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Currency Conversion Concerns: New York Issues Guidance on Virtual Currencies

by McDermott Will & Emery | Dec 23, 2014 | Income Tax, Nationwide Importance, New York, Sales Tax, Tax Base, Unclaimed Property

On December 5, 2014, the New York Department of Taxation and Finance (Department) released TSB-M-14(5)C, (7)I, (17)S. This (relatively short) bulletin sets forth the treatment of convertible virtual currency for sales, corporation and personal income tax purposes. The bulletin follows on a notice released by the Internal Revenue Service (IRS) in March of this year, Notice 2014-21.

The IRS Notice indicates that, for federal tax purposes, the IRS will treat virtual currency as property, and will not treat it as currency for purposes of foreign currency gains or losses. Taxpayers must convert virtual currency into U.S. dollars when determining whether there has been a gain or loss on transactions involving the currency. When receiving virtual currency as payment, either for goods and services or as compensation, the virtual currency is converted into U.S. dollars (based on the fair market value of the virtual currency at the time of receipt) to determine the value of the payment.

The IRS Notice only relates to “convertible virtual currency.” Virtual currency is defined as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Convertible virtual currency is virtual currency that “has an equivalent value in real currency, or that acts as a substitute for real currency.”

The Department’s bulletin also addresses only convertible virtual currency, and uses a definition identical to the IRS definition. The Department indicates that it will follow the federal treatment of virtual currency for purposes of the corporation tax and personal income tax.

For sales and use tax purposes, the bulletin states that convertible virtual currency is intangible property and therefore not subject to tax. Thus, the transfer of virtual currency itself is not subject to tax. However, the exchange of virtual currency for products and services will be treated as a barter transaction, and the amount of tax due is calculated based on the fair market value of the virtual currency at the time of the exchange.

The Department should be applauded for issuing guidance on virtual currency. It appears that these types of currencies will be used more and more in the future, and may present difficult tax issues.

However, the Department’s guidance is incomplete. There are a couple of unanswered questions that taxpayers will still need to ponder.

First, the definition of convertible virtual currency is somewhat broad and unclear. The Department and the IRS define “convertible” virtual currency as currency that has an “equivalent” value in real currency, but equivalent is not defined in either the IRS Notice or the bulletin. Many digital products and services use virtual currency or points that cannot be legally exchanged for currency to reward users, and the IRS and the Department should be clearer about the tax treatment of those currencies.

Second, although the Department will follow the federal treatment for characterization and income recognition purposes, the bulletin does not discuss apportionment. This is likely a very small issue at this point in time, but the Department will, [...]

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NYS Tax Department Reverses Position on Statutory Residence Rule

by McDermott Will & Emery | Dec 19, 2014 | Income Tax, New York

The New York State Department of Taxation and Finance (the Department) has backed off from an aggressive position that it has been taking in cases involving New York residence issues.

Under New York law, a person who is not domiciled in the state can be treated as a resident for income tax purposes (and, hence, taxed on all of his or her worldwide income) for a taxable year if the person maintains a “permanent place of abode” in the state and is in the state for more than 183 days during the year. This is known as the statutory residence rule. New York City has an identical rule for purposes of taxing individuals as city residents.

The Department has historically taken the position that a house or apartment is a “permanent place of abode” if it is capable of being lived in as a regular residence even though the taxpayer does not so use it. This has presented a significant problem for people who live in the Connecticut and New Jersey suburbs of New York City and work in the city and keep a small apartment that they use occasionally when they work late or attend the theater. The Department has been treating them as residents because the apartment was a “permanent place of abode” even if they used it for only a few nights a year and their presence in the city for more than 183 days was a result of their jobs and had no relationship to the apartment. Similarly, out-of-state residents who commute to New York jobs and keep a vacation home in New York State have been held to be income tax residents even though they only use the vacation home for a few weeks each year.

The Court of Appeals, New York’s highest court, held recently that a person must actually use a dwelling as a residence for it to constitute a “permanent place of abode”. Matter of Gaied v. New York State Tax Appeals Tribunal, 22 N.Y.3d 592 (2014) (see prior coverage here). The taxpayer in that case lived in New Jersey but owned a house in New York City in which his parents lived. He spent a few nights a year in the house when his parents asked him to come over to help with medical problems. When he did so, he slept on a couch in the living room. He kept no personal effects in the house. The Court held, over the Department’s objections, that the purpose of the statutory residence test was to treat as residents people who really lived in New York but claimed that they were domiciled outside the state for the purpose of avoiding taxes. Mr. Gaied, in contrast, really lived in New Jersey, and the New York house could in no sense be viewed as his real residence.

