New Laws Take On Delaware Subsidiaries

A Delaware tax break is broken.

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One of the advantages that companies gain by incorporating in Delaware was recently stripped away by New York tax courts. The case involved paint maker Sherwin-Williams, which, as of 1991, maintained two subsidiaries in Delaware to manage its trademarks. Because the state does not require corporations to pay taxes on revenue derived from intellectual property (trademarks, patents, and copyrights), such subsidiaries -- known as passive investment companies, or PICs -- are common.

In the past few years, however, 15 states have passed so-called Add-Back legislation that challenged Delaware PICs. These laws assert that if a company uses intellectual property on a state's turf, the state has every right to tax the resulting revenue. Earlier, a case testing the Add-Back law in Massachusetts resulted in a ruling in Sherwin-Williams' favor. But then in October, a New York tax tribunal ruled that "tax avoidance" was the only reason to establish a Delaware PIC and supported Albany's right to send Sherwin-Williams a tax bill.

Does the ruling mean the party's over for PICs? Hardly. Delaware's business-friendly law books are still filled with many precedents that support PICs. Ultimately, the Supreme Court will probably have to weigh in. In the meantime, Michael J. Semes, a partner in the Philadelphia offices of law firm Blank Rome, says that "even with the increased risk of attack, there are tax and business advantages to this structure that every company should consider."

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