MD AIMS TO CLOSE THE "DELAWARE HOLDING COMPANY" CORPORATE INCOME TAX LOOPHOLE (4/1/2004)
Again in the 2004 legislative session, the Maryland General Assembly is attempting to close the corporate tax loophole associated with the Delaware holding company. After nearly a decade of administrative and judicial appeals by Maryland corporations opposing the Comptroller’s attempts to collect corporate income tax avoided through the use of such holding companies, Maryland House Bill 297 (and a counterpart bill introduced in the Maryland Senate) may finally resolve the issue.
Background
Maryland is one of eleven states that calculate corporate income tax based on the income of each individual corporation, as opposed to the majority of states, which combine the earnings of all related entities to determine the corporate tax. Delaware, on the other hand, does not tax income generated from intangible property such as trademarks, logos etc. Combining these separate tax concepts, creative tax planning allows a Maryland corporation to transfer its intangible property to a Delaware holding company, and thereby render income generated from such property free from taxation by either state.
For example, a Maryland parent corporation could create a Delaware subsidiary whose only asset is the parent’s trademark. The Delaware subsidiary would then “charge” the parent for the use of the trademark. These “charges” reduce the taxable income of the Maryland corporation and are treated as non-taxable income by the Delaware company. In this fashion, income originally generated by operations in Maryland, which is paid to the Delaware company for use of the trademark, escapes taxation in both states. The “charges” may then be redistributed in various forms tax-free back to the Maryland parent corporation.
Beginning in the mid-1990’s, the Maryland Comptroller began auditing Maryland corporations that maintained Delaware holding companies in an attempt to recapture the taxable income that passed through them. Two notable cases were decided by the Maryland Court of Appeals in June 2003: SYL, Inc. v. Comptroller of the Treasury and Crown Cork & Seal Company v. Comptroller of the Treasury. SYL, Inc. and Crown Cork & Seal Company are wholly owned Delaware subsidiaries of Maryland corporations. After the Companies’ successful appeals in the Maryland Tax Court, the Maryland Court of Appeals held that “an appropriate portion” of the Delaware holding companies’ income generated from fees paid by the Maryland parents was subject to Maryland income tax.
Legislative Action
In order to capture the millions of dollars in tax revenues Maryland loses each year due to dozens of other corporations taking advantage of the Delaware holding company loophole, the Maryland General Assembly is again attempting to reform the corporate tax laws. Facing a nearly three-quarter of a billion dollar state budget deficit, House Bill 297 is poised to finally close the Delaware holding company loophole. Although similar legislation was passed by the General Assembly in 2003, it was vetoed by Governor Ehrlich for various reasons, including a tax on HMO premiums which was included in the bill. House Bill 297, which is a narrowed version of the legislation that Governor Ehrlich vetoed, would codify and clarify the Court of Appeals’ decisions in SYL, Inc. and Crown Cork & Seal Company cases so that the State may uniformly tax corporate income. House Bill 297 and its Senate counterpart passed in the 2004 Legislative Session. It is uncertain whether Governor Ehrlich will again veto the legislation.
The Future
It is undeniable that a significant amount of otherwise taxable corporate income is lost to the Delaware holding company as a tax avoidance vehicle. Many people worry that the Court of Appeals’ recent decisions and the proposed legislation will make Maryland less attractive to large companies. However, the cumulative effect on the average Maryland business or individual will not be clear for years to come.
Home
Contact Us
Sitemap
