If a subsidiary pays its parent corporation a 'management fee' that reimburses the parent's own officers' salaries and overhead, does the subsidiary have to count part of that fee as compensation to a 5%-plus stockholder when computing New York's entire-net-income-plus-compensation franchise tax -- even though the fee is technically paid to a corporation, not an individual?

Plain-English summary

Landauer Associates, Inc., a Delaware corporation doing real-estate consulting in New York, Georgia, and Illinois, is a subsidiary of Landauer International Inc. ("LII"), a holding/management company whose officers are viewed as real-estate experts. LII performs managerial services for its subsidiaries -- including Landauer Associates -- and charges each a "management fee" that bundles together reimbursement for LII's out-of-pocket expenses on the subsidiary's behalf (like accounting and bookkeeping) along with a share of LII's own overhead, including its officers' salaries and benefits.

Landauer Associates argued that none of this management fee should count as "compensation" for purposes of New York's Article 9-A tax measured by entire net income PLUS compensation paid to officers and 5%-plus stockholders (section 210.1(a)(3)) -- reasoning that a lump-sum "management fee" paid to a corporation is categorically different from paying individual salaries, and that including it would tax the same money twice (once to Landauer Associates as imputed compensation, and again to LII, which already reports the fee as its own New York taxable income and pays tax on it).

The Department rejected this argument, relying on a 1961 internal Tax Department Counsel memorandum addressing the same fact pattern: a subsidiary paying its parent "service charges" that included genuine expense reimbursement (shipping, selling, storage -- deductible, per Funkhouser Industries v. Commissioner) alongside administrative and corporate overhead (the parent's own officers' salaries), which counsel determined WAS effectively compensation. Applying that precedent, the Department held that whatever portion of Landauer Associates' management fee to LII exceeds genuine reimbursement of LII's expenses incurred specifically on Landauer Associates' behalf -- including LII employees'/officers' salaries and any built-in profit margin -- must be included in Landauer Associates' entire-net-income-plus-compensation tax base. The double-taxation concern didn't move the Department: Article 9-A is a franchise tax on the privilege of doing business (not a direct income tax), and its entire-net-income-plus-compensation measure exists specifically to prevent groups from avoiding tax by dressing up profit distributions as fees rather than dividends -- so the same dollars legitimately can be counted in both the subsidiary's and the parent's tax bases.

What this means for you

Corporate groups using intercompany management/service fees

Labeling a payment a lump-sum "management fee" rather than itemized salary reimbursement doesn't exempt it from New York's compensation add-back. Break the fee into (1) true reimbursement of the parent's actual out-of-pocket costs incurred specifically on your behalf, versus (2) a share of the parent's own general overhead and profit -- only the first category is safely excluded.

Anticipating "double taxation" arguments

The Department will not waive the compensation add-back just because the same dollars are also taxed to the recipient parent as its own income -- the entire-net-income-plus-compensation tax is deliberately structured to prevent using intercompany fees to shift what is economically compensation for officers/major stockholders out of the tax base.

Common questions

Q: Does labeling a payment a "management fee" instead of "salary" avoid New York's compensation add-back?
A: No -- the Department looks at substance, not labels. The portion of any fee that functions as reimbursement for the parent's own officers'/corporate overhead is treated as stockholder compensation regardless of what it's called.

Q: What part of a management fee is safe from the add-back?
A: Only the portion that reimburses genuine out-of-pocket expenses the parent incurred specifically on the subsidiary's behalf (e.g., shipping, storage, direct selling costs) -- not general administrative or corporate overhead.

Q: Does it matter that the parent is also taxed on the same fee?
A: No -- the Department expressly rejected the double-taxation argument; the compensation add-back and the parent's own income tax are separate measures that can both reach the same dollars.

Q: Can another corporate group rely on this specific ruling?
A: No. It binds the Department only for this petitioner's specific facts and can't be relied upon by other parent/subsidiary groups, even with similar management-fee arrangements.

Citations and references

Statutes and regulations:

• Tax Law § 210.1(a)(3) (entire net income plus compensation)
• Business Corporation Franchise Tax Regulations § 3-3.1(b), § 3-3.2(f)
• 1961 Tax Department Counsel memorandum (Edward Best)
• Funkhouser Industries, Inc., 16 TCM 890, TC Memo. 1957-197

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1986.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a86_21c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-86 (21) C
Corporation Tax
October 22, 1986

