Court Opinion

ID: 5157211
Source: CourtListenerOpinion
Date Created: 2022-01-02 02:25:01.201446+00
Date Added: 2024-06-11T08:25:25.412741
License: Public Domain

GURICH, J.,
with whom TAYLOR, C.J. joins dissenting:
11 I respectfully dissent. I would affirm the imposition of corporate income tax by the Oklahoma Tax Commission.
I 2 Scioto Insurance Company is a subsidiary of Wendy's International, Inc. The company is responsible for providing business interruption insurance to Wendy's and its affiliates.1 Oldemark, LLC is a Vermont holding company whose sole purpose is to maintain ownership of Wendy's intellectual property rights.2 Oldemark controls the *785fast-food company's trademarks, copyrights, and knowledge related to opening and operating a Wendy's restaurant. In return, Olde-mark receives revenue associated with the use of these intangibles by Oklahoma Wendy's franchises. Scioto is the sole member of Oldemark; therefore, the LLC is a disregarded entity for tax purposes.3 All income of Oldemark is attributable to Scioto.
T3 Pursuant to an October 2001 amended licensing agreement, Oldemark granted Wendy's the right to use and sublicense its intellectual property to affiliate-owned and franchisee-owned restaurants. In return, Wendy's paid Oldemark a license fee equal to three percent (8%) of restaurant gross sales. Wendy's sublicensed the intellectual property rights to individual franchises for a fee equal to four percent (4%) of the restaurant's gross sales.
T4 Wendy's franchise disclosure documents informed prospective franchisees that Oldemark was the owner of the intellectual property. The disclosure documents also indicated that Oldemark "records on its books the royalty income received by Wendy's from you and its other franchisees, while Wendy's serves as the collecting agent for the Oldemark royalty income."4 Following receipt of royalty payments from Oklahoma franchises, Oldemark loaned the income back to Wendy's in exchange for demand notes. Wendy's claimed deductions equivalent to the three percent (8%) royalties and interest on the notes which was paid toOldermark.5 The practical effect of these transactions was the virtual elimination of state income tax liability on earnings associated with licensing fees emanating from Oklahoma sales.6
T5 For the relevant taxable periods, only Wendy's filed Oklahoma corporate income tax returns. On February 21, 2008, the Oklahoma Tax Commission (OTC) issued an assessment of corporate income tax, penalties, and interest against Scioto totaling $546,644.00. A revised assessment was issued on October 5, 2009, in the amount of $434,361.00.7 Scioto filed a protest, alleging the company lacked minimum contacts with the State of Oklahoma and that levying a tax constituted a violation of the Commerce Clause.
DUE PROCESS CLAUSE
T6 In its first assignment of error, Scioto argues that the OTC corporate tax assessment is a violation of the Due Process Clause of the United States Constitution because the company lacks minimum contacts with Oklahoma. In Quill Corp. v. North Dakota By and Through Heitkamp, 504 U.S. 298, 306, 112 S.Ct. 1904, 119 L.Ed.2d 91, (1992), the Supreme Court defined the limitations placed on state taxing authorities by the Due Process Clause:
The Due Process Clause requires some definite link, some minimum connection, *786between a state and the person, property or transaction it seeks to tax, and that the income attributed to the state for tax purposes must be rationally related to values connected with the taxing State. (internal citations & quotations omitted).
However, physical presence is not mandatory to establish a constitutionally sufficient connection to meet the minimum contacts requirements of the Due Process Clause. When a taxpayer "purposefully avails itself of the benefits of an economic market," exercise of in personam jurisdiction will not offend due process, "even if [the taxpayer] has no physical presence in the state." Id. at 307-808, 112 S.Ct. 1904. In this case, Scioto authorized the use of Wendy's intellectual property rights in all fifty (50) states, including Oklahoma. Scioto directed its activities at the residents of Oklahoma and benefitted from the economic contact created via the Wendy's name and proprietary information. To put it another way, every hamburger sold in Oklahoma by Wendy's had a direct economic benefit to Scioto.
T7 The first state court case to address the interplay between the Due Process Clause and taxation of an out-of-state corporation's income attributable to intellectual property was decided by the South Carolina Supreme Court in Geoffrey, Inc. v. South Carolina Tax Comm'n, 813 S.C. 15, 437 S.E.2d 13 (19983). Geoffrey, Inc. was an entity created and solely owned by Toys R Us, Inc. Id. at 15. The parent company transferred its intellectual property rights to Geoffrey, who in turn, allowed the toy company to utilize those rights and business know-how in exchange for a payment equal to one percent (1%) of net sales. Id. Toys R Us filed income tax returns, but offset its corporate revenue with a deduction equivalent to the one percent (1%) license fee paid to Geoffrey. Id. The South Carolina taxing authority issued an assessment, and Geoffrey protested. Id. Finding Geoffrey had a sufficient connection to the state, the court rejected any claim that taxation violated the Due Process Clause:
