The New York State Department of Taxation and Finance (Department) has just revised its Guide to Sales Tax in New York State, Publication 750.

The Guide will be particularly useful for companies that are just starting to do business in New York State. It provides a well-organized and easy-to-read outline of the steps that should be taken to register as a vendor selling products that are subject to the sales tax and to collecting and remitting taxes. Small businesses and their advisors will find the Guide particularly useful.

The Guide confirms the State’s required adherence to the United States Supreme Court decision in Quill Corp. v. North Dakota (a case in which the taxpayer was represented by McDermott Will & Emery) to the effect that an out-of-state company must have a physical presence in New York to be required to collect use tax on sales to New York customers. It confirms that a company need not collect use tax on sales to New York buyers if its only contact with the State is the delivery of its products into the State by the U.S. Postal Service or a common carrier. It cautions, however, that use tax must be collected if the company has employees, sales persons, independent agents or service representatives located in, or who enter, New York. Although the law has been clear for many years that a sales representative can create nexus for an out-of-state company even though he or she is an independent contractor and not an employee, some companies still seem to be under the mistaken impression that this is not the case. Moreover, although there is no New York authority directly in point, cases in other states have established the principle that nexus can be created by the presence in the state of a single telecommuting employee, even if the employee’s work is not focused on the state.

The Guide contains a cryptic reference to New York’s click-through nexus rule under which an out-of-state company can be compelled to collect use tax on sales to New York purchasers if people in the state refer customers to the company and are compensated for doing so. Such persons are presumed to be soliciting sales for the company and, although the presumption can be rebutted, that will prove to be impossible in the vast majority of cases. The Guide contains cross-references to Department rulings that explain the presumption and the manner in which it can be rebutted, but it would have been helpful if the Guide could have provided more detail about these rules.

One attractive feature of the Guide is that people accessing it online can use links in the Guide to get to relevant rulings.

In addition to the state-wide sales and use tax, special sales taxes that are imposed only within New York City are discussed. These include taxes on credit rating services and certain localized personal services such as those provided by beauty salons, barber shops, tattoo parlors and tanning salons. Interestingly, the Guide does not address the Department’s position that services provided by credit rating agencies in rating debt and preferred stock offerings are taxable. This represents a reversal of a position that the Department had taken in audits for some 40 years. McDermott Will & Emery represented the industry in negotiating the terms of the change of position with the Department. Under the Department’s new position, offerings after September 1, 2015, are subject to the New York City tax if the invoice address of the issuer or representative is in the city.

The Guide discusses the treatment of taxable business purchases. Although one can argue that all purchases by a business that sells products that are subject to the sales tax should be exempt from tax, the law has never so provided and, while there are exemptions for property purchased for resale and for property directly used in manufacturing goods that are sold, the purchases of many items that contribute to the production of taxable items (e.g., computers, furniture, supplies) are subject to the tax, even though their cost is effectively included in the price of the taxable products that the company sells to its customers.

The discussion of the resale exclusion indicates that the exclusion does not apply if “you later use the property or services rather than reselling them.” This does not address the common situation in which property that was purchased and is being held for resale is incidentally used for other purposes. Companies often pledge their inventory as collateral for loans and the Department has never contended that this use defeats the resale exclusion. It would be helpful if the Department issued guidance on the incidental situation.

Companies and their advisors should be aware that the resale exclusion is just that: an exclusion and not an exemption. It is part of the definition of what constitutes a taxable retail sale. This can be important in audits and litigation, because the law is clear that the Department has the burden of persuasion if the issue involves the interpretation of a statute imposing a tax whereas the taxpayer bears this burden in a case involving the application of an exemption. Since the resale exclusion is part of the definition of a taxable retail sale, the burden with respect to its application is on the Department.

The Guide contains a useful section on procedures for filing sales and use tax returns. Although it mentions that a vendor is “a trustee for the state” in connection with the remittance of sales tax that it collects, it does not mention that the responsible persons at a company can be personally liable for sales taxes that are not remitted. This often comes up in audits and it is common for the Department to ask a company’s officers to agree to extend the statute of limitations on collections of delinquent taxes from them personally. We hope that future editions of the Guide will mention this point.

Unfortunately, the Guide does not discuss the many controversial issues involving cloud computing and internet transactions.

On July 24, 2015, the New York Department of Taxation and Finance published guidance on the sales and use tax exemption for “general aviation aircraft,” effective September 1, 2015.  N.Y. Dep’t of Taxation & Finance, TSB-M-15(3)S (July 24, 2015).  The exemption, to be added as subsection (a)(21-a) of section 1115 of the Tax Law, exempts from sales and use tax “general aviation aircraft, and machinery or equipment to be installed on such aircraft.”  Previously, such sales and uses were fully taxable.

“General aviation aircraft” is defined broadly as aircraft used in civil aviation, except for commercial or military aircraft or “an unmanned aerial vehicle or drone.”  With respect to “general aviation aircraft,” the ruling states receipts from the following items are tax-exempt:

  • Aircraft itself
  • Property affixed to aircraft for its equipping, including furniture, fixtures, built-in appliances, window coverings, climate control systems or entertainment systems
  • Property that the aircraft has at the time of its sale that is necessary for its operation, such as avionics, radios, weather radar systems, and navigation and emergency lighting

Similarly, receipts from machinery and equipment installed on a general aviation aircraft after its purchase and necessary for equipping and normal operation are also tax-exempt.  The sales and use tax exemption for “general aviation aircraft” also applies to leases of one year or more of certain noncommercial aircraft (seating capacity of less than 20 passengers and maximum payload capacity of less than 6,000 pounds) subject to the accelerated tax payment provisions of section 1111(i) of the Tax Law.  However, effective September 1, 2015, these provisions no longer apply to aircraft.

However, receipts from the following items (termed “accessories”) are not exempt with respect to a general aviation aircraft:

  • Items of décor (paintings or other artwork)
  • Tableware, glassware or cookware
  • Small appliances
  • Linens, pillows, or towels
  • Other ancillary property

Regarding timing, the exemption applies generally to sales or uses occurring on or after September 1, 2015.  For the transition period, the exemption applies to sales made prior to September 1 if the purchaser takes delivery on or after that date, and applies to leases entered into before September 1 to the extent of the lease term beyond that date.

