Kimberly–Clark Corp. v. Comm'r of Revenue

83 Mass.App.Ct. 65

981 N.E.2d 208

KIMBERLY–CLARK CORPORATION & another ¹

v.COMMISSIONER OF REVENUE.

No. 11–P–632.

Appeals Court of Massachusetts, Suffolk.

Argued Jan. 6, 2012.

Decided Jan. 11, 2013.

Philip S. Olsen, Boston, (Natasha Varyani with him) for the taxpayer.

David A. Guberman, Special Assistant Attorney General, for Commissioner of Revenue.

Present: KANTROWITZ, TRAINOR, & HANLON, JJ.

TRAINOR, J.

Kimberly–Clark Corporation (Kimberly–Clark) and Kimberly–Clark Global Sales, Inc. (Global), a wholly-owned subsidiary of Kimberly–Clark (collectively, taxpayer),²appeal from a decision of the Appellate Tax Board (board) affirming the denial by the Commissioner of Revenue (commissioner) of the taxpayer's requests to abate corporate excise taxes in 2001, 2002, and 2003.³ The three appeals were consolidated and heard together in October and November, 2009. In July, 2010, the board ruled in favor of the commissioner. Specifically, the board affirmed the denial of Kimberly–Clark's requested abatement of $1,514,355 for the tax years ending December 31, 2001 and 2002, and Global's requested abatement of $1,113,418 for the tax year ending December 31, 2003.

Conclusions of the board. For the tax year ending December 31, 2001, the board concluded that the commissioner had properly disallowed interest expenses claimed by Kimberly–Clark on transfers made between related entities by way of the taxpayer's cash-management system. The board therefore affirmed the commissioner's assessment of corporate excise against Kimberly–Clark in the total amount of $817,797.25.

For the tax year ending December 31, 2002, the board concluded that the commissioner had properly disallowed (1) interest expenses claimed by Kimberly–Clark on transfers made between related entities through the taxpayer's cash-management system, and (2) patent royalties Kimberly–Clark had paid to Kimberly–Clark Worldwide, Inc. (Worldwide), a related entity. The board therefore affirmed the commissioner's assessment of corporate excise against Kimberly–Clark in the total amount of $1,089,700.

For the tax year ending December 31, 2003, the board concluded that the commissioner had properly disallowed (1) interest expenses claimed by Global related to its participation in the cash-management system, and (2) payments among related entities that the taxpayer referred to as “rebate payments.” The board therefore affirmed the commissioner's assessment of additional corporate excise against Global in the total amount of $1,113,418.

The taxpayer appeals from the decision of the board, arguing that (1) Kimberly–Clark was entitled to interest expense deductions because the cash-management system created real debt between the parties; (2) Kimberly–Clark was entitled to the royalty deductions because the transactions and entities at issue had both business purpose and economic substance; (3) the 2003 rebate payments were improperly characterized by the board as royalty payments and, therefore, should not have been added back by the commissioner; and (4) the board erroneously applied a clear and convincing evidence standard to the hearings before the board, when the actual standard was a preponderance of the evidence.

We conclude that the taxpayer's arguments are without merit, and affirm.

Background. For the facts, we refer to the board's January 31, 2011, detailed findings of fact and report, and repeat only those facts most relevant to our decision on appeal.

Kimberly–Clark began doing business in the 1870s and has since grown into a leading manufacturer of toiletries and paper and tissue products, among other items. In the mid–1990s, Kimberly–Clark entered into an agreement and plan of merger (the merger) with the Scott Paper Company (Scott), whereby Kimberly–Clark acquired all of the outstanding shares of Scott, which became a wholly owned subsidiary of Kimberly–Clark.⁴

1. Cash-management system. For each of the tax years at issue the taxpayer utilized a centralized cash-management system, through which all the cash receipts of each of Kimberly–Clark's subsidiaries were deposited into a lock box maintained by Kimberly Clark Financial Services, Inc. (Financial). The cash was “swept up” daily to Kimberly–Clark and placed in a single pool, from which the expenses of the various subsidiaries were paid. Kimberly–Clark recorded each installment of cash it received from the lock box at Financial as a payable, with interest calculated monthly. The record contains no evidence indicating that any subsidiary received any return of its advances to Kimberly–Clark in excess of the amount required to pay the subsidiaries' expenses. At the end of each of the tax years at issue, 2001, 2002, and 2003, Kimberly–Clark was a self-described net borrower.

