On January 22, 2016, the New York State Department of Taxation and Finance (Department) released draft regulations (Draft Regs. tit. 20 Section 6-2.1 through 6-2.8) on the new combined reporting filing requirements for Article 9-A taxpayers (i.e., business corporations) enacted as part of the New York State and New York City corporate tax reform in 2014 and 2015, respectively (A. 8559-D / S.6359-D; A. 3009-B / S. 2009-B; and S. 4610-A/ A. 6721-A, collectively Tax Reform; see also N.Y. Tax Law Section 210-C, Tax Alerts 2014-655; 2015-667). Under the Tax Reform, and effective for tax years beginning on or after January 1, 2015, New York State and City business corporation taxpayers must file a combined report when the capital stock and the unitary business requirements are met. In addition, a group of corporations satisfying certain capital stock ownership requirements may elect to file a combined report. Under prior law, combined reporting in New York was generally only required if, in addition to satisfying the unitary requirements, substantial intercorporate transactions existed among the unitary group members. The draft regulations provide an in-depth description of the new filing requirements.

Once final, the draft regulations are intended to have retroactive effect and will be effective for tax years beginning on or after January 1, 2015. We understand that New York City will likely follow the State's regulations in this area.

General requirements; tax calculation¹

The draft regulations require each combined group to have a designated agent to act on its behalf. The designated agent must be an Article 9-A taxpayer and must be identified in the combined report. The designated agent acts on the combined group's behalf, and its actions are binding on all combined group members. General business corporation franchise taxpayers that are members of the combined group are jointly and severally liable for the tax due on the combined report of the combined group.

The tax due on the combined report is the sum of: (1) the higher of the combined business income base multiplied by the tax rate specified in N.Y. Tax Law Section 210.1(a); the combined capital base multiplied by the tax rate specified in N.Y. Tax Law Section 210.1(b); or the fixed-dollar minimum tax specified in N.Y. Tax Law. Section 210.1(d) attributable to the designated agent of the combined group, and (2) the fixed-dollar minimum tax specified in N.Y. Tax Law. Section 210.1(d) attributable to each member of the combined group (other than the designated agent) that is a taxpayer under N.Y. Tax Law Article 9-A.

Capital stock requirement²

Capital stock of a corporation is the issued or outstanding stock of the corporation. A taxpayer and another corporation meet the capital stock requirement if: (1) the taxpayer owns or controls, either directly or indirectly, more than 50% of the voting power of the capital stock of another corporation; (2) more than 50% of the voting power of the capital stock of the taxpayer is owned or controlled, either directly or indirectly, by another corporation; or (3) more than 50% of the voting power of the capital stock of the taxpayer and more than 50% of the voting power of the capital stock of one or more other corporations are owned or controlled, either directly or indirectly, by the same interests (e.g., an alien, foreign or domestic corporation, partnership, or individual).

The draft regulations define "ownership"³ and "control,"⁴ define the voting power of the capital stock of a corporation, and discuss how to satisfy the capital stock requirement. Under the draft regulations, the capital stock requirement can be satisfied through direct or indirect ownership, direct or indirect control, or through a combination of direct or indirect ownership or control. Examples provided in the draft regulations illustrate both ownership and control, because both do not need to be met concurrently to meet the capital stock requirement.

Unitary business requirement⁵

The draft regulations provide that "unitary business," for purposes of determining the corporations required to be included in a combined report, is to be construed to the broadest extent permitted under the US Constitution as interpreted by the US Supreme Court, New York State courts and the New York State Tax Appeals Tribunal. "Attributes of a unitary business" is characterized by the flow of value as evidenced by functional integration, centralized management and economies of scale.

