Scioto Insurance Co. v. Oklahoma Tax Commission

REIF, J. 1 This case concerns the liability of Scio-to Insurance Company, a Vermont corpora [783] tion, for Oklahoma corporate income taxes for the years 2001 through 2005. The Oklahoma Tax Commission assessed Scioto corporate income taxes for these years based on payments it received from the use of Scioto's intellectual property by Wendy's restaurants in Oklahoma. The intellectual property in question consists of trademarks and operating practices for Wendy's restaurants. T2 In support of its assessment, the Oklahoma Tax Commission points out that the amount of money Scioto receives for use of this intellectual property is based on a percentage of the gross sales of the Wendy's restaurants in Oklahoma. The Tax Commission contends that the case of Geoffrey, Inc. v. Oklahoma Tax Commission, 2006 OK CIV APP 27, 182 P.3d 632, holds that this type of business connection to Oklahoma is sufficient to support taxation of an out-of-state corporation. T3 In support of its protest of the assessment, Scioto notes it was established under the laws of the State of Vermont by Wendy's International, Inc., to insure various risks of Wendy's International and its affiliates. In establishing Scioto, Wendy's International transferred the intellectual property to Scio-to to meet the capitalization requirements of the State of Vermont for an insurance business. Seioto stresses that it is not in the restaurant business and has no say where a Wendy's restaurant will be located, including Oklszhoma. Scioto notes that it does not provide insurance to any person or entity in Oklahoma. T4 Scioto admits that it derives income from licensing the use of the intellectual property but notes its only licensing agreement is with Wendy's International. Individual Wendy's restaurants in Oklahoma acquire the right to use the intellectual property under a sub-license with Wendy's International. Wendy's restaurants in Oklahoma pay 4% of their gross sales to Wendy's International for use of the intellectual property and Wendy's International reports such income to the Oklahoma Tax Commission. Wendy's International, in turn, pays an amount equal to 3% of such gross sales to Scioto under the licensing agreement with Scioto and deducts this 3% payment amount on its Oklahoma tax return. T5 It is clear that use of the intellectual property in question by individual Wendy's restaurants in Oklahoma has several taxable consequences. First, it produces both sales of products and income that are taxable under Oklahoma law. Second, the use of the intellectual property by Wendy's restaurants in Oklahoma plays an important role in the production of employment-based taxes. Third, the right to use the intellectual property by an individual Wendy's restaurant is subject to ad valorem taxation as personal property in the county where the restaurant is located. See Southwestern Bell Telephone Co. v. Oklahoma State Board of Equalization, 2009 OK 72, 231 P.3d 688. Finally, there is no question that Oklahoma can tax the value received by Wendy's International in contracting with individual Wendy's restaurants in Oklahoma to use the intellectual property. T 6 What is not clear is the basis for Oklahoma to tax the value received by Scioto from Wendy's International under a licensing contract that was not made in the State of Oklahoma and no part of which was to be performed in Oklahoma. Any further transfer of the right to use the intellectual property, including sub-licensing agreements with Wendy's restaurants in Oklahoma, is the legal act and sole responsibility of Wendy's International. In addition, the obligation of Wendy's International to pay Scioto based on a percentage of sales by Wendy's restaurants in Oklahoma is not dependent upon the Oklahoma restaurants actually paying Wendy's International. Wendy's International must pay Scioto under their licensing agreement whether or not any of the Oklahoma restaurants ever pay Wendy's International. T7 Oklahoma simply has no connection to or power to regulate the licensing agreement between Scioto and Wendy's International, any more than it had a say in whether the State of Vermont should license Scioto or allow the intellectual property to be one of Seioto's capital assets. Unlike the situation in the Geoffrey case, Scioto is not a shell entity and the licensing agreement between Scioto and Wendy's International is not a [784] sham obligation to support a deduction under Oklahoma law.1 The sum paid by Wendy's International under the licensing agreement with Scioto is a bona fide obligation, and the payments received by Scioto are a source of income for Scioto's insurance business (none of which is carried on in Oklahoma). The Oklahoma Tax Commission cannot summarily disregard the licensing agreement simply because it produces a deduction that the Commission does not like. T8 Scioto and Wendy's International, like any taxpayers, are entitled to rely on settled law in the use of their property and in ordering their affairs, to maximize any benefits allowed under the state and federal tax laws of this nation. One of the most important principles of settled law upon which a taxpayer may rely is that a state will apply its tax laws consistent with due process of law. In the case at hand, due process is offended by Oklahoma's attempt to tax an out of state corporation that has no contact with Oklahoma other than receiving payments from an Oklahoma taxpayer (Wendy's International) who has a bona fide obligation to do so under a contract not made in Oklahoma. See Quill Corp. v. North Dakota, 504 U.S. 298, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992). The fact that the Oklahoma taxpayer can deduct such payments in determining the Oklahoma taxpayer's income tax liability is not justification to chase such payments across state lines and tax them in the hands of a party who has no connection to the State of Oklahoma.2 CERTIORARI PREVIOUSLY GRANTED; COURT OF CIVIL APPEALS OPINION IS VACATED; ORDER OF THE OKLAHOMA TAX COMMISSION IS REVERSED AND REMANDED WITH INSTRUCTIONS. T9 COLBERT, V.C.J., KAUGER, WATT, WINCHESTER, REIF, and COMBS, JJ., concur. 1 10 TAYLOR, C.J., and GURICH, J., dissent. 11 EDMONDSON, J., disqualified. Footnotes [1] Geoffrey, Inc. was formed and incorporated as a part of a reorganization of its parent corporation Toys 'R' Us, Inc. The parent corporation assigned its trademarks and operating practices to Geoffrey in exchange for Geoffrey, Inc. stock. Geoffrey, Inc., in turn, licensed use of the trademarks and operating practices back to its parent corporation. The parent corporation engaged in business in Oklahoma and paid taxes on its Oklahoma derived income, but deducted the royalty paid to Geoffrey. During the tax years at issue, Geoffrey had no full-time employees, conducted its business from office space it leased from an accounting firm and its sole activity was to license the trademarks and operating practices to the parent corporation. Geoffrey, 2006 OK CIV APP 27, 13, 132 P.3d at 634. In contrast, Scioto is a licensed and regulated insurance company that carries on a business entirely different from Wendy's restaurant business. [2] The proper point at which Oklahoma can assess taxes on the amount that Wendy's International pays to Scioto is when those funds are in the hands of Wendy's International. If the Tax Commission believes the amount paid by Wendy's International to Scioto should be taxed, then the Tax Commission should ask the Legislature to eliminate the deduction for payments made under licensing arrangements like the one in this case. While the Tax Commission is properly concerned with the taxation of business activity in Oklahoma, the Tax Commission cannot unilaterally close deduction lacunae or gaps in the revenue law with which the Commission disagrees. "[The proper remedy for OTC is not to have the courts expand the ... Tax Code's scope ... but rather to press for the gap's closure by the Legislature." Globe Life & Accident Ins. Co. v. Oklahoma Tax Commission, 1996 OK 39, ¶ 19, 913 P.2d 1322, 1329.