Geoffrey's business is the ownership, licensing, and management of trademarks, trade names, and franchises. By electing to license its trademarks and trade names for use by Toys R Us in many states, Geoffrey contemplated and purposefully sought the benefit of economic contact with those states. Geoffrey has been aware of, consented to, and benefitted from Toys R Us's use of Geoffrey's intangibles in South Carolina. Moreover, Geoffrey had the ability to control its contact with South Carolina by prohibiting the use of its intangibles here as it did with other states. We reject Geoffrey's claim that it has not purposefully directed its activities toward South Carolina's economic forum and hold that by licensing intangibles for use in South Carolina and receiving income in exchange for their use, Geoffrey has the minimum connection with this State that is required by due process.
Id. at 16. Geoffrey sought review in the United States Supreme Court; however, cer-tiorari was denied. Geoffrey, Inc. v. South Carolina Tax Comm'n, 818 S.C. 15, 487 S.E.2d 18 (1998), cert. denied 510 U.S. 992, 114 S.Ct. 550, 126 L.Ed.2d 451 (1998).
8 Scioto intentionally placed Wendy's intellectual property in the stream of Oklahoma commerce, and purposefully sought the advantages of economic contact with our state. The income generated from restaurant sales in Oklahoma was recorded on the books of Oldemark. 'This economic presence was sufficient contact to satisfy the fundamental principles mandated by the Due Process Clause.
COMMERCE CLAUSE
T9 Scioto also challenges Oklahoma's assessment of income tax based on an alleged violation of the Commerce Clause of the U.S. Constitution.8 Although review of the constitutional constraints on state income taxation *787under the Commerce Clause is similar to the analysis required by the Due Process Clause, the two are not identical. Quill, 504 U.S. at 305, 112 S.Ct. 1904. The validity of a state tax under the Commerce Clause is measured according to a four-part test:
Under Complete Auto's four-part test, we will sustain a tax against a Commerce Clause challenge so long as the tax (1) is applied to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (8) does not discriminate against interstate commerce, and (4) is fairly related to the services provided by the State.
Quill, 504 U.S. at 311, 112 S.Ct. 1904, (citing Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279, 97 S.Ct. 1076, 51 L.Ed.2d 826, (1977)); see also In The Matter Of The Assessment Of Personal Property Taxes Against Missouri Gas Emergy, A Division Of Southern Union Company, For Tax Years 1998, 1999, and 2000, 2008 OK 94, I 48, 234 P.Sd 938, 953. The first and fourth prongs of the Complete Auto analysis limit a state's ability to impose taxation which would burden interstate commerce. Quill, 504 U.S. at 313, 112 S.Ct. 1904. The second and third requirements prohibit taxation that places an unfair share of the tax burden on interstate commerce. Id.
[ 10 Scioto suggests that taxation by Oklahoma would offend the protections provided by the Commerce Clause because the company lacks a substantial nexus with the state. The Oklahoma Court of Civil Appeals rejected the application of a bright-line physical presence requirement. Geoffrey, Inc., v. Oklahoma Tax Commission, 2006 OK CIV APP 27, 119, 132 P.3d 632, 688-6839 (declining to apply the physical presence test required for sales/use tax and finding the real source of the holding company's income was customers from Oklahoma).9 Since 1996, an OTC regulation put foreign corporations on notice that the licensing of intangible property rights in this state creates a nexus sufficient to subject the entity to income taxation.10 I agree with the Geoffrey analysis and would hold that the substantial nexus test was satisfied because Scioto's receipt of royalty income was directly connected to the use of its intellectual property in Oklahoma. The use of the Wendy's name and other intangibles in Oklahoma created an economic presence justifying taxation in this state. The majority of jurisdictions addressing the Commerce Clause and taxation of royalties received by an out-of-state holding company for use of the company's intellectual property have rejected the physical presence test and allowed imposition of state income tax based on an economic nexus.11
*78811 Scioto also maintains that the income tax imposed by Oklahoma was not fairly apportioned. The OTC applied 68 O.8.Supp. 2010 2858(A)(5) and prior opinions from this Court to determine whether Scioto's income was derived from a unitary business enterprise. The OTC sufficiently established that Wendy's, Scioto, and Oldemark were part of a unitary business enterprise. The motivation behind this corporate anatomy was to shelter royalties generated from use of Wendy's trademarks and the company's proprietary information throughout the United States. The OTC correctly imposed corporate income tax.
CONCLUSION
[ 12 Electronic commerce continues to expand, and increasingly, interstate and international businesses have significant economic impact in a state without having a physical presence. While new legal concepts are challenging established law, the taxation of intangibles is not a recent phenomenon. Oklahoma courts and the OTC are in harmony.12 Scioto intentionally placed its property into the stream of Oklahoma commerce, realizing the benefits and protections afforded by the people and laws of this state. The presence of Scioto's intellectual property within Oklahoma is a sufficient nexus for the imposition of corporate income taxes. As such, I would affirm the determination by the OTC and authorize the imposition of income tax against Scioto.

