The New York State Department of Taxation and Finance has promulgated extensive corporation franchise tax and insurance franchise tax regulations to reflect and implement the major tax reform legislation that generally was effective for tax years beginning on or after Jan. 1, 2015.1 The final regulations follow a series of draft regulations released over the past several years and are substantially similar to the “final draft” regulations issued in Aug. 2023, with minor modifications.2 The tax reform legislation established an economic nexus standard, adopted market-based sourcing, changed the rules for mandatory and permissive combined reporting, and merged the banking corporation franchise tax into the general corporation franchise tax. Most significantly, the final regulations provide guidance on the apportionment sourcing rules, apportionment of gain from the sale of partnership interests and goodwill, the Department’s discretionary powers to use alternative apportionment, and activities that are protected by Public Law 86-272 (P.L. 86-272). This SALT Alert discusses the most noteworthy provisions of the final regulations.
Retroactive application of regulations
The Department released a separate Assessment of Public Comment that addresses the effective date of the final regulations. As noted by the Department, the regulations technically are effective on the date of publication, Dec. 27, 2023, but there were questions concerning the applicability of the regulations to prior tax years. Because the regulations interpret the tax reform statutory amendments that generally applied to tax years beginning on or after Jan. 1, 2015, the Department explained that the regulations will be applied to the same periods. However, the Department noted that “based on a totality of the circumstances,” it may choose not to apply penalties in cases where taxpayers took a position in their tax filings before adoption of the final regulations in reliance on the prior regulations or previous drafts of the proposed regulations.
Apportionment
For tax years beginning on or after Jan. 1, 2015, New York State made significant statutory changes for computing the business apportionment factor (BAF) and adopted market-based sourcing.3 The apportionment statutes include intricate customer-based sourcing rules. Specific provisions exist for various types of sales including other business receipts, rents and royalties, and digital products. Receipts from intangible property, such as patents and trademarks, are sourced to New York based on the extent the activities related to the intangible take place in the state.4 Also, receipts from services and other business receipts are sourced to the state based on a customer location hierarchy, specifically starting with where the customer receives the benefit of the transaction.5 The Department’s regulations interpret and implement the apportionment statute and include numerous examples.6
Specific apportionment rules
A subpart of the regulations is comprised of 17 specific apportionment rules interpreting many of the statutory changes that first applied to the 2015 tax year.7 Under one of the new regulations, receipts and net gains from the sale of tangible personal property are sourced to New York if the final destination is in the state.8 To determine the amount of net gains from sales of tangible personal property or real property to be included in the numerator and denominator of the BAF, the taxpayer first subtracts the sum of all losses from the sum of all gains.9 If the result is equal to or less than zero, no amount is included in the numerator (New York receipts) or the denominator (everywhere receipts) of the BAF. In addition, the regulations limit the amount included in the numerator to the amount included in the denominator.10 Accordingly, for these sales, the BAF cannot be less than zero or greater than 100%.
