This installment of Inside the New York Budget Bill examines the Budget Bill’s proposed changes to apportionment and discusses how those proposals vary from  current law and how they will affect New York taxpayers. A chart comparing the most significant  apportionment sourcing provisions of the Budget Bill to the current sourcing provisions in Articles  9-A and 32 appears at the end of this installment.

Current Law

Article 9-A

Part two of this  series  addressed the need for apportionment under the entire net income (ENI)  base and the capital base of Article 9-A, and can be found at Business  income and capital  is apportioned by the taxpayer’s business allocation percentage (BAP), and  investment income and capital is apportioned by the taxpayer’s investment allocation percentage  (IAP).    Since  the  Budget  Bill  would  exempt  newly  defined “investment income” and eliminate the need for an IAP, only the BAP is addressed here.

The BAP is the ratio of the taxpayer’s New York receipts to its total receipts. In general, New  York receipts are those generated from (1) sales of tangible personal property shipped or delivered  to the taxpayer’s customers in New York, (2) sales of services to the extent the services were  performed in New York and (3) other business receipts to the extent “earned” in New York.

Determining proper receipts sourcing has become a very contentious audit issue, particularly given  the evolution of corporate business transactions. For example, difficulties have arisen under  current law regarding the sourcing of receipts earned from performing services that are delivered  or made available through the Internet. Is revenue derived therefrom more properly classified as  from the performance of services or from “other”? If services, where are those services performed,  and if “other,” where are those receipts “earned”?

Article 32

Under  Article  32,  in  computing  the  portion  of  a banking corporation’s ENI that will be subject to tax by New York (if the resulting tax amount is greater  than the amount computed under the gross assets base or under the alternative ENI base), ENI is  multiplied by a three-factor formula consisting of the deposits factor, the payroll factor and the  receipts factor. The three factors are averaged, with the deposits and receipts factors being  double- weighted. The same formula generally applies in apportioning the Article 32 gross assets  base.

Much audit controversy has developed in the context of determining the deposits factor under  current law (which requires taxpayers to source deposits to the extent that those deposits are  “maintained” by the taxpayer at a “branch” location). These controversies largely involve whether  any office of the taxpayer constitutes a “branch” and what it means, in today’s world, to “maintain” a deposit at a particular “branch” location.

Proposed Changes

The Budget Bill retains the current receipts-only apportionment scheme under Article 9-A but would  eliminate the disparate apportionment schemes applied to general business corporations and banking  corporations; the same rules would apply to both categories of corporations (thus, for example,  ending deposit factor controversies).

In general, the Budget Bill would expand the market-based sourcing regime that currently applies to  sales of tangible personal property and certain asset management and investment advisory services  to all receipts “that are included in the computation of the taxpayer’s business income for the  taxable year.” The Budget Bill also expands the categories of receipts for which sourcing is  specifically addressed by law and provides guidance on how to apply the sourcing rules, for  example, by including hierarchies for determining where to assign particular receipts, likely  eliminating much of the current controversy. Under this hierarchical approach, a taxpayer would be  required to exercise due diligence under each method before rejecting it and moving to the next  method in the hierarchy.

While the Budget Bill’s approach to categorization is commendable, and while it may be argued that  the regime provides clarity and uniformity in its “market” focus, many taxpayers may be adversely  affected by such changes, particularly those in the service industry that benefit from the current  performance-focused method, and those with receipts in the “other business receipts” category that  “earn” those receipts outside of New York. In  addition, several provisions  in the Budget Bill  would allow for use of the customer billing or mailing address as the determination of where the  customer is located. However, billing and mailing addresses can often be moved (particularly in  business-to-business transactions) and often reflect only the location of a customer’s back-office  functions, not the location where a customer really benefits from goods or services purchased. An  alternative, such as commercial domicile (which is used in the Budget Bill for some sourcing), may  provide a better indication of where the “market” for a good or service really is (of course,  commercial domicile has its own drawbacks in that sellers do not always know their customers’  commercial domicile location).

As in current law, the Budget Bill would provide the Commissioner with discretion to apply  alternative methods “to effect a fair and proper apportionment of the business income and capital  reasonably attributed to the state” when the standard statutory scheme “does not result in a proper  reflection of the taxpayer’s business income or capital within the state.” While the Budget Bill  does not address which party would have the burden of proof in this instance, the majority (and  better) view in the country is that the party seeking alternative apportionment should bear the burden of proof.

New York City

Currently, New York City’s apportionment regime is substantially similar to the State’s current  regime (although New York City will not fully phase in a single receipts factor for tax years  beginning after 2017). The Budget Bill’s apportionment provisions would not automatically affect  New York City’s regime, resulting in vastly different treatment of certain categories of receipts.  This will add to compliance difficulties when filing returns.

Effective Date

If enacted, the apportionment provisions would apply to taxable years beginning on or after January 1, 2015.

Click here to view the Appendix.