Following New York City’s recent victory in a case regarding the apportionment of income earned by an out-of-state corporation from its sale of a non-unitary investment, the New York State Department of Taxation and Finance (NYS Department) memorialized the litigation position in an August 4, 2022 revision to the “final draft” regulations that it had published only three months ago.

In Matter of Goldman Sachs Petershill Fund Offshore Holdings (Delaware) Corp. v. New York City Tax Appeals Tribunal, 2022 NY Slip Op 02361 (NY App. Div. 2022), the Appellate Division of the New York State Supreme Court dismissed an out-of-state corporation’s appeal from the New York City Tax Appeals Tribunal, and held that the Tribunal’s decision to uphold a tax assessment on the corporation’s gain from the sale of an indirect interest in a limited liability company was “rational.” The out-of-state corporation had no property or employees in New York City, but it was a limited partner in a partnership that owned an interest in an LLC that conducted business in the City. Even though the corporation and the LLC were not engaged in a unitary business, the New York City Department of Finance (NYC DOF) required the corporation to apportion the gain from the disposition of the LLC interest using the LLC’s apportionment factor of 100%. The Appellate Division ultimately upheld the NYC DOF’s assessment on the out-of-state corporation’s gain from the sale. Our coverage of the case can be found here.

On April 29, 2022, the NYS Department published a set of “final draft” regulations that contained the following provision regarding “constitutionally protected investment capital” in Section 3-4.2:

In the case of a corporation incorporated and commercially domiciled outside New York State, the United States Constitution prohibits the state from apportioning income or gain from intangible assets when such income or gain lacks a sufficient connection to a unitary business being carried on in the state by the corporation.

On August 4, 2022, the NYS Department revised the provision, and Section 3-4.2 now states:

In the case of a corporation incorporated and commercially domiciled outside New York State, the United States Constitution prohibits the state from apportioning income or gain from intangible assets when such income or gain lacks a sufficient connection to a unitary business being carried on activities or presence in the state by the corporation.

The NYS Department also added a new example to the “final draft” regulations, resembling the Goldman decision, that addresses “constitutionally protected investment capital” in the context of a sale of a minority interest in a partnership operating in New York. The new Example 16 provides:

InvestCo is a foreign corporation that owns a minority interest in Asset Manager, a partnership operating solely in New York State that performs a variety of investment activities. InvestCo and Asset Manager are not engaged in a unitary business. Aside from its investment in Asset Manager, InvestCo has no physical presence or activities in New York State.

In 2022 InvestCo sells its interest in Asset Manager for a gain. Because the increase in Asset Manager’s value was a result of its activities within New York State and the benefits provided by New York State, InvestCo’s interest in Asset Manager is not constitutionally protected investment capital. As such, the interest in Asset Manager is business capital and the gain from disposition of such interest is business income.

The NYS Department has requested comments on the investment capital revisions by August 26, 2022.

It should be noted that the NYC Department has stated that it “intends to issue rules that generally correspond to” the State’s regulations, and that it “will make draft regulations available after the State has finalized its new and revised regulations.”