IIB Annual Tax Seminar (June ) State & Local Developments

Transcription

1 IIB Annual Tax Seminar (June ) State & Local Developments June 14 15, 2011 Russell D. Levitt kpmg.com

2 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 1

3 IIB Annual Tax Seminar (June 14-15, 2011) State & Local Developments Panel (June 10:45 am 12:30 pm) New York Developments 2

4 Interaudi Bank Case A. Decided by the New York StateTax AppealsTribunal (April 14, 2011) 1. Government succeeded in forcing a bank tax combined report between a New York nexus U.S. bank and its Delaware investments holding company ( DHC ) subsidiary, for the tax years. 2. The State Tax Tribunal affirmed, in all respects, the January 28, 2010 decision of the chief administrative law judge. 3. Even the substantial understatement penalty was upheld. 4. The taxpayer could appeal to the five member intermediate appellate court, Third Department. 5. Meanwhile, the case is now equally binding precedent for the New York City bank tax. (NYC Charter 170.d) 6. Second quarter financial statement event a. Tax compliance and audit controversies aside, taxpayers with investment holding subsidiaries should evaluate whether: 3

5 Interaudi Bank Case, continued Interaudi affects their reserves posture i. The impact of Interaudi on reserves should consider not merely whether a non-nexus bank tax classified investment holding company subsidiary could be combined, but also ii. B. Facts of Interaudi The case s possible application to force an income realignment with a Grandfathered 9A subsidiary. 1. In 1997, the bank created the DHC with $98 million of investment securities and a small amount of cash, in an IRC 351 qualifying non recognition transaction a. Viewed in isolation, the Tribunal agreed that such transaction would not be distortive (i.e., not a basis for combination) since the stock in the DHC received by the bank was of equal value to the assets it transferred down. 2. Contemporaneous documents revealed that New York bank tax minimization was a strong motivation for the use of the DHC including comments that, while the New York auditors often challenge such arrangements, experience had shown a willingness by New York auditors to settle. 3. The need for a DHC, in the bank tax realm, as compared to the Article 9A realm, is the bank tax treatment of all taxable income as business income, whereas Article 9A apportions most portfolio income favorably as investment income. 4

6 Interaudi Bank Case, continued 4. The DHC in Interaudi did not pay dividends up to the bank (i.e., New York was unable to tax at least 40% of the DHC s income as non-excludible subsidiary capital dividend income at the bank s level). C. Arguments of the parties in Interaudi 1. The bank argued that the Tribunal s recent decision in Premier National Bancorp (8/2/2007) and the Tribunal s 4/11/1996 decision in U.S. Trust prohibit a finding of distortion of tax liability and, thus, foreclose combination. a. In Premier National, the Tribunal rejected the Department s argument for an income realignment (under Tax Law section 1462[g]) of portfolio income earned by a Grandfathered 9A subsidiary, which had been purchased for the purpose of aiding the bank to minimize New York taxation. The Tribunal reasoned that to allow such income realignment would violate the legislative intent behind the maintenance of Grandfathered 9A subsidiaries. b. In U.S. Trust, the Tribunal rejected the Department s assertion of distortion (and, thus, combination) for a DHC apparently similar to that of Interaudi. 5

7 Interaudi Bank Case, continued c. Since semi-automatic vertical nexus combination did not present, nor were there substantial intercorporate transactions between the Interaudi bank and the DHC, the taxpayer argued that the Department bore the burden of proof to demonstrate where there was distortion sufficient to enable combination. d. The bank also argued that, if it were to be combined, penalties would not be appropriate, since combination would only be achieved by means of the Department s discretion. 2. The Department argued that distortion existed due to the DHC s earning of income from investments there were financed by debts and expenses (i.e., customer deposits) incurred by the bank. D. The Interaudi Tribunal held that, in 1997, the bank created a distortive arrangement by transferring to the DHC approximately $100 million in borrowed funds (its customer deposits money being fungible and difficult to trace), on which the bank attained interest expense deductions in New York, while the income earned on such funds was in a subsidiary that was not taxed by New York. 6

