Thank you for the opportunity to comment on the Department s draft Article 9-A and Article 32 regulations regarding combined reports.

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1 TO: John W. Bartlett, Director of Regulations, NYS Department of Taxation and Finance FROM: Kenneth J. Pokalsky SUBJECT: Draft Combined Report Regulation DATE: 11/7/08 Thank you for the opportunity to comment on the Department s draft Article 9-A and Article 32 regulations regarding combined reports. Once you have reviewed these comments, I would appreciate any opportunity to discuss the proposed rules, and our concerns, with you and/or appropriate staff. It would be helpful if we could include several members of The Business Council s Tax Committee in this discussion, to provide you with additional input and insights as to the business community s concerns. Basically, these comments mirror those we submitted in January 2008 regarding your then-draft TSB-M-08(xx)C. Unfortunately, the Department dismissed those comments in their entirety. We have reached out to our corporate members that will be affected by the 2007 statutory changes. Based on their input, we continue to see the Department s approach, first set forth in guidance, now proposed to be given force and effect of law through regulation, imposes an onerous methodology that will be difficult for large companies to follow. In our members view, the Draft s interpretation of the new statutory provisions particularly the Department s Ten-Step Analysis of whether and to whom combined reporting applies will impose a significant, near unmanageable, administrative burden on large, multinational companies doing business in New York. Moreover, we find that the Department s proposed approach also exceeds the specific scope of statutory authority granted by the Legislature, and exceeds legislative intent, which was to eliminate the issue of transfer pricing with respect to distortion from substantial inter-company transactions. The Draft goes well beyond this objective, and in effect moves the state toward unitary tax state status. Finally, the procedure undoubtedly risks pulling companies or groups of companies into a combined reporting group even if they have no substantial inter-company transactions with a New York taxpayer. This is clearly at odds with the new statutory requirements governing mandatory combined reporting.

2 Tax Law Provisions - Under prior law, the Commissioner of Taxation and Finance had the discretion to require or permit combined reports if three prerequisites were satisfied: the corporations for which combination was considered must have been related; the related corporations must have been engaged in an unitary business; and as a result of the inter-corporate relationship there must be a distortion in the income or capital reported to New York State by a taxpayer (see former Tax Law 211.4). With respect to the distortion prerequisite, regulations were promulgated indicating that distortion was presumed to exist if there were substantial intercorporate transactions. The current New York Tax Law 211.4(a), which took effect on January 1, 2007, mandates that related corporations file on a taxpayer s combined report if there are substantial inter-corporate transactions among the related corporations. However, the new statutory language makes it clear that combined reporting is applicable only where there are substantial inter-corporate transactions between a taxpayer and the related corporations to be included on the combined report). It is not necessary that there be substantial inter-corporate transactions between any one corporation and every other related corporation. It is necessary, however, that there be substantial intercorporate transactions between the taxpayer and a related corporation or collectively, a group of such related corporations. (italics added, see current Tax Law 211.4(a)). The Ten-Step Analysis The Department s Ten-step methodology requires a taxpayer to include in its combined report not only those corporations (or groups of corporations) with which it has substantial inter-corporate transactions, but also certain corporations with whom the taxpayer may not have had any transactions. This is clearly contrary to the above-quoted language of the statute. Under Article 9-A, a taxpayer is defined as any corporation subject to tax under this article. (See Tax Law ) Thus by its own terms, the mandatory combined-reporting statute precludes the type of attribution that the Department s method requires -- substantial intercorporate transactions between two remote non-taxpayers simply cannot be attributed to the taxpayer when a taxpayer itself has no transactions with either. The Department s approach is clearly designed to capture as many corporations as possible on the combined return, but the Department s approach is overinclusive and pushes beyond the limits expressed in the statute. The Department s Ten-step analysis, therefore, should be limited to require: 1. Identification of all the corporations to which a taxpayer is related; 11/7/08 Page 2 of 5

3 2. Identification of all the taxpayers among this group of related corporations; 3. For each taxpayer, identification of the related companies with whom (either individually or as a group acting in concert) the taxpayer has substantial inter-corporate transactions; and 4. Elimination from the groups formed in Step 3 any alien corporations, corporations taxable pursuant to another article of the Tax Law, and corporations that compute their business allocation percentage differently than the taxpayers (step 10 under the Department s draft rules). Our proposed method would produce combined reporting groups that not only reflect the groups envisioned in Tax Law 211.4(a), but whose transactions among each other truly do risk distorting a taxpayer s true income and capital reported to New York. This four-step approach may produce several combined reports within one overall group of related corporations. However, this approach also does more to ensure that each of the combined groups is involved in a unitary business, since it is more likely that corporations are engaged in a unitary business if they have direct substantial inter-company transactions. Indeed, the new statute presumably relies on substantial inter-corporate transactions as a proxy for unitary business. In contrast, the Department s approach, which does not require substantial intercorporate transactions with a taxpayer, could result in several distinct unitary businesses filing on one combined report, and this is contrary to accepted combined reporting doctrine. We would also noted that this purported ten step analysis, proposed in the draft Section 6-2.3(c), understates the actual number of steps that would be needed to complete the process for many taxpayers, and minimizes the true complexity of the Department s proposed approach. For example, Steps 6, 7 and 8 need to be run independently for each unattached group. Furthermore, Step 9 requires that Steps 4, 6, 7 and 8 be re-run numerous times so that the actual number of steps grows geometrically with the number of unattached groups. Substantial asset transfers -- The Department s ten-step methodology becomes even more problematic where the substantial transactions involved are not the flow of receipts and expenses as in the examples included in the TSB-M but one-time asset transfers. Under the Department s approach, a transfer of assets to a related corporation will satisfy the substantial incorporate transactions requirement if at least 20 percent of the transferee s gross income is derived from the asset, and that test continues for as many years as remain in the asset s depreciation/amortization period. Thus, under the Department s final guidance and proposed rule, a lone substantial asset transfer between two remote, non-taxpayer corporations in 2007 could still trigger combined reporting for a taxpayer in That is so even if the taxpayer itself never had a substantial inter-corporate transaction with 11/7/08 Page 3 of 5

