993), app. denied sub nom, 512 N.W.2d 846 (Mich. 1994),

and Rylander v. Bandag Licensing Corp., 18 S.W.3d 296 (Tex.

App. 2000), also do not create a conflict. Neither of these

intermediate appellate opinions applies the Commerce Clause

to the [HC factual paradigm addressed below. Rylander

rejected an attempt by Texas to tax an out-of-State corporation

merely because it possessed a license to do business in that

State. /d. at299. The court held that possession of a license to

do business, without further economic activity, did not satisfy

the substantial nexus requirement of Complete Auto Transit.

Given the exceedingly narrow basis upon which Texas

attempted to impose its tax, the Rylander opinion creates no

conflict with the decision below or the many precedents of this

Court with which it is in accord. In Guardian Corp., the court

was faced with an unusual question — whether “sales” in other

States were subject to tax in the other States and, therefore,

eligible for exclusion from Michigan income. Although the

Guardian Corp. court held that Quill established a physical

presence requirement for the imposition of all State taxes, the

peculiar fact pattern before the Guardian Corp. court renders

its decision of limited precedential value, and far afield from

presenting a conflict with the decision below.

B. State Legislatures, In The Absence Of

Congressional Action, Have Largely Eliminated

The Tax Avoidance Potential Of Intangible

Holding Companies Through Legislation,

Greatly Reducing the Significance Of The Issue

Addressed By The Lower Court And Militating

Against Review By This Court.

As States have come to recognize the tax avoidance artifice

of IHCs, legislative action has largely eliminated this tax

shelter for income from intangible licensing agreements

between related companies. These statutory developments

reduce the significance of the issue raised by petitioner, provide

further consistency in the treatment of taxpayers and militate

against review by this Court.

When applying stare decisis in Quill to continue the

physical presence requirement in the context of the sales and

use tax collection obligation for out-of-State entities, this Court

noted that the contours of Commerce Clause limitations on

State taxation was an area ripe for legislative action. “Our

decision is made easier by the fact that the underlying issue is

not only one that Congress may be qualified to resolve, but also

one that Congress has the ultimate power to resolve.” 504 U.S.

at 318. Congress has not acted, leaving the States to address

the issue through legislative action. |

In fact, the States’ legislative activity has been consistent

and widespread. In response to the decision of the trial court in

this matter, New Jersey enacted legislation disallowing a

deduction in Corporation Business Tax for royalty payments

made to-a related company for the use of intangibles. N.J. Stat.

Ann. §54:10A-4.4(b); N.J. Admin. Code §18:7-5.18. Fourteen

other States have acted to preclude the tax sheltering benefit

intended to be gained by the creation of IHCs. See Ala. Code

§40-18-24, 40-18-35 (disallowing deductions for payments for

use of intangibles to related entities); Ark. Code Ann. §26-51-

423(g)(1){limiting circumstances in which deduction is

available for payments to related companies for the use of

intangible property); Conn. Gen. Stat. §12-218c(b)(requiring

add-back for payments made to related company for use of

intangible property); D.C. Code Ann. §47-1803.03(a)(19)

(disallowing deductions for payments associated with the use

of intangibles of related companies); Ga. Code Ann. §48-7-

28.3(b) (requiring add-back of royalty payments to related

companies for the use of intangible property); Ind. Code §6-3-

2-20(b)(requiring add-back of expenses associated with

intangible property of related company); Ky. Rev. Stat. Ann.

§141.205(2) and (4)(disallowing deduction for expenses paid

to related company for use of intangible property); Md. Code

Ann. Tax-Gen. §10-306.1(b)(2)(requiring add-back of

payments to related companies for use of intangible property);

Mass. Gen. Laws ch. 63, §311 (a) and (b)(requiring add-back of

expenses to related companies associated with intangible

property); Mississippi, Miss. Code Ann. §27-7-17(2)(b)

(providing for add-back of expenses associated with intangibles

from a related entity); N.Y. Tax Law §208(9)(0) (requiring add-

back to income of royalty payments to a related company for

the use of intangible property); N.C. Gen. Stat. §105-130.7A

(where recipient and “payer” of expenses associated with

intangible property are related, expenses must be added back to

the income of “payer” or included in the income of recipient);

Ohio Rev. Code Ann. §5733.042(C)(requiring add-back to

income of expenses paid to related company for use of

intangible property). See also Va. Code Ann. §58.1-446

(allowing for adjustments to reported income for improper

exclusions) and Ruling of Comm'r, P.D. 05-29, Va. Dep’t of

Taxation (Mar. 2, 2005) and Ruling of Comm’r, P.D. 05-28,

Va. Dep’t of Taxation (Mar. 7, 2005)(exercising equitable

authority of Commissioner to disallow deduction of expenses

paid to related company for use of intangible property). In

these States, tax avoidance through the use dad IHCs has been

eliminated.

