The New York State Department of Taxation and Finance has made several significant revisions to its draft corporate income tax regulation for the sourcing of receipts from other services and other business activities. Draft Rule Related to Other Services and Other Business Receipts, Regulation § 4-2.18 (N.Y.S. Dep’t of Taxation & Fin., released July 3, 2019). The revised draft regulation relates to services performed by a variety of businesses, including those in the financial services industry. This is the second set of revisions to the draft regulation, which was originally released in October 2015, and revised in October 2016.

Special Sourcing Categories. The draft regulation expands the special sourcing rules for specified categories of receipts:

(1) in-person services (e.g., medical, child-care, and entertainment services and the facilitation of those services);

(2) services related to tangible personal property (e.g., repair and food services and the facilitation of those services);

(3) services related to real property (e.g., real property improvement and maintenance services and the facilitation of those services);

(4) sales of intangible property not otherwise addressed under Tax Law § 210‑A (e.g., from sales of trademarks, copyrights, goodwill, and similar items); and

(5) management services provided to “passive investment customers.”

These special sourcing rules are to be used in place of the general rules for determining where the benefit of the service is deemed received. The only exception is where the taxpayer does not have sufficient information to apply either the special rules or prescribed rules of “reasonable approximation” to the special rules. In that case, the taxpayer must use the general sourcing rules.

Passive Investment Customers. Of particular interest to the financial services industry is the creation of a new term, “passive investment customer,” which is defined as an unincorporated entity that pools capital from passive investors for the purpose of trading or making investments and does not otherwise conduct an active business. As such, most private equity funds and investment funds such as hedge funds would likely constitute passive investment customers.

Under this new provision, management services, which are broadly defined to include rendering investment advice and determining when sales or purchases are to be made on behalf of passive investment customers, are sourced in one of two ways. If the provider of the management services has broad discretionary authority by contract to execute investment advisory and management decisions on behalf of the passive investment customer, the management service provider’s receipts are sourced to the location where it executes those decisions. In all other cases, the receipts are sourced to where the passive investment customer “makes the decision to utilize the investment or management decisions.” These sourcing methods are in direct contrast to the Department’s earlier draft regulation, which had sourced receipts from services provided to similarly defined passive investment companies to the location of the underlying investors in the investment company. They also contrast with the customer-based sourcing of receipts from management services that are provided to regulated investment companies.

Intermediary Transactions. The new draft regulation specifies that the sourcing rules applicable to receipts from intermediary transactions, which are generally sourced based on the location of the consumer rather than the intermediary, do not apply to the five types of services sourced under the special rules. However, the draft regulation also seems to soften the requirements for a transaction to qualify as an intermediary transaction. It does this by now allowing a look-through to the ultimate consumer of the services where the services are being provided in an intermediary transaction under the “explicit or implicit” (emphasis added) terms of a contract between the taxpayer and the intermediary.

Reasonable Approximation. Another notable change is an expansion of the methods of reasonable approximation of customer location to include reasonable approximation based on general population or a subset of general population if such a method reasonably reflects the geographic distribution of where the customer actually receives the benefit.

The new draft regulation also contains several new examples illustrating the various sourcing rules.

The Department asks that comments to the draft regulation be submitted by October 9, 2019.

While the draft regulation provides helpful guidance on the Department’s current view of certain apportionment issues, it should be kept in mind that the draft regulation is not final and as a legal matter cannot be relied upon.