Kathleen Johnston Jarboe

Maryland-Delaware-D.C. Press Association Awards: 1st Place in Business/Economics Reporting

Check out follow-up coverage of how the state closed the corporate tax loophole:

• High court keeps loophole ban
• State House moves to close the loophole
• State collects back taxes 

MD Comptroller's office tries to collect taxes from Delaware shell companies

The Daily Record (Baltimore, MD)

October 5, 2002 Saturday

Copyright 2002 Dolan Media Newswires

Section: NEWS; Legal activity (lawsuits etc.)

Length: 1991 words

Byline: Kathleen Johnston Jarboe

As the state budget faces drought-like conditions with revenue streams drying up, the Maryland comptroller's office has found a new spring of revenues -- potentially.

Using what the office calls unpaid tax bills from the years of 1982 to 1994, it is attempting to extract more than $31.5 million from corporations that squirreled part of their Maryland profits into Delaware trademark holding companies via royalty and interest payments.

The comptroller says the money was earned in Maryland and should be taxed, but the companies say the state has no right to tax an entity out of its jurisdiction.

The fate of the revenue hinges on the outcome of a court case stuck in the Maryland Court of Appeals against Syl Inc., a subsidiary of the discount clothing chain Syms Corp.

In 1986, the retailer was approached by accountants promising them they could save thousands of dollars in state taxes by setting up a shell company in Delaware to hold their trademarks, according to court documents.

With their marks held by another company, Syms would pay a percentage of their sales to the company for the use of the multiple "S" trademark and the "an educated consumer is our best customer" slogan.

Delaware didn't tax this income and the fees would allow Syms to make significant deductions to their taxable state income.

The savings could amount to $950,000 a year, wrote Syms Vice President of Finance Richard Diamond in a Dec. 12, 1986, memo outlined in the court documents.

"To accomplish these savings and to help insure that they are not overturned on a state income tax audit," the company had to take certain steps, Diamond continued.

The steps included paying Delaware-based Gunnip & Co. $2,400 a year to create a shared-office in Gunnip's facilities for the trademark holder, Syl, complete with telephone, furniture and bookkeeping -- a standard package Gunnip provided to hundreds of other corporations.

With this facade, "most other states [except New York] will not even realize the impact of the transactions," Diamond wrote.

Syl would receive the royalties and invest them for a few weeks before returning them to its sole shareholder, Syms, in the form of a dividend, according to court papers.

"They took money out of their right pocket and put it in their left pocket" so they didn't have to pay taxes, said Assistant Attorney General Gerald Langbaum, who pursued the case.

"In terms of economic reality, nothing really changed," he said.

Trademark protection?

But the company's Maryland tax bill did change. During the eight-year period from 1986 to 1993, Syms paid about 40 percent less than it should have on its Rockville and Baltimore store profits, according to the comptroller's office.

The savings amounted to $326,685, which the comptroller decided to charge Delaware-based Syl.

The company, whose board of directors was filled with Syms executives plus one Gunnip accountant, contested the out-of-state tax bill, arguing the company had no Maryland operations to tax.

Syl was a separate entity from its parent with legitimate business goals, Syl said.

Such goals were outlined in an Aug. 20, 1986, memo.

By spinning the trademarks into a separate company, there would be less incentive for a hostile takeover, wrote Diamond in the memo.

Acquisition of Syms wouldn't necessarily mean acquisition of Syl and the right to use the company's brand name, he wrote.

The spin-off also would make it easier to license the mark to third-party vendors and allow the company to borrow money with low interest rates via the high-asset, low-debt Syl, Diamond continued.

The earlier memo mentioned nothing of tax benefits, and the company contends the earlier memo reflected the true intent.

"Our reasons (for creating Syl) are not for tax reasons but for the protection of our trademarks," said current Syms Chief Financial Officer Antone F. Moreira.

The Maryland Tax Court, in 1999, and the Baltimore City Circuit Court, in 2000, both agreed with Syl.

But a pending decision from the Court of Appeals could overturn those rulings.

And a green light to the comptroller would open the floodgates to state coffers as hundreds of similar cases get in line behind the 61 companies the state is targeting in court, according to court testimony from the comptroller's office.

"There are cases pending all over the place," said Syl lawyer Harry D. Shapiro of Baltimore-based Saul Ewing LLP.

