New York requires royalty payments received from foreign affiliates


On Oct. 20, 2022, the Appellate Division of the New York Supreme Court ruled that the Walt Disney Company and its consolidated subsidiaries (Disney) could not exclude royalty payments from foreign affiliates in computing their New York corporation franchise tax for the 2008–2010 tax years.1 In affirming the New York Tax Appeals Tribunal,2 the Appellate Division held that since the foreign affiliates, as nontaxpayers in New York, would not be required to add back royalty payments to their nonexistent New York tax returns, Disney could not deduct the royalty payments from its entire net income (ENI) base.




Disney, a worldwide entertainment company, is comprised of a group of corporations with operations separated into five business segments during the 2008–2010 tax years at issue. Disney’s consumer products segment engaged with licensees, manufacturers, publishers and retailers to design, develop, promote, and sell a variety of products based on existing characters. Disney licensed characters from its film, television and other properties to its foreign affiliates pursuant to licensing agreements and earned substantial royalties in return, based on a fixed percentage of the selling price of the products. 


On its 2008–2010 New York corporation franchise tax returns, Disney included all affiliates that were included on its consolidated federal corporation tax returns filed for the same tax periods. Organized under the laws of foreign countries, Disney’s foreign affiliates were not members of Disney’s New York corporation franchise tax group during the tax years at issue. On an amended 2008 tax return, Disney excluded royalty payments from its foreign affiliates in calculating its taxable income and filed a corresponding refund claim. On its original 2009 and 2010 tax returns, Disney excluded royalty payments from the same foreign affiliates. In support of the exclusions taken, Disney pointed to a provision of New York tax law that permitted an exclusion for royalty income during the tax years at issue where the royalty payments were received from a related member.3


Following an audit of the 2008–2010 tax years, the New York Department of Taxation and Finance disallowed the royalty income exclusions taken because the foreign affiliates were not New York taxpayers. The Department issued a deficiency notice with a tax assessment of approximately $4 million and denied Disney’s refund request filed for the 2008 tax year. Disney protested the notice by filing a petition with the New York Division of Tax Appeals.


New York’s exclusion of royalty payments


Prior to 2013, New York law provided for a royalty income exclusion that allowed taxpayers to deduct royalty payments received from a related member to the extent included in a taxpayer’s federal taxable income “unless such royalty payments would not be required to be added back” under the expense disallowance provisions or similar provisions of New York tax law.4 This provision required a taxpayer to add back royalty payments made to a related member in computing ENI to the extent they were deductible in computing federal taxable income unless: (i) the royalty payor was included in the combined report with the payee; (ii) the payee later paid the royalty amounts to an unrelated party during the taxable year; or (iii) the royalty payments were made to a non-U.S. related member subject to a comprehensive tax treaty with the U.S.5 None of these exceptions applied to Disney.


ALJ determination


While agreeing with Disney that the payments from its foreign affiliates were royalties, the New York Division of Tax Appeals, Administrative Law Judge (ALJ) Division determined that the payments were improperly excluded from Disney’s ENI base under the New York tax law in effect during the relevant tax years.6 The ALJ observed that the New York legislature intended for the royalty income exclusion to “work in tandem” with a corresponding addback provision for royalty payments made to controlled affiliates. In the ALJ’s view, the legislature intended for such royalty payments to be subject to tax once, and not to “escape taxation.” However, the ALJ noted that the addback provision did not apply to Disney’s foreign affiliates because these entities were not New York taxpayers. If Disney were entitled to the exclusion, the ALJ reasoned, the royalty payments would not be subject to tax, contrary to the legislative intent of the exclusion. The ALJ also rejected Disney’s contention that the Department’s interpretation of the royalty income exclusion violated the Commerce Clause of the U.S. Constitution. Both Disney and the Department filed exceptions to the ALJ determination with the Tax Appeals Tribunal.