Now is the time to begin brownfield redevelopment projects in the State of New York. Reauthorization of and reforms to New York’s Brownfields Cleanup Program, which provides tax credits to redevelop contaminated properties, came into effect on July 1, 2015. The program has been reauthorized until 2026, giving businesses and developers a chance to remediate brownfields while generating millions of dollars in refundable credits.

State brownfield tax credit programs encourage remediation of contaminated property that might otherwise remain abandoned. New York, with its industrial heritage, has more than its share of such locations. The Brownfields Cleanup Program was started in 2003 as a way to encourage redevelopment of these properties. Once a participating project is granted a certificate of completion, it generates credits calculated as percentages of the site preparation costs and groundwater remediation costs, and of the costs of tangible property (buildings and capital equipment). The site preparation and groundwater remediation costs are the environmental expenses, which generate credits ranging from 22 to 50 percent of costs. The tangible property costs are the redevelopment (generally non-environmental) expenses, which generate credits ranging from 10 to24 percent of costs. Tangible property credits are capped as a multiplier of site preparation and groundwater remediation costs: three times the costs for most projects and six times the costs for manufacturing projects. All brownfields credits are refundable to the extent that they exceed the taxpayer’s income tax or franchise tax otherwise due. Essentially, under the Brownfields Cleanup Program, New York will pay for up to half of a project’s environmental remediation costs and a quarter of other redevelopment costs.

In recent years, the program came under criticism for allegedly excessive credit awards, which sometimes exceeded the overall costs of remediation. The program had been scheduled to expire at the end of the year, and a short-term extension of the program through March 2017 was vetoed by Governor Cuomo as not providing needed reform. The reforms package and reauthorization were enacted with the FY 2016 budget. L. 2015, ch. 56, pt. BB (S. 2006-B / A3006-B). With proposed regulations for some definitional terms pending, the reformed law came into effect for projects approved by the Department of Environmental Conservation on or after July 1, 2015. Preexisting projects are grandfathered in under the old provisions as long as they are completed by the end of 2019 (and projects approved before June 23, 2008, must be completed by the end of 2017). New projects will have until March 31, 2026, to obtain certificates of completion under the reformed Brownfields Cleanup Program.

Key reforms coming into effect include the following:

  • To address a sense that projects do not need as many incentives in the tight New York City real estate market, projects in the city now have to meet one of three special criteria to qualify for the tangible property component of the credits. This special requirement is for tangible property credits only; site preparation and groundwater remediation credits are unrestricted. The three ways to qualify are:
    • Locating the project within designated environmental zones.
    • Having a property that is “upside down” or “underutilized.” “Upside down” means that remediation costs exceed 75 percent of property value. Under the proposed regulatory definition, “underutilized” property must be more than 50 percent vacant for the past five years, require government assistance for redevelopment to be feasible and meet other criteria for being distressed.
    • Proposing an affordable housing project for the redeveloped brownfield, which generally means that the project will qualify for a federal, state or municipal affordable housing program.
  • The criteria for accepting a project into the Brownfields Cleanup Program now require that there be contamination measured at levels exceeding applicable soil cleanup objectives or other health or environmental standards. This test replaces a more subjective standard of whether development was complicated by the presence or potential presence of a contaminant.
  • The definitions of eligible site preparation costs and groundwater remediation costs now are only those necessary for investigating the property, remediating the contamination and obtaining a certificate of completion, and the definitions include numerous specific examples of qualifying costs. Essentially, these classifications are intended to reflect environmental costs only. Non-environmental costs that previously were considered site preparation costs (g., foundations) instead may count toward the tangible property credit.
  • The definition of qualifying tangible property costs was narrowed. Now, qualifying property must have a useful life 15 years or more or be non-portable equipment or structures.
  • A “BCP-EZ” program will be offered for streamlined review of remediation projects for developers that agree to waive the brownfield tax credits but want the environmental liability release of the Brownfield Cleanup Program.

Even with these reforms, New York continues to have a very attractive brownfield redevelopment program. As brownfield redevelopment is a process that lasts years, businesses interested in participating should contact their advisers about getting started on potential projects.

On July 7, 2015, the New York Department of Taxation and Finance issued guidance (TSB-M-15(4)C, (5)I, Investment Capital Identification Requirements for Article 9-A Taxpayers) on the identification procedures for investment capital for purposes of the New York State Article 9-A tax and New York City Corporate Tax of 2015. Income from investment capital is generally not subject to tax in New York. For New York State and New York City corporate income tax purposes, investment capital is investments in stocks that meet the following five criteria:

  1. Satisfy the definition of a “capital asset” under section 1221 of the Internal Revenue Code (IRC) at all times the taxpayer owned the stock during the taxable year;
  2. Are held for investment for more than one year;
  3. The dispositions of which are, or would be, treated by the taxpayer as generating long-term capital gains or losses under the IRC;
  4. For stocks acquired on or after January 1, 2015, have never been held for sale to customers in the regular course of business at any time after the close of the day on which they are acquired; and
  5. Before the close of the day on which the stock was acquired, are clearly identified in the taxpayer’s books and records as stock held for investment in the same manner as required under IRC section 1236(a)(1) for the stock of a dealer in securities to be eligible for capital gain treatment (for stock acquired prior to October 1, 2015, that was not subject to IRC section 1236(a),such identification must occur before October 1, 2015).

Criterion five, regarding identification procedures, has been an area of concern for many New York taxpayers. While identification has been a concern of securities dealers for federal income tax purposes for many years, the New York identification requirement applies to all taxpayers that seek to have stock qualify as investment capital. Thus, all New York taxpayers, many in uncharted waters, must develop appropriate procedures to comply with this new identification requirement. Unfortunately, the Department’s guidance is somewhat sparse and does not address some important issues that could arise and that have been raised with the Department. The guidance also adopts a troubling position with respect to investments made by partnerships.