Functional integration includes transfers between, or pooling among, business activities that significantly affect the operation of the business activities regardless of arm's-length pricing. Centralized management exists when directors, officers and/or other management employees jointly participate in management decisions that affect the respective business activities (albeit day-to-day management and accountability have been decentralized) and that also may operate to the benefit of the entire economic enterprise. Finally, economies of scale are a relation among and between business activities, resulting in a significant decrease in the average per unit cost of operational or administrative functions due to the increase in operational size (i.e., resulting from cost savings arising from the presence of functional integration or centralized management).

Functional integration, centralized management, and economies of scale are analyzed in conjunction with one another for the cumulative effect, and a determination of unitary business depends on all the facts and circumstances. New York will presume, however, that a unitary business exists, unless either the Commissioner or the taxpayer proves otherwise by clear and convincing evidence, when any of the following presumptions are present:

— Horizontal integration - the related corporations are in the same general line of business

— Vertical integration - the related corporations are engaged in different steps in a vertically structured enterprise

— Strong centralized management - strong centralized management is coupled with centralized departments for such functions as financing, advertising, research and development, or purchasing

— For newly formed corporations - from the date the forming corporation(s) and the newly formed corporation satisfy the capital stock requirement or

— For newly acquired corporations - the newly acquired corporation and the acquiring corporation in the first tax year that the capital stock requirement and certain unitary business presumptions above (i.e., horizontal or vertical integration, or strong centralized management) are satisfied.

The draft regulations provide examples intended to illustrate the these presumptions. If none of the these presumptions apply, a unitary business will be determined based upon the facts and circumstances. Finally, New York deems a "passive holding company" to be engaged in unitary business if the passive holding company and one or more operating companies satisfy the capital stock requirement.

Filing combined reports; prohibitions⁶

To file on a combined basis, the group's designated agent must file a completed combined report. Certain information must be provided by the designated agent with the combined report and certain information may be required to be provided to the Department at another time (e.g., upon audit). Except for combined reports filed using the commonly owned group election (discussed later), among the information that may be required to be provided is information establishing that each of the included corporations meets the unitary business requirement.

Certain corporations are prohibited from filing a combined report (including the combined report filed under the commonly owned group election). These are: a corporation that is taxable under a franchise tax imposed by New York Tax Law Article 9 (taxes on transportation and transmission companies, telecommunications companies, utility services providers, and farmers' cooperatives and agricultural cooperatives) or Article 33 (franchise tax on insurance corporations); a corporation that would be taxable under a franchise tax imposed by Articles 9 or 33 if subject to tax; a real estate investment trust (REIT) that is not a captive REIT; a regulated investment company (RIC) that is not a captive RIC; a New York S corporation; or an alien corporation that under any IRC provision is not treated as a "domestic corporation" as defined in IRC Section 7701 and has no effectively connected income for the tax year.⁷ Finally, certain corporations that are subject to New York business corporation franchise tax solely as a result of their ownership of a limited partner interest in a limited partnership or a membership interest in a limited liability company are not required or permitted to file a combined report. ⁸

Rules related to certain captives⁹

A captive REIT and captive RIC, both of which are defined in the New York Tax Law, that are not required to be included in a combined report under Article 33 are required to be included in a combined report under Article 9-A. The draft regulations provide that a captive REIT or captive RIC must be included in a combined report under Article 33 when: (1) the corporation that directly owns or controls more than 50% of the voting power of the capital stock of the captive REIT or captive RIC is a life insurance corporation subject to tax or required to be included in a combined return under Article 33; or (2) when the closest controlling stockholder of the captive REIT or captive RIC is a life insurance corporation subject to tax or required to be included in a combined return under Article 33. The draft regulations define "closest controlling stockholder" and also include provisions discussing when combinable captive insurance companies and when alien corporations are required to be included in combined reports under Article 9-A. ¹⁰

