United States: Inside The New York Budget Bill Part Two: Tax Base And Income Classification

This is the second installment of a series that takes an inside look at the corporate tax reform proposals in Governor Andrew Cuomo's 2014–15 New York Budget Bill.  This proposed reform is sweeping and, if enacted, is likely to result in major changes for many New York corporate taxpayers.  This installment of Inside the New York Budget Bill examines the Budget Bill's changes to the various Franchise Tax bases and changes to income classifications within those bases.  Some taxpayers, such as those that currently apportion investment income using an investment allocation percentage that is substantially lower than their business allocation percentage, may experience tax increases (often substantial), whereas other taxpayers may experience decreases in tax as a result of income classification changes and rate reductions.  The next installment of this series will address proposed changes to apportionment.

This second installment of Inside the New York Budget Bill focuses on changes to the various Franchise Tax bases and changes to income classifications within those bases.  Some taxpayers, such as those that currently apportion investment income using an investment allocation percentage that is substantially lower than their business allocation percentage, may experience tax increases (often substantial), whereas other taxpayers may experience decreases in tax as a result of income classification changes and rate reductions.

Changes to the Tax Base

Currently, Article 9-A taxpayers (general corporations) must compute the amount of tax that would be due using four different bases—entire net (i.e., federal taxable) income (ENI), capital, minimum taxable income and a fixed dollar minimum—and pay tax on the highest of those four bases plus a tax on subsidiary capital, and, in some cases, the Metropolitan Transportation Business Tax.

Under Article 32, every banking corporation subject to tax must compute its basic tax, which is measured by ENI (the computation of which varies from the computation of ENI under Article 9-A), and its alternative minimum tax (which is paid on the highest of three bases: taxable assets, alternative ENI and a fixed dollar minimum) and pay the greater of the two tax amounts.  As discussed in part one of Inside the New York Budget Bill, the Budget Bill proposes the elimination of Article 32 in its entirety, leaving taxable banking corporations subject to Article 9-A's Franchise Tax.  This installment of Inside the New York Budget Bill focuses on the most sweeping changes to Article 9-A. 

The Budget Bill proposes the elimination of the tax on minimum taxable income and the tax on subsidiary capital.  Thus, Article 9-A taxpayers, whether general corporations or banks, would be required to calculate tax on three different bases: (1) business income (described below), (2) capital and (3) a fixed dollar minimum. 
The Budget Bill would reduce the current tax rate on the ENI base (renamed the business income base) from 7.1 percent to 6.5 percent for most taxpayers (some taxpayers, such as qualified New York manufacturers, would see even lower rates).  The Budget Bill would maintain the current capital base tax rate of 0.15 percent but would increase the cap under this base for most taxpayers from $1 million to $5 million and would increase the fixed dollar minimum tax for taxpayers with receipts of more than $25 million. 

One might assume that reduced rates and the elimination of the tax on subsidiary capital would reduce corporations' tax burdens—and these changes certainly will have that effect for some taxpayers—but other elements of the proposed changes (such as changes to the definition of investment capital) will likely result in tax increases for others.

Changes to Tax Base Classifications

Currently, the starting point for calculating ENI is federal taxable income, including income earned within or outside of the United States (worldwide income).  Several modifications are then made to ENI, including the exclusion of income, gains and losses from subsidiary capital, and any expenses directly or indirectly attributable to subsidiary capital. 

ENI is then divided into two categories: investment income and business income.  Investment income is apportioned by an investment allocation percentage (IAP), and business income is apportioned by a business allocation percentage (BAP).  

Investment income is income from "investments in stocks, bonds and other securities, corporate and governmental, not held for sale to customers in the regular course of business, exclusive of subsidiary capital and stock issued by the taxpayer" (investment capital) less expenses that are directly or indirectly attributable to investment capital.  A taxpayer can elect to treat cash as investment capital or business capital.  Investment income is then apportioned to New York using an IAP, which is determined by reference to the total New York allocation percentages of each issuer or obligor of the items of investment capital, as is required to be reported to and published by the Department of Taxation and Finance (Department).  Calculating the IAP can be a very labor-intensive process, particularly for large investors. 

Business income is ENI less investment income.  It is apportioned by a BAP consisting of the taxpayer's New York receipts over all receipts.

