On April 13, 2015, Governor Andrew Cuomo signed New York’s 2015-2016 budget legislation, which, among other changes, conforms the New York City general corporation tax (GCT) to the most significant changes from last year’s New York State corporation franchise tax reform. The reforms include:
- elimination of a separate tax regime for banking corporations;
- adoption of unitary combined reporting with an election for all commonly owned entities to file on a combined basis;
- exemption of investment income;
- adoption of market-based sourcing;
- modification of net operating loss rules; and
- incentives for qualifying manufacturers.
The City’s tax reform changes are effective for tax years beginning on or after January 1, 2015.
The City’s tax reform largely retains the nexus provisions from the prior GCT regime. The GCT applies only to corporations that: (1) exercise the privilege of doing business in the City; (2) employ capital in the City; (3) own or lease property in the City; or (4) maintain an office in the City. A corporation that is a partner in a partnership having nexus with the City has nexus with the City and is subject to the GCT.
The State adopted an economic presence nexus approach with a $1 million threshold, but the City’s tax reform did not include an economic presence nexus provision for general corporations. Banking corporations engaged in certain activities were subject to economic presence nexus under the old law. The tax reform seems to limit the activities that would subject them to nexus starting in 2015, but we understand there is a push to amend the tax reform through a technical correction to return to the prior economic presence nexus regime for certain banking corporations.
Unitary Combined Reporting
The City’s tax reform includes new unitary combined reporting rules that mirror the State’s combined reporting regime. Taxpayers must now file combined reports with entities that: (1) they own or control directly or indirectly (50% ownership threshold); and (2) are engaged in a unitary business. In so doing, the City no longer requires taxpayers or the City Department of Finance to prove the existence of “substantial intercorporate transactions” or “distortion.”
Like the State, the City’s tax reform also provides an election to permit taxpayers to include all eligible members of its commonly owned group in a single return, regardless of whether such members have a unitary relationship. City taxpayers must make this election on an original, timely filed combined group return. The election is irrevocable for seven years and, after the expiration of such term, automatically renews for another seven years unless revoked by the group. However, if the combined group revokes the election, the group cannot make a new election for three years following the revocation.
Sutherland Observation: The City does not require taxpayers to make the combined filing election if the taxpayer has made the election at the State level (and vice versa). Therefore, a taxpayer could have different group compositions at the State and City levels if the taxpayer makes the combined filing election for one and not the other.
Furthermore, the City’s unitary combined reporting regime now permits banking corporations to be included in a combined group. The City’s tax reform further expands the scope of corporations includible in a combined group by now including: (1) combinable captive insurance companies; (2) alien corporations, to the extent of their effectively connected income; (3) captive real estate investment trusts (REITs) and regulated investment companies (RICs); and (4) certain vendors of utility services that are also subject to the City’s utility tax regime. Changes to the Tax Bases
Prior to the City’s tax reform, taxpayers computed tax on four bases (entire net income base, capital base, alternative tax base, and minimum tax) and then paid tax on the highest base plus a tax on subsidiary capital. Like the State, the City has eliminated the tax on subsidiary capital and has renamed the “entire net income” base the “business income” base. Unlike the State, however, the City did not phase out the capital base.
A. Business Income Base
The City’s tax conforms to the State’s definition of “business income,” which is entire net income less investment income and other exempt income. Also like the State, the City narrows the definition of investment capital, from which taxpayers derive investment income. The City now defines investment capital as stock in a non-unitary, non-combined entity that:
- meets the definition of a capital asset under Internal Revenue Code (IRC) § 1221;
- is held by the taxpayer for more than one year;
- the disposition of which is or would be treated as long-term capital gain under the IRC;
- for stock acquired on or after January 1, 2015, has never been held for sale to customers in the regular course of business; and
- is identified in the taxpayer’s records as being held for investment in the same manner as required under IRC § 1236(a)(1) either before the close of the day on which the taxpayer acquired the stock or prior to October 1, 2015, if the taxpayer acquired the stock prior to such date.
The City adopts the State’s presumption that an entity is not unitary if the taxpayer owns less than 20% of the voting power of the corporation. The City further adopted a controversial provision that limits total investment income to 8% of a taxpayer’s entire net income, which is identical to the State change enacted by this year’s budget legislation. The City’s tax reform also provides that a “debt obligation or other security” that is constitutionally prohibited from being apportioned to New York is included in investment capital.
