Following New York City’s recent victory in a case involving the allocation of income earned by an out-of-state corporation from its sale of a non-unitary investment, the New York Tax and Finance Department New York State (NYS Department) commemorated the litigation position in an August 4, 2022 revision of the “final draft” settlement it issued just three months ago.
In Case Goldman Sachs Petershill Fund Offshore Holdings (Delaware) Corp. vs. New York City Tax Appeals Tribunal, 2022 NY Slip Op 02361 (NY App. Div. 2022), the New York State Supreme Court Appellate Division dismissed an out-of-state company’s appeal to the court of New York City tax appeal and ruled that the court’s decision to uphold a tax assessment on the company’s gain from the sale of an indirect interest in a limited liability company was “rational”. The out-of-state company had no property or employees in New York, but was a limited partner in a partnership that held an interest in an LLC that carried on business in the city. Even though the company and the LLC were not engaged in a unitary business, the New York City Department of Finance (NYC DOF) required the company to allocate the gain from the disposition of the LLC’s interest using the allocation factor of 100%. The Appellate Division ultimately upheld the NYC DOF’s assessment of the company’s out-of-state gain from the sale. Our case coverage can be found here.
On April 29, 2022, the New York Department of State released a set of “final drafts” of regulations containing the following provision regarding “constitutionally protected investment capital” in Section 3-4.2:
In the case of a company incorporated and commercially domiciled outside the State of New York, the United States Constitution prohibits the State from distributing income or gains from intangible assets when such income or gains are n do not have a sufficient connection with a unitary enterprise carried on in the State by the company.
On August 4, 2022, the NYS Department revised the provision, and Section 3-4.2 now states:
In the case of a company incorporated and commercially domiciled outside the State of New York, the United States Constitution prohibits the State from distributing income or gains from intangible assets when such income or gains are n do not have a sufficient link with
a unit business operated activities or presence in the state by the company.
The NYS Department also added a new example to the “final draft” of regulations, resembling the Goldman decision, which deals with “constitutionally protected investment capital” in the context of a sale of a minority stake in a partnership operating in New York. New Example 16 provides:
InvestCo is a foreign company that holds a minority stake in Asset Manager, a New York State-only partnership that engages in various investment activities. InvestCo and Asset Manager are not engaged in a unitary business. Other than its investment in Asset Manager, InvestCo has no physical presence or operations in New York State.
In 2022, InvestCo sells its stake in Asset Manager with a gain. Since Asset Manager’s increase in value was a result of its operations in New York State and benefits provided by New York State, InvestCo’s interest in Asset Manager is not constitutionally protected investment capital. As such, the interest in Asset Manager is business capital and the gain from the disposition of that interest is business income.
The NYS Department has requested comment on the investment capital revisions by August 26, 2022.
It should be noted that the New York City Department has stated that it “intends to publish rules that generally correspond” to state regulations, and that it “will make available draft regulations once the state finalizes its new and revised regulations.”