In a ruling that could open a hidden vault of new tax revenue for Maryland, the state Court of Appeals ruled yesterday that companies doing business in Maryland cannot avoid the state's corporate income tax by funneling profits into subsidiaries in Delaware.
The court ruled unanimously that two companies with Maryland operations were circumventing the state's tax laws by transferring profits to Delaware offices that "were little more than mail drops."
The ruling concerned only two businesses and about $2 million in disputed taxes, but officials familiar with the cases said they could affect dozens of similar proceedings and perhaps hundreds of cases that have not reached the state court system.
The Maryland comptroller's office issued a statement yesterday saying that it has identified more than $33 million in potential tax revenue that the ruling might unlock.
The court's decision can be appealed to the U.S. Supreme Court, but consumer advocates were hailing it yesterday for closing what they consider a sizable loophole in the state's corporate tax laws.
"If the court had ruled the other way, essentially it would have said that paying corporate income tax in Maryland is voluntary," said Steve Hill, director of the Maryland Budget and Tax Institute in Silver Spring.
"I'd say there are tens of millions, maybe hundreds of millions of dollars at stake here," Hill said. "I think it's likely there are thousands of shell subsidiaries out there that were created solely to avoid paying state income tax."
Yesterday's ruling concerned clothing retailer Syms Inc. and packaging manufacturer Crown Cork & Seal, which had transferred ownership of their trade names and patents to subsidiaries in Delaware. Profits from their Maryland operations were transferred to those subsidiaries as payments for use of the trademarks.
Unlike Maryland, Delaware does not require companies to pay taxes on income generated by "intangible assets" such as trademarks and intellectual property. The court ruled that the Delaware companies had little purpose beyond sheltering their Maryland cousins from the state's corporate taxes.
"Although officers of the parent corporations may have stated that tax avoidance was not the sole reason for the creation of the subsidiaries, the record demonstrates that sheltering income from state taxation was the predominant reason" the companies were created, wrote Judge John C. Eldridge, the opinion's author.
Disputes over corporate taxes owed by shell companies are an old issue between the states, particularly involving Delaware, but politicians have largely avoided taking on the century-old tax shelter because of the political costs of attacking a much-used corporate-tax loophole, said Richard D. Pomp, an expert on tax law at the University of Connecticut.
He said yesterday's ruling could embolden other state courts and lawmakers to become more aggressive.
"This is very significant, because states watch what is going on and it may give them more of a backbone to do something about the problem," said Pomp.
"It may put the fear of God in corporations, too, not to spend all this time on these techniques. Syms is probably symptomatic and the tip of the iceberg."
The Maryland General Assembly passed a bill in April designed to prevent businesses from using shell companies to avoid state taxes, but it was vetoed by Gov. Robert L. Ehrlich Jr., a Republican who has criticized the taxes imposed on Maryland businesses.
Shareese N. DeLeaver, Ehrlich's spokeswoman, noted that the ruling could be appealed but said Ehrlich "will respect the court's ultimate decision. The governor stands by his veto of the tax bill and remains firm in his belief that Maryland is a highly taxed state."
William Donald Schaefer, Maryland's Democratic comptroller, applauded the ruling and its "far-reaching implications beyond these two companies." He said he will work with the Maryland attorney general's office to go after potential tax revenue from other companies that do business in Maryland and export their profits to Delaware.
"The court's decision upholds our long-standing position that Delaware holding companies should pay their fair share of tax to Maryland when they demonstrate a clear connection to sales activity in Maryland," Schaefer said in a statement released after yesterday's ruling.
An official at Crown Cork & Seal said the company's attorneys had not reviewed the decision and declined to comment yesterday. A spokesman for Syms could not be reached.
Companies nationwide have lobbied in favor of Delaware holding companies as legitimate business tools and as protection against infringements on their intellectual property rights.
Consumer advocacy groups say arguments for corporate rights are likely to find little favor with individual taxpayers.
"The average homeowner can't just take out a P.O. box in Delaware to cheat on their state taxes," said Tom Hucker, executive director of Progressive Maryland, which represents churches, labor unions and community groups. "But we've allowed every corporation to do that for years."
Sun staff writers Andrew Ratner and Greg Garland contributed to this article.
