The Sherwin-Williams Co. v. Commissioner of Revenue (July 19, 2000)

COMMONWEALTH OF MASSACHUSETTS

APPELLATE TAX BOARD



THE SHERWIN-WILLIAMS CO.		v.	COMMISSIONER OF REVENUE

Docket No. F233560				Promulgated:
							July 19, 2000

	This is an appeal under the formal procedure pursuant to G.L. c. 62C, § 39, from the refusal of the appellee to abate corporate excise assessed against the appellant under G.L. c. 63, § 38 for tax year 1991. 
	Commissioner Scharaffa heard the appeal and was joined in the decision for the appellee by Chairman Burns and Commissioner Egan.  Commissioner Gorton took no part in the deliberations or decision of this appeal.
	These findings of fact and report are made at the request of the appellant and the appellee pursuant to G.L. c. 58A, § 13 and 831 CMR 1.32.

	Paul H. Frankel, Esq., Craig G. Fields, Esq. and Maxwell D. Solet, Esq. for the appellant.

	Steven A. Remsberg, Esq., Karen L. Paino, Esq. and 
Michael T. Fatale, Esq. for the appellee. 



FINDINGS OF FACT AND REPORT
On the basis of a stipulation of facts and testimony and exhibits introduced in the hearing of this appeal, the Appellate Tax Board ("Board") made the following findings of fact.  The taxpayer, the Sherwin-Williams Co. ("Sherwin-Williams"), is a corporation engaged in the manufacture, distribution and sale of paints and related products.  It was incorporated under the laws of the State of Ohio with its principal place of business in Cleveland.  The taxpayer manufactures and sells coatings under many brands, including its own signature brand, "Sherwin-Williams," and other brands, including "Dutch Boy," "Martin-Senour," "Kem-Tone," "Dupli-Color" and "Krylon."  To conduct its business, Sherwin-Williams uses hundreds of trademarks, trade names and service marks (the "Marks"), including the "Sherwin-Williams" trademark, several "Dutch Boy"  trademarks, and "The Look that Gets the Look" slogan.
On January 23, 1991, the Sherwin-Williams board of directors resolved to form two wholly-owned subsidiaries, Sherwin-Williams Investment Management Company, Inc. ("SWIMC") and Dupli-Color Investment Management Company, Inc. ("DIMC"), under Delaware law to hold its valuable trademarks.  The board decided that Sherwin-Williams would assign its Marks associated with non-aerosol products to SWIMC and those associated with aerosol products to DIMC.  The subsidiaries were to license the Marks back to Sherwin-Williams according to a License Agreement, under which Sherwin-Williams would pay royalties to these wholly-owned subsidiaries based upon the percentage of its sales of the products bearing those Marks.  SWIMC and DIMC were incorporated in Delaware seven days later.    
	The original board of directors for both SWIMC and DIMC were comprised of three individuals:  John Ault as Chairman of the board of directors, who also served as Vice President and Corporate Controller for Sherwin-Williams; Conway Ivy, who also served as Vice President and Treasurer of Sherwin-Williams; and Donald Puglisi, who was not previously affiliated with Sherwin-Williams.  Mr. Puglisi served as a director or officer of more than one hundred other corporations.  Many of these subsidiary corporations were formed by parent corporations for the purpose of holding the parents' intangibles pursuant to transactions substantially identical to the ones at issue in this appeal.  Before his appointment as President of SWIMC and DIMC, Mr. Puglisi had met with Sherwin-Williams representatives at a very short one and one-half hour lunch meeting during the previous summer to discuss the formation of the subsidiaries.  Mr. Puglisi did not have any trademark experience or experience in the paint industry.  He was paid $18,000 annually each from SWIMC and from DIMC for his services.  The other officers of the subsidiaries were Gordon Stewart, the Secretary for both subsidiaries, and Michael Semes, the Assistant Treasurer of both subsidiaries.  These officers were each paid $500 per year from both SWIMC and DIMC for their services.  The Employment Agreements did not identify any particular job duties for these individuals.  There were no other employees of the subsidiaries.  
SWIMC and DIMC jointly executed a lease agreement with the Bank of Delaware for the lease of an office.  The office was 12 feet by 12 feet with a total rent of $750 per month.  The subsidiaries used this space to store records.  Mr. Puglisi conducted his work as president of the subsidiaries, as well as other work in connection with his business, from his own business establishment, Puglisi and Associates, Inc. ("Puglisi and Associates"), located in Newark, Delaware.  Puglisi and Associates charged a rent of $360 annually to each subsidiary for the use of this space.  
	Sherwin-Williams agreed to contribute $50,000 plus all of its ownership rights in hundreds of its United States Marks to SWIMC in exchange for one thousand (1,000) shares of common stock of SWIMC, constituting all of the issued outstanding common stock of this subsidiary.  In addition, Sherwin-Williams agreed to assign to SWIMC a preexisting license agreement between itself and Taracorp, Inc. ("Taracorp"), an unrelated third party, which agreement gave Taracorp the right to use various "Dutch Boy" trademarks in its solder business.  Sherwin-Williams also agreed to contribute $42,500 plus all of its ownership rights in hundreds of United States Marks to DIMC in exchange for eight hundred and fifty (850) shares of the common stock of DIMC, constituting eighty-five percent of the issued common stock of this subsidiary.  The remaining fifteen percent of DIMC's stock would, according to the agreement, be issued to Dupli-Color Products Company, another wholly-owned subsidiary of Sherwin-Williams. The foreign trademarks of Sherwin-Williams remained with Sherwin-Williams.  After these transactions, the Marks, previously held by one entity, were thus divided among three separate entities.
	The Articles of Organization of both SWIMC and DIMC provided that their activities would "be confined to the maintenance and management of its intangible investments."  The Articles also placed restrictions and prohibitions on the subsidiaries, providing that neither SWIMC nor DIMC could "lease, sell, exchange, transfer, license, assign (except to affiliates) or dispose of any of the assets of the Corporation (except for assets having a value under $2,000)" in the absence of approval by the holder of the majority of shares.  This majority shareholder was at all times the parent, Sherwin-Williams.  In addition, neither subsidiary could pledge any of their assets without the approval of the parent.  These restrictions were reiterated in the Bylaws for both corporations.
	Sherwin-Williams engaged American Appraisal Associates ("AAA"), a company that performs valuations specially for Delaware holding company transfers of intangibles, to perform a fair market evaluation of the Marks to be transferred.  The AAA Appraisal Report ("AAA report") was premised on the assumption that the Marks would be used as "part of an operating company."  However, as evidenced by the Articles of Organization and Bylaws for both SWIMC and DIMC, the subsidiaries were always intended to be tax-exempt investment management and holding entities under Delaware law, which status prevented them from engaging in any active trade or business.  The AAA report also claims that the royalty rates were set pursuant to royalty rates for comparable products.  However, Sherwin-Williams conceded by way of stipulation that there were no documents identifying any comparables to support the range of royalties set forth in the AAA report.  Finally, the royalty rates were computed based upon the actual and projected sales of Sherwin-Williams' own products.  However, neither SWIMC nor DIMC actively tracked Sherwin-Williams sales.  Instead, Sherwin-Williams would send quarterly reports showing its sales figures to these subsidiaries, which would then apply the royalty rates based upon the Licensing Agreements to these figures submitted by the parent. 
	The subsidiaries undertook to perform certain services related to the Marks.  For example, the president of SWIMC and DIMC, Mr. Puglisi, made occasional visits to retailers to check whether the products bearing a SWIMC or DIMC Mark were properly displayed.  However, the Board found such tasks to be inconsequential.  Sherwin-Williams, the user of the Marks, paid the vast majority of expenses and retained ultimate control in the administration, maintenance and enhancement of the Marks.  Mr. Puglisi lacked any trademark or paint business experience.  The subsidiaries, therefore, executed Service Agreements with Sherwin-Williams under which the parent corporation would provide trademark administration, maintenance and protection services to the subsidiaries.  Under this agreement, Sherwin-Williams was required, among other obligations, to "provide a docketing/reminder system to identify renewal and affidavit dates for the Trademark(s)," to "prepare for [the subsidiaries'] review and signature, all necessary documentation for renewal and maintenance of the Trademark(s)," to "prosecute on behalf of [the subsidiaries] any pending trademark application for the Trademark(s)," and to review all "appropriate communications" with respect to "any legal matters regarding the Trademark(s)" and "to initiate, on behalf of [the subsidiaries] such legal action" as appropriate to enforce and protect the Marks.  The Service Agreements provided a Fee Schedule for payment by the subsidiaries to Sherwin-Williams.  All other work not specified on the Fee Schedule was to be billed to the subsidiaries at $140.00 per hour.  
As a result of these Service Agreements, the same Sherwin-Williams employees who were responsible for administration, maintenance and legal protection of the Marks before the transfers retained those same responsibilities after the transfers.  
