NEW YORK STATE AND CITY TAX DEVELOPMENTS · 212.773.1535 jeffrey.gotlinger@ey ... existing NY State...

NEW YORK STATE AND CITY TAX DEVELOPMENTS

Andrew D. Barkin, BTMU (Moderator)Peter L. Faber, McDermott Will & Emery LLP

Jeffrey B. Gotlinger, Ernst & Young LLPRussell D. Levitt, KPMG LLP

Institute of International BankersAnnual Seminar on U.S. Taxation of

International Banks19 June 2009

NEW YORK STATE & CITY TAX DEVELOPMENTS PANEL

DISCUSSION TOPICS

► Legislative Update (J. Gotlinger)Ø New York Metropolitan Commuter Transportation Mobility Tax Ø New York City Proposed Conformity LegislationØ The New Paradigm: Bank Tax Conformity and Convergence of Articles 32 and 9-A

► Combined Reporting: Issues and Developments (P. Faber)

► Audit Controversies (R. Levitt)Ø Sourcing of End-of-Lease Sales [BTMUL&F Case, DTA No. 821525, 11/26/08]Ø New York City Allocated Capital Stock TaxØ IBF Scaleback

► Transfer Pricing: Issues and Developments (J. Gotlinger)

► Bankruptcy: Issues and Developments (P. Faber)

Institute of International BankersAnnual Seminar on U.S. Taxation of International Banks19 June 2009

NEW YORK STATE AND CITY TAX DEVELOPMENTS

Jeffrey B. GotlingerErnst & Young LLP5 Times SquareNew York, NY [email protected]

mailto:[email protected]

Legislative Update

Metropolitan Commuter Transportation Mobility Tax► Enacted May 7, 2009 to fund the Metropolitan Transit Authority► Tax on the payroll expense of employers doing business in the

Metropolitan Commuter Transportation District (MCTD)► Employer Tax Effective March 1, 2009 - Tax rate 0.34%

► Initial payments due November 2, 2009► Tax on self-employment Income, including partners & members of

partnerships and LLC’s doing business in the MCTD► Self-employment Tax Effective January 1, 2009 – Tax rate 0.34%

► Prorated 10/12ths for 2009► Allocation to MCTD based on books & records or BAP per PIT rules

► Self employed – initial estimated payments due November 2, 2009

Metropolitan Commuter Transportation Mobility Tax (MCTMT)

Metropolitan Commuter Transportation Mobility Tax► TSB-M-09(1) MCTMT - State guidance issued June 1, 2009► The MCTMT applies to employers that have “covered employees”

operating within the MCTD required to deduct and withhold tax from wages, and that have a “payroll expense” for all “covered employees”in excess of $2,500 in any calendar quarter

► Payroll Expense – FICA wage base without regard to annual cap► Covered Employees – an employee is deemed to be a covered

employee if the employee’s services are allocated to the MCTD► Payroll expenses for a covered employee that works both within and

without the MCTD cannot be allocated - all of the payroll expenses of such employees are subject to tax


Allocation of employee’s services MCTD:1. Localization -- All of an employee’s services are allocated to the

MCTD if the services are localized in the MCTD (i.e., the services are either performed entirely within the MCTD or are performed both within and without the MCTD and those performed outside the MCTDare incidental to the employee’s services performed within the MCTD).

2. Base of Operations -- If an employee’s services are not localized in the MCTD, then all services are allocated to the MCTD if the employee’s base of operations* is in the MCTD. This test is not applicable if the employee has more than one, or no, base of operations.

*The term “base of operations” means “the place at which the employee is not continuously located, but from which the employee customarily starts out to perform his or her functions in or out of the MCTD.”


