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New York requires inclusion of related royalties

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On Aug. 6, 2020, the New York Tax Appeals Tribunal ruled that the Walt Disney Company and its consolidated subsidiaries (Disney) could not exclude royalty payments from foreign affiliates in computing its New York corporation franchise tax for the 2008-2010 tax years.1 In affirming an Administrative Law Judge (ALJ) determination,2 the Tribunal found that since payments from foreign affiliates were not required to be added back to taxable income because the affiliates were not New York taxpayers, Disney could not exclude such payments from its entire net income (ENI) base.

Background Disney, a worldwide entertainment company, is comprised of a group of corporations with operations that were 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 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 The former royalty expense addback 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 that is subject to a comprehensive tax treaty with the United States.5 None of these exceptions applied in Disney’s case.

ALJ determination While agreeing with Disney that the payments received by Disney from its foreign affiliates were in fact royalties, the ALJ determined that the payments were improperly excluded from Disney’s ENI base under the version of New York tax law in effect during the relevant tax years. 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 at all, 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. Finding that the statute was designed to tax royalty payments only once regardless of whether the royalty payor was a New York taxpayer, the ALJ concluded that the statute as applied to Disney did not discriminate against interstate commerce. For these reasons, the ALJ denied Disney’s petition and sustained the deficiency notice.

Tribunal decision Both Disney and the Department filed exceptions to the ALJ determination. On appeal to the Tribunal, Disney argued that its interpretation of the statute permitted taxpayers to deduct royalties from related members unless such royalties “would not be required to be added back.” Disney read the statutory definition of related members to expressly include nontaxpayers. Under Disney’s interpretation, the royalty income exclusion applied if the royalty is the type that would be required to be added back, regardless of whether it was actually added back. Therefore, Disney contended, the royalty income was excludible if none of the statutory exceptions to the addback requirement applied. Disney likewise argued that the ALJ incorrectly looked to the legislative history and intent behind the expense addback provision, while disregarding the legislative history surrounding the income exclusion provision. Further, Disney maintained that the Department’s application of the royalty income exclusion discriminated against interstate commerce because it foreclosed tax-neutral decisions by pressuring taxpayers to conduct intellectual property licensing activity with affiliates doing business in New York. Rather, Disney argued, the Department should have compared Disney’s facts to similarly situated taxpayers by comparing Disney’s related-entity transactions to similar ones between non-related entities.

In response, the Department relied on New York case law in arguing that ambiguous tax statutes should be interpreted strictly against the taxpayer.6 The Department disagreed with the ALJ’s conclusion that the foreign affiliate payments to Disney were royalties as defined under the statute.7 Even if considered royalties, under the Department’s interpretation of the statutory provision, royalty recipients could not deduct royalty payments if they were not required to be added back by the royalty payor. In Disney’s case, the Department argued that the royalty payments “would not be required to be added back” because Disney’s foreign affiliates were not New York taxpayers and thus not subject to the expense addback provision. Instead, the Department argued, only a New York taxpayer would be required to add back a royalty payment. The Department further asserted that its reading of the tax law was consistent with the 2013 amendments to the statute and corresponding legislative history. Finally, in response to Disney’s constitutional arguments, the Department asserted that the royalty income exclusion and deduction addback provisions must be construed as a whole, and that Disney’s arguments improperly considered them in isolation.

Foreign affiliate royalty payments not excludable from ENI Like the ALJ, the Tribunal agreed with Disney that the royalty payments in question were in fact royalties. The Tribunal rejected the Department’s argument that payments to distribute complete and final films were not directly connected to intangible assets. Instead, the Tribunal determined that the payments were made under licensing agreements to distribute motion pictures and television programming, which are subject to copyright protection. The Tribunal concluded that payments for the use of copyrights are “expressly included in the definition of royalty payments.”

The Tribunal next analyzed the royalty income exclusion provision, focusing on the meaning of the words “would not be required to be added back.” The Tribunal determined that the phrase “requires that we consider or imagine the possible circumstances or situations under which related member royalty payments would not be required to be added back” under the tax law. Disagreeing with Disney, the Tribunal determined that related-member royalty payments would not be 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. Unlike other provisions of the tax law cited by Disney defining the circumstances under which an entity would be subject to tax, the Tribunal noted that the royalty income exclusion provision contained no language limiting the circumstances under which related-member royalty payor payments would not be required to be added back. Accordingly, the Tribunal found it reasonable to consider all circumstances, including where the payor is a related member but not a New York taxpayer.

