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New York State and City Corporate Tax Reforms for the 2015 Tax Year
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Speakers
Jon Zefi LL.M., J.D., M.B.A.PrincipalEisnerAmper LLP750 Third AvenueNew York, New York [email protected]
Stephen J. Bercovitch, J.D.Director, State and Local TaxesEisnerAmper LLP750 Third AvenueNew York, New York [email protected]
Speakers
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Jennifer Banister, J.D., M.B.A., LL.M.SeniorEisnerAmper LLP750 Third AvenueNew York, New York [email protected]
Agenda
1. Income Classifications a. Business Incomeb. Investment Income c. Expense Attributiond. Investment Capital
• Identification Requirements 2. Apportionment
a. Qualified Financial Instruments b. Marked to Market Treatment
3. New York City Reforms a. S Corporation Treatment
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Prior to 2015 New York Corporate Taxation
• The highest tax calculated under four alternative tax bases:• Entire Net Income (“ENI”)
– Business Income Base (Allocated by the “Business Allocation Percentage” or “BAP”)
– Investment Income Base (Allocated by the “Investment Allocation Percentage” or “IAP”).
• Capital Tax Base (.15% for State, .15% for City) on capital allocated at BAP– Capital Tax is capped at $350,000
• Minimum Taxable Income Base (ENI modified by certain preference items)
• Fixed Dollar Minimum Tax, capped at $5,000
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Prior to 2015 New York Corporate Taxation
• Plus:• Subsidiary Capital Tax (at .09% or $9 per
$1,000) is then computed and added to the highest tax calculated under the four alternative bases– Because subsidiary capital is taxed separately,
interest expenses and other expenses were added back to federal taxable income.
• Note: Investment capital specifically included: stocks and similar corporate equity instruments, bonds, and other securities
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I. New Income Classifications
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Unitary business concept
• The tax on the combined report is the highest of the following three bases:
– The combined business income multiplied by the Business Allocation Percentage (“BAP”) (receipts at 100%) and the business income tax rate (7.1%, lowered to 6.5% in 2016);
• Business income equals ENI less investment income and other exempt income
– The combined capital base multiplied by the BAP and the capital base tax rate (0.15% lowered to 0.125% in 2016);
– The fixed dollar minimum (“FDM”) tax (capped at $200,000 for companies with New York receipts over $1 billion). A special FDM rate applies to manufacturers and Qualified Emerging Technology Companies (capped at $4,385)
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Business Income
• Business income includes:– Interest income – Gains and losses from debt instruments or other
obligations• unless the income cannot be included in apportionable
business income under the U.S. Constitution
– Gains and losses from stock of a unitary corporation
– Dividends and gains and losses from stock held in a non-unitary corporation for one year or less
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Investment Income
• Investment income is income derived from investment capital less any interest deductions directly or indirectly attributable to investment capital or income.
– Exempt from tax
– May not exceed entire net income (ENI).
– Any excess amounts of interest deductions over investment come must be added back to ENI
• Investment income is limited to 8% of the taxpayer’s ENI
– Determined without regard to interest deductions
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• Attribution must be done in one of two ways: 1. An add back of interest expenses directly and indirectly
attributable to investment and other exempt income• If the actual expense exceeds the income, the excess is added
back to ENI• Other exempt income includes CFC dividends and dividends from
unitary corporations not in the combined group.• Taxpayers are no longer required to attribute hedging expenses to
investment income.
2. An annual election to reduce investment income by 40% in lieu of assigning actual interest deductions. • Election is applied after the 8% “cap” on investment income• Election applies to all members of the combined group• The election is revocable 11
Expense Attribution for Tax Exempt Income
Expense Attribution for Tax Exempt Income
• Companies should consider making the 40% election: – if their actual interest expenses are higher than 40% or – if computing actual interest expense is too complicated
• Revocation of the 40% election for investment income also applies to:– exempt CFC income
• Income received from a controlled foreign corporation that is conducting a unitary business but is not included in the combined group. This includes Subpart F and IRC Section 956 dividends.