Tribunal decision


In affirming the ALJ, the Tax Appeals Tribunal agreed that the foreign affiliate royalty payments were not excludable from ENI. The Tribunal analyzed the royalty income exclusion provision, focusing on the meaning of the words “would not be required to be added back.” Disagreeing with Disney, the Tribunal determined that related-member royalty payments were not required to be added back if the royalty payor is not a New York taxpayer, since they are not subject to the royalty expense addback provision. The Tribunal considered the legislative intent and explained that the royalty income exclusion provision should be read in conjunction with the addback provision since both were enacted together. According to the Tribunal, the addback was intended to impose franchise tax on deductions taken by taxpayers on royalties paid to related members, and that the income exclusion provision was conditioned on the application of the addback. Finally, the Tribunal rejected Disney’s argument that disallowing the royalty income exclusion violated the dormant Commerce Clause. Disney subsequently filed the instant case with the New York Supreme Court Appellate Division to challenge the Tribunal’s determination.

Appellate Division decision


The Appellate Division affirmed the ALJ and Tribunal and held that Disney could not deduct the foreign affiliate royalty payments. On appeal, Disney argued that New York law unambiguously allowed a taxpayer to exclude royalty payments received from a related member unless it met one of the three statutory conditions which did not apply to Disney. Because the definition of “related member” did not require such entity to be a taxpayer, Disney argued that it was entitled to deduct royalty payments as income from its foreign affiliates.


No deduction of royalties received from foreign affiliates


As explained by the Appellate Division, the statutory provision at issue contained two operating sections — one governing payments from a “related member” and the other governing payments to a “related member.”7 A related member was defined as “a person, corporation or entity, . . . whether such person, corporation or entity is a taxpayer or not, where one such person, corporation, or entity or set of related persons, corporations or entities, directly or indirectly owns or controls a controlling interest in another entity.”8 A taxpayer is defined as any corporation subject to New York corporation franchise tax.9 As an entity receiving royalty payments from a “related member,” Disney would be allowed to deduct the royalty payments unless they “would not be required to be added back.”10


The Appellate Division noted that in order to determine whether an entity receiving royalty payments is entitled to deduct them from its income, an examination must be made whether the entity that made the payments is entitled to add them back. When the statute was amended in 2013, the legislature indicated that the existing statute had been “interpreted by some taxpayers in ways that are inconsistent with the intent of the statute and the Department’s interpretation” and the amendment “would eliminate those inconsistent readings with clear language on the applicability of the required add-back . . . in order to prevent tax avoidance while allowing for fair and equitable administration.”11


The Department’s employees testified that Disney was denied the royalty deduction because the foreign affiliates making the payments were not New York taxpayers. The Appellate Division quoted language from the ALJ that the contested addback and exclusion provisions “work in tandem to ensure that royalty payments between related members are taxed only once” and do “not escape taxation altogether.” Also, the Appellate Division noted the Tribunal’s explanation 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.” 


The Appellate Division determined that the plain meaning of the statute supported the Tribunal’s interpretation. Under the statute, Disney would be entitled to deduct royalty payments received from its foreign affiliates unless the foreign affiliates would not be required to add back the royalty payments on their own tax returns. Because only taxpayers are required to add back royalty payments, the foreign affiliates, as nontaxpayers, would not be required to add back the payments. Although Disney argued that the definition of “related member” includes nontaxpayers, the Appellate Division determined this was immaterial because the operative paragraph only applies to taxpayers. Since the foreign affiliates were nontaxpayers that could not add back royalty payments on their nonexistent returns, Disney was statutorily precluded from deducting the royalty payments. The Appellate Division explained that “[s]uch construction of the statutory text provides the clearest indication of the legislative intent, and is construed in a manner to ‘to give effect to its plain meaning.’”12


Dormant Commerce Clause not violated


Finally, the Appellate Division affirmed the holdings of the ALJ and Tribunal that the statute does not violate the dormant Commerce Clause. Disney unsuccessfully argued that the statute discriminates against out-of-state commerce because Disney is not permitted to deduct royalty payments from its foreign affiliates that do not file taxes in New York, but could deduct royalty payments from affiliates that file New York tax returns. The Appellate Division noted that this argument did not consider that the reason Disney would be able to deduct the royalty payments from affiliates that were New York taxpayers is because the affiliates would be paying tax on the income. As a result, the income tax on royalties would be paid by either Disney or its affiliates, but the tax would not be paid by both. The Appellate Division concluded that Disney failed to show differential treatment between in-state and out-of-state economic interests rising to a level of unconstitutional discrimination.