Sutherland Observation: The City’s definition of investment capital makes it more difficult for taxpayers’ investments in stock to qualify as investment capital. The City’s tax reform, like the State, creates onerous recordkeeping requirements for taxpayers by requiring taxpayers to identify in their books and records, on the day they acquire the stock, whether they are holding the stock for investment purposes. Proving that a taxpayer held the stock solely for investment purposes could prove difficult for corporations that become New York taxpayers after October 1, 2015, as they may not already have been identifying the stock as being held for investment purposes in their books and records.
For Sutherland’s prior coverage of the troubling issues with the new investment income and investment capital requirements, see New York Budget Incorporates More Significant Tax Changes.
The City’s tax reform defines “other exempt income” as exempt unitary corporation dividends and exempt controlled foreign corporation (CFC) income. Exempt unitary corporation dividends are dividends (less attributable expenses) from a corporation conducting a unitary business with the taxpayer and the corporation is not included in the taxpayer’s unitary combined return. Exempt CFC income means income (less attributable expenses) required to be included in federal taxable income pursuant to IRC § 951(a) from a unitary entity that is not included in the unitary combined report.
Finally, the City’s tax reform requires taxpayers to continue to attribute interest expenses to investment income and other exempt income and permits taxpayers to make a revocable election to reduce such income by 40% (which has the effect of increasing business income by the same amount).
B. Capital Base
While the State’s tax reform limits the tax on the capital base to $5 million and phases out use of the tax to eliminate it for tax years beginning on or after January 1, 2021, the City establishes a $10 million cap and does not phase out the base. Furthermore, the City’s tax reform modifies the capital base to benefit small businesses, excluding from the capital base the first $10,000 of tax due.
The City’s tax reform generally adopts market-based sourcing for receipts included in a taxpayer’s business allocation percentage. Unlike the State, however, which uses a single sales factor business allocation percentage, the City requires an unequally weighted three-factor business allocation percentage, which reflects the controlled phase-out of the property and payroll factors. Most City taxpayers will begin using a single sales factor business allocation percentage for tax years beginning on or after January 1, 2018. Taxpayers or combined groups with $50 million or less in receipts allocated to New York City may make a one-time, revocable election to retain the 2017 factor ratios for tax years beginning on or after January 1, 2018. Such election remains in effect until revoked by the taxpayer or combined group.
Sutherland Observation: Taxpayers that qualify for the election to retain 2017 factor ratios and have little property and payroll in the City should consider making the election and taking such election into account in computing their financial statement items associated with City taxes.
Similar to the State’s tax reform, the City’s new GCT provides ten categories of sourcing receipts: (1) tangible personal property; (2) rents and royalties; (3) digital products; (4) financial transactions, including receipts from broker-dealer activities; (5) advertising services; (6) gas transportation or transmission services; (7) railroad and trucking services; (8) aviation services; (9) other services and other business receipts; and (10) receipts from the operation of vessels.
A. Digital Products Receipts
The City’s tax reform incorporates a new four-step hierarchy for sourcing receipts from digital products. Taxpayers must source digital products to the location of the customer’s “primary use” of the digital product (the law contains no guidance as to identifying this location). If the taxpayer cannot determine the customer’s place of primary use, then the taxpayer must source the receipts to the location where the customer receives the product. If the taxpayer cannot identify the location where its customer receives the product, it must apply the prior year’s apportionment factor for digital products. Finally, if the taxpayer cannot determine the prior year’s apportionment factor, then the taxpayer must use the current year’s apportionment factor for any digital products that the taxpayer was able to source using the first or second method.
B. Financial Transaction Receipts
The City’s sourcing provisions for financial services receipts mirrors the State’s. The new GCT regime provides sourcing provisions for nine categories of financial instruments, consisting of: (1) loans; (2) federal, state and municipal debt; (3) asset-backed securities and other government agency debt; (4) corporate bonds; (5) reverse repurchase and securities borrowing agreements; (6) federal funds; (7) dividends and net gains from stock or partnership interests; (8) physical commodities; and (9) other financial instruments.
The City generally sources receipts to the location of the customer. With respect to certain categories of receipts—such as reverse repurchase agreements, securities borrowing agreements, and federal funds—the City requires taxpayers to source 8% of such receipts to the City.
