Part One of our 2020 review of state and local tax developments in New York focused on legislative and regulatory developments. In Part Two, we review some of 2020’s most noteworthy New York administrative and judicial decisions.
In an important defeat of retroactive tax legislation, the New York State Tax Appeals Tribunal held that a taxpayer’s due process rights were violated when the New York State Department of Taxation and Finance retroactively applied a law change. Matter of Franklin C. Lewis.
In 2009, Franklin C. Lewis, a New York nonresident taxpayer, sold shares in an S corporation. The taxpayer and the buyer agreed to make a federal tax code Section 338(h)(10) election, which had the effect of treating the sale of stock as the sale of the corporation’s assets (and giving the buyer a step-up in the basis of the corporation’s assets). Before closing on the sale, the taxpayer was advised by his tax accountant that the Section 338(h)(10) election did not change the nature of the transaction for New York tax purposes. The tax accountant’s advice was based on Matter of Gabriel & Frances Baum, where the tribunal concluded that regardless of an Section 338(h)(10) election, a sale of S corporation stock would be treated as the sale of stock (an intangible) and not the sale of the business’s assets. Relying on this advice, the taxpayer did not seek an increased purchase price or an indemnity from the buyer for any additional New York taxes that may arise due to the Section 338(h)(10) election.
After the transaction, and in response to Baum, the New York State Legislature passed legislation that reversed New York’s position and characterized the sale of stock in an S corporation with a Section 338(h)(10) election as an asset sale, with the shareholders’ proceeds apportioned to New York in accordance with the S corporation’s business allocation percentage. The 2010 legislation was made retroactive to tax periods beginning on or after Jan. 1, 2007, on the basis that the legislation was “correcting” the erroneous decision in Baum and confirming the department’s “longstanding policies.” The governor signed the legislation into law on Aug. 11, 2010.
The tribunal held that “public policy considerations against retroactivity” dictate a finding that retroactively applying legislation to a taxpayer who relied on a final tribunal decision interpreting New York tax laws when structuring a stock sale transaction violates a taxpayer’s right to due process. The tribunal distinguished two prior decisions by the New York Court of Appeals (Caprio v. Dep’t of Taxation & Fin.) and the tribunal (Matter of Jeffrey & Melissa Luizza). These cases concluded that the same 2010 legislation could be applied retroactively to taxpayers who completed transactions prior to the issuance of the tribunal’s decision in Baum. The tribunal explained that the taxpayer “made his decision to agree to” sell his stock with a Section 338(h)(10) election “and forgo any accommodation from the seller in return for agreeing to the election” based on his reliance on the tribunal’s Baum decision, which was “final, irrevocable and precedential” under New York law.
Because the department currently may not appeal decisions of the tribunal, the Lewis decision is final. The most important takeaway from the Lewis decision is that in order to prove reasonable reliance on the current state of the law when structuring a transaction, taxpayers should retain evidence of contemporaneous advice from tax professionals. As demonstrated in Lewis, that advice will carry the most weight if it is based upon precedential guidance, such as a tribunal or court decision.
Like a number of states (including New Jersey), New York subjects property storage services to its sales and use tax. A common question for storage service providers is whether their services are taxed by the state where its customer is located or by the state where the storage services are provided. In Vital Records, Inc. v. N.Y. State Dep’t of Tax’n & Fin., No. 900088-19 (N.Y. Sup. Ct. Aug. 18, 2020), the Albany County Supreme Court granted a taxpayer’s petition for declaratory judgment, holding that there was no rational basis for the New York State Department of Taxation and Finance’s assessment of sales tax on storage services exclusively provided in New Jersey, even if the customers of such services are located in New York.
The taxpayer, Vital Records, Inc. (Vital) sold corporate record transportation and storage services. As part of the service, Vital picked up some records from its New York-based customers and transported the records to its New Jersey storage facility. Customers were billed on a monthly basis for the storage services and certain inventory management services performed at the facility in New Jersey.
The department assessed the taxpayer for the monthly charges for all New York-based customers regardless of whether the customer incurred additional charges for transportation services in that month. The court agreed that the initial storage services charges (which related to the pickup of records in New York) were subject to the state’s sales tax. The court reasoned that the transportation services were not incidental to the storage but part of the overall service being provided and were necessary to initiate the storage services. However, the court held that New York did not have the authority to impose sales tax on the subsequent monthly charges for the storage services because the storage services were provided entirely in New Jersey at the storage facility.
In reaching its decision, the court disagreed with a Tax Bulletin issued by the department, which stated that storage services are taxable when delivered inside New York, and that “[s]torage services are considered to be delivered at the location where the storage service provider takes possession of the property to be stored, without regard to the location of the storage facility itself.” The court concluded that the guidance in the Tax Bulletin was an interpretation of New York statutes, and that in cases of “pure statutory construction,” the department was not entitled to deference. Taxpayers questioning other positions in department Tax Bulletins should keep the court’s conclusion in mind before deferring to the department.
Corporate Franchise Tax
Qualified New York Manufacturer Classification
A taxpayer classified under New York law as a “qualified New York manufacturer” may receive favorable New York franchise tax treatment, including a 0% rate on its business income base and preferential treatment on its capital base. The New York State Tax Appeals Tribunal’s decision in Matter of TransCanada Facility USA, Inc., held that an electricity generation company was a qualified New York manufacturer for purposes of calculating franchise tax on a corporation’s capital base, even though the company did not qualify for purposes of the income base.
The department contended that the electricity generation company was not a manufacturer because electricity generation is not a qualifying activity. However, the tribunal pointed out that even though the statutory definition of a manufacturer for calculating the income base expressly excluded activities related to “the generation and distribution of electricity” from the qualifying activities, the statutory definition for the capital base contained no such language. As a result, the tribunal held that “the clear and unambiguous language of the capital base paragraph leads to the conclusion that [the electricity generation company] is a manufacturer.”
Franchise Tax Apportionment
In re BTG Pactual N.Y. Corp., the New York State Tax Appeals Tribunal affirmed the denial of the taxpayer’s refund claim based on the use of the income sourcing rules applicable to registered broker-dealers to its receipts from its separate investment advisory business. The taxpayer structured its business so that its broker-dealer operations and its investment advisory operations were in two separate single-member limited liability companies. The taxpayer argued it was entitled to apply the customer-based sourcing rules for registered broker-dealers under former N.Y. Tax Law Section 210(3)(a)(9) to income from its investment advisory business because the SMLLCs were disregarded and deemed divisions under the federal check-the-box regulations.
The tribunal held that the broker-dealer rules did not apply to all of the taxpayer’s receipts because “a disregarded entity that is not a registered broker-dealer is not disregarded under the check-the-box regulations in determining where its receipts are sourced for New York State corporate franchise tax purposes.” The tribunal further concluded that the status of the broker-dealer could not be imputed to the separate companies that earned non-broker-dealer receipts.
While the Covid-19 crisis slowed down some litigation activity during 2020, we anticipate an increase in activity in New York (and other states) this year. Future editions of New York Slice will keep you up to date on the anticipated increase in important New York decisions.
This column doesn’t necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.
Eversheds Sutherland (US) LLP Counsel Michael Hilkin focuses on tax controversy and transactional issues relating to state and local income, franchise, sales and use, gross receipts and other business taxes. Chelsea Marmor is an associate with Eversheds Sutherland in New York.