To save state paperwork, the comptroller finally got the tax court to extend the statute of limitations on filing until the Syl case was resolved, Shapiro said.

Lure of a tax break

The backlog results from more than a decade of increasing competition among states to lure companies within their borders with tax incentive programs. The result has been varied tax laws from state to state that companies have learned to use to their advantage.

Maryland is not the only state to prosecute such cases. New York, South Carolina, New Mexico, Ohio, Texas, Massachusetts and Tennessee have all either heard or are hearing similar cases.

Delaware became attractive to companies like Syl when it passed lax tax laws in the 1980s for passive investment, said Scott Somerville, a partner at Ernst & Young in Baltimore.

"It doesn't tax profits from an intangible holding company," Somerville said.

In return, Delaware has a flourishing management service provider sector for companies like Gunnip and lots of incorporation fees, he said.

Many accountants advise companies to take advantage of such regulations, Somerville said.

"Some people think it is tax avoidance, but really it is that there are different laws in different states," he said.

But others find long-term problems with such outcomes.

The Multistate Tax Commission has been studying the dropping rate of state corporate income taxes.

The commission found that corporations are paying 46 percent less in state taxes than they did in 1980. That figure totals about 5.2 percent of the current annual profits.

At least 25 percent of that drop comes from states offering tax incentive programs. The commission is still determining where the rest of the drop comes from.

"There are lots of things businesses can do to take advantage of gray areas in the tax codes," said Elliott Dubin, an economist at the commission.

One hypothesis has been the growth of trademark companies like Syl in states such as Delaware and Nevada and in offshore countries, Dubin said.

Other factors could include the recession and the proliferation of S-corporations whose profits go to shareholders who then pay smaller taxes on an individual level.

"It is really difficult to say which is the most important factor for the loss," Dubin said. The commission hopes to have more exact causes when it publishes its report later this year.

Regardless of the findings, the high court still has the upper hand in deciding Maryland's fate. The court has not announced when it will rule on the case that has been on the docket for more than a year and a half. But some are already placing bets.

"I don't think the court is going to rule" against the previous findings, said Syl attorney Craig B. Fields of Morrison & Foerster.

Maryland Court of Appeals will pitch the third strike to the comptroller's efforts to collect $31.5 million from 61 companies accused of cheating the Free State out of revenues through sophisticated transfers to Delaware companies. But that doesn't mean the game is over.

Changing the site or angle of a public policy debate can often turn a loss into a win, policy wonks say.

The options available to the comptroller's office would depend on how the court words the blow, said Assistant Attorney General Gerald Langbaum who is representing the comptroller in the suits.

The defendants, companies ranging from clothing stores like The Limited and Syms to Toys R Us and spice giant McCormick & Co., shuttled income from their Maryland operations to trademark shell companies in the form of royalty payments, allowing them to deduct the payments from their taxable profits, even when the trademark companies often gave the money back within a matter of weeks.

Some of the money was returned through dividends to the parent company, the sole shareholder. At other times, it was returned as loans, which allowed the Maryland outlets to deduct even more from their tax statements in the form of interest payments.

The Maryland Tax Court, in 1999, and the Baltimore City Circuit Court, in 2000, ruled in favor of the companies in the case against SYL Inc., a subsidiary of the discount clothing store Syms.

They found there wasn't enough of a connection between the parent and subsidiary business to force the Delaware-based SYL to pay Maryland tax -- especially since the formation of the subsidiary had the legitimate business goal of protecting trademarks.

At least 60 other suits hinge on the outcome of the SYL case in the high court.

But even a third blow in the courts could leave room for more maneuvering against the businesses in the courtroom.

If the court doesn't mention deductions for royalty payments, the state could go back to the court and try pending cases where it sought taxes for the deductions, Langbaum said.

The SYL case did not target its parent company Syms for such taxes, but many other cases did.

Another opening for the comptroller would happen if the court says a new regulation should stipulate the tax collection instead of a court ruling, he said.

In that case, the comptroller could issue one, Langbaum said.

But the comptroller doesn't have a good record in passing regulations either.

Regulations must be approved by the General Assembly's committee on Administrative, Executive, and Legislative Review.

The office tried to pass one in 1997 to force state contractors to either submit tax forms for subsidiaries that they paid royalties to or to discontinue deducting such payments from their state taxes. The motion was denied.

