- New York Tax Reform Made Easy: Apportionment
- April 21, 2014
- Law Firm: Sutherland Asbill Brennan LLP - Washington Office
The New York State Governor and Legislature recently enacted the 2014-2015 New York State Budget, Senate Bill 6359-D and Assembly Bill 8559-D (Budget), which results in the most significant overhaul of New York’s franchise tax on corporations in decades. In this edition of New York Tax Reform Made Easy, we will address the changes made to apportionment sourcing in computing a taxpayer’s apportionment factor.
The Budget restructures the receipts sourcing provisions of the Corporate Franchise Tax and adopts apportionment sourcing provisions that require market (customer) based sourcing for all receipts. In addition, the Budget provides sourcing rules for a new category of receipts, digital goods. Further the new apportionment provisions include specific sourcing provisions for financial transactions and an election for taxpayers to source a flat 8% of their receipts from “qualified financial instruments” (QFIs) to New York.
1. Categories of Receipts
Presently, New York tax law requires taxpayers to characterize receipts for sourcing purposes into four general categories, and several special rules apply to specific industries, as follows: (1) sales of tangible personal property; (2) sales of services; (3) rents and royalties; (4) sales of services to an investment company; (5) a registered broker-dealer; (6) an air-freight forwarder; (7) a gas pipeline transmission or transportation business; (8) a railroad business; and (9) other business receipts.
The new apportionment provision creates a new category for digital products, replaces the general services category with specific service categories, and incorporates any residual services (other services) into the other business receipts category. As a result, taxpayers must characterize receipts into nine categories for sourcing purposes, including: (1) tangible personal property; (2) rents and royalties; (3) digital products; (4) financial transactions; (5) advertising services; (6) gas transportation or transmission services; (7) railroad and trucking services; (8) aviation services; and (9) a catch-all category for other services and other business receipts.
2. Market Sourcing for Service Receipts
In addition to modifying the categories of receipts, the Budget includes new sourcing rules for services. Historically the characterization of receipts has been a very controversial issue because of the fact that “services” were sourced on an origination (location of performance) basis and all other categories were sourced based on a destination (location of the market) basis. As a result, a change in the characterization of receipts from a “service” to anything else had profound consequences for the computation of the taxpayer’s New York apportionment factor. The Budget eliminates this controversial issue by providing consistent sourcing rules for all receipts, i.e., destination (market) based sourcing.
Further, the Budget provides specific rules related to advertising based on the type of media used for delivery. In general, the new law sources advertising receipts to the location of the advertisement’s viewership. The new apportionment provision’s advertising receipts category encompasses advertising from newspapers and periodicals, television and radio, and other advertising receipts such as Internet advertising. Specifically, the new law provides that print advertising is sourced to the location where the print is delivered, and television, radio, and Internet advertising receipts are sourced to the location where the program or website is viewed.
3. Digital Goods Receipts
The Budget creates a new receipt category for sales of digital products and generally sources the receipts to the customer’s location. The new apportionment provision will impose a four-step hierarchy for determining the location of a digital product’s source. The new law sources digital products, which include services or property combined with services, to the location where the customer primarily uses the digital product. If the taxpayer cannot identify the primary use location, then the receipts are sourced to the location where the customer receives the digital product. If the taxpayer cannot identify the receipt location, then it must apply the prior year’s apportionment factor for the digital product, followed by the current year apportionment factor for digital products that can be sourced.
The sourcing of digital goods is an issue that has been controversial across the country. The new legislation provides some guidance regarding how to handle such transactions, but the Department will need to provide additional guidance in the form of regulations to provide further certainty.
4. Financial Transaction Receipts
The Budget sources financial transactions on a market approach. The new provisions include specific applications of the market sourcing rules for receipts received by certain providers of financial services and for financial transactions.
The Budget provides specific rules regarding the receipts earned by providers of financial services, including (1) receipts from broker-dealer activities; (2) receipts from credit card activities; and (3) receipts from services to investment companies. Specifically, the new law requires taxpayers to source receipts from broker-dealer activities or credit card activities to the location of the paying customer. In most instances, individual customers will be deemed located at their mailing addresses, and business customers will be deemed located at their commercial domiciles. In addition, the new apportionment provision for receipts from services to investment companies will be sourced based on the number of shares held by shareholders in New York divided by the total shares.
In addition, the Budget provides rules regarding the application of the market sourcing provisions to eight categories of financial instruments, including:
Federal, state and municipal debt;
Asset-backed securities and other government agency debt;
Reverse repurchase and securities borrowing agreements;
Dividends and net gain from stock or partnership interests; and
Other financial instruments.
Generally, the new provisions source receipts whenever practicable to the location of the market (e.g., borrower for non-real property lending, purchaser for asset-backed securities, commercial domicile for corporate bonds). However, in several circumstances (e.g., reverse repurchase agreements, securities borrowing agreements, and federal funds), the new law resorts to a proxy of 8% of the New York market, which is based on the New York portion of the U.S. gross domestic product.
In addition, the Budget provides taxpayers an election to source 8% of all net income from QFIs to New York (the QFI Election). The QFI Election is an annual, irrevocable election that applies to all QFIs, and applies to all members of a combined group. The new law defines QFI as a financial instrument that is marked to market under Internal Revenue Code § 475 or § 1256, and is not a loan secured by real property. The election provides taxpayers with a simple method to source their receipts from such financial instruments without having to spend resources tracking down the proper sourcing for each QFI.
5. Other Service and Business Receipts
The Budget renames and modifies the “other business receipts” (residual) category to “other service and business receipts,” and to include all receipts that are not specifically addressed in the defined categories. The new law will impose a hierarchy, similar to the hierarchy for sourcing sales of digital products, for determining how to source other services or business receipts. First, other service and business receipts are sourced where the benefit is received. Next, the new apportionment provision sources such receipts to the delivery location. Finally, if the location where the benefit is received or the delivery location is unknown, taxpayers must source other service and business receipts according to their apportionment factor for those receipts from the prior year, followed by the current year’s apportionment factor for locatable other service and business receipts.
As with the digital goods sourcing provision, the Department will likely be asked for additional guidance regarding transactions that fall into the residual “other service and business receipts” category.