United States: New York City Tax Appeals Tribunal Affirms Exclusion Of Mortgage Subsidiary From Combined City Bank Tax Return

The New York City (NYC) Tax Appeals Tribunal has affirmed the determination of the Chief Administrative Law Judge's previous decision in Matter of Astoria Financial Corp.,1 holding that a federal savings and loan association was not required to include its Connecticut subsidiary in its combined NYC banking corporation tax (BCT) returns for the 2006-2008 tax years.2 The Tribunal concluded that the investment subsidiary had both economic substance and its own business purpose separate and apart from that of its parent corporation, and did not cause distortion of income.

Background

Astoria Financial Corporation (Astoria Financial), is a publicly-held holding corporation for Astoria Federal Savings & Loan Association (Astoria). Astoria is the parent corporation of several subsidiaries including Astoria Federal Mortgage Corporation (Astoria Mortgage), Astoria Preferred Funding Corporation (Preferred Funding), and Fidata Service Corporation (Fidata). Astoria, in turn, owned Suffco Service Co. (Suffco). In 2005, Astoria reorganized its structure, which included contributing all of the assets of Preferred Funding to Fidata, a Connecticut passive investment company (PIC). These assets consisted primarily of non-New York real estate mortgage loans. Fidata then used the income generated by these loans to purchase mortgage loans from Astoria and Astoria Mortgage at face value.

Also effective during 2005, Fidata entered into several agreements with related members, including: (i) a Master Loan Purchase and Servicing Agreement pursuant to which Fidata agreed to purchase loans from Astoria and Astoria Mortgage on a periodic basis, and Astoria agreed to act as a servicer for the loans at an industry standard rate, equal to that charged by Astoria to Fannie Mae; (ii) an Expense Sharing Agreement, under which Fidata was able to use Astoria facilities and personnel, and (iii) a Custodial Agreement with Suffco, which agreed to take possession of loans acquired by Fidata under the Master Loan Purchase and Servicing Agreement. For the tax years at issue, Astoria filed NYC combined tax returns for banking corporations which did not include Fidata.

The NYC Department of Finance audited Astoria's NYC returns for the 2006-2008 tax years and determined that although Fidata was a Connecticut subsidiary and did not do business in NYC, it was required to be included in the combined BCT returns. Specifically, the Department alleged that the transactions between Fidata and various Astoria subsidiaries lacked economic substance and business purpose. Further, even if these transactions were considered to have economic substance, the transactions resulted in a distortion of Astoria's income as reflected in the combined BCT returns. Astoria countered the Department's claims, contending that Fidata was formed for non-tax business purposes. Also, Astoria noted that the acquisition of mortgage loans was not an intercorporate transaction considered for purposes of the requirements of combination.3 Finally, Astoria argued that the loans purchased under the Master Loan Purchasing and Service Agreement by Fidata were purchased at arm's-length prices and the intercompany loan servicing fees were computed based on well-known industry practices.

In a 2014 determination,4 the Administrative Law Judge (ALJ) rejected the Department's arguments and determined that Fidata was not a sham corporation, the intercorporate transactions were conducted at arm's-length, and there was no discernable distortion of income caused by excluding Fidata from the combined BCT returns. The Department's Commissioner of Finance filed an exception to the determination.

Banking Corporation Tax Combined Reporting

The NYC Administrative Code in effect for the years at issue required that banking corporations doing business in NYC file combined BCT returns with any 80 percent or more owned banking corporations.5 The Code further provided that a corporation not doing business in NYC could not be included in a combined return unless the combination was necessary to properly reflect BCT liability because of intercompany transactions or "some agreement, understanding, or arrangement" between the nontaxpayer corporation and the corporations filing as part of a combined group.6

Pursuant to a related NYC regulation, a presumption existed under which reporting on a separate basis would improperly reflect the taxpayer's liability where there are substantial intercorporate transactions among banking corporations or bank holding companies engaged in a unitary business.7 Notably, the substantial intercorporate transaction test could be met in instances where as little as 50 percent of a corporation's receipts or expenses were from one or more of the following qualified activities:

