The New York State Department of Taxation and Finance (Tax Department) has posted for comment draft corporate franchise tax regulations under Article 9-A of the New York Tax Law (N.Y. Comp. Codes and Regs. tit. 20, Subparts 3-13.1 through 3-13.5 and Section 4-6.5) ¹ addressing how a corporate partner would compute its tax under the aggregate and entity methods.

The proposed provisions would repeal the existing separate accounting election for foreign corporate limited partners ² based on the Tax Department's finding that those corporate partners often do not have the necessary detail to properly compute the tax, especially after changes to investment capital and customer-based sourcing. In conjunction with the repeal of this election, the Tax Department also would amend its nexus regulations for foreign corporate limited partners by increasing the basis and interest thresholds for determining whether a foreign corporate limited partner is deemed to be directly or indirectly participating in, or dominating or controlling, all or part of the partnership's business activities or affairs. The threshold ³ would increase to a 5% or more interest in the partnership (from the current 1%) or a $5 million basis in the partnership to more closely reflect the presumptions for when a partner must file under the aggregate method. The Tax Department said, however, that these nexus changes would only be adopted if the separate accounting election is repealed.

The Tax Department has requested comments on the entire corporate partners draft regulation and has specifically requested feedback on the changes previously described. Comments are due by February 7, 2020, but comments submitted after the due date may still be considered, according to the Department's website. ⁴

Background: general provisions and determination of applicable methodology ⁵

While the draft regulations would repeal and replace N.Y. Comp. Codes and Regs. tit. 20, Subparts 3-13 related to Corporate Partners, some provisions would change minimally from the existing regulations. The provisions that would not change include the general provisions under draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-13.1, which require a corporation that is a partner in the partnership to compute the tax on its partnership interest using either the aggregate method or entity method.⁶ Under the aggregate method, a corporate partner is viewed as having an undivided interest in the partnership's assets, liabilities, and items of receipts, income, gain, loss, and deduction, and is treated as participating in the partnership's transactions and activities. Under the entity method, the partnership is treated as a separate entity, and a corporate partner is treated as owning an interest in the partnership entity, which itself is treated as an intangible asset of the corporate partner.

A corporation must use the aggregate method to determine the tax due on its partnership interest if the corporation has access to the information necessary to make this calculation. The corporation would be presumed to have access to the required information if:

• It conducts a unitary business with the partnership
• It is a general partner of the partnership or is a managing member of a limited liability company (LLC) that is treated as a partnership for federal income tax purposes
• It has a 5% or more interest in the partnership
• It has reported information from the partnership in a prior tax year using the aggregate method
• Its partnership interest is more than 50% of its total assets ⁷
• Its basis in its partnership interest under federal provisions is more than $5 million as of the last day of the partnership year ending within or with the corporation's tax year
• Any member of its affiliated group or New York combined group has the information necessary to make the computation or
• It claims a tax credit based on the partnership's activities or its share of the tax credit from the partnership

A corporate partner must use the entity method if (i) it does not meet any of these presumptions, (ii) does not and will not have access to the information necessary to compute its tax using the aggregate method within the filing period, and (iii) certifies these representations to the Commissioner. A corporate partner that meets one of the aggregate method presumptions must use the entity method if it establishes that it, any of its affiliated group members, or any of its New York combined group members do not and will not have access to the information necessary to compute the corporate partner's tax using the aggregate method within the filing period.

The draft regulations also provide information on determining how the tax bases are computed when a corporation is a partner in a partnership (i.e., an upper-tier partnership), and the upper-tier partnership is a partner in another partnership (lower-tier partnership). Corporations that are partners in tiered partnerships may find themselves in structures in which they are obligated, or elect, to use the aggregate method for one tier and the entity method for another, based on the information the partner has available.

Elimination of separate accounting election by foreign corporate limited partners, and treatment of gain or loss from the sale of a partnership interest ⁸

Among other amendments, the draft regulations would repeal and replace the current separate accounting election available to foreign corporate limited partners. Specifically, the draft regulations would treat as business income or loss any gain or loss that a corporate partner recognizes from a sale of its interest in a partnership and includes in entire net income.

Under the current regulation, a separate accounting election is available when a foreign corporation is solely subject to tax in New York as a result of being a limited partner in one or more limited partnerships and is not a member of a combined group. Under the separate accounting election, the corporation would compute its tax by taking only into account: (1) its distributive share of each partnership item of receipts, income, gain, loss, and deduction (including any related modifications); ⁹ (2) its proportionate part of each partnership asset and liability; and (3) each partnership activity of each limited partnership that is doing business, employing capital, owning or leasing property, or maintaining an office in New York State. Such shares do not have to be actually distributed. A foreign corporation, however, cannot make the election if the limited partnership and corporate group are engaged in a unitary business and the parties have substantial inter-entity transactions. If a corporation elects to file separately for one or more partnerships (election partnerships) but does not make that election for other partnerships (nonelection partnerships), the corporation must compute its tax bases for nonelection partnerships by reducing its deductions and liabilities by the amounts that are directly and indirectly attributable to the election partnerships.