Allocation of employee’s services MCTD:3. Place of Direction and Control -- If neither the localized nor the base

of operations test results in the application of all services to the MCTD, then the “place of direction and control” test applied. Under this test, all services are allocated to the MCTD if -► the direction and control emanates from only the MCTD, and

► the employee performs some servicers within the MCTD► The term “direction and control” means “the place from where the

employer directs and controls the activities of the employees. It is not necessarily the location of the principal office, but rather the point from which basic authority over the supervision of services emanates…”


Allocation of employee’s services MCTD:4. Residence -- If the aforementioned tests do not result in clear

allocation of services, the residence test is applied. Under this test, all of the employee’s services are allocated to the MCTD if the employee resides within, and performs some services in, the MCTD

► Note : Employers are prohibited from passing the MCTMT through to employees and, therefore are prohibited from deducting any amount from the employee’s wages or compensation that represents all or any portion of this payroll tax

Legislative Update

New York City Conformity Legislation► Proposal to conform the NYC GCT, UBT, and Bank tax laws to

existing NY State franchise tax provisions of Article 9-A & 32General Corporation Tax Conformity with Article 9-A► Single Sales Factor - 10 year phase in 2009 – 2017► Broker / Dealer customer sourcing rules – effective 2009► Mandatory combination where substantial inter-corporate

transactions exist between affiliates – effective 2009► Mandatory combination with Captive REITs & RICs – (2009)► Capital tax cap raised to $1 million (State $10 million) – (2009)► Fixed dollar minimum taxes – $25 - $5,000 based on NYC allocated

gross receipts – (2009)

New York City Conformity Legislation

City Bank Tax Conformity with Article 32► Net operating loss deduction – losses incurred in 2009 forward► Mandatory combination with Captive REITs & RICs – (2009)► Foreign Banks – alternative tax on assets – effective 2011► Credit Card Banks - economic nexus – effective 2011► Banking corporation – includes investment subsidiaries (2009) ► GLB loop-hole closers – rules limiting grandfathered “9-A Corps”► Mutual fund service companies – Single sales factor -10 year phase-

in 2009 – 2017

Other City Tax Conformity Changes

► Unincorporated Business Tax► Single sales factor -10 year phase-in 2009 – 2017► Broker / Dealer Customer sourcing rules (2009)► Intended to conform the UBT and GCT apportionment rules

► NYC Financial Data match► NYC Voluntary Disclosure & Compliance Provisions► NYS Corporation Law – NYC tax clearance for dissolutions

New York City Conformity Legislation

► Broadest Goals/Principles:► Equity► Economic Efficiency► Simplicity► Ease of Compliance and Administration► Reliability/Stability► Economic Competitiveness► NYC Tax Conformity► Legislation by December 31, 2009

The New Paradigm: Bank Tax Conformity and Convergence of Articles 32 and 9-A

► Specific Goals:► Merge Article 32 into Article 9-A► Allocate income based on single receipts factor using customer

sourcing► Adopt full water’s edge unitary method with ownership

requirement of more than 50%► Do away with the separate treatment of subsidiary capital and

income► Narrow the current definition of investment capital► Eliminate special provisions to the extent possible► Maintain an alternative tax base to serve as a backstop to ENI

Tax► Couple base broadening with significant rate reduction


Points to consider – Foreign Bank Tax Perspective► Maintain ECI as starting point

► Adopt / follow U.S. tax treaties► NOL’s must carry-over to new tax► Eliminate Alternative ENI base

► Allow alien – domestic combination► Elective vs. mandatory combined reporting

► Tax on capital - eliminate tax on gross assets► Reduced rate on investment income

► Assets held for investment► Assets held for regulatory capital requirements► Proprietary trading


COMBINED REPORT ISSUES

Peter L. Faber McDermott Will & Emery LLP340 Madison AvenueNew York, NY 10173Phone: 212-547-5585Email: [email protected]



§ Legislation adopting mandatory combined reports.− More states are likely to move in this direction.

§ NYS: will foreign banks be allowed to combine their U.S. branches with U.S. subsidiaries, despite technically being alien corporations?


§ How is apportionment calculated?− Separate company basis?− Group basis?

§ Are factors of a non-nexus affiliate included in a combined return: Disney Enterprises, Inc. v. Tax Appeals Tribunal.