Receipts from the rental of motor vehicles and other rolling stock, such as trucks or construction equipment, may be sourced to New York based on the proportion of: (i) miles operated in the state; (ii) time operated in the state; (iii) number of pickup and delivery locations in the state; or (iv) any other method that fairly apportions the receipts.11
Digital products and services
A subpart of the final regulations discusses the apportionment of receipts from digital products and services.12 Receipts from the sale of, rental of, license to use, or granting of remote access to digital products and services are sourced to New York if the location where the customer derives value from the digital product or services, according to a hierarchy of methods, is in the state.13 The following hierarchy of methods applies to sourcing digital products or services: (i) customer’s primary use location; (ii) location where the digital product or service is received by the customer; (iii) sourcing used in the preceding tax year; or (iv) sourced in the same way as the corporation’s other digital products or services in the current tax year.14
The regulations provide the following specific guidance as it applies to digital products and services: (i) special and general rules for determining primary use location; (ii) reasonable approximation based on customer or general information; (iii) use of the “where received” method; (iv) rules for intermediary transactions; and (v) use of the preceding tax year or the current tax year method.15 Finally, the regulation provides 23 examples to illustrate the apportionment of receipts from digital products and services.16
Other services and business activities
The final regulations include a subpart that addresses receipts from other services and other business activities, including rules for determining where the benefit of the service is received.17 For such purposes, the following hierarchy of apportionment rules applies: (i) location where the benefit of the service or other business activity is received; (ii) delivery destination; (iii) sourcing used in the previous tax year; or (iv) sourced in the same way as the corporation’s receipts from other services or business activities in the current tax year.18
Determining where the benefit is received generally depends on whether the customer is an individual customer, a business customer, or a passive investment customer.19 The regulations also provide guidance on the following: (i) special rules for determining where the benefit is received; (ii) general rule for determining where the benefit is received; (iii) reasonable approximation based on customer information; (iv) reasonable approximation based on general information; (v) delivery destination method; (vi) rules for intermediary transactions; (vii) preceding taxable year method; and (viii) current taxable year method.20 The regulations also provide 19 examples illustrating the apportionment of receipts from other services and business activities.21
Sales of partnership interests and intangible assets
Under New York law, gains from the sale of a partnership interest are excluded from the apportionment fraction calculation unless the commissioner determines that inclusion of the gain is necessary to properly reflect the taxpayer’s business income or capital.22 A regulation discusses the apportionment of income from qualified financial instruments for corporations other than non-captive real estate investment trusts (REITs) and non-captive regulated investment companies (RICs).23 The regulation clarifies that a “qualified financial instrument” includes a stock or partnership interest that is marked to market.24 If a corporation has marked to market a partnership interest, any other partnership interest that has not been marked to market is considered a qualified financial instrument in the tax year.25 A corporation with gain from the sale of a partnership interest that is classified as a qualified financial instrument may elect the fixed percentage method to include 8% of the net income from qualified financial instruments in New York receipts and 100% of all net income from qualified financial instruments in everywhere receipts.26
For sales of intangible property such as goodwill, copyrights, and patents, the benefit of the sale is presumed to be received at the location where the value of the intangible was accumulated.27 The location where the value of goodwill is accumulated is specifically determined using a three-year average of the BAF or other percentage used to apportion or allocate income to New York State of the entity that is sold, unless the facts and circumstances indicate another period of time is a better measure of where the value is accumulated.28 The sourcing treatment of sales of such intangible property stands in contrast to the sales factor sourcing of receipts from the use of patents, copyrights, trademarks, licenses, and similar intangibles, which are included in New York receipts to the extent that the activities generating the fees paid for the use of the intangible are carried out in the state.29
Business address presumption
The regulations include a business address presumption for receipts from digital products/services, other services, and other business receipts.30 For digital products or services, the billing address presumption allows a corporation to use a customer’s billing address as the primary use location.31 For other services and business activities, a corporation may use a customer’s billing address as the benefits received location.32 A corporation may use the billing address presumption if it has: (i) more than 250 business customers purchasing substantially similar services or activities, and (ii) no more than 5% of receipts from those services or activities are from one particular customer.33
Lump sum payments
