As we do each January, we set out below our annual list of the Top 10 New York tax highlights for the past year.
1. Court of Appeals Issues Far-Reaching Sales Tax Decision in Wegmans Food Markets. In what may turn out to be one of the most significant tax decisions by New York’s highest court in recent years, a sharply divided Court of Appeals upheld the assessment of sales tax on information services – competitor pricing information furnished to a supermarket chain – holding that the sales tax exclusion for information services that are “personal or individual in nature” is inapplicable to information obtained from publicly available sources. Wegmans Food Mkts., Inc. v. Tax Appeals Trib., 33 N.Y.3d 587 (2019). Yet, it is the court’s holding on statutory interpretation (by a slender 4-3 majority) that ambiguities in a statutory exclusion provision (like the “personal or individual” information services exclusion) must be interpreted like a tax exemption statute – that is, in favor of the government rather than the taxpayer – that could have the most far-reaching impact.
2. Treatment of GILTI Undergoes Two Different State Legislative Changes. In April 2019, Governor Cuomo signed legislation enacting a New York State and New York City corporate tax sourcing rule for GILTI, requiring that it be included in the denominator, but not in the New York numerator, of a corporation’s apportionment fraction, for taxable years beginning on or after January 1, 2018. Some business groups had urged that the legislation exclude GILTI from the income tax base altogether, and it was generally known that the Governor and State Tax Department had been open to such an approach had New York City agreed to it, but since the City did not, the legislation was enacted as proposed. Then, in June 2019, in the closing hours of the legislative session, the April 2019 legislation was replaced by a new rule for New York State purposes that, for taxable years beginning after 2018, allows an exclusion of 95% of a corporation’s GILTI from the New York State corporate income tax base (leaving in place for 2017 the initially enacted GILTI rule). However, in light of New York City’s continued resistance, the Legislature did not enact the same 95% exclusion for New York City corporate tax purposes. As a result, there is now a stark dichotomy between the State and City corporate taxes on GILTI treatment starting in 2019. It seems reasonable to expect the Legislature to be asked to reconcile this considerable disparity between the State and City laws when it convenes again in early 2020.
3. U.S. Supreme Court Denies Review of Constitutional Challenge to NYS Disallowance of State Tax Credits Claimed by Statutory Residents. Hoping that the legal landscape may have changed in light of the U.S. Supreme Court decision in Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787 (2015), in June 2019, two separate New York State nondomiciliaries who were New York “statutory residents” asked the Supreme Court to review two New York court decisions that upheld the denial of credits for taxes paid to Connecticut, their state of domicile, on their investment income. The taxpayers argued that, under Wynne, where the Court had held that Maryland’s resident income tax credit regime violated internal consistency under the dormant Commerce Clause, it was unconstitutional for New York State to deny a credit for taxes paid to Connecticut on the same investment income also being taxed by New York State. However, in October 2019, the Supreme Court denied certiorari, evidencing the difficulties that taxpayers may face, at least for the foreseeable future, in persuading the Court to accept a legal challenge to New York State’s controversial statutory residency regime. Chamberlain v. N.Y.S. Dep’t of Taxation & Fin., 166 A.D.3d 1112 (3d Dep’t 2018) and Edelman v. N.Y.S. Dep’t of Taxation & Fin.,162 A.D.3d 575 (1st Dep’t 2018), cert. denied, 140 S. Ct. 134 (2019).
4. Federal Judge Dismisses New York State Lawsuit Challenging $10,000 SALT Deduction Cap. In a case that generated considerable press coverage, a federal district court judge dismissed a lawsuit brought by New York State (together with Connecticut, New Jersey, and Maryland) seeking to invalidate on constitutional grounds the $10,000 cap on state and local tax deductions that was enacted as part of the federal TCJA of 2017. New York v. Mnuchin, No. 18-CV-6427 (JPO) (S.D.N.Y. Sept. 30, 2019). The court rejected New York’s two principal arguments, that the Constitution precludes any congressional attempt to meaningfully limit the SALT deduction and that the purpose for the limitation was to unconstitutionally “coerce” the states into changing their tax policies (i.e., imposing high state and local taxes). The lawsuit was widely viewed as more of a political act than a bona fide constitutional challenge, and the dismissal of the lawsuit was not surprising. Nonetheless, in November 2019, New York State and the other states filed a Notice of Appeal with the U.S. Court of Appeals. New York v. Mnuchin, No. 19-3962 (2d Cir., Nov. 26, 2019).
5. Tribunal Finally Given Opportunity to Rule on Sourcing of “Other Business Receipts.” After several years of litigation, the Tax Appeals Tribunal was finally given the opportunity to rule on the Tax Department’s controversial interpretation of the sourcing of receipts from services provided “electronically” under the pre-2015 corporate tax, and it rejected the Department’s attempt to apply customer-based sourcing for the years at issue. Matter of Catalyst Repository Sys., Inc., DTA No. 826545 (N.Y.S. Tax App. Trib., July 24, 2019). Catalyst earned receipts from the provision of litigation support services, which it made available to customers online through its computer software system. The Tribunal agreed with the Department that the receipts were not from the performance of services, but rather constituted “other business receipts” under the Tax Law, and should be sourced based on where they are “earned.” The Tribunal nonetheless held that the Department could not source the receipts – which the Tribunal concluded were from the licensing of the taxpayer’s computer system – based on customer location. In two earlier cases, ALJs had also rejected the Department’s attempt to apply customer-based sourcing in analogous circumstances, but in those cases the Department chose not to appeal, so the ALJ decisions remained non-precedential. Although customer-based sourcing is now the general rule under the New York corporate tax beginning after 2014, the Tribunal decision in Catalyst, which cannot be appealed by the Department and is precedential, should provide some clarity for corporations facing similar assertions by the Department for pre-2015 tax years.
