New York Governor Andrew Cuomo introduced his 2015-2016 budget and accompanying legislation on January 19, 2015 (the 2015 Budget Bill). If enacted, New York’s tax law will be significantly altered for the second time in two years. The sales tax provisions of the legislation will tax most intercompany transactions and will also accelerate the payment of sales tax on leases. The corporate income tax provisions make many tweaks to the substantial tax reform changes enacted last year. Several of the provisions impact the taxation of telecommunications service providers subject to tax under Article 9. The proposed legislation also contains substantial changes to New York City’s General Corporation Tax that largely conform to the State’s tax reform initiative.
Sales Tax Changes Impacting Intercompany Transactions
The proposed legislation would alter several sales and use tax provisions with the stated purpose of closing “loopholes,” but the changes would also impose new taxes on many legitimate and common intercompany transactions, such as internal reorganizations and consolidated purchasing. The intercompany sales tax changes, contained in Part Y, would become effective immediately if the legislation is enacted.
Section 1 of Part Y adds §1118-A to the N.Y. Tax Law and includes three distinct changes to the sales tax law.
- §1118-A(a) eliminates the current use tax exclusion for uses of property or services purchased by a nonresident business while outside of New York then subsequently brought into New York. The new provision allows for a use tax exclusion only if the taxpayer was doing business for at least six months outside of New York before bringing the property into New York. This provision does not apply to individuals. In other words, newly formed nonresident businesses are not eligible for the use tax exclusion, but older nonresident businesses are.
- §1118-A(b) eliminates the separate status of a single member LLC and its member for all sales tax purposes. The single member LLC would be disregarded and considered part of its sole member for sales tax purposes, regardless of whether the LLC is disregarded for income tax purposes. Presumably, the impact of this provision would be to disregard any intercompany transactions (such as a distribution of property or an intercompany sale or lease) for sales tax purposes. New York, like most states, currently treats single member LLCs and their members as separate, consistent with the form-driven nature of sales taxes. While the provision is intended to eliminate sales tax minimization structures, it may also impede centralized purchasing and other structures that are designed to ensure that that ultimate user in a corporate group bears the burden of sales taxes.
- §1118-A(c) changes the general rule for leases of tangible personal property between related entities where the lease term is for more than one year. New York’s current general rule is that sales and use tax is imposed when each lease payment is made, except in the case of certain property like motor vehicles. However, the proposed law treats the total amount due under any intercorporate lease as immediately fully taxable when the lease begins, regardless of the duration of the lease. The full amount of the lease includes any option to renew. If the Commissioner believes the lease is improperly valued, the Commissioner can also make estimates that reflect the true value and assess tax based on the estimate.
Perhaps the most far-reaching and troubling part of the Governor’s budget is a provision that taxes most intercompany transfers of tangible personal property between related parties, even if the property is transferred solely for stock or a partnership interest. Currently, New York law—like nearly every other state—excludes from its definition of a retail sale a transfer or contribution of property to either a corporation or a partnership solely in exchange for shares of stock or a partnership interest. The exclusion also covers corporate and partnership distributions of tangible personal property, such as those compliant with IRC sections 351 and 721. This exclusion is routinely relied upon for most intercompany reorganizations because New York’s occasional sale exemption is severely limited. In 2010, New York enacted legislation that made this exclusion inapplicable to transfers of aircraft and vessels between affiliated persons. This year’s budget limits availability of the exclusion to transfers of any type of tangible personal property between affiliated persons.
Sutherland Observation: The legislation would prohibit tax-free transfers of any tangible personal property between affiliated corporations or partnerships in exchange for stock in the corporation or for an interest in the partnership, or for the corporation or partnership to distribute the property back to a stockholder or partner upon liquidation. The only exception would be where property is transferred to a corporation in exchange for stock under a merger or consolidation plan. If enacted, New York’s sales and use tax imposition on corporate reorganization may present a significant tax cost on an otherwise tax-free transaction.
New Tax Collection Duty on Marketplaces
The legislation also contains a new sales tax nexus provision, which reflects New York’s continued aggressiveness toward electronic commerce. In 2008, New York was the first state to directly target electronic commerce through the creation of a “click-through” nexus provision. This controversial nexus provision was subsequently enacted by numerous states and challenged in court. The legislation proposes an even more controversial and legally suspect nexus provision, which this time targets marketplaces. Part X of the legislation would establish a new unique sales tax collection obligation on “every marketplace provider with respect to sales, occupancies, or admissions facilitated by it” in connection with a marketplace seller. No other state has such a provision. If enacted, this provision would require certain Internet platforms— referred to as a “marketplace provider”—to collect New York sales tax on sales made by remote Internet sellers that sell on the platform, irrespective of whether the seller has nexus in New York.