An additional twenty States use combined reporting for

related corporate entities, eliminating the State tax avoidance

benefits of [HCs because the deduction for royalty payments to

IHCs will effectively be canceled by the concomitant income

to the related entity. The States with combined reporting are:

Alaska, Alaska Stat. §43.20.073(a); Arizona, Ariz. Rev. Stat.

Ann. §43-947; California, Cal. Rev. & Tax. Code §23362;

Colorado, Colo. Rev. Stat. §39-22-303(1 1); Hawaii, Haw. Rev.

Stat. §18-235-22-03; Idaho, Idaho Code §63-3027(t); Illinois,

35 Ill. Comp. Stat. §5/502e; Kansas, Kan. Stat. Ann. §79-

32,142(a); Maine, Me. Rev. Stat. Ann. §5220 and §5200.4;

Minnesota, Minn. Stat. §289A.08.3; Montana, Mont. Code

Ann. §15-31-141(1) and (2); Nebraska, Neb. Rev. Stat. §77-

2734.01 and .05; New Hampshire, N.H. Rev. Stat. Ann. §77-

A:6; North Dakota, N.D. Cent. Code §57-38-14; Oregon, Or.

Rev. Stat. §317.710(2); Texas, Tex. Tax Code §171.1014 feff.

1/1/08); Utah, Utah Code Ann. §59-7-402; Vermont, Vt. Stat.

Ann §5862; West Virginia, W. Va. Code §11-24-13a(a). New

York enacted combined reporting legislation on April 1, 2007,

to begin with the 2007-2008 fiscal year. Michael Mazerov,

Center on Budget and Policy Priorities, Growing Number of

States Considering a Key Corporate Tax Reform (Apr. 5,

2007). Seven additional States (Iowa, Maryland,

Massachusetts, Michigan, New Mexico, North Carolina, and

Pennsylvania) are considering enacting combined reporting.

Institute on Taxation and Economic Policy, Combined

Reporting: How Does Your State Stack Up? (Apr. 2007).

As demonstrated above, a majority of State legislatures and

taxing authorities, including in New Jersey where this appeal

initiated, have sharply curtailed the value of IHCs as State tax

avoidance mechanisms. Legislatures are engaged in addressing

the issue raised in the petition, and the response has been an

unwavering march toward State taxation of royalties paid

between related companies for the use of intangible assets.

This Court should refrain from entering a field that the other

branches of government are manifestly resolving in a uniform

fashion.

Ii The Decision Below Does Not Leave Matters In An

Unprincipled Or Confused State Because The New

Jersey Supreme Court’s Decision Is Consistent With, ~

And Reflective Of, The Commerce Clause

Jurisprudence Of This Court.

In requesting certiorari review, petitioner clamors for a

“default rule,” suggesting that no bright line now exists with

respect to the limits on State taxation under the Commerce

Clause to guide lower courts or taxpayers in Lanco’s wake.

The proverbial “parade of hornbles” raised by petitioner does

not exist, however, because as noted above, the per curiam

decision by New Jersey’s Supreme Court respects, in full, this

Court’s Commerce Clause jurisprudence and is wholly

consistent with other States’ highest courts.

Moreover, the decision below comports with this Court’s

Commerce Clause precedents on the larger question of the

meaning of the substantial nexus prong of Complete Auto

Transit. Petitioner’s claim of uncertainty rests on the incorrect

notion that this Court’s prior rulings established a “bright line”

requiring physical presence in the context of all State taxes,

including corporate franchise or income taxes. The

underpinning of petitioner’s argument is flawed, however,

because it reflects an overly narrow reading of Quill, Bellas

Hess and the other cases upon which petitioner relies, as well

as petitioner’s failure to recognize crucial differences between

the sales and use tax collection obligation at issue in those

cases and the corporate income tax under scrutiny here.

A. This Court’s Precedents Have Not Required A

Single, Wooden Application Of The Commerce

Clause To All Types Of State Taxes.

In Quill, this Court noted that the relevant nexus analysis

is “informed. not so much by concerns about faimess for the

individual defendant as by structural concerns about the effects

of state regulation on the national economy.” 504 U.S. at 312.

Thus, the standard for application of the Commerce Clause to

State taxes is a flexible one: State tax laws may not unduly

burden interstate commerce. Kassel v. Consol. Freightways

Corp., 450 U.S. 662 (1981); City of Philadelphia, supra.

Indeed, the test as articulated by Complete Auto Transit

requires a four-prong balancing which does not demand

physical presence in all contexts, especially in light of the

recent social, economic, commercial and legal innovations in

interstate commerce.