Securities Dealers

For taxpayers that are dealers subject to IRC section 1236, stock must be identified before the close of the day on which the stock was acquired (with the exception of floor specialists as defined in IRC section 1236(d) that have stock subject to the seven-day identification period in IRC section 1236(d)(1)(A)) as held for investment under IRC section 1236(a)(1) to satisfy the New York investment capital identification requirement. The presence or absence of a federal identification under IRC section 1236(a)(1) will be determinative, and a separate New York identification will not be allowed. A federal identification under IRC section 475 (relating to marked to market rules) is insufficient.

As a practical matter, many securities dealers that are taxed as corporations for federal income tax purposes do not comply with the identification procedures under IRC section 1236(a)(1) given the lack of a preferential federal income tax rate for capital gains. Those dealers will have to start complying with the federal identification rules for their stock to qualify as investment capital for New York State and City tax purposes. Additionally, the Department’s guidance does not provide a transitional rule for securities dealers, so a securities dealer that has not been complying with the IRC section 1236(a) identification requirements will not be afforded investment capital treatment for stock that it has already purchased.

Taxpayers Other Than Securities Dealers

For taxpayers that are not securities dealers subject to IRC section 1236 (non-dealers), stock must be recorded before the close of the day on which the stock was purchased in an account maintained for investment capital purposes only (e.g., the account cannot also be used for stock held for sale to customers). The investment capital account must disclose the name of the stock, CUSIP number of the stock (or CINS number for international securities), date of purchase, number of shares purchased and purchase price. If the stock is later sold, the account must also disclose the date of sale, number of shares sold and sales price.

The investment capital account may be an account maintained in the taxpayer’s books of account for recordkeeping purposes only, or it may be a separate depository account maintained by a clearing company as nominee for the company; in either case, the account must be set up in a manner that readily identifies the length of time the stock was owned by the taxpayer. Each corporation in a combined report must follow the identification procedures described above and maintain its own investment capital account.

While the Department’s guidance reiterates the transitional rule for stock acquired before October 1, 2015 (such stock must be clearly identified in accordance with these procedures by October 1, 2015), the guidance does not address other transitional issues that could arise in the normal course of business.

For example, what if a corporation is not taxable in New York State when it acquires a stock investment, and five years later it starts doing business in New York? When the corporation acquires the stock, it may not expect to be a New York taxpayer, so it may not know about the election, or if it does, it may not think that the election is needed. If the corporation later starts doing business in New York or becomes a New York taxpayer (for example, because of an acquisition), can it treat the investment as investment capital? As a matter of tax equity and practicality, corporations that first become New York taxpayers on or after October 1, 2015, should be permitted to identify any stock held as investment at the time they become a New York taxpayer.

The Department’s guidance also does not address certain merger and acquisition situations. For example, what if a corporation makes the identification and its stock is later bought in an IRC section 338(h)(10) transaction, where the corporation is treated as a new taxpayer for most income tax purposes but is the same legal entity? Must the “new” taxpayer make a new identification? What if a corporation makes an identification and then merges into another unrelated corporation? Must the surviving corporation in the merger make a new identification? As matter of practicality, identifications should carry over in acquisition situations. These issues have been brought to the Department’s attention and they are being considered.

Stock Acquired Pursuant to Options

If stock is purchased pursuant to an option, the stock may be identified as investment capital only if the taxpayer, before the close of the day on which the option was acquired (or by October 1, 2015, for options acquired before that date), had clearly identified the option in its records as held for investment.

Corporate Partners

Perhaps the most troubling aspect of the Department’s guidance is the identification procedures for investments owned by partnerships. The guidance provides that if a corporation is a partner in a partnership and the corporation uses the aggregate method to compute its tax—whereby the partner aggregates its share of the partnership’s income (or loss) and apportionment factors with its own income (or loss) and apportionment factors—the partnership must follow the required identification procedures at the partnership level. The guidance further provides that if a corporation becomes a partner in a non-dealer partnership and the partnership has not identified any stock as investment capital using the procedures described in this memorandum before the corporation became a partner, only stock acquired by the partnership on or after the date the corporation became a partner may potentially qualify as investment capital.

To highlight the potential issues with a partnership-level identification requirement, consider a corporation that invests in a partnership that is organized and operates entirely in another state or country. The partnership would have no way of knowing the New York rules and would have no legal obligation to comply with them. A partnership often does not know whether any of its partners are, or will become, New York taxpayers. Additionally corporate partners (particularly minority partners) often do not have the ability to require their partnerships to comply with these types of procedures and may not have the ability to monitor the partnership’s compliance.

A more workable rule would be to allow the identification to be made at the partner level. This rule would be consistent with the language of Tax Law section 208(a), which provides that stock be identified in “the taxpayer’s records,” and would facilitate compliance by taxpayers that invest in foreign or alien partnerships.

The McDermott Difference

We have been working with a number of taxpayers on these and other similar issues and encourage taxpayers to raise their concerns with the Department (either directly or through an advisor) so the Department can refine these identification procedures as it drafts the proposed regulations (which, unlike the recently issued TSB, will be subject to a notice and comment period).

The New York State Tax Appeals Tribunal has just provided timely guidance respecting the unitary business rule in New York State.  In SunGard Capital Corp. and Subsidiaries (DTA Nos. 823631, 823632, 823680, 824167, and 824256, May 19, 2015), the Tribunal found that a group of related corporations were conducting a unitary business and that they should be allowed to file combined returns, reversing an administrative law judge determination.

The unitary business rules have assumed increased importance in New York this year because of recently-enacted corporate tax reform legislation.  Effective January 1, 2015, the only requirements for combination in New York State and City are that the corporations must be linked by 50 percent stock ownership and must be engaged in a unitary business.  It is no longer necessary for the party seeking combination (whether the taxpayer or the Department of Taxation and Finance) to show that separate filing would distort the corporations’ New York incomes.

