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Client Alert - Trademark Holding Companies Face Increasing Tax Scrutiny



Many companies with valuable and well-recognized trademarks have organized separate subsidiaries to own and administer those trademarks. One of the principal objectives for creating a separate entity is to reduce the operating company's state and local corporate income tax liabilities. These entities, commonly referred to as 'Trademark Holding Companies' or 'Intellectual Property Holding Companies,' are usually established in a state which does not have a corporate income tax or does not impose a corporate income tax on intangibles, such as Delaware or Nevada.

The structure works like this: The trademark owner transfers its trademarks to the holding company in exchange for stock in the holding company. The trademarks usually are the sole asset of the holding company (although patents and copyrights generating significant royalty income also may be transferred to the new company). The holding company licenses the trademarks to its operating parent company and possibly also to non-affiliated operating companies. Each operating company pays a royalty to the holding company and deducts the payment as a business expense, thereby reducing its tax liability in states where it conducts its business. The holding company, by virtue of its being located only in the state which does not tax intangibles, pays no income tax on the royalty income it receives. Consequently, the original trademark owner is able to divert a portion of its income to a subsidiary without paying a state corporate tax on that income.

With a number of states facing budget shortfalls and looking for new ways to generate income, several states have re-examined the structure and taxability of the trademark holding company over the past several years. Last month, in the first judicial decision rendered in New York on this issue, New York joined the small but increasing group of states which subject the royalty income received by a trademark holding company to taxation.

New York Decision

In Sherwin-Williams Co. v. Tax Appeals Tribunal,1 the New York Appellate Division, Third Department, upheld a New York State Tax Appeals Tribunal determination which required two subsidiaries of Sherwin-Williams, whose sole assets consisted of over 500 domestic trademarks, to file a New York combined corporate franchise tax return with its parent, Sherwin-Williams. Sherwin-Williams, an Ohio corporation, conducted business in New York through the manufacture and sale of paint, wall coverings and related products using the trademarks under license from the subsidiaries, and it filed a separate corporate income tax return in New York. The subsidiaries, both Delaware corporations, did not file corporate returns in New York.

The Tax Tribunal found that the transfer of trademarks to the two subsidiaries and the license back to the parent company lacked a business purpose or economic substance apart from tax avoidance. It further determined that the royalties paid by the parent were not at arm's length rates. The Tax Tribunal reached its determination notwithstanding the fact that Sherwin-Williams presented evidence that the purposes for the formation of the subsidiaries were to improve quality control oversight, to enhance the ability to enter into third-party licensing arrangements at advantageous royalty rates, to insulate the trademarks from the parent's liabilities and to have flexibility in preventing a hostile takeover. The subsidiaries leased separate office space in Delaware, each had its own board of directors (some of whom were affiliated with the parent) and named as President an individual that had no previous association with the parent company (but who also had no experience in administering trademarks). The royalty paid by Sherwin-Williams to its subsidiaries had been based on the advice of an independent appraisal firm retained by the company to determine an arm's length royalty rate.

The Appellate Division upheld the Tax Tribunal's determination, finding that Tax Tribunal's determination was supported by substantial evidence. As a result, the subsidiaries were required to file a combined return with its parent, the deduction for royalties paid by the parent was disregarded and the combined income of the parent and its subsidiaries was subjected to taxation in  New York.

Prior Decisions

The Sherwin-Williams decision continues a trend of states subjecting trademark holding companies to taxation which began with the South Carolina Supreme Court decision in Geoffrey, Inc. v. South Carolina Tax Commission in 1993.2 The Geoffrey case involved the creation of a subsidiary in Delaware to which the 'Toys R Us' trademarks were transferred. The subsidiary licensed them back to its operating parent which made royalty payments to its subsidiary and deducted those payments. The South Carolina Tax Commission disallowed the deduction and contended that the subsidiary was independently subject to taxation in the state. The South Carolina Supreme Court agreed with the Tax Commission's contention and held that the licensing of trademarks by the holding company created a sufficient nexus in South Carolina so as to subject it to corporate income tax in South Carolina.

Since Geoffrey, several states have actively pursued the taxation of trademark holding companies. In the last couple of years, Maryland (in a 2003 Maryland Court of Appeals case involving 'Syms' trademarks),3 New Jersey (in a 2003 New Jersey Tax Court case involving 'Lane Bryant' trademarks),4 North Carolina (in a December 2004 North Carolina Court of Appeals case involving 'Limited' trademarks)5 and New Mexico (in a 2001 case involving 'Kmart' trademarks)6have successfully subjected a trademark holding company to taxation in that state.


While the recent New York and North Carolina decisions have emboldened some states to challenge the effectiveness of the trademark holding company to avoid state taxation, the benefits of a trademark holding company have not been totally eliminated. Besides the trademark law benefits of centralizing the control and management of a company's intellectual property, tax savings may still be realized. Because each case depends on the facts of the particular situation and prevailing law differs from state to state, not all states have been successful in their challenges. For example, while Sherwin-Williams lost in New York, it prevailed in a similar action in Massachusetts.7  A Louisiana Court of Appeals decision rendered earlier this year ruled in favor of the taxpayer in a case involving the taxability of passive income paid to a Nevada corporation from an affiliated company.8

For those companies that currently own a trademark holding company or are considering forming one, considerable thought and planning should be undertaken—both as to the structuring and the operations of the holding company. We have been involved in the creation and operation of a number of trademark holding companies.

For more information, please contact:


Robert J. Giordanella    (212) 790-9234
William M. Borchard    (212) 790-9290


1  Sherwin-Williams Co. v. Tax Appeals Tribunal, 784 N.Y.S. 2d 178 (A.D. 3d 2004)

2  Geoffrey, Inc. v. South Carolina Tax Commission, 437 S.E.2d 13 (S.C. 1993).

3  Comptroller of the Treasury v. SYL Inc., 825 A. 2d 399 (Md. 2003).

4  Lanco, Inc. v. Director, Division of Taxation, 21 N.J. Tax 200 (N.J. Tax Ct. 2003).

5  A & F Trademark, Inc., et al. v. Tolson, 2004 N.C. App. LEXIS 2162 (N.C. Ct. App. 2004).

6  Kmart Properties, Inc. v. Taxation and Revenue Department of New Mexico, No. 21,140 (N.M. Ct. App., Nov. 27, 2001).

7  Sherwin-Williams Co. v. Commissioner of Revenue, 778 N.E. 2d 504 (Mass. 2002).

8  Bridges v. AutoZone Properties, 873 So. 2d 25 (La. Ct. App. 2004).


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