New York City income tax reforms enacted
Effective Jan. 1, 2015
TAX ALERT |
On April 13, 2015, New York Gov. Cuomo signed into law the state's 2015-16 Fiscal Year Budget, which amends New York City's general corporate tax structure to bring it into partial conformity with New York's state-level tax reform package passed on March 31, 2014. Similar to the state-level reform, the budget bill replaces the city's general corporate tax and bank franchise tax with a new corporate tax effective Jan. 1, 2015. However, the general corporate tax will continue to apply to S corporations and qualified S corporation subsidiaries.
Specific changes enacted as a result of the budget bill are as follows:
Pursuant to the budget bill, New York City-based corporations are subject to the city's corporate tax if they are doing business, employing capital, owning or leasing property in New York City in a corporate or organized capacity, or if they maintain an office in New York City. Additionally, the legislation extends nexus to corporate partners of partnerships who have nexus, and retains the bank tax nexus regulations applicable to credit card companies that were previously promulgated under the bank franchise tax. Further, as with state-level provisions, a foreign (non-U.S.) corporation is not deemed to be doing business in New York City if either (1) its activities are limited solely to investing or trading in stocks, securities or commodities on its own account, or (2) it has no income effectively connected to the state or city.
It should be noted, however, that for New York City taxpayers, the budget bill does not adopt the $1 million in gross receipts threshold with respect to economic nexus that was enacted last year by the state for corporate franchise tax purposes.
New York City has not adopted the immediate transition to a single sales factor apportionment formula enacted at the state level, but, rather, will continue the gradual introduction of the single sales factor formula. Most New York City taxpayers will transition over to single sales factor apportionment in 2018. However, single taxpayers or combined groups with $50 million or less in New York City allocated receipts may make a revocable election to retain the 2017 factor ratios for tax years beginning on or after Jan. 1, 2018.
Unlike factor weighting, New York City is now aligned with the state with respect to sourcing business receipts using a market-based approach. Under the budget bill, the city recognizes 10 categories for sourcing of receipts:
- Tangible personal property
- Rents and royalties
- Digital products
- Financial transactions
- Advertising services
- Gas transportation or transmission services
- Railroad and trucking services
- Aviation services
- Receipts from the operation of vessels
- As a catch-all for any receipts that do not fit into any of these other categories, other services and other business receipts
These categories are subject to a complex array of sourcing provisions. For example, digital products receipts are subject to a four-part cascading rule under which a taxpayer must source receipts from digital products to the location of the customer's primary use of the digital product. If that location cannot reasonably be determined, the taxpayer must source the receipts to the location where the customer receives the product. Next, if that location cannot reasonably be determined, the taxpayer must apply the prior year's apportionment factor for digital products. Finally, if the taxpayer cannot determine its prior year digital products apportionment factor, the taxpayer must apply to its total digital products receipts the current yeas apportionment factor for any digital products that the taxpayer was able to source using the first or second method. The budget bill does not provide any additional guidance to clarify how these rules are intended to be applied or any indication regarding how and when uncertainties are going to be resolved.
This cascading approach also applies to receipts from other services and other business receipts not specifically categorized. In general, such receipts are sourced to the location where the benefit of these uncategorized services or business receipts is received. If this location cannot reasonably be determined, these receipts are sourced to the location of delivery. If this location cannot reasonably be determined, these receipts are sourced using the apportionment factor for similar receipts from the prior year. Finally, if the taxpayer cannot determine the prior year's apportionment factor applicable to uncategorized services and business receipts, then the taxpayer must use the current year's apportionment factor for any uncategorized service or business receipt that the taxpayer was able to source using the first or second method.
Financial services receipts, on the other hand, are subject to a variety of sourcing rules based on the type of receipt rather than a generally applicable cascading rule. For example, taxpayers with net gain from certain qualified financial instruments may elect to source these gains based on an individual customer's billing address or the commercial domicile of a business customer, or by including a flat 8 percent of total net gains from these instruments in the numerator of the apportionment factor. Receipts from services performed for investment companies, however, are sourced using the average ratio of the number of investment company shares held by New York City shareholders at the end of each month divided by the total number of shares. Still other receipts, such as receipts from securities borrowing agreements, are sourced using a flat 8 percent factor. To successfully navigate these rules, taxpayers will need to be able to identify which receipts fall within a particular category of financial services.
New York City has replaced its combined reporting provisions requiring substantial intercorporate transactions with the unitary combined reporting provisions enacted by the state in 2014. The budget bill provides that a taxpayer must file a combined report with any corporation with which the taxpayer engages in an unitary business, and either: (1) the taxpayer owns or controls, directly or indirectly, more than 50 percent of the capital stock of the corporation, (2) the corporation owns or controls, directly or indirectly, more than 50 percent of the capital stock of the taxpayer, or (3) more than 50 percent of the voting power of the capital stock of the taxpayer and the corporation is owned or controlled, directly or indirectly, by the same interests. For this purpose, corporations include captive REITs, captive RICs, captive insurance companies in certain circumstances, and non-U.S. corporations that either are treated as domestic corporations under section 7701 or have effectively connected income for the tax year.