In a related but different context, the Department’s unpublished position with respect to when an acquiring corporation and a recently purchased subsidiary can begin filing combined returns (the so-called “instant unity” issue) generally is that combined returns can be filed from the date of acquisition only if the corporations were engaged in a unitary business before they became linked by common ownership.  In a recent set of questions and answers about the new law, the Department indicated that instant unitary decisions would be done on a facts-and-circumstances basis, but we understand from conversations with the Department that the existence of a unitary business between the corporations before the acquisition will be of great importance.

The SunGard case involved prior law under which distortion was an issue, but the interesting aspects of the case involve the question of whether the corporations were engaged in a unitary business, as the taxpayers contended.  The corporations’ primary business involved providing information technology sales and services information, software solutions and software licensing.  The administrative law judge had concluded that there were similarities among the different business segments but that the different segments operated autonomously.  Although the parent provided general oversight and strategic guidance to the subsidiaries, the judge concluded that centralized management, one of the traditional criteria for a unitary business, was not present because the parent’s involvement was not operational.  The centralization of certain management functions such as human resources and accounting did not involve operational income-producing activities.  The judge held that holding companies, inactive companies, and companies with little or no income or expenses could not be viewed as unitary with the active companies.  The judge noted that there were few cross-selling or intercompany transactions.  Although programs had been developed to encourage cross-selling, they were not initiated until after the taxable years at issue.

The Tribunal reversed the administrative law judge’s decision and engaged in a detailed discussion of the elements of a unitary business that will provide useful guidance to both taxpayers and tax administrators in the future.

Although there were differences among the different segments of the group’s business, the Tribunal found that they complemented and supported each other.  The Financial System (FS) business provided data processing services for customers in the financial services industry, such as investment banks, broker/dealers and insurance companies.  The Public Sector (PS) business segment provided data processing services for government and non-profit entities.  The Higher Education (HE) business segment provided data processing services for colleges and universities.  The Availability Services (AS) business segment provided system management, business continuity, data protection, and death and disaster recovery services for customers in all sectors of the economy.

Although there were differences between the FS and the HE/PS segments with respect to specific products and services, both these segments primarily were engaged in selling software and processing services to institutional consumers, and the Tribunal found that these lines of businesses were similar for purposes of its unitary business analysis.  Further, the AS segment complemented the FS and HE/PS segments by providing system management services to other members of the group.  A number of the different segments had customers in common.

Centralized management was found to exist because the parent directed a group-wide cash management system pursuant to which funds were transferred from group members to other group members as needed.  To the extent that these were reflected by receivables, no interest was charged.  The cash management system was deemed to result in the kind of flow of value that is central to the unitary business concept.  Centralized management also was shown by the parent’s responsibility for budgetary matters, its management of the group’s debt, and its role as the group’s sole contact with banks and bondholders.  It also handled all central office functions, including accounting, taxes, insurance, legal, human resources and benefits.  Summarizing, the Tribunal stated that the group was run “as a single business enterprise from a strategic corporate planning perspective” by officers with group-wide responsibilities.  The management functions exercised by the parent were “grounded in the parent’s own operational expertise and operational strategy” and were not confined to the traditional stewardship that a parent exercises over its subsidiaries’ activities.  The failure of the subsidiaries to compensate the parent for its centralized management and services was held to be a further indicator of a unitary business relationship.

The Tribunal did find, however, that there was an insufficient flow of value between the holding companies and the inactive companies to justify including them in the combined return group.  The Tribunal stopped short of saying that a holding company could never be unitary with an operating subsidiary, but it said that there was no evidence in the record of the hearing indicating that the holding companies played a role in the operating companies’ activities.  We have generally advised holding companies that wish to be combined with operating companies to centralize headquarters management activities in the holding company and to make sure that the holding company provides valuable services to the operating subsidiaries so as to avoid this problem.

A similar issue that was not present in SunGard is whether a holding company that is sandwiched between two operating companies that are unitary with each other will be included in the unitary group because of its position in the corporate structure.  We believe that it should be and there are authorities to this effect in other jurisdictions.

Since the SunGard decision involved years under prior law, it was also necessary for the taxpayer to demonstrate that separate filing would have distorted the New York State incomes of the group members.  The Tribunal found that there was sufficient distortion because the parent was not compensated for management and other services provided to the subsidiaries, noting that the Tribunal had previously held (Matter of IT US, Matter of Mohasco) that the provision of services at cost created the distortion necessary to justify combination.  In SunGard, the distortion was greater because the parent did not charge the subsidiaries anything for its services.

On May 18, the U.S. Supreme Court issued its decision in Comptroller of the Treasury of Maryland v. Wynne. In short, the Court, in a five-to-four decision written by Justice Alito, handed the taxpayer a victory by holding that the county income tax portion of Maryland’s personal income tax scheme violated the dormant U.S. Constitution’s Commerce Clause.

Specifically, the Court concluded that the county income tax imposed under Maryland law failed the internal consistency test under the dormant Commerce Clause, because it is imposed on both residents and non-residents with Maryland residents not getting a credit against that Maryland local tax for income taxes paid to other jurisdictions (residents are given a credit against the Maryland state income tax for taxes paid to other jurisdictions).

The Supreme Court emphatically held (as emphatically as the Court can be in a five-to-four decision) that the dormant Commerce Clause’s internal consistency test applies to individual income taxes. The Court’s holding does create a perilous situation for any state or local income taxes that either do not provide a credit for taxes paid to other jurisdictions or limit the scope of such a credit in some way.

The internal consistency test—one of the methods used by the Supreme Court to examine whether a state tax imposition discriminates against interstate commerce in violation of the dormant Commerce Clause—starts by assuming that every state has the same tax structure as the state with the tax at issue. If that hypothetical scenario places interstate commerce at a disadvantage compared to intrastate commerce by imposing a risk of multiple taxation, then the tax fails the internal consistency test and is unconstitutional.

Although the Wynne decision does not address the validity of other taxes beyond the Maryland county personal income tax, the decision does create significant doubt as to the validity of certain other state and local taxes such as the New York State personal income tax in the way it defines “resident.” New York State imposes its income tax on residents on all of their income and on non-residents on their income earned in the state; this is similar to the Maryland county income tax at issue in Wynne.

