AMERICAN INTERNATIONAL GROUP, INC. - DECISION - 09/24/04 TAT (E) 00-36(GC) - DECISION GENERAL CORPORATION TAX RESPONDENT'S CLAIM THAT LOSSES FROM FOREIGN CURRENCY CONTRACTS, ENTERED INTO IN ORDER TO STABILIZE PETITIONER'S FOREIGN CURRENCY EXPOSURE RELATING TO PETITIONER'S INVESTMENT IN ITS SUBSIDIARIES, SHOULD BE DISALLOWED IN THE COMPUTATION OF ENTIRE NET INCOME AS A DEDUCTION DIRECTLY ATTRIBUTABLE TO SUBSIDIARY CAPITAL WAS REJECTED AND PETITIONER'S REFUND CLAIM WAS GRANTED. THE FOREIGN CURRENCY CONTRACTS DID NOT MEET THE DEFINITION OF SUBSIDIARY CAPITAL OR INVESTMENT CAPITAL FOR THE TAX YEAR AND WERE, THEREFORE, BUSINESS CAPITAL. RESPONDENT'S DISALLOWANCE OF THE REFUND CLAIM BASED UPON AN EXERCISE OF DISCRETION WAS IMPROPER AS THE LOSSES IN QUESTION WERE NOT DIRECTLY ATTRIBUTABLE AS A CARRYING CHARGE OR OTHERWISE TO SUBSIDIARY CAPITAL. THE TRIBUNAL DID NOT ADDRESS THE ISSUE OF WHETHER THE MATCHING APPROACH ADOPTED BY THE CITY IN 1991 IN THE INVESTMENT CAPITAL RULES (APPLICABLE ONLY WITH RESPECT TO POSITIONS TAKEN DURING TAXABLE YEARS BEGINNING ON OR AFTER JANUARY 1, 1990) MUST APPLY BY ANALOGY TO CHARACTERIZE THE FOREIGN CURRENCY CONTRACTS AS SUBSIDIARY CAPITAL AS THE TAX YEAR (1984) WAS THE ONLY YEAR AT ISSUE. SEPTEMBER 24, 2004 NEW YORK CITY TAX APPEALS TRIBUNAL APPEALS DIVISION
New York City Tax Appeals Tribunal -------------------------------------------------------------------------x : In the Matter of : : DECISION AMERICAN INTERNATIONAL GROUP, INC. : : TAT (E) 00-36 (GC) Petitioner. : : : -------------------------------------------------------------------------x The Commissioner of Finance of the City of New York (the "Commissioner" or "Respondent") and American International Group, Inc. (the "Petitioner") filed Exceptions to a Determination of the Chief Administrative Law Judge ("CALJ") dated June 20, 2003. The CALJ's Determination cancelled a Notice of Disallowance (the "Notice"), dated November 4, 1999. The Notice was issued by the New York City Department of Finance (the "Department") to Petitioner and disallowed, in part, Petitioner's claim for refund of 1 general corporation tax ("GCT") for the 1984 calendar year (the "Tax Year"). The Commissioner appeared by Martin Nussbaum, Esq., Assistant Corporation Counsel, New York City Law Department. Petitioner appeared by Stanton Alan Young, Esq., Senior Tax Counsel, American International Group, Inc. Both parties filed briefs and oral argument was granted by the Tribunal. Petitioner, whose principal office was located in New York City (the "City"), is a Delaware corporation and the parent of a group of corporations that were engaged in a broad range of insurance and insurance-related businesses in the United States. 2 1 Petitioner took exception to certain conclusions of the CALJ. While these conclusions did not negatively impact Petitioner's refund claim for the Tax Year they may, however, impact future tax years which are not included in the Notice of Disallowance (the "Notice"). See infra footnote 13. 2 The CALJ's Findings of Fact are based on a Joint Stipulation of Facts, dated July 13, 2001 and submitted exhibits and such findings have generally been adopted for purposes of our decision. Some of the findings have been paraphrased. Neither party has taken exception to any of the CALJ's Findings of Fact. Unless otherwise indicated, all statements herein refer to the Tax Year.