  1. Performing services for other corporations in the group;
  2. Providing funds to other corporations in the group; or
  3. Performing related customer services using common facilities and employees.8

Here, Astoria did not dispute that Fidata was engaged in a unitary business with the combined group. Based on the regular intercompany loan purchases by Fidata from Astoria and Astoria Mortgage, the custodial services provided by Suffco, and the loan servicing fees paid to Astoria, the Tribunal determined that there were substantial intercorporate transactions between Fidata and the combined group. These transactions created a presumption that Astoria's BCT liability was improperly reflected when it excluded Fidata.

Economic Substance and Business Purpose

Prior to addressing the presumption of distortion, the Tribunal first focused on whether the intercorporate transactions in question had economic substance or business purpose apart from tax benefits.9

Business Purpose

With respect to business purpose, Astoria had provided evidence showing that Fidata was established to accomplish several business purposes, which consisted of a mix of operational and tax benefits.10 In considering these, the Tribunal rejected the testimony of the Department's expert witness, a professor claiming that the purported business purposes had no validity. Specifically, the Tribunal noted that "[t]he fact that a business purpose could have been accomplished in a way other than that chosen by the taxpayer does not negate the validity of that business purpose." Also, the Tribunal relied on the New York State Tribunal's decision in Matter of Kellwood Company holding that "[a] subjective business purpose for engaging in a transaction need not be free of tax considerations."11 The Tribunal found that the separation of the non-New York loans from Astoria was a sufficient non-tax business purpose, despite the noted tax reasons behind the creation and operation of Fidata.

Economic Substance

The Tribunal then turned to the economic substance of the transaction, which rested on whether there was a "reasonable possibility of profit" from the transaction aside from tax benefits12 and on whether the transaction "objectively affected [the taxpayer's] net economic position.13 Notably, the transfer of the mortgage loan portfolio to Fidata and its continued activity facilitated in raising Astoria's Community Reinvestment Act (CRA) rating, which enhanced its business in multiple ways.14 Based in part on this fact, the Tribunal determined that the transactions in question had economic substance. The Tribunal also reasoned that Fidata was a separate operating entity with its own employees, office, and bank accounts over which the president had at least dual signatory power.

Income Distortion

Having found both business purpose and economic presence, the Tribunal turned its attention to whether Fidata's inclusion in Astoria's BCT returns was necessary to properly reflect BCT liability because of intercompany transactions or "some agreement, understanding, or arrangement" between Fidata and the corporations filing as part of a combined group.15

Intercompany Transactions

Notably, the presumption of distorted income can be rebutted when the transactions at issue are conducted on an arm's length basis.16 In its examination of the transactions between Fidata and Astoria, the Tribunal determined that the mortgage loans acquired by Fidata were purchased at arm's length prices and were consistent with industry practices. Therefore, while the transactions were substantial in nature, they did not function to distort Astoria's income. Also, the loan servicing fees paid by Fidata to Astoria were paid at a rate consistent with industry standards, at the same rate charged by Astoria to Fannie Mae.17 Finally, regulations provided that incidental services, including accounting, legal and personnel services, such as those included in the Expense Sharing Agreement, were not considered for purposes of the substantial intercorporate transaction requirement.18

Therefore, the Tribunal determined that Astoria successfully rebutted the presumption of distortion.