Sutherland Observation: When the State adopted the 8% sourcing method for receipts from certain financial instruments, the rationale was that 8% represented New York State’s portion of the U.S. gross domestic product. The City borrowed the State’s 8% proxy, even though the City is only a subset of the State’s contribution to the gross domestic product
The City further adopted an annual, irrevocable election to source 8% of receipts from qualified financial instruments (QFIs) to the City, similar to the State’s QFI election. The City defines a QFI the same as the State to include receipts, if marked to market under IRC §§ 475 or 1256, from: (1) interest and net gains from loans that are not secured by real property; (2) net gains from United States or state-issued debt; (3) net gains from asset-backed securities or government agency issued securities; (4) interest and net gains from corporate bonds; (5) receipts from stock that is not investment capital; (6) interest and gains from “other financial instruments”; and (7) gain from the sale of physical commodities. Furthermore, if a taxpayer has marked to market a financial instrument that falls within one of the above categories, then any financial instrument that has not been marked to market but falls within the same category is considered a QFI. Finally, the City provides sourcing provisions for: (1) receipts from broker-dealer activities; (2) receipts from credit card activities; and (3) receipts from services to investment companies. Receipts from broker-dealer activities or credit card activities (except merchant discount receipts and credit card authorization processing, clearing, and settlement receipts) generally will be sourced to the location of the customer, which is the mailing address for individual customers or the commercial domicile for business customers. Receipts from services to investment companies will be sourced by multiplying such receipts by the average ratio of the number of shares held by shareholders in the City at the end of each month divided by the total shares.
C. Other Services and Other Business Receipts
The City’s tax reform also adopts a hierarchy method for sourcing receipts from “other service and other business receipts” as the catch-all for receipts that cannot be sourced using any of the other enumerated apportionment provisions. Using this hierarchy, a taxpayer must first look to where the benefit of the other service or business receipt is received (the law contains no guidance as to identifying this location). If the taxpayer cannot determine where the benefit is received, the taxpayer sources the receipts to the location of delivery. If the taxpayer cannot determine such information, the taxpayer sources the receipts using the apportionment factor for those receipts from the prior year. Finally, if the taxpayer cannot determine the prior year’s apportionment factor, then the taxpayer must use the current year’s apportionment factor for any other service and other business receipts that the taxpayer was able to source using the first or second method.
Net Operating Losses
The City’s tax reform decouples City net operating losses (NOLs) from the federal NOL and requires taxpayers to compute NOLs on a post-apportionment basis. Because of the decoupling and computation on a post-apportionment basis, two types of NOL deductions are now allowed: a “prior net operating loss (PNOL) conversion subtraction” for NOLs remaining on December 31, 2014 (for calendar year taxpayers) and a net operating loss deduction (NOLD) for NOLs generated on or after January 1, 2015. A taxpayer may use its PNOL or NOLD only to the extent that the PNOL or NOLD reduces the taxpayer’s tax on allocated business income to the higher of the tax on business capital or the fixed dollar minimum tax. The taxpayer therefore does not have to use the PNOL or NOLD to reduce the tax on business income to zero.
A. Prior Net Operating Loss Conversion Subtraction
NOLs created prior to the effective date of the tax reform are characterized as a PNOL, which taxpayers may deduct over a 10-year period on a pro-rata basis (10% per year). If a taxpayer cannot use the entire 10% of the PNOL permitted in a tax year, it may carry forward the excess PNOL to subsequent tax years through and including 2035. Taxpayers must deduct the PNOL to offset taxable income of the group before they may utilize the NOLDs generated during tax years beginning on or after January 1, 2015. A taxpayer can make a revocable election to accelerate the use of its PNOL during the 2015 and 2016 tax years (not to exceed 50% per year), with any unused portion being forfeited.
Taxpayers calculate the PNOL using the “unabsorbed net operating loss” from the last tax period (Base Year) prior to the effective date of the tax reform. The unabsorbed NOL is the unused NOL that was not deductible in prior years and was eligible for carryforward on the last day of the Base Year. A taxpayer must multiply the unabsorbed NOL by its Base Year effective tax rate (business allocation percentage times tax rate). The product is then divided by 8.85% (or 9% for financial corporations) to arrive at the PNOL pool that can be used in the post-unitary combined reporting periods.
B. Net Operating Loss Deduction
For net operating losses generated during tax years beginning on or after January 1, 2015, the City’s tax reform permits a NOLD, which is the business loss generated during the year multiplied by the taxpayer’s business allocation percentage for such year. Taxpayers may carry forward a NOLD for 20 years and carry back a NOLD, including those created by members included in the unitary combined report, for three years. Taxpayers may not carry back a NOLD to years beginning before January 1, 2015. Taxpayers may make an irrevocable election to waive the NOLD carryback for a taxable year on a timely filed original return for the taxable year of the NOL. An election must be made every time a new NOL is generated, and such an election applies to all members of a combined group.
