New York: Royalty Payments from Foreign Affiliates Included in Entire Net Income Base

Recently, an Administrative Law Judge for the New York Division of Tax Appeals held that for purposes of computing New York entire net income for the tax years at issue, a taxpayer could not exclude royalty payments received from foreign affiliates. The taxpayer, a diversified worldwide entertainment company, entered into licensing agreements with its foreign affiliates that granted the affiliates the right, in exchange for royalty payments, to exploit certain intellectual property in specified non-U.S. territories. For the tax years at issue (2008-2010), the taxpayer deducted the royalty payments in computing entire net income on its combined New York tax returns.  The foreign affiliates were not included in the combined returns. The Division later asserted that the royalties could not be excluded.  

Under New York law in effect at the time, a taxpayer could deduct royalty payments received from a related member to the extent included in the taxpayer’s federal taxable income unless the payor was not required to add back those payments under New York’s statutory add back rules.  This provision, which has since been eliminated, ensured that royalties were taxed only once.  In the case, the Division argued (1) that the payments at issue were not royalties, and (2) that the exclusion did not apply in this instance because the foreign affiliates were not New York taxpayers. Conversely, the taxpayer argued that the exclusion applied regardless of whether the payor of the royalties was a taxpayer. The ALJ first determined that the payments made by the foreign affiliates were indeed royalties. In the ALJ’s view, the payments “were made in connection with the licensing of intangible assets.” The ALJ next held that the royalty payments could not be excluded because the deduction did not apply to royalties received from foreign affiliates that were not taxpayers. If an exclusion was allowed, it would have been inconsistent with the legislative purpose behind the deduction statute, which was to ensure royalty transactions between related members were taxed only once, but did not escape taxation altogether. The ALJ concluded that the now-repealed income exclusion provision required the related member royalty payor to be a New York taxpayer for the royalty recipient to qualify for the royalty income exclusion. The ALJ also rejected the taxpayer’s argument that the statute was facially discriminatory.   The taxpayer has the right to appeal the decision to the State’s Tax Appeals Tribunal. For more information on In the Matter of The Walt Disney Company and Consolidated Subsidiaries, please contact Russ Levitt at 212-872-6717.