Furthermore, Sherwin-Williams remained responsible for all advertising and substantially all quality control relative to the Marks.   The subsidiaries performed no quality control functions for almost two years after the transactions.  They later hired an accounting firm, Wade & Santora, which was inexperienced in such functions, to perform quality control.  Moreover, this firm still had provided no such services as of the end of 1992, the year after the tax year at issue.  The subsidiaries did not incur any expenses for advertising; such expenses continued to be borne by Sherwin-Williams, the user of the Marks.  Sherwin-Williams expended $114 million on advertising in 1991 and continued to increase its expenditures, by ten to twelve percent, each year thereafter.  During 1992, the subsidiaries still had not engaged in any quality control functions, nor had they incurred any expenses for advertising. The Board also found that, even though the subsidiaries ostensibly brought legal proceedings to defend the Marks, it was Sherwin-Williams' in-house trademark attorney, Mr. McDonald, who retained responsibility for overseeing these proceedings and who controlled all decisions in such proceedings.
	In the first year of the subsidiaries' operations, more than ninety-nine percent of the royalty income to the subsidiaries came from Sherwin-Williams.  Less than one percent of the royalty income came from third-party licenses which  Sherwin-Williams had already granted prior to the transfers of the Marks to the subsidiaries.  The Board also found that, according to Mr. Puglisi's own testimony, the subsidiaries relied upon Sherwin-Williams to solicit third-party license agreements.
	The subsidiaries invested the net income from Sherwin-Williams after paying expenses, including the fees paid to Sherwin-Williams for the services provided under the Service Agreements.  During the first quarter of 1991, SWIMC loaned Sherwin-Williams seven million dollars.  The term of maturity on this loan was ninety days.  The interest rate, set by Mr. Puglisi, was based on the London Inter-bank Offer Rate (LIBOR) plus three-eighths of one percent.  Sherwin-Williams repaid this loan one year later, during the first quarter of 1992.  
	Sherwin-Williams timely filed, pursuant to extension, its Massachusetts corporate excise return for tax year 1991.  In this return, it claimed as tax deductions $41,358,254.00 in royalty expenses under its license agreement with SWIMC, $6,034,459.00 in royalty expenses under its license agreement with DIMC, and $80,245.00 in interest expenses under its loan agreement with SWIMC.  The Commissioner's auditor noted that, of this amount, only $18,680,175.00 was actually paid to SWIMC during 1991. 
Following the audit, and pursuant to a duly authorized consent extending the time for assessment of taxes, the Commissioner made a deficiency assessment against the taxpayer based on the disallowance of deductions for the royalty fees and for the interest paid to SWIMC on its loan, stating that Sherwin-Williams was the true owner of these intangibles for tax purposes.  Sherwin-Williams paid the assessed amount of $70,198.00 plus interest, as additional corporate excise for 1991.  Of this amount, $59,445.40 of the tax assessment remained in dispute; $59,344.92 resulted from the disallowance of deductions for the royalty fees, and the remaining $100.48 resulted from the disallowance of the deduction for the interest expense.  Sherwin-Williams filed its application for abatement within two years from the date of the assessment.  The Commissioner denied this application.  Within the requisite sixty days of the Commissioner's denial, Sherwin-Williams filed its appeal with the Board.  On the basis of this information, the Board found it had jurisdiction over the appeal. 
	On the basis of the evidence of record, the Board found that the Commissioner properly disallowed the taxpayer the disputed deductions for royalty and interest payments.  The Board found that the transactions were not supported by valid business purposes other than tax avoidance.  Sherwin-Williams asserted several business purposes in support of its decision to engage in the transfer and license-back transactions.  However, the Board agreed with the Commissioner that each of these alleged business purposes either could not be achieved, had already been achieved by Sherwin-Williams prior to the creation of SWIMC and DIMC, or would actually expose Sherwin-Williams and its shareholders to serious economic risk.  The Board also rejected one of the alleged business purposes as contradictory.
The Board first rejected Sherwin-Williams' alleged prime motivating factor for the transfers: the protection and management of the Marks.  As to protection of the Marks, the Commissioner's expert witness, Professor Coates, persuaded the Board that a wholly-owned subsidiary would be powerless to protect the Marks from claims of creditors, as the assets of wholly-owned subsidiaries would be reachable by creditors of the parent.  Likewise, the Board found that the use of a wholly-owned subsidiary could not afford protection of assets against a hostile takeover of the parent.  A takeover bidder would acquire the stock of Sherwin-Williams' wholly-owned subsidiaries, thereby acquiring the Marks and other assets held by the subsidiaries.  Thus, adequate protection of the Marks could have been achieved only by transferring the Marks to independent third parties so as to isolate them from the parent.  Of course, Sherwin- Williams realized that such a clear separation with no guarantee of an ongoing license would be, as stated by Attorney Bromberg, "tantamount to corporate suicide," because it would destroy the value of the company.  Because Sherwin-Williams transferred its Marks to wholly-owned subsidiaries, rather than to independent third parties, the Board found that protection of the Marks was not a valid business purpose for the transactions.  
As to management of the Marks, Attorney Bromberg, a specialist in trademark law, persuaded the Board that distributing the Marks among three corporations rather than one actually created inefficiencies in management.  In addition, the Board found that the divisions of Sherwin-Williams retained responsibility for these activities after the transfer.  The Board was not persuaded that the subsidiaries' hiring of an inexperienced accounting firm to perform quality control functions, two years after the transfer of the Marks, indicated a serious effort to take over the management of the Marks.  Moreover, other activities associated with the Marks, such as advertising and quality control, were still performed by the divisions of Sherwin-Williams that used the Marks.  Because Sherwin-Williams continued to be responsible for management of the Marks, the transaction only separated these management functions from the legal ownership of those Marks.  As Attorney Bromberg testified, the coordination and consolidation of all these activities within Sherwin-Williams would have maximized the management of the Marks.  Instead, these transactions resulted in the opposite effect, creating a diffusion of management and, therefore, conflicting interests.  The Board, therefore, rejected better management of the Marks as a valid business purpose.
Sherwin-Williams also did not persuade the Board that their other purported reasons for the transactions were bona fide business purposes.  First, Sherwin-Williams asserted that the transactions would result in greater financing flexibility.  However, the Board did not find this to be a valid purpose under the facts of this appeal.  The Articles of Organization and Bylaws of both SWIMC and DIMC actually prohibited their use as financing vehicles, indicating that such purpose was not a plausible motivation for the transfer of the Marks to the subsidiaries.  Moreover, even Mr. Puglisi confirmed that none of the credit agreements that he reviewed provided any lesser borrowing restrictions on the subsidiaries than those imposed on Sherwin-Williams.  The Board was also persuaded by the testimony of the Commissioner's expert, Professor Coates, that, to the extent that creditors did not impose meaningful legal restrictions on the taxpayer's ability to obtain credit, the creditors of Sherwin-Williams would view the total set of companies as being intermingled, and therefore would not offer any different total financing costs to the family of companies than they would offer to any of these entities separately.  Therefore, the Board found that the subsidiaries were unnecessary vehicles for the taxpayer to accomplish its stated financing goals. 
Sherwin-Williams next asserted that the subsidiaries would serve as appropriate vehicles for the parent to acquire other businesses.  First of all, Sherwin-Williams president, Mr. Puglisi, testified that SWIMC and DIMC had never been used to acquire new businesses.  Moreover, the Board found that the acquisition of new businesses would actually conflict with the taxpayer's purported main purpose in forming the subsidiaries - the protection of the Marks.  Acquisition of new businesses, with their associated liabilities, would expose the Marks to these liabilities.  This result would frustrate the taxpayer's purported original intent of transferring the Marks so as to insulate them from the liabilities of the parent.  Finally, the Board found no indication that the transfer of Marks to SWIMC and DIMC would have been necessary for Sherwin-Williams to have acquired new businesses.  The Board, therefore, rejected the acquisition of new businesses as a valid business purpose.
Sherwin-Williams also argued that the subsidiaries would enable it to benefit from Delaware's corporate law and judicial system.  However, aside from the state tax advantages available to corporations that limit their activities to maintenance of intangibles, the Board found no specific advantage to securing Delaware jurisdiction.  The taxpayer could not substantiate this purported purpose with any specific advantages.  Even the taxpayer's corporate controller testified that he was not aware of any such advantages.  The prospect of a corporate legal dispute between the taxpayer and its wholly-owned subsidiaries, which would allow Sherwin-Williams the benefit of litigating in the Delaware court system, would be highly remote at best.  Therefore, the Board found that this stated purpose did not justify the transactions.
Another purported business purpose was that the transactions would improve Sherwin-Williams' ability to perform a profit center analysis.  However, the Board found that a profit center analysis being performed by the subsidiaries would add little to the information that was already available to Sherwin-Williams, considering that the subsidiaries received sales information from the parent, and did not track the sales themselves.  Moreover, a thorough analysis could be performed only by those responsible for manufacturing the products, advertising, and actually using the Marks.  These functions at all times remained with Sherwin-Williams, and thus, the Board found that Sherwin-Williams, not the subsidiaries, was in the better position to perform a profit center analysis, evidenced by the fact that the parent had already performed such an analysis prior to the transactions.
