Affirming a decision by the New York City Tax Appeals Tribunal, the Appellate Division, First Department, held that a taxpayer was not entitled to a 17% deduction for interest income it received from its third- and fourth-tier subsidiaries under the City bank tax. Bankers Trust Corp. v. Tax Appeals Tribunal, No. 7057-36, 2012 NY Slip Op. 01761 (1st Dep’t, Mar. 13, 2012).
Bankers Trust Corporation and several affiliated corporations filed combined City Bank Tax returns for the years 1986, 1987, and 1993 (the “years in issue”). They reported interest income that Bankers Trust Company (“BT”) had received from affiliated corporations not included in those returns, including non–U.S., lower-tier companies (called the “Indirect Subsidiaries” in the Tribunal decision), owned through several “Intermediate Subsidiaries.” The corporate structure was made necessary by the laws and regulations of the various jurisdictions in which these corporations did business, as well as by the Edge Act, 12 U.S.C. ch. 6, subch. II, and served to insulate and protect BT’s assets.
Deductions were claimed for 17% of the interest income paid by all subsidiaries as interest income from subsidiary capital. On audit, the Department of Finance allowed the 17% deduction to the extent the interest was paid by first-tier subsidiaries, but disallowed a deduction for the rest.
The City Tribunal Decision. Administrative Code § 11-641(e)(11)(i) allows a deduction under the City bank tax for 17% of interest income from subsidiary capital. “Subsidiary capital” is defined as “investments in the stock of subsidiaries and any indebtedness from subsidiaries. . . .” A “subsidiary,” in turn, is “a corporation or association of which over fifty percent of the number of shares of stock entitling the holders thereof to vote for the election of directors or trustees is owned by the taxpayer.”
These provisions were enacted by the State Legislature in 1985 as part of a major overhaul of the taxation of banks. The City Tribunal found that, while the relevant definition of “subsidiary” refers to voting stock “owned by the taxpayer,” elsewhere in the same legislation the State Legislature used different language in establishing stock ownership requirements for other purposes. For example, the definition of a banking corporation includes “any corporation sixty-five percent or more of whose voting stock is owned or controlled, directly or indirectly,” by certain other types of banking entities, Code § 11-640(a)(9), Tax Law § 1452(a)(9); and the statute requires the filing of combined returns if a banking corporation “owns or controls, directly or indirectly” the stock of another corporation. Code § 11-646(f)(2); Tax Law § 1462(f)(2).
The Tribunal noted that where different language was used, the Court of Appeals has held that “‘courts may reasonably infer that different concepts are intended,’” and therefore that the State Legislature intended the word “owned” in the definition of subsidiary for purposes of the 17% deduction to mean something different from “owned or controlled . . . directly or indirectly.” Instead, the City Tribunal determined that the test for “ownership” for purposes of the 17% deduction was “actual beneficial ownership,” as set forth in the City’s regulation, 19 RCNY § 11-46(b).
BT argued that it had demonstrated actual beneficial ownership, primarily relying on Matter of The Racal Corp. and Decca Elec. Inc., DTA No. 807361 (N.Y.S. Tax App. Trib., May 13, 1993); and Matter of Bankers Trust NY Corp., DTA No. 811316 (N.Y.S. Tax App. Trib. March 14, 1996) (“Bankers Trust I”). In Racal, the New York State Tax Appeals Tribunal addressed 20 NYCRR §3-6.2, relating to the definition of a subsidiary under the State corporation franchise tax, and applied it to stipulated facts, including the fact that intermediate corporations in the chain were inactive shell corporations, and that the party claiming the deduction “had absolute control over” the election and removal of the subsidiaries’ operations and their officers and directors. The City Tribunal held that the decision in Racal merely stood for the proposition that, where a corporation controls all aspects of a remote subsidiary’s operations and management, beneficial ownership is established, and that those facts were stipulated in Racal. It also held that Bankers Trust I confirmed that, in order to establish beneficial ownership, an indirect shareholder “must prove a degree of control over that subsidiary beyond…power to control the voting of the shares, board membership and personnel of the lower-tier subsidiary through a chain of ownership.”
The City Tribunal found that BT had failed to submit sufficient proof that it so controlled the Indirect Subsidiaries to come within the rule of Racal or Bankers Trust I. While BT introduced evidence concerning four specific transactions, the Tribunal found that each transaction was initiated by local personnel, the manner of the transactions was often dictated by local regulatory requirements, and that there was not sufficient testimony based on actual personal knowledge to demonstrate complete beneficial control of those transactions or the Indirect Subsidiaries in general. Therefore, the City Tribunal found that BT did not prove that it “possessed or exercised sufficient control over the Indirect Subsidiaries to be considered the actual beneficial owner of those entities.”
The First Department Decision. The Appellate Division, in a brief opinion, affirmed the City Tribunal’s decision, which it found was based on “a rational interpretation” of the statutes. It also held that the two State cases cited by BT did not require a different result, since in Racal the parties had stipulated that the direct parent of the indirect subsidiary was a “‘paper’ entity that performed no business,” so there was no real issue that beneficial ownership existed, and in Bankers Trust I¸ the taxpayer had failed to introduce enough evidence to allow the criteria to be applied. The appellate court found that BT’s control of the Remote Subsidiaries was through the Intermediate Corporations, which were fully functioning entities, and therefore the Tribunal’s decision that BT was not the beneficial owner was rational.
Additional Insights. At the time of the decision in 1993, Racal was seen as potentially having a significant effect on the treatment of second-tier and more remote subsidiaries. In fact, there seem to be few decided cases in which relief was actually granted. In addition to the fact that both the State and City regulations were quickly amended, so that they now both provide that “[a]ctual beneficial ownership of stock does not mean indirect ownership or control of a corporation through a corporate structure consisting of several tiers and/or chains of corporations,” 20 NYCRR §§ 3-6.2(b), 16-2.22; 19 RCNY § 11-46(b), the burden of proving actual beneficial ownership of remote subsidiaries can be substantial. In Racal itself, that issue was stipulated, but on the facts of the instant case, the City Tribunal found that the taxpayer had not met its burden of showing complete control, and the appellate court let the decision stand.
