National companies can't divide up their business in ways designed solely to minimize their Arizona corporate tax liability, the state Court of Appeals has ruled.
In a unanimous ruling, the judges rebuffed a bid by Home Depot USA Inc. to claim that an affiliate which owns that “Home Depot” trademark is not really part of the retail chain that is doing business in Arizona. The judges said the arguments presented by the company make no sense.
The ruling most immediately affects Home Depot with dozens of retail stores in the state, and the numbers may be huge.
Nationally, the company claims that the income from Home Depot stores in a three-year period at issue was $3.8 billion. But it says that revenues for that same period for the out-of-state affiliate known as “Homer” which happens to own the “Home Depot” trademark — and whose income the corporation argued could not be considered in Arizona — were $4.7 billion.
The exact dollar effect for Arizona was not listed in the court records.
But the ruling has broader implications, affecting all major corporations and the ways they divide up their business.
In this case, Home Depot challenged the findings by the Department of Revenue that Home Depot and Homer were, in fact, one corporation for Arizona tax purposes — and that Homer's income had to be considered in the parent corporation paying Arizona income taxes. But Assistant Attorney General Kimberly Cygan, arguing for the state, said that contention made no sense.
She pointed out that the only real business of Homer was to hold the trademarks for Home Depot.
“Home Depot needed the intellectual property to make its sales and be able to secure repeat business in the state,” Cygan said. “And the subsidiary that held the trademark needed Home Depot obviously just because that's how it made its money.”
Put another way, she said, they could not exist separately.
“If Home Depot were to go out of business, then the trademarks would not be worth anything,” Cygan said.
The Court of Appeals agreed.
“Home Depot would not be ‘Home Depot’ without the trademarks that it licenses from Home for its retail stores, advertising and website,” Johnsen wrote. “By the same token, without Home Depot's continuing efforts to promote its brand, the trademarks that constitute Homer's only assets would be worthless.”
Johnsen said that during the tax years at issue, Homer earned between $789 million and $2 billion a year. All but 3 percent of those revenues came from domestic Home Depot affiliates, with two thirds of the remainder involved in licensing to foreign affiliates.
The judge said it's also irrelevant that many of the products sold at Home Depot bear trademarks from other manufacturers.
“Home Depot's advertisements and website use the ‘Home Depot’ trademark to invite customers looking for home improvement products to visit its stores,” she wrote. And once they arrive they are greeted with “Home Depot” signs on everything from the front of the store to shopping carts, employee badges and shopping bags.
“Under these circumstances, the company's argument that it most certainly can advertise and promote the products it sells without relying upon its own trademarks does not withstand scrutiny,” Johnson said.
A Home Depot spokesman declined to comment on the ruling.
Ernest Powell, manager of tax research and analysis at the Department of Revenue, said the court's decision is in line with Arizona law which uses a “unitary” tax system.
He said the purpose of the Arizona law is to ensure that all sources of income attributable to business here are taxable. Otherwise, he said, a corporation could adjust what one affiliate charges another in a way to push as much of its income into a more tax-favorable state.
“What the unitary purpose does is you combine them together and you look at the sale to the final consumer,” Powell said.
“They can mark it up however they want at each level,” he explained. “But in reality you're still selling it for the same amount to the final entity.”