Tuesday, June 13, 2006

The Strength of Hercules

I follow a policy of not commenting on cases that either I or my firm are or have handled. However, that policy does not extend to commenting on cases that rely on cases that either I or my firm are or have handled. Science Applications International Corp. v. Comptroller, handed down by the Maryland Tax Court on May 11 falls into this category.

The holding in Science Applications was primarily based on the holding of the Court of Appeals of Maryland in Hercules Inc. v. Comptroller, 351 Md. 101(1998) where I represented the taxpayer. The opinion in Science Applications indicates that the Comptroller's Office either does not or is incapable of understanding the basic Constitutional principles concerning a state's ability to tax companies conducting interstate business.

The principles can be stated simply: A state can only tax economic activities that take place within its borders. However, a state can utilize a formula to tax a portion of a unified business conducted in more than one state so long as the formula reasonably reflects the actual business being conducted in the state attempting to levy the tax. Two or more entities may be aggregated into a single business for state tax purposes if there is an "operational connection" between their business activities.

Science Applications International Corporation had operations in Maryland. However, it also was the parent corporation that owned Network Solutions, Inc. Network Solutions operated independently of its parent. According to the findings of fact:
[Network Solutions] was managed independent of and separate from [Science Applications]. Approximately 5 of the 385 [Network Solutions] employees . . . came from [Science Applications]. [Network Solutions] hired a separate management team from outside [Science Applications], including technical, sales and marketing personnel. [Network Solutions] had a separate Board of Directors. [Network Solutions] had its own Human Resources Director and made its own decisions as to whom to hire and fire. Its first post-acquisition CEO was recruited through a national search campaign.
Based on these facts, it would seem beyond question that, as interpreted by the Court of Appeals in Hercules, there was no operational tie between Network Solutions and Science Applications. The Comptroller apparently argued, much as it had in Hercules, that statements in the parent's annual reports and the parent's financial statements supported a finding that there was an operational connection between the two businesses.

Apparently, the Comptroller hasn't figured out that the "operational function" test means that there have to be facts which show an active flow of "operational value" between two businesses before their respective incomes can be aggregated for state income tax purposes. That test requires that the the direction and control exercised by the parent to the subsidiary has to be greater than that which is exercised by any member of the board of directors of a company. In fact, as the name of the test would seem to indicate, the operations of the parent and the subsidiary have to be intertwined.

My understanding is that the Comptroller is not appealing this decision. However, I also understand that the Comptroller is going to refuse to pay interest on the refund due to Science Applications. Since I am currently involved in litigation on a similar issue, I will not comment on the Comptroller's obstinance or cramped reading of the statute that requires that interest be paid on tax refunds.

1 comment:

Susan Craze said...

My understanding from reading different pieces on the From The Wilderness website is that the Hercules Corp. is a front for the CIA. That's what I got out of what Hercules does and who they do it for.