A New York State Administrative Law Judge has accepted a taxpayer's interpretation of an agreement permitting use of an alternative apportionment method, and canceled a Notice of Deficiency seeking additional tax and interest that was based on the Department's interpretation. Matter of S&P Global, Inc., f/k/a The McGraw-Hill Companies, Inc., DTA No. 825598 (N.Y.S. Div. of Tax App., Nov. 16, 2017). The issue in dispute concerned whether reduction of the company's "MTA surcharge"--the additional tax applied to businesses operating in the Metropolitan Commuter Transportation District ("MCTD")--was included in the amounts of "tax savings" that had been capped under the terms of the agreement or whether the reduction in the MTA surcharge was a separate benefit not subject to the cap.

Facts. Although the years in issue in the case were 2002 through 2005, the relevant facts began in 1997, when S&P Global, Inc. ("S&P"), then a division of The McGraw-Hill Companies engaged in the business of rating debt offerings, was considering whether to keep its headquarters in New York or move to New Jersey to reduce costs. At the time, S&P had approximately 3,000 employees, primarily working in lower Manhattan, and certain of its leases for office space in New York City were due to expire in 1997 and over the next few years. S&P had been offered a package of tax incentives from New Jersey in exchange for relocating there, and its corporate tax burden in New York was substantially higher than it would have been in New Jersey. S&P estimated that moving to New Jersey could result in approximately $5.8 million in annual savings and approximately $108 million in savings over 20 years.

S&P and its representatives approached the Department in an effort to reduce its New York tax costs. S&P's internal tax executives and external consultants met and corresponded with senior representatives from the Department, including then-Commissioner Michael Urbach, then-Deputy Commissioner and Counsel Steven Teitelbaum, and then-Director of the Corporation Tax Audit Bureau Dominick Sciortino. S&P presented models calculating amounts of annual tax savings that could be achieved under various alternative scenarios, which included moving the S&P division to New Jersey, creating a Delaware trademark subsidiary that the Department would agree not to include in a combined return, using destination sourcing rather than cost-of-performance sourcing for S&P's debt rating receipts, or some combination of these alternatives. Annual savings of $6.8 million was identified as a "target" amount during the parties' negotiations.

The Department responded with letters proposing a discretionary adjustment to S&P's business allocation percentage ("BAP"), on the basis that the reported BAP did not fairly reflect S&P's business activity in New York. No specific mention was made of the MTA surcharge, and the S&P representatives who testified at the hearing could not recall specifically discussing the MTA surcharge. The negotiations eventually resulted in a draft agreement proposed by S&P that included two possible alternatives, and also included a provision that limited the annual savings that would be allowed. Both proposed models included destination sourcing of debt rating receipts, and other potential percentage decreases to the calculation of the property and payroll factor numerators of the BAP. A final "Implementing Agreement" was reached, dated June 13, 1997, pursuant to which the Commissioner exercised his discretionary authority under Tax Law 210.8(d) to adjust S&P's BAP in specified ways, including sourcing debt rating receipts on a destination basis, calculating the numerators of the property and payroll fractions at 25% of the ordinarily calculated amounts, and calculating the numerator of the sales fraction at 50% of the amount determined under the revised sourcing method. A savings cap was put in place, so that the annual savings arising from the described methodologies could not exceed $6.8 million, which would be adjusted annually by an Applicable Growth Factor referred to as the future value of $6.8 million ("FV $6.8 million") with certain carry forwards being available if the savings in any one year were less than the available cap amount.

During the years 1996 through 2003, S&P's Director of State and Local Taxes computed S&P's New York State corporation franchise tax liability in accordance with the apportionment provisions set forth in the Implementing Agreement, and also computed the liability as it would have been without the destination sourcing and BAP fraction numerator adjustments, and compared the two amounts to determine the amount of the annual savings. She computed S&P's MTA surcharge liability using the statutory formula without adjustment to reflect the BAP changes under the agreement, and also by computing the amount of the MTA surcharge base (which is, under Tax Law 209-B(1), (2), equal to a taxpayer's 209 tax liability), and then, if the total annual tax savings for both the 209 tax and the MTA surcharge exceeded the permitted savings cap, increased the tax due to the Department accordingly.

However, for the years 2004 and 2005, after review of the Implementing Agreement by a senior manager at its outside accounting firm, S&P adopted a new method for applying the limitation on annual tax savings. S&P concluded that the tax savings limitation did not apply to the MTA surcharge, and, starting in 2004, S&P applied the FV $6.8 million limitation on annual tax savings only to the savings of 209 liability and did not limit the MTA surcharge savings. It also changed its method of computing its MTA surcharge and no longer applied the BAP numerator reductions to reduce its MCTD apportionment numerators, on the theory that the MTA surcharge was not specifically mentioned as included in the Implementing Agreement. For 2004 and 2005, S&P's 209 tax liability was adjusted upward so that the savings did not exceed the available FV $6.8 million tax savings. The reductions to the 209 liability, although not as great as they would have been without the FV $6.8 million limitation, also resulted in a reduction to S&P's MTA surcharge, since the base amount used to determine the MTA surcharge is the company's tax liability under 209.