The final regulations discuss the apportionment of lump sum payments for multiple types of goods.34 When a sale is comprised of a digital product and a digital service, both of which are sourced under the digital product rules, the receipt cannot be divided into separate components and is considered to be one receipt regardless of whether the receipts are separately stated for billing purposes.35 For other types of transactions, if there are multiple assets or services in one transaction, the proceeds must be reasonably divided among the types of assets or services sold by the corporation and the receipts or net gains from each type must be separately apportioned.36 A corporation cannot use the rules for intermediary transactions “unless almost all of the activities carried on under the agreement are intermediary transactions.”37 For intermediary transactions, the receipt is sourced using the hierarchy of methods based on the location of the end-user consumers rather than the intermediary.38
Installment sales
When an asset sale occurs in which proceeds of such sale are received by a seller on an installment basis (per Internal Revenue Code Sec. 453), the sourcing of such sale to New York is determined in the year of such sale per the New York statute and final regulations, with installment payments received in later years sourced to New York in the same manner as the first-year installment payment.39
Alternative apportionment
A detailed section of the final regulations concerns alternative apportionment and the power of the Commissioner of Taxation and Finance to adjust the BAF.40 If the BAF does not properly reflect the taxpayer’s business income or business capital in the state, the commissioner may adjust the BAF to properly reflect the taxpayer’s business income or business capital in New York, or the taxpayer may request an adjustment.41 In general, a taxpayer must submit a request to vary the BAF in writing and separately from any report to which it relates.42 However, a taxpayer may file an amended report using its proposed BAF if the commissioner did not respond to the taxpayer’s written request for an adjustment to the BAF before the taxpayer filed its original report.43
The party seeking to change the BAF has the burden to show by clear and convincing evidence that the statutory computation of the BAF does not properly reflect the taxpayer’s business income or business capital in the state and that the proposed adjustment is appropriate.44 Also, the party that wants to change the BAF must demonstrate that application of the statutory formula attributes income or capital to the state out of all proportion to business transacted by the taxpayer in the state.45
The final regulations provide three detailed examples to illustrate the alternative apportionment concepts. In one of the examples, a corporation that owns an interest in a partnership for four years computes the tax on its partnership interest under the aggregate method. In the fifth year, the corporation’s only business receipts are from selling financial investments, with 75% of its business receipts arising from the net gain on the sale of its partnership interest.46 Under the current statute, the net gain from the partnership sale would not be included in the BAF (to the extent the taxpayer did not make the fixed percentage election to source such gain).47 However, the example implies that the Department would determine in this instance that because of the significance of the net gain in comparison to the overall amount of receipts reported by the taxpayer, the net gain should be included in order to properly reflect the corporation’s business income.
Application of P.L. 86-272 protection to internet activities
P.L. 86-272, enacted in 1959, prohibits states from taxing out-of-state corporations on income derived from business activities within the state if their activities are limited to mere solicitation of orders for the sale of tangible personal property and the orders are then approved and filled from outside the state.48 In August 2021, the Multistate Tax Commission (MTC) issued a revised statement of information addressing the application of P.L. 86-272 to the modern economy and internet transactions.49 The MTC’s revised statement includes 11 examples that tend to narrow the scope of P.L. 86-272 as it relates to internet vendors.50
Consistent with the MTC’s position, the Department’s final regulation acknowledges P.L. 86-272 protections solely for corporations engaged in the solicitation of online orders in New York State for sales of tangible personal property where the orders are sent outside New York State for approval or rejection.51 The scope of P.L. 86-272 protection includes an out-of-state internet vendor presenting static text or images on its website.52 The New York regulation includes the examples from the MTC’s statement and reaches the same conclusions regarding whether each transaction is protected by P.L. 86-272.53
While the New York regulation generally is consistent with the MTC’s statement, the regulation differs from the MTC’s statement by providing that “[s]olicitation activities [that are protected] do not include those activities that the corporation would have reason to engage in apart from the solicitation of orders but chooses to allocate to its New York State sales force, or to engage in via the Internet, including interacting with customers or potential customers through the corporation’s website or computer application.”54 This fairly broad language conceivably could be used to further reduce the P.L. 86-272 protection for internet sellers beyond the intent of the MTC’s statement.
Qualified New York manufacturer status
Qualified New York manufacturers principally engaged in a specified set of activities with specified property within New York are entitled to a 0% tax rate on the business income base.55 The regulations provide clarifying definitions applicable to manufacturers, including activities that specifically do not qualify as manufacturing.56 In addition, the regulation provides rules for how to determine whether a combined group is a qualified New York manufacturer.57
Commentary
The Department’s extensive corporation franchise tax regulations have been in development for several years and will affect virtually all industries. These regulations are particularly significant because they implement the major legislative tax reform that was enacted nearly 10 years ago. The Department is likely to increase enforcement of the regulations and engage in more audit activity.
