Comptroller of the Treasury v. Armco Export Sales Corp.

JAMES S. GETTY, Judge, Specially Assigned. The Comptroller of the Treasury has filed this appeal from an order of the Circuit Court for Baltimore City affirming a decision of the Maryland Tax Court relating to income tax assessments against three separate corporations. The Tax Court reversed assessments for the years 1981 through 1985 against Armco Export Sales Corp. (Arm-co); General Motors Export Corp. (GM); and Thiokol International, Inc. (Thiokol). The issues presented are whether the three corporations are required to pay Maryland corporate income taxes and, if so, whether limitations bars the assessments for 1981 through 1983?

Each of the corporations is a Domestic International Sales Corporation, or DISC, which is a phantom book entry corporation created under the federal tax laws as a device to encourage exports through an exemption from otherwise taxable profits. By definition, a sales DISC (I.R.C., sec. ⁴³¹ 992(a)(1)(A)), earns income because it buys goods from its parent company and then resells the goods to an actual overseas customer; a commission DISC earns its income by a contractual agreement with its parent company giving it a percentage of each qualifying export sale made by the parent (I.R.C., sec. 992(a)(1)(C)). In either case, no activity is performed by the DISC to earn the income. DISC income is taxable income, but if the DISC transactions meet the tests of I.R.C., secs. 991-997, a DISC pays no federal taxes.

Instead, a percentage of its income is imputed to the parent company as a constructive taxable dividend; the balance is taxable to the parent when it is actually distributed as a dividend. In short, DISC’S are an approved device designed to defer paying the full amount of tax due when the income is received. This artificial accounting between related corporations is an exception to the general rule, I.R.C. sec. 482, requiring transactions between parent and subsidiary corporations to be arms length dealing. 1 The following facts are applicable to each of the three corporations involved herein. Each is a DISC; none of the three has ever filed a Maryland corporation income fax return or paid corporate income taxes in this state; each is a wholly owned subsidiary of a multinational parent doing business in Maryland and filing a Maryland corporate tax return; each parent is a unitary business with a unitary relationship with its DISC; in all of the tax years at issue (except January, 1981 and January, 1982 for Thiokol) each parent produced goods in this state that were exported outside the United States, generating taxable income for the DISC which, except for the DISC, would have accrued to the parent; none of the ⁴³² DISC’S had any tangible assets or employees anywhere; each DISC functioned solely as a bookkeeping entity recording profits from foreign sales by its parent; no DISC or parent was incorporated in Maryland and none of the parent companies had its headquarters in Maryland.

GM has an automobile assembly plant in Baltimore. During the tax years in issue, export sales of goods manufactured in Maryland ranged from $39,000,000 to $138,785,000. The accounting and bookkeeping functions for the DISC were performed by headquarters personnel in Detroit, Michigan. Thiokol is in the rocket and chemical business and has a rocket engine facility in Elkton, Maryland.

The DISC’S books and records were kept in Marshall, Texas, and sales data would be delivered there by letter or telephone from the parent company. Armco has steel production facilities in Maryland. Its accounting procedures were handled by its various divisional branches. Armco’s Maryland tax returns disclosed the amount of dividends from the DISC to the parent, but not the taxable income of the DISC.

On these facts, the Comptroller asserts that taxation is required by state law and is necessary to reflect the economic reality of DISC transactions. The Tax Court reversed the assessments, reasoning that the Comptroller had failed to establish any nexus between Maryland and the three DISC’S. The Comptroller’s response to the Tax Court holding is that a DISC is doing business in Maryland within the meaning of Article 81, sec. 316, and the nexus is established by the parent of the phantom corporation engaged in the export business in the state. The law relied upon by the Comptroller for imposition of the tax is Article 81, sec. 288(b) and (c), which imposes a tax on any corporation having income allocable to Maryland under the provisions of sec. 316. The latter section allocates income between Maryland and other states by use of an apportionment formula.

The factors employed in the ⁴³³ allocation are not relevant to the issues herein. The Comptroller finds further authority for taxing the DISC income in Xerox v. Comptroller, 290 Md. 126, 142 , 428 A.2d 1208 (1981), which defined the reach of sec. 316 as extending as far as the constitution permits. Thus, the Comptroller claims, if the constitution permits a tax, Maryland imposes it. See also NCR Corp. v. Comptroller, 313 Md. 118 , 544 A.2d 764 (1988).

The Comptroller also cites two recent decisions of this Court involving DISC’S, Ward Europa Inc., v. Comptroller, 66 Md.App. 332 , 503 A.2d 1371 (1986), and Comptroller v. Armco, Inc., 70 Md.App. 403 , 521 A.2d 785 (1987). In Ward, this Court (Bloom, J.) allowed a modification of the formula in calculating the tax due from a DISC. Expressing legislative intent, Judge Bloom said: We do not believe that the legislature intended as bizarre a creature as a DISC to escape all tax liability in this State, and we shall not interpret the statute in question to produce such a result. 66 Md.App. at 344 , 503 A.2d 1371 . In Armco, we said (Pollitt, J.) in footnote 11: Armco did not actually endure a double tax, because its DISC paid no corporate income tax____ There would have been no constitutional bar to taxing Armco’s DISC, however, as all DISC’S face the same tax consequences regardless of how much of their income is subject to Maryland tax. 70 Md.App. at 413 , 521 A.2d 785 .

We agree that the DISC in Ward was subject to tax, but a significant difference between Ward and the three DISC’S involved herein lies in the fact that Ward’s only place of business was located in Maryland, and whatever activity was performed by the DISC occurred here. In the present case, none of the DISC’S performed any services or transacted any business in Maryland. The question then arises, do we construe the footnote in Armco as establishing that every DISC whose parent con ⁴³⁴ ducts business in Maryland is subject to taxation? The issue of taxing Armco’s DISC was not before the Court and the holding of the ease was that sec. 280A(e)(7) of Code Article 81 is unconstitutional because it discriminated against parent corporations who conduct less than 50% of their business here by denying them the same tax exclusion granted corporations doing more than 50% of their business in Maryland.

We said, in Armco, that until 1978 the Maryland tax scheme did not contain any special provision for DISC’S. Without legislation clarifying the status of DISC’S, the possibility, if not the probability, of double taxation was readily apparent. The state could tax the DISC’S allocable income when it was in the “hands” of the DISC and then tax the allocable “deemed distributed income” a second time when the income was, by a bookkeeping entry, transferred to the parent. . The General Assembly attempted to remedy the problem by repealing and re-enacting Art. 81, sec. 280A(c), in 1978. The title to the Act states that its purpose is to tax dividends received by a Maryland corporation from the earnings of an affiliated subsidiary domestic international sales corporation (DISC) to the same extent as dividends received by Maryland corporations from any other affiliated corporation.

As amended, the