"Opposition was based largely on the grounds that the regulation raises substantial issues about the appropriateness of using the state procurement process to address an issue that appears to be essentially a matter of tax policy," wrote Del. John Arnick, D-Baltimore County, who presided over the joint force.

Legislators said tax policy issues should be dealt with in the General Assembly, Arnick wrote.

The legislative arena, however, also failed to approve the comptroller's efforts.

Del. Clarence Davis, D-Baltimore, introduced a bill for the same measure in the 1998 session, but had to withdraw it before it was heard in the House Ways and Means Committee.

"There were fierce industry objections to it, and it became clear the hearing would become very contentious," said Steve Cordi of the comptroller's office.

Plus there was little support for it within the committee, Cordi said.

The committee chairwoman, Del. Sheila Hixson, D-Montgomery, had written a letter in the fall of 1997 denouncing such a move.

Such a measure would "have an adverse affect on our efforts to nurture Maryland's reputation as a fair and friendly place to do business," Hixson wrote.

But the times have changed since 1998.

With the entire General Assembly facing reelection this fall, term-limited Gov. Parris N. Glendening stepping down, and the state facing more than a $1 billion structural deficit, it is unclear how the new state government would react.

A different reaction might depend on how much money would be collected as a result of any legislation passed, said Michael Golden, a spokesman for the comptroller.

The only killer to the entire effort would be a reference in the court's ruling to the commerce clause of the Constitution, which only grants Congress the right to tax interstate operations, Langbaum said.

"There is little the state can do [in that case] because we can't change the constitution," Langbaum said.

And then again, the court could just tell the companies to pay up.

Whatever the outcome, the comptroller's department remained mum on its future plans.

"We're waiting to see what the court says," Golden said.

Load-Date: November 19, 2002

Continuing coverage from award-winning story about Maryland businesses using Delaware tax loopholes to cut their state tax bills.

The Daily Record (Baltimore, MD)

November 4, 2003 Tuesday

Copyright 2003 Dolan Media Newswires

Section: NEWS; Legal activity (lawsuits etc.)

Length: 641 words

Byline: Kathleen Johnston Jarboe

Maryland's high court decision in June barring the use of Delaware holding companies to reduce state business taxes will stand for now.

The U.S. Supreme Court yesterday declined to hear an appeal on the ruling by discount clothing chain Syms Corp., and some legal experts say a similar appeal will likely receive the same reaction.

The decision is a win for Maryland's effort to collect taxes from businesses it says have used the holding companies to improperly avoid paying their fair shares of taxes.

State analysts have estimated the tax shelters cost the state from $35 million to $180 million annually -- close to one-fifth of the state's projected budget deficit of $1 billion for 2005.

It was a nice way to start the week, said Assistant Attorney General Gerald Langbaum, who argued the case for the Maryland Comptroller's Office.

But business representatives have said the Maryland ruling is anything but clear, and many plan to question whether the ruling applies to them.

Scott Somerville, a partner with Ernst & Young LLP in Baltimore, said the Syms case was decided on the facts and every taxpayer will have different facts.

The Maryland Court of Appeals decision involved New Jersey-based Syms and the company that invented the bottle cap -- Crown Cork & Seal of Philadelphia.

Both businesses had set up Delaware subsidiaries to protect trademarks and other intangible assets like advertising slogans. Syms and Crown Cork & Seal would then pay the subsidiaries licensing fees for using the trademarks and deduct those payments from state income taxes. The practice earned Syms $326,685 in tax relief from 1986 to 1993. Crown Cork & Seal saved $990,400 between 1989 and 1993.

But the Maryland high court found the Delaware subsidiaries "were little more than mail drops." Although Crown Cork & Seal hired service companies to give the affiliates an address in a shared office, the Delaware subsidiaries had no full-time employees and performed no real work, since the parent continued to direct and fund the protection of the marks, according to the decision.

Yesterday's Supreme Court decision means the ruling in regard to Syms will stand. And many, including Langbaum, expect the Crown Cork & Seal appeal will also be denied.

Still business attorneys said they were surprised at the move by the nation's top court. They said the Maryland court used conflicting tax principles to justify its decision, and the result will create an even more complicated patchwork of taxation laws in Maryland and across the country.