A “marketplace provider” is defined as a person who contracts with a marketplace seller to facilitate a “sale, occupancy, or admission” by the marketplace seller. Facilitation occurs when:
- such person, or an affiliated person, collects the receipts, rent, or amusement charge paid by a customer . . . to a marketplace seller; and
- such person performs either of the following activities:
- provides the forum in which, or by means of which, the sale takes place or the offer of occupancy or admission is accepted . . .; or
- arranges for the exchange of information or messages between the customer . . . and the marketplace seller.
A “marketplace seller” means any person who (i) contracts with a marketplace provider, whereby the marketplace provider agrees to facilitate sales, occupancies or admissions; and (ii) either (A) sells taxable tangible personal property or the services; (B) operates a restaurant, tavern or other establishment, or acts as a caterer; (C) is a hotel operator; or (D) collects, receives or is under a duty to collect an amusement charge.
Sutherland Observation: The marketplace provider provision aggressively shifts the sales tax collection burden from the seller to the marketplace. The marketplace provider is then subject to New York sales tax as if it were the vendor for the sale. A marketplace provider is only relieved of liability for failure to collect the correct amount of sales tax owed to the extent that it can show that the error was due to incorrect information provided by an unaffiliated marketplace seller. The marketplace provider nexus provision furthers New York’s reputation as the most aggressive, and possibly hostile, state regarding the taxation of electronic commerce.
Telecommunications Tax Provisions
Part P of the legislation would extend the imposition of Article 9— “184 tax”—to wireless telecommunications services providers. Section 184 currently imposes tax on the intrastate sales of a local telephone company. Part P expands the scope of Section 184 to a “mobile telecommunications business”. The legislation likewise expands N.Y. Tax Law § 184-a, which imposes a Metropolitan Transportation Surcharge on local telephone companies, to mobile telecommunications businesses.
Part Q creates a new tax section, N.Y. Tax Law § 195, which limits refund and credit claims for telecommunications providers taxable under Article 9. For refund claims filed after January 1, 2015, the legislation would require telecommunications providers to refund passed-through taxes to customers prior to claiming a refund from the State.
Section V amends the definition of a “prepaid telephone calling service” under N.Y. Tax Law § 1101(b)(22) to include a “prepaid mobile calling service.” and expands upon permissible sourcing methods.
Technical Corrections to the 2014 Corporate Franchise Tax Reform
Last year’s budget legislation—which was enacted—included an overhaul of New York’s Corporate Franchise Tax. (See Sutherland’s prior coverage of the Tax Reform.) Part T of this year’s budget legislation includes what are referred to as “technical corrections” changing some elements of last year’s legislation. Some of the noteworthy changes follow:
- Clarification of economic nexus for a combined group
Last year’s legislation included an economic nexus standard for general corporations. The economic nexus standard requires the filing of a Franchise Tax Return if a taxpayer has at least $1 million in receipts sourced to New York based on the market-based apportionment provisions included in § 210-A. A combinable group will trigger the threshold if enough individual group members with $10,000 in receipts sourced to New York aggregate to $1 million (so, for example, 100 companies with $10,000 each or four companies with $250,000 each).
The Technical Corrections clarify that for purposes of aggregating a group’s receipts, only receipts from corporations engaged in a unitary business are considered; receipts from corporations that would not be included in the mandatory unitary combined return (such as non-unitary corporations that could be included in an elective common ownership combined report) would not be included towards the $1 million threshold.
- Further restriction of the definition of “investment capital”
Last year’s legislation exempted “investment income” (i.e., income from “investment capital”) from Franchise Tax but significantly reduced the list of assets that could qualify as investment capital. The restricted list is limited to investments in stock of non-unitary, non-combined entities but only if the stock is held for at least six consecutive months.
The Technical Corrections add the additional limitation that such stock can never have been used by the taxpayer in the regular course of its business. Thus, stock that otherwise could qualify but that was, for example, used as collateral in a lending transaction 20 years ago would not be considered by the Department of Taxation and Finance to qualify as investment capital.
Sutherland Observation: The Technical Corrections do not indicate how a taxpayer can prove the negative (i.e., that the stock was never used in the regular course of business) or who will bear the burden to prove such use or non-use.
The Technical Corrections also clarify application of the six-month holding period presumption for stock acquired during the last six months of the taxpayer’s tax year. The presumption allows a taxpayer to assume it will meet the six-month holding period for stock purchased during the last six months of the taxable year and held on the last day of the taxable year. The Technical Corrections clarify that the presumption is only available if the taxpayer still owns the particular stock at the time it files its return reflecting the presumption. While unstated in the Technical Corrections, a taxpayer that has disposed of stock prior to filing its Franchise Tax Return will know whether it actually held the stock for at least six months.
