Disney Enterprises v. Tax Appeals Tribunal

• Court: New York Court of Appeals Court of Appeals
• Writing for the Court: Kaye
• Citation: Disney Enterprises v. Tax Appeals Tribunal, 888 N.E.2d 1029, 10 N.Y.3d 392, 859 N.Y.S.2d 87 (N.Y. 2008)
• Decision Date: 25 March 2008
• Docket Number: 37.
• Parties: In the Matter of DISNEY ENTERPRISES, INC., et al., Appellants, v. TAX APPEALS TRIBUNAL OF the STATE of New York et al., Respondents.

888 N.E.2d 1029

10 N.Y.3d 392

In the Matter of DISNEY ENTERPRISES, INC., et al., Appellants, v. TAX APPEALS TRIBUNAL OF the STATE of New York et al., Respondents.

37.

Court of Appeals of New York.

March 25, 2008.

Morrison & Foerster LLP, New York City (Paul H. Frankel, Craig B. Fields and Roberta Moseley Nero of counsel), Michael H. Salama, Burbank, California, and Brandee A. Tilman, for appellants.

Andrew M. Cuomo, Attorney General, Albany (Robert M. Goldfarb, Barbara D. Underwood and Andrew D. Bing of counsel), for Commissioner of Taxation and Finance, respondent.

OPINION OF THE COURT

KAYE, Chief Judge.

This appeal tests the validity, under federal law, of New York's franchise tax apportionment formula.

Petitioner, Disney Enterprises, Inc., is a worldwide entertainment conglomerate with hundreds of parents, subsidiaries and affiliates. Disney conducts general operations in three interrelated business segments pertinent to the present appeal: theme parks and resorts, filmed entertainment and consumer products. Its consumer products segment licenses and distributes merchandise (apparel, toys, gifts, housewares) and publications (books, magazines, comic books). It also licenses its properties for promotional use to, for example, soft drink companies and fast food chains. Disney receives royalties from these licensing activities, both tangible (from manufactured products) and intangible (from copyrights). Through its Synergy Group, Disney coordinates the three business segments for cross-promotional purposes, parlaying the success of a movie or Broadway show (such as "The Little Mermaid") into sales of its licensed products. These cross-promotional activities (or synergies) create flows of value among Disney's interrelated corporate subsidiaries and affiliates.

For corporate franchise tax purposes, New York permits or requires¹ related corporations to report their income on a "combined basis" where "there are substantial intercorporate transactions among the corporations" (see 20 NYCRR 6-2.3[a]), on the theory that if the members of the group filed separately the financial activities of the group as a whole would be distorted. Combined reporting treats the unitary business as a single, taxable entity, thus the net income of the combined group forms the basis for calculation of the percentage of income taxable by the state. To determine the portion of net income that can be allocated to the state, New York uses an apportionment formula that multiplies the taxpayer's combined worldwide business income by a business allocation percentage (BAP) based upon the New York percentages of the group's overall property, receipts and payroll (Tax Law § 210[3][a]). The three percentages are then added together, divided by the number of percentages overall² (Tax Law § 210[4]) and multiplied by the tax rate. A taxpayer calculates the receipts factor — the focus of this appeal — by:

"(2) ascertaining the percentage which the receipts of the taxpayer, computed on the cash or accrual basis according to the method of accounting used in the computation of its entire net income, arising during such period from

"(A) sales of its tangible personal property where shipments are made to points within this state, ...

"(D) all other business receipts earned within the state, bear to the total amount of the taxpayer's receipts, similarly computed, arising during such period from all sales of its tangible personal property services, rentals, royalties, . . . and all other business transactions, whether within or without the state" (Tax Law § 210[3][a]).

Thus, the New York percentage is calculated by computing the combined New York totals for the factor (the numerator) and dividing them by the worldwide totals (the denominator).

During relevant years, Disney filed combined reports for certain of its corporate subsidiaries, including Buena Vista Home Video (Video), the subject of the present litigation. For tax years 1990, 1991 and 1992, Video filed separately from the combined group.³ Although it had $662,038,872 in gross receipts in 1990 and large sales shipped to points within New York State, Video reported a fixed dollar minimum tax due of $1,500 and a New York allocation of 0%. It reported the same minimum tax due and 0% New York allocation for years 1991, when it had $989,510,226 in gross receipts, and 1992, when it had $1,372,034,743 in gross receipts.