– exempt unitary corporation dividends
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Tax on Subsidiary Capital Eliminated
• The ENI deduction for income from subsidiary capital no longer exists.
• Each item of income that qualifies as income from subsidiary capital will now be classified as either:
– Investment income
– “Other exempt income”
– Business income
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Investment Capital
1. Satisfy the definition of a “capital asset” under section 1221 of the IRC at all times the taxpayer owned the stock during the taxable year;
2. Are held for investment for more than one year;
3. The dispositions of which are, or would be, treated by the taxpayer as generating long-term capital gains or losses under the IRC;
4. Have never been held for sale to customers in the regular course of business at any time after the close of the day on which they are acquired;• For stocks acquired on or after January 1, 2015 14
Investment capital is redefined as investments in stocks that:
Investment Capital
5. Before the close of the day on which the stock was acquired, are clearly identified in the taxpayer’s books and records as stock held for investment. (“Identification Requirement”)
Other requirements are:
• The issuer of the stock is not conducting a unitary business with the taxpayer;
• The issuer and the taxpayer are not filing a combined NYS return under an election that permits non-unitary corporations to combine.
– A corporation is presumed not to be unitary with the taxpayer if the taxpayer owns or controls less than 20 percent of the voting power of the corporation’s stock.
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Investment Capital: Identification
Identification for IRC § 1236 Dealers – Stock acquired must be clearly identified in the
corporation’s records as stock held for investment under IRC section 1236(a)(1)
– A separate New York identification is not allowed – The presence or absence of the Federal identification under
IRC section 1236 is determinative – Identification of the stock as held for investment for
purposes of IRC section 475 is not sufficient.– In the absence of federal identification the stocks will be
treated as business capital producing business income
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Investment Capital: Identification
Identification for Non-Dealers 1. The stock must be recorded in an account maintained
for investment capital purposes only
• Must be separate from any account maintained for stock held for sale to customers
• May be an account maintained:
– in the taxpayer’s books of account for recordkeeping purposes only or
– a separate depository account maintained by a clearing company as nominee for the corporation
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Investment Capital: Identification
2. The Investment Capital Account must disclose: • the name of the stock• the CUSIP number of the stock (or CINS number)• date of purchase • the number of shares purchased • the purchase price of the stock.
– If the stock is sold, the investment capital account also must disclose:
• the date of sale • the number of shares sold • the sales price for that stock.
– The investment capital account must be set up in a manner that readily identifies the length of time the stock was owned by the corporation.
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Investment Capital: Identification
• If the corporation is a partner in a partnership and is using the aggregation method to compute its tax: – the corporation’s proportional part of the stock owned
by the partnership may qualify as investment capital if the statutory requirements for investment capital are satisfied at the partnership level.
– A partnership’s identification of investment capital can benefit a corporate partner up the chain that is domiciled outside of New York, yet could be filing in New York.
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Investment Capital: Identification
• Stock Options – If stock is acquired under an option, the stock will
be treated as investment capital only if the corporation identified the option in its records as being held for investment on the day on which the option was acquired.
• Combined Returns – If corporations file combined returns, each
corporation in the return that is not a dealer subject to section 1236 must maintain its own investment capital account and follow the required identification procedures.
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Issues Raised
• Tiered partnership issues– The source and character of the partner’s distributive share
of each partnership item that is attributable to the lower-tier partnership will be retained.
• Partnerships with no New York State tax nexus
• Corporate merger and acquisition context – Section 338(h)(10) transactions and the need to identify
investment capital on the same day
• Stock purchase agreements
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II. Apportionment
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Business Income
• The new law implements a single receipts apportionment factor using customer based sourcing rules for all taxpayers– Receipts from digital products are generally sourced to the
customer’s primary use location of the product.
