WASHINGTON -- Children know Geoffrey as the friendly giraffe at the Toys "R" Us store. State officials may come to know Geoffrey as a financial wizard who is able to fill their coffers with tax revenue.
But Geoffrey Inc., which holds and manages trademarks for Toys "R" Us and related properties, is asking the Supreme Court to limit the reach of state taxing powers, arguing that states should not be allowed to tax corporations that have no physical presence within their jurisdictions.
The case, Geoffrey v. South Carolina Department of Revenue and Taxation, highlights the aggressiveness with which some states are attempting to expand their revenue base. A Supreme Court ruling in the case could reward that aggressiveness by opening the tap nationwide to a multimillion-dollar revenue stream, or it could turn off the faucet entirely.
The justices may announce as early as Nov. 29 whether they will review the case.
Business interests have warned that, if allowed to stand, the South Carolina Supreme Court's ruling in the case could have staggering financial implications for multistate taxpayers, especially those that deal with intangible property.
For example, an author who is paid royalties on book sales might be subject to taxation in every state in which the book is sold. Television producers paid royalties by a network might be subject to taxation in every state in which the producer's programs are aired.
The dispute's roots reach to January 1984, when Toys "R" Us underwent a corporate restructuring. Geoffrey Inc. was established to manage the trademarks of the "R" Us children's empire, which among other things includes Kids "R" Us, Books "R" Us, and Sports "R" Us, in addition to Toys "R" Us.
The restructuring was undertaken in part to realize state tax savings. Geoffrey was incorporated in Delaware. which does not impose an income tax on corporations whose activities within the state are confined to maintenance and management of intangible assets such as trademarks.
Meantime, Toys "R" Us outlets would be able to reduce their state tax liabilities by deducting royalty payments made to Geoffrey for use of the "R" Us trademarks.
Toys "R" Us opened its first South Carolina store in 1985. During the tax years at issue in the case, 1986 and 1987, Toys paid South Carolina income taxes of $25,843 and $68,438, respectively. During that time, Toys paid royalties to Geoffrey. At no time did Geoffrey have employees, offices, or real or tangible personal property in South Carolina.
State officials conducted an audit for the 1986 and 1987 tax years, and additional taxes. They claimed that the retailer could not deduct the royalties it had paid to Geoffrey because Geoffrey was "a paper corporation" designed to help Toys escape some tax liabilities.
Toys challenged the assessment, arguing that there was no reason to disregard Geoffrey as a separate corporate entity. State tax Officials then shifted course and said Geoffrey itself was subject to tax in South Carolina on the royalties it received from Toys' operations in the state.
After an administrative hearing, state tax officials ruled that although Toys could deduct its royalty payments to Geoffrey, Geoffrey was subject to taxation of those royalties. Consequently, Geoffrey was assessed $10,612 in taxes, plus interest.
Geoffrey appealed, but a state trial court rejected its claims that the corporation lacked a sufficient nexus, or tie, with South Carolina to satisfy the U.S. Constitution's commerce and due process clauses.
The commerce clause prevents states from erecting unreasonable barriers to the free flow of goods and services across state lines, absent congressional authorization. The due process clause prohibits states from depriving people "of life, liberty, or property, without due process of law."
The court found that Geoffrey's "exploitation" of the state market was "a sufficient basis upon which to find a valid nexus." Secondarily, the court found that Geoffrey's intangible property -- a franchise and the receivables from the license agreement -- was in South Carolina, providing another basis for nexus.
The South Carolina Supreme Court affirmed the trial court ruling, holding that "the nexus requirement of the due process clause can be satisfied even where the corporation has no physical presence in the taxing state if the corporation has purpose-fully directed its activity at the state's economic forum."
In its petition for review by the U.S. Supreme Court, Geoffrey said, "The basic tax nexus issue presented by this case is one of enormous Practical significance that will create chaos in interstate tax administration unless resolved by this court."
In reply, the state revenue department quoted from Henny Penny: "~The sky is falling, the sky is falling!' cried Chicken Little to Henny Penny. The sky did not fall in the tale of Chicken Little and neither has the Supreme Court of South Carolina shattered the heavens by the Geoffrey decision."