Recent New York State and City corporate tax law changes may affect the tax liabilities of and filing requirements for a non-captive regulated investment company (RIC) in 2016 and subsequent years. Most significantly, New York State has capped the maximum minimum tax a RIC must pay at $500; New York City, however, has not made this change. New York State and City also have adopted an elective 8% apportionment method that may affect a RIC's computation of New York-source receipts for purposes of calculating the minimum tax. Overall, these changes should resolve minimum-tax issues that RICs were facing at the state level but do not resolve these issues at the city level (see Tax Alert 2016-207 for a discussion of these issues).

Review of NY State and City corporate tax on RICs

A RIC with New York State and City nexus is subject to New York State and City corporate tax based on the higher of: (1) its business income or (2) a fixed-dollar minimum tax. In calculating its business income, a RIC may claim a dividends-paid deduction, just as it does for federal income tax purposes. Consequently, most RICs have business income of zero (or close to zero), leaving RICs that are subject to tax in New York generally paying the fixed-dollar minimum tax. The fixed-dollar minimum tax is based on the amount of a RIC's New York State and City sourced receipts.

For tax years beginning on or after January 1, 2015, a RIC was required to determine the New York receipts from its assets based on a direct-tracing approach, which varied depending on the type of asset. For example, receipts from the sale of securities generally would be sourced to the location of the buyer, while interest income from loans secured by real property would be sourced to the location of the property. See Attachment 1 for a summary of these sourcing rules, which are very detailed and require manual determinations in many instances. Some RICs have found these determinations so difficult to make that they may have opted to assume that all receipts from certain asset classes are New York-sourced.

New cap on minimum tax for RICs

For tax years beginning on or after January 1, 2015, each of the New York State and City fixed-dollar minimum taxes ranged from $25 for a taxpayer with New York-sourced receipts totaling not more than $100,000, to $200,000 for taxpayers with New York-sourced receipts over $1 billion. For tax years beginning on or after January 1, 2016, the New York State minimum tax starting point remains $25. The revised maximum minimum tax, however, has been reduced to $500. The $500 minimum tax will apply when a RIC has New York State-sourced receipts totaling more than $500,000. New York City has not revised the cap on its minimum tax, so the range applicable to 2015 tax years remains in effect. See Attachment 2 for a table listing all of the ranges.

New 8% apportionment method for RICs

Applying the direct-tracing method to determine the portion of a RIC's income that is New York-sourced is likely to be very difficult for RICs. The amended statute potentially simplifies the computation of New York-sourced receipts, as it allows a RIC to elect to allocate most categories of income to New York at a flat 8% rate (which is supposed to be a proxy equivalent to New York State's share of US GNP compared to the rest of the US). While this fixed percentage election streamlines certain computations, using it can be detrimental to some taxpayers. For example, under the direct-tracing approach, interest income from US government obligations would not be a New York-sourced receipt. If the fixed percentage method is elected, however, 8% of the interest income from US government obligations would be treated as a New York-sourced receipt. An increase in New York-sourced receipts can result in an increase in the RIC's minimum tax liability.

Loans secured by real estate are not eligible for the flat 8% apportionment election. Instead, direct-tracing of income from those loans is required. Since it may be very difficult for a RIC to differentiate between secured and unsecured loans, let alone determine where any real estate securing a loan is located, RICs may need to take a conservative approach and apportion 100% of income and gains from loans to New York.

If the 8% election is not made, no apportionment to New York is required for income and gains from stock that is, nothing is included in the numerator or denominator of the RIC's apportionment fraction. If the 8%election is made, New York-sourced receipts would include only 8% of the net gains and dividends from stock that did not qualify as investment capital. "Investment capital" generally is stock that is properly identified at the time of acquisition and held for more than one year.

Note that use of the 8% apportionment method is an "all-or-nothing" election (except for loans secured by real estate and investment capital). A fund cannot apply direct tracing to certain asset classes and elect to use the 8% apportionment method for others (unless 8% apportionment is required under the direct-tracing approach, as is true for receipts from repos, for example).

Implications for RICs

As a result of these changes, RICs that are subject to tax in New York may find it less burdensome to determine their fixed-dollar minimum tax liability, at least at the state level. In lieu of using either the direct-tracing or 8% apportionment method, a RIC may choose to assume that 100% of its receipts are New York-sourced. In such cases and as a result of the reduced fixed-dollar minimum tax, the most a RIC will owe New York State is $500 for a given year. The situation is more complex, however, at the New York City level — a RIC will need to consider carefully whether to utilize either the direct-tracing or 8% apportionment method if treating all of its receipts as New York-sourced would result in a significant minimum tax liability.

These statutory changes likely may result in tax return processing issues for certain RICs. The New York State Department of Finance (the Department) has indicated that the processing system for 2016 tax returns will not recognize the changes discussed in this Alert. Hence, erroneous notices of underpayment of fixed-dollar minimum tax could be issued. If this occurs, the Department advises RICs to contact the person and phone number listed in the correspondence to resolve the matter. It is unclear if the same processing problem will exist for New York City returns filed by RICs.

In addition, for the 2015 tax year, the Department has released guidance indicating that it would be reasonable for a RIC to apply the 8% apportionment method in computing New York State-sourced receipts. It does not appear that New York City will release comparable guidance.

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ATTACHMENTS

Summary of New York sourcing rules for financial instruments

2016 New York State minimum tax