Petitioner's subsidiary corporations operated in approximately 130 jurisdictions worldwide. Petitioner and the Combined Subsidiaries timely filed a combined GCT return on 3 Form NYC-3A and timely paid the tax shown as due thereon. Petitioner's consolidated financial statements: (a) included its subsidiaries; (b) were filed with the Securities and Exchange Commission; (c) were published in Petitioner's Annual Shareholders Report; and (d) were denominated in U.S. dollars. During the Tax Year, much of Petitioner's subsidiaries' revenue and expenses were earned and incurred in foreign currencies. Similarly, a significant portion of the assets owned and liabilities owed by Petitioner's foreign subsidiaries and U.S. subsidiaries with foreign branches (the "Subsidiaries") were denominated in foreign currencies. Since the foreign business operations were conducted in the currencies of the local operating environment, when Petitioner's foreign currency net investment was affected by changes in the foreign exchange rates relative to the U.S. dollar, exchange gain or loss occurred from one reporting period to the next. Since fluctuations arising from foreign exchange rates could result in a reduction in the U.S. dollar value of the Subsidiaries' foreign currency denominated assets, undistributed earnings, and contributed capital, Petitioner had foreign currency exposure from its investments in the Subsidiaries. Petitioner's Foreign Exchange Operating Committee evaluated each of its worldwide 3 The CALJ noted that the Petition for Hearing was filed in the name of the "American International Group, Inc. and Combined Subsidiaries." The "Combined Subsidiaries" were those of Petitioner's subsidiaries with which it filed a combined GCT return. Although the workpapers of the Department indicate that the audit included Petitioner and the "Combined Subsidiaries", the Petition for Hearing specifically protested a November 4, 1999 Notice of Disallowance listing only "American International Group, Inc." Since Petitioner is the only corporation to which the Notice was sent, the CALJ determined that it was the only entity with standing to petition for a review of that Notice and dismissed the Petition for Hearing as to the "Combined Subsidiaries." -2-
consolidated foreign currency net asset or liability positions and managed Petitioner's translation exposure to adverse movement in currency rates, including Petitioner's foreign currency exposure from its investments in the Subsidiaries. 4 To stabilize its foreign currency exposure, Petitioner entered into foreign currency contracts, primarily forward contracts, in which it agreed to deliver or receive a set amount of a specific foreign currency at a future date at a fixed price in U.S. dollars (the "Foreign Currency Contracts"). During the Tax Year, Petitioner realized a net loss of $3,590,460 on the Foreign Currency Contracts (the "Loss"). The Loss was deducted on Petitioner's GCT return. Petitioner requested a refund for the Tax Year. The Department granted most of the requested refund but denied $94,716.97 of the amount requested. The bases for the disallowance were that: (a) the Loss (which the Notice described as: "Capital Loss disallowed Re: Subsidiary Capital hedging transactions") was a deduction directly attributable to subsidiary capital; and (b) the computation of Petitioner's insurance company subsidiary issuer allocation percentage should be based on a ratio of City premiums to total premiums. Respondent no longer asserts the second issue, leaving the deductibility of the Loss as the only basis for the disallowance. 5 A schedule prepared by the Department's auditor, contained in the Audit workpapers, and entitled "Computation and allocation of entire net income - 1984," shows a total combined entire net income, as adjusted, of $15,793,660 and allocated taxable income of $8,039,660. 4 The Stipulation of Facts also provides that Petitioner had the option of reducing its translation exposure by using forward exchange contracts and purchase options where their cost was reasonable and the markets were sufficiently liquid. 5 Petitioner has not asserted that it is entitled to any part of the denied refund as a result of the Commissioner's concession regarding this issue. -3-
On January 26, 2000, Petitioner timely filed a Request for Conciliation with the Department's Conciliation Bureau in which it requested a refund of GCT in the amount of $94,716.97 for the Tax Year. On August 3, 2000, the Department's Conciliation Bureau issued a Conciliation Decision to Petitioner discontinuing the conciliation proceeding. Petitioner timely filed a Petition for Hearing with the Tribunal, dated September 28, 2000, requesting a refund of GCT of $94,716.97 for the Tax Year. Before the CALJ, the Commissioner asserted that the Loss was properly disallowed as a deduction directly attributable to subsidiary capital since the Foreign Currency Contracts would not have been entered into but for Petitioner's investment in the stock of the Subsidiaries. The Commissioner asserted that allowing the Loss would create a double tax benefit since the same foreign currency fluctuations that resulted in