8 Interaudi Bank Case, continued 1. The Tribunal described this arrangement as a significant mismatching of related income and expenses resulting in distortion As a result, either [the bank s] deductions were overstated, or its income was understated. By including [the DHC s] income in the combined report, this distortion was properly eliminated. 2. The Tribunal did not even mention the tax minimization planning, behind the creation and use of the DHC, as a factor in its conclusion that there was sufficient distortion to enable combination (though that did play an important role in the upholding of penalties). 3. The Tribunal distinguished U.S. Trust as a case where the Department had not pointed out specifically both the subject arrangement and the distortion created by the arrangement, i.e., a less than stellar argued/failure of proof case. 4. While a distortive arrangement seemingly can be identical to support either combination or an income or expense realignment at the Department s choosing (assuming the affiliates are classified under the same Article to support combination), the Interaudi Tribunal did not quite close the loop on how Premier National is distinguishable, nor what the continuing vitality is of that case in the wake of Interaudi. 7

9 Interaudi Bank Case, continued a. Given the recent vintage of Premier National, it seems fair to conclude that such case is still valid, i.e., the legislative intent to support the use of Grandfathered 9A companies outweighs an income realignment distortion (under Tax Law section 1462[g]) which might well otherwise be inferred from Interaudi s rationale. E. Points to consider in the wake of Interaudi 1. Did the Tribunal overlook the bank tax situation whereby, essentially as a trade-off, back in 1985, for no Article 9A type interest and other expense attribution disallowance to subsidiary capital, a bank would be afforded only a 60% subsidiary capital dividends received deduction and 17% subsidiary capital interest income exclusion? Interaudi essentially punishes the bank, through combination, as a result of the statutory inability under the bank tax to achieve subsidiary capital expense attribution disallowance (arguably that would fix the mismatch). 8

10 Interaudi Bank Case, continued 2. The DHC in Interaudi paid no dividends up to the bank, hence New York did not tax the bank on even the 40% of subsidiary capital dividends which are not excludible under the Tax Law. Could Interaudi be successfully distinguished by a fact pattern where the DHC s earnings were, indeed, dividended to the bank (albeit, taxed only 40% by New York, as a matter of law)? 3. Factually, in Interaudi, it was brought out that the DHC s infused capital far exceeded the stockholder s equity in the bank, leaving a logical inference that the DHC s income-producing assets related to borrowings on which the bank was currently attaining interest deductions. What if, for reasons of time passage (for example, the DHC was formed decades ago), or due to the manner in which the DHC was acquired, such inference of an income/expense mismatch is not justifiable: Would that be sufficient to distinguish Interaudi? 9

11 Gramm-Leach-Bliley Articles 9A/32 Classification Transition Rules Developments A. The GLB classification transition rules which, like the bank tax, had again sunsetted after the 2010 tax year, were legislatively extended to cover the 2011 and 2012 tax years. (NY Laws of 2011, Chapter 61, Part J.) 1. The rest of the bank tax, though, was finally made permanent, with a legislative history comment that even such permanency is subject to alteration by the ongoing New York corporate tax reform effort B. Informal unpublished clarification has been obtained from the State Tax Department as to certain vexing issues embedded in the statute, which triggers the reevaluation of a corporation s article 9A classification upon the occurrence of any of a number of events (State Tax Law section 1452[n][3], as to events in a post-2006 tax year, and City Admin. Code section [m][3][A]-[E] as to events in a post-2008 tax year.) 1. Section 1452(n)(3)(E): Reevaluate Article 9A status if in a transaction or series of transactions, its assets expand by more than 40% (measured by value or adjusted basis, whichever is greater) into a new line of business (if defined as a bank type permissible business in Tax Law section 1452[a][9][i]-[iii]) and the corporation is thereby principally engaged in that new line of business. 20XX KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. <Insert DOCID> 10

