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K-Mart Properties, Inc.



Kmart Corporation created a wholly owned subsidiary, Kmart Properties, Inc., (“KPI”) and transferred all of its domestic trademarks, tradenames and service marks, (“the Marks”) to KPI. KPI licensed them back to Kmart and Kmart paid KPI a royalty fee for the use of the marks based on a percentage of its sales. KPI loaned its excess profits back to Kmart at market rates of interest. KPI was set up in Michigan and it owns no real or tangible property and has no employees in states other than Michigan. Kmart reports to New Mexico for corporation income tax purposes as a separate corporate entity. The effect of the transfer and license back of Kmart’s Marks is that Kmart deducts from pre-tax income the royalty fees.  It also deducts the interest it pays to KPI from pre-tax income. Thus, Kmart has shifted part of its taxable income to KPI. The Department assessed corporation income tax, corporation franchise tax and gross receipts tax against KPI. In calculating the amount of corporation income tax due, the Department modified the standard three-factor apportionment formula to eliminate the property and the payroll factor because they were deminimis and inclusion of those factors would distort the apportionment formula. The Department also modified the sales factor to calculate it based upon KPI’s income from royalties from Kmart’s sales in New Mexico divided by KPI’s royalties from everywhere. The Department assessed gross receipts tax on the royalties KPI received from the use of its Marks in New Mexico. KPI protested the assessments, arguing that because it has no real or tangible property and no employees in New Mexico that it lacked minimum contacts with New Mexico under the Due Process Clause for New Mexico to subject it to its tax jurisdiction. KPI also argued that it lacked physical presence in New Mexico and it therefore lacked the substantial nexus required under the Commerce Clause for New Mexico to subject it to its tax jurisdiction. Kmart also challenged the manner in which the corporation income tax was apportioned to New Mexico. It argued that its situation was not unique and non-recurring, and therefore the Department lacked the authority under Section 7-4-19 to modify the standard three-factor apportionment formula to be applied to apportion its income. KPI argued that the Department’s income tax assessment should be abated because it should only be allowed to address the situation presented by a rule-making proceeding to apply prospectively. Finally, it argued that it had no gross receipts because the legislature amended the definition of license to say it was the sale of property and not a lease, and KPI argued that it was not selling property in New Mexico because the license agreement was executed out-of-state.  KPI’s protest was denied except for their protest of penalty.  Their protest of penalty was granted because they had followed the advice of their accountants in concluding that they weren’t subject to New Mexico’s jurisdiction to tax. It was held that because KPI was purposely availing itself of New Mexico’s markets by licensing the use of its Marks in New Mexico, that sufficient minimum contacts existed with New Mexico under the Due Process Clause. Additionally, it was held that there was a substantial identity of interest between KPI and Kmart under the trademark license agreement and under trademark law such that KPI could be considered to have a physical presence in New Mexico so that substantial nexus exists under the Commerce Clause.  Thus, New Mexico had jurisdiction to subject KPI to tax based on its licensing its trademarks to Kmart for use in New Mexico. It was also held that KPI’s case was sufficiently unusual for the Department to modify the apportionment factor under Section 7-4-19 and that the Department’s modified apportionment factor was fair and reasonable.  It was also held that this protest adjudication was not a rule-making and that the Department had the discretion to proceed in this matter by litigation.  Finally, it was held that KPI’s license receipts were subject to gross receipts tax as receipts from the sale of property in New Mexico.  The sale was considered to be in New Mexico because KPI’s property was delivered to New Mexico when it licensed Kmart to use the Marks in New Mexico.