Massachusetts courts are poised to rule on three tax disputes at the crux of the Department of Revenue's efforts to reclaim $1 billion from corporations it has accused of skirting tax laws. The outcome will have major ramifications, as a massive budget shortfall is causing Massachusetts to cut staff and services.
The rulings, expected within the next several months, will likely determine hundreds of similar corporate tax fights. The underlying issue revolves around how companies apportion profits and other business activities to entities in other states.
A Massachusetts victory would result in a flood of revenues that would offset budget problems. If the state loses, however, refunds of several hundred million dollars will exacerbate its financial condition.
The Massachusetts Supreme Judicial Court last month heard final arguments in cases against Toys Inc., operator of Toys "R" Us, and Capital One Financial Corp. And yesterday a state Appeals Court heard the state's case against TJX Cos.
These are being closely watched around the country, as other states seek to curb strategies that companies use to lower tax bills. Some of the biggest names in corporate America are fighting Massachusetts on this front: Microsoft Corp., Comcast Corp., and Home Depot Inc., among other firms.
"These decisions are going to be big news nationwide," said Donald Griswold, a Washington, D.C., attorney who has represented MBNA Corp., the credit card company owned by Bank of America Corp., in similar cases before supreme courts in Indiana and West Virginia.
Indiana and West Virginia tax authorities won those cases, and officials in other states have also prevailed against Toys "R" Us, prompting some tax specialists to predict the Commonwealth will also win.
If it does, revenue Commissioner Navjeet K. Bal predicts companies with similar disputes will promptly settle instead of fighting the legal odds.
"Any time a ruling goes in the department's favor, it helps with settlement discussions. There's really no question about that," Bal said.
The dispute arose in the 1990s when corporations began employing aggressive tactics to save on tax bills. Since then, Massachusetts has sued hundreds of companies for back taxes totaling more than $1 billion. Some firms have agreed to pay before the cases have been resolved, reserving their right to get their money back if the state loses.
The Toys "R" Us case is the most prominent of such disputes. The toy company nearly 20 years ago set up a subsidiary in Delaware, and gave that unit ownership of its trademark, Geoffrey the Giraffe. Delaware does not tax income on intangible assets such as trademarks.
The company had its stores in Massachusetts and other states pay royalties to the Delaware firm for use of the Geoffrey trademark, according to court filings. Tax officials said the move effectively transferred profits that would be taxable in Massachusetts to a nontax jurisdiction. The amount now in dispute is $1.6 million, plus penalties and interest between 1997 and 2001.
The legal battle involves competing interpretations of the Commerce Clause of the US Constitution, which regulates trade across state borders. Massachusetts and tax officials from other states argue the clause gives them authority to collect income taxes when a company's business activities are substantially connected to the state.
Lawyers for Toys "R" Us and other companies with similar disputes contend in court filings the Constitution only allows states to tax businesses that are physically present within their borders, an interpretation that would prevent the Delaware subsidiary from being taxed by other states.
That interpretation, however, has failed to persuade courts in South Carolina, Louisiana, New York, and Oklahoma, which over the years have ruled against Toys "R" Us.
A Toys "R" Us spokesman did not respond to a call seeking comment. A spokesman for Microsoft, which has a similar legal fight here, said it has complied with state tax laws and will continue to seek a resolution in court.
In the Capital One case, the state argues the bank effectively has a taxable business presence in Massachusetts because of the thousands of credit card transactions it has with card holders and businesses, even though it doesn't have a local branch office or other physical presence here.
Capital One did not return a phone call seeking comment. In court documents, Capital One argued that because it does not have employees or property in Massachusetts, it should not pay state taxes under the Commerce Clause. And lawyers for other companies said the state is trying to equate a transaction on an electronic network with one in a local bank branch.
"This is about something much more important than tax dollars," said Griswold, the attorney who represents MBNA. "It's about the principle of federalism and when states are going to be permitted to reach beyond their borders to exercise dominion over citizens of another state."
MBNA has a dispute with Massachusetts that mirrors the Capital One case.
The TJX lawsuit involves an arrangement the company set up in the early 1990s that treated royalty and interest payments from subsidiaries as deductions that lowered its overall tax liability. In the late 1990s, Massachusetts pressed the retailer to pay more taxes on the grounds the deductions were improper.
The contested amount is around $19.6 million. In 2006, the state's Appellate Tax Board ruled in the revenue department's favor, although it later allowed TJX some of the deductions. A TJX spokeswoman declined to comment.
In a similar case, a Comcast spokeswoman said the company believes it has complied with tax laws and is working with the state to resolve the matter, which involves issues from its acquisition of AT&T Broadband in 2002. A spokesman for Home Depot also said the company is working with the state.
This year, the Massachusetts Legislature changed the state's corporate tax law to prevent many of these disputes from arising in the first place. The law, known as combined reporting, requires companies to lump income together from all their business units and apportion a share to Massachusetts, thus preventing them from shifting profits to nontaxable subsidiaries.
Source: lexisONE
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