United States: MoFo New York Tax Insights, Volume 7, Issue 5

Retroactive Application of 2010 Statutory Amendment Permitted by Tribunal

By Hollis L. Hyans

Reversing the decision of an Administrative Law Judge, the New York State Tax Appeals Tribunal has upheld the constitutionality of retroactively applying to the 2008 tax year a 2010 statutory amendment to Tax Law § 632(a)(2) concerning the treatment of installment payments by nonresident shareholders of an S corporation. Matter of Jeffrey M. and Melissa Luizza, DTA No. 824932 (N.Y.S. Tax App. Trib., Mar. 29, 2016). Despite the fact that the taxpayers had reasonably relied on the then-current state of the law in structuring their 2008 transaction, the Tribunal found that the recent decision of the Court of Appeals in Caprio v. New York State Dep't of Taxation and Fin. et al., 25 N.Y.3d 744 (2015), reh'g denied, 26 N.Y.3d 955 (2015), required it to apply the statutory amendment retroactively.

Facts. The petitioners, Mr. and Mrs. Luizza, were nonresidents of New York. Mr. Luizza owned 100% of the stock of an S corporation that did business in New York and other states, and in December 2007 he agreed to sell the company to an unrelated purchaser. At the purchaser's request, Mr. Luizza agreed to an election to treat the sale as a deemed sale of the company's assets pursuant to Internal Revenue Code ("IRC") § 338(h)(10), but only to the extent that there would be "no negative federal or state tax implications for the S corporation or himself individually," and requested that he be reimbursed for any such tax consequences. The purchaser requested instead that the tax consequences of the election be addressed up front, so Mr. Luizza and his accountants researched the federal and New York State tax implications, including the effects of Tax Law § 632(a)(2) and other New York State authority available in late 2007 and early 2008. Mr. Luizza was advised by his tax advisors that there would be no tax consequences in New York as a result of the election, and he therefore agreed not to require the purchaser to increase the purchase price or to provide indemnity when the sale closed in March 2008. The Department of Taxation and Finance stipulated that "Mr. Luizza reasonably relied on the New York law applicable at the time of the sale when he agreed not to require the [b]uyer to increase the purchase price nor to provide indemnity for any additional taxes arising as a result of the election."

Mr. Luizza reported a capital gain of approximately $8 million on his 2008 New York nonresident income tax return, but did not include the gain as income attributable to New York sources.

Background to the 2010 Statutory Amendment. Mr. Luizza's research correctly stated the law at the time of the transaction. Furthermore, in 2009, the Tax Appeals Tribunal expressly held that, under Tax Law § 632(a)(2), nonresident shareholders did not have New York source income when they sold their stock in an S corporation where an election had been made under IRC § 338(h)(10). Matter of Gabriel S. & Frances B. Baum, DTA Nos. 820837 & 820838 (N.Y.S. Tax App. Trib. Feb. 12, 2009). A few months after Baum, an ALJ reached a similar conclusion in Matter of Myron Mintz, DTA Nos. 821806 & 821807 (N.Y.S. Div. of Tax App., June 4, 2009).

Having lost in litigation, the Department sought to change the statute. In August 2010, Tax Law § 632(a)(2) was amended to specifically provide that gain recognized by a nonresident shareholder of an S corporation will be treated as New York source income based on the S corporation's New York business allocation percentage for the year in which the assets were sold. The amendment was made retroactive to years beginning on or after January 1, 2007, that were open for assessment or refund, and was accompanied by legislative findings stating that the change was "necessary to correct a decision of the tax appeals tribunal and a determination of the division of tax appeals that erroneously overturned the longstanding policies of [the] department of taxation and finance . . . ."

In reliance on the statutory amendment, the Department took the position that the Luizzas had to allocate a portion of the capital gain to New York and issued a Notice of Deficiency for nearly $200,000, including tax and interest, but without penalty. The Luizzas argued that the retroactive application of the amended Tax Law § 632(a)(2), under the circumstances, violated their right to due process.

ALJ Decision. The ALJ agreed with the Luizzas. In deciding whether to apply the statute retroactively, he relied on an analysis that was set out by the Court of Appeals in James Square Assocs. LP, et al. v. Mullen, 21 N.Y.3d 233 (2013), which reviewed three factors: (1) the taxpayer's forewarning of a change and the reasonableness of reliance on the old law; (2) the length of the period of retroactivity; and (3) the public purpose for retroactive application.