The Department responded to the Gaied case by revising the internal guidelines that it gives to [...]

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Yes, Distortion is Enough: New York Tax Appeals Tribunal Clarifies Combined Reporting Requirements

by Jane Wells May | Oct 6, 2014 | Income Tax, New York, Tax Base

On September 18, 2014, the New York State Tax Appeals Tribunal released its first decision interpreting New York State’s post-2007 combined reporting laws and, in doing so, answered a question that has been lingering in the minds of taxpayers and the Department’s auditors—whether distortion alone can still justify combined reporting. Reversing a June 2013 determination of a New York Division of Tax Appeals Administrative Law Judge, the Tribunal, in Matter of Knowledge Learning Corp. et al., DTA Nos. 823962; 823963 (N.Y. Tax App. Trib. Sept. 18, 2014), held that distortion, even in the absence of substantial intercorporate transactions, can provide the basis for combined reporting.

Before January 1, 2007, New York required combined reporting for companies that were linked by common ownership and engaged in a unitary business if separate filing would result in distortion of income. Under prior law, distortion was presumed where taxpayers in a purported combined group engaged in substantial intercorporate transactions (SIT). The 2007 amendment to the combined reporting statute converted the presumption arising from the presence of SIT into a rule of law, with taxpayers now required to file combined reports if SIT are present. Unclear after the 2007 law change was whether taxpayers could be permitted or required to file on a combined basis if separate filing would distort the taxpayers’ New York incomes, even if the combined group did not engage in SIT.

The petitioners in Knowledge Learning Corporation filed a combined return for the tax year ending December 29, 2007 and argued (1) that the parent and subsidiaries included on the combined report engaged in SIT and (2) that, regardless of whether the SIT test was met, separate filing would result in distortion. The ALJ declined to address the petitioners’ argument that there was actual distortion even if there were not SIT, stating that “distortion is not the proper analysis in light of the 2007 statutory amendment”—a conclusion with which many practitioners disagreed. (See prior coverage here). The Tribunal reversed, concluding that the amended law “allows combined reports to be filed, even in the absence of substantial intercorporate transactions, when combined filing is necessary to properly reflect income and avoid distortion.” The Tribunal also overruled the ALJ’s conclusion that the petitioners did not engage in SIT and, after conducting a fact-intensive inquiry into the group’s operations, held that the leasing of employees to the subsidiaries by the parent and the parent’s payment of all of the subsidiaries’ expenses met the SIT test such that combination was required.

This decision is noteworthy for a number of reasons: First, because the Tribunal found in favor of the taxpayer, the New York State Department of Taxation cannot appeal and the decision constitutes binding precedent. Furthermore, although the Tribunal did not reach the issue of whether the petitioners had actually proved distortion, a wealth of New York case law discussing what is necessary to prove distortion (such as Matter of Autotote Limited, Matter of Heidelberg Eastern Inc. and Matter of Mohasco Corporation) exists, and [...]

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New York ALJ Rejects Retroactive Application of Statute

by McDermott Will & Emery | Sep 8, 2014 | Constitutional Issues, Income Tax, New York, Procedure

State courts generally have allowed legislatures a fair amount of flexibility in adopting retroactive statutes, but a recent New York case held that, under the circumstances presented, the retroactive application of a statute was unconstitutional. In Matter of Jeffrey and Melissa Luizza (DTA No. 824932) (Aug. 21, 2014), Mr. Luizza agreed to sell all of the stock of an S corporation to an unrelated buyer in a transaction governed by Section 338(h)(10) of the Internal Revenue Code. Under Section 338(h)(10), Mr. Luizza’s sale of his stock was ignored for income tax purposes and the transaction was treated as if the corporation had sold its assets and distributed the proceeds to Mr. Luizza. Under the Subchapter S rules, the liquidation was essentially tax-free. The corporation’s gain was passed through to Mr. Luizza as the sole shareholder. Mr. Luizza was a nonresident of New York and under the law in effect when the sale occurred (March 2008) it appeared that a nonresident shareholder was not taxed on the gain in a 338(h)(10) sale because the transaction was treated as a sale of stock.

In 2009, the State Tax Appeals Tribunal confirmed that although a 338(h)(10) transaction was treated as a sale of assets by the corporation for federal income tax purposes, it was in fact a sale of stock and, since nonresidents are not subject to New York State income tax on gains from the sale of stock, even of a corporation doing business in New York, a nonresident selling stock of an S corporation in a 338(h)(10) transaction cannot be taxed by New York State on the resulting gain. In Matter of Gabriel S. and Frances B. Baum, et al., (DTA Nos. 820837, 820838) (Feb. 12. 2009) (McDermott Will & Emery filed an amicus brief supporting the taxpayer’s position in that case.)