“Resident” is defined as either a domiciliary of New York or a person who is not a domiciliary of New York but has a permanent place of abode in New York and spends more than 183 days in New York during the tax year. N.Y. Tax Law § 605. (New York City has a comparable definition of resident.) N.Y.C. Administrative Code § 11-1705. Thus a person may be taxed as a statutory resident solely because they maintain living quarters in the state and spend more than 183 days in the state, even if those days have absolutely nothing to do with the living quarters; this category of non-domiciliary resident is commonly referred to a “statutory resident.” As such, under New York’s tax scheme, a person can be a resident of two states—where domiciled and where a statutory resident—and thus be subject to taxation on all of their income in both states.

Although New York State grants a credit to residents for taxes paid to another jurisdiction, that credit is only for taxes paid “upon income derived” from those other jurisdictions. N.Y. Tax Law § 620. As such, New York State does not grant a credit for taxes paid to another jurisdiction on income earned from intangible property, such as stocks, because income earned from intangible property is not ‘derived from’ any specific  jurisdiction.

To illustrate using an example, suppose an investment banker is unquestionably a domiciliary of New Jersey and has an apartment, i.e., permanent place of abode, in New York that he uses only occasionally. Further, suppose that the investment banker spends more than 183 days in New York during a tax year by going to his office in New York on most workdays. In such a case, the investment banker is a resident of both New Jersey and New York and subject to tax as a resident in both states on his entire worldwide income. New York does not give a credit for taxes paid to New Jersey on income derived from intangible property, and thus the investment banker pays tax on this income twice, once to New Jersey and once to New York, clearly disadvantaging interstate commerce and resulting in double taxation.

This is not some hypothetical example. This is actually the fact pattern in In the Matter of John Tamagni v. Tax Appeals Tribunal of the State of New York, 91 N.Y.2d 530 (1998). In that case, the New York Court of Appeals (New York State’s highest court) held that New York State’s taxing scheme did not violate the dormant Commerce Clause and did not fail the internal consistency test. The validity of the Court of Appeals’ decision is seriously called into question under the Wynne case.

The Court of Appeals, relying upon Goldberg v. Sweet, held that the dormant Commerce Clause did not apply to residency-based taxes because those taxes were not taxing commerce, but rather a person’s status as a resident. However, the U.S. Supreme Court’s decision in Wynne not only repudiates the very dicta from Goldberg v. Sweet cited by the New York Court of Appeals in Tamagni, but the U.S. Supreme Court also determined that even if a state has the power to impose tax on the full amount of a resident’s income, “the fact that a State has the jurisdictional power to impose a tax [under the Due Process clause of the Constitution] says nothing about whether that tax violates the Commerce Clause.” After Wynne, it is clear that the dormant Commerce Clause applies to residency-based personal income taxes.

The second reason that the vitality of the Tamagni decision is in question is its application of the internal consistency test. The Court of Appeals held that even if the dormant Commerce Clause applied, the internal consistency test was not violated because the tax at issue was imposed upon a purely local activity and thus could not violate the Complete Auto tests. However, as discussed above, New York State’s lack of a credit for taxes paid to other jurisdictions mirrors the lack of a credit under Maryland’s county income tax scheme.

New York State taxpayers should be cognizant of the Wynne decision and should consider filing refund claims if they have paid— or will pay—tax to New York State as a statutory resident (i.e., not as a New York domiciliary). One would expect the New York State Department of Taxation and Finance to be quite resistant to granting such refunds and likely to vigorously defend the existing taxing scheme.

It may be worthwhile to note that this problem of double taxation was acknowledged and addressed in an agreement executed in October 1996 by the heads of the revenue agencies of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. Under that agreement, the “statutory resident” state would provide a credit for the taxes paid by the individual on his or her investment income to his/her state of domicile. Unfortunately, that agreement was never implemented through legislation— maybe now is the time for that to be done.

Finally, a word about New York City: New York City imposes a personal income tax on residents, allowing no credit for taxes paid to other jurisdictions. However, New York City does not impose a tax on non-residents, making its personal income tax different than the Maryland county income tax. Thus, the constitutionality of the New York City personal income tax is not specifically addressed by the U.S. Supreme Court’s decision. However, similar to the New York State definition of resident, a person can be a resident in two different jurisdictions under the New York City definition of resident. As such, New York City’s personal income tax could be imposed twice on a person if the person is a domiciliary of one state and a statutory resident in another. Thus, the tax potentially fails the internal consistency test.

On April 13, 2015, Governor Andrew Cuomo signed into law two bills related to the 2015-2016 budget (S2009-B/A3009-B and S4610-A/A6721-A) (Budget Bill), containing several significant “technical corrections” to the New York State corporate income tax reform enacted in 2014, along with sales tax provisions and amendments to reform New York City’s (the City’s) General Corporation tax.  For additional information regarding these changes see our Special Report.

One of the less-publicized changes to the New York City Administrative Code involves an amendment to the provision that prohibits changes to the City allocation percentage during the additional period of limitation that is initiated by the reporting of federal or New York State corporate income tax or certain sales and use tax changes to the City where a taxpayer is not conceding the reported changes for New York City purposes.  N.Y. Admin. Code § 11-674(3)(g).  Under the former rule, if the general three-year statute of limitations had expired (i.e., the three-year period from the date the City return was filed), neither the taxpayer nor the City could make changes to the taxpayer’s allocation percentage due to the reporting of federal or New York State changes.  (This same prohibition on changes to the allocation percentage applied (a) when the taxpayer had not notified the City as to a federal or New York State change, but in such situation there would be no limitation on the time period during which the City can issue an assessment and (b) when a deficiency was attributable to the application of a net operating loss or capital loss carry back.)