Commonly owned group election¹¹

Certain taxpayers can elect to treat as their combined group all corporations that meet the capital stock requirement (commonly owned group). For taxpayers making this election, all of the corporations that are members of the commonly owned group are treated as members of a single combined group for combined reporting purposes, regardless of whether, for example: (1) these corporations are included in more than one federal consolidated return filed by more than one federal consolidated group, or (2) these corporations are engaged in one or more unitary businesses. Once this election is made, the commonly owned group must calculate the combined group's combined business income, combined capital, and fixed-dollar minimum bases of all members in accordance with N.Y. Tax Law Section 210-C and related regulations. In addition, the commonly owned group is deemed to be engaged in a single unitary business for all purposes, including the calculation of business and investment capital, business and investment income, and the apportionment factor. Any corporation that enters a commonly owned group during the time the election is in effect is included in the combined group.

The draft regulations provide information on the mechanics of making the election. Once the election is made, it cannot be revoked until seven tax years have passed. At that point, the designated agent can affirmatively revoke it, and New York would not permit a new election in any of the three tax years that immediately follow the revocation. Also, note that a short year is disregarded for purposes of the election, i.e., does not count as one of the seven years.

Policy matters: disregarding tax effect of election

The draft regulations state that the purpose of the commonly owned group election is to simplify the filing of returns for commonly owned corporations by avoiding the fact-intensive analysis associated with determining the scope of a unitary business. The seven-year binding requirement ensures that the elections are made for tax simplification purposes rather than for tax reduction purposes. Therefore, the draft regulations provide that the Commissioner can disregard the tax effect of the election when it appears from facts available at the time of the election that the election will not have a meaningful continuing application.

Implications

New York's draft regulations address when combined reports are and are not required or permitted for New York business corporation franchise taxpayers. Taxpayers may provide comments on the draft regulations to the Department by April 21, 2016.

Although the draft regulations cannot be relied upon until promulgated as final, taxpayers should consider such rules (i.e., the unitary presumptions and commonly owned group election) in determining their New York State and City combined groups for purposes of the 2015 extension, 2016 estimated tax, and current and deferred tax provisions, inasmuch as New York unitary combined reporting is effective for tax years beginning on or after January 1, 2015. In addition, taxpayers may also consider combined unitary filings in other states (e.g., California, Illinois, Massachusetts and Texas) in comparing and contrasting such filings to their New York combined group.

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ENDNOTES

¹ 20 Section NYCRR 6-2.1.

² 20 Section NYCRR 6-2.2.

³ Ownership includes actual or beneficial ownership, rather than mere record title as shown by the stock books of the corporation. To be considered the owner, the stockholder must have the right to vote and the right to receive any dividends declared. (Emphasis added to indicate new language).

⁴ The term "control" refers to all cases when one corporation directly or indirectly possesses the power to dictate or influence the management and policies of another corporation through the direct or indirect ownership of more than 50% of the voting power of the capital stock of that corporation. In addition, a corporation controls the voting power of capital stock if it has been given the right to vote that stock by proxy or otherwise. The determination as to whether or not a corporation is controlled by or controls another corporation or is controlled by the same interests will be determined by the facts in each case. (Emphasis added to indicate new language).

⁵ 20 Section NYCRR 6-2.3(e).

⁶ 20 Section NYCRR 6-2.4; 6-2.6.

⁷ An alien corporation with effectively connected income that meets the capital stock and unitary requirements will be included in a combined return.

⁸ Draft Regulation Section1-3.2(a)(7), (8).

⁹ 20 Section NYCRR 6-2.5.

¹⁰ The Draft regulations provide that certain captive insurance companies are required to be included in a combined report if more than 50% of the voting power of its capital stock is owned or controlled directly or indirectly by a corporation subject to tax under Article 9-A or a corporation required to be included in a combined report under Article 9-A. Draft Regulation Section6-2.5(3)(b). The Draft regulations also provide that an alien corporation with effectively connected income must be included in a combined report with other corporations satisfying the capital stock and unitary business requirements. Draft Regulation Section 6-2.5(3)(c).

¹¹ 20 Section NYCRR 6-2.7.