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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Opposition Brief
- **Published:** January 1, 2007

## Text

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

ae

i

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
CL

il

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

iV

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

Vv

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

vi

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

2

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

3

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

4

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”

5

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

6

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

7

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.

8

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

9

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

10

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

1]

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

12

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

13

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

14

“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).

15

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

16

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.

17

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 °

18

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

19
CONCLUSION

For the foregoing reasons, the petition for a writ of
certiorari should be denied.

Respectfully submitted,

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

Dated: May 14, 2007

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386016_2273%3A2. Public record. Not legal advice.