By James A. Woehlke, CPA

To millions of parents, "Geoffrey" conjures up the image of a cute giraffe printed on the play money used to give store credit on returns to Toys-R-Us. To many tax CPAs and other business advisors, the same Geoffrey means innovative corporate and tax planning. The Toys-R-Us corporate structure has spawned a number of tax cases. The latest is a New York City case that allowed Geoffrey, Inc.--whose only business is to lease trademarks to Toys-R-Us and Kids-R-Us stores--to file separately its return for city general corporation tax (GCT) purposes.

Geoffrey, Inc., is a second-tier subsidiary set up in 1984 to make the Toys-R-Us empire a little less appetizing in a corporate takeover. Geoffrey holds all the trademarks used by Toy-R-Us and Kids-R-Us, which it then makes available to all Toys-R-Us and Kids-R-Us corporations in exchange for a royalty. Another second-tier subsidiary of Toys, Inc., the group's parent, is ABG, Inc., which provides real estate financing for the retail stores owned by the corporate group.

New York City Administrative Law Judge Karen Murphy's ruling in the case, In the Matter of Toys-R-Us--NYTEX, Inc. [TAT(H) 93-1039(GC) (8/25/99)], addressed whether the income of Geoffrey, ABG, and several other related corporations needed to be included in a combined tax return for city GCT purposes. The corporations previously filed their New York state corporate franchise tax return on a combined basis but had reported their city GCT return separately.

Judge Murphy's decision began by stating the statutory preference that corporations file on a separate basis. She also noted that the tax commissioner can require a combined return "where: (1) there is common ownership among the corporations to be combined, (2) the corporations in the proposed combined group are engaged in a unitary business, and (3) filing on a separate reporting basis 'distorts' a taxpayer's income and GCT liability."

In this case the first two requirements were met. All hung on whether filing on a separate basis distorted the taxpayer's income and GCT liability. According to Murphy, there is a presumption of distortion if there are substantial intercorporate transactions between corporate group members, as there were in this case. Murphy ruled that it then fell to Toys-R-Us--NYTEX to prove that there was no distortion of income by showing that the intercorporate transactions were "carried on at arm's length."

To meet this burden, Toys-R-Us presented two detailed economic studies, one by Irving H. Plotkin of Arthur D. Little, and the other by Mohamed Sherif Lotfi of Ernst & Young LLP. The Lotfi study concluded that while there indeed had been distortion, it was de minimis. The Plotkin study, on the other hand, found that a number of the intercompany transactions were not at arm's length and that there had been more significant distortion. This distortion, however, had caused Toys-R-Us to pay more tax than it otherwise would have. Plotkin further stated that to require a combined return under these circumstances would have been improper and would increase the distortion.

Editor's Note: Judge Murphy recently met with the NYSSCPA New York State, Municipal, and Local Taxation Committee and encouraged CPAs to take a more active role representing taxpayers in tax controversies with the city. See the August issue of The Trusted Professional for more details.