The New York Supreme Court, Appellate Division, Third Judicial Department, has upheld the Tax Appeals Tribunal’s decision that BTG Pactual NY Corporation’s (“BTG”) refund claim for tax years 2012 and 2013, based on New York’s broker-dealer sourcing methodology, was properly denied. BTG is the single corporate member of BTG Pactual US Capital LLC (“US BD”), a registered broker-dealer, and BTG Pactual Asset Management US LLC (“US AM”), a registered investment advisor with the SEC.Since US BD and US AM are single member limited liability companies they were treated as disregarded entities for federal tax and New York corporation franchise tax purposes.
The New York Supreme Court ruled that BTG was not entitled to utilize broker-dealer sourcing methodology for receipts generated by US AM, since neither BTG nor US AM is a registered broker-dealer. BTG’s argument that the broker-dealer rules should apply to the entity as a whole, including the disregarded entities, was rejected previously by the New York Administrative Law Judge (“ALJ”) and the New York Tribunal, and now upheld by the New York Supreme Court, concluding that the statutory language for the broker-dealer sourcing rules were unambiguous and, furthermore, the check-the-box regulations “do not dictate whether US AM’s receipts are broker-dealer receipts.”
Broker-dealer sourcing rules
For tax years ending before 2015, New York’s general sourcing rule was based on where services are performed, also known as the cost of performance methodology (N.Y. Tax Law Section 210(3)(a)(2)(B), in effect prior to January 1, 2015). Broker-dealers were allowed a different methodology, under former N.Y. Tax Law Section 210(3)(a)(9) (in effect prior to January 1, 2015), where receipts could be sourced based on the customer’s location. For New York-based taxpayers, such as BTG, the customer-based sourcing methodology provides a significant tax benefit in that a large amount of revenue resulting from services performed in New York, could now potentially be sourced outside of New York
BTG originally filed 2012 and 2013 New York corporation franchise tax returns using the following methodology: for US BD’s revenues, the customer-based methodology specifically provided for broker-dealers was used; for US AM’s revenues, the amounts were sourced based on where services were performed. As a New York-based company, US AM’s cost of performance methodology resulted in high apportionment percentages - 82.1% in 2012 and 66.4% in 2013.
Later, BTG filed amended franchise tax returns to change the way US AM’s receipts were sourced. As a New York-based company, changing US AM’s receipts from where the services were rendered to the broker-dealers customer-based methodology resulted in a significant decrease in the New York Business Allocation Percentage, to 5.6% in 2012 and 8% in 2013.
Similar to many other taxpayers, BTG took this position based upon the Division’s prior advisory opinions which state that “if a SMLLC that is treated for tax purposes as a disregarded entity is a registered broker-dealer, its single member should be treated for purposes of the allocation rules under Tax Law Section 210.3(a)(9) as a registered broker-dealer.”
BTG requested a refund of $7.4 million as a result of these changes.
ALJ and Tax Tribunal rulings
Subsequent to BTG’s filing of the amended returns, the Division issued guidance clarifying their position on the issue. Through an Office of Counsel memorandum, NYT-G-17(2)(C) (August 2,2017), the Division provided an example where an entity is the single member of a broker-dealer, and the broker-dealer is disregarded for federal and New York corporation franchise tax purposes. In this instance, the memorandum states that the taxpayer is required to identify the portion of its distributive share of the broker-dealer’s receipts and apportion only these receipts using the broker-dealer sourcing methodology provided for in Section 210(3)(a)(9). It further clarifies that the broker-dealer’s status cannot “serve to qualify” the single member or other related members as registered broker-dealers and that any receipts other than this distributive share of broker-dealer receipts cannot be sourced under the special broker-dealer methodology.
Consistent with this guidance, the ALJ upheld BTG’s refund denial stating that the US BD’s broker-deal status “cannot carry over to the non-broker dealer receipts” that belong to US AM. The ALJ found no basis for BTG’s argument that the check-the-box regulations allow US AM’s receipts to be sourced as if a broker-dealer, stating that the statutory language in former N.Y. Tax Law Section 210(3)(a)(9) is unambiguous in that the customer-based sourcing rule was not meant to apply “to the financial services industry as a whole.”
The New York State Tax Appeals Tribunal and the New York Supreme Court upheld the ALJ’s decision.
What is notable here, is that while advisory opinions are not binding, other than for the taxpayer requesting it, the Division’s preceding guidance appeared to agree with BTG’s position. The Division’s revised position could be very costly to some taxpayers.
In TSB-A-13(11)(C) (December 20, 2013), the Division reviewed the status of a taxpayer that was the single member of several registered broker-dealers. In this case, the taxpayer itself was not a registered broker-dealer. The Division suggested that since a single member LLC “that is treated as an entity disregarded from its single member for federal tax purposes will be disregarded for state tax purposes,” the single member that is not a registered broker-dealer would be deemed a broker-dealer since the several SMLLCs it owns are registered broker-dealers.
The Division later issued TSB-A-16(1)C (January 11, 2016), which came to a similar conclusion. While neither TSBs specifically addressed broker-dealer apportionment, they both concluded that a single member of a registered broker-dealer that is disregarded for federal tax purposes would also be deemed a broker-dealer.
NYT-G-17(2)C was issued in 2017, clarifying the Division’s interpretation of its position on these broker-dealer complexities in the context of federal check-the-box regulations. In this memorandum, the Division reverses its position taken inTSB-A-13(11)(C) and TSB-A-17(1)C and clarifies that the taxpayer can utilize broker-dealer sourcing methodology to apportion income “passed through to it” from its direct and indirect ownerships in those SMLLCs that are broker-dealers.
The Division states that it had not made any previous conclusions therein on the treatment of the taxpayer’s own receipts, which is addressed in the most recent memorandum to establish its updated position on a single member’s utilization of broker-dealer sourcing methodology.
Effective for tax years beginning on or after January 1, 2015, N.Y. Tax Law Section 210-A provides an overhaul of New York’s apportionment methodology, including the application of customer-based sourcing to replace cost of performance.
In a current scenario where the single member is precluded from utilizing broker-dealer sourcing rules, it would no longer have the detrimental impact that we see in the BTG case, under the former corporate apportionment regime. However, it is important to note, that this could still have an impact on New York City Unincorporated Business Tax, since the cost of performance methodology is still used for UBT.
In a broader scope, this decision changes our understanding of how the federal check-the-box regulations are to be applied to state taxes. “Disregarded” treatment is no longer implicit and may need to be considered in certain state contexts.
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The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.