The division between investment income and business income, and the separate apportionment of each, was designed to encourage investing corporations and those with significant treasury operations to establish their headquarters and other physical operations in New York, and tends to result in a lower tax for many corporations, because a company's IAP is often significantly lower than its BAP.  This was especially true for New York-based companies prior to the phase-out of the three-factor formula as their BAPs were increased by having employees and property in the state.  The exclusion of income from subsidiary capital in computing the ENI base was similarly intended to encourage parent corporations to locate in New York and offers further benefits for many taxpayers because such income is not subject to tax in New York and subsidiary capital itself is taxed at a much lower rate.  Thus, the current classifications of items of income as derived from subsidiary capital, investment capital or business capital are frequently the subject of contention during audits, often resulting in litigation.

The Budget Bill would substantially change this complex regime, eliminating many of the current controversies in the following ways. 

First, income from subsidiary capital would no longer be subtracted from ENI.  As a result, a taxpayer would be required to determine whether income that currently qualifies as income from subsidiary capital would now qualify as investment income (which, as discussed below, will be exempt from tax), as a new category of "other exempt income" (discussed below) or as business income (which will be subject to tax).

Second, investment income would no longer be subject to tax.  However, the Bill dramatically restricts what would qualify as investment income.  Dividends, capital gains and other income from stock of a non-unitary corporation would qualify as exempt investment income, while most interest income and income from stock of a unitary corporation would be subject to tax.  For purposes of determining "investment income," corporations less than 20 percent directly or indirectly owned by the taxpayer would be presumed to be non-unitary with the taxpayer. 

The considerable restriction of what qualifies as "investment income" raises an interesting issue that the Budget Bill attempts to address in a commendable way, but which may result in audit or litigation controversies nonetheless.  In most states, when a taxpayer computes tax, constitutional "fair apportionment" requirements dictate that the taxpayer should remove gain from the sale of a non-unitary asset from the apportionable tax base and allocate that gain directly to the particular jurisdiction that is connected with the gain at issue.  For example, a taxpayer's sale of an interest in a non-unitary partnership would generate gain (or loss) that would not be subject to apportionment but would be specifically allocated to, for example, the taxpayer's commercial domicile.  The Department has long argued that such gain (or loss) would not be removed from the New York apportionable tax base because its unique investment income allocation regime overcomes such constitutional concerns since the gain (or loss) would likely be apportioned based on the issuer's or obligor's IAP (taking into account the asset's contacts with New York instead of the taxpayer's contacts).  However, by removing many assets from the definition of investment capital and causing the income or gain they generate to become apportionable business income, New York's apportionment regime no longer overcomes such constitutional concerns for non-unitary assets that fall outside of the new restrictive definition.  The Budget Bill seems to recognize this change by, in effect, determining that certain income ("income or gain from a debt obligation or other security [that] cannot be apportioned to the State using the business allocation percentage as a result of United States constitutional principles") will be treated as investment income and therefore exempt from tax.  This provision may be a move in the right direction, but taxpayers should assume that the burden of demonstrating that income or gain cannot be apportioned using the BAP as a result of constitutional principles (i.e., that it is from a non-unitary asset) will be on the taxpayer, and that disputes are likely to arise regarding whether that burden has been met.

The third major change with respect to income classification is that the Bill would create a new category of "other exempt income," which consists of exempt I.R.C. Subpart F income and dividends from unitary subsidiaries that are not included in the taxpayer's combined report (for example, certain alien corporations or corporations taxable under Article 9 or 33; for further discussion, see part one of Inside the New York Budget Bill).

Finally, as a result of the ENI base being limited to tax on business income, the ENI base would be renamed the "business income base."

Changes to Rules Regarding Expense Attribution

Under both the current rules and the Budget Bill, taxpayers assign certain expenses attributable to investment income and to business income before apportionment.  (Under the current rules, expenses related to subsidiary capital are generally added back as a modification to ENI on the basis that the income from subsidiary capital is exempt, so a corporation should not have the benefit of deducting expenses related to that exempt income.)  Generally, taxpayers would prefer to attribute an expense to the income category with the highest New York allocation percentage to maximize the benefit of the expense, whereas the Department auditors seem to prefer to minimize the double tax benefit a taxpayer would receive if the taxpayer were allowed to use an expense incurred while generating income apportioned at a low rate to offset income apportioned at a higher rate.  Indeed, expense attribution has been the subject of countless controversies in New York, particularly in the context of "indirect" expense attribution, whereby Department auditors would classify expenses as "indirectly attributable" to each income classification, thereby reducing the amount of expenses that could be attributable to business capital.  