. During oral argument, counsel for Scioto acknowledged the company has never paid an insurance claim.

. Oldemark acquired the intellectual property rights through a series of corporate reorganizations, licensing agreements, and assignments, beginning in approximately 1989.

. It is undisputed that Oldemark was a disregarded entity under federal law-meaning any tax obligation of the LLC became the responsibility of Scioto. Oklahoma follows the federal rule for tax treatment of a single member LLC. 68 O.S. 2011 202(j). No error is alleged.

. Wendy's International, Inc. Franchise Offering Circular (2005) (emphasis added). This language would seem to create a direct connection between use of the intellectual property in Oklahoma through Oldemark and Scioto.

. The dynamic behind this kind of corporate structuring to eliminate taxation was explained in a legal treatise:
One of the standard tax-planning devices corporations have employed to reduce taxable income in states where they conduct their operations is to transfer their trademarks or trade names to an intangibles holding company (IHC) and license back the trademarks or trade names for a royalty. The royalty, which is deductible to the operating company, reduces its income in the states where it carries on its business. The IHC, on the other hand, ordinarily pays no tax on its royalty income because it is taxable-or at least taxpayers so contend-only in a state that does not tax such income (e.g., Delaware).
J. Hellerstein & W. Hellerstein, State Taxation 1 9.20[71G] (3d ed.2012).

. Examining the precise tax scheme faced in this case, the South Carolina Supreme Court noted that the "net effect of this corporate structure has been the production of 'nowhere' income that escapes all state income taxation." Geoffrey, Inc. v. South Carolina Tax Comm'n, 313 S.C. 15, 437 S.E.2d 13, 15, n. 1 (1993) (citing Rosen, Use of a Delaware Holding Company to Save State Income Taxes, 20 Tax Adviser 180 (1989)).