A. General Corporations
The GCT rate applicable to corporations, other than financial corporations and certain qualified New York manufacturing corporations, is 8.85%. The City has retained its 0.15% tax rate for the tax on the capital base.
B. Higher Rate for Large Financial Corporations
The GCT rate applicable to large financial corporations is 9%. For corporations filing on a separate basis, this rate applies if the corporation: (1) has total assets on its balance sheet at the end of a taxable year exceeding $1 billion; and (2) apportions more than 50% of its receipts to the City. For corporations filing on a combined basis, this rate applies if 50% or more of the group’s assets at the end of the year are held by one or more corporations that are classified as: (i) registered under state law as a bank holding company or registered as a savings and loan company under federal law; (ii) a national bank organized and existing as a national bank association under federal law; (iii) a savings association or federal savings bank under federal law; (iv) a bank, savings association, or thrift institution incorporated or organized under the laws of any state; (v) a corporation organized for purposes of engaging in international or foreign banking; (vi) an agency or branch of a foreign depository; (vii) a registered securities or commodities broker or dealer; or (viii) any corporation whose voting stock is more than 50% owned by any person or entity described in (i) through (vii).
C. Lower Rates for Some Qualified New York Manufacturing Corporations
The City’s tax reform provides preferential treatment for some “qualified New York manufacturing corporations.” The City’s definition of a “manufacturing corporation” is more restrictive than the state’s definition. A manufacturing corporation is a corporation principally engaged in the manufacturing and sale of tangible personal property and includes processes: (1) of working raw materials into wares suitable for use; or (2) that give new shapes, qualities, or new combinations to matter that has already gone through some artificial process. A taxpayer, or a combined group, is principally engaged in such activities during the taxable year if it derives over 50% of its receipts from the sale of goods produced by such activities. A manufacturing corporation is a “qualified New York manufacturing corporation” if, at the end of the year, its basis in certain property in the State for federal income tax purposes is at least $1 million, or over 50% of its real and personal property is located in the State (not just the City).
The City does not conform to the State’s zero business income tax rate for qualified manufacturers. Instead, the City imposes GCT on business income from qualified New York manufacturing corporations using four categories of tax rates, as follows:
- Taxpayers with $40 million or more in business income before apportionment, regardless of the amount of their apportioned business income, compute tax at a rate of 8.85%.
- Taxpayers with less than $40 million but at least $20 million of business income before apportionment, regardless of the amount of their apportioned business income, compute tax at a rate of: 4.425% plus a graduated portion of the remaining 4.425%, which is tied to their business income before apportionment.
- Taxpayers with less than $20 million but at least $10 million of apportionedbusiness income compute tax at a rate of: 4.425% plus a graduated portion of the remaining 4.425%, which is tied to their apportioned business income.
- Taxpayers with less than $10 million in apportioned business income compute tax at a rate of 4.425%.
Sutherland Observation: The City’s tax reform defines the upper two income levels with regard to business income before apportionment and the lower two income levels with regard to apportioned business income. This seeks to ensure that only small and mid-sized New York manufacturing corporations receive the benefit of the reduced rates that apply to the lower two income levels. As such, large corporations cannot receive the benefit of the reduced rates.
Adjustment Authority Related to a Report of New York State Changes Historically, City taxpayers have had to report both federal and State-level changes to taxable income to the City Department of Finance. The City’s tax reform includes a noteworthy procedural amendment related to reporting changes to New York State taxable income for tax years beginning on or after January 1, 2015.
Previously, the City’s GCT regime provided that if a taxpayer reported changes to federal or State taxable income, neither the City nor the taxpayer could make changes to the taxpayer’s business allocation percentage during the extended statute of limitations period resulting from the report of such changes. The City’s tax reform amends this provision for tax years beginning on or after January 1, 2015, providing that taxpayers and the City may adjust a taxpayer’s business allocation percentage during the extended statute of limitations period. This permissible adjustment authority applies when a taxpayer reports an adjustment based on: (1) an increase or decrease in State taxable income or other basis of State tax; (2) a change, correction, or renegotiation of tax; or (3) the execution of a notice of waiver report for State purposes. However, neither the City nor taxpayers may make such an adjustment where the taxpayer is claiming a refund resulting from the State change. These procedural amendments apply to corporations subject to the new GCT regime as well as corporations that remain subject to the prior GCT regime.