The Technical Corrections also remove from the definition of investment income the exclusion for losses, deductions or expenses from hedges related to stock qualifying as investment capital.
- Apportionment clarifications
Last year’s legislation adopted market-based sourcing for apportionment purposes and provided several hierarchies for determining how the new rules should be applied.
- Sourcing of marked-to-market financial instruments
The Technical Corrections expand the definition of a “qualified financial instrument” from those instruments that are marked to market under Internal Revenue Code sections 475 or 1256 (but not loans secured by real property), to those instruments that are eligible to be marked to market under such provisions, regardless of whether actually marked to market. The Technical Corrections also provide a series of definitions related to these instruments and default sourcing rules for marked to market financial instruments (i.e., qualified financial instruments for which the fixed percentage election is not made).
- Determination of commercial domicile
Some receipts from financial instruments are assigned based on the customer’s commercial domicile. Last year’s legislation provided a hierarchy for determining the location of customers’ commercial domiciles that looked first to the location of their treasury functions, second to their seats of management, and lastly to billing addresses. The Technical Corrections remove the location of a customer’s treasury function from consideration altogether.
- Sourcing for special industries
The Technical Corrections add a sourcing rule for operators of vessels. Receipts are included in the numerator of the apportionment fraction based on the aggregate number of days a vessel owned or leased by the taxpayer is operating in New York waters, and the denominator is the total number of working days of all vessels owned or leased by the taxpayer during the tax year.
The Technical Corrections also clarify that aviation receipts include receipts from a qualified air freight carrier and provide a definition of such a carrier.
- An election to waive carrying back new Net Operating Losses
Last year’s legislation changed the way that net operating losses are computed, used and carried forward by decoupling from federal computations. NOLs are now computed, used and carried forward and back on a post-apportionment basis instead of on a pre-apportionment basis. As a result, last year’s legislation provided for two types of NOL-related deductions: a current year NOL deduction and a “prior year NOL conversion subtraction” (the PY NOL subtraction). The PY NOL subtraction is a deduction for NOL carryforwards that remain on the last day of the taxpayer’s last taxable year before the new NOL provisions takes effect (December 31, 2014, for calendar-year taxpayers).
Last year’s legislation created the ability to carry back newly generated NOL for three years, though not to any years before the new law was in effect. The Technical Corrections would add an election to forego carrying back the NOL altogether and instead apply it prospectively. The election would be irrevocable and must be made on a timely-filed original return. Every time a new NOL is generated, a separate election to forgo carrying it back would be needed.
- Clarification of eligibility for the Qualified Manufacturer incentives
- Clarification of types of qualifying property
Last year’s legislation dramatically increased the benefits available to Qualified Manufacturers, reducing such entities’ tax liabilities to no more than $350,000, plus any applicable MTA surcharge.
There are two ways to meet the definition of a Qualified Manufacturer: (1) the “Principally Engaged In” test that looks at receipts and property; and (2) the “Alternative” test that looks at employment and property. Satisfying either test is sufficient to qualify.
The receipts component of the Principally Engaged In test requires that more than 50% of the gross receipts of the taxpayer in a given year are derived from the sale of goods produced by “manufacturing, processing, assembling, refining, mining, extracting, farming agriculture, horticulture, floriculture, viticulture, or commercial fishing.”1 The property portion of the Principally Engaged In test has two separate requirements, both of which must be satisfied. First, the corporation must have property eligible for the investment tax credit. Second, the corporation must also meet one of the following two requirements: either (a) have adjusted bases for federal income tax purposes in Qualifying Property of at least $1 million, measured on the last day of the tax year, or (b) have all its real and personal property located in New York.
A corporation that does not satisfy the Principally Engaged In test may still qualify for the manufacturer incentive if it satisfies an alternative test that looks at the corporation’s employment and property. This test is satisfied if the corporation (or combined group of corporations) employs at least 2,500 employees in manufacturing in New York and the corporation (or combined group of corporations) has manufacturing property in New York with an adjusted basis for federal tax purposes of at least $100 million. For purposes of the Principally Engaged In test, “property” included the entire list of property eligible for the investment tax credit, which is rather broad, including property principally used in manufacturing, as well as property used for research and development, waste treatment facilities, and certain property owned by commodities brokers.
The Technical Corrections restrict the qualifying property to property described in only a particular subsection of the Investment Tax Credit (ITC) provisions. The term describes property “principally used by the taxpayer in the production of goods by manufacturing, processing, assembling, refining, mining, extracting, farming, agriculture, horticulture, floriculture, viticulture or commercial fishing.” “Manufacturing” is defined elsewhere in the ITC provisions as “the process of working raw materials into wares suitable for use or which gives new shapes, new quality or new combinations to matter which already has gone through some artificial process by the use of machinery, tools, appliances and other similar equipment.” “Property used in the production of goods” is defined elsewhere in the ITC provisions as including “machinery, equipment or other tangible property which is principally used in the repair and service of other machinery, equipment or other tangible property used principally in the production of goods and shall include all facilities used in the production operation, including storage of material to be used in production and of the products that are produced.”