Institute of International BankersState and Local Tax

Russell D. LevittTax Managing DirectorKPMG LLPNew York CityJune 19, 2009

BTMU Leasing and Finance, Inc., NYSAdministrative Law Judge, DTA# 821524 (11/26/08)

§ NYS Article 32 Bank Tax Case:§ Taxpayer prevailed against asserted deficiency§ State chose not to appeal to the Tax Tribunal§ As an ALJ case, BTMU is not a precedent§ No word on whether the State’s decision not to appeal was

intended as silent acquiescence, or whether, instead, the State intends to disregard the BTMU result and eventually relitigate§ As an apportionment case, there theoretically are taxpayer winners

and losers, hence it wouldn’t seem to be a net big dollar issue for the State

§ Taxpayer was a bank tax classified entity, due to its being a subsidiary of a bank, engaged in a bank-permissible business


§ Issue: Receipts factor sourcing for proceeds from end-of-true-lease (not finance lease) sales of manufacturing equipment, to the lessee/purchasers

§ Facts:§ Taxpayer was a relatively small (at least in terms of

employee headcount) corporation, headquartered in New York City, with other affiliates and its Japanese parent’s New York branch

§ Taxpayer had no other office location


§ Taxpayer’s Japanese parent, back in Japan, maintained relationships with manufacturers that had U.S. operations (such as for automotive parts):§ In a highly competitive environment, when the Japanese parent

learned of a business opportunity for an equipment leasing client in the United States, a high-level deal would be struck, with BTMU and the U.S. manufacturing subsidiary formalizing the contract between themselves

§ Credit investigations by the parent, and third-party appraisals (usually on site, to some extent) were performed

§ The contracts were so-called “integrated” lease-purchase deals:§ The lessees (all, in the United States, located outside New York)

had the option, at the end of the lease, to purchase the equipment for a price that, essentially, had been negotiated and incorporated upfront into the unified lease-purchase contract


§ Only once, in 25 years of experience testified to by BTMU’s vice president and general manager, did the lessee not exercise its purchase option

§ BTMU’s tax return reporting: BTMU receipts factor sourced the end-of-lease sale proceeds (as it had with the prior lease rental stream) to the situs of the equipment

§ The NYS audit division disagreed:§ The State claimed that, because the bank tax regulations are (literally)

silent as to the receipts factor sourcing of sales of tangible personal property, the receipts should be considered “other business receipts”under regulation 20 NYCRR Section 19-6.9§ If correct, then such “other business receipts” would be sourced to where

BTMU had “earned” them


§ Both sides agreed that if the regulations applied, “where earned”would follow the framework of “SINAA” (used to source interest income under bank tax regulation 19-6.2, and to some degree endorsed by the Article 9A Siemen’s case from the Court of Appeals in 1997)§ But the State argued that because BTMU’s only office was in New York

City, “where earned” would settle 100% in the City§ BTMU argued that, if “other business receipts” and “where earned”

governs, then the critical solicitation, negotiation, and de facto final approval role played by its parent in Japan, as well as the investigation of worthiness credit conducted largely outside New York City, and the role played by the appraisers outside New York City, should be countered and heavily weight the SINAA to outside New York City

§ The case proceeded on the assumption that the sale proceeds werederived in the regular course of BTMU’s business and so merited inclusion in the receipts factor


§ BTMU’s primary argument was that the legislative intent should be read in a logical manner, by which the proceeds from the sale of the equipment at the end of the lease are sourced in the same manner as was the lease rental stream, within the bounds of bank tax regulation 19-6:3

§ The ALJ agreed with BTMU’s primary argument, and, so, did not (not even in the alternative) opine on the “other business receipts”/“which earned”/SINAA approach§ The ALJ held that the Legislature’s use of the term “receipt,” in Tax

Law Section 1454(a)(2)(c) [the State mirroring regulation being 19-6.3] is broadly defined in the dictionary, and, especially with an integrated lease purchase contract, should not be read as limited to the periodic lease payments

§ The ALJ held that a more narrow reading would be illogical and unreasonable

New York City Issued Capital Stock TaxAudit Issue for Alien Banks as to Alleged “No-Par” Stock

§ Background§ The NYC bank tax, since 1985, imposes, as an

alternative base applicable to only alien banking corporations, a so-called “issue capital stock” tax. (NYC Administrative Code Section 11-643[b][5][2] and Bank Tax Rules Sections 3-03[a][1][iii][A][2] and 3-03[f]):§ For U.S. banking corporations, the City’s relevant alternative

tax is on (apportioned) “assets.” (NYC Administrative Code Section 3-03[e])

