In an unpublished letter ruling, the New York City Department of Finance has ruled that a limited partnership engaged in the securities and commodities business qualifies for broker-dealer sourcing of certain receipts under the New York City unincorporated business tax (“UBT”), even though the partnership is not itself a “registered” broker-dealer.  Finance Letter Ruling, N.Y.C. Dep’t of Fin. (FLR 12-4934/UBT, Aug. 19, 2013).

Facts. The ruling involves two related limited partnerships: “Partnership,” which manages various investment funds in securities and commodities on behalf of investors, and “Taxpayer Partnership,” in which Partnership owns a 99% interest. 

Partnership receives asset-based management fees from investors in the securities and commodities that it manages. It is registered as a “broker-dealer” with the SEC and Financial Industry Regulatory Authority (“FINRA”), and it maintains a Central Registration Depository number.

Taxpayer Partnership is subject to the UBT.  It solicits investors for Partnership’s various investment funds. Taxpayer Partnership is not registered as a broker-dealer with the SEC. According to the letter ruling, Taxpayer Partnership “acts as a broker dealer,” “performs all functions of a security broker or dealer, holds itself out to customers as a broker or dealer,” and is a “broker and dealer under the 34 Act.” Approximately 20 of its employees are “registered representatives” of Partnership.

The issue presented was whether Taxpayer Partnership qualified for broker-dealer sourcing under the UBT, despite the fact that it was not a “registered” broker-dealer.  The Department ruled that it did qualify.

Background. Under the UBT, a taxpayer’s business income is apportioned based on a three-factor business allocation percentage (“BAP”) consisting of property, payroll, and receipts. For the receipts factor, most receipts derived from providing services are sourced based on where the services are performed. However, beginning in 2009, the UBT law (as well as the City general corporation tax law) was amended to provide customer-based sourcing rules for receipts from enumerated services performed by “registered securities or commodities brokers or dealers.”  Admin. Code § 11-508(e- 3).  Under those sourcing rules, designated receipts are sourced in the receipts factor based on the mailing address of the taxpayer’s customers, rather than the address where the services are performed.

In order to qualify for this “registered broker-dealer” sourcing, however, the UBT law provides that the taxpayer must be a “broker or dealer registered as such by the Securities and Exchange Commission or the Commodities Futures Trading Commission.”  Admin. Code §11-508(e-3)(2) (emphasis added). The question presented was whether this language required that the taxpayer be formally registered with the SEC (or with the CFTC) as a broker or dealer in order to qualify for the special broker-dealer sourcing.

Ruling. The Department concluded that the phrase “registered as such by the [SEC]” does not require that a taxpayer actually register with the SEC.  Instead, as long as the taxpayer complies with all of the requirements of the SEC to act as a broker-dealer in securities, it will qualify for broker- dealer sourcing.  The ruling noted that the SEC provides exceptions to the broker-dealer registration requirement, which meant that certain persons can act as securities broker- dealers without having formally been registered as such with the SEC. According to the Department, to require that a taxpayer be formally registered with the SEC as a broker or dealer in order to qualify for special sourcing would result in inconsistent tax treatment among similarly situated taxpayers.

As for the comparable UBT “regist[ration] as such” requirement for brokers or dealers in commodities, the Department noted that the CFTC has no formal “broker- dealer” designation or registration for commodities brokers or dealers at all.  According to the Department, a literal reading of the registration requirement in the UBT law with respect to broker-dealers in commodities would mean that no taxpayer could ever qualify as a commodities broker-dealer. Thus, the Department also ruled that to qualify for sourcing for commodities brokers or dealers under the UBT, it was sufficient that the taxpayer meet the CFTC requirements “to act” as a broker or dealer in commodities.

Additional Insights

The letter ruling – which is not on the Department’s website but was obtained under the Freedom of Information Law – takes a reasonable approach in applying substance over form in its interpretation of the UBT law. Presumably, the Department could have reached a similar result by exercising its discretionary authority to adjust the BAP under Administrative Code § 11-508(h). (Applying the Department’s reasoning, a registered securities broker-dealer’s income from its non-dealer trading activities should not constitute business income merely because of its formal registration as a broker-dealer.) As for the requirement in the UBT law that commodities broker-dealers be “registered as such” with the CFTC, the ruling notes that such registration does not even exist at the CFTC (which raises the question of why the provision appears in the law in the first place). The letter ruling is significant since the New York City UBT and general corporation tax sourcing rules – including the special broker-dealer sourcing rules – are likely to remain unchanged in 2015, despite the fact that Article 9-A will apply customer-based sourcing across the board beginning in 2015.