Colt Industries, Inc. v. New York City Dept. of Finance

Decision Date19 December 1985
Citation66 N.Y.2d 466,497 N.Y.S.2d 887,488 N.E.2d 817
Parties, 488 N.E.2d 817 In the Matter of COLT INDUSTRIES, INC., Respondent, v. NEW YORK CITY DEPARTMENT OF FINANCE, Appellant.
CourtNew York Court of Appeals Court of Appeals
OPINION OF THE COURT

JASEN, Judge.

The issue presented upon this appeal is whether the management fee imposed by petitioner upon its subsidiary corporations included interest income from subsidiary capital, and was to that extent excludable from entire net income for purposes of the New York City general corporation tax.

Petitioner, Colt Industries, Inc., a Pennsylvania corporation with its headquarters in New York City, is the successor in interest by merger to Colt Industries, Inc., a Delaware corporation, which was the taxpayer during the years in issue. 1 Colt was both a managing company and a holding company. As a management company, Colt's functions and responsibilities were in the areas of general management, policy development and formation, and centralized service functions. As a holding company, Colt owned all the stock of operating subsidiaries. Colt's principal subsidiaries were Crucible, Inc., Colt Industries Operating Corp., Central Moloney, Inc. and Trent Tube B.V. In its capacity as a holding company, Colt served as the principal financing vehicle for its subsidiaries, borrowing money from third-party lenders and advancing funds to its subsidiaries to satisfy their working capital needs. Funds borrowed by Colt which were not needed by the subsidiaries at the time of each loan were temporarily invested in short-term securities for cash management purposes. Colt performed this borrowing function on behalf of its subsidiaries on a centralized basis because, by backing each loan with the combined assets of all the subsidiaries, it could borrow funds at more favorable rates and terms than could the subsidiaries acting individually.

In order to recover its operating costs, which included general administrative, selling and net interest expenses, incurred for services rendered to its subsidiaries, Colt imposed upon each of its subsidiaries a charge, denominated by Colt a "management fee". This management fee was based upon a percentage of the gross projected sales of each subsidiary. In determining the percentage of sales to be charged in a given year, Colt estimated its over-all head office operating costs which included general administrative, selling and net interest expenses. Colt then estimated the sales of each subsidiary for the coming year and totaled all of its projected sales. This ratio of parent costs over subsidiary sales constituted the percentage of sales which Colt generally charged each subsidiary as a management fee for the coming year.

The management fee imposed upon the subsidiaries by Colt included an interest factor. The interest factor of the management fee represented Colt's net interest expense, determined by subtracting from its gross interest expense the estimated income it derived from temporarily investing funds borrowed from third-party lenders in short-term money market instruments. The management fee did not contain a profit element. During the years in question, the major portion of the management fee represented interest expenses. Colt, however, failed to identify any portion of the management fee as interest income on its books or tax returns. Similarly, the subsidiaries did not label the management fee as "interest" upon their tax returns. The management fee represented a unified charge for all services rendered by Colt to its subsidiaries, and while the fee contained an interest factor, it could not, according to the New York City Department of Finance (Department), be broken down into component parts.

The Department issued notices of determination dated September 28, 1978, advising Colt that there were due general corporation tax deficiencies for the years 1971 through 1974. Colt filed a timely petition for redetermination of such deficiencies and, further, sought a refund of general corporation tax for 1971. Before the Department, Colt contended that a portion of the management fees paid to Colt by its subsidiaries contained a verifiable interest factor, so that the management fee constituted income from subsidiary capital which is excludable from entire net income under New York City Administrative Code § R46-2.0(8)(a)(1). The Department disagreed with this view, and determined that there existed a deficiency in New York City general corporation tax in the principal amount of $759,008 plus interest of $463,722.33, representing a total of $1,222,730.33 for 1972, 1973 and 1974. The Department also denied Colt's claim for a refund of general corporation tax for 1971 in the amount of $6,586.82. Colt commenced this article 78 proceeding to review the determination of the Department. The Appellate Division vacated that determinati of the Department, dated June 24, 1983, and thereby reversed the assessment of deficiencies against Colt for the years 1972-1974 and the denial of Colt's refund claim for 1971. For the reasons that follow, we now reverse the judgment of the Appellate Division.

The Administrative Code of the City of New York (Administrative Code) provides that for the privilege of doing business in the City of New York, every domestic or foreign corporation shall annually pay a tax upon the basis of its entire net income. (Administrative Code §...

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