Be wary of tax risks when assessing IP holding companies

When the Talbots Company went public in 1993, it loaned $103 million to a subsidiary to purchase the Talbots trademark and collect royalties, permitting the parent company to shave over $1.1 million from its annual state tax bill. But the holding company returned over 96% of royalties to its parent—and in Talbots v. Mass. Comm’r of Revenue (Sept. 29, 2000), the Massachusetts Appellate Tax Board found that the entire transaction lacked economic and business substance “aside from state tax avoidance.” The Board upheld the Commissioner’s decision to disallow any deductions the company claimed for royalty payments to the subsidiary and reattributed all the sub’s taxable royalties to Talbots.

“In short, the Massachusetts Board decided that any company using an intangible holding company structure (which usually includes a ‘shell’ company holding trademarks and patents) is at risk unless the intangible holding company has economic substance,” writes David R. Jarczyk, CFO at ktMINE. “This topic is a hybrid valuation/transfer pricing issue. Lawyers and business appraisers should review this topic when working on IP projects for their clients.”