Disney Urges Justices to Review NY Foreign Royalty Tax Ruling

New York’s highest court applied the wrong standard for evaluating commerce clause challenges in a lawsuit over the state’s tax treatment of foreign royalties, The Walt Disney Co. told the US Supreme Court.

The New York Court of Appeals ruled in April that Disney and IBM Corp. can’t deduct payments from their foreign affiliates that produce and license intellectual property under a state law add-back provision in effect from 2003 to 2013. The court upheld the New York Department of Taxation and Finance’s interpretation of the statute and held that any burden it created on interstate or foreign commerce was incidental and constitutional.

The decision joins one side of a split among state courts of last resort by conflating the demanding standard for plaintiffs seeking to invalidate a whole statute and the burden on states that facially discriminate against out-of-state taxpayers, Disney argued in a petition obtained Monday by Bloomberg Tax. “Multiple state courts of last resort now hold that, to show that a state law textually discriminates against interstate or foreign commerce, a challenger must also show that there is no set of circumstances under which the law would operate evenhandedly,” it said.

“Hundreds of millions of dollars in tax liabilities turn on the decision below in New York alone, and that is just the tip of the iceberg given that numerous state high courts have made the same basic mistake,” Disney argued. Disney and IBM have $4 million and $64 million on the line, respectively.

Geographical Distinction

New York’s royalty expense add-back provision required taxpayers to add royalty payments to their federal taxable income when computing their entire net income allocated to New York. A related exclusion allowed taxpayers to leave out royalty payments from a related member unless the royalties “would not be required to be added back” by that member under the add-back provision.

The state declined to allow Disney and IBM to take the exclusion, interpreting the statute to mean that because the foreign affiliates weren’t subject to New York franchise tax, they “would not be required” to add back the same royalty payments.

Disney faulted the state high court for holding that a company’s obligation to pay the tax depended on the geographical distinction of whether the royalty-paying affiliate did business exclusively outside New York. “That textbook discrimination resulted in textbook injury here,” it said.

The highest courts of Ohio, New Mexico, and Rhode Island have applied the proper test for invalidating a statute as facially discriminatory, while New York joined New Hampshire and got it wrong, Disney said.

“The issue is important, and this case is a clean vehicle,” the company said. “Indeed, it is difficult to imagine a more prototypical as-applied challenge than a tax-deficiency proceeding or a refund action.”

If the court doesn’t grant the case on its own merits, it should at least hold it until it decides whether to review the Zilka petition about Philadelphia’s tax credit policy currently awaiting the Solicitor General’s input, Disney said.

IBM’s petition for review of the same underlying decision was also due Sept. 20 but hasn’t yet been posted on the court’s website.

Clement & Murphy PLLC and State Tax Law LLC represent Disney.

The case is Walt Disney Co. v. N.Y. Tax App. Trib., U.S., petition filed 9/20/24.