Recent legislation passed by the New York Legislature and signed by the Governor conforms New York City taxation to New York State taxation in a number of key areas. Perhaps most importantly, the legislation phases in a single sales factor formula for the New York City general corporation tax and the unincorporated business tax, and also requires general corporation tax combined reporting if there are “substantial intercorporate transactions” between related corporations. The legislation, which is effective immediately unless stated otherwise, also contains several so-called “loophole-closers” that have been enacted by New York State over the last few years and that have not previously been adopted by New York City. A summary of many of the most important provisions, along with brief commentary, is provided below.
Adoption of a Single Factor Sales Business Allocation Percentage Formula
Taxpayers have been required to apportion income to New York City for general corporation tax and unincorporated business tax purposes by using an equally weighted business allocation percentage (BAP) formula, consisting of property, payroll and sales factors (manufacturers have been allowed to double-weight their sales factor). The recently enacted legislation phases in a single factor sales formula and eliminates the property and payroll components from the BAP formula by 2018.
While the new BAP formula will doubtlessly benefit companies with significant operations relative to sales in New York City, the formula will punish companies with insubstantial operations in New York City relative to sales. Such companies can be expected to suffer a tax increase as a result of the new BAP formula. Some companies – such as those with substantial New York City sales coupled with almost no New York City property or payroll—may be able to show that the single factor sales BAP formula fails the external consistency test as applied to them and thus produces unconstitutional results.
Substantial Intercorporate Transactions Combined Reporting Standard
The legislation conforms the New York City combination standard to the “substantial intercorporate transactions” between “related corporations” standard passed at the state level as part of the 2007-2008 state budget.
The legislation does not fully describe how the new statute will be implemented, but it is almost certain to be implemented in a similar manner as its New York State counterpart, as the language in the enacted city legislation is identical to the language in the state statute. As with the New York State legislation, taxpayers may be able to show under some circumstances that, although there are substantial intercorporate transactions between companies, the companies are not unitary so combination is not constitutionally permissible.
Captive REITs and RICs
The New York City legislation follows the New York State 2007-2008 budget legislation in mandating combined reporting of “captive” real estate investment trusts (REITs) and regulated investment companies (RICs). REITs and RICs are considered “captives” if they are not regularly traded on an established securities market and are more than 50 percent owned by a single corporation not exempt from federal income tax. The legislation also eliminates the dividends paid deduction for captive REITs and RICs making payments to any member of an affiliated group that owns directly or indirectly more than 50 percent of the voting stock of the captive REIT or RIC.
The captive REIT and RIC legislation is aimed at curtailing strategies that result in no New York City tax being paid on income earned by a REIT or a RIC. For example, a New York City REIT may own a building in New York City, earn income from that building, distribute the income to a related out-of-state corporation with no New York City nexus, take a dividends paid deduction for the amount distributed to the out-of-state corporation and thereby avoid New York City tax on the REIT’s income. The legislation changes this result. Under the legislation, the REIT in that fact pattern would be denied a dividends paid deduction and accordingly would have New York City income on which tax would be owed.
Credit Card Banks Doing Business Provision
Effective January 1, 2011, a banking corporation will be considered to be doing business in the city if it has issued credit cards to 1,000 or more customers who have a mailing address within the city; merchant customer contracts with merchants that have 1,000 or more locations in the city to which the banking corporation remitted payments for credit card transactions during the taxable year; receipts of $1 million or more in the taxable year from its customers who have been issued credit cards by the banking corporation and have a mailing address within the city; receipts of $1 million or more arising from merchant customer contracts with merchants relating to locations within the city; or the sum of the number of customers plus the number of locations covered by its contracts equals 1,000 or more of the amount of its receipts with customers or merchants equals $1 million or more total. New York State has enacted an identical provision.
The provisions assume that a bank can have the constitutionally required “substantial nexus” based on economic presence and absent a physical presence. It is uncertain whether the Supreme Court of the United States would agree that mere economic presence is sufficient to establish a substantial nexus under the Commerce Clause. State courts confronting have arrived at conflicting conclusions on this crucial issue. (The taxpayer won in J.C. Penney Nat’l Bank v. Johnson, 19 S.W. 3d 831 (Tenn Ct. App. 1999), and lost in Tax Comm’r of W. Va v. MBNA Am. Bank, 640 S.E. 2d 226 (W. Va. 2006) and in Capital One Bank v. Mass. Comm’r of Rev., 899 N.E. 2d 76 (Mass. 2009).).
