Many businesses are surprised not only that the City of Seattle has a tax on business receipts to begin with, but that the City of Seattle attempts to extend its taxing authority so far. This article looks at one case in which the courts drew a line – a case involving the well know “Blistex” lip balm name.
Louis D. Bracken invented a formula for lip balm and, in 1947, he entered into an agreement giving an Illinois corporation, Blistex, Inc., the exclusive right to use the trademarks he owned, including “BLISTEX, BLISTIK and BLIST-FZE.” In exchange, Blistex, Inc. agreed to pay Louis royalties based on a percentage of sales of the products. Blistex, Inc. uses the trademarks to develop, manufacture, and license lip balm and skin care products throughout the United States and worldwide. After Louis died, his family inherited the trademarks. Later, to avoid probate and re registering the trademarks each time an heir died, the heirs formed the “Blistex Bracken Limited Partnership” (the LP) to hold the trademarks the family owned and to receive the royalty payments from Blistex, Inc.
The LP organizing papers stated that the purpose of the LP was to manage the trademarks and to conduct all business activities related thereto. The LP identified its attorney’s offices in Seattle as its principal place of business, although it also rented an office in downtown Seattle to store LP records and receive mail. The registration form filed with the Secretary of State stated that the LP was a “profit” corporation. The heir who served as managing partner of the LP testified that he made sure that the trademarks stayed current (which the licensing agreement between LP had Blistex required) and that he was responsible for assuring that all of the Bracken heirs received their share of the royalty income from the trademark.
The royalty payments the LP received from Blistex, Inc. were either mailed or sent by wire transfer to a banking account in Seattle. The certified public accountant who prepared the federal income tax returns for the LP from 1990 to 2006, testified that from its inception, the royalty income received by the LP was reported as “portfolio income” – that is a type of income which is not derived in the ordinary course of a trade or business.
In 2006, a City tax auditor noticed the LP name and the “BLISTEX” logo on the door of the office rented by the LP. The City of Seattle notified the LP of a B&O tax review, stating that “it has come to our attention that Blistex Bracken LP is engaging in business in the City of Seattle without a City of Seattle Business License.” After examining the articles of incorporation, the LP agreements with Blistex, Inc., and various other documents, the City issued an assessment notice. In the January 19, 2007 assessment notice, the City auditor concluded that because the LP was “‘engaging in business'” as defined by the City of Seattle Municipal Code (SMC), the royalty income was subject to the City’s B&O tax. The City assessed the LP $131,439.84 in unpaid B&O taxes, interest and penalties from January 1, 1996 through December 31, 2005 based on the LP’s receipt of royalty income from Blistex, Inc.
The LP paid the assessment and then filed an action in Superior Court to refund the B&O taxes, interest and penalties it paid. Although the City of Seattle conceded the LP was an estate planning mechanism, it contended that under the SMC the LP was, nonetheless, engaged in business activities by owning, managing, and maintaining the trademarks. The City also argued that the tax was related to the services provided by the City that allow the LP to own, maintain, and manage the trademarks, and that therefore the City was entitled to assert is taxing jurisdiction. The LP countered that Blistex Inc., not the LP, engaged in the business activities that generated income. The LP argued that it was an estate planning mechanism and that the receipt of royalty income, the preparing of federal income tax returns, and the maintenance of an office did not constitute engaging in business under the SMC. The LP also argued that imposition of a B&O tax violated due process and the Commerce Clause. The Superior Court granted summary judgment for the LP and the City of Seattle appealed.
In an unpublished opinion the Court of Appeals expressed some frustration with the case. Where the Superior Court had viewed the case as raising the question whether the LP had sufficient “nexus” with Seattle to allow the City to tax its activities, the Court of Appeals raised what it called “the more difficult question and the one most thoroughly briefed by the parties [which was] whether the royalty amounts are subject to Seattle’s B&O tax.” In other words, were the royalties income from engaging in business activities in the first place? Thus,the Court of Appeals first reviewed the SMC’s B & O tax provisions and concluded that while the Code broadly defined “income,” there was a requirement that the income had to be derived from “engaging in business” to be taxable. The Court indicated that since it was Blistex Inc. of Illinois which engages in the business activities that generate the sales and royalty income, the fact that the LP received royalties does not necessarily make that income taxable.
Interestingly, either the City did not raise the point, or the Court chose not to discuss it, but the State Department of Revenue has ruled administratively that an estate which merely collects royalties is engaged in a business activity which is subject to Washington State B & O tax. Given the similarity between the State and City taxing codes, the State’s decision in another case might have appeared relevant. For whatever reason, the Court of Appeals in Blistex assumed for argument’s sake that the taxpayer had received taxable income, but went on to find that the nexus between the minimal business activities of the LP and the City was insufficient to justify imposition of the B&O tax on the receipt of royalties.
The Court focused on the Dravo test, long standing case law that a taxable event had to occur within city limits, and that there then has to be a reasonable relationship between the taxable event and the taxing entity which was sufficient to justify taxation. The measure of the tax sought also had to fairly and closely relate to the taxed activities of the taxpayer within the boundaries of the municipality. The City contended the taxable event was the business activities the LP engages in that were related to owning, managing and maintaining the trademarks. The Court felt, however, that the record revealed very minimal activities that the LP engages in related to owning, managing and maintaining the trademarks. The City also argued that maintenance of an office, use of banking services, and hiring accountants and lawyers satisfied the nexus requirement. The Court of Appeals rejected this because whether the LP maintained an office and hired accountants to prepare yearly federal income tax returns was not a determining factor in deciding whether the City exceeded its taxing authority. Finally, although the LP’s legal agreement with Blistex required the LP to register trademarks if requested by Blistex, Inc., there was nothing in the record that indicated that the LP had actually done so during the assessment period. Nor was there any evidence in the record that the LP retained or paid attorneys for activities concerning the trademarks during the assessment period.
The Court concluded that there was insufficient nexus between the limited business activities of the LP and imposition of the B&O tax on the royalties received. The City of Seattle petitioned the Washington Supreme Court for review of the decision, but the Supreme Court declined review.
The question of whether a person or entity is actually engaging in business is somewhat infrequent, but the question whether an out of City (or out of State) business has sufficient nexus to be taxable is not. The City of Seattle is among the more aggressive cities in asserting its jurisdiction but, as the Bracken case suggests, some businesses may have good reason to question whether their activities in Seattle are sufficient to trigger nexus. We hope to shortly post an additional blog discussing in more detail the general principles of City of Seattle nexus.
Learn more about Attorney Martin Silver, PS.