US vs. Sherwin-Williams Company, October 2002, Massachusetts Supreme Judicial Court, Case No 438 Mass. 71

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Sherwin-Williams is an Ohio corporation, headquartered in Cleveland, and is engaged in the manufacture, distribution and sale of paints and paint-related products. In 1991, it formed two subsidiaries under Delaware law to hold certain tradenames, trademarks and service marks that it had developed. Sherwin-Williams and the subsidiaries teen entered into nonexclusive licensing agreements for the right to use these various intangibles.

In filing its 1991 state income tax return, Sherwin-Williams deducted all royalty and interest expenses accrued under the agreement, in computing taxable income.

Following an audit, the Department of Revenue disallowed the deductions and assessed additional tax, because the transfer and license back of the marks was a “sham” disallowed under the “sham-transaction doctrine”. According to the Department of Revenue the royalty payments were not deductible, because the transactions had no valid business purpose and transactions were not at “arm’s-length.”

On appeal, the Appellate Tax Board upheld the assessment of the tax authorities.

Judgement for the Court

The Supreme Judicial Court of Massachusetts concluded that the Appellate Tax Board incorrectly found that certain transfer and licensing back transactions between the corporate taxpayer and its subsidiaries were without economic substance and therefore a sham, where the record established that the transactions between the corporate taxpayer and its subsidiaries were genuine, creating viable businesses engaged in substantive economic activities apart from the creation of tax benefits for the taxpayer.

Certain royalty payments made by a corporate taxpayer to two wholly owned subsidiaries for the use of certain trade names, trademarks, and service marks (marks) that the taxpayer had transferred to the subsidiaries and licensed back as part of a corporate reorganization of its intangible assets were deductible by the taxpayer as ordinary and necessary business expenses, where obtaining licenses to use the marks was necessary to the conduct of its business; and where, even assuming G. L. c. 63, s. 39A, empowered the Commissioner of Revenue to eliminate payments made between a foreign parent corporation and its subsidiaries, it did so only to the extent that such payments were in excess of fair value, and in light of the substantial evidence that the royalties paid by the taxpayer reflected fair value, that was no basis to support the elimination of the payments.

This court concluded that certain interest expense paid by a corporate taxpayer to a wholly owned subsidiary in connection with a loan made to it by the subsidiary, which was later repaid, was deductible, where certain transfer and license back transactions between the taxpayer and its subsidiary were not a sham, where royalty payments by the taxpayer to the subsidiary were necessary and ordinary business expenses of the taxpayer, and where there was no dispute that the loan was actually made.



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