The Budget Bill departs from current expense attribution in three significant ways.  First, the role of expense attribution changes dramatically.  Under current law, expense attribution merely shifts expenses between investment income and business income, resulting in a shift between the amounts that will be apportioned using the taxpayer's BAP or IAP, but, in general, the total amount of income subject to tax does not change.  However, under the Budget Bill, any expense attributed to investment income (or other exempt income) actually increases the amount of the taxpayer's liability.  Specifically, any expense attributed to investment income reduces the amount of the taxpayer's investment income; since business income is ENI less investment income and other exempt income, a reduction to investment income (or other exempt income) results in greater business income. 

The second and third significant changes appear to be taxpayer-favorable.  Taxpayers would be required to attribute interest expenses only to investment and other exempt income.  As a result, it appears that all of a taxpayer's non-interest expenses would be attributed to business income.  Since business income will remain taxable, the more expenses that are attributed to business income, the lower the resulting tax will be. 

Third, the Budget Bill creates a new election for computing the amount to be attributed.  Under the Budget Bill, attribution must be done in one of two ways.  A taxpayer can determine the amount of interest expenses directly and indirectly attributable to investment income (and to other exempt income) and then reduce investment (and other exempt income) by such amounts.  Under this approach, if the attributed expenses exceed the exempt income, the excess is added to business income.

As an alternative, the Budget Bill provides an annual election to reduce investment income by a fixed 40 percent in lieu of assigning actual interest deductions.  This election may be desirable for taxpayers whose actual interest deductions are greater than 40 percent of investment income, as taxpayers will want investment income (which is exempt) to be as high as possible, and for taxpayers who prefer the administrative ease of a fixed amount. 

It should be noted that the expense attribution provisions of the Budget Bill raise many unanswered questions (including the interplay between it and the computation of business capital for purposes of the tax on capital base) and would benefit from clarification in a final bill adopted by the State Legislature.  Taxpayers making the 40 percent fixed deduction against investment income must make similar elections for other exempt income. 

ENI Tax Base Changes for Foreign Corporations

Currently, foreign corporations subject to Franchise Tax include income from all sources in ENI.  The Budget Bill would limit their ENI to income that is effectively connected with the conduct of a U.S. trade or business, as defined in I.R.C. section 882.  However, all dividends and interest on stock, securities or indebtedness of any kind would be included in ENI only if such income is effectively connected with the conduct of a U.S. trade or business as determined under I.R.C. section 864.  Such income would then be divided into investment income, other exempt income and business income as described above.  Additionally, alien corporations also would be required to add back income that is exempt from taxation under a federal income tax treaty, but only if that income is effectively connected with the conduct of a U.S. trade or business, as defined in I.R.C. section 882, and if the relevant treaty does not prohibit state taxation of such income. 

Changes to the Capital Tax Base

Currently, taxpayers compute the tax on capital base by allocating investment capital (less attributable liabilities, including debt and other liabilities) by the IAP described above, allocating business capital (less attributable liabilities) by the BAP described above and computing tax on the sum of those two amounts. 

The Budget Bill removes investment capital from the computation of the capital base so that it will be computed solely on business capital.  However, since business capital is defined by reference to investment capital, the new restricted definition of investment capital would mean that business capital would include substantially more than it does under the current rules.

Metropolitan Transportation Business Tax Surcharge

A "temporary" metropolitan transportation business tax surcharge has been imposed on New York taxpayers with activities in the "metropolitan commuter transportation district" (which is generally the New York City metropolitan area) since 1982.  The surcharge is imposed at a rate of 17 percent of the tax computed on the ENI base (after credits).

Under the Budget Bill, the metropolitan transportation business tax surcharge would become permanent, would be assessed based on economic nexus standards (the topic of a future installment in this series) and would be imposed at a rate of 24.5 percent of the tax computed on the business income base (before credits).

New York City

Under current law, New York City's tax bases and income classification are similar to the State's current regime.  The Budget Bill's changes to the tax bases and income classification would not automatically affect New York City's regime, resulting in vastly different methodologies for computing tax.  This disparity will add to compliance difficulties when filing returns, as well as when reporting State audit changes to the City.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions