United States: MoFo New York Tax Insights, Volume 7, Issue 1, January 2016

The Top 10 New York Tax Highlights of 2015

By Irwin M. Slomka

This past year turned out to be another eventful one in New York taxation. We continue our tradition and present our list of the Top 10 New York tax highlights of 2015.

1. New York City enacts corporate tax reform legislation.  Belatedly but prudently, New York City substantially conformed its corporate tax to the New York State corporate tax reform legislation. Effective for tax years beginning on or after January 1, 2015, a new Subchapter 3-A tax is now imposed on both bank and non-bank C corporations. 2015–2016 New York State Budget (S. 4610A, A.6721A and S. 2009B, A. 3009B). The new law adopts market-based sourcing and imposes mandatory water's edge unitary combined reporting but, unlike the State tax, does not include an economic nexus provision. The City chose to retain the general corporation tax ("GCT") solely to apply to S corporations, while the City conducted a study on how all pass-through entities (S corporations, LLCs and partnerships) should be taxed. As of this writing, the results of the City's study have not been published, but it does not appear that the City will propose any pass-through entity legislation in the upcoming legislative session, which means the GCT will remain on the books for at least another year for S corporations.

2. Court of Appeals rejects Constitutional challenges to State taxation of gain from sale of S corporation stock. In two decisions, Burton v. New York State Department of Taxation and Finance, et al., 25 N.Y.3d 732 (2015) and Caprio v. New York State Department of Taxation and Finance, et al., 25 N.Y. 3d 744 (2015), the New York State Court of Appeals rejected separate challenges to the validity of a 2010 statutory amendment to Tax Law § 632(a)(2), made retroactive to tax years beginning after 2006. That legislation provided that gain recognized by a nonresident shareholder of an S corporation relating to the distribution of an installment obligation or from a stock sale for which an IRC § 338(h)(10) election was made would be considered New York source income of the nonresident shareholder, based on the S corporation's apportionment percentage. In Burton, the court rejected the taxpayer's claim that the law violated the New York State Constitution, which prohibits the taxation of income from intangibles unless the intangibles are used in the conduct of a trade or business in the State. In Caprio, the court overturned an Appellate Division decision in favor of the taxpayer, and in doing so rejected the taxpayer's claim that retroactive application of the 2010 amendments to 2007 was unconstitutional under the Due Process Clause.

3. Court of Appeals allows qui tam suit against Sprint Nextel to move forward, but Vanguard successfully obtains dismissal of action brought by a former in-house lawyer. The 2010 legislative expansion of the New York False Claims Act, permitting private "whistleblower" qui tam State tax actions, remains one of the most ill-advised New York State tax enactments in memory. Qui tam lawsuits continued to be brought, some unsealed (as recently disclosed in a more than $2 billion action brought against Citigroup, Inc. by an Indiana University professor), but others undoubtedly remain sealed and are not yet known to the public. In 2015, in a setback for taxpayers, the Court of Appeals rejected a motion made by Sprint Nextel to dismiss a more than $100 million qui tam action brought by New York State Attorney General Schneiderman, holding that the AG's complaint sufficiently set forth a cause of action, permitting the case to proceed to discovery. People of the State of New York et al. v. Sprint Nextel Corp., et al., No. 127, 2015 NY Slip Op. 07574 (Oct. 20, 2015).

Meanwhile, a New York County Supreme Court judge dismissed a qui tam suit against the Vanguard Group in which the AG had declined to intervene, brought by a former in-house counsel to Vanguard, on the grounds that the former counsel violated rules of attorney professional conduct in bringing the action. State of New York ex rel. David Danon v. Vanguard Group, Inc., et al., No. 100711/13, 2015 NY Slip Op. 32213(U) (Nov. 13, 2015). Unfortunately, no meaningful initiatives surfaced in 2015 to repeal or scale back the controversial 2010 qui tam legislation.

4. City Tribunal overturns ALJ decision, rejects McGraw-Hill First Amendment claim for audience factor apportionment. The New York City Tax Appeals Tribunal reversed an Administrative Law Judge decision, and held that McGraw-Hill did not have a First Amendment right (freedom of the press) to source its Standard & Poor's credit rating receipts for New York City corporate tax purposes using an "audience-based" methodology similar to that available to publishers and broadcasters. The City Tribunal also held that the credit rating receipts were from the performance of services, sourced to where the services are performed, and were not "other business receipts" sourced to where the receipts are "earned." Matter of The McGraw Hill Companies, Inc., TAT(H) 10-19(GC) et al. (N.Y.C. Tax App. Trib., Oct. 28, 2015). It is expected that McGraw-Hill will appeal the City Tribunal decision to the New York courts.

5. State Tribunal permits corporate taxpayer to file combined returns despite the absence of substantial intercorporate transactions. In another loss by the State Tax Department regarding pre-2015 permissive combination under Article 9-A, the State Tribunal reversed an Administrative Law Judge decision, and held that SunGard Capital Corp. could file on a combined basis for 2005 and 2006 based on a showing of a unitary business relationship and proof of actual distortion, despite the absence of substantial intercorporate transactions. Matter of SunGard Capital Corp., et al., DTA Nos. 823631, et al. (N.Y.S. Tax App. Trib., May 19, 2015).