The final business purpose which the taxpayer advanced was that the transactions would enhance the taxpayer's ability to enter into license agreements for the use of the Marks, thereby maximizing its royalty rates and license fees.  However, the Board found that the transactions did little to add to the ability of Sherwin-Williams to license the Marks to third parties.  Sherwin-Williams had already actively participated in third-party licenses of its Marks, as evidenced by the preexisting licensing agreement with Taracorp, which it transferred to SWIMC.  The taxpayer offered no evidence that either of the subsidiaries actively solicited third-party licensing opportunities.  In fact, the Board found that instead of initiating their own search for third-party licensing opportunities, the subsidiaries relied upon Sherwin-Williams to bring those opportunities to the subsidiaries.  The fact that less than one percent of the subsidiaries' income actually came from third-party licenses during tax year 1991 was also significant in discounting third-party licensing as a sufficient business purpose to support the transactions.
Furthermore, because the taxpayer maintained that the subsidiaries were the true owners of the Marks, the Board also found this justification to be contradictory.  According to the testimony of its own representative, Mr. Puglisi, Sherwin-Williams did not control whether and to whom the Marks would be licensed; these decisions were purportedly to be made by Mr. Puglisi as President of SWIMC and DIMC.  For Sherwin-Williams to argue as a justification for the transactions the maximizing of royalty rates payable to SWIMC and DIMC, to which it had no entitlement, was on its face contradictory, and thus could not constitute a valid business purpose for the transactions.
The Board also found that the transfer and license-back transactions did not have any practical economic effect other than the creation of tax benefits.  The subsidiaries had no real control over the predetermined arrangements.  Such lack of control was evidenced by the intertwining boards of directors and officers for the subsidiaries and Sherwin-Williams.  Moreover, the Board found persuasive Attorney Bromberg's testimony that it is hardly customary for a user of a trademark to relinquish decisions on such vital matters as whether and how to register, renew, advertise or sell a trademark; rather, such entity "jealously guards" these trademarks and customarily maintains them under a centralized management to monitor these decisions.  The fact that Sherwin-Williams and not its subsidiaries retained responsibility for advertising and pursuing legal proceedings concerning the Marks confirmed for the Board Attorney Bromberg's position.  Sherwin-Williams retained tight control over the Marks, as well as control over the subsidiaries themselves, through its placement of the majority of directors on their boards of directors and the restrictions on the subsidiaries' abilities to "lease, sell, exchange, transfer, license" or otherwise dispose any of their assets, as specified in the Articles of Organization for SWIMC and DIMC.  Moreover, Sherwin-Williams retained control of the Marks through its performance of maintenance and management services pursuant to the Service Agreements executed with SWIMC and DIMC.
Sherwin-Williams retained not only control of but also the benefits from the Marks after the transfer and license-back transactions.  Therefore, the Board found that the transactions lacked economic substance, and accordingly, it found that the Commissioner's disallowance of the royalty expense deductions was proper based upon the theories of "sham transaction" and "substance over form."
The Board also found that the deductions were not ordinary and necessary business expenses as that term is used in Internal Revenue Code ("Code") § 162.  The Board found the testimony of the Commissioner's experts to be persuasive.  According to the Commissioner's trademark expert, Attorney Bromberg, after a transfer of intangibles from a parent to a wholly-owned subsidiary, for whatever rational business purpose, the license-back is quite typically royalty-free.  The Commissioner's tax expert, Professor Feld, noted in his testimony that "[i]f it pays a royalty for the use of those marks, it's paying a second time to achieve the same result; namely, to use the marks that it earlier developed and paid for."  On the basis of this testimony, the Board found that the license-back arrangement, created at the outset of the transfer, merely transferred back to the parent exactly what the parent had transferred to the subsidiaries.  As such, payment to the subsidiaries was neither ordinary nor necessary, because the subsidiaries had not added any value to the Marks for which they should have been compensated. 
The Board also found that the Commissioner properly disallowed Sherwin-Williams' deductions for the royalty expenses pursuant to his authority under G.L. c.63, § 39A to adjust the taxable income of foreign corporations.  The Board found that the Commissioner acted within the powers granted to him when he adjusted the taxable income of Sherwin-Williams.  The Board also found that the disallowance of the deductions for the royalty expenses was necessary to correct the non-arm's length transaction between Sherwin-Williams and its wholly-owned subsidiaries.  Moreover, the elimination of these deductions was also necessary to prevent the distortion of income caused by the assignment of income by Sherwin-Williams to its subsidiaries.  
The taxpayer's valuation studies, the AAA report and the "Section 482 Arm's Length Analysis" prepared by The Genetelli Consulting Group (the "Genetelli report") did not persuade the Board that the transactions between Sherwin-Williams and its wholly-owned subsidiaries were at arm's length.  The Board found that the reports' "freedom from royalty" approach, which is premised on the assumption that a company would have to license a trademark it did not own in order to sell products bearing that trademark, is invalid, based on Attorney Bromberg's testimony that in circumstances like those in the present case, transfers of intangibles to related entities would typically be accompanied by royalty-free license-back arrangements.  Moreover, the Board found that the reports failed to consider Sherwin-Williams' continued responsibility for the maintenance of the Marks and their enhancement, including its expenditures for advertising, in their evaluation of the arm's length pricing of the royalty rate. 
The Board also found several technical faults with the reports.  The AAA report assumed as a basic premise for appraisal of the Marks that they would be part of an operating company.  However, the Articles of Organization and Bylaws for both SWIMC and DIMC mandated that they be non-operating companies in order to be exempt from income tax pursuant to § 1902(b)(8) of Title 30 of the Delaware Code.  This same report also claimed to have conducted a search for comparable products for its determination of the range of possible arm's length royalty rates.  However, Sherwin-Williams conceded by stipulation that there were no documents identifying any of the comparables that would support the range of royalty rates set forth in the AAA report.  In addition, the AAA report erroneously used a capitalization of income approach, which applied a rate of return factor against gross sales figures rather than net sales figures.  As the Commissioner properly noted, the capitalization rate is properly applied to net operating income, which is operating revenues less operating expenses. 
The Genetelli report, entitled "Code § 482 Arm's Length Analysis," included a comparison with H.B. Fuller Company ("Fuller"), an adhesives manufacturer whose product line consisted of virtually all adhesives products. Sherwin-Williams' own records demonstrate a dramatic difference in profitability between its paint products and adhesives products; in fact, its paint business was about twice as profitable as its adhesives business.  The Board, therefore, found that the inclusion of Fuller skewed the results of the study by creating a wider range of possible arm's length pricing for the Marks than was warranted.
The Genetelli report also automatically selected Sherwin-Williams as its "testing party."  The report thus failed to make an analysis of which entity of the three corporations was the "least complex," as is required by the regulations under Code § 482.  Moreover, the Board found that, as between the three entities, Sherwin-Williams, and not its subsidiaries, engaged in significant advertising, manufacturing and quality control functions, and had the most assets and employees.  For reasons that are more fully stated in the Opinion, the Board found that the failure to analyze which entity should be the "testing party" damaged the report's credibility. 
On the basis of the foregoing, the Board found that the transfer and license-back transactions had no business purpose and lacked economic substance and, therefore, the Commissioner properly disallowed the deductions for royalty fees under the doctrines of substance over form and sham transaction.  Moreover, the deductions were not ordinary and necessary business expenses.  The transactions also violated the prohibition against the assignment of income.  The Board also found that the Commissioner properly exercised his authority under G.L. c. 63, § 39A in disallowing the deductions for the royalty expenses.  The Board found further that Sherwin-Williams failed to meet its burden of proof in challenging the assessment of taxes based on the disallowance of the deduction for the interest payment to SWIMC.  Finally, the Board rejected Sherwin-Williams' argument that the denial of deductions for its royalty and interest expenses imposed a unitary business combination, finding that the Commissioner's adjustment of taxable income of a corporation subject to apportionment and taxation by Massachusetts does not infringe upon any constitutional principles.  The Board therefore concluded that Sherwin-Williams was not entitled to an abatement of its corporate excise based upon the disallowance of the deductions for the royalty and interest expenses and issued a decision for the appellee in this appeal.   

