By: Nicholas Montorio and Samantha Dragotto
The New York Department of Taxation and Finance (the Department) is expected to soon begin the State Administrative Procedure Act process to formally propose and adopt regulations to account for New York’s 2015 corporate tax reform. This article, part of a 3-part series analyzing selected topics from those rules, reviews a proposed change to the separate accounting election rules available to certain corporate limited partners. The potential impact of this change could be significant, especially if the Department applies the proposed regulations retroactively.
In general, the separate accounting election allows a corporate limited partner meeting certain requirements and subject to New York’s Business Corporation Franchise Tax to compute its alternative tax bases by “taking into account” only its distributive share or proportionate part of the partnership’s activity, and, in the event of a sale of the partnership interest, the corporation “shall not take into account” the gain or loss from such sale in its tax bases.1
In the proposed regulations addressing corporate partners, the Department initially removed the existing separate accounting election rule promulgated prior to the 2015 tax reform. However, in the current version of the proposed regulation for corporate partners released in April 2022, the Department revived the separate accounting election – but with a significant change that restricts a corporation’s ability to make the election.
Current Separate Accounting Election Rules
The regulations promulgated prior to the 2015 tax reform, which are generally still effective unless and until the proposed regulations are adopted, allow a corporation to make the separate accounting election when the corporation:
- 1. is not incorporated under New York law;
- 2. is a “limited partner” in a “limited partnership”; and
- 3. has nexus with New York solely as a result of its ownership of its limited partnership interest under 20 NYCRR 1-3.2(a)(6).2
Historically, the Department has provided limited guidance on the application of the separate accounting election. In 2011, the Department released TSB-A-11(5)C, which analyzed the availability of the separate accounting election for a corporation that was a general partner of a partnership, which in turn owned an interest in a limited liability company (LLC) that was taxed as a partnership for federal income tax purposes. When the partnership sold the LLC interest, the gain from the sale flowed through to the corporation. The corporation requested guidance on whether it could make the separate accounting election to exclude such gain from its tax base. The Department concluded that the taxpayer was ineligible for the separate accounting election because, as a general partner in an intermediary partnership, it did not have nexus with New York “solely” as a result of its indirect interest in the LLC. Rather, the taxpayer had nexus with New York because it was a general partner in the intermediary partnership, which had nexus with New York as a result of its ownership interest in the LLC.
The Department’s analysis and discussion in TSB-A-11(5)C appears to extend the separate accounting election to interests in LLCs. The Department does not directly address whether the sale of an LLC interest is eligible for the separate accounting election. However, in addressing the taxpayer’s nexus-creating activities with New York, the Department notes that the applicable nexus regulations contained in 20 NYCRR 1-3.2(a)(6) are applied to LLCs even though the regulatory language only mentions “limited partnerships”. According to the Department, the threshold matter in evaluating a corporate limited partner’s nexus-creating activity is whether its ownership interest is “more like a limited partnership” interest rather than a “general partnership interest.” Further, if the formal distinction between LLCs and limited partnerships was determinative for purposes of the separate accounting election, then the Department’s analysis in TSB-A-11(5)C presumably would have addressed that issue.
The current regulations provide that a corporate partner cannot make the separate accounting election if:
- 1. the limited partnership and the corporate partner are engaged in a unitary business; and
- 2. there are substantial inter-entity transactions (SITs) between the limited partnership and the corporation.3
Regarding the unitary business test, the separate accounting election rules specifically reference paragraph (e) of 20 NYCRR 6-2.3 to determine when a corporation is part of a unitary business. Pursuant to those rules, the unitary business analysis is narrow as it focuses on whether the corporation’s activities are related to those of the limited partnership. For example, the current regulations explain that related activities would include:
• manufacturing or acquiring goods or property or performing services for other corporations in the group; or
• selling goods acquired from other corporations in the group; or
• financing sales of other corporations in the group.
In addition, a unitary business relationship may exist when the entities are engaged in related lines or businesses. The current regulations provide the following examples:
• manufacturing or selling similar products; or
• performing similar services; or
• performing services for the same customers.
The SITs test is satisfied when “qualified activities” account for at least 50% of the receipts or expenses of either the corporate partner or the partnership. For purposes of identifying “qualified activities,” the Department’s regulations provide the following examples:
- 1. the manufacturing or acquiring of goods or of property or the performing of services by the limited partnership for the corporate group, or by the corporate group for the limited partnership;
- 2. the selling of goods acquired by the limited partnership from the corporate group, or by the corporate group from the limited partnership;
- 3. the financing of sales of the corporate group by the limited partnership, or of the limited partnership by the corporate group; and
- 4. the performing of related customer services using common facilities and employees.4
The Proposed Regulations and Separate Accounting Election
Upon reading the Department’s revised separate accounting election rules in its proposed regulations, a taxpayer can be forgiven for not appreciating that a tremendous change has occurred. Under the proposed regulations, the electing corporation still must be incorporated outside of New York, must be a “limited partner” in a “limited partnership,” and must have nexus with New York solely as a result of its partnership interest. Unlike the current rules, however, the proposed regulations prohibit a corporate partner from making the separate accounting election solely if there is a unitary business relationship with the partnership, as there is no longer a conjunctive SIT test. The removal of the SIT test is consistent with New York’s 2015 tax reform regarding its combined reporting rules.
For many corporate limited partners, the availability of the separate accounting election under the proposed regulations will hinge solely on whether the corporation and the partnership are engaged in a unitary business relationship. The proposed regulations explain that the Department will construe the term “unitary business” “to the broadest extent permitted under the U.S. Constitution as interpreted by the U.S. Supreme Court, the courts of this state and the New York State Tax Appeals Tribunal.”5 In addition, the Department’s proposed regulations create rebuttable presumptions for when a unitary business relationship exists (e.g., a passive holding company is presumed engaged in a unitary business relationship with an operating company when the capital stock requirement is satisfied).
Given the expansive definition for the unitary business relationship, taxpayers that are considering whether to make the separate accounting election may be hesitant because the inherently subjective nature of the unitary business relationship analysis. Thus, the removal of the SIT test, coupled with the general expansion of the definition for the unitary business relationship, will limit the number of corporations eligible to make the separate accounting election.
1 N.Y. Comp. Codes R. & Regs. tit. 20, § 3-13.5(a)(1) and § 3-13.7(b). Starting in 2015, the New York State Corporate tax bases consist of three alternative taxes: a tax on business income, a tax on business capital, and a fixed dollar minimum tax that is based on the corporation’s New York sourced receipts.
2 N.Y. Comp. Codes R. & Regs. tit. 20, § 3-13.5(a)(1).
3 N.Y. Comp. Codes R. & Regs. tit. 20, § 3-13.5(a)(1)(i), (ii).
4 N.Y. Comp. Codes R. & Regs. tit. 20, § 3-13.5(b)(1)-(4).
5 Prop. Regs. 6-2.3(a).
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