New York Broker-Dealer Tax Stance Likely to Spark Pushback

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By John Herzfeld

New York state tax agency guidance on the type of entities that can use broker-dealer status to compute corporate income taxes will likely encounter resistance from taxpayers and their representatives, practitioners told Bloomberg BNA.

The Department of Taxation and Finance guidance addressed inquiries about whether a corporation may be considered a registered securities broker or dealer in determining its receipts factor when calculating corporate income taxes, even if it isn’t a registered broker-dealer.

The guidance (NYT-G-17(2)C), issued Aug. 2, puts into writing a policy the state had already been following in audits and that the New York City tax agency had adopted in advice issued in November 2016. But it represents a change from a long-standing position that a disregarded entity will be treated as disregarded for all purposes, practitioners said Aug. 9.

The policy will affect the positions that money managers take in disputes with state and city tax agencies on owner relationships between partnerships and single-member limited liability companies, and it covers open tax years before a broad business tax overhaul that kicked in with tax year 2015.

It particularly affects financial services companies earning revenue from broker-dealer activities performed in New York with customers located outside the state, said Douglas J. Upton of Mayer Brown LLP in New York.

Policy Shift Seen

One reason taxpayers are likely to resist the state’s stance is that it represents a shift in the long-standing policy that a disregarded entity will be treated as disregarded for all purposes, said Alysse McLoughlin of McDermott Will & Emery LLP in New York, who has worked in the financial services industry and in the chief counsel division of the Internal Revenue Service.

Under the state’s prior position, “a disregarded regulated broker-dealer has essentially been treated as a division of its sole member,” McLoughlin said in an email.

That meant that the regulated broker-dealer status of a disregarded entity “should apply to all of the sole member’s activities, just as the regulated broker-dealer status of a division of a taxpayer would apply to all of the taxpayer’s activities,” she said.

To the extent the new position signifies an attempt by the state to deny broker-dealer status to the sole member of a disregarded broker-dealer, McLoughlin said, “it represents a switch” from long-standing policy on a retroactive basis.

The new guidance outlines the position that the state had already been taking in audits and in matters before the Division of Tax Appeals, Upton said in an email.

Like the city guidance, he said, it narrowly applies customer-based broker-dealer sourcing rules “to only those broker-dealer receipts that are earned by a legal entity that is a registered broker-dealer—even if that entity’s separate legal status is otherwise disregarded for income tax purposes.”

Pre-Tax Reform Years

The state’s deeming the guidance to be a continuation of existing policy indicates that it “clearly intends to challenge taxpayer structures for all open, pre-tax reform tax years,” where the new position “has the most impact,” Upton said.

During the pre-tax reform years, New York permitted broker-dealers to source certain receipts using a market approach, as opposed to an origination approach, which provided broker-dealers potential apportionment relief, said Nicole Boutros of Eversheds Sutherland (US) LLP in New York.

The state overhaul’s shift to market-based sourcing “therefore eliminated many of the opportunities for apportionment relief that previously existed for broker-dealers,” she said in an email.

“However, the opportunities that do exist will likely be the focus of the debate in those years, such as for receipts from corporate bonds or certain asset-backed securities sold through broker-dealers. In those instances, taxpayers with a larger market in New York could benefit from registered broker-dealer treatment,” Boutros said.

Federal Principles Overridden?

New York adopts established federal income tax principles that deem a disregarded entity and its owner to be a single taxpayer, Upton said.

“Because the broker-dealer sourcing rules apply to a ‘taxpayer’ which is a registered broker-dealer,” he said, “many taxpayers reasoned that the owner of a disregarded, but registered, broker-dealer was required to apply the broker-dealer sourcing rules to assign the owner’s broker-dealer receipts—whether derived at the entity-level or passed through from its disregarded broker-dealer.”

Requiring a separate accounting of the disregarded entity’s receipts “represents a significant departure from New York’s prior treatment of disregarded entities,” Upton said.

Many taxpayers with refund claims or open audits on the receipts factor issue “are sticking to their positions,” while others implicated by the shift in the state and city positions “are taking a wait-and-see approach, to see whether this issue is raised in audit,” McLoughlin said.

Challenges Likely

Challenges to the state’s and city’s stance are likely in audits and through the appeals process, given the “significant tax impact” of the position, Upton said.

The challenges “could focus on whether the position is supported by the statutory broker-dealer apportionment provisions or on whether retroactive application of a changed policy complies with due process requirements,” he said.

The new state guidance “seems inconsistent with what the industry understood the department’s position to be with respect to flow-through and disregarded entities,” said Jack Trachtenberg, a principal with the multistate tax controversy services team at Deloitte Tax LLP in New York who has served as a deputy commissioner at the state tax agency.

It also appears inconsistent with the state’s treatment of partnerships and disregarded entities in other contexts, he said in an email.

‘Questionable’ Position

Trachtenberg called the state’s position “questionable” and said “we encourage taxpayers to consult with their tax adviser to determine if their structure and operations offer an opportunity to challenge the guidance.”

The new policy “could result in significant tax assessments,” he said. “It involves questions of statutory interpretation, and given the stakes, this is definitely something that could end up in court.”

One point of vulnerability, Trachtenberg said, is that it is inconsistent with the state’s “typical conformity to the federal treatment,” in which a disregarded LLC should be treated as a division of its parent.

“Thus, if the disregarded LLC is a broker-dealer, its owner arguably should also be treated as a broker-dealer,” he said.

He also raised questions about whether the policy can be applied retroactively.

Mismatch With Past Guidance?

“The state claims that the position asserted in the guidance has always been its position, but that seems questionable given the language in the state’s prior guidance,” Trachtenberg said, pointing to advisory opinions issued in 2013 ( TSB-A-13(11)C) and 2016 ( TSB-A-16(1)C).

“Should evidence arise that this is actually a change of policy, the state may be restricted to applying it on a prospective basis only,” he said.

The guidance appears to formally align the state with the city on this issue, Trachtenberg said.

“Like the state guidance, the city guidance is meeting with taxpayer challenge and taxpayers are carefully analyzing the guidance to determine if a contrary position may be taken,” he said.

To contact the reporter on this story: John Herzfeld in New York at jherzfeld@bna.com

To contact the editor responsible for this story: Jennifer McLoughlin at jmcloughlin@bna.com

For More Information

The state's Aug. 2 guidance is at http://src.bna.com/rwB.

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