On December 31, 1998, Kimberly–Clark and Worldwide executed an “Amended and Restated Loan Agreement” that stated the parties' intention and agreement to make loans to each other on an ongoing basis. Also in evidence were promissory notes payable from Kimberly–Clark to Worldwide on December 31, 2003, and December 31, 2008. Neither the loan agreement nor any of the promissory notes in evidence contained “collateral” or “default” provisions, or any similar provisions describing what should be done in the event that the debts between the entities went unpaid. Regarding the interest rates charged to the subsidiaries, a representative of Kimberly–Clark testified that for each lending transaction the company charged “the rate that would be published by the IRS as what is representative of an arm's-length transactional rate as opposed to going into individual negotiations....” No evidence was offered that any of the notes were repaid by Kimberly–Clark, or that any substantial requests for, or efforts toward, repayment were made by either Kimberly–Clark or its subsidiaries. Based on the evidence presented, the board affirmed the commissioner's disallowance of the interest expenses related to the cash-management system, finding that the taxpayer had not incurred true debt.

2. Royalty expenses of 2002. As a result of Kimberly–Clark's acquisition in 1995 and liquidation in 2000 of Scott's outstanding stock, Kimberly–Clark began to consolidate and centralize several operational functions of the two large merging entities. Paul McGuire, Kimberly–Clark's assistant controller for tax accounting, testified that as a result of the merger the parent companies needed to restructure in order to centralize ownership and control of their intellectual property. As a result, in November 1996, Kimberly–Clark and Scott transferred ownership of their patents and the management of their trademarks to Worldwide, a newly created subsidiary of Scott.^5,6,7 Worldwide granted licenses to the patents and sublicenses to the trademarks back to Kimberly–Clark and Scott. In consideration of these licenses and sublicenses, Kimberly–Clark agreed to pay a royalty to Worldwide of three percent of sales as defined in each agreement, and Scott agreed to pay Worldwide a royalty of 3.1 percent to 3.3 percent of sales, the rate changing depending on the time period specified.

The ostensible reasons for the restructuring are stated in a 1996 internal document entitled the “Project Partners Communication Guide” (guide), issued by Kimberly–Clark to “those teams affected by the creation of [Worldwide].” The guide states that the “change centralizes the ownership of intangible assets of three companies” and “will produce ... significant tax savings.”

Kimberly–Clark and Scott transferred full ownership of the patents to Worldwide, thus generating the substantial royalty payments that followed, but notably retained ownership of the trademarks. There was no explanation offered for the retention of the trademarks in the context of Kimberly–Clark's stated goals to increase efficiencies and enhance the protection of their intellectual property following the merger. The board found that this disparate treatment of the patents and trademarks undermined the taxpayer's assertion that tax reduction was not a principal purpose of the 1996 reorganization.

The board also found it significant that company tax personnel played a dominant role in the 1996 restructuring. The restructuring apparently did not include significant involvement by operations personnel, company managers, or employees responsible for evaluating intellectual property issues, despite the fact that the taxpayer claims such issues as the impetus behind the restructuring. The board also noted that the only witnesses presented by the taxpayer to support their claims on appeal were the company's director of tax defense, assistant controller for tax accounting, and controller.

The board concluded that the license agreements between Kimberly–Clark and its affiliated entities were de facto exclusive licenses, in that the record did not indicate that Worldwide or any other subsidiary entered into any third-party licensing agreements with respect to either the patents or the trademarks. The board further found that the royalties paid by Kimberly–Clark and Scott to Worldwide effectively were immediately returned to Kimberly–Clark, by way of the cash-management system.

Based on the foregoing facts, the board found that the taxpayer failed to demonstrate that tax reduction was not a principal purpose of the 1996 restructuring, and that the taxpayer did not sustain its burden of demonstrating that the commissioner's “add back” of the royalty expenses for the tax year 2002 was unreasonable under G.L. c. 63, § 31I.

3. Global's rebate payments of 2003. As a part of Kimberly–Clark's efforts to centralize and increase efficiencies, in 2002 it created Global to serve as the entity that controlled the conglomerate's entire supply-chain management process. Manufacturing was done primarily by Kimberly–Clark, but also through contracts with other entities that were qualified by Worldwide as “certified suppliers.”

Prior to the 2003...