On August 5, 2016, the New York State Department of Taxation and Finance (Department) updated its instructions for the 2015 Article 9-A tax forms on its website to provide additional comments highlighting the Department's position on "other financial instruments." The updates state that in determining whether "other financial instruments" should be treated as qualified financial instruments (QFIs) and how they should be treated under the marked-to-market (MTM) apportionment section, taxpayers should not view the entire "other financial instruments" bucket of NY Tax Law Section 210-A.5(a)(2)(H) as one broad type of financial instrument. Rather, taxpayers must narrowly review each financial instrument on an "instrument-by-instrument" basis.

For any Article 9-A taxpayers that may have already filed 2015 returns and that have any QFIs that are affected by the updates to the instructions, the Department recommends that they amend their previously filed returns to conform to the new guidance. In addition, the Department has indicated that a partnership with any Article 9-A taxpayer partners should monitor updates to the 2015 corporation tax forms and instructions. Similar to Article 9-A taxpayers, a partnership with an Article 9-A taxpayer partner that has already filed its Form IT-204 for the 2015 tax year will need to consider if an amended 2015 tax return should be filed and a revised IT-204-CP form provided to each corporate partner.

Overview

Taxpayers that have not filed Form CT-3, Form CT-3-S, or Form CT-3-A for the tax year beginning on or after January 1, 2015, or that have already filed these forms, must incorporate the following updates into their original or amended filings, respectively, if:

1. For purposes of MTM net gains (Part 6, line 28), the taxpayer sourced the MTM net gain from loans secured by real property using the 8% fixed percentage method, or the taxpayer netted MTM gains/(losses) across different "types" of "other" financial instruments

2. For purposes of Part 6, line 29, the taxpayer reported more than one "type" of "other" financial instrument, and the taxpayer treated certain financial instruments as QFIs that were not, in fact, MTM

3. For purposes of Part 6, line 30, the taxpayer reported more than one "type" of "other" financial instrument, and/or reported both N.Y. Tax Law Sections 210-A.5(a)(2)(G) and 210-A.5(a)(2)(H) financial instruments and, in addition, the taxpayer treated certain financial instruments as QFIs that were not MTM, or the taxpayer netted gains/(losses), or income (loss) across different "types" of "other" financial instruments

Details on the changes

The Department made the following changes to the instructions to Form CT-3-A (General Business Corporation Combined Franchise Tax Return):

1. The instructions related to Part 6, line 8 dealing with QFIs and the 8% fixed percentage method were updated to provide that "[f]inancial instruments reported on lines 29 and 30 [of Part 6 (i.e., other financial instruments),] are not necessarily all of one type." (Emphasis in original.)

2. The instructions related to Part 6, line 8 were updated to provide: "For lines 28, 29, and 30 [of Part 6, (i.e., MTM net gains and other financial instruments),] when the QFI box next to the section heading above line 28 or 29 is marked: (1) in the case of line 28 it does not indicate that all financial instruments being reported on line 28 are QFIs ([MTM] net gains from loans secured by real property are reported on line 28, but such loans are never QFIs; all financial instruments for which [MTM] net gains are reported on line 28 are QFIs, except for such loans); and (2) in the case of line 29 or line 30 it does not indicate that all financial instruments being reported on line 29 or line 30 are QFIs (due to the fact that lines 29 and 30 may report more than one type of financial instrument). For lines 29 and 30 it is an instrument-by-instrument determination as to when "other" financial instruments are of the same type. When the 8% fixed percentage method is elected, use such method for all financial instruments, including financial instruments reported under [Section] 210-A.5(a)(2)(G), that are QFIs (see second paragraph of line 30 instructions)." (Emphasis in original.)

3. The instructions for the apportionment of MTM net gains were updated to provide that "when sourcing [MTM] net gain from loans secured by real property, always use customer-based sourcing (even when the 8% fixed percentage method election was made). If using customer-based sourcing to source such [MTM] net gains, when [Section] 210-A.5(a)(2)(j)(iii) applies, never include any amounts sourced under the 8% fixed percentage method election in computing the NYS aggregate [MTM] factor in Part 2 of Worksheet C."

