New York Enacts Major Corporate Income Tax Changes for Out-Of-State Businesses
On March 31, 2014, New York Gov. Andrew Cuomo signed the budget for 2014-15. The act includes a number of major corporate tax changes affecting not only New York-based businesses, but also out-of-state corporations doing business in New York. These changes generally are effective for tax years beginning after 2014, unless noted below. The text of the act is available online.
The touted objectives of the act are to provide simplification, improve compliance, retain New York businesses and expand their growth opportunities and provide favorable tax treatment to businesses considering relocation or expansion into New York. As indicated below, several changes to New York’s taxing provisions increase the potential exposure of many out-of-state corporations, including those not currently required to file New York corporate income tax returns.
Among the prominent changes:
- Reduction of the corporate franchise tax rate to 6.5 percent from 7.1 percent for tax years starting after 2015 and lowering the tax rate on manufacturers’ income to zero for tax years starting in 2014
- Repealing the bank franchise tax, thereby bringing all corporations under the corporate franchise tax
- Adoption of economic nexus jurisdictional rules activated if a corporation has receipts of $1 million or more in a tax year from New York activities
- Specifying nexus and tax reporting consequences of a corporate partner of a partnership doing business in New York
- Substitution of a unitary combined reporting regime for the existing combined reporting rules
- Expansion of the single receipts factor apportionment formula generally based on market-based sourcing to all receipts, particularly receipts from services and intangibles
Reduction in Corporate Tax Rates
For tax years beginning after 2015, the corporate franchise tax rate will be reduced to 6.5 percent from 7.1 percent. However, the Metropolitan Tax Authority (MTA) surcharge will be increased from 17 percent to 25.6 percent for tax years beginning after 2014 and ending before 2015. Future MTA surcharge rates will be set based on state financial projections.
The corporate franchise tax rate imposed on a “qualified New York manufacturer” will be 0 percent for tax years beginning in 2014. In addition, the capital base tax rate will be phased out gradually by 2021, with qualified New York manufacturers paying a lower rate than other taxpayers during this phase-out period. A “qualified New York manufacturer” is a manufacturer with New York property eligible for the investment tax credit and either its fair market value has an adjusted basis for federal income tax purposes of at least $1 million at the close of the tax year or all of the manufacturer’s real and personal property is located in New York. Special rules may permit a taxpayer or combined group that does not satisfy the manufacturer conditions to be treated as a qualified New York manufacturer if it or the group employs at least 2,500 persons in New York manufacturing during the tax year or has property used in New York manufacturing with an adjusted federal income tax basis of at least $100 million at year-end.
Bank Tax Repeal
The bank franchise tax (under Article 32) will be repealed in its entirety, bringing these corporations under the purview of the corporate franchise tax (under Article 9-A). In effect, the bank franchise tax has been merged into the corporate franchise tax. Due to this change, banks will be subject to the same apportionment rules applicable to other corporations. On the other hand, banks will be able to file combined returns with other corporations with which they could not combine in the past. Taxpayers currently subject to the bank franchise tax should evaluate the impact of this changeover, especially any administrative pronouncements issued under the bank franchise tax that are the basis for important tax positions.
Economic Nexus Provisions
In addition to the existing New York “physical presence” nexus standards, e.g., doing business or employing capital, a corporation may become subject to the state’s taxing jurisdiction based on its in-state “economic presence.” The act provides an economic nexus threshold to determine whether out-of-state corporations are subject to tax in New York regardless of whether they have an in-state physical presence. A corporation will be deemed taxable in New York if it has at least $1 million of receipts in its New York apportionment factor numerator as determined under the act’s new sourcing provisions (discussed below). This threshold will also apply to taxability under the MTA surcharge.
Special threshold calculation rules apply to combined reporting groups. A corporation that is part of a combined reporting group with more than $10,000 but less than $1 million of New York receipts is deemed to satisfy the economic nexus receipts threshold if the New York receipts of all members of the group that separately exceed $10,000 collectively meet the $1 million threshold.