Grandfathered Article 9-A Corporations
New York State and New York City have separate taxing regimes for banking corporations and regular corporations. Certain corporations that otherwise would be taxed as banking corporations may be “grandfathered” and permitted to be taxed as regular corporations under New York State and New York City provisions. Classification as a banking corporation may be advantageous for a business depending on a variety of factors. For example, it may be advantageous to own or control a corporation that is able to source receipts from investment income based on the issuer’s presence in New York (as under the general corporation tax) rather than based on the corporation’s own presence in New York (as under the banking corporation tax). Under the statutes, businesses are generally taxed as regular corporations unless they meet one of the statutory “banking corporation” definitions, in which case they are taxed as a banking corporation unless one of the grandfather provisions applies.
One grandfather provision allowed subsidiaries of banking corporations that were already in existence and were more than 65 percent or more owned by a banking corporation as of 1985 to make a one-time election to continue to be taxed as regular corporations. The election was made by filing a general corporation tax return for the taxable year ending in 1985.
Another grandfather provision was introduced in 1999 following enactment of federal Gramm-Leach-Bliley Act legislation. At that time New York State and New York City adopted “transitional” provisions, which allowed corporations that had been taxed as regular corporations prior to 2000 to continue to be taxed as regular corporations. Additionally, another transitional rule allowed any corporations newly formed after 2000 that fit certain criteria to choose to be taxed as a regular corporation or banking corporation. These transitional rules continue to be extended, and now apply to tax periods prior to 2010.
The New York City legislation contains provisions that cancel a company’s “grandfather” status if any one of five conditions occur:
The corporation ceases to be a taxpayer under Article 9-A.
The corporation becomes subject to the fixed dollar minimum tax.
The corporation has no wages or receipts allocable to New York State, unless the corporation engages in an active trade or business or substantially all of the assets of the corporation were stock and securities of corporations engaged in the active conduct of a trade or business.
At least 65 percent of the voting stock of the corporation became owned or controlled directly by a corporation that acquired the stock in a qualified stock purchase within the meaning of I.R.C. § 338(h)(3)
The corporation acquires assets in a transaction or series of transactions having an average value in excess of 40 percent of the average value of all the assets of the corporation immediately prior to the acquisition.
A New York State statute enacted during the 2007-2008 legislative session contains these same five conditions.
Broker-Dealer Market-Based Sourcing
The legislation conforms New York City sourcing rules for broker-dealers under the General Corporation Tax (and also to the unincorporated business tax) to the New York State rules. Under the legislation, broker-dealers source receipts from brokerage commissions, margin interest and gross income from the purchase or sale of stocks, bonds, foreign exchange or other securities, loans and advances to affiliates, account maintenance fees, and management and advisory services will be sourced to the location of the customer (generally the mailing address in the records of the taxpayers).
Conformity to New York State’s Fixed Dollar Minimum Tax
New York City presently imposes a flat $300 fixed dollar minimum tax on corporations under the general corporation tax. The legislation changes this by basing the fixed dollar minimum tax on a corporation’s New York City gross receipts (as with the New York State fixed dollar minimum tax). At one end of the spectrum, a corporation with no more than $100,000 in New York City gross receipts pays a fixed dollar minimum tax of $25. At the other end of the spectrum, a corporation with more than $25 million in New York City gross receipts pays a fixed dollar minimum tax of $5,000.
Voluntary Disclosure Program
The legislation enacts a statutory voluntary disclosure program, like the New York State program, that requires applicants to submit an advance “disclosure statement” containing the applicant’s name. This requirement has been widely criticized by practitioners because it may dissuade companies that only arguably have a filing obligation (due to questionable nexus) from coming to the table and seeking a voluntary disclosure agreement. Such companies are concerned that they may reveal their names upfront and then receive an unfavorable lookback period offer from the taxing authority that cannot be negotiated since their one bargaining chip (their name) has already been lost.
Regardless of the new statutory program, it is possible that the New York City Department of Finance may still entertain anonymous voluntary disclosure requests.
Interestingly, while the legislature was debating the New York City conformity legislation, the New York State Department of Taxation and Finance was considering substantial corporate tax reform. One proposal is to merge the banking corporation tax into the regular corporation tax. Another proposal is to eliminate the “substantial intercorporate transactions” combination standard in favor of a California-style unitary combined reporting standard.
If such measures ultimately become enacted, they could occur jointly with identical New York City legislation. On the other hand, it is possible that there could be a one or two year lag before New York City adopts similar legislation. Accordingly, taxpayers and tax practitioners should be sure to monitor differences between New York State and New York City laws, and should never assume that the law at the city level will match the law at the state level. As the above examples illustrate, it sometimes takes a year or two before passage of New York City tax legislation corresponding to New York State tax legislation.