2014 turned out to be a very eventful year in New York taxation. As we enter the New Year, here is our list of the Top 10 New York tax highlights of 2014.
- Corporate Tax Reform legislation enacted. In what is surely the most significant New York development of 2014, on March 31, 2014 comprehensive corporate tax reform legislation was enacted and signed into law, effective for tax years beginning after 2014. Part A, Ch. 59, N.Y. Laws of 2014. Sweeping in scope, the new law undoubtedly represents the broadest revision to Article 9-A since its enactment in 1944. The legislation not only substantially overhauled Article 9-A — such as by adopting economic nexus, unitary water’s edge combination, market-based sourcing, and a 0% income tax rate for qualified New York manufacturers, and by eliminating the long- standing subsidiary income exclusion — it also merged the 30-year- old bank tax (Article 32) into Article 9-A. The corporate tax reform legislation was the culmination of a more than five-year initiative by the New York State Department of Taxation and Finance, and was carried out with the active participation of various industry groups. While the New York City general corporation tax was not amended, reportedly the City will attempt to enact similar legislation in 2015.
- State Tribunal clarifies existing rules for permissive combination under Article 9-A in IT USA and Knowledge Learning decisions. The New York State Tax Appeals Tribunal issued two significant decisions involving combined returns under Article 9-A. In Matter of IT USA, Inc., DTA Nos. 823780 & 823781 (N.Y.S. Tax App. Trib., Apr. 16, 2014), the Tribunal upheld an Administrative Law Judge’s decision permitting two New York taxpayers to file combined Article 9-A returns, even in the absence of substantial intercorporate transactions, because the taxpayers established not only the existence of a unitary relationship but also the lack of arm’s length intercompany pricing. The Tribunal concluded that the furnishing of various intercorporate services at cost resulted in actual distortion. The case had been watched by many because of concerns that the State Tax Department was routinely decombining long-standing State combined groups, and giving insufficient weight to the actual distortion basis for combination.
Matter of Knowledge Learning Corp. and Kindercare Learning Centers, Inc., DTA Nos. 823962 & 823963 (N.Y.S. Tax App. Trib., Sept. 18, 2014) may be even more significant because it addressed a controversial conclusion by an ALJ last year that distortion was no longer a factor for combination after the 2007 statutory changes regarding the presumption of distortion (a conclusion that many taxpayers and practitioners believed was incorrect). The Tribunal reversed the ALJ decision, and permitted two related corporations to file combined returns. Although the Tribunal concluded that substantial intercorporate transactions were present — and therefore it did not need to consider whether actual distortion existed — it nonetheless reversed the ALJ’s conclusion regarding the purported irrelevance of actual distortion, noting that combination still will be allowed if “necessary to properly reflect income and avoid distortion,” even in the absence of substantial intercorporate transactions. The two decisions should provide important clarity regarding permissive combination, at least until the new unitary combination rules take effect for tax years beginning after 2014.
- Court of Appeals reverses Gaied “Permanent Place of Abode” decision. In Matter of John Gaied v. Tax App. Trib., 22 N.Y.3d 592 (2014), the Court of Appeals took the rare step of addressing what constitutes a “permanent place of abode” for statutory residency purposes. Reversing the Appellate Division (and the Tribunal), the Court held that a New Jersey resident’s ownership and maintenance of a house in Staten Island occupied by his parents did not make it his “permanent place of abode.” Most important was the Court’s rejection of the State Tax Department’s position that a taxpayer need not “reside” in the permanent place of abode, but that “maintaining” the place of abode was sufficient. Instead, the Court established a “residential interest” requirement to constitute a permanent place of abode. The Department later revised its Nonresident Audit Guidelines to set forth its interpretation of what it means to have a “residential interest” in a place of abode. Some view the Gaied decision as a signal that the State’s highest court may be willing to address other controversial aspects of the statutory residency test.
- New York City ALJ rejects City’s forced combination of bank and its mortgage subsidiary. The Chief Administrative Law Judge for the New York City Tax Appeals Tribunal held that a bank was not required to file a combined New York City bank tax return with its Connecticut subsidiary that held non-New York mortgage loans. Matter of Astoria Financial Corporation & Affiliates, TAT (H) 10-35 (BT) et al. (N.Y.C. Tax App. Trib., Admin. Law Judge Div., Oct. 29, 2014). The ALJ found that the subsidiary had economic substance, was formed for legitimate business purposes, and conducted its transactions with the bank at arm’s length. Significantly, the ALJ rejected the City’s reliance on the controversial decision in Matter of Interaudi Bank, DTA No. 821659 (N.Y.S. Tax App. Trib., Apr. 14, 2011), where the State Tribunal upheld the forced combination of a bank and its investment subsidiary in order to avoid a “mismatching of income and expenses.” The ALJ concluded that the facts in Interaudi were distinguishable, and that Interaudi did not constitute binding precedent. The City has filed an Exception to the decision.
- Qui tam developments: “whistleblower” action is revealed; New York’s highest court will hear the Sprint Nextel appeal. With no meaningful effort having yet been made to amend the 2010 legislative expansion of the New York False Claims Act, which permitted private “whistleblower” qui tam State tax actions, some glimmers of hope for limiting the scope of such actions did surface in 2014. First, in June 2014, after upholding a trial court decision allowing the New York Attorney General to bring a $100 million qui tam lawsuit under the False Claims Act against Sprint Nextel, the Appellate Division, First Department, granted Sprint Nextel’s request to have the case heard by the Court of Appeals. State of New York v. Sprint Nextel Corp., et al., 114 A.D.3d 622, leave to appeal granted (App. Div. 1st Dep’t, June 12, 2014).
