On November 25, 2016, the New York City Department of Finance (the Department) released an Update on Audit Issues (the Update) addressing the use of broker-dealer sourcing rules by an entity that is not itself a registered securities or commodities broker or dealer (Nonregistered Entity) when computing New York City Unincorporated Business Tax (UBT), General Corporation Tax or Corporate Tax of 2015.

The Update affects entities, such as certain investment management companies, that provide investment management and advisory services to investment partnerships. Under the Update, a limited partnership that is a Nonregistered Entity may be required to measure New York City-source receipts based on where services are performed rather than customer location when computing its New York City receipts factor.

By way of background, an unincorporated business applies a business apportionment percentage based on property, payroll and receipts factors¹ to determine its New York City-source business income. In most circumstances, an unincorporated business calculates New York City-source receipts related to services based on where those services were performed. Administrative Code sections 11-508(e-3) (within the UBT) and 11-604(3)(a)(10) (within the General Corporation Tax) (collectively, the broker-dealer rules), however, permit "registered securities or commodities brokers or dealers" to source certain enumerated receipts based on customer location.²

Finance Letter Rulings #12-4934/UBT (August 19, 2013) and #13-4950/UBT (March 28, 2014) provided a fairly broad application of the broker-dealer rules. The taxpayers in those letter rulings, limited partnerships that were Nonregistered Entities, were considered to be eligible for the broker-dealer rules on the basis of certain representations, including that the limited partnerships acted as a broker-dealers, performed the functions of broker-dealers and were treated as broker-dealers by other parties. The taxpayers indicated that they functioned as broker-dealers under an exemption from Securities and Exchange Commission registration requirements and under specific Commodities Future Trading Commission registrations.

The Update stems from the Department's concern that some taxpayers have erroneously availed themselves of the broker-dealer rules to the extent their facts were similar to those of the taxpayers in the two letter rulings. The Department states that the letter rulings do not represent the current position of the Department as the representations in the letter rulings are unreliable and it was not established that the registrations associated with persons of a registered company would permit persons associated with a Nonregistered Entity to act as a broker-dealer and earn securities or commodities transaction-based compensation.

The Update also tackled owners of a single member limited liability company (SMLLC) that is disregarded for income tax purposes and also a registered securities or commodities broker or dealer. In computing their UBT or General Corporation Tax receipts factor, taxpayers have applied broker-dealer sourcing rules based on a New York State Advisory Opinion (TSB-A-13(11)C (December 20, 2013)), in which it was held that the owner of a such a registered SMLLC was able to use the status of the SMLLC to determine the owner's status. Hence, taxpayers have applied broker-dealer sourcing rules to determine New York City-source receipts of both the unregistered owner and the registered SMLLC. The Update states that there is no basis to extend the registration status of a SMLLC to its owner for purposes of applying the broker-dealer rules to any receipts other than the receipts earned by the registered SMLLC.

Lastly, the Update indicates that the Department will consider the taxpayer's facts when determining the applicability of the broker-dealer rules on a "case-by-case" basis. The broker-dealer sourcing provisions would apply to the enumerated receipts earned by an entity that is legally acting in the capacity of a broker-dealer. The Update specifically states that the Department will not permit use of the broker-dealer rules on the same facts presented in letter rulings. As examples, the Department indicates that a Floor Broker or Futures Commission Merchant may qualify as a broker-dealer but that a Commodities Pools Operator would not.

It should be noted that Finance Letter Rulings are not precedential and other taxpayers cannot rely on them. In addition, there have been no regulatory or legislative changes. The purpose of the Update is to provide guidance on the Department's interpretation of the statute. Each taxpayer will need to consider its facts and circumstances in determining what, if any, effect the Update will have on its New York City filing position.

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ENDNOTES

¹ The business apportionment percentage is transitioning to a single factor receipts formula.

² For tax years beginning on or after January 1, 2015, the provisions of the Corporate Tax of 2015 apply to most C corporations and, generally, adopts a customer location sourcing rule to those corporations.