12 Gramm-Leach-Bliley Articles 9A/32 Classification Transition Rules Developments, continued a. Principally engaged: Utilize regulation 20 NYCRR section (f)(4) - More than 50% of the corporation s gross receipts for the year for Federal income tax purposes. b. The >40% assets infusion occurs in a year prior to the derivative principally engaged (>50% gross receipts ) year: The reevaluation does apply, but can affect classification only for the derivative principally engaged year -- not retroactively to the >40% assets infusion year. c. The >40% assets infusion occurs during a tax year, and the derivative principally engaged test is satisfied from that point through the balance of the tax year: Does the Article 9A corporation experience a short-period Article 9A status filing, followed by a short-period Article 32 status filing from the 40% assets infusion point through the balance of the tax year? i. Yes. (Regulation 20 NYCRR section ) ii. Indeed, measure the principally engaged test in that situation by comparing receipts only from the point of the >40% assets test s fulfillment. 11

13 Gramm-Leach-Bliley Articles 9A/32 Classification Transition Rules Developments, continued C. Article 9A status is reevaluated, under Tax Law section 1452(n)(3)(B), if the corporation becomes subject to the State s $800 flat-fee minimum tax (per the specific reference to Tax Law section 210.1[d][1][F]). 1. By contrast, for the City, such status is reevaluated if the corporation becomes subject to any of the sliding scale flat-fee minimum taxes not only the $800 flat-fee tax. (City Admin. Code section [m][3][B], which references section [1][E][4].) D. If the Article 9A corporation has no wages and no receipts allocable to New York, or is otherwise inactive, it can lose its Article 9A status, but it nonetheless would retain its Article 9A status if it is engaged in the active conduct of a trade or business. 1. What is meant by the term there, the active conduct of a trade or business? a. Is it the Federal D reorganization meaning, in IRC section 355? 12

14 Reporting of Federal or New York State Changes to New York City A. City GCT form NYC-3360 B. Relevant City Administrative Code statutes : Duty on taxpayer to report Federal or NYS audit changes to income or (from NYS) capital [Broadened in 1988 for non-income based taxes] (a): City statute of limitations for the changes doesn t start to run until the changes are reported a. If reported, the limitations period is 2 years (g): No change can be made to City apportionment during the additional (i.e., re-opened) limitations period C. Ethyl Corp. The City Tax Tribunal very literally applied (g), to deny a recomputation of City apportionment after a State audit apportionment change. (6/28/99.) 1. Logical in that City apportionment rules (e.g., receipts sourcing, or issuer s allocation percentages) could often be different from those of the State, and not simply a mechanical run-through 13

15 Reporting of Federal or New York State Changes to New York City, continued 2. Query: If the City period is still open of its own volition, and the State changes apportionment, to what extent is that State change reported and run-through for the City? It seems that a taxpayer is not required to run-through the apportionment, though the City (with its limitations period open, anyway) can attempt to effect a parallel change in its own audit a. The 90 day (120 days if filed combined) change reporting period, may make it more difficult (or impossible) for the City to assert its own apportionment change (NYC Admin. Code ) 3. Ethyl might be curtailed, somewhat, if the federal or State change is to gross income, such that, logically, an adjustment to business receipts could follow suit. See, Sumitomo Mitsui Banking Corp. (NYS Tax Tribunal 5/31/07), which is binding precedent on the City, per City Charter 170.d. 4. Query: Does Ethyl (that is to say, NYC Admin. Code and [g]) preclude the ability to flow down to the City a State GCT change which reclassifies income from investment income to business income (be it by category or expense attribution)? a. Isn t that another precluded species of a change to the allocation of income or capital upon which the taxpayer s return was based? ( [g]) b. How is that a change to the amount of taxable income or other basis of tax? ( ) 14

