The New York City Tax Appeals Tribunal has held that an investment advisor partnership subject to the New York City unincorporated business tax (“UBT”) must add back a management fee paid to its corporate general partner representing compensation for services of employees of the corporate partner who were also individual partners of the partnership. The decision further limits the exception in the UBT regulations to the add-back for compensation paid for services performed by a corporate partner’s employees. Matter of Tocqueville Asset Mgmt. L.P., TAT(E)10-37(UB) (N.Y.C. Tax App. Trib., May 29, 2015).
Facts. Tocqueville Asset Management L.P. (“Tocqueville”) is an investment advisor limited partnership that conducts business in New York City and is subject to the UBT. Tocqueville has no employees of its own. All of its activities—the management of client investment portfolios and the performance of related research—are performed by the employees of its sole general partner, Tocqueville Management Corp. (“TMC”), an S corporation that also managed a related securities broker-dealer.
Tocqueville paid TMC an annual management fee based on TMC’s expenses incurred to provide the services.
Approximately two-thirds of TMC’s expenses was compensation paid to its employees, many of whom were also limited partners in Tocqueville. Prior to 2005, the sole year in issue, those employees had been shareholders of TMC but, as a result of a restructuring, many of those individuals redeemed their shares and became limited partners in Tocqueville.
On its federal partnership return and UBT return for 2005, Tocqueville claimed deductions for the portion of TMC’s operating expenses that related to the management fee Tocqueville paid to TMC. This included compensation paid by TMC to its own employees. TMC did not report the management fee as income on its own tax returns, but also did not deduct the related expenses, including the compensation paid to its employees.
On audit, the Department of Finance disallowed Tocqueville’s deduction for compensation paid (in the form of the management fee) to the TMC employees who were also limited partners in Tocqueville. The basis for the disallowance was the provision in the UBT law that disallows a deduction “for amounts paid or incurred to a proprietor or partner for services or for use of capital.” Admin. Code § 11-507(3). This add-back has been the subject of considerable controversy for many years. From the time of the initial promulgation of the UBT regulations in 1985, the Department has permitted a carve-out to the add-back for amounts paid to a corporate partner “which reasonably represent the value of services provided the unincorporated business by the employees of such partner.” 19 RCNY § 28-06(d)(1)(ii)(D) (emphasis added) (the “D Exception”). The regulation conditions deductibility on the payment being “included in that partner’s gross income for Federal income tax purposes.”
ALJ determination. At the administrative hearing, Tocqueville took the position that the UBT regulations do not require the add-back of payments to a corporate partner for the services of an employee who is also a partner in the taxpayer partnership. Thus, Tocqueville maintained that the management fee paid with respect to TMC’s employee compensation was not a payment to a partner for services performed for the partnership and was properly deductible. The ALJ rejected this argument, holding that the management fees were compensation for services provided by partners in Tocqueville, and therefore they were not deductible. This appeal followed.
Tribunal decision. On appeal, the City Tribunal upheld the ALJ’s determination in its entirety, holding that the add-back of the management fee was fully consistent with the UBT law. The Tribunal first addressed Tocqueville’s claim that the payment qualified for the “D Exception” to the add-back in the UBT regulations, which (as discussed above) allows a deduction to the extent the payment to the corporate partner is for services provided by employees of the corporate partner. Tocqueville noted that the regulation was clear on its face and did not preclude the exception where the employees were also partners of the taxpayer. The Tribunal held that such an interpretation “produces a result directly at odds with the plain language” of the add-back statute and ignores another regulation, 19 RCNY § 28-06(d)(1)(ii)(A), which provides that, in determining whether a payment is a non-deductible payment to a partner, it is irrelevant that the person receiving payment was not performing the services in his or her capacity as a partner.
The City Tribunal found the case to be substantially identical to Miller Tabak Hirsch & Co., TAT(E) 94-173(UB) (NYC Tax App. Trib., Mar. 30, 1999), where it had held that payments made to employees who were also partners in the taxpayer partnership were not deductible, regardless of the capacity in which the payments were received. The Tribunal also rejected Tocqueville’s argument that 19 RCNY § 28-06(d)(1)(i)(B), which treats as a non-deductible payment to a partner payments made “to any person,” i.e, a third party, for the services provided by a partner of the unincorporated business, was not enacted until 2007, after the year in issue, and therefore was inapplicable. The Tribunal held that the interpretation reflected in the regulation “was well established in judicial precedent prior to the Tax Year,” citing to decisions in Guttman Picture Frame Assocs. v. O’Cleireacain, 209 A.D.2d 340 (1st Dep’t 1994) and Matter of AGS Specialist Partners, TAT(E) 00-10(UB) (N.Y.C. Tax App. Trib., May 21, 2003) (both upholding the add-back of amounts paid to the officers of a corporate partner) and Matter of Horowitz, TAT(E) 99-3 (UB) (N.Y.C. Tax App. Trib., Sept. 1, 2005), aff’d, 41 A.D.3d 101 (1st Dep’t 2007), lv. denied, 10 N.Y.3d 710 (2008) (holding that payments by a sole proprietor to third parties for his insurance and retirement plan were not deductible).
Although it may be appealed to the New York courts, Matter of Tocqueville is another in a line of City Tribunal decisions limiting the exceptions to the add-back contained in the Department’s regulations, only some of which have been appealed and upheld by the New York courts. The Tribunal correctly observed that the UBT law itself is clear that payments to a partner for services are not deductible. However, the Department long ago recognized that it would be unreasonable to require the add-back of all payments to a corporate partner. Since the “D Exception” regulation is silent on the effect of the corporate partner’s employees also being limited partners of Tocqueville, it could also be reasonably concluded that the Department should be bound by its own regulation and the exception to the add-back allowed. At a minimum, the Department should give consideration to amending its UBT regulations to provide further clarity regarding the scope of the add-back exception.