SJC rules for Mass. in pair of tax cases

Companies argued against levy on out-of-state profits

Massachusetts has won a pair of closely watched tax cases against two companies that had argued the state could not tax profits from their out-of-state operations, even if those units had done millions of dollars in business here.

The Massachusetts Supreme Judicial Court ruled yesterday the state Department of Revenue was right in its method of taxing Toys 'R' Us and the credit card giant Capital One. The companies had fought their tax bills for years, arguing the state could not tax business units with no physical presence in Massachusetts.

Officials with the Department of Revenue estimated about $90 million of taxes was at stake, including payments from the two companies and other businesses that had claimed similar tax positions in disputes with the department. Toys 'R' US, Capital One, and some of the other businesses had already begun paying the disputed taxes even before the court's decision. But about $20 million of the total represents money the state believes other affected companies must now pay because of the court rulings.

Officials also celebrated the ruling because it established a clear precedent in state tax law, eliminating ambiguity that has led to several multimillion dollar disputes.

"This really does affirm the way we've been approaching this issue," said Navjeet K. Bal, the state's revenue commissioner. "You're not required to have a physical presence here in order to be subject to a corpo rate tax."

If the state had lost both cases, it would have been in the position of refunding up to $70 million at a time when the economic downturn is already forcing officials to cut public services to resolve a $1 billion deficit in the state budget.

The disputes with the companies, though different in the details, turned on the question of whether they had enough of a business presence in the state to justify the taxes the state said they owed. The cases were part of a wave of lawsuits that arose in the early 1990s, when corporations began employing more aggressive tactics to save on tax bills.

The Toys 'R' Us case is the most prominent. The toy company nearly 20 years ago set up a subsidiary in Delaware and gave that unit ownership of its trademark, Geoffrey the Giraffe. Delaware does not tax income on intangible assets such as trademarks.

The company had its stores in Massachusetts and other states pay royalties to the Delaware firm for use of the Geoffrey trademark, according to court filings. State tax officials said the royalty payments were a way of effectively transferring profits that would be taxable in Massachusetts to a nontax jurisdiction. The amount in dispute was $1.6 million, plus penalties and interest between 1997 and 2001.

In yesterday's ruling, the SJC found that the subsidiary in Delaware was subject to taxation because it relied on employees and stores in Massachusetts to generate its profits. Toys 'R' Us did not return a phone call seeking comment.

In the Capital One case, the company argued it did not owe taxes to the state because it did not have any employees or property in Massachusetts, and that the state could not reach across its borders based solely on electronic transactions.

But the court agreed with the Department of Revenue's argument that it was entitled to collect taxes from the company because of the thousands of credit card transactions it has with residents and businesses in Massachusetts.

A spokeswoman for Capital One declined to comment on the ruling yesterday.

Bal said the Capital One decision will help the state resolve similar disputes worth about $20 million.

"It just recognizes the reality of modern commerce," she said of the decision. "It doesn't result in a huge dollar amount for us, but it gives the department and taxpayers clarity that they will be subject to taxation under the standards the court articulated."

Casey Ross can be reached at cross@globe.com.