Major Corporate Franchise Tax Overhaul Takes Effect in New York State
By Jeremy Katz, J.D., LL.M., MBA, Tax & Business Services
The New York State Department of Taxation and Finance recently issued new regulations and proposed rules for corporate tax laws enacted in New York from 2014 to 2016, known as “Tax Reform.” These changes to Tax Reform update the regulations to conform with the new law under Tax Law Article 9-A franchise tax on general business corporations. The new regulations provide guidance to taxpayers regarding the computation of tax, unitary combined reporting, market-based sourcing, and several others.
The changes to the regulations are so numerous that the previous New York Codes, Rules & Regulations (NYCRR) Subchapter A. Business Corporation Franchise Tax Parts 1-9 are replaced with these new regulations. Several key provisions of the new regulation are summarized below.
Part 1 – Imposition of Tax
Part 1 includes definitions of key terms for the subchapter and guidance on nexus to be used in assessing when corporations are subject to tax.
- Foreign Corporate Partners nexus – foreign corporate partners nexus provisions remain unchanged from the prior provisions, including the thresholds determining the corporate partner’s engagement in the partnership’s business activities. This threshold defines a foreign corporation’s engagement as 1% or more interest as a limited partner in the partnership or the basis of its interest in the limited partnership is more than $1 million. The new regulations extend this threshold to apply to limited liability companies (LLC), treated as partnerships, that have limited management and participation authority akin to the limitations of a limited corporate partner.
- Deriving receipts for nexus purposes – the regulations carved out limited exceptions from including certain receipts in New York activity for determining if a foreign corporation has economic nexus in New York. Receipts from the following are not derived from New York activity:
- Interest income and net gains from government agency-issued securities.
- Interest income from Federal funds.
- Interest paid directly to the corporation by a federal reserve bank on reserves maintained with the federal reserve.
- Protection under Public Law 86-272 – the Department aligns the regulations with the Multistate Tax Commission’s (MTC) most recent guidance on the protections of Public Law 86-272. Notably, the Department provides direction on the use of internet activities, stating that “interacting with customers or potential customers through the corporation’s website or computer application” would be beyond mere solicitation and exceed the protections of Public Law 86-272. However, “a corporation will not be made taxable solely by presenting static text or images on its website.” The Department also includes the example of static FAQ pages on a corporation’s website that would amount to de minimis activity and be protected under Public Law 86-272.
Part 3 – Computation of Tax
Part 3 provides guidance on the computation of tax on the business income base, capital base, and fixed dollar minimum tax. These are some highlights of the changes made:
- Investment Capital – the Department rejected comments proposing changing the current requirements to identify investment capital at the partnership level in the corporation’s records. The Department stated that the corporate partner’s activity is treated as the activity of the partnership, and “the partnership, as owner of the record of the stock, is the appropriate entity to make the required identification.” Thus, the investment capital identification requirement remains.
- Constitutionally Protected Investment Capital – the regulations provide examples of constitutionally protected investment capital to qualify the income or gain from an intangible asset as tax exempt. On the other hand, the regulations state, “the income or gain from an intangible asset (i.e., a debt obligation or other security) is apportionable where the underlying activities of the recipient of the intangible income and the source of the income constitute a unitary business; or where the intangible asset or the income from the intangible asset serves an operational function in the taxpayer’s business.”
- Prior Net Operating Loss Conversion (PNOLC) Subtraction and Federal Changes – Prior net operating loss conversion subtractions cannot be changed after the expiration of the statute of limitations of the report on which the corporation first claimed the PNOLC subtraction. Any federal changes (i.e., audit adjustments) finalized after the statute of limitations will not be considered in the computation of the unabsorbed net operating loss (UNOL) or the base year business allocation percentage (BAP).
Part 4 – Apportionment
Part 4 provides guidance on computing the business apportionment factor (BAF) and specific direction on the apportionment of different categories included in the BAF.
- Sourcing Tangible Personal Property (TPP) to Final Destination – The regulations state that TPP is sold in New York if the final destination is in New York. The Department included the following examples to sufficiently demonstrate a final destination: 1) a bill of lading or another shipping document, regardless of the F.O.B point, and 2) a purchase invoice designating the final destination location.
- Sourcing Digital Products or Digital Services – Receipts from the sale of digital products or digital services are in New York if the “location where the customer derives value” is in New York. The Department provided a hierarchy of methods to determine where the value is derived: 1) customer’s primary use location; 2) location where received; 3) preceding taxable year method; 4) current taxable year method, which is the same apportionment method the corporation uses to apportion other digital products or services using a combination of the primary use location method and the location where received method. Notably, the final regulation removes references to cryptocurrency as a digital product (previously referenced as such in a prior draft of the proposed regulation). Accordingly, it is uncertain whether the Department will treat cryptocurrency and other digital assets, such as NFTs, as digital products or intangible property.
- Benefit Is Received Due Diligence – After referring to the special rules and the hierarchy analysis, the taxpayer is required to make “reasonable inquiries to a business customer.” However, if the corporation has more than 250 customers “purchasing substantially similar services or activities… and no more than 5% of receipts are from a particular customer, then the benefit… is presumed to be received at the customer’s billing address.”
- Sourcing Gain from Intangible Property – the regulations define intangible property to include, but not limited to, goodwill, copyrights, patents, trademarks, trade names, brand names, licenses, and trade secrets. The net gain from the sale of intangible property is “presumed to be received at the location where the value of the intangible was accumulated.” With respect to goodwill specifically, the value is presumed to accumulate in New York based on a three-year average business apportionment factor.
- Receipts from Unusual Events – the final regulation abandons the Department’s pre-reform regulation and policy of excluding capital assets (property not held by the taxpayer for sale to customers in the regular course of business) from the business apportionment factor. One exception is outlined in the statute (Tax Law 210-A) – the disposition of stock or partnership interest is excluded from the numerator and denominator of the business apportionment factor. Where the standard rule does not fairly reflect income to the state, a taxpayer may petition for (or the Department may require) alternative apportionment. The final regulation provides an example where net gains from the disposition of a partnership interest accounted for 75% of a taxpayer’s business receipts. The Department indicates that under this scenario, it is appropriate to include the net gain in the business apportionment factor to reflect the taxpayer’s business income properly.
Part 6 – Reports
- Combined Reporting – The regulations provide guidance requiring combined reporting when the capital stock and unitary business requirements are met. The Department offered numerous examples of these requirements, particularly when examining the unitary business requirement.
Effective Date and Retroactivity
The Department has stated that the amendments and regulations will “generally apply to tax years beginning on or after January 1, 2015. These regulations interpret the statutory amendments of the Tax Reform, and therefore will apply to the same periods.”
While this can be harmful to some taxpayers, it can also benefit other taxpayers by providing potential refund claim opportunities. Taxpayers with significant stock or asset dispositions in recent years should evaluate the potential impact of the final regulation. Significant refund opportunities may be available under certain facts. Additionally, corporations with significant net operating losses or tax credit carryforwards should evaluate whether the final regulation may impact these attributes.
Finally, while the final regulation specifically impacts New York State, taxpayers should note that New York City is drafting its own regulations. During the interim, where New York City substantially mirrors New York State law, corporate taxpayers should consider relying on the state’s regulation for city purposes.
If you have any questions about what these changes may mean for you or your business, please reach out to Marcum’s State and Local Tax Team.