With regard to the first factor, which has been held to be the "predominant" factor, the ALJ found that neither Mr. Luizza nor his advisers had any knowledge or reason to believe in 2008 that there would be a statutory change two years later, that Mr. Luizza reasonably relied on the law applicable at the time of the sale, and that Mr. Luizza was harmed by his reliance, since he did not have the opportunity to seek a higher purchase price or require an indemnity from the purchaser as he originally intended. With regard to the period of retroactivity, the ALJ relied on the "guidance" of the Appellate Division in an earlier level of the Caprio litigation, in a case involving the same set of statutory amendments but concerning the tax treatment of installment obligations rather than deemed asset sales, and found that the period of retroactivity was excessive. Caprio v. New York State Dep't of Taxation and Fin. et al., 117 A.D.3d 168, 177 (1st Dep't 2014). The ALJ also noted the Appellate Division's conclusions in Caprio that there was no legislative history to support the Department's position that the amendment was correcting any specific defect, rather than changing the statute to adopt the position requested by the Department, and that there was no valid public purpose in correcting the "mistakes" of the Tribunal in Baum and an ALJ in Mintz, since the Appellate Division had clearly found that the purpose of the amendment was not corrective but to raise tax revenues by $30 million.

In 2015, after the ALJ's decision in Luizza, the Court of Appeals reversed the Appellate Division in Caprio, and, as discussed in the January issue of New York Tax Insights, held that the retroactive application of the portion of the 2010 statutory amendments applicable to the tax treatment of installment obligations did not violate the taxpayers' Due Process rights.

Tribunal Decision. In light of the reversal in Caprio by the Court of Appeals, the Tribunal found that it needed to decide, first, whether it was bound by the decision in Caprio to uphold the constitutionality of the 2010 amendments as they applied to the Luizzas' facts. While noting that it was "not without serious concerns as to the ramifications of this decision," the Tribunal held that Caprio must control.

Although the retroactivity of the deemed asset sale amendments was not directly before the Court of Appeals in Caprio, where the plaintiffs had limited their challenge to the retroactive application of the amendments concerning the tax treatment of installment obligations, the Tribunal found that the clear intention of the Court of Appeals in Caprio was to uphold the retroactivity of all of the 2010 amendments.

Next, the Tribunal considered whether fact differences distinguished the case from Caprio, since the Luizzas, unlike the plaintiffs in Caprio, had sought and relied upon professional advice and demonstrated that they would have adjusted the purchase price if they had any forewarning of the change in law, and the Department stipulated their reliance was reasonable. However, the Tribunal found that Caprio required it to conclude that "petitioner's reliance on the law cannot be held to be reasonable despite the stipulation signed by both parties and the additional facts that petitioners have proven . . . because, according to Caprio, petitioner should have been aware . . . of the long standing policies" of the Department. In reaching this conclusion, the Court of Appeals in Caprio had relied on the legislative findings, as well as an affidavit of an auditor concerning that policy. The Tribunal rejected the Luizzas' argument that the Department had submitted no evidence of any such long-standing policy in their case, stating that Caprio required the conclusion that the Department's policy made their reliance on their interpretation unreasonable and defeated their argument that they had no way of foreseeing the 2010 changes.

With regard to the period of retroactivity, the Tribunal found that, since Caprio had concluded the purpose of the 2010 amendments was curative or corrective, the two-and-a-half to three-year period of retroactivity was not unreasonable.

Finally, the Tribunal also rejected the Luizzas' attempt to distinguish their case from Caprio on the grounds that the actual issue in Caprio was the retroactive application of the installment obligation amendments, which had been ruled on only in the non-precedential Mintz ALJ decision, rather than the deemed asset sale amendments, which had been ruled on by the Tribunal in the precedential Baum decision. While noting that the legislature "cannot cure or correct a decision of this Tribunal that is final and irrevocable," the Tribunal found that the decision in Caprio about the "curative, rational public purposes" in the legislative findings overcame any arguments about the finality and continued effect of Tribunal decisions such as Baum.

Additional Insights

Given the decision in Caprio, the result in Luizza may not be surprising, but these two decisions taken together raise troubling questions about the administration of tax policy in New York State. The only evidence of the "curative" and "corrective" nature of the 2010 arguments found by the Court of Appeals was the legislative findings and an affidavit submitted by a Department auditor concerning the Department's internal policy— but no evidence that there had been any external statements of this policy that would have put taxpayers on actual notice. Indeed, the Department itself stipulated that the Luizzas had "reasonably relied" on the state of the law at the time they made a decision on whether or not to seek indemnity from the buyer. Both an ALJ and the Tribunal, in a precedential decision, had disagreed with the Department's interpretation of the original statute, regardless of the internal policy followed or arguments made by the Department in litigation. The combination of the Caprio decision and the Luizza Tribunal decision, if it is the last word on this case, seem to indicate that taxpayers rely on contemporaneous research and Tribunal decisions at their own peril. While the precise issue involved in these cases—the retroactive application of the 2010 statutory amendments—probably does not apply to many more cases by now, the underlying principles could end up having broader application whenever the Department seeks to reverse an unfavorable Tribunal decision via retroactive legislation.

As of this writing, it is not known whether further appeal will be sought in Luizza.

