All seems right in the world, or at least in Michigan, where the Michigan Court of Appeals recently held that the Department of Treasury (Department) improperly disallowed Pfizer’s deductions of “royalties” for Michigan Single Business Tax (SBT) purposes. Pfizer, Inc. v. Dep’t of Treas., Docket No. 301632 (Mich. Ct. App. Feb. 14, 2012). 

To calculate the SBT tax base (now two tax regimes ago), “royalties” were subtracted from federal taxable income.  Pfizer calculated its royalty income based on the “profit split methodology” under  Internal Revenue Code § 482 regulations, which treat 50% of a subsidiary’s profits as “intangible property income” to the parent. Pfizer subtracted these “royalty” amounts to compute its SBT tax base.

The Department disallowed the royalty deduction, claiming that “intangible property income” was not synonymous with the term “royalties” as defined by the Michigan Supreme Court in Mobil Oil Corp. v. Dep’t of Treas., 373 N.W.2d 730, 736 (1985): “payment received by the transferor in patent . . . transactions[.]”  The Department claimed that the definition of “royalties” in Mobil is narrower than the term “intangible property income,” as used in IRC § 936(h)(3)(B), and thus items that may be included in “intangible property income” may not necessarily be considered “royalties” for SBT purposes. 

However, the court dismissed the Department’s theoretical arguments because Pfizer met its burden of proof through uncontroverted affidavits that all of the relevant income related to the subsidiary’s use of Pfizer’s patents. The court placed great weight on the Department’s failure to produce any evidence that Pfizer’s royalty payments were for anything other than the use of its patents.