New York Corporate Tax Increases And Massachusetts Legislative Update

Originally published April 11, 2008

The New York Legislature has enacted a budget bill that reflects significant changes and poses potential new tax liabilities for a wide range of corporate taxpayers. The Sutherland SALT team describes below the most controversial new provisions and the potential implications for corporate taxpayers. Unless otherwise noted, all provisions are effective immediately.

Article 9A Capital Tax Base: Cap Increase and Tax Rate Decrease

New York corporate taxpayers (other than manufacturers) subject to the Article 9A corporate franchise tax will now temporarily have a higher cap on the maximum amount of tax under the capital base. Under Article 9A, corporate franchise taxpayers are subject to the highest tax based on several alternative tax bases. The two primary bases are the entire net income base and the capital base. Historically, the capital base has been capped at a maximum tax liability and that cap has been increased ten-fold from $1 million to $10 million for tax years beginning on or after January 1, 2008. In return, taxpayers receive a decrease in the tax rate from 0.178% to 0.15%. The cap is scheduled to return to the $1 million amount for tax years beginning on or after January 1, 2011. Unlike the temporary increase in the cap, the rate decrease is permanent.

Sutherland Comment: Previously, the maximum amount of tax liability under the capital base was $1 million. The Governor's initial budget proposed a complete removal of the cap with no sunset date. The final negotiated increase in the capital base cap means that taxpayers previously paying a tax under the capital base that maxed out on the cap or that paid a tax of less than $10 million under the entire net income base could see a significant jump in their tax liability. The sunset date was a significant element of the legislature's agreement to increase the cap, but it remains to be seen whether future legislatures will extend the sunset date if budget pressures continue.

Manufacturers retain their preferential $350,000 cap for the Article 9A capital tax base. However, to qualify for this preferential cap, manufacturers must now meet the additional requirements of having property in New York principally used by the taxpayer in the production of goods by manufacturing, processing, assembling, refining, mining, extracting, farming, agriculture, horticulture, floriculture, viticulture or commercial fishing, AND either (i) the adjusted basis of that property is at least $1 million or (ii) all of the taxpayer's real and personal property is located in New York. A qualified manufacturer also includes certain companies that meet the definition of an "emerging technology company" without limitation.

Sutherland Comment: The questionable constitutionality of the new requirements for a manufacturer to receive the preferential cap amount has been noted by several people involved in the budget process. The requirement that "qualified" manufacturers invest in New York property recalls the recent challenge to Ohio state and municipal tax incentives in Cuno. DaimlerChrysler Corp. v. Cuno, 547 U.S. 332 (2006). Although that case was remanded by the U.S. Supreme Court on standing grounds, the theories presented in that case are directly relevant to this sort of "incentive," which some manufacturers will instead view as a discriminatory tax burden.

Substantial Changes for Credit Card Companies Economic Nexus, Receipts Sourcing, Combined Reporting Rules

Nexus: A corporation engaged in a credit card business will now be subject to the New York Article 32 bank tax (primarily a corporate income tax, with some alternative bases), based solely on meeting certain economic nexus thresholds. An out-of-state credit card company with no physical presence in New York is subject to tax if its business activity satisfy any of the following thresholds:

1. has issued credit cards to 1000 or more customers with a mailing address in New York;
   
   
2. has merchant customers with 1000 or more total locations receiving payments from the credit card company in New York;
   
   
3. has receipts of $1 million or more from its credit card customers with a mailing address in New York;
   
   
4. has receipts of $1 million or more from its merchant customer contracts relating to locations in New York; or
   
   
5. the total number of credit card customers and merchant locations under (i) and (ii) equals 1000 or more, OR the total of receipts from credit card customers and merchants under (iii) and (iv) equals $1 million or more.
   
   

Note: "Receipts" includes merchant discounts from merchants in New York.

Sutherland Comment: This is the first time that New York has adopted an economic presence nexus approach, as opposed to the historical physical presence jurisdictional standard. Department personnel have indicated that they do not think this should be seen as a trend or interpreted as potentially applying to other types of businesses. The Department personnel consulted believe that using an economic nexus standard for credit card businesses accurately captures where that industry earns its income. This new provision has some odd language. First, it is not clear why the individual thresholds in (1) (4) are necessary given the aggregated thresholds in (5). Second, it is not clear from the language whether the threshold for merchant payments requires that each location receive payments from the credit card company to be counted in the total, or that any location in the state counts as long as the merchant has a contract with the credit card business under which the merchant receives payment.

Sourcing: Interest, service charges, and fees are considered earned in New York if the credit card holder's mailing address is in New York.

Sutherland Comment: This is a significant change from the prior rule in Tax Law § 1454 in which service charges and fees were sourced based on where the card was serviced. This new rule adopts a pure market sourcing theory. The change to market sourcing is likely in response to the negative feedback the Governor's initial budget proposal (that did not include the sourcing rules), had received from in-state financial organizations. These organizations asserted that the economic presence nexus provisions hurt in-state credit card companies. The market sourcing provisions provide in-state credit card companies some relief on the sourcing of income from the credit card services to the address of the customer.

