News and Insights

Alabama Taxpayer Files Petition for Certiorari with U.S. Supreme Court to Review the Issue of Royalty Payments to Intangible Holding Companies in VFJ Ventures, Inc. v. Surtees

Tax Development Feb 26, 2009

On January 21, 2009, Alabama taxpayer VFJ Ventures, Inc. (“VFJ Ventures”) requested that the United States Supreme Court (“Court”) review its constitutional challenge to an Alabama statute, enacted in 2001, requiring the add-back of royalty payments made to related parties for purposes of calculating the state’s corporate income tax. This appeal was filed after the Alabama Supreme Court affirmed the decision of the State Appellate Court (“Appellate Court”) against the taxpayer. The taxpayer has asked the Court to consider two separate issues. The first is whether Alabama’s add-back statute discriminates against interstate commerce in violation of the Commerce Clause of the United States Constitution, by denying a deduction for ordinary business expenses because they are paid to out-of-state corporations located in states that do not tax the income. The second is whether the add-back statute violates the Due Process and Commerce Clauses of the United States Constitution by denying a deduction for ordinary business expenses paid to out-of-state corporations, based on the tax policies of states in which those corporations are located.

VFJ Ventures, a jeans manufacturer, made payments to two Delaware-based subsidiaries for use of their trademarks, deducting the payments as ordinary business expenses. An audit by the Alabama Department of Revenue (DOR) required the taxpayer to add these expenses back under Ala. Code § 40-18-35(b)(1), the state’s add-back statute. The taxpayer challenged the state’s add-back statute in state court on state statutory and federal constitutional grounds and was successful at the trial court level on the state statutory grounds. However, the Court of Civil Appeals reversed, holding that the add-back statute did not discriminate against interstate commerce because the subject-to-tax exception does not benefit in-state corporations to the detriment of out-of-state corporations. Also, the Appellate Court held the taxpayer had not demonstrated that the add-back statute resulted in taxation of income that was not fairly attributable to Alabama. The taxpayer argued the intangible holding companies that received the royalty payments were subject to tax in North Carolina, and the add-back did not apply. However, the Appellate Court noted that the “subject to tax” exception required that the intangible income both be reported and included in income for other state income tax purposes, and since the Legislature had used both words, “included” meant something different than “reported.” The taxpayer appealed to the Alabama Supreme Court, which affirmed the Appellate Court decision.

Ryan will continue to monitor future developments in this case before the Court.

VFJ Ventures, Inc. f/k/a VF Jeanswear, Inc., v. G. Thomas Surtees, Commissioner, Alabama Dept. of Revenue, U.S. Supreme Court Docket No. 08-916.