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Out-of-state corporations that have no New Jersey physical presence but draw revenue from affiliates located there are subject to the state’s Corporate Business Tax, the Appellate Division held Wednesday in a closely watched case. The court said that Lanco Inc., which holds trademarks for the Lane Bryant clothing company and receives royalties from stores in New Jersey and elsewhere, must pay New Jersey taxes even though it has no premises or employees in the state. The stakes are high because many retail chains have moved their trademarks into Delaware-based subsidiaries along the same lines as Lanco and Lane Bryant. In litigation brought by companies such as the Gap and Toys ‘R’ Us around the country, courts have generally upheld the right to impose taxes on such nonresident intellectual property subsidiaries. The ruling, in Lanco Inc. v. Director, Division of Taxation, A-3285-03T1, could embolden New Jersey authorities to tax a wide array of out-of-state entities doing business there, such as software makers and credit card issuers, say tax lawyers following the case. The appeals court overturned Tax Court Judge Peter Pizzuto’s November 2003 decision that applying the corporate tax to Lanco violated the Commerce Clause of the federal Constitution. Pizzuto relied on the U.S. Supreme Court decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), by which a mail-order vendor of office furniture was held exempt from North Dakota’s sales tax because it lacked a sufficient nexus to the state under the Commerce Clause. But Presiding Appellate Division Judge Edwin Stern, joined by Judges Barbara Byrd Wecker and Ronald Graves, found that Pizzuto wrongly applied Quill, where the furniture company’s only connection with customers was the mail or a common carrier. By contrast, in Lanco, the plaintiff had a long-term contractual relationship with a related entity that runs stores throughout New Jersey. The appeals judges bought the state’s argument that Quill applied to sales and use taxes only and should not be extended to a corporate tax case. Assistant Attorney General Patrick DeAlmeida said in court papers that sales taxes impose a greater compliance burden on companies doing business nationwide than corporate taxes do, because more than 6,000 cities, states and counties impose sales tax at varying rates, generally requiring monthly remittances. Conversely, only 46 states, New York City and the District of Columbia impose corporate taxes, most of them require annual returns and reporting requirements are similar to those for federal corporate taxes. “We agree with the [Division of Taxation] Director that Quill does not apply to taxes other than sales and use taxes, and that the Corporation Business Tax may be constitutionally applied to impose a tax on plaintiff’s income from licensing fees attributable to New Jersey,” wrote Stern. The appeals court relied heavily on a ruling from an intermediate appeals court in North Carolina that was decided after Pizzuto’s decision. In A&F Trademark Inc. v. Tolson, 605 S.E.2d 187 (N.C. Ct. App. 2004), North Carolina’s Court of Appeals found that a subsidiary of the Limited stores was subject to that state’s corporate franchise and income taxes even though it had no tangible presence there. That ruling specifically cited the Tax Court of New Jersey’s decision in Lanco and disagreed with is finding regarding physical presence of the taxpayer. Stern’s ruling recited the holding of the A&F court, which said, “We reject the contention that physical presence is the sine qua non of a state’s jurisdiction to tax under the Commerce Clause for purposes of income and franchise taxes. Rather, we hold that under facts such as these where a wholly-owned subsidiary licenses trademarks to a related retail company operating stores located within North Carolina, there exists a substantial nexus with the state sufficient to satisfy the Commerce Clause.” For more than 20 years Lane Bryant paid 5.5 percent of its net sales to Lanco, the state said in court papers. Until a change in the state’s code in 2003, such payments were deductible from New Jersey taxes, the state said. Delaware, where Lanco is based, does not tax revenue based on intangible items like trademarks, New Jersey said in its brief. DeAlmeida argued that the Quill court was bound by stare decisis to a bright-line requirement for in-state physical presence from a previous Supreme Court ruling on sales tax, National Bellas Hess Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967). But he advocated a more “flexible” approach because technology was causing commerce to shift away from bricks-and-mortar stores to new types of sales like Internet shopping. The attorney representing Lanco, Paul Frankel of Morrison & Foerster in New York, declines to comment on the ruling except to say his client has not decided whether to appeal. Frankel also represented the taxpayer in A&F. The North Carolina Supreme Court declined to hear that case, but Frankel has petitioned for certiorari by the U.S. Supreme Court. STATES FALLING IN LINE Taxation of nonresident entities like Lanco is hotly contested around the nation but rulings have generally found such companies subject to state corporate tax, says Frank Katz, general counsel for the Multistate Tax Commission, a Washington, D.C.-based coalition of state taxation authorities, including New Jersey, which filed an amicus curiae brief in Lanco. “Our position on this is [that] a company that licenses to a subsidiary its trade names is doing business in the state and should pay income tax,” Katz says, insisting that retail chains that organize in the fashion of Lanco and Lane Bryant do so for no other reason than to avoid state taxes. “It looks like states are becoming pretty consistent,” he adds. New Jersey Treasurer John McCormac said in a statement that the state had long sought to counteract “income-shifting strategies” used by multistate corporations for tax planning purposes. “This decision affirms our longstanding interpretation of tax responsibility for companies doing business in New Jersey and obligated to pay their fair share to state government. The thoughtful decision rendered by the Appellate Division is a victory for tax fairness and the New Jersey taxpayer,” McCormac said. Treasury spokesman Tom Vincz said the department could not estimate how much the state collects from nonresident companies that collect royalties from related entities with operations here. But overall, the corporate business tax brought in $2.27 billion in the fiscal year ending June 30, about 8 percent of total revenues to state government. Kyle Sollie, a taxation lawyer at Dechert in Philadelphia who has followed the Lanco case closely, says pending legislation in Congress would take away states’ rights to tax nonresident companies like Lanco. Sollie thinks Congress may be reluctant to act in favor of corporations, unless states become aggressive in their pursuit of revenues from such companies. He cites a West Virginia court ruling in June, Steager v. MBNA America Bank, 04-AA-157 WV Circuit Court, that credit card issuer MBNA is subject to state corporate income and franchise taxes despite its lack of physical presence. “What’s worrisome is that the states are going to abuse the authority that these cases are going to give them. If they abuse the authority, the pendulum is going to swing the other way,” Sollie says.

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