Thus, property used for research and development would not be included, nor would several other types of property discussed elsewhere in the ITC provisions. Incidentally, this definition of qualifying property is the same definition of qualifying property that had been included in the pre-2014 definition of a Qualified New York Manufacturer.
Sutherland Observation: While the Alternative Test references property used in manufacturing, neither the 2014/2015 law changes nor these Technical Corrections define such property by reference to the ITC provisions, arguably allowing for a broader definition of the term.
- Clarification of qualifications for combined group members
Last year’s legislation clearly allowed for a separately reporting corporation to meet the Qualified Manufacturer requirements and for a group to meet them on a combined basis. The legislation seems to have left open the possibility that a single entity within a combined group could qualify on its own and enjoy the related benefits while the rest of the group would not qualify. The Technical Corrections appear to attempt to correct this by clarifying that where a combined report is filed, the group must meet the requirements together.
- Other income tax changes
- The legislation proposes to reform the Investment Tax Credit provided for master tapes by limiting eligibility to costs associated with master tapes that were produced only in New York. The legislation also targets entertainment companies by limiting their eligibility for the excelsior jobs program.
- The legislation provides sunsets for the financial institution tax credit as of October 1, 2015.
New York City’s General Corporation Tax Reform
Historically, New York City’s General Corporation Tax (GCT) has largely mirrored New York State’s Franchise Tax, albeit often with some delay on the enactment of changes. The current legislation includes the City’s GCT conformity provisions.
The City tax reform proposal has adopted most of the State’s significant 2014 tax reform, including merging the separate regimes for financial institutions and for general corporations, adopting an election to file on a combined basis, exempting investment income from tax, adopting market-based sourcing, changing the computation and use of net operating losses, and providing expanded benefits to qualifying manufacturers. However, there are many notable areas where the City has declined to conform. Some of the noteworthy items follow:
- Unlike New York State, which provides for the pass-through treatment of S corporation income, New York City has historically imposed tax directly on S corporations. However, the currently proposed provisions would not apply to S corporations. The City will be reviewing its overall treatment of pass-through entities (including S corporations) in 2015 and expects to propose legislation for pass-through entity tax reform in the future.
- Unlike the New York State, which established a $5 million cap for tax computed on the capital base and will phase out the tax on the capital base for tax years beginning on or after January 1, 2021, New York City would establish a $10 million cap, would not phase out the tax on the capital base, and would retain the alternative base on capital.
- New York City’s new economic nexus standard would apply to a corporation or combinable group of corporations have at least $1 million in receipts assigned to New York City. The State’s economic nexus standard looks to receipts assigned anywhere in the state.
- While New York City would adopt market-based sourcing for apportionment, it would retain the property and payroll factors for the remainder of the phase-out of these factors adopted years ago. The City will fully phase in single sales factor apportionment for tax years beginning on or after January 1, 2018.
- Like the State, the City provisions would provide benefits to qualifying manufacturers. However, instead of the State’s 0% business income tax rate, the City would impose tax on business income at the rate of 6.5% for large manufacturers and 4.425% for small manufacturers. In addition, the City proposed its own qualification requirements, which are more restrictive than the State’s.
- The City also proposed benefits for small businesses, including an exclusion from the capital base for the first $10,000 of tax due on the capital base.
- If enacted, the GCT provisions will be effective for tax years beginning on or after January 1, 2015.
Legislative review of the proposed budget will move at a quick pace with the first hearing on taxes scheduled on February 9. New York’s budget process uses an executive budget model. Under this system, the Governor is responsible for preparing a balanced budget proposal that the Legislature modifies and enacts into law. The Governor coordinates requests from agencies and submits a budget to the Legislature along with the appropriation bills and other legislation required. The Legislature, primarily through its Senate Finance and Assembly Ways and Means committees, analyzes the Governor’s budget, holds public hearings, and seeks further information from agency staffs. Following that review, both houses of the Legislature reach agreement on spending and revenue recommendations which may amend the Governor’s proposed appropriation bills and related legislation. Unchanged appropriation bills become law without further action by the Governor. The Governor must approve or disapprove all or parts of the appropriation bills covering the Legislature and the Judiciary and may use the line item veto to disapprove items added by the Legislature while approving the remainder of the bill. The Legislature may override the Governor’s veto by a vote of two-thirds of the members of each house. The state’s fiscal year begins April 1, so the timeline for the Legislature to review the budget is compressed.