Tribunal Overturns ALJ and Holds That Bank Must Apply NOLs in Year Taxed on Non-Income Base

By Kara M. Kraman

The New York State Tax Appeals Tribunal has held that a taxpayer was required to use its net operating loss ("NOL") carryforward deduction to decrease its entire net income in a year in which its banking corporation tax liability was not measured by its entire net income. Matter of TD Holdings II, Inc., DTA No. 825329 (N.Y.S. Tax App. Trib., Apr. 7, 2016). The Tribunal overturned the determination of the ALJ, who had held that the taxpayer was not required to use any portion of its NOL in a year in which its entire net income was already low enough to trigger the application of an alternative tax base.

During tax years 2005 through 2007, TD Holdings II, Inc. ("TD Holdings") was subject to the New York bank tax under former Article 32 and filed New York bank tax returns. In 2005, TD Holdings reported a loss of approximately $11.7 million for federal income tax purposes and approximately $9.2 million for New York bank tax purposes. In 2006, TD Holdings claimed approximately $3.7 million of its 2005 federal NOL carryforward on its federal return, but did not claim any of its 2005 New York NOL carryforward on its New York bank tax return because its 2006 entire net income was low enough that the alternative tax on assets was instead triggered. In 2007, TD Holdings claimed the remainder of its 2005 federal NOL carryforward on its federal return and claimed the remainder of its 2005 New York NOL carryforward on its New York bank tax return. On audit, the Department required TD Holdings to use its available New York NOL carryforward to offset its entire net income in 2006, even though it was not taxed on its entire net income in that year.

During the years at issue, the New York bank tax was imposed on one of four alternate bases, whichever resulted in the highest tax: (i) entire net income; (ii) taxable assets; (iii) alternative entire net income; or (iv) a minimum tax. Tax Law former § 1455. The Tax Law also provided that the allowable New York NOL deduction was "presumably the same" as the federal NOL deduction claimed in the same year, and the New York NOL deduction could not exceed the maximum federal NOL deduction allowed for the same year. Tax Law former § 1453(k‑1).

The ALJ had concluded that under the plain language of the statute, TD Holdings was not required "to hypothetically apply the 2005 New York NOL to an entire net income [base] that was already sufficiently low enough to cause use of an alternative tax base," and that while the statute provided that a taxpayer's New York NOL deduction could not exceed its federal NOL deduction, it did not provide that the deduction could not be less than its federal NOL deduction. In reaching his conclusion, the ALJ had relied heavily upon a Tax Appeals Tribunal decision holding that the similar corporate income tax statute that placed a ceiling on New York NOL deductions equal to allowable federal NOL deductions did not provide that a New York NOL deduction "can never be less than the [f]ederal deduction." Matter of Brooke-Bond Group (U.S.), Inc., DTA No. 810951 (N.Y.S. Tax App. Trib., Dec. 28, 1995) (emphasis in original).

The Tribunal overturned the ALJ determination, noting at the outset that tax exemption and deduction statutes must be strictly construed against the taxpayer, and that the taxpayer must prove that the Department's interpretation of the statute is "irrational" and that the taxpayer's interpretation is the only reasonable construction. The Tribunal then held that the taxpayer failed to meet its burden to show that the Department's interpretation was unreasonable because there was no language in Tax Law former § 1453(k-1) which limited the application of an NOL carryforward to years in which the taxpayer measured its bank tax liability on its entire net income base. The Tribunal also found Matter of Brooke-Bond to be inapplicable, noting that the decision did not in any way tie the New York NOL deduction to the payment of New York tax on an alternative basis. Instead, it found that Brooke-Bond simply established that given the legislative intent to conform New York law to federal law with respect to NOLs, New York taxpayers should benefit from the federal rule that NOL deductions should be limited to an amount that brings a taxpayer's income to zero, even where such an amount results in a New York NOL deduction that is less than the federal NOL deduction.

The Tribunal also found that the New York State corporate tax reform legislation effective for tax years beginning on or after January 1, 2015, which expressly limits the maximum allowable NOL deduction in a year to "the amount that reduces the taxpayer's tax" on its income base to the higher of the other potentially applicable bases, also supported the Department's interpretation of the Tax Law in effect for tax years prior to 2015. The Tribunal reasoned that "when the Legislature amends a statute, it is presumed that the amendment was made to effect some purpose and make some change in the existing law."

Additional Insights

It is not known at this time whether TD Holdings will appeal the Tribunal's decision. Although the issue of NOL utilization is now clearly addressed under the new corporate tax reform legislation, if the Tribunal's decision is appealed and overturned, it could potentially create refund opportunities for both banks and nonbanks that utilized NOL carryforward deductions in years when they were not subject to tax on the entire net income base. In particular, the ultimate resolution of this case will impact the computation of a taxpayer's prior NOL conversion subtraction (the device by which pre-2015 NOLs are calculated and carried forward for use in tax years beginning on or after January 1, 2015).

To continue reading this article, please click here.

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

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
Check to state you have read and
agree to our Terms and Conditions

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.

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 by clicking here .

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.

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.