By Nicole Boutros and Andrew Appleby

In a case of first impression interpreting when substantial intercorporate transactions are present for purposes of New York’s mandatory combined reporting provisions, a New York State Division of Tax Appeals Administrative Law Judge (ALJ) concluded that the taxpayers could not file on a combined basis. In 2007, New York State amended Tax Law section 211[4] to provide that a combined report is required for corporations engaged in a unitary business if substantial corporate transactions exist between the corporations. Knowledge Learning Corporation (KLC) acquired KinderCare and moved all of KinderCare’s employees to KLC. KLC and KinderCare, along with certain other affiliates, filed on a combined reporting basis for their 2007 tax year. Despite all employees being KLC employees and KLC paying all of KinderCare’s expenses, the ALJ failed to find “substantial intercorporate transactions.” The ALJ weighed “heavily” against the taxpayers because of the absence of written intercompany agreements memorializing the claimed intercorporate transactions and disregarded witness testimony specifically supporting the existence of such intercorporate transactions. The ALJ inexplicably declined to analyze the taxpayers’ alternative argument that there was actual distortion even if there were not substantial intercorporate transactions, permitting “forced combination.” Although the “forced combination” provision remains in New York Tax Law, the ALJ summarily concluded in a footnote that the 2007 amendment eliminated the need to entertain a distortion analysis. Matter of Knowledge Learning Corp., DTA Nos. 823962 and 823963 (June 27, 2013).