Last week, the Maryland Tax Court issued its decision in the consolidated cases of Staples, Inc. v. Comptroller of the Treasury1 and Staples the Office Superstore, Inc. v. Comptroller of the Treasury2. The cases involved the Comptroller’s assertion of nexus over Staples, Inc. (“Staples”) and Staples the Office Superstore, Inc. (“Superstore”), based on their receipt of intercompany interest and franchise fee payments, respectively, from operating companies that did business in Maryland.

Background Staples and Superstore are Delaware corporations with their principal place of business in Massachusetts. Both corporations had significant amounts of property and paid millions of dollars of salaries and wages to employees. However, neither corporation had any employees or owned any real or tangible property in Maryland.

In 1998, Staples undertook a reorganization. After the reorganization, Staples’ stores in Maryland were operated by two subsidiaries: (1) Staples, The Office Superstore East, Inc. (“Staples East”) and (2) Staples Contract & Commissions, Inc. (“Staples C&C”). Subsequent to the reorganization, Staples provided a variety of managerial and administrative services for the benefit of certain subsidiaries, including Staples East and Staples C&C. These services included certain back-office functions, such as centralized accounting, legal, and human resource services, as well as cash management. Under the cash management system, Staples employed a cash pooling arrangement with its subsidiaries whereby amounts were loaned or borrowed and interest was paid by corporations participating in the system that were net debtors. Staples East and Staples C&C paid interest to Staples under the cash management system.

Superstore operated retail stores and distribution centers in various states, but none in Maryland. It also provided a franchise system to Staples East and Staples C&C, which included a license to use certain trademarks and other intellectual property and merchandising, marketing and real estate services. Staples East and Staples C&C, in turn, paid Superstore a franchise fee for use of the franchise system.

The Comptroller issued assessments against Staples and Superstore, asserting nexus with Maryland, based upon their receipt of interest income and franchise fees, respectively, from Staples East and Staples C&C.

The Tax Court Rules in Favor of the Comptroller The Tax Court upheld the Comptroller’s assessments stating that the facts supported the Comptroller’s position that enterprise dependency existed between Staples and Superstore and the affiliated corporations. Specifically, the court noted that Superstore, Staples C&C, and Staples East relied on Staples for corporate necessities, such as cash and credit, payment of their bills, the provision of legal, financial and accounting services, and strategic planning. It further noted that Staples C&C and Staples East relied on Superstore for purchasing goods, advertising and marketing, inventory control, site selection, store construction and layout, licenses to use the trademarks and other intellectual property, and research and development. Based upon these facts, the Tax Court determined that Staples and Superstore lacked economic substance as separate business entities, because they were part of a unitary business enterprise that included Staples C&C and Staples East. Accordingly, the Tax Court determined that Staples and Superstore had nexus with Maryland.

Are There Any Unitary Businesses That Can Pass Muster Under Gore? Staples represents a disturbing trend. The decision comes just three months after the Tax Court’s decision in ConAgra Brands Inc. v. Comptroller of the Treasury,3in which the Tax Court also ruled in favor of the Comptroller with respect to a nexus assessment for an entity that, among other operating activities, licensed intangibles to affiliated entities.4 Both ConAgra Brands and Staples purport to interpret the Maryland Court of Appeals’ clarification in Gore Enterprise Holdings, Inc. v. Comptroller of the Treasury5, that a subsidiary must have economic substance as a separate entity from its parent to avoid nexus and taxation. However, both decisions leave taxpayers wondering, are there any unitary businesses that can pass the Gore “real economic substance as separate business entities” test? In both ConAgra and Staples, the Tax Court treated entities with significant assets and operations and millions of dollars of payroll as lacking substance as separate business entities.

On a positive note, the Tax Court granted an abatement of more than six years’ worth of interest and all penalties, similar to the abatement granted to the taxpayer in the ConAgra decision, noting that the law in Maryland on this issue has evolved through various court decisions, and that the taxpayer’s challenge was in good faith and was supported by a reasonable basis.

A copy of the Tax Court’s Staples decision is here.