Whole Foods lost a New York tax decision to the tune of $3.5 million, but in my opinion that’s a small price to pay to avoid a decision inconsistent with ownership of the WHOLE FOODS trademarks.
Whole Foods Market Group, Inc. (WFMG), a Delaware corporation, is the operating company that distributes and sells natural and organic food products at retail stores in the US. Whole Foods Market IP, LP (WFMIP), a Delaware limited partnership, owns the trademarks, trade names and other intangible assets. Both companies are owned and controlled by Whole Foods Market, Inc.
WFMG pays royalties to WFMIP for the right to use trademarks and other intellectual property in its retail operations. WFMG deducted the royalty payments from its federal income tax returns and the same amount was included in WFMIP’s federal taxable income.
There were two ways that WFMG could have filed its New York taxes, either as a combined report with WFMIP or filing separately and adding the royalty payments back in to its income to calculate its New York entire net income. WFMG did it the latter way but the Division of Taxation challenged the decision, claiming that WFMG should have filed a combined report with WFMIP.
A combined report must be filed when the companies are related and engaged in a unitary business, which wasn’t disputed, and where there are substantial intercorporate transactions between them. WFMG argued that, by adding the royalty payments back into its New York return, there were no qualifying intercompany transactions. WFMG further argued that doing so did not “give rise to distortion, such as where one corporation proved management, corporate, administrative and logistical services to a related corporation at cost without reimbursement.” In other words, WFMG argued that WFMIP did not provide any management, corporate, administrative, or logistical support to WFMG.
And there we have the definition of a naked license. What WFMG argued was that WFMIP had nothing to do with WFMG except to passively receive royalties. But a trademark owner can’t be uninvolved in the use of its trademarks or it’s a naked license that leads to a judgment that a trademark is abandoned.
Instead the tax court held that, merely based on percentages alone (i.e., that more than 50% of WFMIP’s income was from WFMG royalty payments) the two companies should have filed a combined return.* Had they done so the tax obligation would have been $2.5 million higher, which through interest and penalties ended up at $3.5 million owed to New York.
But $3.5 million is a small price to pay when, had it gone the other way, there would be a legal opinion holding that trademark owner WFMIP did not exercise quality control, sweet future evidence that the WHOLE FOODS trademarks were abandoned.**
Disclaimer: I’m not a tax attorney, so if I have mischaracterized anything about the opinion please let me know.
*For the three years being audited, about 56-57% of WFMIP’s income was royalty payments, which begs a question for me—where did the rest of the income come from?
** I think that would be a foolish outcome, of course they’re not abandoned. But it’s a risk until the 9th Circuit and other circuits that follow it get their law straightened out.
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