OPINION
	Domestic and foreign companies that do business in the Commonwealth are required to pay an excise based in part on their net income derived from business activities carried on in Massachusetts.  G.L. c. 63, §§ 32, 38 and 39.  The "gross income" of a corporation for Massachusetts tax purposes is generally equal to gross income as defined under the Code as amended and in effect for the taxable year, with some exceptions not relevant to these appeals.  G.L. c. 63, § 30.3.  Net income is equal to gross income minus all deductions allowable under the Code, with several exceptions contained in G.L. c. 63, § 30.4.  The Code allows a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business."  Code § 162(a). 
	In this appeal, Sherwin-Williams argued that the formation of two corporate subsidiaries involved a Code § 351 transfer, under which Sherwin-Williams transferred its Marks and cash to these controlled entities in exchange for stock, resulting in a formation without tax consequences to either the subsidiaries or the parent.  Furthermore, Sherwin-Williams argued that the Supreme Court has recognized that a corporation conducting business is to be recognized as a separate entity and may only be disregarded if it is a sham.  Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943).  Sherwin-Williams concluded, therefore, that because the formation of SWIMC and DIMC involved corporations that are valid under the Code, the payment of royalties and interest by it to these subsidiaries must be accorded appropriate treatment under Code § 162. 
The Board agrees that, in accordance with Moline Properties, a corporation which has corporate purpose and activity must be recognized for tax purposes.  The Board also notes that the degree of corporate purpose and activity required for the recognition of a corporation as a separate legal entity for tax purposes is extremely low.  See Strong v. Commissioner, 66 T.C. 12 (T.C. 1976), aff'd, 553 F.2d 94 (2nd Cir. 1977).  However, contrary to Sherwin-Williams' argument, Code § 351, which controls only the tax effects of the actual formation of a corporate entity, does not thereafter control the tax effects of all subsequent transactions involving these entities.  The Board must look at the tax effects of transactions beyond the initial transfer creating an entity.  See Higgins v. Smith, 308 U.S. 473, 476-77 (1941) ("But the existence of an actual corporation is only one incident necessary [for the recognition of a transaction] . . . The government may look to actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham may sustain or disregard the effect of the fiction."); see also Gregory v. Helvering, Commissioner of Revenue, 293 U.S. 465, 469 (1935)(in denying tax consequences of sham transaction, "[n]o doubt, a new and valid corporation was created.  But that
corporation was nothing more than a contrivance to the end last described.").  
The Board, therefore, found that Moline Properties was not significant to the inquiry of whether the Commissioner properly disallowed Sherwin-Williams' deductions for royalty and interest expenses.  The Board found instead that it must look critically at individual transactions involving these entities, with an eye toward reviewing such transactions for economic substance beyond mere tax avoidance.  "While the courts recognize that tax avoidance or reduction is a legitimate goal of business entities, the courts have, nevertheless, invoked a variety of doctrines such as lack of business purpose, substance over form, sham arrangement, economic reality and step transaction to disregard the form of a transaction where the facts show that the form of the transaction is artificial and is entered into for the sole purpose of tax avoidance and there is no independent purpose for the transaction."  Falcone v. Commissioner of Revenue, 20 Mass. App. Tax Bd. Rep. 61, 64-65 (1996). 


