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.
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 http://bit.ly/1lwq2qU. 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”?
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.
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.
If enacted, the apportionment provisions would apply to taxable years beginning on or after January 1, 2015.
Click here to view the Appendix.