Other Improper or Inaccurate Reflection

Finally, the Tribunal considered whether an "agreement, understanding or arrangement" existed between Fidata and Astoria "whereby the activity, business, income or assets" of Astoria in NYC was "improperly or inaccurately reflected."19 The Tribunal addressed the Department's reliance on the Interaudi20 decision and focused on the factual distinctions from the instant case. The Department argued that the relationship between Fidata and Astoria was similar to that in Interaudi, as Astoria claimed a deduction on its combined BCT returns for interest expense on deposits while the interest income on mortgage loans held by Fidata was not included in Astoria's income reported on those returns. According to the Department, this treatment resulted in a mismatch of income and expense. However, the Tribunal found Interaudi factually distinguishable, in that the original assets held by the investment subsidiary in Interaudi were acquired by the parent bank and transferred to that subsidiary directly by the parent bank shortly before the relevant tax years. This resulted in a clear shift in the related income from the parent bank to the subsidiary. In contrast, Astoria did not transfer assets directly to Fidata. Instead, the record included no facts regarding the source of the original assets included in the mortgage portfolio business which were contributed to Fidata's New Jersey predecessor corporation. Therefore, no clear mismatch of income could be discerned between Astoria and Fidata.

Commentary

This administrative matter reaffirms the holding of the October 2014 decision by the NYC Tax Appeals Tribunal and highlights the key roles that arm's length pricing and business purpose may play in determining the required combination of entities for pre-tax reform years.21

A key point of analysis was the method in which the Tribunal distinguished the facts in this matter from the facts as presented in Interaudi. Specifically, the Tribunal focused on "one significant and material" difference. In Interaudi, the assets held by the subsidiary were transferred directly to the subsidiary from the parent, while in this matter, Astoria did not transfer any assets to Fidata during the years under examination. The Tribunal focused on the fact that there was no "specific evidence" that assets were transferred to Fidata from Astoria.22 It is possible that if the Department had sought to gather additional facts during the audit regarding the funding of the predecessor corporation's loan portfolio in earlier years that was subsequently contributed to Fidata, the Tribunal would not have been able to distinguish the precedential Interaudi Tribunal decision so easily. Taxpayers should be aware of this and not disregard Interaudi's potential application in the future.

Another key element analyzed by the Tribunal was the testimony of the professor that served as the Department's expert witness. The professor testified that the business purposes noted by Astoria had no validity. The Tribunal determined that the professor was "not a tax expert" and the professor's testimony "deserve[ed] little weight," was "somewhat inconsistent" and was "disregarded . . . on these points."23 Whether or not such testimony would be disregarded in the same way in future Tribunal matters is something that taxpayers facing similar situations should consider.

Prospectively, NYC combined reporting rules for banks will follow most of what New York State enacted in its recent tax reforms, except that the new mandatory unitary combined reporting rules do not apply to any corporation that for federal income tax purposes is an S corporation or a qualified subchapter S subsidiary.24 These S corporations will continue to be taxed as they were under the pre-reform rules.25 For tax years beginning on or after January 1, 2015, NYC will require unitary combined reporting and will no longer rely on intercompany transactions, distortion, and the 80 percent ownership test. Based on the application of mandatory unitary combined reporting, a corporation which prior to 2015 had not filed a NYC BCT return may be required to be included within the NYC unitary group tax return prospectively. Taxpayers should take this into consideration when filing their post-reform tax returns.

Footnotes

1 For a discussion of the previous ruling, see GT SALT Alert: New York City Tax Appeals Tribunal Finds Subsidiary Properly Excluded from Combined City Bank Tax Returns. See also, Matter of Astoria Financial Corp., New York City Tax Appeals Tribunal, Administrative Law Judge Division, No. TAT(H) 10-35(BT), Oct. 29, 2014.

2 Matter of Astoria Financial Corp., New York City Tax Appeals Tribunal, No. TAT (E) 10-35 (BT), May 19, 2016.

3 Based on the decision in Matter of U.S. Trust Corp., New York Division of Tax Appeals, Tax Appeals Tribunal, DTA No. 810461, Apr. 11, 1996. In that case, the Tribunal concluded that capital contributions are not intercorporate transactions that give rise to presumption because they are not directly connected with the business of the group. The Tribunal accepted this reasoning and disregarded the initial contribution of loans to Fidata in considering the relevant intercompany transactions in this decision.

4 Matter of Astoria Financial Corp., New York City Tax Appeals Tribunal, Administrative Law Judge Division, No. TAT(H) 10-35(BT), Oct. 29, 2014.

