Opinion ID: 2681025
Heading Depth: 2
Heading Rank: 2

Heading: The Comptroller’s Apportionment Formula

Text: Petitioners also contest the Comptroller’s application of Gore’s apportionment factor 35 to GEH and FVI’s income in order to calculate the subsidiaries’ tax obligations. First, Petitioners claim that the use of this formula was prohibited by a binding regulation that the Comptroller ignored. Petitioners also contend that the Comptroller violated the Due Process and Commerce Clauses of the Constitution by applying an apportionment formula that was fundamentally unfair. We will address each argument in turn. Petitioners’ first argument concerns the interplay of Md. Code Ann. (1988, 2010 Repl. Vol.), § 10-402(a) of the Tax-General Article (“TG”) and Code of Maryland Regulations (“COMAR”) 03.04.03.08(C)(3)(d). TG § 10-402(a)(2) reads: (2) if a corporation carries on its trade or business in and out of the State, the corporation shall allocate to the State the part of the corporation’s Maryland modified income that is derived from or reasonably attributable to the part of its trade or business carried on in the State, in the manner required in subsection (b), (c), or (d) of this section. Petitioners argue that COMAR 03.04.03.08(C)(3)(d) requires that a taxpayer earning income from intangibles be apportioned according to a two-factor payroll and property formula. Petitioners claim that the Comptroller ignored this regulation, and instead improperly borrowed an apportionment formula from Gore that included Gore’s property, payroll, and sales figures.23 Based solely on the language of the statute and regulation, we reject Petitioners’ argument that the Comptroller ignored a binding regulation. Both TG § 10-402 and COMAR 23 COMAR 03.04.03.08(C) and its subdivision COMAR 03.04.93.08(C)(3)(d) both reference a “Three-Factor Formula,” not a two-factor formula. 36 03.04.03.08 are provisions with exceptions. TG § 10-402(d) allows the Comptroller to “alter, if circumstances warrant, the methods under subsections (b) and (c) of this section[.]” COMAR 03.04.03.08(F)(1) allows the Comptroller to alter both a formula or its components where an apportionment formula “does not fairly represent the extent of a corporation’s activity in [the] State[.]” As Respondent correctly points out, the three-factor formula set forth by TG § 10-402(a)(2) and COMAR 03.04.03.08(C) would have yielded an apportionment factor of zero, which did not fairly represent the subsidiaries’ activity in Maryland. Thus, a plain reading of either the statute or regulation empowers the Comptroller to do precisely that to which Petitioners object. Petitioners’ second argument attacks the fairness of the apportionment formula used by the Comptroller. Specifically, Petitioners allege that the Comptroller’s formula ignored the limiting principle of taxing only “an apportionable share of the multistate business carried on in part in the taxing State.” See Allied-Signal, 504 U.S. at 778, 112 S. Ct. at 2258. The core of Petitioners’ argument is that because neither GEH nor FVI have property or payroll in Maryland, no taxes are due in Maryland, and any apportionment that generates Maryland tax liability is unfair. Concerning the Comptroller’s apportionment formula, the Tax Court reasoned: The tax calculation utilized by the Comptroller was intended to apportion to Maryland only the Delaware Holding Company income connected to the operating transactions of W. L. Gore. Expenses were deducted from the income if the Delaware Holding Company made an affirmative demonstration that the expenses were directly related to the income. GEH made no 37 attempt to allocate Delaware Holding Company expenses to the W. L. Gore connected income. Consequently, GEH’s tax liability was calculated by multiplying royalties paid by W. L. Gore times the W. L. Gore apportionment formula. For FVI, the tax is calculated by multiplying interest paid by W. L. Gore times the W. L. Gore apportionment formula. There was no other evidence offered by the Petitioners that this formula method was unfair. The Comptroller’s use of an apportionment formula is authorized by the unitary business principle, described by the United States Supreme Court as follows: The unitary business/formula apportionment method is a very different approach to the problem of taxing businesses operating in more than one jurisdiction. It rejects geographical or transactional accounting, and instead calculates the local tax base by first defining the scope of the “unitary business” of which the taxed enterprise’s activities in the taxing jurisdiction form one part, and then apportioning the total income of that “unitary business” between the taxing jurisdiction and the rest of the world on the basis of a formula taking into account objective measures of the corporation’s activities within and without the jurisdiction. This Court long ago upheld the constitutionality of the unitary business/formula apportionment method, although subject to certain constraints. Container Corp., 463 U.S. at 165, 103 S. Ct. at 2940. The constraints on the unitary business principle are posed by the Due Process and Commerce Clauses, which require: (1) showing the existence of a unitary business, “part of which is carried on in the taxing state[,]” and (2) demonstrating “‘a rational relationship between the taxing State and the intrastate values of the taxpayer’s enterprise[.]’” NCR Corp., 313 Md. at 132, 544 A.2d at 770–71 (quoting Xerox, 290 Md. at 145, 428 A.2d at 1218–19). 