The New York State Department of Taxation and Finance has released revisions to its draft business corporate franchise tax regulations interpreting the general rules in Tax Law 210-A for computing the business apportionment factor under New York State corporate tax reform, which went into effect in 2015. The revisions, if promulgated, will impact many businesses, including those in the financial services industry. Draft Apportionment Rules, Part 4 (N.Y.S. Dep't of Taxation & Fin., released July 18, 2019). The new draft comes just two weeks after the Department released other draft regulation revisions relating to digital products and other services and other business receipts.
The latest revisions are extensive in scope, and include both changes to provisions in the previous draft version and the addition of some entirely new provisions. Some of the more notable changes and additions are summarized below:
Business receipts. The latest draft changes the definition of "business receipts" includable in the apportionment factor, so that the term now includes receipts from unusual events that are not received in the regular course of the taxpayer's business. This would be a departure from both the long-standing Article 9-A practice which, for example, excluded from the factor receipts from sales of capital assets or from sales outside the ordinary course of the taxpayer's business and from the earlier version of the draft regulation, which specifically excluded receipts from unusual events.
Marked to market financial instruments. "Qualified financial instruments" ("QFIs"), which are prescribed financial instruments marked to market by the taxpayer, qualify for the election to use an 8% fixed apportionment method. The new draft rule provides that securities held by a dealer that meet one of the exceptions from being marked to market for federal income tax purposes under IRC 475(b)(1) such as securities held for investment will not be considered marked to market for apportionment purposes and, thus, will not be considered QFIs eligible for the 8% election, even where the dealer has not identified the securities for purposes of the marked to market exception under IRC 475(b)(2). The result of this new draft rule would appear to be that a corporation could have securities that are actually marked to market for federal income tax purposes, but that do not qualify as QFIs for Article 9-A purposes. As a result, a securities dealer having marked to market income for both federal and Article 9-A purposes may be required to source that income in the apportionment factor under the prescribed customer sourcing methods.
Broker-dealer sourcing. Various categories of receipts of registered broker-dealers are subject to special sourcing rules. A new rule provides that the term "registered broker or dealer" does not include any corporation that is merely a partner or member in a broker-dealer entity but is not itself a registered broker or dealer.
Discretionary adjustments. The new draft now specifies that the party seeking to vary the apportionment factor bears the burden of proof to demonstrate by "clear and convincing evidence" that the standard formula does not result in a proper reflection of the taxpayer's business income or business capital in the State, and that the application of the standard formula attributes income or capital to the State that is "out of all proportion" to the business transacted by the taxpayer in the State. The earlier version permitted a discretionary adjustment whenever the factor did not "properly reflect" income or capital. The draft contains new examples involving financial services, including one involving a corporation with 95% of its income consisting of dividends and net gains from investments in stock, and 5% consisting of fees for investment advisory services. The example concludes that a discretionary adjustment would be made to include the otherwise excluded dividends and net gains in the apportionment factor in order to properly reflect the taxpayer's business income in the State.
Credit card processing services. Receipts received by credit card processors for authorizing, clearing, and settlement are sourced to where the processor's customer accesses the processor's network, with receipts not specifically addressed by statute sourced to New York based on an average of (i) 8% (roughly based on New York's share of U.S. GDP) and (ii) the percentage of customer "access points" in New York out of all of its access points in the United States. The draft contains a new sourcing method applicable to third-party processors, including receipts from volume-based activities, where the processor cannot identify the access points. In that case, the draft provides for sourcing to New York the processor's other receipts based on the average of (i) 8% and (ii) the percentage of customers with "billing addresses" in the State.
The draft regulations also contain new rules for apportioning interest income and net gains from asset-backed securities and other government agency debt, interest income, and net gains from corporate bonds, brokerage commission receipts, and net interest income from federal funds.
The Department is seeking comments by October 18, 2019. While the draft regulations contain helpful guidance, they cannot be relied upon by taxpayers until they are adopted, although the Department has not provided a timetable for their adoption. The New York City Department of Finance has indicated on its Business Corporation Tax FAQ page that it intends to issue rules that correspond to the regulations issued by New York State under Article 9-A where the underlying statutes correspond, and that corporations can rely on draft regulations posted on New York State's website until such time as the City issues its regulations.