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December 7, 2007

DiNapoli: NYRA Underpaid Franchise Fees by $10.9 Million

Urges Governor and Legislature to Ensure Strong Oversight of
Future Race Track and VLT Operators

State Comptroller Thomas P. DiNapoli today urged the Governor and Legislature to include strong oversight provisions in the legislation for the operation of the state’s racetracks and related video lottery terminals (VLT). DiNapoli’s recommendations follow the release of an audit today that found the New York State Racing Association (NYRA) underpaid franchise fees owed to the state in 2004 and 2005 by a combined total of $10.9 million. Comptroller audits have found that NYRA failed to pay the state nearly $54 million in franchise fees from 2000 to 2005.

“NYRA is legally required to pay taxpayers a reasonable amount in exchange for operating the state’s thoroughbred race tracks. But over and over again our auditors have found that NYRA has continually misinterpreted the mathematical formula for calculating the franchise fee and shortchanged taxpayers,” DiNapoli said. “NYRA appears to have cleaned up some of its past practices but they’re still shortchanging taxpayers on franchise fees.

“The horse racing franchise is a valuable state asset. In any new proposal, the Governor and the Legislature should include provisions for strong oversight of the operators and clearly stipulate how any payments owed to the state are calculated so the operators can’t play games with what they owe taxpayers.”

Under state law, the Comptroller is required to certify NYRA’s annual franchise fee, which the Comptroller does every two years. NYRA is required to perform certain year-end tests of expenses (106 and 90 percent tests defined in law) to determine its entire net adjusted income. The franchise fee is calculated based on NYRA’s entire adjusted net income, less $2 million, which is to be allocated for horsemen’s stakes and purses. If the adjusted net income for the year is less than $2 million, the entire amount is to be allocated for horsemen’s stakes and purses, and NYRA pays no franchise fee to the state.

When verifying the franchise fees for 2004 and 2005, auditors found that instead of using actual expenses (those expenses which comply with generally accepted accounting principles) as intended, NYRA calculated the fee using tax-basis expenses (those expenses which are deductible on its federal corporate tax return). As a result, auditors found that NYRA did not pay $14.3 million it owed the state in 2004 because it calculated the franchise fee to be $0. In 2005, auditors found that NYRA actually calculated it owed the state $3.3 million when auditors found that it did not owe anything to the state for that period.

Auditors note that specific tests exist in law to limit the amount of expenses incurred by NYRA. Using only tax-basis expenses allows a significant amount of NYRA’s expenses to escape the budget and spending limitations set forth in statute. For example, on NYRA’s 2005 tax return, its total tax-basis operating expenses were $146.4 million, while its actual operating expenses were $167.3 million, a difference of $20.9 million.

NYRA’s flawed methodology for calculating the franchise fee has also been used for developing its budgets. Therefore, the NYRA Board of Trustees has not had an accurate picture of its financial situation when they voted on its budget. Auditors found in 2005 NYRA started providing the board with both anticipated actual and tax-basis expenses when it prepared its budget. Auditors noted that it was NYRA’s actual, and not tax-basis, expenses which have resulted in its current dire fiscal condition, deficits and bankruptcy.

Auditors also questioned NYRA’s practice to deduct accrued interest on its annual federal tax returns for a $74.5 million loan. One of the Comptroller’s prior audits also questioned this practice and urged NYRA to obtain an Internal Revenue Service (IRS) ruling. In a recent ruling, the IRS agreed with Comptroller auditors and also took issue with other deductions NYRA made over the years. IRS auditors initially identified a tax liability of $1.6 billion; however, the IRS recently notified NYRA that it anticipates adjusting its claim against NYRA to below $25 million.

NYRA’s franchise to operate the state’s three tracks ends December 31, 2007. The Governor has recommended that a newly reconstituted NYRA be awarded a new franchise for 30 years to operate the tracks, while another yet to be named entity would run the VLTs. The final agreement requires legislative approval.

To ensure strong oversight and address problems identified by past Comptroller audits, DiNapoli recommended the Governor and the Legislature include the following recommendations in the enabling legislation:

  • Confirm the Comptroller’s broad audit authority and stipulate the Comptroller’s right to examine all financial and operational matters associated with racing and gaming activities.
  • Clearly define all financial terms, including revenues, expenses and all other payment obligation terms to ensure that all racing and gaming operators fully understand and meet their fiscal responsibilities.
  • Ensure all contracts meet guidelines consistent with applicable state procurement laws.

NYRA disputed the audit’s findings and the auditors’ calculation of the franchise fees. NYRA’s full response is included in the audit.

Click here for a copy of the audit released today.

Click here for a copy of the audit of the 2002 and 2003 franchise fee.

Click here for a copy of the audit of the 2000 and 2001 franchise fee.



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