16 Reporting of Federal or New York State Changes to New York City, continued c. The City s audit division asserts that taxpayers must report, and pay on such State change, to the City, citing Statement of Audit Procedure, PP (3/20/2008) d. The issue seems to revolve around what section means by a change or correction to New York State taxable income : Is that pre-apportionment entire net income, or postapportionment entire net income? i. There is no official New York State term taxable income (whereas Federally there is such term); the New York State (and City) term is entire net income. ii. Some New York tax cases have interchangeably used the terms New York entire net income and New York taxable income, and apparently in a pre-apportionment connotation. A. Norcliff Thayer, Inc. v. Chu, 123 Misc.2d 16,17 (1984) B. Aetna Casualty and Surety Company v. Tax Appeals Tribunal of the State of New York, 214 AD2d 238, 239 (Third Dept. 1995) 15

17 Reporting of Federal or New York State Changes to New York City, continued C. General Signal Corp. v. NYS Tax Commission, 49 AD2d 419, 421 (Third Dept 1975) D. Scholastic Bus Service, Inc., NYS Tax Commission Hearing Decision, TSB-H-84(40)C (8/13/1984) E. Brookhaven Servicing Corp., NYS Tax Commission Hearing Decision, TSB-H-84(37)C (8/10/1984) iii. Other rulings, in referring to entire net income, arguably mean that in a pre-apportionment sense, such as: A. Infosys Technologies Limited (NYS Tax Appeals Tribunal, 2/21/2008) B. Gold Fields Mining, NYS Tax Commission Hearing Decision, TSB-H-85(11)C (3/19/1985) C. International Nickel, Inc. (NYS Tax Appeals Tribunal, 10/19/1995) 5. On March 14, 2011, the NYC Department of Finance introduced Program Bill #11, in the State Legislature, to amend section (g), apparently to reverse the Ethyl case, and allow City apportionment to be changed if the State changes apportionment. Not yet enacted, the Memorandum in Support describes the current law as a windfall to taxpayers. 16

18 Reporting of Federal or New York State Changes to New York City, continued D. Penalties: Can the City assert late filing/late payments, etc., penalties (such as by a look-back at the valid extension safe-harbors) that might appear applicable following an NYC-3360 reporting, during the additional period of limitations? Seems to not be statutorily supportable. E. Is the City entitled to a State change as to the composition of a combined reporting group? 1. Is that a change to income or capital? a. A 1985 City policy bulletin says that the City is entitled to that change b. City regulation 19 RCNY section11-91(g)(4) instructs that if New York State changes a combined report (by adding or deleting a member), then within 30 days, the taxpayer must report such change to the City. This regulation refers to the City s combined reporting statute (section ). i. Query: Does report there also mean and recompute (such change for the City), or is it merely an informational directive? ii. Compare City regulation section 11-83(a) which refers to statute and requires a taxpayer to report and concede the State change for the City income base. a. Literally, the point is arguable. If the reporting down was not done timely, consider arguing reasonable cause, for penalty abatement 17

19 Reporting of Federal or New York State Changes to New York City, continued D. Offsets: Remember that even in the additional limitations period, either the City or the taxpayer can introduce otherwise statute-barred offsets, up to the Federal or State change, such as more or less income/deductions, and combined reporting changes 1. Bankers Trust Corp. v. New York City Department of Finance, 301 AD2d 321 (1st Dept. 2002), modified and affirmed on other issues, 1 NY3d 315 (2003) 2. The City and the taxpayer can also go back to closed years to adjust the NOL then generated, which is being carried to an open (or partially re-opened) year. See, Davies Lake Hotel Inc. (NYS Tax Tribunal, 1/20/89) a. Citing Department policy as the authority, recent audit experience with the City has revealed a one-way street, whereby the City asserts that it can go back to closed years to make adjustments adversely affecting NOLs, yet taxpayers (even in the same audit) are precluded from favorably adjusting such closed year s NOLs. By contrast, it seems that, under Federal law, this topic has long been a two-way street. 18