The Transactions Lacked Business Purpose and Economic Substance Other Than Tax Avoidance.

	A.  Sham transactions.
The Board found that the Commissioner was correct in disallowing the deductions for royalty payments to the subsidiaries based on the sham transaction doctrine,  because the transfer and license-back transactions lacked business purpose and economic substance beyond the creation of tax deductions.  Compare Koch v. Commissioner of Revenue, 416 Mass. 540 (1993)(taxpayer's transfers of stock respected for tax purposes because they were motivated by substantive business objectives).  Massachusetts follows federal case law reasoning for disregarding transactions that are a sham.  Falcone, 20 Mass. App. Tax Bd. Rep. at 64; see also Second National Bank, 308 Mass. at 6 (citing Helvering v. Helmholz, 296 U.S. 93 (1935)).  Under the federal cases, the tax effects of a transaction must be disallowed where the transaction lacks economic substance beyond the creation of tax benefits.  See Commissioner of Internal Revenue v. Court Holding Co., 324 U.S. 331 (1945), Gregory v. Helvering, 293 U.S. 465 (1935), Ferguson v. Commissioner of Internal Revenue, 29 F.3d 98, 101 (2nd Cir. 1994)("A sham transaction analysis requires a determination whether the transaction has any practical economic effects other than the creation of income tax losses"), James v. Commissioner of Internal Revenue, 899 F.2d 905 (10th Cir. 1990).  
Economic substance can be proven by the existence of a business purpose for the transaction other than mere tax avoidance.  See Casebeer v. Commissioner of Internal Revenue, 909 F.2d 1360 (9th Cir. 1990), Illes v. Commissioner of Internal Revenue, 982 F.2d 163 (6th Cir. 1992), cert. denied, 507 U.S. 984 (1993), Rice's Toyota World, Inc. v. Commissioner of Internal Revenue, 752 F.2d 89 (4th Cir. 1985).  However, the Board found that Sherwin-Williams failed to prove that the transactions served any business purpose beyond mere tax advantages.  Sherwin-Williams pointed out that whether a taxpayer has a business purpose for entering into a transaction is subjective.  See, e.g., Kirchman v. Commissioner, 862 F.2d 1486, 1492 (11th Cir. 1989).  Therefore, it argued the reasonable beliefs of its senior management that the transactions would achieve the purported results would be sufficient to demonstrate the requisite business purpose.  However, the Board must look critically at whether the taxpayer's alleged business purpose was valid.  See Shriver, 899 F.2d at 726 (8th Cir. 1990)(citing Kirchman, 862 F.2d at 1492 (11th Cir 1989)).  
The Board found the subject transactions to be no more than "a pure paper shuffle, having no potential consequences for the business in which the corporations engaged."  Yosha v. Commissioner of Internal Revenue, 861 F.2d 494, 497 (7th Cir. 1988).  A taxpayer cannot merely invent "canned" business reasons as sufficient justification for transactions.  As detailed in the Board's findings, each of the non-tax business purposes alleged by Sherwin-Williams either could not be achieved, had already been achieved prior to the transactions, or would actually expose Sherwin-Williams to serious economic risk.  Moreover, as explained in the Findings above, the Board rejected enhancement of licensing opportunities as contradictory.  Because the subsidiaries, not Sherwin-Williams, were purported to be the true owners of the Marks, Sherwin-Williams would have no interest in increasing the royalty rates to which they, as licensees, would have no entitlement.  See Shriver, 899 F.2d at 726 (due to "self-serving" evidence, court found "petitioner did not manifest a subjective business purpose").   
The Board found the facts of this appeal to be substantially similar to the case of In re Burnham Corporation, 1997 WL 413931 (N.Y.Div.Tax.App. 1997).  The issue in that case was whether the state's revenue department could require the taxpayer to file tax reports on a combined basis with two of its Delaware subsidiaries.  However, the taxpayer attempted to justify the formation of a separate entity to hold its trademarks by advancing business reasons apart from tax savings, which were similar to those advanced by Sherwin-Williams.  For example, the taxpayer asserted that the value of the transferred Marks would be enhanced by transferring the trademarks to a separate entity so as "to focus on their value."  Burnham, 1997 WL 413931 at *17.  The taxpayer also argued that protection of the trademarks would be achieved by transferring them to a subsidiary, even though the wholly-owned subsidiary was an asset of the parent.  Id.  
The New York Division of Tax Appeals in Burnham found that those stated reasons were "abstract at best."  Id.  For example, in dismissing management of trademarks as a valid business purpose, the court found that the taxpayer "never clearly explained how the transfer of the Burnham trademarks to a separate holding company . . . increased [its] ability to manage or monitor the trademarks."  Id.  As to protection of the trademarks, the court found such alleged protection as illusory, because a takeover bidder would acquire the stock of a parent corporation's wholly-owned subsidiaries, thereby acquiring the trademarks and other assets held by the subsidiaries.  Similarly, the Board in this appeal found that the purposes cited by Sherwin-Williams were abstract and not sufficient to justify the tax effects of the transactions, despite the subjective nature of the business purpose test.
The Board also found that, even if there were some valid business purpose for the transactions, the transactions were nonetheless a sham, because they lacked economic substance beyond the creation of tax benefits.  See Casebeer, 909 F.2d 1360 (taxpayer must show both that transaction was supported by business purpose other than tax avoidance, and that transaction has economic substance other than creation of tax benefits), James, 899 F.2d at 908-909 (under the "better approach" to sham transaction analysis, "the consideration of business purpose and economic substance are simply more precise factors to consider in whether the transaction had any practical economic effects other than the creation of income tax losses.")(quoting Sochin v. Commissioner, 843 F.2d 351, 354 (9th Cir.), cert. denied, 488 U.S. 824(1988)).  The transactions did not create any risk of a loss of control to the taxpayer.  See Estate of Sanford v. Commissioner, 308 U.S. 39, 43 (1930)("the essence of a transfer is the passage of control over the economic benefits of property rather than any technical changes in its title")(citing Burnet v. Guggenheim, 288 U.S. 280, 287 (1933)), Yosha, 861 F.2d at 500 (transactions "that involve no market risks are not economically substantial" but are mere "artifices created by accomplices in tax evasion").  Although the License Agreements of the Marks were characterized as nonexclusive, the Board found that there was never a question that Sherwin-Williams would be able to retain its exclusive use and control of these Marks.  Otherwise, the transfers would be "tantamount to corporate suicide," and the taxpayer would not have reasonably entered into the transfers.  
Moreover, the Articles of Organization for both SWIMC and DIMC specifically did not permit the subsidiaries to "lease, sell, exchange, transfer, license, assign (except to affiliates), or dispose of any of the assets of the [subsidiary] (except for assets having a value under $2,000)" without the express approval of the holders of a majority of their shares.  As wholly-owned subsidiaries, this majority shareholder was none other than the parent, Sherwin-Williams. 
In Higgins v. Smith, the Supreme Court disallowed a loss deduction to a parent on the sale of its wholly-owned subsidiary, finding that the stock ownership had not changed the "continued domination and control" exerted by the parent over the transferred assets.  Higgins v. Smith, 308 U.S. at 476.  The Court thus denied the tax deductions, finding that "transactions, which do not vary control or change the flow of economic benefits, are to be dismissed from consideration."  Id.  Likewise in this case, the transactions did not change the economic position of Sherwin-Williams.  If Sherwin-Williams were to refuse to pay the royalties due under the License Agreement, the subsidiaries would not be in the position of an independent third-party creditor.  Because two of the three directors of the subsidiaries were Sherwin-Williams' officers, Sherwin-Williams could simply dissolve or merge its wholly-owned subsidiaries back into itself or otherwise exert influence over the subsidiaries to prevent them from taking action against Sherwin-Williams.  See K Mart Corp. v. Cartier, Inc., 486 U.S. 281, 299 (1988)("But whether 'ownership' is the '[c]ollection of rights to use and enjoy property, including [the] right to transmit it to others,' or '[t]he complete dominion, title, or proprietary right in a thing,' or '[t]he entirety of the powers of use and disposal allowed by law,' id., at 997, the parent corporation -- not the subsidiary whose every decision it controls -- better fits the bill as the true owner of any property that the subsidiary nominally possesses.")(quoting Black's Law Dictionary (5th ed. 1979)). 
Sherwin-Williams' economic position did not change as a result of the transactions.  Sherwin-Williams retained control over the development of the Marks, from the decisions of which Marks to place on which products to decisions relating to advertising and quality control functions.  As explained in the Findings, the Board found that the user of a trademark "jealously guards" them and customarily maintains them under a centralized management to monitor these decisions.  The Board found that it was the same Sherwin-Williams personnel who continued to promote the Marks by spending over one hundred million dollars annually on advertising, by engaging in the manufacturing, marketing and selling of the products bearing the Marks, by performing quality control functions, and by choosing which products would carry those Marks.  Moreover, as explained in the Findings, it was Sherwin-Williams' in-house trademark attorney, Mr. McDonald, who retained responsibility and control over all legal proceedings involving the Marks.  The Board also found the presence of interlocking directors and officers vis-à-vis Sherwin-Williams and its two subsidiaries, and the Articles of Organization for the subsidiaries with their prohibition against the sale, lease or other transfer of assets without the approval of the majority shareholder, Sherwin-Williams, further demonstrated the control over the Marks which the parent continued to exert after the transactions.
This appeal is very similar to Alpha Tank & Sheet Metal, in which the United States Court of Claims denied the taxpayer's deduction of rental expenses, because the same two stockholders owned and controlled the taxpayer as well as the entity to whom it had transferred the operating plant for which it was paying rental expenses.  Alpha Tank & Sheet Metal Mfg. Co. v. United States, 116 F.Supp. 721 (U.S.Ct.Cl. 1953).  "The attempted creation of deductions for rentals . . . when there was no real change in ownership in the circumstances of this case is not a sufficient business motive."  Id. at 724.  See also, White v. Commissioner, 193 F.2d 398, 400 (5th Cir. 1951), cert. denied, 343 U.S. 928 (1952)(denial of deduction for rental payments following gift-leaseback transaction with wife, where "it was the taxpayer's expectation that no action would be taken by the wife in exercise of her rights of ownership of the . . . property which would be detrimental to the plaintiff's interests"). 
Furthermore, Sherwin-Williams claimed as tax deductions $41,358,254.00 in royalty expenses under its license agreement with SWIMC, $6,034,459.00 in royalty expenses under its license agreement with DIMC, and $80,245.00 in interest under its loan agreement with SWIMC.  However, only $18,680,175.00 was actually paid to SWIMC during 1991, resulting in an accounts receivable for SWIMC of $29,758,324.00.  Similarly, DIMC reported royalties receivable from Sherwin-Williams totaling $3,493,435.
Moreover, the Board notes the circular nature of the transactions.  As a result of the royalty payments from Sherwin-Williams, the subsidiaries had available substantial funds from which they could pay a tax-free dividend to Sherwin-Williams, or which would cause an increase in value of SWIMC and DIMC and could later be transferred tax-free to Sherwin-Williams by way of a
liquidation of the subsidiaries.  "Such a circular flow of funds among related entities does not indicate a substantive economic transaction for tax purposes." Merryman v. Commissioner of Internal Revenue, 873 F.2d 879, 882 (5th Cir. 1989); see also Zirker v. Commissioner, 87 T.C. 970, 976 (1986), Estate of Franklin v. Commissioner, 544 F.2d 1045 (9th Cir. 1976).
The Board, therefore, found the transactions to lack economic substance.  No risk of loss to Sherwin-Williams was created by the transfers to its wholly-owned subsidiaries.  Sherwin-Williams retained all the benefits and control with respect to the Marks transferred to SWIMC and DIMC.  No practical economic effect resulted from the transfer and license-back transactions. 
Accordingly, the Board found no valid business purpose or economic substance to the transactions.  The Board, therefore, found that the Commissioner properly disallowed the deductions for the royalty expenses based upon the doctrine of sham transaction.