Another qui tam action with even more far-reaching implications, originally filed under seal in 2013 and then unsealed in July 2014, has been brought in the New York courts by a lawyer formerly employed by (and terminated by) the Vanguard Group, Inc. The former Vanguard lawyer claimed that the company had evaded more than $1 billion in federal taxes and more than $20 million in New York State taxes. State of New York ex rel. David Danon v. Vanguard Group, Inc., No. 100711-13 (Sup. Ct., N.Y. Cnty., May 8, 2013). Unlike in Sprint Nextel, the Attorney General declined to intervene in this case. In October 2014, Vanguard filed a motion to dismiss the Complaint, and to disqualify the plaintiff (and his attorneys) on ethics grounds.
- Caprio and Luizza decisions limit retroactive application of statutory amendments on Due Process grounds. In a decision that could call into question the constitutionality of some retroactive legislative enactments, the Appellate Division, First Department, held that a 2010 retroactive statutory amendment concerning the treatment of installment payments by nonresident shareholders of an S corporation violated the taxpayers’ Due Process rights. Caprio v. N.Y.S. Dep’t of Taxation & Fin., No. 651176/11, 11231, 2014 NY Slip Op. 2399 (App. Div. 1st Dep’t, Apr. 8, 2014). Later in 2014, an ALJ reached the same conclusion in Matter of Jeffrey M. and Melissa Luizza, DTA No. 824932 (N.Y.S. Div. of Tax App., Aug. 21, 2014). The Caprio decision is currently on appeal to the Court of Appeals, and an Exception has been filed in Luizza.
- ALJ upholds denial of sales tax refund due to vendor’s failure to first refund the tax to customers. Adhering to the strict language of the Tax Law for obtaining sales tax refunds, in Matter of New Cingular Wireless PSC LLC, DTA No. 825318 (N.Y.S. Div. of Tax App., July 17, 2014), a State ALJ upheld the denial of a more than $100 million sales tax refund claim made by a telecommunications vendor because the vendor had not complied with the statutory requirement that the sales tax first be refunded to customers. The opposite conclusion had been reached in a 2014 New Jersey Tax Court decision involving a New Jersey sales tax refund claim made by the same taxpayer. As discussed elsewhere in this issue, the ALJ has now denied the taxpayer’s request to reopen the hearing to introduce evidence that in August 2014, subsequent to his July 17, 2014 decision, the taxpayer deposited more than $100 million of collected sales tax into a pre-refund escrow account.
- ALJ decision upholding partial liability of LLC members for LLC’s sales tax may result in a new legal challenge to strict liability of LLC members. A State ALJ upheld the State Tax Department’s 2011 policy that a member of a limited liability company (“LLC”) holding a minority interest in the LLC will be strictly liable for a portion of the LLC’s sales tax liability. Matter of Eugene Boissiere and Jason Krystal, DTA Nos. 824937 & 824938 (N.Y.S. Div. of Tax App., Sept. 18, 2014). After the State Tribunal upheld, in Matter of Santo, DTA No. 821797 (N.Y.S. Tax App. Trib., Dec, 23, 2009), strict liability of an individual LLC member for the full amount of the LLC’s sales tax liability, the State Tax Department issued Technical Memorandum, TSB-M-11(17)S (N.Y.S. Dep’t of Taxation & Fin., Sept. 19, 2011), limiting the liability of LLC members with a less than 50% ownership interest who are not under a “duty to act” for the LLC with respect to sales tax, based on their percentage interest in the LLC. The Boissiere action challenged any strict liability against an LLC member as being inconsistent with the New York LLC law — which limits an LLC member’s liability — and as violating the taxpayers’ Due Process rights. An Exception to the decision has now been filed, and the case may be a vehicle for an eventual judicial challenge to the imposition of any strict liability on LLC members.
- Decision holds that the First Amendment required the exercise of the Commissioner’s discretionary authority for apportioning receipts. In a noteworthy decision involving the First Amendment (freedom of the press), the Chief ALJ of the City Tribunal held that First Amendment principles mandated that the City exercise its discretionary authority to adjust a corporation’s receipts factor for general corporation tax purposes. Matter of The McGraw Hill Companies, Inc., TAT(H) 10-19(GC) et al., (N.Y.C. Tax App. Trib., Admin. Law Judge Div., Feb. 24, 2014). The ALJ thus permitted McGraw-Hill’s Standard & Poor’s credit rating agency division to source its credit rating fees based on the location of the website viewers of its credit ratings, rather than under the statutory method based on where the services are performed. The last time the New York courts invoked the First Amendment in an apportionment case was nearly 25 years ago — in a case involving the same taxpayer. McGraw-Hill, Inc. v. State Tax Commission, 75 N.Y. 2d 852 (1990). The City has filed an Exception to the decision.
- HMO is held exempt from New York City corporate tax as an insurance corporation. In one of the few decisions to address the scope of a 1974 legislative enactment that exempted insurance companies from the New York City general corporation tax (“GCT”), a City ALJ held that a health maintenance organization (“HMO”) was exempt from the GCT as an insurance corporation, and therefore could not be included in Aetna, Inc.’s combined GCT return. Matter of Aetna, Inc., TAT(H) 12-3(GC) and TAT(H) 12-4(GC) (N.Y.C. Tax App. Trib., Admin. Law Judge Div., July 22, 2014). The decision reached the opposite conclusion of the State Tax Department in a 1993 Advisory Opinion holding that HMOs are not engaged in an insurance business for State tax purposes. If upheld, the decision could also impact the State and City taxation of captive insurance companies, which both the State and City have sometimes attacked for allegedly not providing true insurance. The City has filed an Exception to the decision.