Note, however, that corporations may make an irrevocable six-year election to file combined returns with their non-unitary affiliates if the ownership thresholds discussed above are met. This election is automatically renewed for seven additional years unless it is explicitly revoked.
The budget bill also redefines the New York City corporate tax base as net income minus investment and other exempt income. This mirrors the changes at the state level. Investment is also redefined and cannot exceed net income under the new provisions. Furthermore, investment income is capped at 8 percent of a taxpayer's entire net income.
In the event that interest deductions subtracted exceeds investment income, the excess is added back to the taxpayer's entire net income. Alternatively, the taxpayer may elect to reduce total investment income by 40 percent.
Net operating loss
New York City has made similar revisions to its net operating loss provisions to those which the state enacted last year. Specifically, a prior net operating loss conversion subtraction has been created, and is applied against the net income base before the net operating loss deduction. Taxpayers may calculate the prior net operating loss according to the new provisions or elect to use an amount equal to 50 percent of their net operating loss conversion subtraction pool until the pool is exhausted. This election may only be made for tax years 2015 and 2016.
Tax rates and manufacturers
New York City has adopted the business income tax rates enacted by the state last year. Taxpayers are liable for the greatest of 8.85 percent of business income allocated to New York City (or 9 percent for certain financial corporations), 0.15 percent of total business capital, or a fixed dollar minimum tax based on New York City sourced receipts. However, unlike the state where the capital tax is being phased out, New York City has kept the tax but with a $10 million cap.
New York City manufacturing corporations are subject to a rate reduction when their business income is less than $40 million. To qualify for rate reduction, a manufacturing corporation must have qualified property in the state, the adjusted basis of which at the close of tax year is at least $1 million or more than 50 percent of the manufacturer's real and personal property is located in the state. A manufacturing corporation is a taxpayer or combined group where, during the tax year, more than 50 percent of the gross receipts of the taxpayer or group are derived from the sale of tangible personal property produced by the taxpayer or group as a result of manufacturing activities. In computing a combined group's gross receipts, intercorporate receipts are eliminated.
The reduced rate brackets for manufacturing corporations are as follows:
- For qualified New York manufacturing corporations with allocated business income of less than $10 million the applicable rate is 4.425 percent.
- For qualified New York manufacturing corporations with allocated business income equal to or greater than $10 million but less than $20 million, the applicable rate is 4.425 percent plus 4.425 percent multiplied by a fraction, the numerator of which is allocated business income of less than $10 million and the denominator of which is $10 million.
- For qualified New York manufacturing corporations with allocated business income equal to or greater than $20 million but less than $40 million, the applicable rate is 4.425 percent plus 4.425 percent multiplied by a fraction, the numerator of which is unallocated business income less than $20 million and the denominator of which is $20 million.
For manufacturers with business income of $40 million or greater, the applicable rate is the standard business income tax rate of 8.85 percent.
This bracketed rate reduction is a notable distinction from the state level where the same manufacturers are provided with a 0 percent business income rate, a reduced cap to the capital tax, a reduced fixed dollar minimum, and reduced capital tax rates while the state phases out the capital tax.
Extended city statute of limitations for federal and state-level changes
When a taxpayer reports a federal or state-level change to New York City, the taxpayer's statute of limitations for refund or assessment is automatically extended. Under the previous tax regime, neither New York City nor a taxpayer could modify the taxpayer's apportionment factor during this extended statute of limitations period. The budget bill modifies this provision to allow an adjustment to the taxpayer's apportionment factor when the reported adjustment is based on: (1) an increase or decrease in New York taxable income or other basis of state tax; (2) a change, correction or renegotiation of state tax; or (3) the execution of a New York notice of waiver report. This change is applicable solely to assessments. Neither New York City nor a taxpayer may make an adjustment to the taxpayer's apportionment factor where a state change results in a refund claim.
Despite the increased conformity of New York City's tax provisions with those of the state, there are some significant distinctions that could substantially impact taxpayers. Most notable of these are the decision by the city not to adopt the $1 million receipts nexus test, the continued application of the capital tax, and differences in rate reductions for manufacturers. Additionally, the continued application of the old regime to S corporations and qualified S corporation subsidiaries, and the lack of reform for unincorporated businesses, such as partnerships and LLCs, leaves many taxpayers with a heavy compliance burden. Because the budget bill was signed on April 13, these changes will be a second quarter event for tax provision purposes and should be considered when reviewing deferreds.