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Tax Law

New York Administrative Court (Again) Holds Royalties Received from Foreign Related Parties Cannot be Excluded from Taxable Income

New York Administrative Court (Again) Holds Royalties Received from Foreign Related Parties Cannot be Excluded from Taxable Income

On December 19, 2019, the New York Division of Tax Appeals (DTA) held that a corporate taxpayer must include royalties received from foreign affiliates in the computation of its entire net income for its 2007 through 2012 tax years. Matter of IBM Corp., DTA Nos. 827825, 827997, and 827998 (N.Y. Div. Tax App. Dec. 19, 2019).

Under prior law enacted in 2003, New York put in place a royalty add-back regime requiring a taxpayer that paid royalties to a related party to add back the payments to the extent they were deductible in calculating federal taxable income. At the same time, New York also enacted a “royalty income exclusion” that allowed royalty payees (the parties that received, rather than paid, the royalties) to exclude from income the royalty payments received from a related entity to the extent the payments were included in the payee’s federal taxable income, “unless such royalty payments would not be required to be added back” by the related payor entity under the royalty add-back provisions. The use of the word “would” in the “royalty income exclusion” indicated that there was no explicit requirement that the related payor of the royalty actually be a New York taxpayer that added back a royalty payment.

In the case, the corporation/payee that received related party royalties was a New York taxpayer, but the related foreign affiliate payors of the royalties were not. The corporation argued that the royalty payments received from its foreign affiliates qualified for the “royalty income exclusion” because the foreign affiliates would be required to add back such payments if they were New York taxpayers. However, the DTA concluded that the “royalty income exclusion” required that the payees be New York taxpayers to qualify for the exclusion and, therefore, that the royalty payments at issue could not be excluded from the corporation’s entire net income.

The DTA’s decision is nearly word-for-word identical to a DTA decision that was authored by the same Administrative Law Judge and issued on May 30, 2019, in Matter of Walt Disney Company and Consolidated Subsidiaries. The Disney decision has been appealed to the New York Tax Appeals Tribunal.