In addition, the “doing business” nexus threshold for corporations issuing credit cards (such as bank, credit, travel or entertainment cards) has been transferred to Article 9-A and expanded. As before, an out-of-state corporation will be deemed to have a New York corporate income tax nexus if it has issued cards to at least 1,000 customers with an New York mailing address, has 1,000 or more New York locations covered by merchant contracts to which the corporation has remitted payments for credit card transactions or has a combined total of 1,000 or more New York customers and merchant locations. The act expands the scope of this threshold where a corporation issuing credit cards is part of a combined reporting group. A credit card corporation with at least 10 New York customers, at least 10 New York merchant locations or at least 10 New York customers plus merchant locations would be deemed to have a New York corporate income tax nexus if the total number of New York customers and merchant locations for all combined reporting group members with at least 10 New York customers and merchant locations is at least 1,000.
The act also repeals the existing nexus exception for corporations for which the only New York connections are the use of fulfillment services provided by an unrelated person and storing their inventory at the fulfillment provider’s New York location. As a result of this repeal, an out-of-state corporation using unrelated fulfillment service providers located in New York will be taxable if the corporation stores inventory with the fulfillment provider or otherwise meets the economic nexus thresholds.
When combined with the change to customer-based sourcing for apportionment purposes (discussed below), the act’s economic nexus rules likely will have a serious impact on nexus determinations for many out-of-state businesses. For the first time, many out-of-state corporations may be subject to New York’s corporation franchise tax merely by meeting the act’s economic nexus threshold. It is an open question whether economic nexus without any physical presence is, by itself, enough of a connection to permit New York to impose its taxing jurisdiction. Since the economic nexus provisions are an aggressive approach to taxing jurisdiction, there may be taxpayer challenges based on the due process and commerce clauses of the U.S. Constitution. Moreover, the economic nexus aggregation rules for combined reporting groups (discussed below) can create nexus for certain members of a combined reporting group based solely on the New York activities of other members of the group. Thus, these rules may extend the concept of “attributional nexus” beyond permitted limits, so constitutional challenges also may be expected.
Corporate Partner Nexus & Reporting
The act authorizes the New York State Department of Taxation and Finance to enact regulations that subject a corporation to state taxation if it is a partner in a partnership that does business in New York or that has an economic nexus with New York. Corporate partners will be required to compute their New York State corporate income tax based on the “aggregate method” (and not on the “entity method”) as provided by regulation unless it prescribes another means of calculation. Under the aggregate method, a corporate partner is deemed to have an undivided interest in the partnership’s assets, liabilities and items of receipts, income, gain, loss and deduction. Accordingly, the corporate partner is required to flow through and report its share of the partnership’s income and loss items and the apportionment factors and combine these items with its other income and factors prior to determining the amount of its income that is subject to New York taxation. In addition, a corporate partner will be treated as participating in the partnership’s transactions and activities. As a result, when the partnership has nexus with New York, its corporate partner(s) likewise will have nexus. Thus, if a partnership is doing business, employing capital, owning or leasing property in New York or deriving receipts from New York activities, any corporation that is a partner in this partnership will be subject to New York taxation.
Just like the act’s economic nexus provisions described above, these reporting changes are likely to have a serious impact on nexus determinations for many out-of-state corporations. For many of the same reasons, these changes may be challenged on constitutional grounds. The likely candidates include corporate partners that are not unitary with the partnerships in which they own an interest.
Unitary Combined Reporting
New York currently requires each corporation to file a separate corporate income tax return. It also can require combined reporting when separate company filing otherwise would be distortive, such as when a corporation has substantial intercompany transactions with related parties or certain intercompany transaction percentage thresholds are exceeded.
The act’s rules may lead to significant changes in some reporting groups but should make the group’s composition clearer than under the current method, though there likely will be more controversies regarding membership in the unitary group. The act mandates unitary combined reporting for groups of related corporations that meet certain common characteristics. It also eliminates the concept of distortion as a basis for requiring combined returns—and thus the substantial intercorporate transactions test.
