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Multistate Tax Alert: New York State Proposes Amendments to Regulations Addressing Combined Reports

Department Will Accept Comments through October 27, 2012


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Overview

The New York State Department of Taxation and Finance (the “Department”) recently proposed amendments primarily addressing  the combined reporting regulations applicable to general business corporations (including REITs and RICs) subject to the tax (Franchise Tax) imposed by Article 9-A of the New York Tax Law.  The New York Tax Law provides generally that “related corporations” with “substantial intercorporate transactions” must file a combined report.  Current guidance from the Department on combined reporting is provided in TSB-M-08(2)C (Mar. 3, 2008), from which many of the proposed amendments are derived. In this External Tax Alert we summarize how the proposed amendments differ from the guidance contained in TSB-M-08(2)C and, in certain instances, the currently applicable regulation.

TSB-M-08(2)C and the proposed regulations compared

The requirements for filing a combined report set forth in the proposed amendments are in many respects similar to the requirements set forth in TSB-M-08(2)C. However, the proposed regulations contain the following notable changes from TSB-M-08(2)C:

  • TSB-M-08(2)C does not contain an explicit unitary business requirement for mandatory combined reporting arising from substantial intercorporate receipts or expenditures (although it appears highly unlikely that a taxpayer could be subject to mandatory combined reporting under these tests without being part of a unitary business). Proposed Reg. Sec. 6-2.1(a) includes a unitary business requirement that is essentially the same as that found in current Regulation Sec. 6-2.2(b).
  • Proposed Reg. Sec. 6-2.3(b)(2) states that “[i]nterest paid and received on loans between related corporations is considered in determining if there are substantial intercorporate transactions, including interest on loans that constitutes [sic] subsidiary capital pursuant to section 3.6 of this Title and section 208.4 of the Tax Law.” In contrast, under TSB-M-08(2)C, interest paid and received on loans treated as subsidiary capital does not qualify as an intercorporate transaction. In addition, Proposed Reg. Sec. 6-2.3(b)(2) states that taxes paid or reimbursed will not be considered in determining if there are substantial intercorporate transactions. TSB-M-08(2)C does not address this point.
  • Proposed Reg. Sec. 6-2.3(b)(1)(v) states that “[i]n determining whether there are substantial intercorporate transactions, the Commissioner will consider and evaluate all activities and transactions of the taxpayer and its related corporations, including but not limited to. . .incurring expenses that benefit, directly or indirectly, one or more related corporations.” This does not appear to be an expansion upon the previously established guidance of TSB-M-08(2)C. Proposed Reg. Sec. 6-2.3(b)(2) adds language stating that “[i]ntercorporate cost allocations are not considered.” Thus, a mere allocation of costs to an affiliate does not appear to be an intercorporate transaction. The precise dividing line between cost allocations and expenditures incurred on behalf of an affiliate (which are intercorporate transactions under TSB-M-02(8)C and the proposed regulation) is not entirely clear.
  • TSB-M-08(2)C contains three separate tests for mandatory combined reporting: one based on substantial intercorporate receipts, one based on substantial intercorporate expenditures (including expenditures incurred on behalf of related corporations), and one based on substantial intercorporate asset transfers. Proposed Reg. Sec. 6-2.3(b)(3)(i)(a)(3) would add an additional test based on whether “during the taxable year a corporation’s expenditures (excluding nonrecurring expenditures) directly or indirectly benefiting a related corporation or a group of related corporations are equal to 50 percent or more of the sum of such expenditures and the expenditures (excluding nonrecurring expenditures) of the beneficiary corporation or corporations.” (emphasis added) 

        In contrast, TSB-M-08(2)C states that:

Expenditures incurred by a corporation that directly or indirectly benefit a related corporation can constitute substantial intercorporate transactions. For example, when a related corporation is incurring expenditures that benefit another related corporation and the amount of those expenditures represent [sic] 50% or more of the expenditures of the first corporation or are equal to 50% or more of the direct and indirect expenditures of the beneficiary corporation, the substantial intercorporate transactions requirement is satisfied. (emphasis added)

It appears that the use of the word “and” in the proposed regulation, instead of “or” as found in TSB-M-08(2)C would result in a larger denominator when testing whether expenditures directly or indirectly benefiting a related corporation or a group of related corporations constitute substantial intercorporate transactions. Moreover, the proposed regulation contemplates that expenditures to be taken into account for purposes of this test include a corporation’s expenditures directly or indirectly benefitting a related corporation or a “group of related corporations” while the test as articulated in TSB-M-08(2)C appears to be limited to those expenditures directly or indirectly benefitting a related corporation.