The Appellate Division’s decision denying the application of New York’s former royalty income exclusion is consistent with recent ALJ decisions addressing the exclusion in similar cases, including both the IBM13 and Moody’s14 decisions. In IBM, an ALJ held that the taxpayer was not allowed to exclude royalty payments received from foreign affiliates from its ENI for the 2007 through 2012 tax years. In Moody’s, an ALJ determined that the taxpayer was not allowed to exclude royalties that it received in the 2011 and 2012 tax years because the foreign affiliates making the payments were not New York taxpayers and therefore were not required to add back the royalty payments. Likewise, the ALJ in both cases determined that the dormant Commerce Clause was not violated. 


The treatment of royalties substantially changed as a result of the New York budget legislation enacted in 2013.15 There no longer is a royalty income exclusion, and a related-party royalty expense addback exists, with the following four exceptions available for taxpayers: (i) if the taxpayer’s related member paid significant taxes on the royalty payment in other jurisdictions; (ii) if the related member paid all or part of the royalty payment it received to a third party for a valid business purpose; (iii) if the related member is organized under the laws of a foreign country that has a tax treaty with the U.S.: or (iv) if the taxpayer and the Department agree with alternative adjustments that more appropriately reflect the taxpayer’s income.16 Also, any ambiguity over the term “related member” was resolved by linking it to the definition in IRC Sec. 465(b)(3)(c), but substituting 50% for the 10% ownership threshold.17 


While the royalty income exclusion was repealed in 2013, the application of the former statute continues to be the subject of Department audits and subsequent appeals and litigation. As shown in the Disney decision, the Appellate Division went beyond the literal text of the statute and holistically looked at the purpose of the exclusion and addback regimes, as a means to arrive at a result that would ensure that related-party royalty transactions are effectively taxed once, and do not escape taxation altogether.



Walt Disney Co. v. Tax Appeals Tribunal, New York Supreme Court, Appellate Division, Third Department, No. 532479, Oct. 20, 2022.
Matter of the Walt Disney Co. & Consolidated Subsidiaries, New York State Tax Appeals Tribunal, DTA No. 828304, Aug. 6, 2020. For further discussion of this opinion, see GT SALT Alert: New York requires inclusion of related royalties.
3 Former N.Y. Tax Law § 208.9(o)(3).
4 N.Y. Tax Law § 208.9(o) was subsequently amended to eliminate the royalty income exclusion effective for tax years beginning on or after Jan. 1, 2013. Ch. 59 (S.B. 2609), Laws 2013, amending N.Y. Tax Law § 208.9(o)(2) and repealing N.Y. Tax Law § 208.9(o)(3).
5 Former N.Y. Tax Law § 208.9(o)(2).
Matter of the Walt Disney Co. & Consolidated Subsidiaries, New York Division of Tax Appeals, ALJ Division, DTA No. 828304, May 30, 2019.
7 Former N.Y. Tax Law § 208.9(o)(2), (3) (emphasis added by Appellate Division).
8 Former N.Y. Tax Law § 208.9(o)(1)(a).
9 N.Y. Tax Law § 208.2.
10 Former N.Y. Tax Law § 208.9(o)(3).
11 Citing a memorandum in support of the 2013-14 executive budget, Ch. 59 (S.B. 2609), Laws 2013, amending N.Y. Tax Law § 208.9(o)(2) and repealing N.Y. Tax Law § 208.9(o)(3).
12 Citing BTG Pactual NY Corp. v. New York State Tax Appeals Tribunal, 203 AD3d 1347, 1351 (N.Y. App. Div. 2022) (internal quotation marks and citations omitted).
13 Matter of International Business Machines Corp., New York Division of Tax Appeals, ALJ Unit, DTA Nos. 827825, 827997 and 827998, Dec. 19, 2019, aff’d, New York Division of Tax Appeals, Tax Appeals Tribunal, March 5, 2021.
14 Matter of Moody’s Corp., New York Division of Tax Appeals, ALJ Unit, DTA Nos. 828094 and 828203, Oct. 24, 2019.
15 Ch. 59 (A. 3009 / S. 2609), Laws 2013, Part E.
16 N.Y. Tax Law § 208.9(o)(2)(B); Summary of Tax Provisions in SFY 2013-14 Budget, New York State Department of Taxation and Finance, Office of Tax Policy Analysis, April 2013. 
17 N.Y. Tax Law § 208.9(o)(1)(A).






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