The issue has come up in several states, including New York, South Carolina, Texas and New Mexico, among others. Many have ruled differently on whether states can change traditional tax taboos of crossing state lines to collect taxes.

"If there ever was a case where there is a split among the states, this is the issue," said Michael Pearl, one of the attorneys for Syms.

Karen T. Syrylo, an accountant and tax consultant for the Maryland Chamber of Commerce, warned Maryland should offer settlements to avoid lengthy court battles as each business argues whether the ruling applies to its situation.

The Comptroller's Office has 35 similar cases pending in Maryland Tax Court that could bring in $21 million. Another 33 cases, which carry bills for $11 million in alleged unpaid taxes, await decisions in the hearings and appeals division of the Comptroller's Office. And an additional 250 companies have been identified as using the structure but still need full audits done before old tax bills can be reassessed.

But state workers said yesterday's denial had a different meaning.

"We expect that a lot of the corporations presently out there that have cases pending at various stages will see that this is litigation that really doesn't pay for them to pursue. We expect them to come forward and pay what they owe," Langbaum said.

Load-Date: November 4, 2003

More continuing coverage from award-winning story about Maryland businesses using Delaware tax loopholes to cut their state tax bills.

The Daily Record (Baltimore, MD)

March 18, 2004 Thursday

Copyright 2004 Dolan Media Newswires

Section: NEWS; Government activity

Length: 702 words

Byline: Kathleen Johnston Jarboe

A measure heading for a final vote in the Maryland Senate to close a tax loophole involving Delaware shell companies but largely giving businesses amnesty for using it will likely be tightened by the House of Delegates, according to government officials.

There is a delicate negotiation going on with Comptroller William Donald Schaefer over the bill, said Gov. Robert L. Ehrlich Jr. yesterday.

His comments came as senators passed the Senate version on second reader without debate. The move means no more amendments can be added before a final vote. But members of the House of Delegates could change it and force a conference committee on the measure.

Senate Minority Leader J. Lowell Stoltzfus, R-Lower Shore, said he expected the House of Delegates to make the bill less business-friendly.

"It will be the most aggressive corporate tax bill in the country when it's finished," Stoltzfus added.

The Senate version closes a loophole businesses could use by setting up a Delaware company to own trademarks like brand names and advertising slogans. Businesses that then transferred their trademarks to the subsidiaries would pay the affiliates royalties for using the marks and deduct those monies from their Maryland tax bills even though the royalty income isn't taxed in Delaware.

The Senate version forces Schaefer to forgive taxes improperly sheltered by companies before 1995 if they pay taxes avoided since 1995 between July 1 and November 1 of this year.

Companies that pay during that window would pay no penalties on the late taxes and have the interest rate charged for the overdue bills cut in half to 6.5 percent.

Many senators supported the move.

"It bothers me somewhat but passing the whole bill is pretty positive," said Sen. Paul G. Pinsky, D-Prince George's.

For many it was a case of expediency.

"Fundamentally we wanted to reduce the burden going backward in terms of what the comptroller was demanding," said Sen. Edward J. Kasemeyer, D-Howard-Baltimore. "Without it, we thought it would drag on for years."

Last June, after spending years in court, the Comptroller's Office won a decision from Maryland's Court of Appeals allowing the office to pursue companies that used the loophole. The comptroller identified 70 companies that used the shelter to avoid more than $78 million in state taxes, penalties and interest before 1995. He suspects another 240 businesses of using the loophole.

In a bid to expedite collection of the back taxes, Schaefer in December offered to reduce penalties from 25 percent to 2 percent if businesses stepped forward to pay their bills by Jan. 30.

But few took the offer. Only 16 responded, netting the state $12.5 million.

Lawmakers estimate the Senate bill will net $85 million in settlements this year, and eventually bring in annual revenues of $55 million.

Senate Budget and Taxation Committee Chair Ulysses Currie, D-Prince George's, said his committee made every attempt to work with the comptroller and the governor to get the bill passed.

But Tuesday Schaefer said he was furious over the settlement compromise, and would ask the governor to veto the bill if passed in its current form.

Recent studies maintain the use of tax avoidance strategies has spread nationwide.

Yesterday, advocates from Progressive Maryland presented a new study showing 90 out of 130 of the state's largest for-profit companies paid no income taxes in 2002.

