New York: NYC conformity provisions, technical corrections

NYC conformity provisions, technical corrections

New York Governor Cuomo on April 13 signed into law a package of legislation that:

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  • Conforms New York City corporate and banking tax laws to reforms enacted for State purposes last year
  • Makes technical corrections to the New York State tax reforms enacted last year

The technical corrections were incorporated into A. 3009/S.2009 (the “technical corrections” bills) and the New York City conformity provisions were included in A.6721/S.4610 (the “conformity” bills). The State technical corrections were generally incorporated into the City conformity provisions.

Retroactive effective date

The New York City conformity provisions and technical corrections provisions are effective retroactively to tax years beginning on or after January 1, 2015.

New York City conformity

One of the key features of last year’s New York State tax reform was the merger of the Article 32, Bank Franchise Tax into the Article 9-A, Corporate Franchise Tax.

For New York City purposes, a new Subchapter 3-A tax is added to Chapter 6 of Title 11 of the Administrative Code of New York City that applies to both corporations and banks in lieu of the Subchapter 2 (City general corporate tax) and Subchapter 3 (City bank tax).

The new 3-A City corporate tax, to a considerable extent, mirrors the revised New York State 9-A Corporate Franchise Tax and includes the following:

  • Three alternative bases. Taxpayers will pay tax on the highest of three alternative bases (1) business income (i.e., entire net income minus net “investment income” and net other “exempt income”) allocated to New York City, (2) business capital allocated to New York City, or (3) an increased fixed-dollar minimum tax based on New York City source receipts.* The separate tax on subsidiary capital is repealed, as is the alternative tax base that was computed on entire net income plus compensation.

*New brackets are added to the City fixed-dollar minimum tax for taxpayers with over $25 million of New York City receipts. Under the new brackets, the highest fixed-dollar minimum tax is $200,000 for a taxpayer with over $1 billion of New York City receipts.

 

  • A substantially revised entire net income tax base, including revised net operating loss (NOL) provisions. As under the State reform, newly defined categories of “investment income” and “other exempt income,” less any interest deductions attributable to such income, is excluded from entire net income to arrive at business income. Pre-reform NOLs are converted to a “prior NOL conversion subtraction” that can be deducted by 1/10th, plus any unused amounts from prior years, over 20 years, or 50% in each tax year beginning on or after January 1, 2015, and before January 1, 2017, in computing business income.
  • Sourcing rules. New customer-based sourcing rules and an 8% election for receipts from qualified financial instruments for receipts factor apportionment purposes is included in the new law.
  • Unitary combined reporting provisions. The “substantial intercorporate transactions” requirement as a prerequisite to filing a combined return is repealed. Under the revised law, general and banking corporations subject to the new City tax are required to file a combined return with greater than 50% owned unitary affiliates. As there is for State purposes, taxpayers can elect to treat all commonly owned entities as the unitary group.

Areas of non-conformity

There are certain areas, however, where the City will not conform to New York State law. Most of the areas of non-conformity involve rates.

  • Business income tax rate reduction. For New York State purposes, with respect to tax years beginning on or after January 1, 2016, the business income tax rate is reduced from 7.1% to 6.5% for most taxpayers. Under the conformity provisions, the City tax rate applied to corporations or combined groups meeting the definition of a financial corporation* is 9.0% and the entire net income rate for all other corporations continues to be 8.85%. The conformity provisions also contain some tax rate relief for smaller businesses whose business income (determined without applying the prior NOL conversion subtraction) is below certain thresholds.

*A financial corporation is generally a corporation or combined group that (1) has over $100 billion in assets and (2) apportions more than 50% of its receipts under the rules applicable to financial receipts, or is a corporation or combined group in which more than 50% of assets are owned by corporations classified or registered as banks, bank holding companies, or other designated entities.

 

  • Capital tax. Under New York State law, the tax on allocated business capital is gradually being reduced and phased out over a number of years. The State caps its capital tax at $5 million. Under the conformity legislation, the City will continue to impose the 0.15% tax on allocated business capital. Certain utility and insurance company taxpayers are subject to a lower rate of 0.075%. In addition, the maximum amount of tax payable under the capital tax is increased from $1 million to $10 million.
  • Zero percent (0%) rate applied to qualified New York manufacturers. Effective for tax years beginning on or after January 1, 2014, a “qualified New York manufacturer” (QNYM) will be taxed for New York State purposes at a rate of 0% on business income.