• Taxpayers are required to use a hierarchy for financial transactions relying on commercial domicile for sourcing income: – Seat of management and control – Billing address of the customer **The Treasury Function provision was removed from the hierarchy for financial transactions**
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Treatment of Excess Investment income
• If investment income exceeds the 8% “cap” of a corporation’s ENI the “excess” investment income that it creates on the apportionment factor will be applied to business income. – Excess investment income will be sourced under the
general customer sourcing rules for financial instruments
– Dividends and net gains from sales of stock are not included in either the numerator or denominator of the apportionment formula.
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Qualified Financial Instruments
• New sourcing rules created for apportioning income from financial instruments.
• Qualified Financial Instruments (QFIs) is defined as an instrument of the type described in the financial transactions sourcing rules (see following slide) and has been marked to market under IRC Sections 475 or 1256.
• Additionally, if a taxpayer has marked to market an instrument of the type listed (on the next slide), then any financial instrument within that type that has not been marked to market under IRC Sections 475 or 1256 is also a QFI.
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Qualified Financial Instruments
• The types of instruments that are specifically referenced in the financial transactions sourcing rules are: – Loans*
• If at the inception of the loan 50% or more of the value of the loan collateral consists of real property, the loan cannot qualify as a QFI
– Federal, State and Municipal debt– Asset-backed securities and other government agency debt – Corporate bonds – Dividends and net gains from sale of stock or partnership
interests – Other financial instruments – Physical commodities
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QFI Apportionment Rules
• Taxpayers can use one of two sourcing methods for financial instruments:1. “Customer” based sourcing for each income stream
2. Elect to apportion 8% of the QFI net income (dividends, interest and gains) to New York• If the election is made, then all QFI income is treated as
taxable business income.• Irrevocable election made on an annual basis and applies
to all QFI income of all members of the combined group• When sourcing net income from QFIs, 8% of all marked to
market net gains should be included in the numerator of the apportionment factor
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Apportionment & Marked to Market Issues
• Some of the apportionment changes reflect a potential mismatch in application of the customer sourcing rules to marked to market income.– Income from financial instruments also became subject
to the customer sourcing rule under the corporate reform – However, customer sourcing may prove to be impossible
to source to the purchaser’s location if the financial instrument has not bee sold by the end of the year.
– Therefore, new apportionment methods have been adopted for both net gains and net losses.
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Sourcing Marked to Market Income
• The amount of marked to market net gains included in the numerator of the apportionment fraction for each type of financial instrument is determined by multiplying the marked to market net gains from that type of financial instrument by a fraction: – The numerator which is equal to the net gains (usually
interest and net gains from sales) included in the numerator of the apportionment formula under the customer sourcing rules for that type of financial instrument
– The denominator of which is equal to all of the net gains (usually interest and net gains from sales) included in the denominator from that same type of financial instrument.
• All marked to market net gains from such financial instruments would be then included in the denominator of the apportionment formula.
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Sourcing Marked to Market Income
• If the taxpayer has a net loss from that type of financial instrument or the financial instrument is not sourced by customer sourcing rules, then the amount of otherwise unsourced marked to market income will be included in the numerator of the apportionment factor by multiplying such unsourced marked to market net gains by a fraction: – The numerator includes all of the receipts included in the numerator
of the business apportionment formula from the customer sourcing rules applicable to financial instruments plus all previously sourced marked to market income that is in the numerator
– The denominator consisting of all receipts included in the denominator under the customer sourcing rules applicable to financial instruments and previously sourced marked to market income included in the denominator.
