In a summary decision, the Appellate Division, First Department, has affirmed a decision of the New York City Tax Appeals Tribunal which 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 for services of employees of the corporate partner who were also limited partners of the partnership. Tocqueville Asset Mgmt. L.P. v. N.Y.C. Tax App. Trib., et al., Case No. 39/15 (1st Dep’t, July 5, 2016).
Tocqueville Asset Management L.P. (“Tocqueville”) was an investment advisor limited partnership subject to the UBT. Since it had no employees of its own, all of its activities —the management of client investment portfolios and the performance of related research—were performed by the employees of its sole general partner, Tocqueville Management Corp. (“TMC”). Many of the employees of TMC performing the services were also limited partners in Tocqueville. Tocqueville paid TMC an annual management fee based on TMC’s expenses incurred to provide the services, approximately two-thirds of which consisted of compensation paid to its employees. On its 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, including compensation paid by TMC to its own employees.
The Department of Finance disallowed Tocqueville’s UBT deduction for compensation paid (in the form of the management fee) to its general partner. The deduction was disallowed as constituting nondeductible “amounts paid or incurred to a proprietor or partner for services or for use of capital.” Admin. Code § 11-507(3).
At the administrative hearing, Tocqueville took the position that the UBT regulations do not require the addback of payments to a corporate partner for the services of employees of the partner, even where the employee is also a partner in the taxpayer partnership. In making the argument, Tocqueville relied on the UBT regulation which permits a deduction 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 ALJ rejected Tocqueville’s argument, concluding that the management fees paid by Tocqueville were compensation for services provided by partners in Tocqueville, and therefore were not deductible. On appeal, the City Tribunal affirmed the ALJ’s determination, holding that Tocqueville’s interpretation “produces a result directly at odds with the plain language” of the addback statute and ignores another regulation, 19 RCNY § 28-06(d)(1)(ii)(A), which provides that, in determining whether a payment is a nondeductible 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. See New York Tax Insights (Vol. 6, Issue 7, July 2015) for a discussion of the City Tribunal decision.
Tocqueville appealed, but in a particularly brief decision, the Appellate Division has now affirmed the City Tribunal’s decision on the grounds that it was supported by substantial evidence and had a rational basis in law.
The Appellate Division’s affirmance is not surprising, given that the UBT law denies deductions for payments to a partner for services, and the management fees in question were paid directly to Tocqueville’s corporate general partner for services performed by individuals who were also Tocqueville’s limited partners. The Appellate Division also applied a deferential “substantial evidence” and “rational basis” standard of judicial review of the City Tribunal’s decision. On the other hand, the Department’s regulations have long recognized that it is unreasonable to require the addback of all payments to a corporate partner— particularly when they are for services performed by employees of that corporate partner. Since the UBT regulation in question does not specifically deny a UBT deduction for payments made to a corporate partner for the services of its employees who are also limited partners of the taxpayer, it could also have reasonably been concluded that the Department should be bound by its own regulation and the exception to the addback allowed.
Among the UBT addback questions that remain is whether the amounts would have been deductible had the employees been employed by the taxpayer directly, and had the employees been stockholders of the corporate partner rather being limited partners in the partnership.