the Loss generated a concomitant increase in the net worth (book value) of the Subsidiaries' stock as translated into U.S. Dollars. Petitioner countered that the Loss was not directly attributable to the stock of the Subsidiaries and did not result in a double tax benefit because the Foreign Currency Contracts were separate assets that generated their own independent gains and losses and, thus, had no impact on the value of the stock of the Subsidiaries. Both parties asserted that the Foreign Currency Contracts constituted business capital and could not be characterized as subsidiary capital by analogy to the investment capital rules. The Commissioner also asserted that gains from Foreign Currency Contracts should be taxable as income from business capital, and that losses from such contracts should be disallowed as being attributable to subsidiary capital, even where the gains and losses from those Foreign Currency Contracts arose in the same taxable year. 6 6 The Commissioner stated on page 14 of her Supplemental Brief filed below that: The taxpayer reported the net loss on the tax return, and... that was the amount that was picked up by the auditor and disallowed.... It is the City's position that this was incorrect, although it is conceded that it -4-
The CALJ found that the Commissioner's exercise of discretion pursuant to 11-602.8(b)(6) of the New York City Administrative Code (the "Code") to disallow the Loss was improper because that provision was intended to apply only to expenses and not losses. 7 The CALJ found that, if this provision was extended to losses, Foreign Currency Contracts would be taxed on a gross basis even where there was no potential for a double tax benefit. In addition, the CALJ also found that both the City and New York State (the "State") had previously abandoned their prior policy of employing a strict statutory construction approach to literally interpret the definition of investment capital. Investment capital is defined in 11-602.4 of the Code as "investments in stocks, bonds and other securities, corporate and governmental, not held for sale to customers in the regular course of business, exclusive of subsidiary capital and stock issued by the taxpayer,..." In 1991, the City amended its investment capital rules (19 RCNY 11-37(c)(4)) to provide that options on assets that are investment capital will themselves be characterized as investment capital unless "the options are purchased primarily to diminish the taxpayer's risk of loss from holding one or more positions in assets that constitute business or subsidiary capital." The City also promulgated 19 RCNY 11-37(g) and adopted this matching approach with respect to futures and forward contracts (although the State did might have been administratively feasible and expeditious to handle it in this way. The reasoning supplied in this brief would support taxing the gains as business income in full, and disallowing the losses, the excess basis of which has absolutely nothing to do with the taxable gains on the other contracts. The CALJ noted that the information needed to assert a deficiency attributable to the gross amount of gain from the Foreign Currency Contracts was not in the record and that the Commissioner had not sought to assert such a deficiency. 7 For ease of reference, we have, as did the CALJ, referenced the New York City Administrative Code provisions in accordance with their current designations rather than the designations that existed during the Tax Year. Similarly, the Rules thereunder are referenced by their current designations rather than the designations that existed during the Tax Year. Any material changes have been noted. -5-
8 not adopt a similar provision). The CALJ found that this matching approach as adopted in the Department's investment capital rules applied by analogy to categorize Foreign Currency Contracts as subsidiary capital and the Loss therefrom as a loss from subsidiary capital which is excluded from ENI. However, as the adoption of the matching approach in the investment capital rules after the Tax Year changed the prior valid literal interpretation of the statute, the CALJ concluded that his ruling that the Foreign Currency Contracts are subsidiary capital should not be applied retroactively to the Tax Year. Since the CALJ found that the Loss was improperly disallowed as being directly attributable to subsidiary capital pursuant to 11-602.8(b)(6) of the Code, and the Foreign Currency Contracts could not be treated as subsidiary capital during the Tax Year (as that would constitute an inappropriate retroactive application of an unforeseen change in tax policy), the Foreign Currency Contracts were treated as business capital and the Loss was 9 properly deductible in computing ENI during the Tax Year. Thus, the CALJ cancelled the Notice and granted Petitioner's refund request. On appeal, the Commissioner contends that the CALJ unnecessarily broadened the scope of the issue by addressing whether the Foreign Currency Contracts themselves are subsidiary capital; by addressing the treatment of gains from the Foreign Currency Contracts when the gains were not taxed (the auditor disallowed