The flexibility inherent in this Court’s Commerce Clause

analysis is reflected in the express delineation in Quill of the

limited scope of the physical presence requirement: “we have

not, in our review of other types of taxes, articulated the same

physical presence requirement” as is required for the sales and

use tax collection obligation. 504 U.S. at 314. The foregoing

Statement was not mere dictum, as petitioner suggests, but an

express recognition by this Court that there exist distinctions

among State taxes-as well as the concomitart Commerce

Clause nexus requirements for those impositions. Jd. at 317.

In Quill, this Court recognized the insignificance of an

entity’s physical presence in a taxing State for Due Process

purposes. In that context, the Court “abandoned more

formalistic tests that focused on a defendant’s ‘presence’ within

a State in favor of a more flexible inquiry ... .” Quill, 504

U.S. at 307. As this Court explained, “[i]n ‘modern

commercial life’ it matters little that . . . solicitation is

accomplished by a deluge of catalogs rather than a phalanx of

drummers: The requirements of due process are met

irrespective of a corporation’s lack of physical presence in the

taxing State.” Jd. at 308.

The rationale for abandoning a physical presence

requirement for Due Process Clause purposes recognizes that

“businesses engage in significant levels of commercial activity

in a State without ever “setting foot” there. In this era of

“virtual offices,” cellphones, BlackBerry devices and the

Internet, rational enterprises can easily foresee being subject to

State laws, including tax laws, as a result of their commercial

activity directed to a particular State whether or not physically

present in that State. Lest there be any confusion on this point,

however, respondent does not suggest that the Due Process and

Commerce Clause tests are identical, but in light of their

similarities, given Quill’s self-limiting application and

Complete Auto Transit's four-part Commerce Clause test, there

is plainly no principled reason why the Commerce Clause

should require a corporation’s physical presence to justify State

taxation, especially when a State is able to establish that the

corporation derives significant benefits from continued and

deliberate economic activity in the taxing State, as New Jersey

did through expert testimony adopted by the trial court below.

37a.

Indeed, while recognizing that over the last half of the

Twentieth Century the Court has crafted a pragmatic approach

to the Commerce Clause, the powerful influence of the doctrine

of stare decisis ultimately swayed the Quill Court to follow its

holding in Bellas Hess with respect to sales and use tax

collection obligations. 504 U.S. at 309-11. The Court noted,

however, that “[w]hile contemporary Commerce Clause

jurisprudence might not dictate the same result were the issue

to arise for the first time today, Bellas Hess is not inconsistent

with Complete Auto and our recent cases.” Jd. at 311.

Having thus expressed its doubts about the continuing

viability of the underlying wisdom of Bellas Hess as long as 15

years ago, the Court nonetheless declared that it would not

abandon “the rule that Bellas Hess established in the area of

sales and use taxes.” Id. at-317 (emphasis added). As New

York’s highest court describes the result: “the Quill decision

cannot be substantively construed as other than a somewhat

begrudging retention of the Bellas Hess physical presence

requirement” for imposition ofa sales tax collection obligation.

Orvis Co., Inc., v. Tax Appeals Tribunal, 654 N.E.2d 954, 960

(N.Y.), cert. denied sub nom, 516 U.S. 989 (1995).

The decisive role of stare decisis in the continuation of the

Bellas Hess standard in Quill cannot be overstated. The

influence that the doctrine had on the holding in Quill is starkly

revealed in the concurring opinion of Justices Scalia, Kennedy

and Thomas, who would have adhered to Bellas Hess on

grounds of stare decisis alone, 504 U.S. at 319-20, and in the

partial dissent of Justice White, who thought that the physical

presence rule was so anachronistic that he would have

abandoned it in spite of stare decisis, id. at 322.

Petitioner is equally mistaken in its contention that the

taxes at issue in Quill and in Lanco “are essentially

indistinguishable” even in their economic effects. Petition for

Certiorari at 19. Significant differences exist between the sales

and use taxes found to require a physical presence for

Commerce Clause purposes in Bellas Hess and Quill and the

corporate franchise tax imposed in Lanco. The Quill Court

expressed great concern about the then-6,000 local taxing

jurisdictions throughout the United States which might impose

varying rates, exemptions and reporting requirements for sales

and use taxes on Quill. 504 U.S. at 313 n.6.

As this Court noted, sales and use taxes are generally due

on a monthly basis. Today there exist approximately 7,500

distinct sales and use tax jurisdictions, many with different tax

bases, different deductions and even different tax reporting

forms. While the burden and cost of complying with such a

vast array of sales and use tax requirements may still require a

heightened presence requirement, petitioner is incorrect in its

contention that “the complexity and burden of complying with

corporate income and franchise taxes are greater than . . . [for]

sales and use tax compliance.” Petition for Certiorari at 20-21.

Corporate franchise taxes, like the Corporation Business

Tax at issue in this case, are imposed on an annual basis.

