On April 7, 2016, the New York Tax Appeals Tribunal (the Tribunal) ruled that a taxpayer must utilize a net operating loss (NOL) deduction to reduce its entire net income for New York bank franchise tax purposes in a year the tax was not measured based on its entire net income. The Tribunal's decision, In the Matter of the Petition of TD Holdings II, Inc.,¹ reversed an Administrative Law Judge (ALJ) determination² that the taxpayer was not required to take a NOL deduction under former NY Tax Law Section 1453(k-1) when computing its 2006 tax liability.

Background

Prior to January 1, 2015,³ Article 32 of the New York State (NYS) Tax Law imposed a franchise tax on banking corporations "[f]or the privilege of exercising its franchise or doing business in [NYS] in a corporate or organized capacity." ⁴ NYS Tax Law required taxpayers to pay tax on the highest of four alternative bases: (1) 7.5%⁵ of the taxpayer's entire net income, or the portion thereof allocated to NYS; (2) one-tenth of a mill upon each dollar of taxable assets, or the portion thereof allocated to NYS; (3) 3% of the taxpayer's alternative entire net income, or portion thereof allocated to NYS for the tax year; or (4) $250.⁶

Additionally, the bank franchise tax permitted taxpayers to use an NOL deduction to reduce entire net income. Under NYS Tax Law former Section 1453(k-1), "a net operating loss deduction shall be allowed which shall be presumably the same as the net operating loss deduction allowed under section one hundred seventy-two of the internal revenue code," subject to certain New York adjustments.

Facts and ALJ determination

The Taxpayer, TD Holdings II, Inc. and its wholly owned disregarded subsidiaries, TD Securities (USA) LLC and Toronto Dominion (Texas) LLC (hereinafter collectively referred to as the "Company") filed NYS returns under Article 32 for tax years 2005 through 2007. Because the Company was included in a federal consolidated return with other entities, it prepared pro forma federal returns reflecting a federal loss of approximately $11.7 million and a New York loss of about $9.3 million for the 2005 tax year.

For Article 32 purposes, the Company paid the alternative tax on taxable assets for tax years 2005 and 2006, and was subject to tax on the entire net income base for tax year 2007. For federal income tax purposes, the Company deducted approximately $3.7 million of NOLs for tax year 2006, but did not make this adjustment for New York corporate tax purposes because the tax on its entire net income was less than the tax determined based on its taxable assets in that year. Instead, the Company applied its 2005 NOL to reduce New York entire net income for tax year 2007 because its tax on entire net income was significantly greater than its tax on an alternative basis.

The NYS Department of Taxation and Finance (the Department) argued, consistent with its position under Article 9-A for general (nonbank) corporations, that the Company was required to reduce its entire net income by about $3.7 million for the 2006 tax year (the extent of the federal NOL taken in tax year 2006), even though the Company was not subject to tax based on entire net income for that year. The ALJ disagreed with the Department's conclusion, and found that the Company was not required to use any portion of its 2005 New York NOL to compute its 2006 entire net income because its entire net income was low enough to require the use of an alternative tax base.

Tribunal decision

The Tribunal, reversing the ALJ's determination, held that the Company should reduce its 2006 entire net income by approximately $3.7 million because the Company's New York NOL deduction was not limited by the measure of franchise tax liability on an alternative non-income base. In reaching this conclusion, the Tribunal analyzed the plain language and legislative history of NYS Tax Law former Section 1453(k-1), consistent with former Article 9-A Section 208(9)(f), to highlight the principle of federal conformity in determining the New York NOL deduction.

Section 1453(k-1) provides that "a net operating loss deduction shall be allowed which shall be presumably the same as the net operating loss deduction allowed under" Internal Revenue Code (IRC) Section 172, subject to certain limitations as listed by statute.⁷ Therefore, although the federal NOL deduction is the starting point for the computation of the New York NOL, Section 1453(k-1)(1) through (4) requires certain specific adjustments that may cause the New York NOL deduction to deviate from the federal NOL. Most significantly, the Tribunal noted that the New York NOL deduction was limited to the amount of the federal NOL deduction for the same year.

The Tribunal also highlighted New York's conformity to the federal deduction through the application of the federal ordering rules as provided in IRC Section 172(b)(2). These rules require a taxpayer to carry any available New York NOL to the earliest of the tax years to which it may be carried and to use it as a deduction for that year to the maximum extent possible.⁸ As a result, the Tribunal relied on this principle to demonstrate that the amount of the Company's federal NOL deduction should be applied against its New York entire net income for the tax year 2006, regardless of the Company's use of an alternative non-income tax base.

Finally, the Tribunal focused on the language of the statute to demonstrate that there is no provision in NYS Tax Law former Section 1453(k-1) to support the Company's position that New York does not require an offset of entire net income if entire net income plays no role in determining its tax liability. It also noted that corporate tax reform legislation enacted in 2014⁹ supported the Department's statutory interpretation. Under the corporate tax reform, a NY NOL deduction reduces a taxpayer's tax on allocated business income to the higher of the tax on the capital base or the fixed dollar minimum¹⁰ (i.e., NYS does not require reducing entire net income beyond the point to which a taxpayer is subject to tax on an alternative tax base). The Tribunal viewed this change to the NYS statute as support for the Department's position that prior law lacked any limitation regarding the use of the New York NOL deduction as related to the payment of tax on an alternative basis. Therefore, the Tribunal ultimately found that the Department's interpretation of the New York NOL provision was reasonable, and that the Company had not met its burden to establish entitlement to its claimed NOL deductions.

Implications

Decisions issued by the Tribunal are precedential and binding on all taxpayers; the Company can, however, appeal the decision by instituting a proceeding to the Appellate Division of the NYS Supreme Court within four months after notice of this decision is served upon the parties. In the interim, taxpayers, both those subject to the former Article 32 and Article 9-A pre-corporate tax reform, should consider how the decision will affect their prior net operating loss conversion subtraction (PNOLCS) pool computation under corporate tax reform. The PNOLCS pool is calculated, in part, based on a taxpayer's unabsorbed NOL at the end of the base year (i.e., 2014). Therefore, the utilization of an additional NOL deduction in pre-corporate tax reform years may ultimately decrease a taxpayer's PNOLCS pool. Moreover, New York City taxpayers also should consider the tax effect of the above since New York City's corporate tax laws generally follow precedent established under the NYS tax law. Finally, taxpayers that filed New York tax returns reflecting the ALJ determination should consider this Tribunal decision.

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ENDNOTES

¹ In the Matter of the Petition of TD Holdings II, Inc., DTA No. 825329 (N.Y. Tax App. Trib. April 7, 2016).

² In the Matter of the Petition of TD Holdings II, Inc., DTA No. 825329 (NY D.T.A. Jan. 22, 2015); see {Tax Alert 2015-401}.

³ Article 32 was repealed effective January 1, 2015. For additional details, see {Tax Alert 2015-71}.

⁴ NY Tax Law former Section 1451(a).

⁵ The Article 32 tax rate in effect during the years at issue was 7.5% on entire net income.

⁶ NY Tax Law former Section 1455.

⁷ Emphasis added.

⁸ In the Matter of Refco Properties Inc., No. 812292 (N.Y. Tax App. Trib. July 11, 1996).

⁹ Laws of New York 2014, chapter 59.

¹⁰ NY Tax Law Section 210(1)(a)(viii)(B)(4) and (ix).