In 2012, Scioto Insurance Company v. Oklahoma Tax Comm’n, 279 P. 3d 782 (Ok 2012), the Supreme Court of Oklahoma was the most recent high court to tackle the question of foreign intellectual property holding companies. Similar to the line of cases addressed above, Scioto is a Vermont holding company with nothing in Oklahoma. Specifically, Scioto receives fees for the use of its intellectual property used based on a percentage of gross sales made by Wendy’s in Oklahoma.
Digging further into the facts of the case, Scioto was established to insure risks of Wendy’s restaurants. In order to establish Scioto, Wendy’s transferred intellectual property to Scioto. Scioto only insures Wendy’s International and does not insure any restaurants in Oklahoma, rather Wendy’s franchises individual restaurants within Oklahoma’s borders. In exchange for use of the intellectual property, Wendy’s restaurants in Oklahoma pay 4% of their gross sales to Wendy’s International and those amounts are included as income for purposes of its state income tax return. Wendy’s International then pays and deducts 3% of this payment to Scioto for use of the intellectual property.
The court began its analysis by stating that whether or not Wendy’s International received any payments from restaurants in Oklahoma it still had an obligation to pay Scioto for use of the intellectual property. The court went on to distinguish the case from Geoffrey in that Scioto was not a shell corporation and actually had a bonafide business purpose. Perhaps most interesting in the short opinion is the fact that the court seem to decide the case on due process grounds. This highlights the importance to a state and local tax professional to argue due process in addition to commerce clause nexus in state and local tax cases.
The dissenting opinion seemed to take exception to the courts reliance on Due Process grounds for deciding the case. The dissent correctly stated that physical presence is not required for Due Process purposes and emphasized that Scioto directed its activities at Oklahoma. Therefore, Scioto met this requirement.
Where the dissent loses me is in its Commerce Clause analysis under Quill. The dissent believes that a company has substantial nexus in a state by receiving royalty income from that state. Without addressing why Quill does not apply in this context, the dissent simply states that the majority of jurisdictions have rejected the physical presence test an allowed economic nexus to apply in the context of intellectual holding company state income tax cases. It then concluded by stating that “[t]he presence of Scioto’s intellectual property within Oklahoma is sufficient nexus for the imposition of corporate income taxes.” As I have stated numerous times, how intellectual property is present anywhere does not make sense.
The cases above are difficult if not impossible to reconcile. Many commentators seem to believe that if a holding company provides intellectual property to a company within a state then the out of state company subjects itself to state taxation. Some courts and commentators seem to believe that if Geoffrey is the correct analysis then it shouldn’t matter if there multi-layers of holding companies, rather it is only where the income is generated that matters. Still other courts and state and local tax professionals seem to believe that if intangible property is “present” in the state then that satisfies the physical presence test of Quill. In my humble opinion, unless a company has property or people soliciting sales in a state then it is immune from state taxation.
State and local tax lawyers and accountants would love to have some guidance from the United States Supreme Court, however, the Court has not ruled on a state and local tax nexus case since Quill. Is this the Court saying this issue has already been addressed? Perhaps, it’s the Court saying it is fine with how the state have been handling it? Or maybe it’s just the Justices and their clerk’s boredom with tax cases in general? One can only speculate, however, it will be interesting to see if and when SCOTUS steps up to the plate and addresses the issue. I will certainly be watching and I look forward to updating this article when the next case comes down. If you are aware of any high level court cases in your state, please email them to me.
About the author: Mr. Donnini is a multi-state sales and use tax attorney and an associate in the law firm Moffa, Gainor, & Sutton, PA, based in Fort Lauderdale, Florida. Mr. Donnini’s primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, and Florida probate. Mr. Donnini is currently pursuing his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email or phone listed on this page.