5 N.Y.C. ADMIN. CODE § 11-646(f)(2)(i).

6 N.Y.C. ADMIN. CODE § 11-646(f)(2)(i)(B).

7 N.Y.C. RULE § 3-05(b)(3)(ii)(C)(a).

8 Id.

9 Citing Matter of The Talbots, Inc., New York Division of Tax Appeals, Tax Appeals Tribunal, DTA No. 820168, Sep. 8, 2008.

10 Specifically, Fidata was to be operated in Connecticut to promote greater retained earnings for Astoria and served to further strengthen Astoria for the following reasons: (i) Fidata would not be subject to New Jersey's REIT dividend distribution requirements, allowing isolation and management of its cash flow; (ii) Fidata's formation would provide an opportunity for Astoria to expand its Connecticut operations; (iii) Fidata would provide security for future investment assets by separating operating and investment assets; (iv) Fidata would help enhance Astoria's income through the recognition of certain tax benefits; and (v) Fidata would also help protect Astoria from potential state taxation other than New York. The Chief ALJ had concluded that these were valid business purposes in Matter of Astoria Financial Corp., New York City Tax Appeals Tribunal, Administrative Law Judge Division, No. TAT(H) 10-35(BT), Oct. 29, 2014.

11 Matter of Kellwood Co., New York Division of Tax Appeals, Tax Appeals Tribunal, DTA No. 820915, Sep. 22, 2011

12 Citing Matter of Sherwin-Williams Co., New York Division of Tax Appeals, Tax Appeals Tribunal, DTA No. 816712, June 5, 2003, aff'd, Sherwin-Williams Co. v. Tax Appeals Tribunal, 12 A.D.3d 112 (3d Dept. 2004), lv denied, 4 N.Y.3d 709 (2005); Rice's Toyota World v. Comm'r, 752 F.2d 89 (4th Cir. 1985).

13 Citing Kellwood; ACM Partnership v. Comm'r, 157 F.3d 231 (3d Cir. 1998).

14 The CRA rating is based on ratings received by banks on three measures: lending, investing and servicing. The lending component is based on the lending activity of the bank in its "assessment area," particularly whether loans are made in low and moderate income parts of the assessment area. A bank sets its own assessment area, usually based on where its main offices are located. An outstanding CRA rating is advantageous to a bank for various reasons, which are outside the scope of this Alert. Testimony as to the effect of Fidata on this rating was provided by the chief executive officer and president of Astoria.

15 N.Y.C. ADMIN CODE § 11-646(f)(2)(i)(B).

16 Citing Sherwin-Williams; Matter of Silver King Broadcasting of N.J., Inc., New York Division of Tax Appeals, Tax Appeals Tribunal, DTA No. 812589, May 9, 1996.

17 Although the fees resulted in a profit for Astoria, the Tribunal found that this fact alone did not establish that the rates were not consistent with an arm's length price.

18 N.Y.C. RULE § 3-05(b)(3)(ii)(C)(a).

19 N.Y.C. ADMIN. CODE § 11-646(g).

20 See Matter of Interaudi Bank F/K/A Bank Audi (USA), New York Division of Tax Appeals, Tax Appeals Tribunal, DTA No. 821659, Apr. 14, 2001. In this case, an initial capital contribution of investment assets to a passive investment company served as the only intercorporate transaction. The passive investment company (non-New York taxpayer) earned income related to the assets, while the parent corporation (New York taxpayer) continued to take a deduction from income for interest paid to the investment fund depositors. However, the Tribunal found that the transfer was an "arrangement, agreement, or understanding" resulting in a mismatch of income and related expense causing distortion for New York State Bank Tax liability purposes.

21 See GT SALT Alert: New York State Enacts FY 2015-16 Budget Legislation providing Extensive New York State and City Tax Reform.

22 Id.

23 Id.

24 Ch. 60 (A.B. 6721 / S.B. 4610), Laws

25 N.Y.C. ADMIN. CODE § 11-651.

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
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.