Computation of tax under the aggregate method and entity method ¹⁰

Aggregate method

Like the current rules, the draft regulations would include a corporate partner's distributive share of each partnership item of receipts, income, gain, loss, and deduction in the corporation's business income base, capital base, and fixed-dollar minimum tax. Additionally, the corporate partner would include its proportionate part of each partnership asset and liability and each partnership activity. All would be treated as having the same source and character in the hands of the corporate partner for N.Y. Tax Law Article 9-A purposes as in the hands of the partnership for federal income tax purposes. If a partnership item, amount, or activity is not characterized or required to be taken into account for federal income tax purposes, it would be determined as if it were realized, incurred, or experienced directly by the corporate partner.

A corporate partner's proportionate share of the partnership's assets and liabilities and activities would be determined according to its capital interest in the partnership. The proposed regulations indicate that if use of capital interest does not properly reflect the corporation's share of the partnership's income, then the corporate partner would use a profits interest in a profit year and loss percentage in a loss year. (An example of this point is provided in the draft regulations.)

Other provisions of the draft regulation would permit a special allocation to a corporate partner of a New York tax credit that is computed at the partnership level if:

• The sole component in the tax credit's calculation is a partnership expenditure
• The tax credit is allocated in the same way that the expenditure is allocated among the partners
• The principal purpose of allocating the tax credit among the partners is not to avoid or evade any tax imposed on the corporation or the combined group of which the corporate partner is a member
• The allocation of the expenditure has substantial economic effect

If a corporation is a partner in an upper-tier partnership that is a partner in a lower-tier partnership, the draft regulations would allow the corporate partner's distributive share or proportionate part of each partnership item of receipts, income, gain, loss, deduction, asset, liability, and activity of the upper-tier partnership that is attributable to the lower-tier partnership to retain the source and character determined at the lower-tier partnership level. The source and character do not change if the item flows through from the upper-tier partnership to the corporate partner.

The draft regulations also provide guidance on how to calculate the business income base, capital base, fixed-dollar minimum, calculations for small business taxpayers, the business apportionment factor, and the Metropolitan Transportation Business Tax surcharge. Examples are included where applicable.

Entity method

Under the entity method, a corporate partner is treated as owning an interest in the partnership entity when determining the taxes measured by the business income base, capital base, and the fixed-dollar minimum, and the corporate partner's interest is an intangible asset that is business capital. The draft regulations outline how to calculate the business income base, capital base, and the fixed-dollar minimum. Additionally, the draft regulations would require a corporation to apportion its distributive share of partnership items of income, gain, loss, and deduction included in its business income and its interest in the partnership included in its business capital by its business apportionment factor, computed without regard to its distributive share of any partnership items of income, gain, loss, or deduction.

Implications

The Tax Department stated on its website that the draft regulations are not to be relied upon until they are finalized and that it is unclear when they will be final and effective. It is not clear if New York City will follow the draft regulations in whole or in part for purposes of its tax laws.

The draft regulations would significantly change the rules for eligible foreign corporate limited partners by disallowing the separate accounting election. Under the draft regulations, foreign corporate limited partners that were able to file under the separate accounting election would now be obligated to consider any gain or loss from the sale of the corporation's interest in the partnership as business income or loss. Additionally, the draft regulations provide greater clarity in calculating tax under the aggregate and entity methods. Furthermore, it appears that the draft regulations would clarify that they also apply to an LLC classified as a partnership for federal income tax purposes.

Corporations that sell partnership interests may need to consider and apply for a discretionary adjustment if the business apportionment formula does not properly reflect activity in New York. For example, this may occur when the net gain on the sale of the partnership interest is a substantial portion of the corporate partner's business receipts.

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ENDNOTES

¹ The provisions would amend N.Y. Comp. Codes and Regs. tit. 20, Subparts 3-13 (Corporate Partners) and repeal N.Y. Comp. Codes and Regs. tit. 20, Section 4-6.5 (rules relating to allocation by a corporate partner of the partnership or joint venture).

² N.Y. Comp. Codes and Regs., tit. 20, Section 3-13.5.

³ Draft N.Y. Comp. Codes and Regs. tit. 20, Section 1-3.2(8)(i)(a).

⁴ N.Y. Dept. of Taxn. and Fin., Corporate tax reform draft regulations.

⁵ Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-13.1 and 3-13.2.

⁶ A gain on the sale of a partnership interest is not "investment income" from "investment capital." However, there may be instances in which such gain could be income that is not apportionable under US Constitutional principles (i.e., nonbusiness, nonunitary, or nonoperational income).

⁷ The proposed rules provide information about the various ways a corporation can determine its interest in the partnership and its total assets and require the method chosen to be used for all the corporation's assets.

⁸ Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-13.5.

⁹ The current regulations do not subject gain on sales of the partnership interest to New York State tax if the N.Y. Comp. Codes and Regs. tit. 20, Section 3-13.5 election is made. See N.Y. Comp. Codes and Regs. tit. 20, Section 3-13.7. Additionally, such gain is not included in the numerator or denominator of the receipts factor.

¹⁰ Draft N.Y. Comp. Codes and Regs. tit. 20, Section 3-13.3 and 3-13.4.