The State Department of Taxation and Finance was not happy about the result of this litigation. It convinced the legislature to reverse that result by amending the statute to provide that a shareholder’s share of the corporation’s gain in a 338(h)(10) transaction would be treated as New York source income that was taxable to nonresidents. The legislation was adopted in 2010 and was made effective retroactively to all years open under the statute of limitations.

Mr. Luizza objected to the retroactive application of the statute to him, and the administrative law judge agreed that, on his facts, the retroactivity was so harsh as to be unconstitutional under the Due Process Clause of the United States Constitution. The ALJ pointed out that the taxpayer relied on the law as it existed in 2008 and that at the time of the sale the prevailing authority was that the transaction was not taxable. Mr. Luizza was advised by his tax advisors that there would be no additional New York tax due. Because of his reliance, he did not have an opportunity to seek a higher sale price or to require the buyer to indemnify him for any additional taxes resulting from [...]

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In Case We Didn’t Know the Difference Between “Big” and “Little” Cigars, the New York State Tax Department Tells Us What it is

by McDermott Will & Emery | Sep 5, 2014 | New York, Sales Tax

The New York State Department of Taxation and Finance has addressed one of the major issues in tax administration: defining the difference between “big” and “little” cigars. Tax Bulletin TP-530 (August 28, 2014). First, the Department has defined “cigar.” A cigar is any roll of tobacco wrapped in leaf tobacco or in any substance containing tobacco. A “little” cigar is a cigar that has all of the following characteristics: (1) it is a “roll” for smoking made with any amount of tobacco, (2) the cigar wrapper contains some amount or form of tobacco that is not “natural leaf tobacco,” and (3) the product must either weigh four pounds or less per 1,000 cigars or have a filter made of cellulose acetate (i.e., a cigarette-type filter) or any other integrated filter. A “natural leaf tobacco wrapper” that can prevent a cigar from being classified as being “little” is any wrapper made from one or more natural tobacco leaves. An example of a substance commonly used to wrap cigars that contains tobacco but is not “natural leaf tobacco” is “homogenized tobacco leaf,” which is made from “tobacco scraps that are pulverized, mixed with other products and rolled into sheets that can be used to wrap cigars.”

The importance of the ruling is that little cigars are taxed at the same rate as cigarettes, which is lower than the rate on big cigars.

This is probably the most important tax development to come along since the Internal Revenue Service released Revenue Ruling 63-194, 1963-2 C.B. 670, explaining the requirements that a martini would have to meet to be considered a “dry martini” for tax purposes.

The McDermott State and Local Tax Practice Group is well positioned to advise clients on these important issues. Although none of us smoke cigars, our Firm’s real estate and corporate departments are well stocked with cigar smokers so we have access to the necessary expertise to advise our clients.

New York State Department of Taxation and Finance Releases Guidance on the Taxability of Computer Software

by McDermott Will & Emery | Aug 12, 2014 | New York, Sales Tax, Transaction Taxes

The New York State Department of Taxation and Finance has just released a Tax Bulletin addressing how the state’s sales tax applies to sales of computer software and related services. The Tax Bulletin does not broach new ground, but it does offer a formal expression of the Department’s position—previously articulated in advisory opinions—that the provision of remote access to prewritten software is subject to sales tax. However, that position does not comport with New York authorities, including a recent administrative law judge determination that is directly on point.

Read the full article.

New York Corporate Tax Reform: Benefits (and Burdens?) for Qualified New York Manufacturers

by Emily Townsend | Aug 7, 2014 | Incentives, Income Tax, New York

Earlier this year, New York enacted sweeping corporate tax reform that included a number of special benefits for qualified New York manufacturers. (For a discussion of this corporate tax reform, see our Special Report.) Unlike most of the corporate tax reform amendments (which are generally effective for tax years beginning on or after January 1, 2015), some of the benefits for qualified New York manufacturers are effective immediately for tax years beginning on or after January 1, 2014.

The new benefits available to qualified New York manufacturers are:

A 0 percent tax rate for purposes of computing tax on the entire net income base (for 2014) or the business income base (for 2015 and later);
New reduced tax rates for purposes of computing tax on the capital base (with the capital base tax to be fully phased out for all taxpayers by 2021)
- Retention of the $350,000 cap on the capital base tax (while the cap was increased to $5 million for other taxpayers);
Lower fixed dollar minimum tax rates; and
A refundable real property tax credit equal to 20 percent of the real property tax paid during the taxable year on property owned (and in some cases leased) by the taxpayer and principally used in manufacturing.