4 either corporation during the entire period. The 20 percent of the gross income the remote transferee derives from a single asset would not be sufficient to distort the true income of a major corporate taxpayer. Yet under the Department s mathematical, over-inclusive test, the transfer would trigger a combined report. Further, the Department s test circumvents the basic principle of the Article 9-A franchise tax that it is a tax on separate corporations. The substantial asset transfers test negates the right of a taxpayer to operate on a separate company basis for business or permitted tax planning purposes. Once the separate company is formed the only test of distortion should be substantial inter-company transactions during each taxable year with other affiliated taxpayers, as stated in the statute. This proposed policy clearly goes beyond the intent of the new statute. Policy considerations - The proposed rules are simply unworkable, as a practical matter, for a large, complex corporation. The ten-step analysis presents an onerous accounting and monitoring task when just 15 related corporations are involved, as in Example 4 presented in the Department s final TSB-M. But for a large corporate taxpayer with a significantly greater number of domestic and foreign subsidiaries, simply determining filing requirements would likely be an enormously burdensome task. Making substantial inter-company transactions the sole factor in the combined reporting inquiry achieves a greater level of objectivity in the process. However, the Department s approach places an undue burden on the taxpayer to trace and monitor transactions and fiscal relationships among remote affiliates that have little to no bearing on the taxpayer s own activities. It is one thing for a taxpayer corporation to monitor its transactions among the corporations with which it has substantial inter-corporate transactions. It is quite another burden to monitor every transfer of assets, every assumption of expenses, and every service performed between companies with whom the taxpayer has no substantial transactions of its own. As noted above, a single arm s length asset transfer between members of an unattached group can ripple its way upward to a taxpayer solely by attribution and aggregation of transactions under the Department s proposed rules. Even though the transfer might make sound business sense to the corporations involved, it now takes on the risk of potentially undesired tax ramifications for a remote taxpayer even if it does not distort the income the taxpayer would otherwise report to New York. This raises the potential for tax considerations to take precedence over valid business reasons for certain transactions for both taxpaying companies desiring to retain their filing status and remotely-related affiliates who risk triggering combined reporting for the taxpayers. Prior to the 2007 statutory amendments, the presence of substantial intercorporate transactions raised a rebuttable presumption that a taxpayer and its related corporations were linked to such an extent that separate reporting would distort the taxpayer s true income. Now that substantial inter-corporate transactions themselves are determinative of combined reporting, the Department proposes a methodology under which substantial transactions among any members of a related group can be attributed to a taxpayer. The 11/7/08 Page 4 of 5

5 Department s existing regulations guide it to select a combined-group configuration that achieves the least distortion of income (see 20 NYCRR ) However, the Department s proposed methodology seems aimed at creating the largest combined-filing group possible, with little regard for whether there is truly distortion or whether the corporations in the group are engaged in a unitary business. Combined Reporting Rules for REITs & RICs Sections and of the Tax Law, as amended in 2007, provide that REITs and RICs are required to file combined reports with an Article 9-A taxpayer that owns or controls substantially all of its capital stock. Under existing Departmental regulations, for the purpose of permitting or requiring combined reporting under Article 9-A, the term substantially all is defined as ownership or control of 80 percent or more of the entity s voting stock (see 20 NYCRR 6-2.2(a)(2)). (We not that this regulatory definition would not be amended by the current rule-making.) In discussing these provisions of Article 9-A, the final TSB-M states that a REIT or RIC would not be required to be included in a combined report under Article 9-A if over 50 percent of its capital stock is owned directly by a Article 32 taxpayer. In effect, this provision of the TSB-M suggests a new definition of substantial ownerships for purposes of Article 9-A combined reporting - if 50 percent or more of its stock is owned or controlled by an Article 9-A taxpayer, the REIT or RIC would be subject to combined reporting under Article 9-A. This language directly contradicts current regulation, and is in conflict with longstanding statutory intent regarding criteria for combined reporting. Moreover, it is unclear how this existing Departmental guidance relates to provisions of the current rule proposal. We believe that the TSB-M should be revised to reflect the substantial ownership test set forth in Part 6-2.2(a)(2); this approach could be reflected in the Department s rulemaking as well. Article 33 The final TSB-M contains provisions addressing Article 33 as well, including a provision that Article 33 taxpayers are subject to the same 10-step analysis imposed on Article 9-A taxpayers under the TSB-M, and that would be imposed on Article 9-A taxpayers under the proposed regulation. The Department s communication regarding this proposal makes no mention of possible amendments to its Subchapter C regulations. Conclusion - The Business Council appreciates this opportunity to share its views and concerns with the Department. Likewise, the Council and members of our Tax Committee would welcome the opportunity to work with the Department to produce a more workable interpretation to the new mandatory combination statute. 11/7/08 Page 5 of 5