For tax year 1993, Disney sought permission to add certain subsidiaries to its combined report, among them Video, stating that the company believed that distortion of the current combined group's activities was present due to the benefits of the "Disney synergy," permeating "virtually all of the inextricably connected entities" — including the proposed additions — and creating substantial value that could not be objectively quantified for each of the associated companies. In support of its request, Disney listed six examples of unitary activities that originated from the motion picture "Beauty and the Beast." Animation for the feature was done at its Disney-MGM Studios theme park facilities. Buena Vista Pictures, its distribution company, handled development of theatrical and television advertising trailers and joint advertising arrangements with promotional partners such as Burger King. The Disney Channel televised "Be Our Guest: The Making of Beauty and the Beast," while Buena Vista Television issued a special featuring Angela Lansbury singing "Beauty and the Beast." Video released the home video "The Jungle Book," which included a trailer segment from "Be Our Guest: The Making of Beauty and the Beast," and later released the home video of "Beauty and the Beast."

The Division granted Disney's request, and in 1993-1995 Video was included in the Disney group's combined report. Video, however, continued to report a fixed dollar minimum tax of $1,500 and a 0% New York allocation percentage, and reported none of its $1,450,727,704 in gross receipts for 1993, its $1,802,840,975 in gross receipts for 1994 or its $2,456,596,414 in gross receipts for 1995 as "sales of tangible personal property shipped to points within New York State," although, again, Video had large receipts from property shipped to points within the state (Video's New York payroll and property factor calculations were negligible).

In omitting Video's destination sales in New York from its combined receipts calculation, Disney relied on a federal exemption that shielded Video, it claimed, from New York franchise income taxation other than for the fixed $1,500 minimum. Section 101 of Public Law 86-272 (73 U.S. Stat 555) provides:

"(a) No State, or political subdivision thereof, shall have power to impose, for any taxable year ending after [September 14, 1959], a net income tax on the income derived within such State by any person from interstate commerce if the only business activities within such State by or on behalf of such person during such taxable year are either, or both, of the following:

"(1) the solicitation of orders by such person, or his representative, in such State for sales of tangible personal property, which orders are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State; and

"(2) the solicitation of orders by such person, or his representative, in such State in the name of or for the benefit of a prospective customer of such person, if orders by such customer to such person to enable such customer to fill orders resulting from such solicitation are orders described in paragraph (1) ...

"(c) For purposes of subsection (a) of this section, a person shall not be considered to have engaged in business activities within a State during any taxable year merely by reason of sales in such State, or the solicitation of orders for sales in such State" (codified as 15 USC § 381[a], [c]).⁴

After audit, the New York State Department of Taxation and Finance adjusted Disney's business allocation percentage for years 1990-1995 to reflect the companies that were included in or should have been included in the combined group. It increased the numerators in each year's receipts factors, representing combined New York destination sales, to include Video's destination sales for tax years 1990-1995. By letter dated October 5, 2000, the Division of Taxation advised Disney that its audit had resulted in an increase of tax liability in the amount of $1,349,640.

Disney claimed that Video was not subject to taxation under Tax Law article 9-A because its New York activities did not amount to more than "solicitation." Video's sole New York activities, it maintained, were the sale of movie cassettes to third parties — large-scale retailers such as Wal-Mart, Toys R Us and Blockbuster — for purposes of resale, and to wholesalers. Although other Disney entities such as the Disney Store promoted Video's products in, for example, "cash-wrap displays" at cashier's counters, Video itself only permitted salespeople to solicit business from New York customers, not to take orders, collect money or accept returned items, and Video did not own or rent any property in New York. When it was included as a member of the combined group, therefore, Disney determined that Video's New York receipts could not be counted in tabulating the combined receipts factor under New York's franchise tax apportionment formula as Video was a nontaxpayer pursuant to Public Law 86-272.

On November 30, 2000, the Department of Taxation and Finance issued a notice of deficiency asserting total taxes due for the six years at issue, plus interest, of $1,359,659.42. On Disney's petition to the Division of Tax Appeals, the administrative law judge sustained the notice, finding that "[i]t simply cannot be concluded that the only business activit[y] within New York . . . by or on behalf of [Video] was the solicitation of orders for sales of tangible personal property." To...