		B. Substance over form.
In addition, the deductions were properly disallowed based upon the doctrine of substance over form.  See Court Holding Co., 324 U.S. at 334 ("The incidence of taxation depends upon the substance of a transaction."), Anderson v. Commissioner of Corporations & Taxation, 312 Mass. 40, 44 (1942)("Substance and not form is to be regarded in the application of the tax laws"), Commissioner of Corporations & Taxation v. The Second National Bank of Boston, 308 Mass. 1, 6 (1941)("Tax laws are to be construed as imposing taxes with respect to matters of substance and not with respect to mere matters of form"); see also Higgins v. Smith, 308 U.S. 473, Alpha Tank & Sheet Metal, 116 F.Supp. 721.  Despite the form of the transaction - a transfer and license-back of valuable Marks - the substance of the transaction is, in effect, as if no transaction ever occurred.  The original owner of the Marks was still in exclusive control of them and retained all the benefits from them; nothing of substance changed as a result of the transactions.  Accordingly, no tax consequence in the form of a royalty deduction will result from the mere form of the transactions where in substance nothing has changed.
II.  The Royalty Payments Were Not Ordinary and  
     Necessary Business Expenses.
The Board also found that Sherwin-Williams' payment of royalties to its wholly-owned subsidiaries was not deductible as an "ordinary and necessary" business expense, as that term is used in Code § 162.  "For the statutory purposes, the mere creation of a legal obligation to pay is not controlling."  White v. Fitzpatrick, 193 F.2d at 400 (citing Interstate Transit Lines v. C.I.R., 130 F.2d 136 (8th Cir., 1942), aff'd, 319 U.S. 590 (1943)).  Rather, there must have been some valid business purpose justifying the payment of expenses by Sherwin-Williams for the use of the Marks, other than a mere paper agreement created between itself and its wholly-owned subsidiaries:  "Standing alone the fact that payment was the result of a contractual obligation does not render it an ordinary business expense."  Interstate Transit Lines, 130 F.2d at 139 (citing Deputy v. DuPont, 308 U.S. 488 (1940)).  Rather, the payment must be, in the business context in which it arose, a "common" or "accepted" method to achieve a business objective in the circumstances. See Welch v. Helvering, 290 U.S. 111 (1933)(Supreme Court denied taxpayer's payment of debt without legal obligation, finding payment not to be "ordinary").
Sherwin-Williams could point to no legal authority or factual circumstance that would compel the payment of a royalty by a parent to its wholly-owned subsidiary, where the wholly-owned subsidiary did little, if anything, to add value to the Marks.  The Board found, on the present record, that the transfer and license-back transactions between Sherwin-Williams and its subsidiaries should have been royalty-free.  It was Sherwin-Williams who maintained the value of the Marks after the transactions, by performing advertising, manufacturing, marketing and quality control functions.  Indeed, the subsidiaries did not incur any expenses for advertising, and during 1991 and 1992 they did not engage in any quality control functions, which neglect would have led to the destruction of the Marks under ordinary circumstances.  When they finally did attempt to engage in quality control, the subsidiaries hired an accounting firm completely inexperienced in this area, an action which the Board finds to be another indication that the transactions were a mere paper shuffle. 
Moreover, the royalty fees paid by Sherwin-Williams were not ordinary or necessary considering that the subsidiaries had not developed the Marks in any way, or built any goodwill, or created anything of value that could be licensed back to the parent.  In fact, Sherwin-Williams made advertising expenditures far exceeding the royalties it paid, while Sherwin-Williams' in-house counsel maintained control over legal proceedings for the defense of the Marks.  However, the royalty payments were not determined by taking into consideration the expenditures made by Sherwin-Williams for advertising and continued maintenance of the Marks.  For Sherwin-Williams to pay the expenses of maintaining the Marks, and to then pay a royalty for those same Marks, Sherwin-Williams was thereby paying twice to use the Marks it had already developed prior to the transfer.  The Board thus found that the license-back arrangements, created at the outset of the transfer, did not add any value or protection to the Marks which could justify the payment of royalties to the subsidiaries as ordinary and necessary expenses.
The facts of this appeal are thus distinguishable from Eli Lilly & Co. v. Commissioner of Internal Revenue, 856 F.2d 855 (7th Cir. 1988), cited by the taxpayer as support for the deductibility of its expenses.  In Eli Lily, the subsidiary actually performed functions relative to the patents which it had received from the parent, including the manufacture of the drugs to which the patents related.  In this case, however, the License Agreement created a mere paper obligation, the payment of which could not be supported as an ordinary or necessary business expense.  
III.  The Commissioner Properly Exercised His 
      Authority Under G.L. c.63, § 39A.
The Commissioner also had the statutory authority and obligation to adjust the income of Sherwin-Williams pursuant to G.L. c. 63, § 39A, which provides that:
The net income of a foreign corporation which is a subsidiary of another corporation or closely affiliated therewith by stock ownership shall be determined by eliminating all payments to the parent corporation or affiliated corporation in excess of fair value, and by including fair compensation to such foreign corporation for all commodities sold to or services performed for the parent corporation or affiliated corporations. 