The Tribunal then explored Disney’s legislative intent argument, 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. In the event that both the royalty payor and payee were New York taxpayers, the Tribunal noted that the provisions shifted the incidence of tax from the payee to the payor and avoided double taxation on the same revenue. Based on this reading, the Tribunal reasoned that a taxpayer could not “gain the benefit” of the royalty income exclusion without the corresponding cost to a related member of the addback.

Acknowledging that both constructions of the royalty income exclusion were reasonable, the Tribunal determined that Disney’s construction may not prevail because it was not “the only reasonable construction.” Instead, the Tribunal agreed with the Department that any ambiguity in the meaning of the statute must be resolved against the taxpayer. For these reasons, the Tribunal concluded that Disney was not entitled to the royalty income exclusion.

No Commerce Clause violation The Tribunal similarly rejected Disney’s argument that disallowing the royalty income exclusion, as applied to Disney, violated the dormant Commerce Clause. The Tribunal considered the hypothetical of similarly situated related members, but where the royalty payor was also a New York taxpayer. In this situation, the Tribunal reasoned, the payee may exclude the royalties from ENI, but the payor would be subject to the addback and required to include the royalties in ENI. In either instance, the Tribunal explained, a related member pays tax on the royalties. Considering the shared economic interest between related members, the Tribunal found that this scenario did not unfairly benefit New York taxpayers. Concluding that the statute’s application did not unlawfully discriminate against Disney, the Tribunal found no burden on interstate or foreign commerce. Having rejected Disney’s statutory and constitutional arguments, the Tribunal affirmed the ALJ determination and sustained the deficiency notice.

Commentary The Disney decision marks the latest case to examine the application of New York’s former royalty income exclusion where the related party making the royalty payment is not a New York taxpayer. The Tribunal’s decision to deny the exclusion is consistent with recent ALJ decisions also addressing the exclusion in similar cases, including both the IBM8 and Moody’s9 decisions. While the royalty income exclusion has been repealed since 2013, the application of the former statute continues to be the subject of Department audits and subsequent appeals and litigation. As demonstrated in the Disney decision, the availability of the exclusion is largely dependent on the taxpayer’s facts and circumstances. Both the Division of Tax Appeals and the Tribunal have consistently interpreted the statute in a way that would not allow royalty transactions between related members to completely avoid taxation.

More broadly, Disney is an example of an ambiguously worded statute that is subject to differing interpretations. In this case, however, the ambiguity of New York’s former royalty income exclusion provision was ultimately resolved against Disney because the Tribunal found the Department’s construction of the statute to be reasonable. Following New York case law, the Tribunal determined that it could not side with Disney because its construction of the relevant statute was not the only reasonable construction. As such, taxpayers in Disney’s position carry a higher burden to prevail in cases of statutory interpretation. Accordingly, they would need to show not only that their interpretation is reasonable, but also that the taxing authority’s interpretation is also unreasonable. Despite the outcome, the Tribunal stopped short of deferring to the Department’s interpretation of the statute outright, instead choosing to examine the language of the statute to determine legislative intent.



1 Matter of the Walt Disney Co. & Consolidated Subsidiaries, New York State Tax Appeals Tribunal, DTA No. 828304, Aug. 6, 2020.
2 Matter of the Walt Disney Co. & Consolidated Subsidiaries, New York Division of Tax Appeals, ALJ Division, DTA No. 828304, May 30, 2019.
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 January 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).
6 Citing Matter of Wegman’s Food Markets, Inc. v. N.Y. Tax Appeals Tribunal, 33 N.Y.3d 587 (2019).
7 Royalty payments are defined as “payments directly connected to the acquisition, use, maintenance, ownership, sale, exchange, or any other disposition of licenses, trademarks, copyrights, trade names . . . and any other similar types of intangible assets . . . to the extent such amounts are directly or indirectly for, related to or in connection with the acquisition, use, maintenance or management, ownership, sale, exchange or disposition of such intangible assets.” N.Y. TAX LAW § 208.9(o)(1)(c).
8 Matter of International Business Machines Corp., New York Division of Tax Appeals, ALJ Unit, DTA Nos. 827825, 827997 & 827998, Dec. 19, 2019. For further discussion, see “New York disallows exclusion of foreign royalties.”
9 Matter of Moody’s Corp., New York Division of Tax Appeals, ALJ Unit, DTA Nos. 828094 & 828203, Oct. 24, 2019. For further discussion, see “New York allows ALJ alternative appointment.”



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