The budget bills do not conform the City tax to the 0% income tax rate for a QNYM, or the reduced capital tax rate for such manufacturers. There are, however, reduced City business income tax rates for certain qualified New York manufacturing corporations (“QNYMC”), with rates graduating from 4.425% for QNYMCs with less than $10 million of allocated business income, to the full 8.85% rate for QNYMCs with allocated business income of $40 million or more.

In addition, the definition of a QNYMC is somewhat different than the definition of a QNYM under the State law, but the requirements are similarly based on the manufacturer’s activity within the State, not within the City.

A QNYMC is a manufacturing corporation that either (1) has property in the State with an adjusted basis for federal income tax purposes at the close of the tax year of at least one million dollars, or (2) has more than 50% of the its real and personal property located in the State. Property includes tangible personal property and other tangible property, such as buildings and structural components of buildings, that: (1) is depreciable under IRC section 167, (2) is acquired by purchase as defined in IRC section 179(D), (3) has a useful life of four years or more, (4) is sitused in the State, and (5) is principally used by the taxpayer in the production of goods by manufacturing.

For City purposes, the term “manufacturing” includes the process of working raw materials into wares suitable for use, or giving new shapes, qualities, or combinations to matter that has already gone through some artificial processes.

  • Single-receipts factor apportionment. Under the revised New York State Article 9-A corporate franchise tax, all taxpayers (general corporations and banking corporations) apportion business income and capital using single-receipts factor apportionment. For revised City tax purposes, property and payroll factors continue to apply in declining proportions (as under current law) in apportioning a taxpayer’s business income and capital until single-receipts factor apportionment is fully phased-in for tax years beginning after 2017. Certain small businesses will be able to make a revocable election to continue to apportion using receipts, property, and payroll (weighted 93%, 3.5%, and 3.5%, respectively) for tax years beginning in 2018 and going forward.
  • General economic nexus. As originally proposed, the City would have conformed to the State’s general $1 million economic nexus threshold. However, in the final conformity legislation, the City did not adopt general economic nexus provisions. The revised City law continues to assert economic nexus for certain credit card banks, similar to the State provisions, but with the exclusion of bright-line dollar thresholds. Specifically, a corporation is doing business in the City if: (1) it has issued credit cards to 1,000 or more customers who have a City mailing address; (2) it has merchant customer contracts that cover City locations and the corporation has remitted credit card transaction payments to 1,000 or more City locations covered by these contracts; or (3) the sum of the amounts in (1) and (2) equals 1,000 or more.
  • Impact of City conformity bills to S corporations and UBT filers. Unlike the New York State tax reform law, the City conformity provisions under Subchapter 3-A do not apply to S corporations doing business in the City. Such S corporations will continue to be taxed under the current City general corporate franchise tax (i.e., Subchapter 2 of the City Administrative Code). The City reform provisions also do not affect pass-through entities filing under the City unincorporated business tax (UBT).

New York State technical corrections, other tax changes

Combined group economic nexus. The 2014 tax reform adopted a bright-line economic nexus standard for all corporate taxpayers. Previously, New York State applied economic nexus only to certain credit card banks. Under New York law, a corporation is considered to be “deriving receipts from activity” in New York if it has $1 million or more in receipts within New York (i.e., included in the New York State apportionment factor numerator) under the state’s customer-based sourcing rules.

As originally enacted in 2014, corporations with less than $1 million but at least $10,000 of receipts within New York will be considered “deriving receipts from activity” in New York if the corporation is a member of a combined group that collectively has $1 million or more receipts attributed to the State. Similar aggregation rules applied to corporations issuing credit cards to New York customers that were members of a combined group.

Under the technical corrections legislation, references to the “combined group” for purposes of meeting the economic nexus threshold have been replaced with “unitary group.” This means that corporations may be counted for purposes of determining if the economic nexus threshold is met only if they are unitary with the taxpayer and meet the greater than 50% direct or indirect ownership test (even if they are part of the combined report group due to the commonly owned group election).

The technical corrections legislation also clarifies that for purposes of applying the aggregation rules, corporations described in New York Tax Law Article 210-C(2)(c) are not counted. This statutory section lists corporations that are not included in the unitary group, such as corporations taxable under another article (e.g., utility and insurance companies), certain foreign corporations, non-captive REITS and RICs, etc.

Revised definition of investment capital. The 2014 reform legislation repealed the separate tax on subsidiary capital and significantly revised the entire net income tax base. Beginning in tax years on or after January 1, 2015, entire net income minus net investment income and net other exempt income, subject to certain modifications, now equals a taxpayer’s business income.

