Tax planning strategies as trade secrets
A tax planning strategy is not a trade secret, a US appeals court said in late July.
TLS Management and Marketing Services in Puerto Rico runs a tax planning business to help clients minimize federal and Puerto Rican taxes.
Ricky Rodriguez-Toledo worked for it initially as a subcontractor starting in March 2012 and then as an employee starting in September 2012. He left in early 2015 and formed a rival tax planning service called ASG Accounting Solutions Group and took two former clients of TLS with him.
His contract while acting as a subcontractor had a non-disclosure clause. When he became an employee, he signed a confidentiality and non-disclosure agreement.
TLS sued him for misuse of trade secrets and breach of the two agreements.
TLS won in federal district court on both claims.
The appeals court overturned the decision. It said TLS has not proven its tax planning strategy is a trade secret since the strategy is based on publicly-available information, and the non-disclosure agreements were so broad as to be unenforceable. They would basically bar Rodriguez-Toledo from ever competing against TLS.
The tax strategy was a way for US companies to reduce income taxes on any part of their operations that could be outsourced to Puerto Rico to 4%.
For example, a US company might outsource its marketing function to a new TLC “division” and take a membership interest in the division and shares in TLS. It would run its marketing costs through TLS, deducting them in the US. TLS would pay the marketing profit back as a dividend to the US company. TLS has been granted a 4% income tax rate in Puerto Rico under Act 73 of 2008 and Act 20 of 2012. The dividend back to the US company would not be taxed in Puerto Rico if, by then, the US company had formed a Puerto Rican subsidiary to own the TLS shares. If it needed the money back before then, the money would be advanced as a no-interest loan.
The Puerto Rican Trade Secrets Act defines trade secret, in part, as information that “has a present or a potential independent financial value or that provides a business advantage, insofar as such information is not common knowledge or readily accessible through proper means . . . .”
The court said TLS failed to prove that the information on which the strategy was based was not common knowledge or readily accessible. Testimony at trial suggested this was a common tax arbitrage strategy used by such companies as Microsoft and Apple, not only in Puerto Rico but also in the US Virgin Islands.
The case is TLS Management and Marketing Services v. Ricky Rodriguez-Toledo.