38 A unitary business features functional integration, centralized management, and economies of scale.24 The test under the Constitution is “not the potential of unitary control, but rather the actual, in fact unitariness or separateness of the subsidiary enterprises.” Hercules, 351 Md. at 112, 716 A.2d at 281 (citing F. W. Woolworth Co. v. Taxation & Revenue Dep’t of State of N.M., 458 U.S. 354, 362, 102 S. Ct. 3128, 3134 (1982)). The Tax Court found that GEH and FVI demonstrated integration of business functions and personnel, centralized management through the inclusion of Gore employees on the subsidiaries’ boards, and a reliance on Gore for everything from furniture to legal services. These findings were well supported by the record. Based on these findings, the Tax Court did not err in concluding that Gore, GEH, and FVI were engaged in a unitary business.25 Cf. Hercules, 351 Md. at 112, 716 A.2d at 281 (declining to find a unitary business where the subsidiary’s dayto-day operations were “relatively autonomous,” the subsidiary had its own business divisions, subsidiary employees had no “‘bridge’ back to the parent company,” and no employee or officer of the subsidiary was simultaneously an employee or officer of the parent). Having been found a unitary business, Petitioners now “bear[] the burden of 24 See supra. 25 We observe that the appropriate standard of review for determination of a unitary business is “whether a reasoning mind, having a proper understanding of the relevant law, could have reached the conclusion reached by the Tax Court.” Supervisor of Assessments of Montgomery Cnty. v. Asbury Methodist Home, Inc., 313 Md. 614, 628, 547 A.2d 190, 196–97 (1988). 39 demonstrating that the income [they] seek[] to exclude from taxation was derived from unrelated business activity that constituted a discreet business enterprise.” NCR Corp., 313 Md. at 132, 544 A.2d at 771. Our review of apportionment schemes is guided by the Supreme Court’s analysis in Container Corp: Having determined that a certain set of activities constitute a “unitary business,” a State must then apply a formula apportioning the income of that business within and without the State. Such an apportionment formula must, under both the Due Process and Commerce Clauses, be fair. The first, and again obvious, component of fairness in an apportionment formula is what might be called internal consistency—that is, the formula must be such that, if applied by every jurisdiction, it would result in no more than all of the unitary business’s income being taxed. The second and more difficult requirement is what might be called external consistency—the factor or factors used in the apportionment formula must actually reflect a reasonable sense of how income is generated. The Constitution does not “invalidat[e] an apportionment formula whenever it may result in taxation of some income that did not have its source in the taxing State . . . .” Moorman Mfg. Co., 437 U.S. at 272, 98 S. Ct. at 2344 (emphasis added). Nevertheless, we will strike down the application of an apportionment formula if the taxpayer can prove “by ‘clear and cogent evidence’ that the income attributed to the State is in fact ‘out of all appropriate proportions to the business transacted in that State,’ or has ‘led to a grossly distorted result[.]’” Moorman Mfg. Co., 437 U.S. at 274, 98 S. Ct. at 2345. 463 U.S. at 169–70, 103 S. Ct. at 2942 (citations omitted) (ellipsis in original). We agree with the Court of Special Appeals that “[t]here is no dispute that, if applied by every jurisdiction, the Comptroller’s apportionment is internally consistent and ‘would 40 result in no more than all of the unitary business’ income being taxed.’” Gore Enterprise Holdings, 209 Md. App. at 543, 60 A.3d at 119 (quoting Container Corp., 463 U.S. at 169, 103 S. Ct. at 2933). Petitioners do not dispute internal consistency in their brief, and we find no reason to depart from the intermediate court’s holding of internal consistency. Regarding external consistency, Petitioners argue that the Comptroller’s apportionment formula is unfair and out of proportion to the business that GEH and FVI conducted in Maryland. Essentially, Petitioners claim that they are being punished for Gore’s manufacturing in Maryland. This is not so. The Comptroller’s apportionment formula captured Gore’s expenses in Maryland—expenses that simultaneously constituted income for GEH and FVI. Thus, the formula reflects “a reasonable sense of how [GEH and FVI’s] income is generated.” See Container Corp., 463 U.S. at 169, 103 S. Ct. at 2942. GEH and FVI bear the burden of demonstrating that the Comptroller’s apportionment formula distorts the proportion of their income traceable to Maryland. For all the reasons discussed above, Petitioners have failed to meet this burden.26 In conclusion, the Tax Court did not err in holding that the Comptroller had the authority to tax GEH and FVI. GEH and FVI are subsidiaries with “no economic substance as separate business entities” from their parent, Gore. Therefore, these subsidiaries are taxable entities under SYL. We also conclude that the Tax Court did not err in upholding the apportionment formula used by the Comptroller. This apportionment formula passes 26 See supra. 41 constitutional muster through a justified application of the unitary business principle. JUDGMENT OF THE COURT OF SPECIAL APPEALS AFFIRMED; COSTS TO BE PAID BY PETITIONERS. 42