Department of Revenue Wins Ruling; Holding Companies Required to Pay

Date: 5/22/2003

RALEIGH –The Department of Revenue has won a case in Wake County Superior Court which affirms that corporations that create intellectual property holding companies must pay their fair share of North Carolina corporate taxes. The decision has implications for more than $150 million in state revenue due to the widespread use of this tax planning technique.

“This ruling is a victory for the taxpayers of North Carolina,” said Secretary Norris Tolson. “This is a matter of fairness for the businesses and individuals who pay their taxes without trying to avoid them.”

The Department had assessed corporate income and franchise taxes against nine wholly-owned subsidiaries of the Limited Stores Inc. In tax-free transactions, the Limited Stores and eight of its retail subsidiaries – Lane Bryant Inc., Lerner Inc., Victoria’s Secret Inc., Abercrombie & Fitch Inc., Cacique Inc., Limited Too Inc., Express Inc. and Structure Inc. – transferred the trademarks they owned to the taxpayers. The taxpayers then licensed the trademarks back to the retail companies, which paid royalties to the holding companies based on the retail companies’ sales. The effect of these transactions was to significantly reduce the retail corporation’s tax liability. The holding companies paid no tax to North Carolina or any other state on the royalties.

On May 7, 2002, the North Carolina Tax Review Board upheld the Secretary’s decision that the holding companies were doing business in the state for corporate income and franchise tax purposes and are required to pay North Carolina corporate taxes. The companies appealed the Board’s ruling to Superior Court.

Today, Judge Leon Stanback issued an order affirming the two lower decisions. At issue in this case is approximately $2 million. The ruling has far-reaching implications for other companies that engage in similar accounting and tax maneuvers. The technique of creating a holding company in a tax haven state to avoid paying North Carolina taxes – one marketed by tax firms – has gained in popularity in recent years. To date, the Department of Revenue has identified more than $150 million in corporate income and franchise taxes at issue due to this practice.

While establishing a holding company in the state is not illegal under North Carolina law, the decision makes clear that companies engaging in these practices are doing business in this state and must pay taxes for this privilege.

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