"By skipping out on their taxes, companies on the level of Wal-Mart, WorldCom and General Motors are robbing all of us by shortchanging our public schools, universities, and hospitals and shifting the tax burden on to the backs of ordinary taxpayers. No wonder we have nearly a $1 billion budget deficit," said Executive Director Tom Hucker in a prepared statement.

Business groups have answered such charges with their own studies.

A January survey by Ernst & Young LLP found that corporate income taxes only made up 9 percent of the $404.1 billion in state and local taxes paid by businesses during fiscal year 2003. Property taxes amounted to more than a third of that bill, according to the study.

The January analysis also said businesses have paid 65 percent of the entire increase in state and local taxes since fiscal year 2000.

Load-Date: March 18, 2004

More continuing coverage from award-winning story about Maryland businesses using Delaware tax loopholes to cut their state tax bills.

The Daily Record (Baltimore, MD)

October 19, 2004 Tuesday

Copyright 2004 Dolan Media Newswires

Section: NEWS; Government activity

Length: 659 words

Byline: Kathleen Johnston Jarboe

More companies than expected have taken a tax amnesty deal offered to those using an improper Delaware loophole, pushing collections $17 million higher than initial estimates as applications continue to arrive before the Nov. 1 deadline.

As of Friday, 155 businesses that had used the loophole had paid $81.5 million in back taxes.

"We always thought [the initial estimate] might be small. But we had no idea how much bigger it would be," said Michael A. Walsh, a spokesman for the Comptroller's Office.

The amnesty offer was part of legislation passed by state lawmakers this year that largely closed a tax loophole for companies owning intangible assets, such as trademarks.

Under the loophole, businesses could create a shell company to own trademarks, like their brand names and advertising slogans, in states like Delaware that didn't tax income from such holdings. Once the subsidiaries owned the trademarks, companies could then pay the affiliates royalties for using the marks and deduct those monies from Maryland tax bills. The tax shelters saved corporations millions since the royalty income was not taxed in Delaware.

The amnesty deal offered to ignore taxes avoided through the loophole before 1995 if companies paid now on taxes skipped since then. The deal also eliminated penalties for those who took the deal, and dropped interest owed on the back taxes in half to 6.5 percent.

Legislative analysts had estimated to collect about $64 million from the program.

"We're very pleased," Walsh said. "All along, our message has been we wanted to make sure companies " in this situation pay their fair share."

A business representative said the response indicated the offer was a win-win deal for the state and taxpayers.

"This is a decent enough deal for them to forgo the time and extra lawyer fees [to fight the law] in order to get this distraction of their list so they can go back to doing business," said Karen T. Syrylo, a tax consultant for the Maryland Chamber of Commerce.

Others attribute the success to a nationwide movement to close such state tax loopholes. About 15 to 20 states have enacted laws similar to that in Maryland. The change has caused many corporations to reconsider their state tax planning approach and to change their mind about taking Maryland's amnesty offer, according to a Baltimore accountant.

"The climate has certainly changed and as a result companies are certainly reacting to that," said Scott Somerville, a partner with Ernst & Young in Baltimore. "It might just be the right time for Maryland to offer this amnesty program."

Still, business groups are continuing to work with officials from the Department of Business and Economic Development to introduce legislation in 2005 to limit the new loophole law's scope.

"Nobody likes Maryland having the worst law like this in the country," Syrylo said.

She said the loophole law prevented foreign-based companies from qualifying for exceptions to the law available to U.S.-based businesses. And, she said, the law penalized companies that took loans from shareholders, since interest payments couldn't be deducted for those shareholders that live in states without an income tax.

"The idea is to take away the overly broad aspects of the bill. The idea is not to reinstate the loophole that was intended to be closed," Syrylo said.

Not all companies are expected to take the amnesty offer.

"I think there are probably still more that are not settling as opposed to those who are," Somerville said.

The Comptroller's Office initially targeted at least 240 businesses operating in the state that could be using the loophole -- almost 100 more than have applied to date.

An official from the Comptroller's Office said he expected many more companies to take the amnesty deal at the last moment.

But Somerville said more than half of his clients still felt their situations were different enough from the tax law abuses targeted by the law to press for their cases in the courts.

Load-Date: October 19, 2004