In the past, the Commissioner has argued that the language in section 11-674(3)(g) was only intended to bar the City from making its own audit adjustments to a taxpayer’s allocation percentage and did not bar the City from making changes to a taxpayer’s allocation percentage that track or reflect State changes to such percentage.  A 1991 Department of Finance Hearing Decision agreed with this interpretation.  See Matter of C.I.C. International Corporation, FHD(390)-GC-9/91(0-0-0) (Sept. 13, 1991).  However, in 1999, the New York City Tax Appeals Tribunal held that the limitation imposed by section 11-674(3)(g) barred the City from making any changes to a taxpayer’s allocation percentage during the additional two-year period of limitation following a report of a State change, even if those changes were merely employed to mirror State changes.  Matter of Ethyl Corporation, New York City Tax Appeals Tribunal, TAT(E)93-97(GC) (June 28, 1999).

In this year’s Budget Bill, the limitation provision was amended with respect to taxable years beginning on or after January 1, 2015 (the provision was not changed for taxable periods beginning before January 1, 2015).  For taxable years beginning on or after January 1, 2015, the City may adjust the allocation percentage within the additional period of limitation when the New York City assessment is based on the reporting of a New York State change.  (The prohibition on changes to the allocation percentage still remains with respect to the reporting of federal changes.)  Similarly, when contesting an assessment based on a New York State change or when seeking a refund of such an assessment, taxpayers can include a challenge to the allocation percentage.

In addition, the refund provisions in Administrative Code section 11-678 have been revised to remove the limitation prohibiting taxpayers from asserting an allocation change when a refund claim is filed with respect to the reporting of a New York State change. (The prohibition on changes to the allocation percentage still remains with respect to the reporting of federal changes.)

Interestingly, in reviewing the changes that have been made to the statutory language, there does not seem to be any limitation providing that the allocation changes being asserted by the City or by the taxpayer need to be related to the underlying New York State changes.

The New York State Department of Taxation and Finance (the Department) has been issuing guidance explaining the 2014 corporate tax reform legislation (generally effective on January 1, 2015) through a series of questions and answers (known as FAQs), recognizing that providing guidance through regulations is cumbersome and takes a long time.  On April 1, the Department issued a new set of FAQs explaining some aspects of the legislation.  Some of the highlights are discussed below.

Under the new law, related corporations may, and may be compelled to, file combined returns if they are engaged in a unitary business.  The old requirement that separate filing distort the incomes of the companies, which led to much controversy, has been repealed.  An issue that has been highlighted by the legislation is whether a newly acquired subsidiary can be considered to be instantly unitary with the parent so that the corporations can file combined returns beginning on the date of the acquisition.  The FAQs explain that this will depend on the “facts and circumstances” of each case, which is not very informative.  We understand from informal conversations with senior Department personnel that their approach, which they have not published, is that corporations will generally be considered to be instantly unitary if they had a significant business relationship before the acquisition (e.g., the subsidiary was a supplier of goods to the parent).  If no such pre-existing relationship exists, the corporations will generally not be found to be unitary until the beginning of the next taxable year after the acquisition.  The FAQs also clarify that corporations with different taxable years can be included in a combined return.  When a related corporation does not have the same taxable year as the company designated as the group’s agent for filing purposes, the related corporation’s income and activities for its taxable year ending within the agent’s taxable year are included in the combined report for the agent’s taxable year.

The FAQs explain that the corporate tax reform legislation has not changed the method for determining the partnership income of a corporate partner in a partnership.  The current approach, under which partnership items of income and expense flow through to the corporate partner, has been retained.  This approach is reflected in Department regulations.  The New York City Department of Finance has not adopted regulations on this subject and we understand that the City does not feel itself bound by the State approach.  Taxpayers should be aware that corporations that are limited partners with limited liability and no voting rights may be able to argue successfully that they do not have nexus with New York if they have no other contacts with New York besides their limited partnership interest.  Courts in other states have so held, although the case law in New York is not favorable.

Several FAQs focus on the new economic nexus rule in New York State.  The FAQs indicate that franchisors that sell goods and services or licenses to franchisees located in New York State are taxable under the economic nexus rules.  Economic nexus is found if a company has $1 million or more in receipts from New York State.  If a corporation is a partner in a partnership, the corporation is deemed for nexus calculation purposes only to have received all of the partnership’s New York receipts (not just its share), and these are added to the corporate partner’s other receipts in applying the $1 million test.  Interestingly, the recent legislation that conforms the New York City general corporation tax to the State tax reform provisions does not include the economic nexus provisions.  Senior Department of Finance officials have explained to me that the reason for this is “politics.”

In lieu of allocating interest expenses to investment income and other exempt income, the law allows a taxpayer to elect to have 40 percent of its interest allocated to such income.  The FAQs explain that the Department does not have the power to override this election and require actual attribution.  The Department must follow the taxpayer’s election.

The law provides that a unitary relationship will be presumed for determining exempt investment income (although not for combination) if a corporation owns 20 percent or more of another corporation.  The FAQs clarify that this presumption is rebuttable, although they indicate that if the Department chooses to rebut the presumption, it will have the burden of proving that the less-than-20 percent- owned subsidiary is unitary with the taxpayer.

The Department expects to issue more FAQs in the coming months and we will provide further explanations as they are released.

The New York Legislature has passed bills related to the 2015–2016 budget (S2009-B/A3009-B and S4610-A/A6721-A, collectively referred to herein as the Budget Bill) containing several significant “technical corrections” to the New York State corporate income tax reform enacted in 2014, along with sales tax provisions and amendments to reform New York City’s General Corporation Tax.

This post is the seventh in a series analyzing the New York Budget Bill, and summarizes the sales tax provisions in the Budget Bill.

Dodd-Frank Act Relief Provisions

The Budget Bill includes provisions that provide relief from potential sales and use tax implications arising from compliance with certain requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as Dodd-Frank).  Under Dodd-Frank, large financial services organizations must develop and implement resolution plans allowing for an orderly wind-down of their banking and broker/dealer operations in the event of an adverse financial event, such as another financial crisis.  The affected financial services organizations and their regulators have agreed in principle to plans where front-office and back-office assets and operations would be segregated into separate legal entities.  As a result, many affected financial services organizations are implementing plans whereby back-office functions are being placed into separate bankruptcy remote legal entities as a way to ensure that an orderly wind-down of the affected entities could occur, with the back-office functions remaining available to all potentially affected entities.

