On January 15, 2019 Governor Cuomo released his FY 2019-2020 Executive Budget (the “Budget Bill”). The Budget Bill includes a number of proposed changes to the New York Tax Law, including but not limited to: (i) amendments to the corporate franchise tax in response to the federal Tax Cuts and Jobs Act (“TCJA”); (ii) a requirement for marketplace providers to collect sales tax; and (iii) various extensions of current provisions in the Tax Law relating to tax preparer penalties, sales tax vendor compliance, and personal income tax. The Budget Bill also proposes an entirely new tax regime based on the Governor’s proposal to legalize recreational use of cannabis.
Interestingly, on the same day the Budget Bill was released, the New York State Department of Taxation and Finance (the “Department”) issued its first notice in response to the Supreme Court’s seminal decision in South Dakota v. Wayfair.1 Notice No. N-19-1 requires any business that makes more than $300,000 in sales of tangible personal property into the state and more than 100 separate sales into the state in the immediately preceding four sales tax quarters to register as a sales tax vendor and begin collecting and remitting sales tax. The Department based its authority for the notice on section 1101(b)(8)(i)(E) of the Tax Law, which defines a “vendor” as any person soliciting business in New York so long as the activities satisfy the nexus requirements of the U.S. Constitution. The notice is effective immediately.
While the Budget Bill includes many proposed changes to New York’s tax scheme, we highlight the following provisions as the most significant.
(i) GILTI sourcing rule
The TCJA created a new category of income under Internal Revenue Code (“IRC”) § 951A, known as Global Intangible Low-Taxed Income (“GILTI”). Under the TCJA, certain US shareholders of a controlled foreign corporation (“CFC”) are required to include their share of the CFC’s GILTI in their federal taxable income. IRC Section 250(a)(1)(B)(i) generally permits a deduction equal to 50% of the GILTI inclusion. Both the GILTI inclusion and the 50% GILTI deduction are included in the computation of a US shareholder’s New York taxable income, as a result of New York’s conformity to federal taxable income.
As currently drafted, the Article 9-A statutory apportionment formula does not provide any representation for GILTI in the apportionment fraction.2 The Budget Bill includes a proposal to include the net GILTI amount included in the tax base in the denominator of the apportionment fraction in order to properly reflect taxpayers’ business income and capital in the state. The bill expressly excludes GILTI from the numerator of the apportionment fraction. This provision would take effect immediately and apply to taxable years beginning on or after January 1, 2018.
In early January, the Department provided its first official response to the many questions raised by the state tax community due to the lack of factor representation that resulted from including GILTI in the entire net income tax base, but not including it in the apportionment fraction. The Department issued instructions to Forms CT-3 and CT-3-A on which it instructed taxpayers to include their net GILTI inclusion in the denominator of the apportionment fraction. The Department relied on its authority in Tax Law section 210-A to make discretionary adjustments to a taxpayer’s business allocation percentage as support for this position.
Rather than relying on the Department’s discretionary authority, the Budget Bill seeks to codify the Department’s guidance by expressly including a taxpayer’s net GILTI inclusion in the denominator of the apportionment fraction. Although the Legislature and the Department should be commended for addressing the factor representation issue, questions remain as to whether this methodology provides adequate factor representation.
(ii) Basis for purposes of the reduced rate provided to qualified New York manufacturers
Article 9-A of the Taw Law provides a zero tax rate for “qualified New York manufacturers.” To qualify for the reduced rate, the Tax Law generally requires a taxpayer to maintain manufacturing property in New York with an adjusted basis for federal income tax purposes at the close of the taxable year of at least $1 million. However, as a result of the new expensing and bonus depreciation rules that were implemented as part of the TCJA, a taxpayer may have significant manufacturing property in New York, and nonetheless be unable to meet the $1 million threshold included in the Tax Law.
In response to the TCJA, many taxpayers have considered various tax planning techniques that would allow them to take advantage of the accelerated expensing and depreciation provided for in the TCJA, while carving out their New York manufacturing property in order to maintain a federal adjusted basis sufficient to meet New York’s statutory requirements for qualified manufacturers.