the net loss as reported on the GCT return for the Tax Year) and by opining on the treatment of the Foreign Currency Contracts for tax years which were not before him. The Commissioner asserts 8 We have referred to the Foreign Currency Contracts as hedges, as did the CALJ, because the term "hedges" is defined in West's Tax Law Dictionary, 437-438 (2004) as "[i]n general, the term 'hedging transaction' means any transaction if such transaction is entered into by the taxpayer in the normal course of the taxpayer's trade or business primarily to reduce the risk of price change or currency fluctuations with respect to property which is held or to be held by the taxpayer,... " The Joint Stipulation of Facts indicates that Petitioner entered into the Foreign Currency Contracts in order to stabilize its foreign exchange exposure from its investment in its Subsidiaries. (Joint Stipulation of Facts at 7 and 8.) 9 The GCT divides capital into three types: investment capital; subsidiary capital; and business capital. While investment capital is specifically defined in 11-602.4 of the Code and subsidiary capital is specifically defined in 11-602.3 of the Code, business capital is defined in 11-602.6 of the Code as generally all assets that are not investment capital, subsidiary capital or stock issued by the taxpayer. -6-
that the issue in this matter is "whether the losses from [Foreign Currency Contracts] incurred by Petitioner to limit one of its risks in carrying its subsidiary investment, i.e., its foreign currency exposure, are 'amounts directly attributable as a carrying charge or otherwise to subsidiary capital' within the meaning of [ 11-602.8(b)(6) of the Code]." (Commissioner's Exception at 1.) The Commissioner contends that since neither party raised the issue of whether the contracts are subsidiary capital, it was not at issue in this case. In addition, the Commissioner asserts that the Loss from the Foreign Currency Contracts was a "deduction" within the meaning of 11-602.8(b)(6) of the Code and that the Loss was incurred by Petitioner to limit its foreign currency risk in carrying its subsidiary investment and was properly disallowed since the Loss was an "amount directly attributable as a carrying charge or otherwise to subsidiary capital" within the meaning of 11-602.8(b)(6) of the Code. The Commissioner contends, therefore, that the Notice should be sustained and the refund requested by Petitioner denied. Petitioner takes exception to some of the CALJ's conclusions and contends that the Foreign Currency Contracts should not be characterized as subsidiary capital (by analogy to the investment capital rules) at some point after the Tax Year. Based on the following, we affirm the CALJ's conclusion that the Commissioner's exercise of discretion pursuant to 11-602.8(b)(6) of the Code to disallow the Loss as directly attributable to subsidiary capital was improper. However, we have not addressed the issue of whether the matching approach adopted by the City in 1991 in the investment capital rules (applicable only with respect to positions taken during taxable years beginning on or after January 1, 1990) must apply by analogy to categorize Foreign Currency Contracts as subsidiary capital. The Tax Year (1984) is the only year presently before us and we decline to opine on the effect of rules adopted in 1991 that by their terms were prospective only. Section 11-603.1 of the Code, in part, imposes the GCT upon every corporation doing business in the City. Pursuant to 11-604.1.E of the Code, the tax imposed on -7-
Petitioner during the Tax Year was the greatest of the following computations or amounts: (1) nine per centum of entire net income ("ENI") or the portion of such ENI allocated within the City; (2) one and one-half mills for each dollar of total business and investment capital, or the portion thereof allocated within the City; (3) nine per centum on thirty per centum of ENI plus salaries and other compensation paid to elected or appointed officers and to every stockholder owning in excess of five per centum of its issued capital stock (minus certain adjustments) or on the portion of any such sum allocated within the City; or (4) one hundred twenty-five dollars. In addition, a tax computed at the rate of three-quarters of a mill for each dollar of the portion of a taxpayer's subsidiary capital allocated with the City was also due. For the Tax Year, Petitioner and the Combined Subsidiaries computed their GCT liability based on the allocated ENI computation. Section 11-602.8 of the Code defines ENI as total net income from all sources. ENI is computed by modifying federal taxable income, pursuant to the Code. One such modification, contained in 11-602.8(a)(1) of the Code, is the exclusion of income, gains and losses from subsidiary capital; i.e., to the extent income, gains and losses from subsidiary capital were included in federal taxable income, they are eliminated in computing ENI. Subsidiary capital is defined, pursuant to 11-602.3 of the Code as "investments in the stock of subsidiaries and any indebtedness from subsidiaries, exclusive of accounts receivable acquired in the ordinary course of trade or business for services rendered or for sales of property held primarily for sale to customers...." Pursuant to 11-602.2 of the Code, a corporation is a subsidiary if the taxpayer owns over 50% of its voting stock. In addition, pursuant to 11-602.8(b)(6) of the Code, the Commissioner had the discretion, during the Tax Year, to exclude from ENI "any amount of interest directly or indirectly and any other amount directly attributable as a carrying charge or otherwise to subsidiary capital or to income, gains or losses from subsidiary capital." In 1988, 11-602.8(b)(6) of the Code was amended (effective for tax years beginning after December 31, 1987) to authorize the Commissioner, in her discretion, to also disallow non-interest -8-
