Court Opinion

ID: 9609205
Source: CourtListenerOpinion
Date Created: 2023-08-22 03:23:52.902872+00
Date Added: 2024-06-11T13:36:27.775592
License: Public Domain

MICHAEL A. WOLFF, Judge,
dissenting.
The economic reality of these cases is simple. The “taxpayers” — or, in light of the result here, perhaps one should say the tax-evaders — are entities that own intellectual property, i.e., patent and trademark rights. These entities, sited in Delaware, license these rights to related corporations that manufacture products sold in Missouri. One holds patents on “Goretex” fabric for outdoor clothing. The other entity holds trademark rights to “Acme” bricks. Without the participation of these “taxpayers,” the Gore clothing would not repel water while “breathing” and the Acme product would be a mere unadorned brick. Thus, these “taxpayers” own the intellectual property essential to the products as they are marketed and sold in Missouri. The income derived from sales in this state is Missouri-source income.
It defies economic reality to hold that income derived from the Missouri market — in which these “taxpayers” participate through their related manufacturing companies — is not taxable here.
Corporate Reorganizations to Avoid Taxes
One of the great achievements of the legal profession in the past two centuries has been the development and creative use of the corporation. The corporate entity as a separate person is a legal fiction essential to the development of the modern capitalistic society.1 The invention of the modern corporation allows investors to aggregate capital while risking only their investments, not their own personal resources beyond the amounts invested. The fundamental concept is that the investor and the corporation are different “persons” so that a mere investor is not personally responsible for the liabilities of the corporation.
The overarching question in these cases is whether the Missouri tax statute, section 143.451.1,2 which taxes “all income derived from sources within this state,” permits this salutary legal fiction to be used perversely for avoiding legitimate taxes imposed by the state of Missouri.
In both these cases, the corporate reorganization appears to be simply for tax avoidance. It starts with a company that makes something — bricks, clothing products, or whatever. The making of the product involves two things: the intellectual property (patent or trademark) and the physical product itself. Before the corporate reorganizations here, the same company owned both the intellectual property and the means of production. The manufacturing companies made and sold their products but did not pay royalties to themselves.
But what if a “separate” person owns the intellectual property, i.e., the patents or trademarks? If a separate person holds the intellectual property, such as an inventor who holds a patent, the separate person would be entitled to charge royalties to the person making the product, and *77the royalty payments would be deducted from the manufacturer’s taxable income.
But in the case of Gore or Acme, what would be the incentive to create a “separate” person to own the intellectual property? How about a “person” that “lives” in a place where there are no taxes to pay on income?
So, here’s the tax avoidance scheme: First, a manufacturing corporation creates a separate person in a state (or foreign country, for that matter3) that does not tax that person’s income. Second, the manufacturer assigns the patent or trademark to the new person, essentially for free. Third, the manufacturer agrees to pay the new “person” royalties for use of the patent or trademark.
To those of us who are unabashed admirers of the modern corporation, this kind of creativity may seem to be an unremarkable use of the corporate fiction. But here is a kicker: the royalty agreement is structured so that most if not all of the manufacturer’s profits — but not one cent in excess of the profits — are paid to the “separate” person.
This new “person” — which received the patent or trademark rights for free — then claims that it has no connection with Missouri and owes Missouri no tax on the income it derived from sales of the products in Missouri.
This certainly is clever, but it is absurd to say that Missouri cannot tax the income derived from economic activity conducted on behalf of these “taxpayers” in this state. The income is, in the words of section 143.451.1, “derived from sources within this state.” There is nothing in the record seriously to suggest that this corporate reorganization is for some legitimate purpose other to disguise the fact that this income from the manufacture and sale of the taxpayers’ products in Missouri is subject to Missouri taxation.
Facts: The Gore and Acme Corporate Structures
W.L. Gore (Gore) sells its goods, which include “Goretex” and other synthetic materials, in Missouri and other states. Gore is registered to do business in Missouri and files Missouri income tax returns. In 1983, Gore formed “Gore Enterprise Holdings” (Holdings) as a holding company for its patents. Holdings is a Delaware corporation that, for two of three tax periods at issue, had no employees or offices of its own. Holdings’ activities, which consisted of collecting royalty payments, were conducted by Gore’s employees at Gore’s offices. For the third tax period at issue, Holdings rented 120 square feet of space, which held a desk, chair, computer and file cabinet, to house its sole employee, a paralegal.
Gore transferred to Holdings all of its patents in return for Holdings’ stock. Holdings then licensed those patents to Gore exclusively in exchange for royalty payments totaling 7.5% of the sales price of all products Gore made in the United States and sold for use in the United States. Seven and one-half percent conveniently amounts to the approximate total of profits Gore historically made on these products. In no event, however, could the royalty payments made by Gore to Holdings exceed Gore’s net income.
Acme Brick employed a similar reorganization scheme. Acme Brick formed Acme Royalty Company (Acme Royalty) in *781991 to manage its trademarks.4 Acme Brick paid Acme Royalty a portion of its sales in exchange for use of the trademarks in connection with its manufacture, sale and distribution of merchandise within Missouri. Like Holdings, Acme Royalty is a Delaware corporation that, during part of the tax period in question, shared approximately 1,100 square feet of office space with 40 other companies and employed one individual who spent two hours monthly on Acme Royalty business. This individual served as officer and director for Acme Royalty, as well as 20 to 30 other companies. Acme Brick paid Missouri income tax but was allowed a deduction for royalties paid to Acme Royalty.
A Tax Avoidance Trend
Using this corporate reorganization, these corporations shifted income taxable in Missouri to Delaware, where income from patents and trademarks is tax-free. The Missouri Director of Revenue aptly describes this recent trend in tax avoidance: “[A] bare corporate change can make income that is taxable today not taxable tomorrow.” The result is the creation of so-called “nowhere income” — income that is taxed in no state.