The Budget Bill proposes to solve this problem by severing the tie between a taxpayer’s federal adjusted basis in their property and their ability to meet the definition of a qualified New York manufacturer. For tax periods beginning on or after January 1, 2018, the value of manufacturing property in New York will be based on the New York basis of qualifying property, instead of being pegged to the federal adjusted basis. Creating a New York basis, separate and distinct from federal adjusted basis, will allow taxpayers to take advantage of the beneficial expensing and depreciation rules enacted as part of the TCJA, while also ensuring that the New York property of multi-state taxpayers is more accurately quantified for purposes of satisfying the qualified New York manufacturer provisions.
Interestingly, the Budget Bill does not include a definition of New York basis. If this provision is enacted, additional guidance will need to be provided to describe how the New York basis of property is computed.
(iii) Requiring marketplace providers to collect sales tax
For the fourth consecutive year, the Governor has included a proposal Budget requiring marketplace providers that facilitate sales of tangible personal property by third-party vendors to collect sales tax on those sales. Under the proposal included in the Budget Bill, a “person required to collect tax” is defined to include “every marketplace provider with respect to sales of tangible personal property it facilitates.”3 A marketplace provider is defined as “a person who, pursuant to an agreement with a marketplace seller, facilitates sales of tangible personal property by such marketplace seller or sellers.”4 A person “facilitates the sale of tangible personal property” when the person: (i) provides the forum in which, or by means of which, the sale takes place or the offer of sale is accepted, including a shop, store, or booth, an internet website, catalog, or similar forum, and (ii) when the person or affiliate collects the receipt, or contracts with a third-party to collect the receipts, paid by a customer to a marketplace seller.5
The Department has consistently touted its marketplace seller proposals as a means to ease the sales tax compliance burdens on small sellers. In an effort to do so, the Budget Bill also includes language that expressly removes marketplace sellers from the need to register and collect and remit sales and use tax so long as the seller receives a good faith certification from the marketplace provider that the provider is collecting the tax.6 If enacted, this amendment would take effect immediately and apply to sales made on or after September 1, 2019.
Although similar legislation was unsuccessfully proposed in the past, several factors suggests that this proposal may fare differently. First, state legislatures have mobilized support for expanding tax collection obligations in light of the United States Supreme Court’s decision in Wayfair. This includes not only imposing obligations on remote sellers, but also on online marketplaces. Second, political opposition may be minimized given that after the 2018 election, the Executive and Legislative branches of New York’s government are both under the control of the same party. However, while this proposal may be more likely to become law than prior proposals, its legality under federal law and the United States Constitution remains an open question. Both the Internet Tax Freedom Act and the Due Process Clause may prohibit imposing a tax collection obligation on marketplace providers.
(iv) Amending the treatment of carried interest
For the second year in a row, the Governor has included a proposal to treat carried interest as income earned from a trade or business (as opposed to investment income). This proposal is part of the Governor’s attempt to impose New York taxes on nonresident partners and shareholders who operate hedge funds and private equity firms within New York. The Budget Bill also includes a proposal to impose an additional 17 percent tax on carried interest income sourced to New York. This additional tax is meant to negate the favorable treatment provided to carried interest income at the federal level that results from its classification as a capital gain, as opposed to ordinary income.
As with last year’s proposal, even if this provision is enacted, it will only go into effect if Connecticut, New Jersey, Massachusetts, and Pennsylvania all enact similar legislation.
The contingent effective date for this proposal is an effort to prevent New York hedge funds and private equity firms from reacting to the enactment of the proposal by moving their operations to a nearby state in order to obtain more favorable tax treatment. To date, New Jersey is the only state at issue that has passed a similar provision.
(v) The Cannabis Regulation and Taxation Act
The Budget Bill includes a proposal to legalize adult-use recreational cannabis by creating a regulatory structure overseeing the licensing, cultivation, production, distribution, and sale of cannabis. In conjunction with such, the Budget Bill proposes to add a new Article 20-C, “Tax on Adult-Use Cannabis Products”, to the Tax Law. The statute would impose three taxes: (i) a tax of $1 per dry weight gram on the cultivation of cannabis flower and $0.25 per dry weight gram on the cultivation of cannabis trim; (ii) a 20% tax on the invoice price of wholesalers selling cannabis to retailers; and (iii) a 2% tax on the invoice price of wholesalers selling to retailers, levied on behalf of the county in which the retailer is located. The Budget Bill does not include a proposal to tax retail sales of cannabis. Under this proposal, New York would join ten other states which have already legalized cannabis for adult consumption.