New York Tax Appeals Tribunal: Related Corporations Not Required to File Combined Franchise Tax Return

New York Tax Appeals Tribunal: Related Corporations Not Required to File Combined Franchise Tax Return

The New York Tax Appeals Tribunal has ruled that the Division of Taxation improperly required a subsidiary to file its franchise tax return on a combined basis with its parent corporation because the subsidiary showed that its transactions with the parent were at arm's length.

For the Tropicana opinion, see Doc 2000-17000 or 2000 STT 123-27 <a href="/lr/resolve//5tz1"> <img src="//s3.amazonaws.com/binary.taxnotes.com/image/etl/doclink.gif" border="0" alt="2000 STT 123-27: State Administrative Rulings"/></a>.

The New York Tax Appeals Tribunal has ruled that the Division of Taxation improperly required a subsidiary to file its franchise tax return on a combined basis with its parent corporation because the subsidiary showed that its transactions with the parent were at arm's length (Matter of Hallmark Marketing Corp., July 19, 2007). Hallmark Marketing Corp. (Hallmark Marketing), a subsidiary of Hallmark Cards Inc. (HCI), purchases greeting cards and other social expression products from HCI and sells the merchandise to third-party retailers throughout the U.S. Under a sales and distribution agreement, Hallmark Marketing is HCI's exclusive sales agent in the U.S. In 1999 HCI retained KPMG to evaluate and recommend a range of transfer prices for its transactions with Hallmark Marketing. KPMG determined that the comparable profits method set forth in Internal Revenue Code section 482 was the best valuation method. KPMG prepared a transfer pricing study, which determined an arm's-length price by analyzing profits earned by nine comparable companies and adjusting the price so that Hallmark Marketing's profitability would be consistent with that of the comparable companies. Hallmark Marketing filed a separate state corporate franchise tax return setting its intercompany pricing consistent with the KPMG report. Following an audit, the Division of Taxation determined that Hallmark Marketing and HCI were required to file a combined tax return because the intercompany transactions distorted Hallmark Marketing's New York income. Hallmark Marketing filed an administrative appeal, arguing that its intercompany pricing with HCI was at arm's length. The administrative law judge found in favor of Hallmark Marketing, and the division appealed to the New York Tax Appeals Tribunal, arguing that the nine companies used as comparables in the KPMG report were significantly smaller than Hallmark Marketing and had different business functions and intangible assets. The division also argued that Hallmark Marketing was not compensated for significant services performed by HCI. The tribunal ruled that the division may not require Hallmark Marketing to file its franchise tax return on a combined basis with HCI because there was sufficient evidence that the intercompany transactions between the corporations were at arm's length. The tribunal explained that the valuation methods set forth in section 482 do not require mathematical precision, but purport to find only ranges of acceptable answers. The tribunal determined that the division's arguments concerning the differences between the nine comparable companies and Hallmark Marketing were insignificant. The tribunal also rejected the division's reliance on Matter of Tropicana Products Sales Inc. (2000) because the expert report at issue in that case was prepared specifically for litigation and no prior pricing study had been conducted. (For the Tropicana opinion, see Doc 2000-17000 or 2000 STT 123-27 <a href="/lr/resolve//5tz1"> <img src="//s3.amazonaws.com/binary.taxnotes.com/image/etl/doclink.gif" border="0" alt="2000 STT 123-27: State Administrative Rulings"/></a>.) The tribunal concluded that Hallmark Marketing diligently sought compliance with the law by engaging recognized experts and that the KPMG report accurately and thoroughly applied the rules and principles of IRC section 482. The tribunal found in favor of Hallmark Marketing.

The New York Tax Appeals Tribunal has ruled that the Division of Taxation improperly required a subsidiary to file its franchise tax return on a combined basis with its parent corporation because the subsidiary showed that its transactions with the parent were at arm's length (Matter of Hallmark Marketing Corp., July 19, 2007). Hallmark Marketing Corp. (Hallmark Marketing), a subsidiary of Hallmark Cards Inc. (HCI), purchases greeting cards and other social expression products from HCI and sells the merchandise to third-party retailers throughout the U.S. Under a sales and distribution agreement, Hallmark Marketing is HCI's exclusive sales agent in the U.S. In 1999 HCI retained KPMG to evaluate and recommend a range of transfer prices for its transactions with Hallmark Marketing. KPMG determined that the comparable profits method set forth in Internal Revenue Code section 482 was the best valuation method. KPMG prepared a transfer pricing study, which determined an arm's-length price by analyzing profits earned by nine comparable companies and adjusting the price so that Hallmark Marketing's profitability would be consistent with that of the comparable companies. Hallmark Marketing filed a separate state corporate franchise tax return setting its intercompany pricing consistent with the KPMG report. Following an audit, the Division of Taxation determined that Hallmark Marketing and HCI were required to file a combined tax return because the intercompany transactions distorted Hallmark Marketing's New York income. Hallmark Marketing filed an administrative appeal, arguing that its intercompany pricing with HCI was at arm's length. The administrative law judge found in favor of Hallmark Marketing, and the division appealed to the New York Tax Appeals Tribunal, arguing that the nine companies used as comparables in the KPMG report were significantly smaller than Hallmark Marketing and had different business functions and intangible assets. The division also argued that Hallmark Marketing was not compensated for significant services performed by HCI. The tribunal ruled that the division may not require Hallmark Marketing to file its franchise tax return on a combined basis with HCI because there was sufficient evidence that the intercompany transactions between the corporations were at arm's length. The tribunal explained that the valuation methods set forth in section 482 do not require mathematical precision, but purport to find only ranges of acceptable answers. The tribunal determined that the division's arguments concerning the differences between the nine comparable companies and Hallmark Marketing were insignificant. The tribunal also rejected the division's reliance on Matter of Tropicana Products Sales Inc. (2000) because the expert report at issue in that case was prepared specifically for litigation and no prior pricing study had been conducted. (For the Tropicana opinion, see Doc 2000-17000 or 2000 STT 123-27 .) The tribunal concluded that Hallmark Marketing diligently sought compliance with the law by engaging recognized experts and that the KPMG report accurately and thoroughly applied the rules and principles of IRC section 482. The tribunal found in favor of Hallmark Marketing.