One important aspect of the decision involved the unitary business requirement — which continues under corporate tax reform — and the Tribunal's conclusion that companies in "complementary businesses" can be unitary, even though conducting different lines of business. The Tribunal also found that a centralized cash management system was evidence of a unitary business, as was the flow of value resulting from providing intercorporate services without charge. As for the pre-2015 distortion requirement for combination, the Tribunal noted that the same factors indicative of a unitary business relationship may also give rise to distortion. The decision may provide further support for the Department to resolve its existing pipeline of de-combination audits.

6. New York State does not appeal the Expedia decision, which held that receipts from providing online travel reservations are sourced to where services were performed, and not to the customer location. To the surprise of many, the State Tax Department decided not to appeal a February 2015 ALJ decision in favor of Expedia, which held that receipts from providing online travel reservations were from the performance of services under Article 9-A and sourced to where the services were performed. Matter of Expedia, Inc., DTA Nos. 825025 & 825026 (N.Y.S. Div. of Tax App., Feb. 5, 2015). The ALJ had rejected the Department's position that the receipts were "other business receipts," sourced to where "earned," which the Department claimed was at the location of the customer.

Several years ago, the Department abruptly changed its policy – through an Advisory Opinion that dealt with credit card processing services — by treating receipts from services provided "electronically," involving what the Department described as minimal human involvement, as "other business receipts" sourced to the customer's location, rather than receipts from services. By not appealing, the Department insured that the Expedia ALJ decision remains nonprecedential. The sourcing of receipts from various forms of "electronically" provided services has been a frequent source of controversy in Article 9-A audits, and it is hoped that the ALJ decision in Expedia, while not precedential, will lead to the informal resolution of audits involving the sourcing of "electronically" furnished services under the pre-2015 law.

7. State Tax Department begins to release corporate tax reform guidance. As expected given the vast changes under corporate tax reform, this past year the State Tax Department began releasing policy statements, including drafts of regulations, interpreting the new law. The policies were released through a variety of pronouncements, including Technical Memoranda, Q&As appearing on the Department's web site, and, in at least one instance, an Advisory Opinion. The most comprehensive policy pronouncements were draft regulations released for comment in late 2015 involving nexus (including economic nexus and nexus through partnerships and LLCs) and the sourcing of receipts from digital products and other business receipts.

As we went to press, the State also began releasing its 2015 Article 9-A tax return forms, and issued a Technical Memorandum regarding interest expense attribution. It is anticipated that further draft regulations will be released in 2016, including regulations interpreting the new water's edge unitary combination regime, as well as guidance involving the calculation of prior net operating losses from the pre-2015 Article 9-A.

8. State Tribunal upholds partial liability of LLC members for LLC's sales tax liability. The State Tax Tribunal sustained an ALJ decision holding that a member of an LLC who owned a minority interest in the LLC was liable for a portion of the LLC's sales and use tax liability. Matter of Eugene Boissiere and Jason Krystal, DTA No. 824467, et al. (N.Y.S. Tax App. Trib., July 28, 2015). The Tribunal rejected the taxpayers' argument that any strict liability of an LLC member — even liability limited to the member's percentage interest in the LLC as set forth in TSB-M-11(17)S — violated the New York State Limited Liability Law. It instead held that the plain language of the Tax Law provided for full member liability, and that the Department's policy of limiting liability in certain instances ameliorated any "harsh consequences" that might warrant a departure from the literal language of the Tax Law. The Tribunal's decision was not appealed, and thus the Department's policy on LLC member liability has survived this legal challenge.

9. State Tax Department does not appeal the ALJ decision holding that a "flat sum settlement" with the IRS is not a reportable federal change for State income tax purposes. In what could be an issue of first impression in New York, in April 2015 a State ALJ held that an individual's "flat sum settlement" with the Internal Revenue Service did not constitute a change in the taxpayer's federal taxable income that triggered a New York State reporting requirement, and therefore the IRS settlement did not extend the statute of limitations for assessment. Matter of Bentley Blum, DTA No. 825455 (N.Y.S. Div. of Tax App., Apr. 16, 2015). Although the issue of whether a flat sum settlement — whether for individuals or corporations — must be reported to the State or City and thus opens an otherwise closed tax year is a significant one, the State Tax Department did not file an appeal. The decision is not precedential, and the Department has not indicated whether it will acquiesce to the result in Bentley Blum.

10. First New York City Taxpayer Advocate is appointed. In July 2015, New York City appointed its first Taxpayer Advocate, Diana Leyden, and created the Office of the Taxpayer Advocate to address both specific taxpayer problems and systemic problems involving taxes administered by the New York City Department of Finance. The office is generally modeled on the Taxpayer Advocate offices at the Internal Revenue Service and State Tax Department. One of the New York City Taxpayer Advocate's first actions was to develop a completely revamped "NYC Taxpayer Bill of Rights." In 2016, the Taxpayer Advocate is expected to issue reports to the Commissioner and to the New York City Council that will, among other things, identify systemic issues and make recommendations for possible procedural or legislative changes.

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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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Kara M. Kraman
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