4. Various updates were made to the instructions for Worksheet B (net gains and other income for line 30) to reflect the narrower position of the Department described above.

5. A new paragraph was added to the instructions for Worksheet C (MTM net gains for line 28) providing that, "[r]egardless of whether or not the fixed percentage for QFIs is in effect, when you have [MTM] gains/(losses) from more than one type of 'other' financial instruments, use an additional line 30 for each separate type of 'other' financial instruments for which you have [MTM] gains/(losses); include the amounts from these additional lines in the same manner as you would for the line 30 provided on the worksheet as you complete the steps below, as applicable." (Emphasis in original.)

The Department made similar amendments to the corresponding instructions for its Form CT-3 (General Business Corporation Franchise Tax Return) and its Form CT-3-S-I (N.Y. S Corporation Franchise Tax Return).

While the above focuses on updated instructions related to "other financial instruments," the Department also amended the following forms and instructions:

— Form CT-3.1-I, Investment and Other Exempt Income and Investment Capital
— Form CT 3.2-I, Subtraction Modification for Qualified Banks
— Form CT-33-A-I, Life Insurance Corporation Combined Franchise Tax Return
— Form CT-33-D-I, Tax on Premiums Paid or Payable to an Unauthorized Insurer - For Taxable Insurance Contracts with an Effective Date on or after July 21, 2011
— Form CT-33-M-I, Insurance Corporation MTA Surcharge Return
— Form CT-43, Claim for Special Additional Mortgage Recording Tax Credit
— Form CT-225-I, New York State Modifications
— Form CT-225-A-I, New York State Modifications (for filers of combined franchise tax returns)
— Form CT-600, Ordering of Corporation Tax Credits
— Form CT-641-I, Manufacturer's Real Property Tax Credit

Implications

The communication instructs Article 9-A taxpayers that have already filed their 2015 returns to file amended returns if their returns were affected by the updates described above.

These updates attempt to restrict a taxpayer's ability to source all of the income that would fall into the "catch-all" "other financial instruments" category and use the fixed income percentage (8%). By employing "instrument-by-instrument" language, the Department appears to be restricting the use of the 8% election within the "other financial instruments" category in either one of two ways (one of which is more restrictive and burdensome than the other). Specifically, under the Department's updated instructions, the 8% election for other financial instruments seems to be restricted to either:

1. All other financial instruments of the same type (e.g., swaps) if at least one of such instruments is MTM (e.g., if a taxpayer has at least one swap instrument that is MTM then all swaps are QFIs that can be sourced at 8% to NY)

2. Each individual instrument within the other financial instrument category that is MTM (e.g., if a taxpayer has 10 swaps and two are MTM, then only those two swaps are QFIs that can qualify for the 8% sourcing)

Although the instructions are indicative of the Department's new position on this matter, its interpretation appears to be contrary to the plain language of the statute.¹ EY believes that the Department intends to issue proposed regulations relating to apportionment and it will be interesting to see how they address this change. In the interim, taxpayers should consider the effect of this change on their New York state (and likely New York City) filings and tax rate.

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ENDNOTES

¹ Under NY Tax Law Section 210-A.5.(a), "a qualified financial instrument means a financial instrument that is of a type described in any of clauses (A), (B), (C), (D), (G), (H) or (I) of subparagraph two of this paragraph and that has been marked to market in the taxable year by the taxpayer under [IRC Sections] 475 or [ … ] 1256 [ … ]. Further, if the taxpayer has in the taxable year marked to market a financial instrument of the type described in any of the clauses (A), (B), (C), (D), (G), (H) or (I) of subparagraph two of this paragraph, then any financial instrument within that type described in the above specified clause or clauses that has not been marked to market by the taxpayer under [IRC Sections] 475 or [ … ]1256 [ … ]is a qualified financial instrument in the taxable year."