A corporation or a combined group is a “qualified New York manufacturer” if (1) more than 50 percent of the taxpayer’s or combined group’s gross receipts are from qualifying activities (e.g., manufacturing, processing or assembling) and (2) it has property meeting the Investment Tax Credit (ITC) requirements located in New York State with a basis of at least $1 million. A taxpayer, or combined group, that fails the receipts test may still be a qualified New York manufacturer if it has at least 2,500 New York manufacturing employees and at least $100 million of manufacturing property in New York.

Notwithstanding these tax benefits, the Department’s recently released FAQs highlight a potential negative financial statement consequence for taxpayers with significant deferred tax assets, including New York net operating loss carryforwards. In the FAQs, the Department confirms that the value of the prior net operation loss conversion subtraction for a qualified New York manufacturer “is $0 due to the 0 % ENI rate.” In other words, a qualified New York manufacturer cannot carry forward or use its existing net operating loss carryforwards in future years, which may result in negative financial statement consequences.

Qualified New York manufacturers with significant New York credit carryforwards may also suffer a financial statement impact, but the forecast is not as bleak. They may still have the ability to apply most unused credits against the capital base tax (until it is fully phased out).

Stay tuned for additional guidance regarding qualified New York manufacturers. The Department is preparing a technical memorandum regarding qualified New York manufacturers that is expected to be released by the end of this year.

New York Releases Corporate Tax Reform FAQs

by McDermott Will & Emery | Jul 25, 2014 | Incentives, Income Tax, New York, Nexus, Tax Base

Earlier this year, New York enacted sweeping corporate tax reform, generally effective for tax years beginning on or after January 1, 2015, including a new economic nexus standard, changes to New York’s combined reporting regime, changes to the tax base and traditional New York income classifications, changes to the receipts factor computation, and changes to the net operating loss calculation and certain tax credits and incentives. (For a more detailed discussion of these changes, see our Special Report.

While this corporate reform is quite comprehensive, a number of open issues remain so taxpayers and practitioners have been eagerly awaiting additional guidance from the Department of Taxation and Finance. As a first step in providing that much-needed guidance, the Department has released its first set of responses to frequently asked questions on a new “Corporate Tax Reform FAQs” section of its website. Most notably, the responses clarify that the non-unitary presumption based on less than 20 percent stock ownership for purposes of determining exempt investment income is a rebuttable presumption. The responses also clarify that the business capital base includes items of capital that generate exempt income. Other topics addressed include economic nexus, credits, the Metropolitan Transportation Business Tax (MTA surcharge) and net operating losses.

The Department plans to update the Corporate Tax Reform FAQs on an ongoing basis as it continues to receive questions from taxpayers and practitioners, which can be submitted on the Department’s website. We will be submitting questions and comments and can do so on behalf of companies that do not want to be identified. The Department is also in the process of revising its current regulations (which are expected to be released before the end of 2015) and plans to issue two technical memoranda in the interim, one discussing qualified New York manufacturers and one discussing the new expense attribution rules. Stay tuned for updates regarding this additional guidance.

New York’s Revised Nonresident Audit Guidelines: A Tool for Taxpayers?

by McDermott Will & Emery | Jul 21, 2014 | Income Tax, New York, Procedure

The New York State Department of Taxation and Finance recently revised its Nonresident Audit Guidelines, updating the guidelines that had been in place since 2012. Included in the revised guidelines are changes to the Department’s views on both domicile and statutory residency audits. Individuals and practitioners involved in residency audits should be aware that certain of the revisions are taxpayer-friendly and can be employed favorably in audits and litigation.

Read the full article.

Tax Reform in New York: Implications for Corporate America

by Arthur R. Rosen | Jul 17, 2014 | Allocation/Apportionment, Constitutional Issues, Income Tax, New York, Nexus, Tax Base

The corporate tax reform portion of the New York State 2014–15 Budget Bill resulted in major changes for virtually all corporations—even many that are not currently New York taxpayers. In this video (produced by SmartPros), McDermott partners Arthur Rosen, Maria Eberle, Lindsay LaCava and Leah Robinson will discuss the implications of New York State’s sweeping corporate tax reform, including changes to the Article 9-A traditional nexus standards, the combined reporting provisions, the composition of the tax bases and computation of tax, the apportionment provisions and the net operating loss calculation.

For more information on these issues, please click here for our Special Report, “Inside the New York Budget Bill: Corporate Tax Reform Enacted.”

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