The purpose of § 39A is to prevent a foreign corporation from depressing its taxable income by entering into non-arm's length transactions with its affiliated corporations.  See Polaroid Corp. v. Commissioner, 393 Mass. 490 (1984), Chateau deVille, Inc. v. Commissioner of Revenue, 11 Mass. App. Tax Bd. Rep. 102 (1989).  As such, the Supreme Judicial Court has found that § 39A has a "broad remedial purpose" and was intended to remedy "tax evasion" by means of inter-corporate transactions.  Commissioner of Revenue v. AMI Woodbroke, 418 Mass. 92, 96-97 (citing Polariod, 393 Mass. 490).  
Pursuant to § 39A, the Commissioner had the authority, indeed the mandate, to adjust the taxable income of Sherwin-Williams.  First, the Board found that § 39A explicitly applied to the Commissioner's adjustment of the income of Sherwin-Williams, because § 39A enables the Commissioner to adjust the taxable income of a foreign corporation which is "closely affiliated" with another foreign corporation "by stock ownership."  As the outright owner of one hundred percent of the stock of SWIMC and eighty percent of the stock of DIMC, Sherwin-Williams was "closely affiliated" with both subsidiaries "by stock ownership."  
The Commissioner had the authority to adjust the taxable income of Sherwin-Williams, both "by eliminating all payments to the parent corporation or affiliated corporations in excess of fair value," and by allowing deductions that represented "fair compensation" to its wholly-owned subsidiaries for the commodities and services they had provided.  The Commissioner could have properly eliminated the royalty payments completely, either because they exceeded fair value or because they exceeded "fair compensation" for any commodities provided or services performed for Sherwin-Williams. 
As recognized by the Supreme Judicial Court, "the first sentence of § 39A mandates correction of the consequences of non-arm's length transactions."  Polaroid, 393 Mass. at 497.  The Board found that the transactions between Sherwin-Williams and its wholly-owned subsidiaries were not arm's length transactions.  If the subsidiaries were truly independent, they could have licensed the Marks to whomever would pay them the highest royalty rates without any consideration of whether the business of Sherwin-Williams was destroyed, so long as the licensing enriched them.  There was never a question that the Marks would be licensed back to Sherwin-Williams, as the very existence of Sherwin-Williams depended upon the use of its Marks.  Acting reasonably, the parent would never have divested control of the Marks to the subsidiaries, for doing so would have been "tantamount to corporate suicide."
Furthermore, SWIMC and DIMC had no real control over the predetermined arrangement.  The officers and boards of directors of the subsidiaries were intertwined with those of the taxpayer.  In fact, the majority of the subsidiaries' directors overlapped with the parent, and were high-ranking officers with the parent.  Only one director, Don Puglisi, had no direct tie with the parent corporation, yet this minority director had no particular experience in trademarks or in the paint business.  The Articles of Organization and Bylaws of SWIMC and DIMC also strictly limited their freedom from the parent, for example, by requiring the approval of the majority shareholder, Sherwin-Williams, before the subsidiaries could sell, lease or otherwise transfer any valuable assets, including the Marks.  Moreover, the original boards of directors for SWIMC and DIMC, which had adopted these Articles of Organization and Bylaws, were controlled by Sherwin-Williams' officers.  Given the presence of overlapping directors and officers of the taxpayer and the two subsidiaries, and the strict control which Sherwin-Williams as majority shareholder retained over the subsidiaries, the Board found that Sherwin-Williams entered the transaction not at arm's length but with the assumed guarantee that it would be able to license back the Marks and maintain unfettered control over the Marks.
The fact that Sherwin-Williams as lessee had created its own obligation to pay for the use of these Marks, and yet retained responsibility for advertising so as to increase the value of these Marks, demonstrated further that the royalty rates were not the result of arm's length bargaining.  An arm's length price would have considered the user's expenses of maintaining the value of the Marks in establishing the royalty rate.  See Burnham, 1997 WL 413931 at *21.  In addition, the royalty rates were set according to sales of the Sherwin-Williams' products to which the Marks related.  The subsidiaries did not track these sales themselves, but rather relied upon Sherwin-Williams to provide such information to them.  Moreover, by retaining control over the advertising and marketing of these products, Sherwin-Williams retained the power to increase its royalty rates so as to increase its tax deductions.    
The Supreme Judicial Court has noted that § 39A, while not granting the identical powers, is "a similar taxing provision" to Code § 482.  AMI Woodbroke, 418 Mass at 96.  Code § 482 is a remedial provision intended to prevent the artificial shifting of income and expenses among a controlled group of corporations.  See Central Cuba Sugar Co. v. Commissioner, 198 F.2d 214 (2d Cir.), cert. denied, 344 U.S. 874 (1952).  The purpose of Code § 482 is "to place a controlled taxpayer on a tax parity with an uncontrolled taxpayer . . . The standard to be applied in every case is that of an uncontrolled taxpayer dealing at arm's length with an uncontrolled taxpayer."  Treas.Reg.Sec. 1.482-1(b). 
The Board finds that, as a provision analogous to Code § 482, § 39A by its terms is likewise intended to prevent the artificial shifting of income and expenses between a corporation and its foreign subsidiaries.  See Chateau deVille, 11 Mass.App.Tax Bd.Rep. at 106.  The Commissioner's elimination of the deduction for royalty expenses was necessary to prevent the distortion of income caused by the assignment of income by Sherwin-Williams to its wholly-owned subsidiaries.  Sherwin-Williams retained control over the Marks and continued to provide their economic augmentation.  Furthermore, Sherwin-Williams' rights and responsibilities as to the Marks did not change after the transfers to the subsidiaries.  As evidenced by the nominal expenses the subsidiaries incurred, as compared to those of Sherwin-Williams, for the maintenance of the Marks, and the amount of control Sherwin-Williams exercised over the Marks, the Board found that Sherwin-Williams remained the true owner of the Marks; the subsidiaries received mere paper title.  Sherwin-Williams could not properly deduct expenses paid for the use of the Marks that it continued to control.  As the true owner of the "tree" (the Marks), Sherwin-Williams could not for tax purposes assign to its subsidiaries the "fruit" (the royalties) harvested from the tree.  See Helvering v. Horst, 311 U.S. 112 (1940).  This would be a violation of the assignment of income principle.  See, e.g., Lucas v. Earl, 281 U.S. 111 (1930). 
In addition, as testified to by Professor Feld, the Commissioner had the power under § 39A to adjust the taxable income of Sherwin-Williams, because the deduction by Sherwin-Williams of royalty payments resulted in a mismatch of income and expenses.  Sherwin-Williams was attempting to deduct twice for the privilege of using the Marks, first, by deducting its advertising and other expenses to develop and maintain the value of the Marks and, second, by deducting the royalty payments for use of the Marks it had already developed and enhanced in value.  The Board found that this attempt to deduct twice for the same expenses was further proof of the distortion of income caused by these transactions. 
The taxpayer's valuation studies did not persuade the Board that the transactions between these controlled entities were conducted at arm's length.  Primarily, the reports were faulty due to their basic assumption, under the "freedom from royalty" approach, that some royalty had to be paid by Sherwin-Williams for the use of the Marks.  As previously discussed, Sherwin-Williams itself had created the Marks and continued to develop them even after the transactions.  In 1991, Sherwin-Williams deducted $47,392,713.00 in royalty expenses to its two subsidiaries; however, it expended more than twice that amount, $114,624,549, in advertising expenses for its products during that same year.  An arm's-length pricing requires the consideration of the parent's expenses of maintaining the value of the Marks, including marketing, advertising and quality control.  See Burnham, 1997 WL 413931 at *21.  Because the taxpayer failed to show that the royalty rates were calculated taking this consideration into account, the reports failed to persuade the Board that the pricing was arm's length.  
Moreover, the subsidiaries did not add value to the Marks for which they should be compensated by the parent.  Thus, there was no evidence that Sherwin-Williams was compelled by legal authority or business purpose to pay a royalty to its wholly-owned subsidiaries who simply held those Marks.  In fact, the Board found persuasive Attorney Bromberg's testimony that it is common business practice for the transfer of intangibles among affiliated entities to result in a royalty-free license arrangement.  The reports assume that the subsidiaries, as owners of the Marks, are the ones entitled to the royalty fees generated from them.  However, it was Sherwin-Williams who continued to maintain the economic value of the Marks after the transfer through activities such as advertising and performance of quality control.  Essentially, Sherwin-Williams was assigning to its subsidiaries the royalty fees which resulted from Marks over which it had not relinquished control.  The Board thus found that the reports' freedom from royalty approach resulted in a prohibited assignment of income on the facts of this case.  See Helvering v. Horst, 311 U.S. 112 (1940).
As explained in the findings, the Board found several technical faults with the reports, including the AAA's assumption that the Marks would be part of an operating company, its inability to specify the comparables, if any, upon which it relied to support the range of royalty rates it documented, its use of a capitalization of income approach which erroneously applied a rate of return factor against gross sales figures rather than net sales (see Young Men's Christian Association of Quincy v. Sandwich Water District, 16 Mass.App.Ct. 666 (1983)(reversible error for judge to permit consideration by fact-finder of appraisal evidence based upon capitalization of gross income)), and the Genetelli report's inclusion of Fuller, an adhesives manufacturer, which thus skewed the report's results by creating a wider range of arm's length pricing than was warranted.  
In addition, the Genetelli Report, a § 482 pricing study, purported to evaluate transactions between related parties by comparison with transactions between unrelated parties, yet it failed to follow the regulations promulgated under that Code section.  The report utilized the "comparable profits method" as one method of evaluation.  According to the Treasury's regulations, this method evaluates the appropriateness of royalty rates by analyzing a "testing party" whose level of profitability is to be compared with the uncontrolled transaction.  Yet the Genetelli study did not perform an analysis as to which entity should be the tested party but simply assumed Sherwin-Williams would be that tested party.  The regulations require the use of the "least complex" related entity to be the "testing party."  Treas.Reg. § 1.482-5(b)(2).  As detailed in the findings, the Board found Sherwin-Williams to be the most complex of the three entities.  Therefore, the study should have at least analyzed which of the related corporations should have been the tested party consistent with the regulations.  If one of the subsidiaries had been the tested party, the study may very well have uncovered that licensors of valuable trademarks earn far less profits than did either SWIMC or DIMC, due to the fact that Sherwin-Williams remained responsible for many expenses that would not have been incurred by a non-controlled licensee.
The Board reviewed the decisions cited by the taxpayer in support of its position, including In re Toys "R" Us-NYTEX, Inc., NY TAT(H) 93-1039(GC)(N.Y.C. Tax App. Trib., Admin. Law Judge Div., Aug. 4, 1999), SYL, Inc. v. Comptroller, Case No. C-96-0154-01 (Md. T.C. Apr. 26, 1999), Aaron Rents, Inc. v. Collins, No. D-96025, Ga. St. Tax Rep. (CCH) ¶250-189 (Super. Ct. Fulton County June 27, 1994), appeal denied, Aug. 24, 1994, and In re Express, Inc. DTA Nos. 812330-812332 & 812334, 1995 N.Y. Tax LEXIS 493 (N.Y.S. Div. of Tax Appeals, Sept. 14, 1995).  The taxpayer cited these decisions for the proposition that the formation and use of a trademark protection company is a common business structure for the protection of intangible assets.  The Board, however, found these cases not to be persuasive in supporting the deductibility of the royalty expenses.  These decisions addressed instead the issue of whether the formed subsidiaries were viable entities such that a state taxing authority could force the parent and subsidiaries to file income taxes on a consolidated basis (In re Express, Toys "R" Us-NYTEX, Aaron Rents), or could impose tax on the entity as an out-of-state affiliate of its in-state parent corporation (SYL).  However, the Commissioner did not disregard SWIMC and DIMC as valid corporations.  Likewise, the Commissioner did not attempt to combine all of the income of these subsidiaries into that of the parent, but only denied certain deductions.  The issue here is far more precise:  the deductibility of certain royalty and interest payments paid by a parent corporation to its wholly-owned subsidiaries.  Because this issue was not addressed in the above-cited cases, they do not aid the analysis of whether the Commissioner properly disallowed the deductions for royalty and interest expenses at issue in this appeal.
Moreover, in those cases where the court or administrative body upheld the validity of the taxpayer's asserted non-tax purposes for the formation of the trademark holding company, it did so in the absence of any substantive discussion or analysis.  See, e.g., SYL, supra, at 5, In re Express, supra, at *81.  The Board thus found the cursory nod given to the taxpayers' purported business purposes to be unpersuasive in the appeal before it. 
On the issue of the deductibility of interest paid by Sherwin-Williams to SWIMC, the Board found that the taxpayer failed to meet the burden of proof necessary to defeat the Commissioner's assessment.  A taxpayer who claims to be aggrieved by the refusal of the Commissioner to abate a tax in whole or in part has the burden of establishing the right to an abatement.  Staples v. Commissioner of Corp. & Tax., 305 Mass. 20, 26 (1940).  See also Commissioner of Corp. & Tax. v. Filoon, 310 Mass. 374, 376 (1941); Stone v. State Tax Commission, 363 Mass. 64, 65-66 (1973).  Especially in the situation of a debt transaction between controlled entities, the Board cannot presume that the transaction is valid.  Special attention must be paid to such transactions, because they can often be a means whereby controlled entities distribute their profits while at the same time obtaining a tax deduction.   See, e.g., Sharcar, Inc. v. Commissioner of Revenue, 1998 ATB Adv. Sh. 198, 212-13 (No. 205544, Mar. 9, 1998)("Special scrutiny should be given to compensation paid by corporations when the stock is closely held, because of the lack of arm's length bargaining which in turn may indicate an intent to affect and disguise distribution of profits.")(citations omitted).  In this case, the taxpayer did little beyond voicing a bare assertion that the debt was an arms' length transaction between two valid entities.  See Shriver, 899 F.2d at 726 (court rejects "self-serving" evidence).  Therefore, the Board found that the taxpayer failed to put forth evidence sufficient to meet its burden of proof and thus upheld the Commissioner's assessment on the interest.  
In addition, as observed by Professor Feld, because the Commissioner properly disallowed the deduction for the royalty expenses paid to the subsidiaries, it follows that SWIMC did not earn the funds that it purported to lend back to Sherwin-Williams.  Therefore, Sherwin-Williams cannot claim an interest deduction to pay SWIMC for the use of money that was not properly loaned to Sherwin-Williams.  See Overnite Transportation Co. v. Commissioner of Revenue, 1999 Mass. A.T.B. Adv. Sh. 353 (Docket Nos. F245440, F245606, August 13, 1999).  
	Finally, the Board rejected the taxpayer's argument that the Commissioner violated constitutional principles of due process by imposing a unitary business combination through the denial of the royalty and interest deductions.  By its definition, the unitary business approach requires the combination of all the income of related entities.  As described by the Supreme Judicial Court, the "unitary business" approach "involves combining the income of all affiliated corporations" in determining the portion of income attributable to a particular state.  Polaroid, 393 Mass. at 492 (citing, inter alia, Container Corp. of America v. Franchise Tax Bd., 463 U.S. 159 (1983)).  By contrast, the Commissioner here did not combine all of the income of Sherwin-Williams with that of its subsidiaries, but instead made adjustments to the  net income of Sherwin-Williams, a taxpayer whose net income is unquestionably subject to apportionment and taxation by Massachusetts under G.L. c. 63, § 38.  No constitutional principles are infringed upon by the disallowance of the deductions at issue in this appeal.
	Based on the foregoing, the Board accordingly issued a decision for the appellee in this appeal.