20 New York State s Regulations Amended to Alter the Procedure for Requesting Discretionary Adjustment Relief to the General Corporation Tax and Bank Tax Method of Allocation A. 20 NYCRR sections 4-6.1[c] & were amended on March 14, B. Taxpayers now must submit a written request, either before or after filing their CT-3 or CT-32 report, for discretionary authority permission to alter their method of allocation (i.e., apportionment). 1. Until such permission is granted, taxpayers must file under the standard apportionment method. 2. If permission is granted after the return is filed, taxpayers are instructed to amend their return. C. Previously, the regulations had instructed taxpayers seeking such permission to file the return using the standard apportionment method, while simultaneously attaching a request to the return for an adjustment and including a computation which shows the tax that would be due under the alternative apportionment. D. Query whether the alteration in the State s procedure can validly preempt a taxpayer s ability to file and pay tax pursuant to an alternative apportionment (without prior permission), if the standard apportionment method would apply in an unconstitutional manner. (Compare, Movie Service Functions, Inc., NYS Tax ALJ [5/5/1988].) 20XX KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. <Insert DOCID> 19

21 New York Sales/Use Tax Responsible Person Liability of Limited Partners & Limited Liability Members A. Recent case law has literally applied Tax Law sections 1131(1) & 1133, to adversely impose personal responsibility for sales and use tax obligations on all partners and members of a partnership or limited liability company which is the primary taxpayer. 1. Santo (NYS Tax Appeals Tribunal, 12/23/2009, penalties abated on remand by the ALJ, 4/15/2010); Davis (NYS Tax ALJ, 2/11/2009). 2. Thus, per se liability for 100% of the entity s sales tax debt could apply even to minor, passive investors with far less of an investment than the sales tax debt of the company. a. By contrast, individuals are so liable as responsible persons only if they have a duty to act for the entity, i.e., a sufficient level of authority and control over the affairs of the corporation. b. Legislative efforts have been underway to alleviate this very harsh and comparatively unfair situation faced by limited partners and passive LLC members. 20XX KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. <Insert DOCID> 20

22 New York Sales/Use Tax Responsible Person Liability of Limited Partners & Limited Liability Members, continued B. Meanwhile, the NYS Tax Department recently issued a bulletin which outlines a fairer policy (TSB-M- 11[6]S, 4/14/2011). C. 1. Under the policy, eligibility is restricted to: a. Limited partners, who may be approved for relief if they can demonstrate they were not under a duty to act, in complying with the Tax Law, on behalf of the partnership; and b. LLC members, who may be approved for relief if their ownership interest and percentage distributive share of the profits and losses of the LLC are less than 50% and they were not under a duty to act for the LLC as to compliance with the Tax Law. 2. Eligible limited partners or LLC members are also expected to cooperate with the Tax Department (to the extent they have relevant knowledge) in identifying responsible persons, especially those involved in the day-to-day affairs of the business. 20XX KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. <Insert DOCID> 21

23 New York Sales/Use Tax Responsible Person Liability of Limited Partners & Limited Liability Members, continued i. The pending expiration of the statute of limitations will be taken into consideration as to the granting of relief. 3. No partner of a limited liability partnership (LLP) is eligible for this relief. 4. The available relief under the policy includes: a. No penalties owed by the business or other responsible persons would be due form the eligible persons; and b. The sales tax liability of the eligible person would be limited to an amount determined by multiplying the business liability for tax and interest by the person s percentage of ownership interest in the business, or by the person s percentage share of the profits and losses of the business, whichever is higher. 5. Treatment of payments: a. Payments made by eligible persons are not to be credited against the liability of other eligible responsible persons. 22

24 New York Sales/Use Tax Responsible Person Liability of Limited Partners & Limited Liability Members, continued That is, those other eligible responsible persons must calculate their liability by applying their applicable percentage to the full value of their assessment, without any credit for payments made by other eligible responsible persons. The amount owed by eligible responsible persons would be the amount so calculated or the business remaining sales/use tax liability, whichever is less. 23

25 Thank you Presentation by Russell D. Levitt

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