“Nowhere income,” it might be noted, is not just affecting individual states. The Wall Street Journal reports that the Internal Revenue Service is also concerned about loss of federal income tax. Companies set up offshore subsidiaries so they can transfer royalties from sales of products made outside the United States to places like Bermuda. Glenn R. Simpson, A New Twist in Tax Avoidance: Firms Send Best Ideas Abroad, Wall St. J., June 24, 2002, at Al. The Journal reports that more than two dozen pharmaceutical and computer companies have set up subsidiaries in Bermuda. Id. “The transfer of intellectual property — such as trademarks and patents — has become so widespread that it has prompted an aggressive crackdown by the Internal Revenue Service on alleged abuses that one IRS consultant says could eventually involve tax claims in the tens of billions of dollars.” Id.
By moving their profits to places where such income is not taxable, companies are avoiding taxation in places such as Missouri where those profits were derived. These companies argue that they should be immune from income taxation because they have no connection or nexus to the taxing state.
The Missouri Connection
Missouri taxable income of a corporation “shall include all income derived from sources within this state.” Section 143.451.1.
Holdings and Acme Royalty argue that the royalty income is derived from the license agreement, which has no Missouri connection. However, the source of income to Holdings and Acme Royalty is not merely a written license agreement. The two derive income from the use of the intellectual property, which is an essential ingredient in the products sold in Missouri. The products sold in Missouri are just as much a result of the patents and trademarks as they are the result of the physical manufacturing processes. In both cases, Goretex clothing and Acme bricks, the source of income is Missouri’s Gore and Acme Brick customers. Gore Enterprise Holdings does not make a cent until Gore makes a sale. Acme Royalty and *79Acme Brick have the same relationship. Missouri sales produce income for Holdings and Acme Royalty; thus, this income is taxable because it is derived from sources within Missouri' — -Missouri customers.
The tax avoidance scheme that has been endorsed by the principal opinion here was apparently first detected and snuffed out by the taxing authority and the Supreme Court of South Carolina in Geoffrey, Inc. v. South Carolina Tax Commission, 313 S.C. 15, 437 S.E.2d 13 (1993). In Geoffrey, Inc., the well-known toy store, Toys R Us, formed a subsidiary in Delaware named Geoffrey5 to own its trademarks and trade names. Geoffrey had no offices, employees or tangible property in South Carolina. As in the instant cases, Geoffrey executed a license agreement allowing Toys R Us to use its trademarks and trade name. In return, Geoffrey received a royalty of one percent of Toys R Us’ net sales. In 1990, Geoffrey had no full-time employees and had an approximate income of $55 million, paying no income tax to any state.
In finding that Geoffrey’s royalty income was subject to South Carolina income tax, the court found that “[t]he real source of Geoffrey’s income is not a paper agreement, but South Carolina’s Toys R Us customers.” Id. at 18. This Court should apply the Geoffrey principle here. The real source of income for Holdings and Acme Royalty is Missouri’s Gore and Acme Brick customers — a relationship that is made possible in part by Missouri’s business infrastructure and legal protections. “By providing an orderly society in which Toys R Us conducts business, South Carolina has made it possible for Geoffrey to earn income pursuant to the royalty agreement,” the South Carolina court aptly concluded. “That Geoffrey has received protection, benefits, and opportunities from South Carolina is manifested by the fact that it earns income in this state.” Id.
Missouri’s Director of Revenue seeks to tax only that portion of income generated within Missouri’s borders. As in South Carolina, this coincides with the notion that assessment of tax is rationally related to the protections the state provides. Missouri, like South Carolina, provides a place that allows these companies to produce their only form of income.
The “taxpayers,” Holdings and Acme Royalty, derive economic benefit from the protection of the Missouri marketplace. Their intellectual properties, the patent and trademark rights, are part of the products that are sold. Or put another way, the manufacturing companies are the vehicle through which the “taxpayers” get money from Missouri for their properties.6 Missouri not only creates a marketplace for these products, including their licenses, but also affords legal protections to these “taxpayers.” For instance, if a company were to sell “Goretex” products or “Acme” bricks in Missouri without licenses from these “taxpayers,” there is no doubt that these “taxpayers” could use Missouri courts to enforce their rights to the intellectual property.
Missouri offers a market to these companies for making money from them licenses through their related manufacturing *80companies. Missouri, accordingly, is due tax from income that is derived within its borders from its citizens.
Doing Business in Missouri
Section 143.441.1(1) defines a corporation subject to Missouri taxation to include "... every corporation, association, joint stock company, and joint stock association, licensed to do business in this state, or doing business in this state, and not organized, authorized, or existing under the laws of this state.... ” Both Holdings and Acme Royalty argue that they did nothing in Missouri and that the director’s focus is instead on the conduct of Gore and Acme Brick.
However, a taxpayer need not have a tangible, physical presence within a state for income to be taxable there. It is not necessary for Holdings and Acme Royalty to be the actual “seller” of the goods for Missouri to tax the income they receive from the sales. It is enough that the transactions, from which Holdings and Acme Royalty receive income, occur in Missouri and, thus, are subject to state regulation and protection. The controlling principle is set forth in Int’l Harvester Co. v. Wisconsin Dep’t of Taxation, 322 U.S. 435, 441-42, 64 S.Ct. 1060, 88 L.Ed. 1373 (1944), where the United States Supreme Court said: “A state may tax such part of the income of a non-resident as is fairly attributable either to property located in the state or to events or transactions which, occurring there, are subject to state regulation and which are within the protection of the state and entitled to the numerous other benefits which it confers.” 7
For these reasons, I would find, as did the South Carolina Supreme Court, that this “nowhere” income is properly taxable somewhere. And one of those places is the State of Missouri.8
This is not a case where Gore, for example, is paying royalties to inventors who created and patented their product materials. Holdings created nothing. Gore created Holdings to shield Gore’s profits from taxation. The same is true of the trademark rights held by Acme Royalty. These profits, derived from sales to Missouri cus*81tomers but siphoned off to related companies through royalty agreements, are subject to the state’s tax.
The modern corporation is an invention that lawyers can rightly be proud of. But the result reached here by the principal opinion rewards this invention inappropriately. The legal fiction of the corporation should not override economic reality.
The bottom line, economic reality is simple: These companies earn money in Missouri. Under section 143.451.1, they should pay taxes here.
I respectfully dissent.

