United States

New York Tribunal considers distortion as a basis for combined reporting


On Sept. 18, 2014, the New York Tax Appeals Tribunal issued its decision in In the Matter of the Petitions of Knowledge Learning Corporation and Kindercare Learning Centers, Inc., holding that, for tax years 2007 through 2014, taxpayers can file New York State corporation franchise tax returns on a combined basis if (1) substantial intercorporate payments resulting from consolidation of payroll, cash management, risk management and purchasing functions are undertaken for a valid business purpose, and (2) even in the absence of these substantial intercorporate transactions, combination is necessary to avoid actual distortion.

2007 through 2014 combined reporting requirements

Pursuant to New York Tax Law section 211(4), in effect for 2007 through 2014, the New York State Division of Taxation (the Division) may require a corporation to file on a combined basis when the commissioner deems that such a report is necessary to properly reflect tax liability due to intercorporate transactions, arrangements, understandings or agreements. The Division has long taken the position that, under this law, taxpayers are not allowed to file on a combined basis in the absence of substantial intercorporate transactions. Per TSB-M-08 [2], the Division has advised that, "The substantial intercorporate transactions requirement will be satisfied when, during the taxable year, 50% or more of a corporation's receipts included in the computation of entire net income (excluding nonrecurring items) are from one or more related corporations […]. Expenditures incurred by a corporation that directly or indirectly benefit a related corporation can constitute substantial intercorporate transactions."


In 2005, Knowledge Learning Corporation (KLC) purchased Kindercare, an operator of child day care centers and after school programs. The two entities filed separate New York State corporation franchise tax returns for the 2005 and 2006 tax years. In 2007, KLC filed a combined return with Kindercare and other affiliates based on its understanding of the amendments to New York Tax Law section 211(4) that took effect for that year. Filing the combined return allowed KLC to utilize its $57.6 million loss to offset Kindercare's $109.3 million of income.

The Division conducted an audit of KLC's and Kindercare's separate 2005 and 2006 tax filings, as well as the taxpayers' combined 2007 tax return, and determined that KLC had not provided adequate support to demonstrate that there had been substantial intercorporate transactions as required for combined filing of the 2007 tax return. KLC appealed this decision, arguing that (1) substantial intercorporate transactions were present because all employees of KLC, Kindercare and the other members of the affiliated group were employees of KLC and were essentially paid by KLC and KLC paid all of Kindercare's expenses, and (2) substantial intercorporate transactions were unnecessary because combined filing under New York Tax Law section 211(4) was allowed where separate filing would result in actual distortion. An administrative law judge (ALJ) rejected these contentions, ruling (1) that insufficient evidence existed to prove that all of the affiliated group's employees were actually employees of KLC and that any transfer of employees lacked a valid business purpose, and (2) that avoiding actual distortion is not a basis on which a combined filing can be made.

KLC appealed the decision of the ALJ to the New York Tax Appeals Tribunal, raising the same arguments as were brought before the ALJ and offering into evidence the following additional facts:

  • KLC engaged a consultant to determine whether Kindercare and other acquired affiliates should continue to operate under different brand names. The consultant's report recommended that KLC establish Kindercare as its single brand name.
  • KLC engaged with a tax consulting service to determine the cost of consolidating all affiliated group employees onto KLC's payroll for state unemployment tax purposes.
  • Beginning in 2006, KLC reported all of Kindercare's employees on its employment tax filings with the IRS, although the transfer was not memorialized in writing to be presented to the tribunal. Kindercare made payments to KLC to reimburse KLC for the use of these employees.
  • KLC entered into contracts with third parties to provide transportation, food and supplies on behalf of Kindercare and contracted for janitorial services for Kindercare.

Additionally, KLC provided internal documents and witness testimony to demonstrate KLC's intention to operate KLC and its affiliates as one entity with centralized payroll, cash management, risk management and purchasing functions.

Reversing the determination of the ALJ, the tax tribunal found that Kindercare had transferred its employees to KLC as part of a valid business transaction intended to allow KLC and Kindercare to operate as a single entity, and that Kindercare's payments to KLC for the use of its employees were valid intercorporate transactions. Moreover, the tax tribunal found that payments made by Kindercare to KLC for janitorial services, food, transportation and supplies were valid intercorporate transactions as well, dismissing the Division's contention that these payments were nothing but the result of KLC's cash management system through which Kindercare effectively transferred funds to KLC to pay Kindercare's expenses. Since these payments exceeded the 50 percent threshold for both companies, the tax tribunal determined that the substantial intercorporate transaction requirement of 211(4) had been satisfied.

As to KLC's alternative argument, the tax tribunal determined that the ALJ had misinterpreted the post-2007 (and pre-2015) version of section 211(4). The Tax Tribunal noted that the amended law provides that a combined report can be required "[…] in order to properly reflect tax liability under [Article 9-A]." Based upon this language, the tax tribunal concluded that "[…] assuming all other requirements are met, combined filing is required to avoid distortion […]." Further, referring to TSB-M-08[2]C, the tax tribunal noted that the Division is empowered to force combination "even where substantial intercorporate transactions are absent" in order to properly reflect income. Accordingly, the tax tribunal agreed with KLC that, even if it could not show that it had engaged in substantial intercorporate transactions with Kindercare, KLC and Kindercare could still have filed on a combined basis in order to avoid actual distortion.


The Division is not permitted to appeal this decision, and it may be too early to predict how it will be enforced until higher courts have weighed in. However, corporations potentially facing an audit of combined returns or considering filing combined returns for 2007-2014 should consider the ramifications of this case in determining whether substantial intercorporate transactions exist or whether combination could be necessary to avoid distortion. Also, New York City has not adopted the changes to New York State tax laws that eliminated the substantial intercorporate transaction and actual distortion tests for post-2014 tax years. Thus, the decision may also remain relevant for New York City purposes after 2014.


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