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C850211A

On February 11, 1985, a Petition for Advisory Opinion was received from Landauer
Associates, Inc., 335 Madison Avenue, New York, New York 10017.
The issue presented is whether a portion of a management fee paid by a subsidiary to its
parent corporation for services rendered by the parent corporation should be included by the
subsidiary as compensation paid to every stockholder owning in excess of five percent of its issued
capital stock when computing the franchise tax measured by entire net income plus compensation
pursuant to section 210.1(a)(3) of the Tax Law, to the extent of salaries paid to officers and
employees of the parent corporation, including any profit sharing and employee benefits.
Petitioner is a taxpayer under Article 9-A of the Tax Law and was incorporated in Delaware
on September 24, 1978. Petitioner's operations consist primarily of consultation on real estate
transactions in New York, Georgia and Illinois. Petitioner is a subsidiary of Landauer International
Inc. (referred to herein as "LII") a holding and management company incorporated in Delaware on
April 3, 1979. The officers of LII are viewed as experts in the real estate field. LII performs
managerial services for its subsidiaries for which it receives a fee. The management fee Petitioner
pays to LII includes reimbursement for expenses incurred by LII on behalf of Petitioner and payment
for various administrative functions such as accounting and bookkeeping services that LII provides.
Petitioner contends that the compensation, profit sharing and employee benefits paid to the
officers and employees of LII included in the management fee, should not be included in the
computation of Petitioner's tax measured by entire net income plus compensation because a
"management fee" is not a payment of salaries and other compensation to elected or appointed
officers or to a stockholder owning in excess of five percent of its issued capital stock. It contends
that compensation for individual services and management fees are two entirely different and unique
items.
Petitioner also contends that Petitioner and LII are both paying the proper amounts of New
York State franchise tax and that there is no attempt to avoid tax. It contends that if the management
fee Petitioner paid to LII is included in Petitioner's computation of the tax measured by entire net
income plus compensation, the fee will be taxed twice by New York State because LII includes the
management fee in its New York State taxable income and pays tax on it at the statutory rate.

RODERICK G. W. CHU, COMMISSIONER
GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR
TP-8 (3/83)

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TSB-A-86 (21) C
Corporation Tax
October 22, 1986

Article 9-A of the Tax Law imposes a franchise tax on general business corporations rather
than a tax on income. The tax is imposed for the privilege of doing business, employing capital,
owning or leasing property, or maintaining an office in New York State in a corporate capacity. The
tax is computed on the value of that privilege, which is measured by income (or some alternate basis)
and is not considered to be imposed directly on income.
Accordingly, compensation paid to a stockholder owning in excess of five percent of its
issued capital stock may be included in the tax base of both a subsidiary and its parent.
Section 210.1(a)(3) of the Tax Law states, in part:
"(a) a tax. . . (3) computed . . . on thirty per centum of the taxpayer's entire net
income plus salaries and other compensation paid to the taxpayer's elected or
appointed officers and to every stockholder owning in excess of five per centum of
its issued capital stock minus thirty thousand dollars... ."
Section 3-3.1(b) of the Business Corporation Franchise Tax Regulations states that:
"The tax measured by entire net income plus compensation is to prevent tax
avoidance by distributing profits in the form of excessive salaries. However, this
measure of the tax does not prevent the Tax Commission from disallowing
deductions claimed for unreasonable salaries in computing entire net income."
Section 3-3.2(f) of the Business Corporation Franchise Tax Regulations provides that "a
stockholder owning in excess of five percent of its issued capital stock" means a person or
corporation who is the beneficial owner of more than five percent of the total number of shares of
the issued and outstanding capital stock of the taxpayer.
In 1961, Edward Best, Tax Department Counsel, addressed in a memorandum the treatment
of service charges as compensation to stockholders. The facts are as follows - A subsidiary
corporation is the distributor of its own product and the parent corporation manufactures, stores, sells
and ships the subsidiary's product. The sales price of the product to the subsidiary consists only of
materials, direct labor cost and factory overhead. The subsidiary corporation pays "service charges"
to its parent corporation for the reimbursement of shipping expenses, selling expenses,
administrative expenses (general office expenses) and corporate expenses (parent's officers' salaries)
incurred by the parent corporation on behalf of the subsidiary.
Counsel determined that the shipping and selling expenses were valid expenses reimbursable
to the parent corporation, citing Funkhouser Industries, Inc., 16 TCM 890, Dec. 22,624(M), TC
Memo. 1957-197, in which the Court held that amounts charged by the parent company on account
of freight charges, warehouse storage of books, records and merchandise and some liquidation

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TSB-A-86 (21) C
Corporation Tax
October 22, 1986

expenses defrayed and furnished by the parent company for the taxpayer's benefit were deductible.
However, Counsel determined that the administrative expenses were not connected with the storage,
sale or shipment of the subsidiary's product. Therefore, administrative expenses were deemed to be
compensation. The corporate expenses were also considered to be compensation. Thus, the portion
of "service charges" which was applicable to administrative expenses and corporate expenses was
deemed to be compensation paid to a stockholder owning in excess of five percent of its issued
capital stock.
As shown, the statute has been interpreted to mean that items in the nature of service charges
or management fees paid by a subsidiary to its parent are included as "salaries and other
compensation paid to a stockholder" to the extent that such fee or charge exceeds the reimbursement
of expenses paid by the parent on behalf of the subsidiary.
Accordingly, when computing the tax measured by entire net income plus compensation
pursuant to section 210.1(a)(3) of the Tax Law, Petitioner must include as "salaries and other
compensation" the portion of the management fee paid to its parent that is in excess of the
reimbursement of expenses paid by the parent on behalf of Petitioner. This amount includes salaries
and the related expenses of the parent's employees and officers as well as any profit factor included
in the management fee.

DATED: October 22, 1986

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.