In an Advisory Opinion with important implications, the Department of Taxation and Finance has ruled that the foreign corporate limited partner election under Article 9-A is not available to a corporation holding a general partnership interest in a partnership that was not itself conducting business in New York State, but which received income from another partnership that did. Advisory Opinion, TSB-A-11(5) (C) (N.Y.S. Dept. of Taxation & Fin., Feb. 24, 2011).

The taxpayer is a corporation (“Taxpayer”) that holds an 85% general partner interest in a limited partnership (“LTD”), which in turn holds a 6% membership interest in a limited liability company (“Channel LLC”). Channel LLC operates a cable television channel in New York City. It is classified as a partnership for both federal and New York tax purposes. LTD licenses a trademark from a related entity and sublicenses it to Channel LLC in exchange for trademark revenues. All of LTD’s activities are conducted in Utah. Taxpayer’s only activity is to hold a general partner interest in LTD. Taxpayer files Article 9-A returns in which it reports its distributive share of the pass-through of income, gains, losses, and deductions generated by Channel LLC, and passed through by LTD, in which Taxpayer is an 85% general partner.

At issue was the treatment of Taxpayer’s distributive share of a gain generated by LTD’s sale in 2005 of a portion of its membership interest in Channel LLC. In its Article 9-A return, Taxpayer claimed the foreign corporate limited partner election, currently 20 NYCRR 3-13.5, and excluded its distributive share of LTD’s gain (although it did include its distributive share of the flow-through of

the Department... ruled that the foreign corporate limited pa rtner election under Article 9-A is not available to a corporati on holding a general pa rtnership interest in a pa rtnership that was not itself conducting business in New York State.

Channel LLC’s income, gain, loss, and deductions). Under this election, in effect since 1990, 20 NYCRR 3-13.5(a)(1) where a non-New York corporation is subject to Article 9-A solely because it holds a limited partnership interest in a partnership that conducts business in New York State, it may “elect to compute its tax bases by taking into account only its distributive share of each partnership item of receipts, income, gain, loss and deduction” of that partnership. This irrevocable “separate accounting” election must be made on the original tax return for the tax year. The election is available unless the limited partnership and the corporate group in which the corporate partner is a member are engaged in a unitary business and there are substantial intercompany transactions with the limited partnership.

The regulation providing the election was adopted the same year the Department issued its “corporate limited partner” nexus regulations (20 NYCRR 1-3.2), which resulted in most non-New York corporate limited partners in New York partnerships being subject to Article 9-A. The election was an attempt to soften the impact of the nexus regulation upon non-New York corporate limited partners by limiting taxability to the corporate partner’s distributive share of income from the limited partnership doing business in New York. Since the results of the normal apportionment rules are often unpredictable, and were viewed by many as discouraging corporations from investing in New York partnership businesses, the election was the Department’s attempt to address that concern by permitting separate accounting in limited circumstances.

The Taxpayer in the Advisory Opinion appears to have argued that it was entitled to make the election because of the “aggregate theory” of taxation of corporate partners under 20 NYCRR 1-3.2(a)(6), adopted in 2007, which attributes the income and activities of a partnership to its corporate partners. Under such argument, since LTD’s income and activities are attributed to the Taxpayer under the aggregate theory, the foreign corporate limited partner election should also be available to the Taxpayer under that same theory. Assuming that LTD’s membership interest in Channel LLC was itself a limited partnership interest, since LTD’s activities were aggregated with the Taxpayer’s, the election that would be available to LTD if it were subject to Article 9-A should be available to the Taxpayer.

The Department ruled, however, that the foreign corporate limited partner election was not available to the Taxpayer, because the corporation was not taxable “solely” by reason of its ownership of a limited partnership interest under the regulations. According to the Department, since its general partnership interest in LTD is what subjected the Taxpayer to Article 9-A, the election was inapplicable. As for the Taxpayer’s position under the aggregate theory — which was not part of the regulations in 2005 — the Department concluded the opposite, that “the aggregate theory demonstrates that Petitioner does not qualify” for the election, because under that theory LTD was considered to be doing business in New York as a result of Channel LLC’s New York activities. Channel LLC’s activities were thus considered the activities of the Taxpayer as a general partner in LTD.

Additional Insights. The Advisory Opinion addresses the application of the foreign corporate limited partner election in a tiered partnership ownership structure, an issue not directly addressed by the regulations. While the Advisory Opinion is correct that a corporate general partner in a New York partnership does not qualify under the regulations for the election, it is questionable why a corporate general partner would not qualify if the partnership itself is considered to be doing business here only because it holds a limited partnership interest in another partnership that does. Unfortunately, the Advisory Opinion does not indicate whether LTD’s membership interest in Channel LLC was considered a limited partnership interest. If it was, then notwithstanding the Taxpayer’s general partnership interest in LTD, the Taxpayer’s connection with New York State was because of LTD’s limited partnership interest in a New York cable television business, not because of the Taxpayer’s general partnership interest. Indeed, since LTD itself did business only in Utah, the Taxpayer would not have been subject to Article 9-A if not for LTD’s limited partnership interest in Channel LLC.

Although the Advisory Opinion does not fully explain the Taxpayer’s position regarding the aggregate theory, it appears to have been based on the seemingly reasonable argument that since the aggregate theory caused LTD’s activities to be considered the activities of the Taxpayer, then the nature of LTD’s interest in Channel LLC should determine the availability of the foreign corporate limited partner election to the taxpayer. If the interest is a limited partnership interest, the Taxpayer had a reasonable basis for claiming the election.