The New York State Tax Department (for Article 9-A) and New York City Tax Department (for the new Subchapter 3-A tax) have issued memorandums containing guidance as to how stock must be “clearly identified” in order to qualify as investment capital.

Technical Memorandum, TSB-M-15(4)C, (5)I, “Investment Capital Identification Requirements for Article 9-A Taxpayers,” (N.Y.S. Dep’t of Taxation & Fin., July 7, 2015); Finance Memorandum, “Investment Capital Identification Requirements for the Corporate Tax of 2015,” (N.Y.C. Dep’t of Fin., July 17, 2015).

Under last year’s New York State corporate tax reform legislation, the definition of “investment capital” was narrowed, and investment income was made entirely exempt from Article 9-A tax. This past spring, significant “technical” changes were made to the definition of investment capital, resulting in a new five-part test. Among other things, in order to qualify as investment capital, the stock must be held for investment for more than one year, and, for stock acquired after 2014, the stock must have never been held for sale to customers in the regular course of the taxpayer’s business. The five-part test also applies to the new Subchapter 3-A tax that replaces the New York City general corporation tax for most corporations.

One important new criterion under the new law is that before the close of the day on which the stock is acquired, the stock must be “clearly identified” in the taxpayer’s records as stock held for investment (as required for securities dealers under IRC § 1236(a), whether or not the taxpayer is a dealer).

The memorandums provide that for securities dealers subject to IRC § 1236, in order to qualify as investment capital, the stock must be timely identified in the corporation’s records as being held for investment under IRC § 1236(a)(1). That federal identification will be determinative in qualifying as investment capital, and a separate New York identification will not be accepted by the Department. It will not be sufficient for a securities dealer to merely identify the stock as being held for investment under IRC § 475 (relating to mark to market accounting for securities dealers).

For non-dealers, in order to be “clearly identified,” the stock must be recorded, by the close of the day it is acquired, in a separate account maintained solely for investment capital purposes. The investment account must disclose, among other things, the CUSIP number for the stock, the date of purchase, the number of shares purchased, and the purchase price. The investment account can be maintained in the taxpayer’s books of account for recordkeeping purposes only, or it may be a separate depository account maintained by a clearing company as nominee for the taxpayer. For stock acquired by non-dealers before October 1, 2015, a transition rule permits the taxpayer to make the necessary identification before October 1, 2015 (the transition rule does not apply to securities dealers). The pronouncements also address the identification requirements where stock is owned by a partnership. If a corporate partner in such a partnership follows the aggregate method of taxation, then the partnership itself must follow the identification rule, even though it is not the actual “taxpayer.”

Additional Insights

The 2015 “technical” changes regarding investment capital were quite substantive, and they impose significant recordkeeping requirements on both dealers and non- dealers in order to treat stock as investment capital. The apparent thrust of the 2015 legislation was to provide a bright-line test for whether stock qualifies as investment capital, particularly for securities dealers, where the failure to designate the stock as an investment for purposes of IRC § 1236(a)(1) will now be determinative. It is likely that many dealer firms currently do not make an IRC § 1236(a)(1) election for stock but will now have to do so in order to obtain investment capital treatment. The absence of a transition rule for dealers means that such firms run the risk that previously purchased stock can never qualify as investment capital if they did not make an IRC § 1236(a)(1) identification.

For non-dealers seeking investment capital treatment for stock acquired before October 1, 2015, it will be critical to comply with the new identification requirements for that stock before October 1, 2015, or else risk foregoing investment capital treatment. It seems clear that one important consequence of corporate tax reform—not fully apparent until the 2015 technical changes were enacted—is to severely limit the availability of investment capital treatment.