Taxes in New York (TiNY) is a blog by the Hodgson Russ LLP State and Local Tax Practice Group members Chris Doyle, Peter Calleri, and Zoe Peppas. The weekly reports are intended to go out every Tuesday after the New York State Division of Tax Appeals (DTA) publishes new ALJ Determinations and Tribunal Decisions. In addition to the weekly reports, TiNY may provide analysis of and commentary on other developments in the world of New York tax law.

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TiNY Report for July 24, 2023
NY state flag and the word TAXES made out of money

According to, the most covered pop song of all time is “Yesterday” by the Beatles. The most covered DTA issue is “Timy,” and this week’s rendition comes from a new voice (at least new to me), Judge Alexander Chu-Fong. His version sounds a lot like all the other versions I’ve heard. 

The only other output is an ALJ determination involving an Article 9-A audit of a corporate partner owning interests in several real property partnerships.

Matter of United Grocery & Deli Corp., ALJ Chu-Fong, July 13, 2023; Div’s Rep. Elizabeth Lyons, Esq.; Pet’s rep. Jonathan Koren, Esq.; Articles 28 and 29. A typical timy with a typical result. The Division demonstrated that the Notice was mailed to both Petitioner and Petitioner’s former representative at their last known addresses on February 28, 2022. Petitioner filed its BCMS request on June 23, 2022, a few weeks after the 90 day time limit had expired. Judge Chu-Fong granted the Division’s motion for summary determination on timeliness grounds.

Matter of Cushlin Limited, ALJ DiFiore, July 13, 2023; Div’s Rep. David Markey, Esq.; Pet’s Reps. Richard Levine, Esq. and Ellen Seiler Brody, Esq.; Article 9-A. 

The facts are complicated, but here is the essence: Petitioner, an Isle of Man corporation (how often does TiNY see one of those?), acquired and refurbished nice hotels in New York. At some point during two different audit periods, Petitioner indirectly owned an interest in 13 different hotels. The hotels were held in LLCs in which Petitioner owned interests. It seems like Petitioner may have been very good at refurbishing hotels, but not great on paperwork details like filing tax returns. Also, it appears there were a lot of intercompany transactions that weren’t substantiated all that well. Compounding the substantiation problem was the fact that the years under audit were pretty old: 2002-2008.

So, this case concerned an audit of a non-filer for years that were way back in the rearview mirror and a taxpayer that, perhaps, didn’t have great records. 

During the audit, Petitioner, through its representatives, made representations that returns would be filed “soon.” But there were delays, some explicable, others maybe not so much. And when the returns were filed, there were discrepancies between the figures the auditors were told to expect and the figures reported on the returns. I expect that the auditors felt that the lengthy filing delays indicated that the back-up documentation might be hazy. So, the Division demanded substantiation of expenses claimed as deductions on the returns. Ultimately, the auditors issued notices reflecting additional tax due based on a disallowance of expenses that the Division felt had not been adequately substantiated. Petitioner challenged the results of the audit claiming the audit didn’t have a rational basis and penalties were inappropriate.

Before digging into the Judge’s analysis, let me reflect that I have experience in cases like this and they are very frustrating for both sides. As a taxpayer representative, it is sometimes difficult to get your client to concentrate the necessary resources on the work necessary to accurately prepare and then defend tax returns. This is particularly true if the taxpayer has had a lot of turnover in its back office, has never filed returns, and has kept its books and records in a haphazard manner. I don’t know that is what happened here, but it seems likely. And it is not unusual for there to be less documentation when all the parties are related: management agreements, financing agreements, common paymaster agreements, tax sharing agreements, etc. do not need to be highly detailed—or even reduced to writing—when all parties are under common control since everyone involved “knows” what the deal is supposed to be. Often substantiation does not exist when the auditors ask for it. But, and I have heard (and said) this many times, “even though there’s no proof, [blank] is clearly what happened.” 

And auditors are supposed to reconcile the tax accounting of the taxpayers they are auditing. If that tax accounting is murky, auditors are supposed to dig until they find some solid ground as a foundation for their work papers. And if they can’t find any solid ground, it is hard for them to demonstrate that the returns were filed correctly. And when the returns are filed years after they were due, should one fault the auditors for being a little suspicious about the bona fides of the returns?

Like I said, these cases can be frustrating for everyone involved.  

Judge DiFiore’s recitation of the facts was much more thorough, and included 77 separate Findings. Her legal analysis started with the presumption of correctness that attaches to a notice issued by the Division, and a reminder that the presumption may be overcome only by a clear and convincing showing by Petitioner. On the issue of whether the notice had a rational basis, the Judge clearly felt that the threshold for rationality was very low. In this case, the Division’s reliance on real estate transaction data provided by Petitioner that was then confirmed on the Division’s real estate transaction database was enough, in the Judge’s view, to satisfy the rational basis standard in light of the inability of Petitioner to substantiate many of the deductions claimed on the returns with original source documentation.

For some of the audit years, tax was assessed by the Division based on the entire net income (ENI) tax base, which was likely inflated by the Division’s denial of deductions that were not substantiated. But for some of the audit years, the auditors determined that the capital base exceeded the ENI base. As background, during the years at issue the Article 9-A tax was calculated as the sum of a subsidiary capital base tax and the highest of four alternative bases: the ENI base, the capital base, the minimum taxable income base, and the fixed-dollar minimum base. The ENI base most-closely resembles the federal income tax. The capital base is a net worth concept the base of which is the New York portion of the excess of the corporation’s gross asset value per the taxpayer’s accounting books (but with real property and marketable securities valued at fair market value) over the corporation’s liabilities. The capital base tax was capped at $350,000. 

In the years during which Petitioner did not have significant revenue from a real property liquidity event, it was possible for the capital base to kick in, and under the auditor’s calculations, it did. One of the issues addressed by the Judge was whether Petitioner’s gross asset value was computed by including the book value of its interest in the subsidiary LLCs, or whether it was instead required to “look-through” the LLCs and take into account its pro rata share of the fair market value of the real property held in the subsidiary LLCs. Relying on National Bulk Carriers v. NYC Tax Appeals Tribunal (1st Dept. 2009), Judge DiFiore found that the capital base required a look-through approach. 

For some of the years, the Division determined that the fair market value of the real property indirectly owned by Petitioner would result in the maximum capital base. However, it is not clear that the auditors offset the gross asset values with liabilities, and one of the facts found was that: “The underlying entities had to borrow funds for working capital, repairs, and capital improvement.” So, we know there were liabilities. But it’s not clear whether any of the liabilities were taken into account in calculating the capital bases. It is possible that the Judge would have found that, even with knowledge of the existence of liabilities, the auditors would not be required to take liabilities into account unless they were substantiated. And it may be the case that Petitioner offered no substantiation for the liabilities.

The applicability of penalties was also listed as an issue.  However, the judge found that Petitioner failed to address the penalty issue during the hearing, so she also sustained the penalties. 

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