ConAgra Foods RDM v. Comptroller

ConAgra Foods RDM v. Comptroller (Ct. of Special Appeals)

Filed: June 27, 2019

Opinion by: Judges Woodward, Arthur and Leahy

Holding:

Foreign intellectual property holding company subsidiaries of corporations doing business in Maryland have no economic substance and are taxable separately from the parent.

Facts:

ConAgra is a processed food conglomerate that sold products in Maryland from 1996 through 2003, filed tax returns in Maryland and paid income tax.  One of its subsidiaries, Brands, was formed for the sole purpose of serving as an intellectual property holding company.  Brands licensed the trademarks to ConAgra and received royalties, and paid royalties back to the parent.

In 2007, the Comptroller of Maryland issued a Notice and Demand to File Maryland Corporation Income Tax Returns for 1996 through 2003 as well as a Notice of Assessment totaling $2,768,588 in back taxes, interest and penalties.  The Maryland Tax Court upheld the Comptroller’s assessment because Brands lacked “economic substance” as a separate business entity, which satisfied the U.S. Constitution requirements of “minimum contacts” and “nexus”. 

Analysis:

To meet U.S. Constitutional standards, the government’s tax collection procedures must provide taxpayers with “fair warning” to satisfy the Due Process Clause of the U.S. Constitution.  Under the Mobil Oil standard there must be a minimal connection between the interstate activities and the taxing State, and a rational relationship between the income attributed to the State and the intrastate values of the enterprise.  Mobil Oil Corp. v. Comm’r of Taxes of Vermont, 445 U.S. 425 (1980).  The Commerce Clause is designed to prevent States from engaging in economic discrimination, and requires that a tax (1) apply to an activity with a substantial nexus with the taxing State, (2) be fairly apportioned, (3) not discriminate against interstate commerce, and (4) be fairly related to the services the State provides.  Philadelphia v. New Jersey, 437 U.S. 617.

These criteria have been implemented by the Court of Special Appeals in several cases, and the Court agreed with the Maryland Tax Court in this case after reviewing the standards from Gore Enter. Holdings, Inc. v. Comptroller, 437 Md. 492 (2013) and Comptroller v. SYL, Inc., 375 Md. 78 (2003) as well as Comptroller v. Armco Exp. Sales Corp., 82 Md. App. 429 (1990).  In Gore, Gore assigned all of its patents and certain other assets to the wholly owned subsidiary in exchange for the subsidiary’s entire stock.  The four factors in Gore that helped the Court determine if the wholly owned foreign subsidiary lacked economic substance and was consequently subject to income tax in Maryland were:  1. How dependent the subsidiary is on the parent for its income; 2. Whether there is a circular flow of money between the two companies; 3. How much the subsidiary relies on the parent for its core functions and services;  4. Whether the subsidiary engages in substantive activity that is in any meaningful way separate from the parent.  Also, in SYL, the Court of Appeals adopted the Armco reasoning and found that sheltering income from state taxation was the predominant reason for the creation of SYL.

Here, Brands was dependent on ConAgra for the “vast majority” of its income, there was a circular flow of money between the companies, Brands relied on the parent for its core functions, and it did not have any meaningful substantive activity separate from ConAgra.

Separately, the Court also approved the State’s blended apportionment formula to determine Brands’ taxable income as an altered formula is permitted by Tax General Article 10-402(d) to clearly reflect income.  Here, the popular 3-factor apportionment formula based on property, payroll and sales would have yielded an apportionment factor of zero.  The blended formula accounted for ConAgra taking deductions for the royalty expenses.

The full opinion is available PDF.

Mas Associates, LLC, et al. v. Harry S. Korotki (Ct. of Appeals)

Filed: August 8, 2019

Opinion by: J. Adkins

Holding: The evidence cannot sustain the simultaneous intent to form both an LLC and a partnership where the parties engaged in negotiations to become members of an existing LLC and never abandoned that intention; they governed the entity and made capital contributions to it consistent with the terms of the existing LLC operating agreement; and in the interim period before becoming members, they agreed to be employees rather than partners, and treated payments made to them as salary rather than shared profits.

Facts:

In 2009, Appellee and two defendants, one of whom was a member of the Appellant LLC, began discussing the possibility of merging their companies to increase profitability. The parties held discussions about what form the merger would take and eventually agreed to dissolve the other companies and join the Appellant LLC.