. See Reisman, Toward an Anthropological Science of Law and the Legal Profession, 57 Am. J. Soc. 121, 126 (1952), quoted in Louis M. Brown & Edward A. Dauer, Planning By Lawyers: Materials on a Nonadversarial Legal Process 55 (1978).

. All references are to RSMo 2000 unless otherwise indicated.

. See Glenn R. Simpson, A New Twist in Tax Avoidance: Firms Send Their Best Ideas Abroad, Wall St. J., June 24, 2002, at Al.

. In 1993, Acme Royalty became a limited partnership in which it contributed all of the trademarks and trade names it owned in exchange for 99% interest in the partnership. Brick Investment Company (BIC) was formed to be the general partner. BIC contributed cash in an amount estimated to be one percent of the value of the trademarks in exchange for one percent general partnership interest.

. Geoffrey is the cartoon giraffe on the Toys R Us logo.

. An alternative analysis is to consider piercing the corporate veil. See, e.g., 66, Inc. v. Crestwood Commons Redevelopment Corp., 998 S.W.2d 32 (Mo. banc 1999). But courts do not lightly pierce the corporate veil, id., and it is not necessary to do so here. It seems preferable to treat Gore Enterprise Holdings and Acme Royalty as separate entities from their corporate creators and to recognize that they participate in the Missouri marketplace with their creators.

. The language used to uphold a state's right to tax an out-of-state corporation mirrors the language used by the United States Supreme Court in personal jurisdiction cases. The due process limitation on a state's exercise of jurisdiction is not offended where a defendant corporation purposely avails itself of the benefits and protections of the state's laws. Quill Corp. v. North Dakota, 504 U.S. 298, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992). See also, Hanson v. Denckla, 357 U.S. 235, 78 S.Ct. 1228, 2 L.Ed.2d 1283 (1958), and Keeton v. Hustler Magazine, Inc., 465 U.S. 770, 104 S.Ct. 1473, 79 L.Ed.2d 790 (1984).

. A simple alternative would seem to be available, though the director of revenue did not pursue it in these cases. Even if Gore Enterprise Holdings and Acme Royalty are not subject to Missouri tax, as the principal opinion holds, the director does have tax returns from W.L. Gore and Acme Brick, which paid their profits as royalty fees to these supposedly untouchable holding companies. Perhaps the director should disallow the deduction of such royalty payments by W.L. Gore and Acme Brick and tax their Missouri income accordingly. That appears to be authorized by section 143.451.7, which allows deduction “for expenses in determining Missouri taxable income as were incurred ... to produce such income....” The director also has statutory authority to prescribe regulations to adjust, assess or compute the tax liability of affiliated corporations "in such manner as clearly to reflect the Missouri taxable income derived from sources within this statq and in order to prevent avoidance of such tax liability.” Section 143.431.3(5). By either route, where related corporations are using the deduction for royalty payments to remove income earned in Missouri from the amount to be taxed, the director should disallow the deduction. That would ensure that these companies that produce income from Missouri pay the taxes they owe to this state.