Appellate Division Upholds Tax Appeals Tribunal in Sherwin-Williams

Client Advisory

November 15, 2004

The Sherwin-Williams Decision

The Appellate Division of the New York courts, 3rd Department, has unanimously affirmed a Tax Appeals Tribunal decision rejecting Sherwin-Williams’ use of an out-of-state intangibles holding company to reduce its New York State tax liability.  The Tax Appeals Tribunal decision was the focus of a July 2003 Client Advisory.

By way of background, in January 1991 Sherwin-Williams formed two Delaware subsidiaries and transferred various trademarks, trade names and service marks to them.  In February 1991, the subsidiaries signed license agreements allowing Sherwin-Williams (the parent operating company) to use the intangibles in return for royalties (intended to reflect arm’s-length pricing).  The subsidiaries also entered into a contract with Sherwin-Williams under which Sherwin-Williams would provide various trademark support services.  Sherwin-Williams filed its 1991 New York State income tax returns on a separate basis, deducting the royalties paid to its subsidiaries.  This resulted in a significantly lower tax liability than would have been reported had it paid no royalties or had it filed on a combined basis with the two subsidiaries.  Finding that Sherwin-Williams failed to rebut the presumption that the transactions resulted in a distortion of income, the Tax Appeals Tribunal ordered Sherwin-Williams to file on a combined basis with the two subsidiaries.

The Appellate Division noted that in order to rebut the presumption that the use of the intangibles holding subsidiaries resulted in a distortion of income, consideration had to be given to whether Sherwin-Williams “established a transaction with economic substance which ‘is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached’ (Frank Lyon Co. v United States, 435 U.S. 561, 583-584 [1978]).”  After listing the business reasons alleged by Sherwin-Williams for establishing the subsidiaries, the Appellate Division found that there was substantial evidence supporting the Tribunal’s determination that Sherwin-Williams’ assignment of the intangibles and the license-back lacked both a business purpose and economic substance.  As such, the Appellate Division ruled that Sherwin-Williams failed to rebut the presumption of distortion of income and sustained the determination of the Tax Appeals Tribunal requiring Sherwin-Williams to report on a combined basis with its Delaware subsidiaries.

The Lowe’s Home Centers, Inc. Decision

In another recent case involving the use of an intangibles holding company, an Administrative Law Judge (“ALJ”) for the New York State Division of Tax Appeals has ruled that Lowe’s Home Centers, Inc., a subsidiary of Lowe’s Companies, Inc., was required to file a combined tax return with its sister trademark holding company, LF Corporation, for its taxable years ending January 31, 1997 and January 31, 1998.  LF Corporation was formed by Lowe’s Companies, Inc. in 1989 for purposes that included the holding of trademarks formerly owned by Lowe’s Companies, Inc.

After reviewing the evidence, the ALJ concluded that the value of the trademarks and trade names owned by LF Corporation had been exaggerated in an effort to justify the payment by Lowe’s Home Centers, Inc. of excessive royalties, thereby understating its taxable income.  The ALJ also concluded that the transfer and license-back transactions “had no business purpose apart from tax avoidance, lacked economic substance other than the creation of tax benefits, and that the royalty payments made to LF were a contrived mechanism to limit [Lowe’s Home Centers, Inc.’s] exposure to state franchise taxes.”  On this basis, the ALJ sustained the notice of deficiency, ruling that the presumption of distortion was not rebutted and the transfer and license-back transactions lacked both a valid business purpose and economic substance.

Anti-Passive Investment Company Legislation

Our July 2003 Client Advisory ( also discussed the anti-passive investment company legislation that was enacted by the New York legislature around the time of the Tax Appeals Tribunal’s decision in Sherwin-Williams, and which is intended to prevent this type of tax planning.  This law was recently amended by technical corrections legislation which:
  • Repeals provisions contained in the earlier legislation requiring the addback of interest payments made to related parties, but expands the definition of “royalty payments” to include patent royalties and amounts allowable as interest deductions to the extent related to the acquisition, use, maintenance, ownership, sale, exchange, or disposition of intangible assets.
  • Provides a new exception for royalties paid to a related member organized under the laws of a foreign country that is subject to an income tax treaty with the U.S., if such payments are taxed in the foreign country at a rate at least equal to that imposed by New York.
  • Eliminates the safe harbor for payments between related members that are made pursuant to a contract that reflects arm’s-length terms and that are made for a valid business purpose.
  • Repeals the rebuttable presumption that a transaction was entered into for tax avoidance purposes where the majority of the taxpayer’s deductions are not reportable as income to New York by the other taxpayers.
  • Repeals the cap on the combined tax paid by a taxpayer and its related member.


The changes to the anti-passive investment company legislation, combined with the Sherwin-Williams and Lowe’s Home Centers, Inc. decisions, impose even further limitations on the use of out-of-state holding companies.  Companies utilizing such structures should review their efficacy.

If you have any questions about the contents of this Advisory, please contact Howard J. Barnet (212-238-8606, or Dan Pittman (212-238-8854,

Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2020 Carter Ledyard & Milburn LLP.
© Copyright 2004

Related practice area:

© Copyright 2020 Carter Ledyard & Milburn LLP