					  THE APPELLATE TAX BOARD	
							
  By:____________________________
					     Abigail A. Burns, Chairman

A true copy:


Attest: _____________________
	    Clerk of the Board

   For simplicity, Sherwin-Williams, as the owner of one hundred percent of Dupli-Color Products Company, has been treated as if it owned all of the stock of DIMC.
   The Fee Schedule for both Service Agreements involving SWIMC and DIMC provide the following rates of compensation to Sherwin-Williams:
	Filing trademark application			$  290.00
	Prosecution of trademark application	$  415.00
	Trademark appeal to board			$2,050.00
	Trademark section declarations		$  220.00
	Trademark renewal applications		$  235.00
   The Commissioner did not challenge the validity of SWIMC and DIMC as separate corporate entities for tax purposes.
   The Code provides a deduction for dividends received by a corporation which is a member of the same affiliated group as the corporation distributing the dividend. See Code § 243.  The Board notes that, because Sherwin-Williams directly owns one hundred percent of SWIMC and directly owns eighty-five percent of DIMC, Sherwin-Williams would receive a one hundred percent deduction for dividends received from its two subsidiaries.
   Code § 332 provides for the nonrecognition of income received by a parent corporation upon the liquidation of a subsidiary in which the parent owns at least an eighty-percent interest.  The Board noted that Code § 332 would apply to Sherwin-Williams if it were to liquidate SWIMC and DIMC, because Sherwin-Williams owned more than eighty percent of the stock of both these subsidiaries.
  Code § 482 applies to transactions that are ordinarily accorded nonrecognition treatment for tax purposes.  Here, the taxpayer contended, and the Commissioner did not challenge, the fact that Code § 351 controlled the formation of SWIMC and DIMC.  However, Code § 482 operates independently of Code sections governing nonrecognition transfers such as § 351.  See National Securities Corporation v. Commissioner, 137 F.2d 600 (3rd Cir.), cert. den., 320 U.S. 794 (1943).

ATB 2000-526