United States: NYS Tax Department Relaxes Investment Income Identification Rules

The New York State Department of Taxation and Finance has announced that it would extend the time for certain taxpayers to identify stocks as being held for investment so that income from those stocks would be tax-exempt [TSB M-15(4.1)C, (5.1)I]. Instead of having to make the identification on the date on which the stock is purchased, many corporations will now have a 90-day grace period to make the identification. This relaxation of the identification rules will come as a major relief to many companies that otherwise may have been ambushed by New York's new rules, particularly out-of-state corporations that start doing business in New York after acquiring investment securities. The announced change is effective immediately.

Under corporate tax reform legislation enacted in 2015, corporations—to treat income from stock held as an investment as tax-exempt investment income—must identify the stock on the date of purchase as being held for investment and follow certain procedures. This requirement has been widely criticized as being unrealistic since a corporation's investment people are unlikely to know about arcane tax rules on the date that they make trades. Securities dealers, to qualify for tax-free investment income treatment, must identify the stock as being held for investment pursuant to Section 1236 of the Internal Revenue Code (IRC), which requires the identification to be made on the date of purchase. Non-dealers must still make the identification on the date of purchase under the statute, but they need not make the federal election under Section 1236 since that provision applies only to dealers.

The Department's new rules significantly relax the requirement for many non-dealer corporations. They do not apply to dealers, which will still be subject to the Section 1236 election requirements.

One criticism that has been made of the identification requirement is that a corporation that had not been doing business in New York and, hence, had not been a New York taxpayer and acquired stock as an investment would not have made the New York identification because it would not have cared about, or known about, New York taxes. If such a corporation later starts doing business in New York and becomes subject to New York taxes, it will be too late to make the identification for previously acquired stock and, hence, the income from that stock will not be exempt investment income. Under the Department's new announcement, a corporation that first becomes a New York taxpayer on or after October 1, 2015, can make the identification within 90 days after becoming a New York taxpayer or, if it became a New York taxpayer before January 7, 2016, by April 6, 2016. Stock purchased after this extended period must still be identified as being held for investment on the date of purchase.

Ordinarily, a corporation becomes taxable in New York on the first day on which it does business, employs capital, owns or leases property, or maintains an office in New York. Under new economic nexus rules, a corporation also becomes taxable in New York on the first day on which it has receipts from the State of $1 million or more. In the case of a corporation that becomes taxable in New York because of the economic nexus receipts requirement, the 90-day period starts with the date on which its receipts first exceed $1 million. This may be hard to calculate because tax managers and investment people may not be aware of the flow of receipts every day. In the case of a unitary group that becomes taxable in the State solely because of the $1 million receipts requirement, the start date for every corporation in the group is the date on which the group in the aggregate first has receipts from New York of $1 million or more. This will require the parent corporation of a unitary group to track the receipts of each of the group's members.

The application of the identification rules in the corporate acquisition context has been unclear. The new announcement indicates that a corporation whose stock is acquired by a New York taxpayer and, hence, meets the capital stock requirement for being included in a combined return (50 percent) begins the 90-day period on the date on which its stock is acquired. The announcement does not address the question of whether a corporation whose stock is acquired in an IRC Section 338(h)(10) transaction and that elects to have the transaction treated as if it had become a new corporation that purchased its assets from itself must make a new identification. Even though the corporation is the same legal corporate entity, I have been advising clients to make a new identification on the day of closing even if it had made a previous identification because it is treated as a new corporation for many income tax purposes.

A controversial position that has been adopted by the Department is that if a corporate taxpayer invests in an investment partnership and the partnership acquires stock as an investment, the partnership must make the identification. I and others have pointed out that investment partnerships may not know that they have partners that are New York taxpayers and, if the partnership is based outside of New York, it may not know about the New York requirements. We have urged the Department to allow the identification to be made by the corporate partner when it first becomes a partner. The Department has not changed its position in this respect, but it has provided in the new announcement that a partnership that has not itself been doing business in New York, or that has not had corporate partners that were taxable in New York qualifies for the extended 90-day period, starting from the first date on which it does business in New York or has New York receipts of $1 million or more, or from the first date on which it has a partner that is a New York taxpayer. This is still unrealistic, because a partnership that is not otherwise doing business in New York is not likely to know when a corporate partner of the partnership first itself starts doing business in New York and, hence, becomes a New York taxpayer.

For a more detailed discussion of the identification procedures, see Peter L. Faber, "Living With New York's New Corporate Investment Income Rules," State Tax Notes, November 2, 2015.

NYS Tax Department Relaxes Investment Income Identification Rules

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