The parties agreed during a business planning meeting that the parties should own Appellant LLC at approximately a third each (plus a minority) and, to achieve this, planned a transfer of interests under the Appellant LLC's existing 2004 operating agreement. They also agreed during the meeting to divide their affairs into an interim and post-interim period. During the interim period, the parties agreed that they would be employees who would receive compensation equal to one-third of the profits. Appellee and the non-owner defendant would also liquidate their companies and surrender their licenses. The parties' attorneys circulated a draft interim agreement and a draft operating agreement, which were extensively negotiated but never signed. For years, the parties engaged in the business and eventually began turning a profit. Other relevant details are discussed in the analysis section.

In 2011, Appellee resigned from his position and attempted to negotiate his departure. The defendants refused to meet with him, and Appellee filed a claim in the Circuit Court for Baltimore County. Among other claims, he pleaded for a determination of the buyout price of his partnership interest. The trial court found in favor of Appellee on all but one of his claims. The trial court found that a partnership had existed because the parties made management decisions together and contributed money equally during the course of the business and awarded damages accordingly. The question presented here is whether competent material evidence exists in the record to support the trial court’s conclusion that the parties intended to form a partnership.

Analysis:

In Ramone v. Lang, No. Civ.A. 1592-N, 2006 WL 905347 (Del. Ch. Apr. 3, 2006), the Ramone court held that there was no partnership between two parties who had discussed buying a swimming center by forming an LLC. When negotiations failed, and one party went on to form an LLC with other individuals, the other party claimed they had formed a partnership in the course of their negotiations. The Ramone court held that the failure to form an LLC without more did not make them partners given the reality that they had never agreed on their obligations to one another.

The Court also cited other case law and sources for the proposition that “it would be inequitable to construe arms-length negotiations between sophisticated parties to form an LLC concurrently as intent to form a partnership when those negotiations fail.” See Grunstein v. Silva, C.A. No. 3932-VCN, 2011 WL 378782 (Del. Ch. Jan. 31, 2011); Christine Hurt, D. Gordon Smith, Alan R. Bromberg & Larry E. Ribstein, on Partnership sec. 204[B]; and Garner v. Garner, 31 Md. App. 641 (1976). The Court concluded that these principles are applicable here.

Here, the parties’ initial goal, which remained consistent throughout the negotiations, was to each obtain a membership interest in the Appellant LLC. To govern their relations until they could reach that goal, the parties entered an interim agreement whereby they would be employees and not partners. Critically, the parties never abandoned their efforts to become members of the Appellant LLC.

As for other factors that courts commonly look toward to evaluate partnership intent, the Court also found in favor of the Appellants. In terms of the management and control factor, the Court held that the parties were acting in accordance with the terms of the existing 2004 operating agreement and that their joint decision-making is consistent with the typical duties of an LLC manager. Also, casual use of the word “partner” is not determinative, particularly when the parties did business under the registered tradename of the Appellant LLC.

As for the capital contributions factor, the parties made payments first to another member of the Appellant LLC who then transferred them to the Appellant LLC because such was the procedure demanded under the existing 2004 operating agreement. Such elaborate steps would have been unnecessary if the parties intended to contribute to a partnership. Finally, the Revised Uniform Partnership Act prohibits blurring the lines between partnerships and other entities. To treat the contribution to an LLC as a contribution to a partnership would be to treat the entities as one in the same in contravention of the express terms of the law.

As for the sharing of profits and losses factor, the Court cited Ingram v. Deere, 288 S.W.3d 898-99 in support of the contention that salary can be a share of gross revenue. Here, the payments to the parties were denoted as salary on the payroll journal, their wages were calculated on W-2 forms--which included typical wage withholdings--they reported wages on their Form 1040 tax returns, and no one filed a K-1 schedule reporting profits. The business paperwork also reflected their titles as managers and officers. Also, Appellee never intended to be equally liable for the debts of the alleged partnership, as evidenced by his unwillingness to be held jointly and severally liable for loans or execute any indemnity agreements to that effect.

As a result, the Court of Appeals reversed the lower court, determining that the trial court was clearly erroneous in finding an intention to form a partnership by the parties to the litigation.

The full opinion is available in PDF.