The 2014 reform legislation defined the term “investment income” to mean generally income—including capital gains in excess of capital losses—from investment capital to the extent included in computing entire net income. “Investment capital” was defined to mean non-unitary investments in stocks held by the taxpayer for more than six consecutive months. Ownership of stock representing less than 20% of the voting power of the corporation was presumed to be non-unitary. Owning stock in a corporation that was included in the taxpayer’s unitary or commonly owned group was not considered investment capital. Also, when income or gain from a debt obligation or other security could not be apportioned to New York using the business allocation percentage because of U.S. constitutional principles (commonly referred to as nonbusiness income in most states), the debt obligation or security was included in investment capital.

The technical corrections provisions adopt a narrower definition of investment capital. Instead of a six-month holding period, taxpayers must now hold investments in non-unitary stock for one year for the stock to constitute investment capital. Also, stocks acquired on or after January 1, 2015, will not be considered investment capital if they have been held for sale in the regular course of the taxpayer’s business at any time after the day on which the taxpayer acquired the stock. Stock will only be considered investment capital if it meets the definition of a capital asset under IRC section 1221 at all times the taxpayer owned the stock during the year and the sale or disposition of the stock must (or would, if sold) constitute capital gain or loss to the taxpayer for federal income tax purposes.

Taxpayers must also comply with a new recordkeeping rule. This rule requires “before the close of the day on which the stock is acquired” that stock be identified as held for investment in the same manner as required in IRC section 1236(a)(1) for securities dealers to be eligible for capital gain treatment (regardless of whether the taxpayer is in fact a securities dealer subject to IRC section 1236). For any stocks owned prior to October 1, 2015, the taxpayer must complete such identification in its books and records before October 1, 2015.

The special rule for stocks purchased during the tax year was modified to mirror the new one-year holding requirement. Now, if a taxpayer acquires stock during its tax year and owns that stock on the last day of the tax year, it will be presumed that the taxpayer held the stock for more than one year (the old rule was six months).

If the taxpayer does not own the stock when it files its original report for the tax year in which it acquired the stock, the presumption will not apply and the actual period of time the taxpayer owned the stock is used to determine whether the stock is to be treated as investment capital.

If the taxpayer relied on the one-year presumption but did not in fact own the stock for more than one year, it must increase its total business capital in the next tax year by the net amount included in investment capital for that stock. Similarly, the taxpayer generally must increase its business income in the next tax year by the amount of net income and net gains from the stock that was included in investment income.

Eight percent (8%) investment income limitation. The technical corrections provisions also adopt a limitation on the total amount of investment income a taxpayer may have.

Specifically, a taxpayer’s investment income is now limited to 8% of entire net income. For purposes of determining this limitation, investment income must be computed without subtracting interest expense related to the investment income (or applying the optional 40% election). Any investment income in excess of the 8% cap is presumably treated as residual apportionable business income.

Election to use pre-reform NOLs in 2015 and 2016 tax years is now revocable; new election to waive NOL carryback. The 2014 tax reform bills created a prior NOL conversion subtraction for NOL carryforwards that were unused as of the last day of the last tax year before the tax reform legislation became effective.

A taxpayer’s prior NOL conversion subtraction for each tax reform year is equal to 1/10th of its NOL conversion subtraction pool, plus any unused prior NOL conversion subtraction from preceding tax years. Unused prior NOL conversion subtraction amounts cannot be used for tax years beginning on or after January 1, 2036, or maximum carryforward of 20 tax years. In lieu of the 1/10th subtraction, taxpayers can elect to deduct ½ of their prior NOL conversion subtraction pool in the tax years beginning on or after January 1, 2015, and before January 1, 2017. If this election is made, no carryovers the prior NOL conversion subtraction pool are allowed beyond the 2016 tax year.

The technical corrections legislation clarifies that this election is revocable; thus, taxpayers that make the election and then find that they cannot use all of their prior NOL conversion subtraction pool in the 2015 and 2016 tax years can retroactively revoke the election.

The technical corrections legislation also allows taxpayers to make an irrevocable election to waive the three-year carryback period applicable to the NOLs generated in tax reform years (i.e., tax years beginning in or after 2015). The election must be made on an originally filed return (computed with regard to extensions) in the tax year of the loss for which the election is to be applied. A separate election must be made for each loss year and the election applies to the combined group.

Sourcing rules for marked-to-market transactions; expanded definition of qualified financial instruments. The 2014 legislation gave taxpayers two options for sourcing receipts from “qualified financial instruments” (QFI). A taxpayer could elect to source receipts from such transactions using a fixed percentage method or to source such receipts using a set of detailed rules specific to various types of financial instruments.