expenses indirectly attributable to subsidiary capital. 10 The purpose of 11-602.8(b)(6) of the Code is to prevent a parent corporation from obtaining a double tax benefit by taking a deduction relating to its investment in its subsidiaries while, at the same time, the parent's income from such investment would be tax-free. Playboy Enterprises, Inc., TAT (E) 93-879 (GC), et al., New York City Tax Appeals Tribunal, (December 11, 2002) citing, Matter of F.W. Woolworth Co. v. State Tax rd Commission, 126 A.D.2d 876, 877 (3 Dept., 1987), aff'd mem., 71 N.Y.2d 907 (1988), which addressed Tax Law 208.9(b)(6), the State counterpart to 11-602.8(b)(6) of the 11 Code. See also, Statement of Audit Procedure, 96-1-GCT (January 29, 1996) ("SAP 96-1-GCT") which states: Consistent with New York City's longstanding tradition as a center of corporate headquarters, under the GCT,... investment income generally is allocated to the City at a lower percentage than business income, and, for GCT purposes, income, gains and losses from subsidiary capital are excluded from entire net income. There is, however, a tax on subsidiary capital, but it is imposed at a very low rate. The purpose of expense attribution is to avoid a double tax benefit resulting from giving favorable tax treatment to income from investment and subsidiary capital while simultaneously allowing a deduction against business income for expenses related to investment or subsidiary capital. Both the Commissioner and Petitioner assert that the Foreign Currency Contracts 10 L.1988, Ch. 525 11 and 68. 11 However, we note as did the CALJ: To warrant the exclusion of a deduction under [ 11-602.8(b)(6) of the Code], there need not exist a guarantee that a double tax benefit will arise. All that is necessary is that there exist a sufficient relationship between the deduction and the subsidiary capital to warrant attributing the deduction to any gain or income that might arise from subsidiary capital. Thus, expenses relating to subsidiary capital are properly disallowed even though the subsidiary may never generate income or gain equal to the amount of the deductions that are disallowed as being attributable to subsidiary capital. [Determination at footnote 13.] -9-
from which the Loss arose constitute business capital. Normally losses from business capital are included in determining a taxpayer's ENI. However, the Commissioner contends that because the Foreign Currency Contracts were entered into as a hedge for currency fluctuations in the stock of the Subsidiaries, the Loss is directly attributable to subsidiary capital and must be excluded from the computation of ENI. A plain reading of the statute at issue as well as a review of the history of the exercise of the Commissioner's discretion with respect to the statute makes it clear that 11-602.8(b)(6) of the Code was never intended to apply to the Loss. Losses from subsidiary capital are excluded from ENI under 11-602.8(a)(1) of the Code. Section 11-602.8(b)(6) of the Code provides, in relevant part, that ENI shall be determined without the exclusion, deduction or credit of, in the discretion of the Commissioner, "... and any other amount directly attributable as a carrying charge or otherwise to subsidiary capital or to income, gains or losses from subsidiary capital." The term "carrying charge" is defined in West's Tax Law Dictionary 125-126 (2004) as "[a]n expense incident to ownership or use of property." The Loss is clearly not an expense. While the words "or otherwise" do imply a broader universe than if only the words "carrying charge" were used, there is nothing that the Commissioner has argued or that we have discovered through our own research that would lead us to the conclusion that the term "or otherwise" was ever intended to include the Loss. This is especially true where the Code has a separate provision ( 11-602.8(a)(1) of the Code) that specifically provides for the exclusion from ENI of losses from subsidiary capital. The Commissioner claims that the word "deduction" controls in an analysis of 11-602.8(b)(6) of the Code and that since a loss is a deduction it does not matter that a loss is not a carrying charge or an expense. We disagree. The word "deduction" is contained in 11-602.8(b) of the Code in the phrase "[e]ntire net income shall be determined without the exclusion, deduction or credit of:" and that phrase precedes a list of items including 11-602.8(b)(6) of the Code. The intent of the Legislature is reflected in the use of phrase "carrying charge or otherwise" and, as we stated above, we have found no support for the -10-
