DISNEY WAS DEDUCTING ROYALTY PAYMENTS MADE BY AFFILIATES WHICH DID NOT PAY NEW YORK TAXES; THE TAX LAW WAS DESIGNED TO PLUG THAT “LOOPHOLE” AND THE DEDUCTIONS WERE PROPERLY DISALLOWED (THIRD DEPT).

The Third Department, in a full-fledged opinion by Justice Fisher, determined the Tax Law did not permit petitioner to deduct royalty payments made by affiliates organized under the law of foreign countries pursuant to intellectual-property licensing agreements. The opinion is too detailed and comprehensive to be fairly summarized here: Essentially, the petitioner was deemed to be taking advantage of a “loophole” to avoid paying franchise taxes which had been addressed and closed by the Tax Law:

At the hearing, the Department’s employees testified that petitioner was denied the royalty deduction because the foreign affiliates it had received payments from were not New York taxpayers. The ALJ [Administrative Law Judge] found that “[t]he addback and exclusion provisions contained in Tax Law [§ 208 former] (9) (o) work in tandem to ensure that royalty transactions between related members are taxed only once” and do “not escape taxation altogether.” In determining that petitioner’s interpretation of the statute effectively allowed it to avoid taxation on that income, which went against the Legislature’s intent in enacting the statute, the ALJ concluded that the Department’s interpretation of the statute was rational and therefore petitioner was not permitted to deduct royalty payments from its income. When the Tribunal affirmed the findings of the ALJ, it added that “the [L]egislature did not intend for a taxpayer to gain the benefit of the income exclusion . . . without the corresponding cost to a related member of the add back.”  Matter of Walt Disney Co. & Consol. Subsidiaries v Tax Appeals Trib. of the State of N.Y., 2022 NY Slip Op 05898, Third Dept 10-20-22

Practice Point: Disney was deducting royalty payments made by affiliates which did not pay New York taxes. The Third Department determined the Tax Law did not allow the deductions.