Taxpayers should be cognizant of the Department’s intention to retroactively apply these regulations beginning with the 2015 tax year (to the extent these tax years are still open under taxpayers’ statutes of limitation). During the years that the Department released the draft regulations, the applicability of the regulations was unclear. Also, some substantial changes were made to the draft regulations during the years that the regulations were being formulated. Thus, a taxpayer may have relied on a draft regulation provision that differs from the final regulation. The Department may consider waiving penalties if a taxpayer relied on a draft regulation, but the retroactive application of the regulations in some cases is likely to generate controversy and result in taxpayer challenges.
The final apportionment regulations are very thorough and provide numerous examples. Taxpayers should carefully evaluate the regulations and consider whether some of their apportionment methodologies need to be changed. Also, taxpayers should be aware that the regulations require the maintenance of documentation and records to support apportionment methodologies and determinations.58 A regulation provides that a “corporation must take reasonable steps to update its existing systems of recording transactions or the current format of its books and records to capture the information required by these rules.”59 As a result, some businesses may be required to change their existing systems to comply with the regulations.
Taxpayers also should consider the alternative apportionment provisions. Taxpayers seeking to use an alternative apportionment methodology usually are required to submit a written request, but a taxpayer may file an amended report using its proposed BAF if the commissioner did not respond to the taxpayer’s written request for an adjustment before the taxpayer filed its original report. Also, taxpayers should note the burden of proof that is required to support an alternative apportionment request.
California and New Jersey have adopted administrative guidance consistent with the MTC’s revised statement on P.L. 86-272, but New York is the first state to promulgate formal regulations that align with the MTC’s statement. Under the new regulation, an out-of-state retailer of tangible personal property with no physical presence within New York State may lose P.L. 86-272 protection by engaging in otherwise typical online customer engagement activities. Therefore, it is imperative that out-of-state businesses that maintain an active online presence and generate sales in New York State reevaluate their online activities as they relate to apportionment and mere solicitation as defined under P.L. 86-272.
While this SALT Alert addresses some of the major provisions in the new regulations, taxpayers also should carefully consider the final regulations that are not covered in this alert as well as the numerous examples provided throughout the regulations. The new regulations encompass numerous areas of corporation franchise tax and will affect many businesses with activities in New York. Finally, New York City is expected to promulgate its own regulations that are consistent with the state’s regulations.
1 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 1-1.1-9-5.4; 32.1-32.9, published Dec. 27, 2023.
2 For a discussion of the draft regulations, see GT SALT Alert: New York finalizing corporate business tax reform.
3 See N.Y. Tax Law § 210-A, which was enacted by Ch. 59 (A.B. 8559 / S.B. 6359), Laws 2014.
4 N.Y. Tax Law § 210-A.3.
5 N.Y. Tax Law § 210-A.10.
6 The apportionment regulations are provided by N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-1.1–4-4.11.
7 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-2.1–4-2.17.
8 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-2.1(a). Examples of the types of evidence that ordinarily will be sufficient to demonstrate the final destination of property include: (i) a bill of lading or other shipping document designating the final destination location, regardless of the F.O.B. point; and (ii) a purchase invoice designating the final destination location. N.Y. Comp. Codes R. & Regs. tit. 20, § 4-2.1(c).
9 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-2.1; 4-2.2.
10 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-2.1(b)(2); 4-2.2(c).
11 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-2.3(a)(4).
12 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-3.1–4-3.11. A “digital product” includes, but is not limited to, an audio work, audiovisual work, visual work, electronic book or literary work, graphic work, electronic database, game, information or entertainment service, website, or digital application that is digitally delivered. In addition, “digital product” includes software by whatever means delivered, including physical media. Further, the term includes the storage of any property that constitutes a digital product. N.Y. Comp. Codes R. & Regs. tit. 20, § 4-3.1(c).
13 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-3.2(a).
