Court of Appeals Unanimously Affirms Trademark Holding Companies Taxable

Date: 12/8/2004

RALEIGH – On December 7, the North Carolina Court of Appeals upheld the Department of Revenue’s position that holding companies which earn income from the use of their trademarks in the state must pay their fair share of North Carolina corporate taxes. The case (A&F Trademark, Inc. v. Tolson) directly involves $2 million, however, it has implications for approximately $150 million in state revenues due to the widespread use of this tax planning technique.

“This decision is a clear victory for all taxpayers of our state,” said Secretary Norris Tolson. “We will continue to do everything within our power to make sure all individuals and corporations meet their tax responsibilities. This is a matter of tax fairness.”

In a unanimous opinion, the Court ruled that the trademark holding companies were doing business in the state and therefore required to pay North Carolina corporate income and franchise taxes. The Court also ruled that taxation of these companies was not unconstitutional.

The case began when the Department of Revenue assessed corporate income and franchise taxes against nine wholly-owned subsidiaries of the Limited Stores, Inc. The Limited Stores and eight of its retail subsidiaries – Victoria’s Secret, Abercrombie & Fitch, Limited Too, Express, Structure, Lane Bryant, Lerner and Cacique – had engaged in income shifting strategies which significantly reduced or eliminated the retail corporations’ tax liability to North Carolina. The holding companies paid no tax to North Carolina or any other state.

The ruling has far-reaching implications for other companies that engage in similar accounting and tax planning maneuvers. The practice of creating a holding company to avoid paying North Carolina taxes – one often marketed by accounting firms – has gained in popularity in recent years. To date, the Department of Revenue has identified numerous taxpayers that have adopted similar structures and has issued proposed assessments of tax totaling approximately $150 million. Of this amount, the Department has collected slightly over $70 million.

The Court of Appeals opinion marks the fourth decision in this matter, all of which have been adverse to the holding companies. The Secretary of Revenue, Tax Review Board and Superior Court have all previously ruled against the taxpayers.

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