. This change reflected an adjustment to coincide with a federal amortization deduction.

. The Commerce Clause contains more than an affirmative grant of power; it also includes a negative component, often referred to as the dormant Commerce Clause. KFC Corp. v. Iowa Dept. of Revenue, 792 N.W.2d 308, 313 (Iowa 2010). This aspect of the clause has been construed as a limit on the power of states to impose taxes, even in the absence of affirmative acts of Congress. Id.

. By a vote of 7-1 this Court denied certiorari in Geoffrey v. Oklahoma Tax Commission, Supreme Court Case No. TC-99,938, on March 20, 2006.

. Okla. Admin. Code § 710:50-17-3(10) (1996). The relevant section, titled "What constitutes 'Nexus,' " reads in relevant part:
If a corporation has one or more of the following activities in Oklahoma, it is considered to have "nexus" and shall be subject to Oklahoma income taxes:
(9) Leasing of tangible property and of intangible rights for use in Oklahoma. (emphasis added). .
Other states have enacted similar administrative regulations. see e.g., Fla. Admin. Code Ann. R. 12C-1.011(1)(p)(1)(2006); Iowa Admin. Code 701-52.1(4)(422), Example 7 (Westlaw 2008); Mass. Dep'i of Revenue, Corporate Excise DOR Directive 96-2, July 3, 1996.

. See eg., KFC v. Iowa Dept. of Revenue, 792 N.W.2d 308, 328 (Iowa 2010) (concluding Commerce Clause is not offended based on Iowa income tax on royalties earned by allowing use of intangibles within the State of Iowa); Geoffrey, Inc. v. Comm'r of Revenue, 453 Mass. 17, 899 N.E.2d 87, 92 (2009) (applying substantial nexus test and rejecting Commerce Clause challenge based on income earned through use of intangible property in state); Lanco, Inc. v. Director, Div. of Taxation, 379 N.J.Super. 562, 879 A.2d 1234, 1242 (N.J.Super.Ct.App.Div.2005) (finding physical presence of Delaware holding company was not mandatory to impose income tax associated with licensing fees attributable to intellectual property targeting New Jersey consumers); Geoffrey, Inc. v. South Carolina Tax Comm'n, 437 S.E.2d at 18-19 (holding that by licensing intangibles for use in South Carolina, holding company had substantial nexus, such that taxing royalties from intellectual property would not violate the dormant Commerce Clause); A & F Trademark, Inc. v. Tolson, 167 N.C.App. 150, 605 S.E.2d 187, 195 (2004), cert. denied, 546 U.S. 821, 126 S.Ct. 353, 163 L.Ed.2d 62 (2005) (determining that "where a wholly-owned subsidiary licenses trademarks to a related retail company operating stores located within North Carolina, there exists a substantial nexus with the State sufficient to satisfy the Commerce Clause"); Tax Comm'r of State v. MBNA America Bank, 220 *788W.Va. 163, 640 S.E.2d 226, 234 (2006) (rejecting physical presence test and noting such a rigid interpretation of the Commerce Clause "makes little sense in today's world"); Comptroller of the Treasury v. SYL, Inc., 375 Md. 78, 825 A.2d 399, 415 (App.2003) (recognizing that entities holding intellectual property for parent company "had no real economic substance," and allowing taxation of a portion of income attributable to parent corporations' business in the state); see also Surtees v. VFJ Ventures, Inc., 8 So.3d 950, 976-981 (Ala.Ct.App.2008), cert. denied, - U.S. -, 129 S.Ct. 2051, 173 LEd.2d 1132 (2009); Secretary, Dept. of Revenue, State of La. v. GAP (Apparel), Inc., 886 So.2d 459, 462 (La.Ct.App.2004); Bridges, Secretary of Dept. of Revenue, State v. Geoffrey, Inc., 984 So.2d 115, 128 (La.Ct.App.2008).

. see n. 9 and n. 10, supra.