conclusion that the phrase was intended to include losses. Furthermore, we find, as did the CALJ that there is no need to read 11-602.8(b)(6) of the Code to include losses. As the CALJ stated "losses, unlike expenses, do not need to be attributed to a class of capital." (Determination at 23.) The Commissioner also asserts that it is appropriate for the Code to specifically provide for the exclusion of losses from subsidiary capital in computing ENI and also provide for the exclusion of losses directly attributable to subsidiary capital in computing ENI because the provisions reflect two separate concerns. According to the Commissioner, "[o]ne provision denies losses from the sale of subsidiary stock, and the other denies deductions attributable to subsidiary stock." (Respondent's Brief in Support of Exception at 4.) However, in one instance (where the loss is from subsidiary capital) any gain is also excluded from the computation of ENI, in the other instance (where the loss is directly attributable to subsidiary capital) any gain is included in computing ENI because it is not from subsidiary capital. While the Commissioner has offered examples to show that it is not uncommon to attribute a deduction from property or an asset to subsidiary capital and yet tax the gain from the property or asset as business capital, all of the examples given discuss the treatment of expenses and gains. None of the examples involve treating a loss from property or an asset in an inconsistent manner than a gain from that same property or asset. (Respondent's Brief in Support of Exception at 8-10.) In any event, we cannot adopt such a strained interpretation of 11-602.8(b)(6) of the Code, as that offered by the Commissioner and endorse an exercise of discretion that uniformly results in a one-sided adjustment ( i.e., subjecting gains on the Foreign Currency 12 Contracts to GCT but never recognizing losses from these types of contracts.) We are 12 The Commissioner's theory with respect to Foreign Currency Contracts would result in subjecting the gross amount of any gain to the GCT while not recognizing the loss. However, we note that in the matter before us, Petitioner reported the net loss on the tax return and that net loss amount was disallowed by the auditor. The CALJ noted that the information needed to assert a deficiency attributable to the gross amount of gain from the Foreign Currency Contracts was not in the record and that the Commissioner had not sought to assert such a deficiency. -11-
unable to reconcile the authority to exercise discretion (generally used to properly reflect activities) with an approach that results in losses and gains from the same property or asset being treated differently in the absence of a legislative mandate. Reading the relevant sections of the statute as a "integrated whole" is certainly appropriate and may be of even greater importance when making a discretionary adjustment. Varsity Transit Inc., TAT (E) 99-17 (GC), New York City Tax Appeals Tribunal (January 16, 2003), aff'd st Varsity Transit Inc., v. Stark, 6 A.D.3d 244 (1 Dept., 2004), motion for leave to appeal denied, 2004 N.Y. Lexis 2195 (2004). Furthermore, nowhere in the numerous City and State rules, revised rules and pronouncements (including GCT Policy Bulletin 2-84 (April 2, 1984); State TSB-M-88(5)C (October 14, 1988); Statement of Audit Procedure AP/GCT 2 (March 22, 1991); Statement of Audit Procedure 93-1-GCT (March 1, 1993); and SAP 96-1-GCT) have either the Commissioner or her State counterpart given any indication that the Commissioner's discretionary authority could or would be exercised to attribute losses arising from business capital to subsidiary (or investment) capital or that the term "or otherwise" was ever intended to be read so broadly as to include losses. Moreover, the Department's latest guidance on the direct and indirect attribution of noninterest deductions among the various classes of capital and income (SAP 96-1-GCT), is entitled "NONINTEREST EXPENSE ATTRIBUTION". In addition, there is nothing in the SAP which would lead one to the conclusion that the Commissioner found it appropriate to attribute losses in the same manner as expenses. Lastly, the Commissioner has not offered a single authority or commentary that would support the theory of attributing losses from business capital to subsidiary capital. Having decided that the Loss cannot be attributed to subsidiary capital pursuant to 11-602.8(b)(6) of the Code, and that the relevant statute with respect to the disallowance of losses is 11-602.8(a)(1) of the Code, we must, as did the CALJ, look to see whether the Foreign Currency Contracts themselves should be characterized as subsidiary capital. -12-
