IBM Owes $64.6 Million in New York State Corporate Franchise Taxes

Matty-Sways

Recently a state administrative court found IBM owes $64.6 million in New York state corporate franchise taxes for royalties paid by foreign affiliates. The issue dealt with the Entire Net Income that IBM owed.

A corporation’s entire net income (ENI) generally consists of its investment income and its business income. The investment income and business income are allocated to New York pursuant to the corporation’s investment allocation percentage (IAC) and its business allocation percentage (BAP), respectively. ENI means the “total net income from all sources, which shall be presumably the same as the entire taxable income, subject to certain modifications.”

IBM argued for a literal translation of the statute, but the court found that while the statute was not ambiguous, and seemingly favored IBM, the court would look to the legislative intent of the lawmakers and held in favor of the government. (Matter of International Business Machines Corp., DTA No. 827825 (N.Y. Tax App. Div. 12/19/19)).

IBM operates in over 170 countries primarily through locally incorporated subsidiary companies referred to as “alien S&D affiliates.” IBM served as the legal owner to all IBM intangible property, including the IBM brand. IBM granted the alien affiliates the right to exploit IBM’s intangible property in a designated region in exchange for specified payments by the alien S&D affiliate.

For federal income tax purposes, IBM included the payments IBM received from the alien S&D affiliates pursuant to the hardware, software, and services agreements (alien payments), but did not file with the alien S&D affiliates as part of IBM’s combined report for New York state corporation franchise tax purposes for the periods at issue.

This issue dates all the way back to 2007 when the N.Y. Division of Taxation denied IBM’s claims for refund for 2007-2010 and issued a notice of deficiency. The combined deficiencies along with the Metropolitan Transit Authority plus interest and penalty for substantial under reporting of the amount asserted due resulted in an amount of $64.6 million owed by IBM. IBM challenged the assessment in the N.Y. Division of Tax Appeals (court).

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