NYC ruling upholds royalty deductions.

• Author: Amitay, Sharlene
• Position: New York City

The New York City Tax Appeals Tribunal (City Tribunal) affirmed a 1999 administrative law judge (ALJ) ruling, holding that, for New York City (City) general corporation tax (GCT) purposes, the Geoffrey, Inc. trademark licensing company and two other affiliates were not required to be combined with the Toys "R" Us entities subject to the City tax (In the Matter of TOYS "R" US--NYTEX, Inc., TAT(E)93-1039(GC), NYC Tax App. Trib., 1/14/04). The City Tribunal found that the taxpayer established that the royalties were priced at arm's length, and that the City did not adequately rebut this showing. The ruling is favorable and is the first City precedential ruling on this issue. However, the effect is limited by the recent enactment of related-party royalty expense disallowance legislation, effective for tax years beginning on or after Jan. 1, 2003.

Although the City Tribunal agreed that the taxpayer had satisfied the three presumptive criteria for combination--common ownership, unitary business and distortion (as evidenced by substantial inter-corporate transactions)--it also agreed with the ALJ's determination that the taxpayer successfully rebutted the presumption by establishing that the royalty rates were arm's length.

The City Tribunal rejected the City's attempt to inject a business-purpose /economic-substance requirement into the arm's-length analysis. The City had argued that the Sec. 482 regulations in effect for the tax years at issue required a business-purpose and economic-substance finding as a condition precedent to establishing arm's-length conditions. However, according to the City Tribunal, the City did not raise this issue timely and, in any event, a taxpayer seeking to rebut a distortion presumption must merely establish that intercompany transactions were conducted at arm's-length rates employing Sec. 482 methods. Further, the City Tribunal found that the City failed to challenge--let alone rebut--the taxpayer's valuation studies or expert testimony on the arm's length issue.

By statute, the City Tribunal must adhere to precedents set by the State "Tax Appeals Tribunal (State Tribunal), but the State Tribunal is not bound to follow City Tribunal precedents. With this mandate in mind, the City Tribunal distinguished the recent State Tribunal decision on this issue in The Sherwin-Williams Company, DTA No. 816712, NYS Tax App. Trib., 6/5/03.Thus, the City Tribunal concluded that, although the State Tribunal did find that the...