  • Proposed Reg. Sec. 6-2.3(b)(3)(ii)(a) states that for purposes of meeting the test for substantial intercorporate asset transfers, in general, assets are considered “qualifying assets” only to the extent that they are transferred in exchange for stock or paid-in capital. Transfers of assets other than in exchange for stock or paid-in capital, including transfers of assets through a nonmonetary property dividend, are not considered unless the principal purpose of the transfer is the avoidance or evasion of the franchise tax imposed on the taxpayer or the combined group by New York State. TSB-M-08(2)C provides that only transactions in which assets are exchanged for stock or paid-in capital of the transferee are to be considered. The requirement in TSB-M-08(2)C that the transferor receive stock from the transferee or that the transferee have an increase in its paid-in capital was apparently intended to eliminate from qualifying assets any assets transferred in dividend distributions.The proposed amendment appears to modify that requirement so that a nonmonetary property dividend would be considered a transfer of qualifying assets if the principal purpose of the transfer is the avoidance or evasion of the franchise tax imposed on the taxpayer or the combined group by New York State.
  • Under TSB-M-08(2)C, a transfer of assets to a related corporation will satisfy the substantial asset transfer test where 20% or more of the transferee’s gross income, including any dividends received, in the taxable year of the transfer or in taxable years subsequent to the year the asset or assets were transferred is derived directly from the transferred assets and the corporations are engaged in a unitary business. Proposed Reg. Sec. 6-2.3(b)(3)(ii)(e) would expand the treatment of income from the sale of items produced from transferred production equipment for purposes of meeting the test for substantial intercorporate asset transfers. The proposed amendment provides that income from the sale of items produced from transferred production equipment, by itself, would not constitute gross income derived directly from the transferred assets, but a transfer of assets constituting substantially all of the production process, including associated intangibles, such as might occur in the transfer of an operating division, would constitute gross income derived directly from the transferred assets.3 As described in TSB-M-08(2)C, income directly derived from a transferred asset is more narrowly defined. TSB-M-08(2)C states that gross income from transferred assets that generate income only when used in combination with other assets is not derived directly from the assets. An example in TSB-M-08(2)C involves the transfer of a lathe to a related corporation. The lathe is one of many machines used on the production line. Therefore, income from the sale of the products produced through the use of the lathe is not considered income directly derived from that lathe. The example provides further that this answer holds true even if all of the equipment used to make the product was transferred to the transferee. Thus, the proposed regulation would significantly expand the substantial asset transfer test relative to the previously established guidance of TSB-M-08(2)C.
  • Also, for purposes of meeting the test for substantial intercorporate asset transfers, Proposed Reg. Sec. 6-2.3(b)(3)(ii)(h) states that if the asset transferred is an interest in another entity, including a partnership, an entity treated as a partnership or a disregarded entity, the interest in the entity is considered the transferred asset and income distributed or deemed distributed to the transferee by such entity is gross income derived directly from the transferred asset. This appears to be the case even though, in general, New York State respects federal treatment of disregarded entities.

This leaves open the possibility that income from a transferred LLC or partnership interest, whose assets constitute less than substantially all of a production process, is gross income derived directly from the transferred asset when income directly derived from such assets would not constitute gross income derived directly from the transferred assets under Proposed Reg. Sec. 6-2.3(b)(3)(ii)(e) discussed above.

  • Proposed Reg. Sec. 6-2.3(c) would be a new regulation setting forth 10 steps that should be used to determine whether a combined report is required and, if so, which corporations are included in that combined report. Those steps generally parallel the steps set forth in TSBM-08(2)C other than in two instances. Regarding step 2, TSB-M-08(2)C states the following:

Identify all of the related corporations that have substantial intercorporate transactions with any taxpayer identified in Step 1. These related corporations and the taxpayers constitute the Step 2 tentative combined group.

        The proposed regulation describes step 2 as follows:

Identify all of the related corporations that have substantial intercorporate transactions with a taxpayer identified in Step 1. These related corporations and the taxpayer with which they have substantial intercorporate transactions constitute the Step 2 tentative combined group.

Thus it appears that the proposed regulation would change the second sentence to “these related corporations and the taxpayer with which they have substantial intercorporate transactions” to eliminate the potentially confusing language in TSB-M-08(2)C where seemingly all related taxpayers (and those corporations identified as related to those taxpayers in step 2) are to be automatically combined regardless of whether there were substantial intercorporate transactions among those related taxpayers.

For step 10, the proposed regulation would add New York S corporations and non-New York taxpayer federal S corporations to the list of corporations eliminated from combination. 

  • Proposed Reg. Sec. 6-3.2(b) confirms that it is not necessary that all corporations in the combined group have the same accounting period. This is consistent with TSB-M-08(2)C,but is a change to the existing regulation.

Although not triggering a comparison with TSB-M-08(2)C, it is noteworthy that Proposed Reg Sec 6-2.2(a)(3) changes the ownership test for combined reporting. Current regulation section 6-2.2(a)(2) bases the ownership test on the percentage of voting stock owned by the affiliated corporations. The proposed regulation bases the test on the percentage of voting power owned by the affiliated corporations.

Department will accept comments through October 27, 2012

The Department is accepting public comments on these proposed regulations through October 27, 2012.

You can also download the attached Alert. To receive these alerts and stay connected, please sign up for our weekly newsletter State Tax Matters.

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1 New York State Register, Sept. 12, 2012. The proposed amendments generally provide guidance with respect to amendments made in 2007 to N.Y. Tax Law Sec. 211.4.

2 N.Y. Tax Law Sec. 211.4.

3 Proposed Reg. Sec. 6-2.3(b)(3)(ii)(e); Proposed Reg. Sec. 6-2.3(b)(3)(ii)(k) Ex. 2.

 

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