In analyzing this issue, we reject Respondent's position that we should be limited to the issue of whether the Commissioner abused her discretion by directly attributing the losses from the Foreign Currency Contracts as a carrying charge or otherwise to subsidiary capital pursuant to 11-602.8(b)(6) of the Code such that the losses were excluded from the calculation of ENI during the Tax Year. Respondent, in addition to disagreeing with the CALJ's analysis, contends that the CALJ erred in both raising and addressing the issue of whether the contracts are subsidiary capital since neither party raised the issue at hearing. Parties cannot bring a case before the Tribunal and then assert that the ALJ must view the case with blinders, only looking at the issues in the manner phrased by the parties as well as only the arguments asserted by those parties. In U.S. Life Realty Corporation, TAT (E) 93-134 (GC), et al., New York City Tax Appeals Tribunal (April 23, 1996), this Tribunal found that an ALJ had abused his discretion in ordering the re-opening of a hearing to address the issue of what adjustments needed to be made to reflect the proper amount of the taxpayer's income allocable to the City during the years at issue. The ALJ, "had effectively placed himself in the role of reinitiating and redirecting a completed audit" when he raised the possibility of under-reported income and called for new proceedings to explore that issue after the record had long been closed. U.S. Life Realty, supra, at 10. The CALJ's actions, in the matter on appeal, did not violate the principle set forth above. In order to review the issues fairly and completely and in order to adjudicate a matter in keeping with the relevant statutes, an ALJ may consider another basis upon which the adjustment at issue may be sustained or denied even though that basis has not been asserted by either of the parties. In the matter before us where the issue is the treatment of the Loss from Foreign Currency Contracts in computing ENI, it is perfectly appropriate to look to the characterization of the Foreign Currency Contracts in order to resolve the issue. Such a course of action on the ALJ's part should never be entertained without ensuring, as was done in this case, that the parties are aware of the ALJ's concerns and that they have the opportunity to submit arguments with respect to the issue. -13-
Having decided that it was appropriate to look to the characterization of the Foreign Currency Contracts, we also find that it was not necessary for the CALJ to decide that the 1991 amendments to the investment capital rules provided a basis by analogy for characterizing the Foreign Currency Contracts as subsidiary capital. After all, even if the matching approach adopted by the 1991 amendments, permitted an application by analogy to subsidiary capital in order to characterize the Foreign Currency Contracts as subsidiary capital and the Loss therefrom as a loss from subsidiary capital which is excluded from ENI, the rules were only applicable for purposes of investment capital with respect to positions taken on or after January 1, 1990. Thus, such rules could not be made applicable to the Tax Year (i.e., 1984). 13 13 We note that the Petitioner filed an Exception to that part of the CALJ's Determination which concluded that the Foreign Currency Contracts were subsidiary capital (although not for the Tax Year) and we find that under these facts and circumstances, the Petitioner reasonably filed a protective exception as the CALJ's Determination contained Conclusions of Law which were relevant to more than just the Tax Year. However, we need not address Petitioner's arguments with respect to whether the Foreign Currency Contracts are subsidiary capital in years other than the Tax Year. -14-
Thus, we find that the Commissioner's exercise of discretion pursuant to 11-602.8(b)(6) of the Code to disallow the Loss was improper because the provision was only intended to apply to expenses and not losses. We decline to address the issue of whether the Foreign Currency Contacts should be characterized as subsidiary capital at some point in the future as the resolution of this issue is premature since the only year before us is 14 1984. Accordingly, we affirm the Determination of the CALJ to the extent that he cancelled the Notice of Disallowance, dated November 4, 1999, and granted Petitioner the refund requested in the Petition. 15 Dated: September 24, 2004 New York, New York GLENN NEWMAN Commissioner and President ARTHUR A. STRAUSS Commissioner KALMAN FINKEL Commissioner 14 In declining to address the CALJ's thorough analysis and conclusions of law with respect to the application by analogy to subsidiary capital of a matching approach adopted in 1991 amendments to the investment capital rules in order to characterize Foreign Currency Contracts as subsidiary capital in years other than the Tax Year, we express no opinion on the validity or correctness of the analysis, except to say that it should be considered as one possible resolution of the issue. W hile we note that it is very difficult to posit a justification for treating hedges of subsidiary capital in a manner different from hedges of investment capital, this matter is best left for the Commissioner to address in the first instance. 15 We have considered all other arguments raised by the parties with respect to the issues relevant to the Tax Year and we deem them unpersuasive. -15-