When effective, a unitary combined return must be filed when a group of related companies meet any of the following criteria:
- A taxpayer owns or controls, directly or indirectly, more than 50 percent of the capital stock of one or more other corporations
- The taxpayer’s capital stock is owned or controlled more than 50 percent by one or more other corporations
- Two or more corporations’ capital stock is owned or controlled, directly or indirectly, more than 50 percent by a common interest
As well as the following:
- The taxpayer is engaged in a unitary business with the other corporations
Certain captive real estate investment trusts and captive regulated investment companies, specially defined “combinable” captive insurance companies and “alien corporations” may also be included in the combined reporting group if they meet these and other statutory criteria.
A combined reporting group also may elect to include its nonunitary affiliates and file as a “commonly owned group” when the affiliate(s) satisfies the ownership conditions applicable to unitary group members. This election would not be revocable and would apply for the year of the election and the next six years thereafter. Any corporation subsequently becoming a member of a commonly owned group while the election is in effect automatically will become a member of the group. If the election is not affirmatively revoked at the end of the initial period, it will automatically renew for an additional seven-year period. If an election is revoked, a new election cannot be made for at least three years.
Market-Based Sourcing Apportionment
New York’s apportionment rules have been revised so that, in general, all business income and capital are apportioned using a single receipts factor that sources receipts based on customer location (market-based sourcing). Banks and other corporations would use the same apportionment scheme. The act expands the market-based sourcing rules currently applicable to sales of tangible personal property to additional categories of receipts, often with category-specific sourcing guidance and receipts assignment hierarchies:
- Receipts from the performance of services will normally be sourced to New York if the customer is either located in New York or receives the benefit of the service in New York. For businesses providing services in New York, this change will yield them substantial relief over the current rules, which source service revenue based on where the services are performed, at the expense of out-of-state service companies with New York customers.
- Receipts originating from the sale or licensing of intangible property—such as copyrights, trademarks, patents and trade names—will be sourced to a state to the extent activities related to such intangible are carried on in such state.
- Customer-based sourcing rules will apply for receipts relating to sales of tangible personal property, digital products, credit card receipts, portfolio income and other types of financial transactions, broker or dealer transactions, royalties, rentals, railroad and trucking businesses, aviation services, electricity, advertising, gas transmission and transportation.
The act, like the current laws it replaces, does not have a specific rule for extraordinary gains. Currently, these gains, if treated as business income, are not included in a corporation’s apportionment factor and can be excluded under the department’s discretionary authority; whether a like treatment will be found in the regulations authorized by the act awaits action. On the other hand, while the act gives the department discretion to apply alternative apportionment methods if it determines that the statutory method does not “effect a fair and proper apportionment of the business income and capital reasonably attributed to the state,” the act specifically provides in such a situation that the party seeking alternative apportionment will bear the burden of proof. This direction is consistent with requirements found in a majority of states with similar statutes.
The act significantly overhauls New York’s taxation of corporate taxpayers. Most of the act’s changes take effect for tax years beginning in 2015, which gives businesses time to digest them.
Out-of-state corporations doing business in New York should assess the act’s impact on their state income tax reporting procedures. In addition to the New York corporate income tax rate changes and the repeal of the bank franchise tax, these corporations should carefully evaluate the impact of the act’s changes involving economic nexus thresholds, market-based sourcing apportionment rules, unitary combined reporting provisions and corporate partner nexus and reporting requirements. Similar changes have been enacted in other states recently and are intended to benefit in-state companies while shifting the tax burden to out-of-state businesses that derive New York-sourced receipts.
It also should be noted that New York City’s tax provisions are not automatically changed by the act. Unless and until there is conformity, differences between state and city tax treatment doubtlessly will create a filing and administrative burden for businesses that must compute their overall state and city liability under these two different tax regimes.
For more information on how these changes could affect your organization, contact your BKD advisor.