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Sales Factor Apportionment from Financial Transactions
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Type of Financial Instrument Sales Factor Treatment
Interest from corporate bonds Commercial domicile of the issuing corporation
Gains from sale of corporate bonds sold through a broker dealer or on an exchange
8 percent rule
Interest from other financial instruments Location of the payor (i.e., seat of management and control)
Gains from sale of bonds sold otherwise Use ratio of gross proceeds of sales to purchasers located in NY, over total gross proceeds
Stock dividends Excluded from apportionment
Net gains from the sale of stock and net gains from the sale of partnership interests
Excluded from apportionment, although Commissioner retains discretion to require inclusion in the event of distortion
Sales Factor Apportionment from Financial Transactions
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Type of Financial Instrument Sales Factor Treatment
Federal funds 8 percent rule
Federal, state and municipal debt (interest and net gains) of New York or its subdivisions
Zero in the numerator, 100% includible in the denominator
Municipal debt issued by other states and their political subdivisions
Zero in the numerator, 50% includible in the denominator
Asset backed securities and other government agency debt (GNMA, FNMA)
8 percent rule
Reverse repurchase agreements 8 percent rule
Physical commodities Net income included based on physical delivery within the State or absent physical delivery, sale to purchasers in the State
Apportionment & the Capital Tax
• The Capital Tax is apportioned by the BAP.• Planning solutions
– Invest in• Instruments that are not taxed
– (stock held more than one year)
• Federal and New York State and municipal debt – (zero apportionment to BAP)
• Corporate bonds of issuers with a treasury with the seat of management and control outside of New York State
– Avoid• Corporate bonds of New York State issuers
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Dealing with the Capital Tax
Capital Tax Example: • A start-up company has $100,000,000 in capital• Apportioned at a Business Allocation Percentage of
100%– $100,000,000 * .15% Rate
• Results in a Capital Tax of $150,000
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Financial Services Investment Tax Credit
• The Investment Tax Credit may not be taken for property first placed in service on or after October 1, 2015. – Ending the investment tax credit for financial services
companies as of October 1, 2015. – For property placed in services before that date, the
updated reforms restore the provision permitting the aggregation of use by certain affiliates to meet the statutory qualifying use requirement.
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III. New York City Corporate Tax Reform
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New York City Reforms
• The New York City reforms largely conform to the New York State corporate franchise tax provisions.
• Changes will be effective as of January 1, 2015 which is the same effective date for the New York State corporate tax reform.
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New York City Reforms
• New York City does not adopt any “economic nexus” provisions (except for credit card banks)
• Instead of using a single rate for all taxpayers, New York City will impose a higher tax rate (9%) on the business income base for certain large financial corporations than will be imposed on other corporations (8.85%). – Qualified manufacturers will not receive a 0% rate in the
city. The lowest potential rate will be 4.425%.
• New York City enacts an “election” to have a modified 3-factor formula apportionment even after the single factor phase in is complete.
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New York City Reforms
• New York City’s taxation of federal S Corporations will not change as a result of the corporate reforms.
• S Corporations will continue to be subject to the General Corporation Tax (“GCT”) under Subchapter 2 of Chapter 6 of Title 11– There are potential issues with combined returns in New
York City that have not been addressed now that federal C Corporations will be taxed under Subchapter 3A.
• For City purposes, but not for New York State purposes, federal S Corporations will continue to use the IAP to apportion investment income and capital under the GCT.
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New York City Reforms
• For federal S Corporations, apportionment for New York State and City purposes is de-coupled
• S Corporations remain subject to the GCT “services performed” sourcing rules – Instead of the new customer based sourcing rules
applicable under New York State Corporate tax reform.
• New York State non-resident S Corporation shareholder pass-through income sourced under new rules– With entity level tax imposed by the City computed under
the current GCT rules.
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Questions?
Jon Zefi LL.M., J.D., M.B.A.PrincipalEisnerAmper LLP750 Third AvenueNew York, New York [email protected]
Stephen J. Bercovitch, J.D.Director, State and Local TaxesEisnerAmper LLP750 Third AvenueNew York, New York [email protected]
Questions?
Jennifer Banister, J.D., M.B.A., LLMSeniorEisnerAmper LLP750 Third AvenueNew York, New York [email protected]
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IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.
EisnerAmper LLP is an independent member firm of PKF International Limited