§ The NYS alternative tax is on (apportioned) assets, as to both U.S. and alien banking corporations

§ Business tax “conformity” (to NYS) legislation, introduced by the City for proposal in Albany, during May 2009, would repeal the alien bank issue capital stock tax, in favor of the assets tax, come 2010


§ The City bank tax rate, on (apportioned) issued capital stock, is 0.26%:§ The audit issue that has arisen keys off the

statutory distinction relative to valuation, by which:§ Par value stock is valued by the “face-value,” which

the City regulation says is “the value written or printed on the face of the instrument” on the last day of the tax year (Rule Section3-03[f][1][i] & [ii]); and

§ Shares without par value are valued at actual or market value, as of the last day of the tax year. (Rule Section 3-03[f][1][i])


§ The NYC Dept. of Finance Audit Policy:§ If the stock certificates do not include a stated value, then they are

“no-par,” and tend to be taxed considerably more adversely than if they were considered to be par shares

§ With the advent of the Euro currency, in the case of non-fractional designations, banks reissued what had historically been, clearly, par value shares, as, now (literally translated), notional “no-par”shares:§ City auditors assert that those are “no-par” shares, valued at FMV§ The City Department of Finance’s legal advocates assert that this

category of stock issuance resembles that long permitted by New York Business Corporation Law Sections 102 and 506 – as “no-par stock”with stated value – and is taxed as “no-par” stock

§ The City is unpersuaded that it is illegal to issue no-par stock under the laws of the European Union


§ Case law and rulings shed too little light to be decisive:§ Roberts & Schaefer v. Emmerson, 271 U.S. 50 (1926): The

differences between par and no-par stock are sufficient to justify a difference in treatment under the Illinois franchise tax

§ New York v. Latrobe, 279 U.S. 421 (1929): Citing Roberts, the court held that New York State’s foreign license fee, which measures the tax differently for par and no-par stock, is constitutionally based on a reasonable classification because ofthe different characteristics

§ Gulf Oil Corporation v. New York State Tax Commission, 65 AD2d 157 (3rd Dept. 1922): Foreign License fee case, exemplifies how little litigation there has been on the foreign license fee

§ Terminal and Town Taxi Corporation v. Walsh, 202 AD 651 (3rd Dept. 1922): Under Tax Law Section 181, the foreign license fee was assumed to be $100 per share for no-par stock. The court held this was so excessively different compared to the tax on “par stock” as to be unconstitutional


§ New York State Tax Department internal memo of Counsel (1/29/1991) concludes that California stock is no-par for New York State’s license fee, even though the California legislature (which ended such distinction) included a statute that “deems” it as par to the extent another state cares

§ Taxpayers potentially could argue for nondiscrimination treatment, as compared to a U.S. banking corporation which computes tax under the “assets” method and not under the “issued capital stock” method, either via:§ Treaty (if any provision in a relevant treaty even exists) and/or§ The Foreign Commerce Clause of the U.S. Constitution§ The City has shown amenability, in general, to allowing alien banking corporations

to file their NYC-1 returns as if they were a U.S. corporation (and compute an assets tax instead of an issued capital stock tax, etc.), but the City’s Department of Finance Letter Rulings then require that such NYC-1 return be computed fully on a worldwide (not ECI-limited etc.) approach, since that’s how a U.S. banking corporation would complete the return (See, e.g., FLR#034810-006 [October 15, 2003])

NYS Tax Department Audit Guidelines for IBF Deposits & Payroll Factors Numerator Eligibility:Scaleback Ratio

§ The methodology that follows is taken directly from the official audit guidelines

§ The following steps should be taken when determining the proper amount of eligible IBF (International Banking Facility) deposits to be excluded from NY when using IBT formula allocation under regulation 19-2.3(b)(3):

1) Obtain a listing of IBF deposits included in the books and records of the IBF

2) Isolate those deposits that are placed by foreign third parties. This amount represents the eligible deposits of the IBF