The Audit and the Parties' Positions. The Department audited S&P's Article 9-A returns for 2002 through 2005 and took the position that there was no basis for the change in the computational method adopted in 2004, arguing that the discretionary adjustments in the Implementing Agreement not only reduced S&P's 209 tax liability, but also reduced its MTA surcharge tax liability, and asserted that both were subject to the total savings limitation in the Implementing Agreement. Based on its interpretation of the Implementing Agreement, the Department issued a Notice of Deficiency for approximately $2.6 million plus interest, which included both a 209 component and an MTA surcharge component.

S&P argued that the savings contemplated in the limitation were only the reductions of its 209 liability, since the adjusted BAP is relevant only to determining 209 liability; that the BAP adjustments do not, as the Department claims, "flow through" to the MCTD allocation percentage; and that the MTA is a separate tax imposed in addition to the 209 tax, citing Matter of Kaiser Aerospace Electronics Corp., DTA No. 812828 (N.Y.S. Tax App. Trib., Jan. 16, 1997) (where the Tribunal held that the statute of limitations on assessment of the MTA surcharge did not begin to run until the separate MTA return was filed, regardless of the filing of the taxpayer's franchise tax return). The Department took the position that the reference to "any New York tax savings" in the Implementing Agreement was broad enough to encompass both taxes.

ALJ Decision. The ALJ agreed with S&P's interpretation of the agreement and canceled the Notice of Deficiency.

First, however, the ALJ rejected S&P's argument that the MTA surcharge is a separate tax from the 209 tax. He found that the Tribunal's decision in Kaiser stands only for the proposition that the limitation period on assessment of the MTA surcharge does not begin to run until the separately required MTA surcharge return is filed, but does not stand for the "broader proposition" that the MTA surcharge is not a New York State franchise tax imposed in addition to the 209 tax.

The ALJ then reviewed the methods imposed by the statutes for calculating 209 liability and the MTA surcharge, as modified by the Implementing Agreement, and found that it provided for alternative apportionment to calculate the 209 tax, which the Commissioner was authorized to invoke by Tax Law former 210.8(d). The ALJ concluded that the discretionary adjustments were specifically applicable to the calculation of S&P's BAP and did not automatically flow through to the calculation of S&P's MCTD allocation percentage. The Implementing Agreement specifically required applying the discretionary adjustments in computing S&P's BAP but contained no similar language calling for those adjustments to be applied to compute S&P's MCTD allocation percentage. The ALJ also noted that, while the Tax Law expressly provides authority for the Department to adjust a corporation's BAP when necessary to properly reflect income, there is no similar authority for the Department to allow or impose discretionary adjustments to the MCTD apportionment fractions for corporate franchise taxpayers such as S&P.

The ALJ determined that the calculation of S&P's MTA surcharge was not dependent upon or impacted by the discretionary adjustments in the Implementing Agreement, but was dependent only upon the actual amount of S&P's 209 liability. He further determined that the MTA surcharge tax savings were "realized simply as the mechanical result of applying the statutory MTA surcharge tax calculation . . . without adjustments under the Implementing Agreement, to the actual (correctly computed) amount" of S&P's 209 liability. Since the MTA surcharge tax savings did not result from application of the discretionary adjustment methods of the Implementing Agreement, the savings achieved by S&P did not fall within the limitation imposed by the language of the savings cap and were not required to be reduced by the amount of that cap. Therefore, the ALJ canceled in full the Notice of Deficiency.

Additional Insights

This case sheds interesting light on the Department's exercise of its power to grant discretionary adjustments, a process that is usually invisible to anyone other than the company involved and the Department, since public record litigations seldom result. Here, S&P, a large New York taxpayer, successfully reached a resolution with the Department in an agreement contemplated to last for over 20 years, resulting in significant reduction of S&P's corporation franchise tax liability, and at least one of the factors apparently considered by the Department was the State's interest in keeping S&P--and the many jobs and other economic benefits it provided--in New York City. The decision also highlights the importance of carefully drafting agreements to consider all eventualities, since the ALJ's determination turned on the language of the agreement, and the fact that it included explicit references to adjustment of the BAP with regard to the 209 liability reduction, but no such language with regard to the MTA surcharge.

As of this writing, the Department's time to seek review of the ALJ's decision by the Tax Appeals Tribunal has not yet run, so there may well be further developments if the Department files an appeal.