6. Marketplace Provider Sales Tax Collection Law Finally Enacted. In April 2019, after several failed attempts in prior years, the New York State Legislature finally passed “marketplace provider” legislation, requiring marketplace providers with the requisite nexus (including specified amounts of inState sales) to collect sales tax on taxable sales of tangible personal property that they “facilitate” for marketplace sellers. Part G, Ch. 59, New York Laws of 2019. The legislation went into effect on June 1, 2019, less than two months after it was signed into law, and surprisingly with little apparent controversy. Although initially made applicable to marketplace providers with an annual New York sales tax threshold of $300,000 for the four immediately preceding quarters, regardless of physical presence, in June 2019 the Legislature increased the threshold to $500,000. Whether that increased threshold validated the statement in the Governor’s memorandum in support of the originally enacted legislation that it applied only to “large marketplace providers” is subject to debate.
7. Appellate Court Upholds Denial of Deductions for Payments to Captive Insurance Company. In May 2019, the Appellate Division, Third Department, held that a corporate taxpayer could not deduct insurance payments it made to its wholly owned captive insurance company because the payments did not qualify as valid insurance premiums under federal income tax law due to the absence of risk shifting and risk distribution. Matter of Stewart’s Shops Corp. v. N.Y.S. Tax Appeals Trib., 172 A.D. 3d 1789 (3d Dep’t 2019). The deductibility of insurance payments to captive insurers has long been a controversial issue for New York State and City corporate tax purposes. The decision suggests that if risk shifting and risk distribution are present under the federal income tax rules for insurance, there should be no impediment to deducting arm’s-length insurance payments made to captive insurers.
8. ALJ Decisions Issued Denying Deductions for Royalties Received From Foreign Nontaxpayer Affiliates. Under the former New York State corporate tax law, a corporation was entitled to deduct from income royalties it received from a related member, unless the payments were not required to be added back by the related member under another provision of the Tax Law. The deductibility of royalty income received from non-U.S. non-taxpayer affiliates – entities that have no obligation to file Article 9-A returns – has been the subject of considerable New York audit activity, with the Tax Department taking the position that such royalties are not deductible since the foreign affiliate is not required to add them back for New York since the foreign affiliate does not file New York returns. This past May, a NYS ALJ upheld the denial of the deduction, rejecting the taxpayer’s argument that the statute itself contained no requirement that the royalty payor must be a New York taxpayer. Matter of Walt Disney Co. & Consolidated Subsidiaries, DTA No. 828304 (NY.S. Div. of Tax App., May 30, 2019). The case is on appeal to the Tax Appeals Tribunal and, as we went to press, yet another ALJ decision was issued denying the deduction on similar grounds (see Insights in Brief, page 6).
9. State ALJ Upholds Limitation on Scope of Special Broker-Dealer Sourcing Law. The 2017 reversal by the New York State Tax Department of its earlier guidance concluding that a corporation was entitled to apportion using the special securities broker-dealer sourcing in order to properly reflect its income, even though the corporation was not itself a registered broker-dealer, was at issue in Matter of BTG Pactual NY Corp., DTA No. 827577 (N.Y.S. Div. of Tax App., Mar. 7, 2019). The ALJ upheld the Tax Department’s reversal of its position, holding that under the Tax Law only a registered broker-dealer qualified for the special sourcing. According to the ALJ, the fact that the taxpayer corporation – the sole member of two single-member LLCs, one a registered broker-dealer, the other an investment advisor – treated both disregarded SMLLCs as divisions, was relevant only to the question of which entity was taxed on its receipts, but could not be used to determine whether the receipts from the investment advisor qualified for broker-dealer sourcing. The case is currently on appeal to the Tax Appeals Tribunal.
10. NYS Tribunal Holds That Taxpayer Timely filed “Informal” Refund Claim. In one of the more welcome, and in some ways surprising, decisions of 2019, the Tax Appeals Tribunal, reversing an ALJ decision, held that a corporate taxpayer had filed a timely “informal” Article 9-A refund claim for the 2007 tax year – which did not actually claim the refund – when it filed its return for 2008 claiming a portion of the refund, and was therefore entitled to the balance of an otherwise time-barred refund for 2007. Matter of Accidental Husband Intermediary, Inc., DTA No. 827186 (N.Y.S. Tax App. Trib., Apr. 11, 2019). The Tribunal concluded that the “informal refund claim” doctrine was met because, among other things, the taxpayer’s 2008 Article 9-A tax return was sufficient to have put the Tax Department on notice of the claim and to enable the Department to investigate further. There was otherwise no dispute as to the taxpayer’s entitlement to the refund, and the Tribunal ordered that the refund be granted.
Although certainly not a 2019 “highlight,” this past year witnessed the practical demise of the New York State Department of Taxation and Finance Advisory Opinion process. In 2019, the Tax Department issued only two Advisory Opinions. In 2009, by way of contrast, it issued 104 Advisory Opinions, 64 of which related to sales tax. (The New York City Department of Finance private letter ruling process also results in few rulings, which curiously are not even timely posted on its website.) The reduced output is likely attributable to often extensive delays by the Department in issuing them, which in turn discourages taxpayers from requesting them in the first place. This is not a new trend, and there may be valid reasons for the reduced output, but without question 2019 yielded the lowest output of Advisory Opinions in many years.