3) Determine the gross income ratio. The ratio is computed as follows:IBF eligible third-party gross income = % (eligible gross income ratio IBF gross income (a))§ (a) IBF gross income included Non Effectively Connected Income (NECI), and

interbranch income


4) The gross income ratio determined in step 3 should then be applied against the eligible deposits of the IBF which were determined in step 2. The result will be the deposits, the expenses of which are attributable to the production of eligible gross income of the EBF per regulation 19-2.3(b)(3)

§ The following procedures should be taken when determining the proper amount of eligible IBF wages to be excluded from NY when using the IBF formula allocation under regulation 19-2.3(b)(1):

1) Obtain a listing of NY wages from the taxpayer2) Determine the amount of NY wages that are indirectly attributable

to the IBF by using either the (a) gross asset, or (b) gross income methods as prescribed in regulation 18-3.8(b)(1) and (2)


a) The gross asset ratio is determined as follows:Average IBF third-party gross assets excluding goodwill & Non Effectively Connected Assets (NECA)Average NY third-party gross assets (including IBF) excluding goodwill and NECA

b) The gross income ratio is determined as follows:IBF third-party gross income excluding NECI NY third-party gross income (including IBF) excluding NECI

3) The ratio determined in step 2 (a) or (b) above should be applied to NY wages determined in step 1 to determine the amount of NY wages that are attributable to the IBF

4) The result computed in step 3 must then be multiplied by a grossincome ratio to determine the amount of IBF wages that are attributable to the production of eligible net income of the IBF

§ The gross income ratio for this purpose is computed as follows:IBF eligible third-party gross incomeIBF gross income including NECI and interbranch income

State & Local Tax Transfer Pricing Issues & DevelopmentsJeffrey B. GotlingerErnst & Young LLP5 Times SquareNew York, NY [email protected]


► States are aggressively auditing intercompany transactions► Separate reporting states (NJ)

► Adjustments to income or expenses – royalties / interest ► Inter-company receivables – input income ► Shared Services companies – cost sharing arrangements► Employee service companies – arms length pricing

► Combined reporting states (NYS & City)► Distortion tests / requirements

► Water’s edge unitary States (IL, MN)► U.S. – foreign affiliated transactions

► State 482 powers - statutes & regulations► Cost vs. markup / profit► Domestic vs. foreign transfer pricing models / policies

State & Local Tax Transfer Pricing Issues & Developments

► New York State & City Audits► Looking to combine non-nexus affiliates► Distortion assumed where substantial intercompany

transactions► Core business transactions► Cost sharing / marketing

► Common officers / management ► Contracts – approval & signing ► Shared core services

► Transactions between Article 32 & 9-A affiliates► Service arrangements ► Business purpose► Apportionment factors


► Audit defense / solutions ► Adequate transfer pricing studies

► Match domestic (state) and foreign (International) policies► Transaction based vs. profit based

► Business purpose► Transactions in-line with business objectives► Substance – independent operations and business activities► Agreements & cash flows must be followed

► Combination / distortion► Non-core services / cost sharing► 482 adjustments


BANKRUPT AND INSOLVENT COMPANIESSTATE TAX ASPECTS

Peter L. Faber McDermott Will & Emery LLP340 Madison AvenueNew York, NY 10173Phone: 212-547-5585Email: [email protected]


STATE TAX CONSEQUENCES CAN VARYFROM FEDERAL TAX CONSEQUENCES

§ Reasons.§ Differences in filing status (consolidated, combined, and separate

returns).§ Differences in asset basis.

§ Need to examine state tax aspects separately.

CANCELLATION OF DEBT INCOME(CODI): FEDERAL RULES

§ The amount of cancelled debt is generally income to the debtor (I.R.C. sec. 108) unless:− The debtor is in a title 11 bankruptcy case, or− The debtor is insolvent (in which case the exclusion is limited to the amount of the

insolvency).§ Excluded CODI reduces favorable tax attributes in the following order.

− Net operating losses.− General business credits.− Capital loss carryovers.− Basis of property.− Passive activity loss and credit carryovers.− Foreign tax credit carryovers.

§ Election to reduce basis of depreciable property before other tax attributes

FEDERAL ATTRIBUTE REDUCTION:CONSOLIDATED RETURNS

§ Insolvency and bankruptcy are determined on a separate entity basis.