Without the relief provided by the Budget Bill, the Dodd-Frank-mandated reorganizations could have resulted in increased New York sales tax compliance burdens and increased New York sales tax liabilities, both upon the reorganization itself and on an ongoing basis.  Many transactions that formerly occurred between different units within the same legal entity (and hence were not subject to sales tax) will have to occur between different legal entities after the restructurings and thus will be taxable.  To prevent this increase in sales tax burdens and liabilities, an exemption was inserted into the Budget Bill that will apply to sales of property or services that are entered into or conducted as a result of the resolution planning required by Dodd-Frank, so that the affected companies are not subject to sales or use tax on transactions that occur solely as a result of their compliance with a federal law that has been put in place to make the global financial systems safer.

The exemption provided by the Budget Bill is tied to the status of the buyer and the seller as a “covered company” or “material company” as defined in section 243.2(l) of the Code of Federal Regulations, which is one of the sections implementing the Dodd-Frank Act.  Under the exemption, sales of tangible personal property or services among related parties are exempt from the New York sales and use tax if the vendor and the purchaser are referenced as either a “covered company” or a “material entity” in a resolution plan (or the vendor and the purchaser are separate legal entities pursuant to a divestiture authorized by the Dodd-Frank Act), and the sale would not have occurred between such related entities were it not for the resolution plan or divestiture.  (For purposes of this provision, parties are considered to be related if they bear a relationship described in Internal Revenue Code Section 267.)  Furthermore, the exemption is only available to the extent that the related-party vendor did not claim a resale exemption upon its original purchase of the property.  This exemption provision will apply only to sales made, services rendered or uses occurring on or before June 30, 2019 (or pursuant to sales made, services rendered or uses occurring pursuant to a binding contract entered into on or before June 30, 2019).  However, in no event will this exemption apply after June 30, 2024.

New Sales and Use Tax Provisions for Boats and Aircraft

The Budget Bill also provides sales and use tax benefits for the purchase and use in New York of expensive boats and general aviation aircraft.  These changes were enacted in an effort to make New York’s aviation and boating sales and use tax policies more competitive with the policies of neighboring jurisdictions.

Under the new rules, boats, including yachts, will be subject to sales and use tax in New York on only the first $230,000 of the sales price.  In addition, use tax will not be owed on the use of a boat within New York State unless (1) the boat is registered, or is required to be registered, under New York’s vehicle and traffic laws, or (2) the boat is used in New York State for more than 90 days.

With respect to aircraft, the Budget Bill provides an exemption from the sales and use tax for “general aviation aircraft,” plus machinery or equipment installed on such aircraft.  Changes also have been made with respect to small non-commercial aircraft.  Previously, leases of certain small non-commercial aircraft were subject to acceleration of sales or use tax on the lease payments, whereby all sales or use tax was required to be paid on all lease payments up-front at the time of inception of the lease.  Under the Budget Bill provisions, however, sales or use tax on lease payments for such aircraft would no longer need to be accelerated.

Furthermore, the provision for tax-free transfers of tangible personal property due to a merger, contribution or distribution between related parties formerly did not apply to aircraft.  (Instead, the purchaser of the aircraft in such a related-party transaction was entitled to a refund or credit against the sales or use tax due in the amount of sales or use tax paid by the seller upon its purchase or use of the aircraft.)  The Budget Bill broadens the application of this exemption so that the transfer of certain aircraft pursuant to a merger, contribution or distribution between related parties will now qualify as a tax-free transfer.

Additional Sales and Use Tax Provisions

The Budget Bill included various other sales and use tax provisions, including the following:

  • In recognition that breweries, distilleries, cideries and wineries are a growing part of New York’s economy, and to encourage more tastings throughout the state, the Budget Bill (1) expands the current sales and use tax exemption for wine furnished for consumption at a wine tasting to also apply to the bottles, corks, caps and labels used to package the wine, and (2) adopts a similar exemption for other alcoholic beverages furnished to customers for consumption at no charge at a tasting held by a licensed brewery, farm brewery, cider producer, distillery or farm distillery in accordance with New York’s Alcoholic Beverage Control Law.
  • The Budget Bill contains incentives for solar power purchase agreements by providing an exemption from the sales and compensating use tax for receipts from the sale of electricity by a person primarily engaged in the sale of solar energy system equipment and, in certain circumstances, electricity generated by a residential or commercial solar energy system.
  • The definition of taxable prepaid telephone calling services has been amended to include certain prepaid mobile calling services. In addition, the sourcing rules for prepaid telephone calling services have been amended to provide that in certain circumstances (e., when the sale does not take place at the vendor’s place of business, there is no item shipped in connection with the sale, or the vendor doesn’t have the address associated with the customer’s mobile telephone number) the vendor of the prepaid telephone calling service can source a sale to an address that reasonably reflects the customer’s location at the time of the sale or recharge, as approved by the Commissioner.

For a more detailed description of these provisions, see our previous post, Inside the New York Budget Bill: Proposed Sales Tax Amendments.

Sales and Use Tax Provisions Not Included 

A large part of the story concerning the sales tax provisions in the Budget Bill concerns the provisions that did not make it into the version that was passed by the legislature.  The governor’s initial draft of the Budget Bill contained provisions that were designed to address what were referred to as “tax avoidance” structures.  One of those provisions would have required the acceleration of sales tax on lease payments for all related-party leases of tangible personal property, and another would have limited the exemption for certain transfers between related parties as part of a contribution, distribution or merger.  (Technically, the exemption was removed, and a corresponding credit was provided that was meant to put taxpayers in the same position as if the original exemption existed, but in theory there were many gaps in coverage under the corresponding credit, and many taxpayers may have been harmed by such provision in a manner never intended by the legislature.)  In addition, the Budget Bill did not include the provisions that would have significantly affected e-commerce companies by imposing a sales and use tax collection responsibility on marketplace providers.  For more information on these eliminated provisions, see our prior posts Inside the New York Budget Bill: Proposed Sales Tax Amendments and The New “Click-Through”?: New York Budget Proposal Requires Marketplace Providers to Collect Tax.