14 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-3.2(b). Note that these methods must be applied sequentially, and the taxpayer must use due diligence before rejecting a specific method of sourcing due to lack of sufficient information.
15 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-3.3-4-3.10.
16 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-3.11.
17 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-4.1–4-4.11. These rules apply to services and business activities including the net gains (not less than zero) from the sale of intangible property, as well as receipts from the compensation for certain services, such as commissions, finder’s fees, loan servicing fees, and fees for professional services.
18 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-4.2(b). Again, the taxpayer must use due diligence before rejecting a specific method of sourcing due to lack of sufficient information.
19 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-4.4. For individual customers, the benefit is presumed to be received at the customer’s billing address. For business customers, the benefit is presumed to be received in New York, without regard to the billing address of the corporation’s customer, if the customer received the benefit in New York. The benefit of management, distribution, and administrative services provided to a passive investment customer is presumed to be received at the location of the investors in such passive investment customer unless the investor is holding the interest in the passive investment customer for a beneficial owner.
20 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-4.3-4-4.10.
21 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-4.11.
22 See N.Y. Tax Law § 210-A.5.(a)(2)(G).
23 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-2.4.
24 “Marked to market” means that a financial instrument is, under IRC § 475 or 1256, treated by the corporation as sold for its fair market value on the last business day of the corporation’s tax year. N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.1(c).
25 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-2.4(a)(2)(ii).
26 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-2.4(c).
27 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-4.3(e). Intangible property includes, but is not limited to, goodwill, copyrights, patents, trademarks, trade names, brand names, licenses, and trade secrets.
28 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-4.3(e)(3).
29 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-2.3(b).
30 N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-3.2(d)(1)(ii); 4-4.2(d)(1)(ii). Note that the draft regulations termed this as a “billing address safe harbor.” The terminology was changed to clarify that this is a presumption, not a safe harbor.
31 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-3.2(d)(1)(ii).
32 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-4.2(d)(1)(ii).
33 See N.Y. Comp. Codes R. & Regs. tit. 20, §§ 4-3.2(d)(1)(ii); 4-4.2(d)(1)(ii). The draft regulations required that there be more than 10,000 business customers purchasing substantially similar services or activities.
34 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.3.
35 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.3(a).
36 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.3(b).
37 Id. An “intermediary transaction” is a transaction where the business customer (intermediary) derives value from a digital product or service at the location of the consumer rather than the location of the business customer itself. N.Y. Comp. Codes R. & Regs. tit. 20, § 4-3.1(e).
38 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-3.8(a).
39 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.4(a).
40 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.6.
41 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.6(a)-(c).
42 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.6(c)(1).
43 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.6(c)(4).
44 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.6(d).
45 Id.
46 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.6(e)(example 3).
47 See N.Y. Tax Law § 210-A.5.(a)(2)(G).
48 15 U.S.C. §§ 381-384.
49 Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272, Multistate Tax Commission, revised Aug. 4, 2021.
50 Generally, when a business interacts with a customer via the business’s website or app, it is engaged in “business activity” within the customer’s state that exceeds P.L. 86-272 protection. In contrast, if the website merely presents static text or photos, there is no engagement or facilitation within the customer’s state.
51 N.Y. Comp. Codes R. & Regs. tit. 20, § 1-2.10(a).
52 N.Y. Comp. Codes R. & Regs. tit. 20, § 1-2.10(f).
53 N.Y. Comp. Codes R. & Regs. tit. 20, § 1-2.10(i).
54 N.Y. Comp. Codes R. & Regs. tit. 20, § 1-2.10(f).
55 N.Y. Tax Law § 210.1(a)(vi). Special rates apply for the capital and the fixed minimum tax bases.
56 N.Y. Comp. Codes R. & Regs. tit. 20, § 9-1.2(b).
57 See generally N.Y. Comp. Codes R. & Regs. tit. 20, § 9-1.2.
58 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.2(g)-(j).
59 N.Y. Comp. Codes R. & Regs. tit. 20, § 4-1.2(j).
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