§ Reduction of tax attributes.− First applied to the debtor.− If all the debtor’s attributes are exhausted, then applied to the debtor’s

subsidiaries.− Then applied to the tax attributes of other group members.

§ The attributes of each corporation include its share of the group’s attributes.

§ Reduction of the debtor’s basis in a subsidiary’s stock requires a reduction in the subsidiary’s tax attributes.

CODI: STATE TAX ISSUES

§ States generally adopt sections 108 and 1017, expressly or through their general conformity rules.

§ Even if a state adopts sections 108 and 1017, problems can arisebecause of different filing status (i.e., the state combined or consolidated group is not the same as the federal group).

§ Even when the group is the same, some states don’t adopt the federal consolidated return regulations, other adopt parts of them, and others adopt their principles in a general sense but are notspecific.

§ State asset basis can differ from federal asset basis (e.g., when there are different depreciation rules), resulting in different consequences when asset basis is reduced under section 1017.

REDUCTION OF NOLs IN ACQUISITIONS:IRC SEC. 382§ General rule: The use of a corporation's NOLs and certain other

attributes is limited when there is a more-than- 50% change in shareholders.

§ Application: The use of NOLs in a post-change year is limited to a percentage of the corporation’s value on the date of the change in shareholders representing a reasonable investment return on thatvalue.

− Reason: eliminate an incentive to pay more when buying a corporate business because the target has NOLs.

SIGNIFICANCE OF SECTION 382

§ Workouts often involve changes in shareholdings of the debtor.

§ Workouts sometimes involve the sale of assets of the debtor.

SECTION 382: SPECIAL BANKRUPTCY RULES

§ Under Sec. 382(l)(5), there is no sec. 382 limit if the corporation is in bankruptcy and pre-change shareholders and “qualified” creditors end up owning at least 50% of the corporation’s stock.§ NOLs are reduced by interest paid on debt that is converted to stock.§ The NOL sec. 382 limit goes to 0 if there is another 50% ownership

change within 2 years after the change subject to 382(l)(5).§ The debtor can elect of sec. 382(l)(5).

§ Then, the sec. 382 limit is based on the post-emergence value of the corporation (including debt exchanged for stock in the reorganization).

SECTION 382: STATE TAX ISSUES

§ Most states adopt section 382, expressly or through federal conformity provisions.

§ Some states have their own NOL regimes, which are generally intended to limit the use of NOLs.§ In these states, an argument can be made that section 382 principles do

not apply if they are not included in the state NOL rules.§ Problems may occur because of differences in composition of federal

consolidated group and state consolidated/combined group.§ Differences between federal and state asset basis can affect

calculation of built-in gains and losses.

SECTION 382: ALLOCATION OF 382 LIMIT

§ Allocation of value within a federal consolidated group can be unclear.

§ General federal approach: determine the value of the whole groupand allocate it among the members, starting with the lowest tier.

§ Lower-tier subsidiaries may have a higher value than the group as a whole because of the parent’s debt.

§ A subsidiary can elect to allocate part or all of its sec. 382 limit to its parent.

ALLOCATION OF 382 LIMIT: STATE TAX ASPECTS

§ Most states do not address how to handle apportionment issues, leaving taxpayers (and revenue departments) some room to maneuver.

§ Some states (e.g., GA, DC, MN) require the limit to be apportioned based on the company’s overall apportionment percentage in the year in which the NOL is used.

§ Can one argue that apportionment should be based on the factors in the years in which the losses were sustained?− Tracing problems.

GENERAL NOL ISSUES

§ Some states have shorter NOL carryover periods than under the federal rules, so NOLs in some states may have expired.

§ NOLs may have been extinguished in states that do not allow NOLs to pass to the acquiring corporation in a tax-free reorganization.− This could be a problem in corporate transactions occurring pursuant to the

workout.

OTHER BANKRUPTCY ISSUES:TRUST FUND TAXES

§ Liability of responsible persons for trust fund taxes is not affected by the corporation’s bankruptcy and is not discharged in the bankruptcy proceeding.

§ State revenue departments are more aggressively pursuing responsible persons in the context of routine sales and employment tax audits, even when there is no reason to anticipate bankruptcy.

QUESTIONS?

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