The New York City Tax Appeals Tribunal, affirming a determination of the Chief Administrative Law Judge, has held that Astoria Bank, which engaged in a banking business in New York City, was not required to include in its combined New York City bank tax returns its Connecticut investment subsidiary that principally held non-New York mortgage loans. Matter of Astoria Financial Corporation & Affiliates, TAT (E) 10-35 (BT) et al. (N.Y.C. Tax App. Trib., May 19, 2016).
Under the former New York City bank tax law, a nontaxpayer subsidiary of a taxpayer bank or bank holding company cannot be included in a combined bank tax return unless it is necessary “to properly reflect the [bank tax] liability . . . because of intercompany transactions or some agreement, understanding, arrangement or transaction . . . .” Admin. Code § 11-646(f)(2)(i). In Astoria Financial, the mortgage investment subsidiary that the Department of Finance sought to combine was not itself subject to bank tax. The subsidiary conducted its activities from its office in Connecticut and qualified as a Connecticut “passive investment company” under the Connecticut tax law.
The City Tribunal concluded that the subsidiary had a sufficient business purpose apart from the acknowledged tax benefits and had economic substance. The Tribunal also concluded that the subsidiary’s transactions with the bank and/or a bank affiliate—which included regular purchases of newly originated mortgage loans and the payment of fees in exchange for loan servicing consistent with industry standards—were conducted at arm’s length.
The City Tribunal also rejected the Department’s claim that the bank’s income was “improperly or inaccurately reflected” (i.e., that actual distortion existed) so as to permit combination on that basis. The Department took the position that the City Tribunal was bound to follow as precedent the State Tax Appeals Tribunal decision in Matter of Interaudi Bank, DTA No. 821659 (N.Y.S. Tax App. Trib., Apr. 14, 2011), where the State Tribunal found distortion resulting from a “mismatch of income and related expense” between a bank and its Delaware investment subsidiary justifying combination with the subsidiary under the former State bank tax.
The City Tribunal concluded, however, that Matter of Interaudi Bank was inapplicable because the facts were materially distinguishable. Notably, in that case, the subsidiary acquired investment assets from its parent bank as a capital contribution shortly before the tax years at issue, and at a time when the bank was significantly undercapitalized, demonstrating a “clear shift” of income to the subsidiary and that the contributed assets were purchased with the proceeds of deposits on which the parent claimed interest deductions. In contrast, in Astoria Financial, the subsidiary’s mortgage loans were initially contributed by a nontaxpayer and the contribution of mortgage loans to a predecessor entity, made nearly a decade earlier, did not support a conclusion that there was a “mismatch of income and expenses.” The Tribunal found the testimony of the City’s expert witness, who had previously testified for New York State in the Interaudi Bank case, “unpersuasive on the issue of distortion.”
The Department of Finance cannot appeal decisions of the New York City Tax Appeals Tribunal.