The New York Legislature has passed bills related to the 2015–2016 budget (S2009-B/A3009-B and S4610-A/A6721-A, collectively referred to herein as the Budget Bill) containing several significant “technical corrections” to the New York State corporate income tax reform enacted in 2014, along with sales tax provisions and amendments to reform New York City’s General Corporation Tax.  The Budget Bill’s technical corrections to last year’s corporate income tax reform include changes to the economic nexus, tax base and income classification, tax rate (including clarifications to rules applicable to certain taxpayers, such as qualified New York manufacturers), apportionment, combined reporting, net operating loss and tax credit provisions.  The technical corrections are effective on the same date as last year’s corporate income tax reform, which was generally effective for tax years beginning on or after January 1, 2015.

This post is the sixth in a series analyzing the New York Budget Bill, and discusses changes to the net operating loss (NOL) and investment tax credit provisions.

Net Operating Losses – Prior NOL Conversion Subtraction

For tax years beginning on or after January 1, 2015, the calculation of the New York NOL deduction has changed dramatically.  As a result, the Tax Law provides for a transition calculation, a prior NOL Conversion Subtraction, for purposes of computing the allowable deduction for NOLs incurred under the prior law.

To calculate the Conversion Subtraction, the taxpayer first must determine the amount of NOL carryforwards it would have had available for carryover on the last day of the “base year”—December 31, 2014, for calendar year filers, or the last day of the taxpayer’s last taxable year before it is subject to the new law—using the former (i.e., 2014) Tax Law, including all limitations applicable under the former law.  This amount is referred to as the “unabsorbed NOL.”  Second, the taxpayer must determine its apportionment percentage (i.e., its BAP) for that base year (base year BAP), again using the former (i.e., 2014) Tax Law; this is the BAP reported on the taxpayer’s tax report for the base year.  Third, the taxpayer must multiply the amount of its unabsorbed NOL by its base year BAP, then multiply that amount by the tax rate that would have applied to the taxpayer in the base year (base year tax rate).  The resulting amount is divided by 6.5 percent (qualified New York manufacturers use 5.7 percent).  The result of these computations is the prior NOL Conversion Subtraction pool.

A taxpayer’s Conversion Subtraction will equal a portion of its Conversion Subtraction pool computed as outlined above.  The standard rule provides that one-tenth of the Conversion Subtraction pool, plus, in subsequent years, any amount of unused Conversion Subtraction from prior years, may be deducted as the Conversion Subtraction.  The Tax Law as originally drafted also provided that any unused Conversion Subtraction could be carried forward until tax years beginning on or after January 1, 2036 (tax year 2035 for calendar year filers).  The technical corrections include slight changes to that carryforward provision.  Now, any unused Conversion Subtraction may be carried forward for no longer than 20 years or until the taxable year beginning on or after January 1, 2035, but before January 1, 2036, whichever comes first.  This language corrected an error in the original law that allowed for the carryforward beyond a 20-year period.

The Tax Law as originally drafted also provided taxpayers with an alternative one-time election to deduct up to one-half of the Conversion Subtraction pool over a two-year period beginning with the tax year beginning on or after January 1, 2015.  However, if a taxpayer makes this election, that taxpayer cannot carry forward any unused Conversion Subtraction beyond that two-year period.  The technical corrections clarify that this election is (1) revocable and (2) must be made on a taxpayer’s first return (not an amended return) for the tax year beginning on or after January 1, 2015, and before January 1, 2016 (with regard to extensions).  The technical corrections also clearly provide (as previously assumed) that any unused portion of the Conversion Subtraction pool will be forfeited at the end of the two-year period.  Since the election is revocable, taxpayers should consider making the election if there is any chance that the taxpayer may be able to use the Conversion Subtraction pool within the first two years.

Net Operating Losses – Current Year

Under current law, a taxpayer can deduct an NOL Deduction from its apportioned business income base.  The NOL Deduction for a particular tax year is the amount of NOL from one or more taxable years that is carried forward or back to that tax year.  An NOL is the amount of “business loss” incurred in a tax year multiplied by the taxpayer’s apportionment percentage for that year (i.e., NOLs are computed and carried forward on a post-apportionment basis).  The maximum amount of NOL Deduction allowed in a taxable year is the amount that reduces the taxpayer’s tax on apportioned business income to the higher of the tax on capital or the fixed dollar minimum tax.

The technical corrections provide new ordering rules for purposes of applying NOL Deductions.  Taxpayers are now required to first carry an NOL back to the three taxable years preceding the loss year (with the exception that no loss can be carried back to taxable years beginning before January 1, 2015).  The NOL must first be carried back to the earliest of the three taxable years.  If the NOL is not entirely used in that year, it must be carried to the second taxable year preceding the loss year, and any then-remaining NOL must be carried to the year immediately preceding the loss year.  After application of the carryback rules, any unused NOL may be carried forward (until entirely used) for up to 20 taxable years following the loss year.  NOLs carried forward must also be carried in order, first to the taxable year immediately following the loss year, and so on.

Taxpayers can irrevocably elect to waive the entire carryback period.  Such an election must be made on an original (not amended) timely filed return (determined with regard to extensions) for the year of the NOL for which the election is to be in effect.  A separate election is required for each loss year, and an election made by a combined group will apply to all group members.

Investment Tax Credit

As with 2014 corporate tax reform in New York, earlier budget bill proposals involving credits, including changes to the investment tax credit calculation for masters of films, television shows or commercials, were not adopted.

With respect to the financial services investment tax credit, the technical corrections provide that the investment tax credit may not be taken for property first placed in service on or after October 1, 2015, thus effectively ending the investment tax credit for financial services companies as of that date.  For property placed in service before that date, language from prior law was restored that permits the aggregation of use by certain affiliates to meet the statutory qualifying use requirement.

Amendments were also made to provide that certain credits may be applied to reduce tax to the fixed dollar minimum rather than to the greater of the tax on capital or the fixed dollar minimum (e.g., the investment tax credit).