Under the fixed percentage method, a taxpayer can make an irrevocable election to assign 8% of all income from qualified financial instruments to the New York numerator. The threshold question is whether a transaction involves a qualified financial instrument. “Qualified financial instruments” were defined in the 2014 reform legislation as financial instruments marked to market under IRC sections 475 or 1256.

The technical corrections provisions expand this definition by specifically referencing certain types of financial instruments described in NYS Tax Law § 210-A.5(a) (2)(A)-(D) and (G)-(I) (e.g., certain loans; federal, state, and municipal debt; asset-backed securities; corporate bonds; dividends and net gains from sales of stock or partnership interests; physical commodities; and receipts and gains from other financial instruments) that have been marked to market under IRC sections 475 or 1256.

Further, if any financial instruments in those respective categories are marked to market, then all financial instruments in that category will be considered qualified financial instruments, regardless of whether those other financial instruments in the category were actually marked to market.

The technical corrections measures also clarified the exceptions to the definition of qualified financial instruments. Consistent with the 2014 reforms, loans secured by real property may not be treated as qualified financial instruments.

The term “secured by real property” is clarified under the technical corrections legislation as a loan where at least 50% of the value of the collateral at the time the loan was made consisted of real property. If the only loans a taxpayer marks to market are those secured by real property, none of the loans held by the taxpayer will be considered qualified financial instruments.

Finally, the technical corrections provisions exclude stock treated as investment capital under Tax Law section 208.5(a) from the definition of a qualified financial instrument. The determination of whether a financial instrument meets the definition of a qualified financial instrument must be made taking into account all members of the taxpayer’s New York combined group.

As mentioned above, taxpayers can make an irrevocable election to assign 8% of all income from qualified financial instruments to New York (including those receipts in the New York sales factor numerator). The technical corrections measures clarify that the election is to be made annually on an original, timely filed return, including extensions. Previously, it was not clear whether a timely filed return included extensions.

A new definition for “marked to market gains” is enacted for clarifying purposes that all income, gain or loss, including such “market to market gains,” from qualified financial instruments is apportionable business income (if the taxpayer makes the 8 %QFI election).

“Marked to market” gains are those amounts recognized for federal purposes under IRC section 475 or 1256 (because the financial instrument is treated as sold on the taxpayer’s last business day of the year).

For taxpayers that do not make the 8% election, the 2014 reform set forth extensive rules for sourcing receipts related to loans, federal, state and municipal debt, asset-based securities, corporate bonds, reverse repurchase agreements and securities borrowing agreements, federal funds, dividends and net gains from sales of stock or partnership interests, other financial instruments, physical commodities, receipts from broker or dealer activities, receipts from credit cards, merchant discounts, credit card authorization processing and similar activities, and receipts from certain services to investment companies.

The technical corrections legislation includes additional rules for apportioning marked-to-market gains. These new rules require taxpayers not using the 8% QFI election to use the rules applicable to the specific type of underlying financial instrument generating the marked-to-market gains (but not losses) recognized during the year. If the underlying financial instrument is not included in the specific types identified in existing law, the taxpayer must multiply the net gains (but not less than zero) by the combined New York apportionment percentages applicable to the types of financial instruments that are specifically identified in the law.

New apportionment rules for receipts from the operation of vessels. The technical corrections legislation adopts new rules for apportioning receipts derived from operating vessels. Such receipts are included in the numerator of the New York apportionment factor by multiplying total receipts by a fraction—the numerator of which is the aggregate number of working days vessels owned or leased by the taxpayer were in New York territorial waters during the tax period and the denominator of which is the aggregate number of all working days of the vessels owned or leased by the taxpayer during such tax period.

Sales and use tax exemption for aircraft. Effective September 1, 2015, a new sales and use tax exemption is created for general aviation aircraft and machinery and equipment to be installed on such aircraft. “General aviation aircraft” means an aircraft that is used in civil aviation that is not a commercial aircraft, military aircraft, unmanned aerial vehicle, or drone.

For more information, contact a tax professional with KPMG’s State and Local Tax practice:

Russ Levitt | +1  (212) 872-6717 | rdlevitt@kpmg.com

Dave Turzewski | +1 (212) 872-5628 | dturzewski@kpmg.com

Hernan Stigliano | +1 (212) 872-6967 | hstigliano@kpmg.com

Fred James | +1 (973) 912-6555 | fjames@kpmg.com

Dale Kim | +1 (212) 954-3920 | dykim@kpmg.com

Judy Cheng | +1 (212) 872-3530 | jycheng@kpmg.com

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