Combined Returns: A credit card company subject to tax based solely on the new economic nexus thresholds must be included in a combined return with affiliated (65% ownership) banking corporations (regardless of whether the affiliates are doing business in New York) if an affiliated banking corporation is providing "services for or support to" the credit card bank's operations, unless the filing of a combined return fails to properly reflect the income of any of the entities. If such services or support are not provided, a credit card bank that is subject to tax in New York solely because of the new economic nexus thresholds for credit card businesses will only be included in a combined return with another banking corporation if that other banking corporation is doing business in New York, and the combined report is necessary to properly reflect the tax liability of any of the taxpayers (unless the credit card bank was previously already included in such a return).

Sutherland Comment: Under the previous law, banking corporations (other than certain bank holding companies) subject to Article 32 tax and with less than 80% and 65% common ownership were only subject to combined reporting if there was proof that a combined report was necessary to properly reflect tax liability. The addition of a presumption of combined reporting based on intercompany services and support with no minimum level of services or support required is a significant change to the bank tax and to New York's approach to combined reporting in general.

Expanded Sales/Use Tax Collection Nexus Provision

Sellers without a direct physical presence in the state will now be subject to a rebuttable presumption that they are a vendor required to collect and remit sales/use tax from sales to customers in the State if the out-of-state seller has an agreement with a New York "resident" to directly or indirectly refer potential customers to the seller for a commission or other consideration. The rebuttable presumption applies if the cumulative gross receipts of the seller from sales in New York from all such referrals are over $10,000 in the prior four quarterly reporting periods. The provision specifies that the term "refer" includes "[using] a link on an internet website or otherwise." A taxpayer can rebut the presumption by demonstrating that the resident did not engage in any solicitation in New York on behalf of the seller "that would satisfy the nexus requirement of the United States Constitution" during the previous four quarterly periods. This provision is effective June 1, 2008 (as long as the affected vendor meets certain conditions). However, if a seller subject to sales/use tax collection as a result of this new provision fails to register as a New York vendor and begins collection by June 1, 2008, the Commissioner may assess retroactive tax, interest and penalties.

All Vendors Must Re-Register

All vendors will be required to re-register for a sales tax certificate, regardless of their current standing. The re-registration program will be administered by the Commissioner and must be completed by March 31, 2012. Re-registration will include a $50 fee. This provision takes effect November 1, 2008.

Sutherland Comment: Deputy Commissioner Robert Plattner recently noted that this re-registration program would (a) clean up the records of the Department regarding vendors no longer doing business and (b) require vendors currently delinquent on their tax payments to become current in order to receive the new registration.

Voluntary Disclosure

New York is establishing a voluntary disclosure and compliance program for all taxes, including corporate franchise and sales tax, administered by the Commissioner. A taxpayer is eligible for the Program if it is not currently under audit by the Department, voluntarily discloses its tax liability to the Department, is not a party to any criminal investigation by any agency of the state, and is not disclosing a tax avoidance transaction (a New York or Federal Reportable or Listed Transaction). The Program provides for the waiver of all penalties and warrants that no criminal action will be brought related to the disclosed tax liability. The Disclosure Program covers vendors who should have collected and reported sales/use tax from customers.

Sutherland Comment: The Voluntary Disclosure Program, by its language, seems to be limited to taxpayers who are not under audit at all by the Department. Taxpayers who are under any audit will potentially not be able to take advantage of the Program even for years not under audit. Furthermore, even if the taxpayer is not under a formal audit, the liability may not be eligible for the Program if it has otherwise been "determined, calculated, researched or identified" by the Department. On the bright side, this is a true amnesty program in the sense that no stick is imposed if an eligible taxpayer fails to take advantage of the program. However, the New York Commissioner has been careful to maintain it is a voluntary disclosure program, not an "amnesty," because it only covers tax liabilities not already discovered by the Department. Another advantage of the Program for some taxpayers is that New York has recently become very aggressive in pursuing criminal charges against delinquent taxpayers and this Program could provide significant protection to potential future targets of the Department. However, a taxpayer who is a party to a criminal investigation by any State agency, not just the Tax Department, is not eligible for the Program. The time period over which the Program will run is unclear. The provision does not limit the Program to any specific tax periods. This program might provide attractive opportunities, for qualified taxpayers, to release financial statement reserves.

Other Changes

1. New York has decoupled from the federal Section 199 Qualified Production Activity Income deduction and such deduction must be added back to calculate entire net income. The administration has indicated that decoupling makes sense because much of the tax benefit was received by taxpayers for activity that had no connection to New York at all. Decoupling applies to tax years beginning on or after January 1, 2008.
   
   
2. Entities defined as Captive REITs and Captive RICs will now be subject to certain combined reporting rules. A Captive REIT or RIC is one that is not regularly traded on an established securities market and in which a single corporation has a more than 50% direct or indirect ownership interest. The new combined reporting requirements include certain look-through provisions to avoid interposing a non-combinable entity between the corporation and the captive entity for tax avoidance purposes.
   
   

Massachusetts

At the time of this Legal Alert, the Massachusetts Assembly passed combined reporting legislation that is anticipated to be enacted next week. The legislation includes the following:

• Water's-edge combined group with a world-wide combined group election;
  
  

• Broad range of legal entities must be including in the combined group captive insurance companies, REITs, RICs, certain non-U.S. intangible holding companies;
  
  

• Finnigan approach to apportionment;
  
  

• Corporate net income tax rate reduction
  
  

The legislation is extensive, and we will is sue a Legal Alert when the legislation is enacted.

© 2008 Sutherland Asbill & Brennan LLP. All Rights Reserved.

This article is for informational purposes and is not intended to constitute legal advice.