INSIGHT: BTG Pactual’s U.S. Investment Adviser May Not Use N.Y. Broker-Dealer Sourcing Rules

The U.S. subsidiary of the of the Brazilian investment bank, Banco BTG Pactual S.A., could not use customer-based sourcing rules applicable to broker-dealers to exclude its advisory business receipts from the computation of its New York general business corporation franchise tax.

The taxpayer, BTG Pactual NY Corp. (BTG NY), could not use its status as the sole member of both the broker-dealer business (BTG Pactual US Capital LLC (USBD)) and the advisory business (BTG Pactual Asset Management US LLC (USAM)) to apply broker-dealer receipts sourcing rules to advisory receipts, the New York Division of Tax Appeals ruled In the Matter of the Petition of BTG Pactual NY Corporation, DTA No. 827577 (N.Y. Tax App. Div. 3/7/19).

The sourcing rules were under former N.Y. Tax Law Section 210(3)(a)(9), which the New York Legislature replaced, effective Jan. 1, 2015, by amending N.Y. Tax Law Section 210-A to provide for customer-based sourcing for the advisory services such as those provided by USAM. Unfortunately for BTG NY, the former law still applies to tax years prior to 2015.

USBD was registered as a broker-dealer with the Securities and Exchange Commission. USBD, therefore, was subject to the SEC’s uniform net capital rule. USAM was registered as an investment adviser with the SEC. USAM earned fees for providing management and advisory services to BTG Pactual Global Asset Management Ltd. (GAM) and BTG Pactual Absolute Return II Master Fund LP (ARF II). USAM also earned trading income or commissions from various third parties located outside of New York state. GAM was, during the tax years at issue, a wholly-owned indirect subsidiary of Banco BTG Factual S.A.

Neither BTG NY nor USAM were registered as broker-dealers with the SEC or FINRA, nor were they subject to the SEC’s uniform net capital rule. By the same token, neither BTG NY nor USBD were registered as investment advisers with the SEC. USAM furnished USBD with office space, certain personnel, information technology support, and shared services, such as human resources, legal, operations, and finance. USBD did not perform services on behalf of USAM.

Disregarded Entities

Both USBD and USAM were, for federal income tax and New York state corporation franchise tax purposes, treated as “disregarded entities.” For 2012 and 2013, BTG NY filed U.S. Corporation Income Tax Returns with the Internal Revenue Service and timely filed General Business Corporation Franchise Tax Returns with the New York Division of Taxation. On its originally filed Forms CT-3 for 2012 and 2013, BTG NY sourced USBD’s receipts utilizing the registered broker-dealer sourcing rules and sourced the USAM receipts based on where the services were performed.

BTG NY timely filed amended Forms CT-3. The receipts factor was modified as a result of sourcing USAM’s receipts via the registered broker-dealer sourcing rules. In computing its Business Allocation Percentage (BAP) on its amended 2012 CT-3, BTG NY reported a New York State receipts factor of only 5.6261 percent. In computing its BAP on its amended 2013 CT-3, BTG NY reported a New York State receipts factor of 8.0159 percent.

In New York, corporate taxpayers report their tax liability based on their computation of the highest of four income bases, one of which is the entire net income base. A corporation’s entire net income base is computed by calculating its entire net income, generally consisting of its investment income and its business income. The investment income and the business income are allocated to New York pursuant to the corporation’s investment allocation percentage and its BAP, respectively, with the resulting amounts totaled to arrive at the corporation’s entire net income base.

The BAP consists entirely of the receipts factor. The BAP is computed by dividing the corporation’s New York business receipts by its total business receipts. With respect to investment advisors, under former N.Y. Tax Law Section 210(3)(a)(9), their receipts were sourced to New York to the extent the services generating such receipts were performed in New York. However, in the case of registered securities or commodities brokers or dealers, the law provided customer-based sourcing rules for certain categories of receipts, including brokerage commissions.

In filing its claims for refund, BTG NY sourced USAM’s receipts using the broker-dealer sourcing rules. BTG NY’s theory was that since USBD was disregarded and deemed a division of BTG NY under the “check-the-box” regulations, BTG NY was deemed a registered broker-dealer and could therefore use the broker-dealer sourcing rules not only for USBD’s receipts but also for USAM’s receipts as well.

A single-member LLC, the court observed, may elect to be disregarded as a separate entity. If the single-member LLC is so disregarded, “its activities are treated in the same manner as a ... division of the owner.” See Treasury Regulation Section 301.7701-2(a). Here, there was no dispute that BTG NY properly sourced USBD’s receipts utilizing the broker-dealer sourcing rules. However, USBD’s status as a registered broker-dealer could not carryover to the non-broker-dealer receipts earned by USAM. Stated simply, a disregarded entity that is not a registered broker-dealer is not disregarded in determining where its receipts are sourced for New York State franchise tax purposes, the court said. The check-the-box regulations, while dictating which entity is taxed on the LLC’s receipts, do not dictate whether USAM’s receipts constitute broker-dealer receipts for purposes of sourcing receipts within and without New York.

BTG NY contended that “these favorable sourcing rules were also meant to apply in situations such as here where the corporate taxpayer’s broker-dealer operations and investment advisory functions are divided into separate LLCs.” The court disagreed, saying the text of former New York Tax Law Section 210(3)(a)(9), which applied to the tax years at issue, was unambiguous. USAM was not a registered broker-dealer.

Accordingly, the customer-based sourcing rules applicable to broker-dealers did not apply to source the receipts earned by USAM in computing BTG NY’s BAP and BTG NY’s ultimate tax liability. BTG NY, the court noted, “deliberately chose to structure its broker-dealer operations and its investment advisory operations into two separate entities because of the regulatory burdens associated with being an entity registered as a broker-dealer and an investment advisor.” BTG NY was “bound by the tax consequences of the form it has chosen,” the court said, citing Matter of CS Integrated v. N.Y. Tax App. Trib.

Brazilian Withholding Income Tax

The court also ruled that BTG NY must add back the Brazilian Withholding Income Tax (BWIT) in computing its entire net income, because the BWIT was an income tax and not a gross receipts tax as BTG NY argued.

USBD earned income on stock trades and from underwriting activities from Brazilian sources, and was therefore subject to the BWIT. On its originally filed Form CT-3 for 2012, BTG NY added back the BWIT in computing its entire net income and reported a receipts factor of 82.1101 percent on its originally filed Form CT-3. Similarly, on its originally filed Form CT-3 for 2013, BTG NY added back the BWIT and reported a New York State receipts factor of 66.3984 percent. When it filed its amended Forms CT-3, the BWIT was no longer added bac in the computation of the entire net income.

The court said entire net income is determined without the deduction of “taxes on or measured by profits or income paid or accrued to the United States, any of its possessions, or to any foreign country,” under N.Y. Tax Law Section 208(9)(b)(3). Thus, it must be determined whether the BWIT was a tax on or measured by profits or income, the court said. USBD, the court noted, “earned income on stock trades and underwriting activities from Brazilian sources and was therefore subject to the” BWIT.

However, the translated version of the Brazilian statute contained in the hearing record did not support BTG NY’s argument. Instead, the statute, as so translated, indicated that the tax was “on or measured by profits or income.” Accordingly, BTG NY did not meet its burden of proving that the BWIT was not a tax on or measured by profits or income, with the result that the Brazilian tax must be added back in computing BTG NY’s entire net income base.

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.