Corporate net income generally follows income computed for

federal tax purposes. See, e.g., N.J. Stat. Ann. 54:10A-4(d).

Only forty-eight jurisdictions -- forty-six States, the District of

Columbia, and the City of New York -- collect a corporate

franchise or income tax. Each such jurisdiction requires an

annual return. Congressional Research Service, State

Corporate Income Tax: A Description and Analysis (June 30,

2006) at CRS-2. Thirty-five States use the same measure of

income as employed by the federal government. /d. at CRS-3.

“The remaining states typically use a measure of income that

closely follows the federal definition of taxable income. Using

the federal starting point likely eases the compliance burden for

corporations, particularly those that have nexus in several

states.” Id.

As one noted commentator put it:

it may well be that the need for a "bright-line" rule in

the context of income taxation is less compelling than

in the context of sales and use taxation because the

burdens of complying with the income tax laws of

various state and local jurisdictions are less daunting

than the burden of complying with the laws of the

nation’s 6,000-plus sales and use tax jurisdictions to

which the Court alluded in Quill. [J. Hellerstein & W.

Hellerstein, State Taxation Warren, Gorham &

Lamont (3d ed. 1998) 46.30[5]}.

Petitioner is thus plainly wrong when it contends that the

court below, and the other State courts that reached the same

result with respect to the taxation of IHCs, have

unconstitutionally facilitated or created “relaxed nexus

requirements” which “increase the burden on _ interstate

commerce.” Petition for Certiorari at 21. New Jersey sought

only to tax income Lanco earned from New Jersey, on an

apportioned basis. The realities of New Jersey - and other

States’ - corporate franchise or income taxes do not threaten to

impose a meaningful administrative burden on the multistate

corporations which reap significant economic benefits from the

State markets they exploit.

B. New Jersey And Other States That Impose

Income Or Franchise Taxes On THCs Do Not

Reach Beyond Their Borders And Lanco

Follows This Court’s Commerce Clause

Analysis Which Is Manageable By The

Judiciary And Taxpayers Alike.

Petitioner suggests that through Lanco and other similar

cases, States have reached “outside [their] borders” to impose

income or franchise taxes on IHCs. Petition for Certiorari at

23. The outer limit of petitioner’s alarmist assertion is that

there now exists no “judicially manageable default rule”

applicable to State taxes. /d. at 22

Nothing could be further from the truth. First, as noted

above, New Jersey’s Appellate Division, in an opinion adopted

by a per curiam decision of the Supreme Court, gave full effect

to the flexible Commerce Clause nexus analysis enunciated by

this Court in Quill and other precedents. In addition, as even

petitioner concedes, the “modern economy may lack borders.”

Id. at 25. Indeed, the artifice of [HCs was created to capitalize

on that very concept. And, as discussed above, the trial court

in this case adopted expert testimony demonstrating that

Lanco’s exploitation of the New Jersey retail clothing sales

market both burdened the State and benefitted Lanco in very

concrete ways.

As a result, while it is true that one of the reasons that the

Quill Court noted for abiding by Bellas Hess in the context of

sales and use tax collection obligation was the idea that

retaining the physical presence test would comport with “settled

expectations and, in doing so, foster[] investment by businesses

and individuals,” 504 U.S. at 316, no such “settled

expectations” exist with respect to other types of State taxes.

This is so in part because of Quill’s express limitation to sales

and use taxes. Moreover, the previously unfathomable

technological changes of the last few decades have dictated that

there are no “settled expectations” in business. The recent

advent of entities such as IHCs, LLCs and other innovative °

corporate formats confirms that “investment” is fostered in

relation to the needs of the marketplace, not by the geopolitical

boundaries of the various States.

Finally, petitioner suggests that principles of federalism

provide a basis for certiorari in this case, asserting that

"sovereignty over a specified geographical area and those who

come within it" are somehow offended by Lanco. Petition for

Certiorari at 26. This contention is erroneous because it

suggests that New Jersey as well as any other States that tax

IHCs are attempting to reach beyond their borders to tax

multistate corporations. If federalism has any application to

this petition at all, it supports the ability of the States to carry

out their core governmental function of raising revenue through

taxation. Petitioner’s view of the law would undermine this

important State function by imposing unnecessary limitations

on State taxation.

State income and franchise taxes are judicially manageable

under Lanco as well as the other State court decisions which

have identically imposed tax on IHCs in accordance with this

Court’s Commerce Clause precedents. There is nothing

“unprincipled” about asking corporations that reach into States

for business and, presumably, profit, to pay their fair share of

tax to those States on a constitutionally-approved apportioned

basis. a

CONCLUSION

For the foregoing reasons, the petition for a writ of

certiorari should be denied.

Respectfully submitted,