Noonan’s Notes Blog is written by a team of Hodgson Russ tax attorneys led by the blog’s namesake, Tim Noonan. Noonan’s Notes Blog regularly provides analysis of and commentary on developments in the world of New York tax law.

New York State Looks to Adopt Final Corporate Tax Reform Regulations

With its announcement, the Tax Department published updated versions of what it labeled “final drafts” on most of the state’s new rules. The Tax Department did not issue updates on its draft apportionment regulations. Instead, those are slated to be released later this summer. We’ll report back then.

Because the recent releases are intended to serve as the state’s final draft regulations, the Tax Department has also “strongly encourage[d] timely feedback,” setting a June 30, 2022 deadline for comments.

Some of the most notable changes in the Division’s recent round of draft regulations include:

Limitations on Public Law 86-272 Protections for Internet Vendors

The headline-grabbing changes in the state’s latest draft regulations seek to broaden the scope of foreign corporations that may be subject to tax in New York State (Subpart 1-2). These changes, which specifically target Public Law 86-272 (P.L. 86-272) protections have already generated significant chatter in the tax community.

P.L. 86-272 prohibits states from taxing out-of-state corporations on income derived from business activities within the state if their activities are limited to “mere solicitation” of orders for the sale of tangible personal property (service vendors do not receive these protections) and the orders are then approved and filled from outside the state. There has been recent uncertainty regarding the scope of these protections as applied to Internet vendors, however, following an updated statement from the Multistate Tax Commission (MTC) on how states could apply the federal law in the Internet age.

Consistent with the MTC’s statement, New York’s revised draft regulations acknowledge P.L. 86-272 protections for corporations engaged only in “the solicitation of orders via the Internet in New York State for sales of tangible personal property [where] the orders are sent outside New York State for approval or rejection.” This includes an out-of-state Internet vendor “presenting static text or images on its website,” along with vendors engaging in certain, limited pre-sale solicitation activities. But New York then blurs the line between protected out-of-state activities and unprotected in-state activities by noting that “solicitation” (which is protected under P.L. 86-272) does not include certain activities that out-of-state corporations may engage in “via the Internet, including interacting with customers or potential customers through the corporation’s website or computer application.” The practical result of this change could be that an out-of-state retailer of tangible personal property—even one without any physical in-state presence in New York State—may fall outside of the protections offered by P.L. 86-272 simply by engaging in the types of online customer engagement activities that have become standard in the Internet retail age.

The following examples in the draft regulations highlight this concern:

Example 7: A foreign corporation regularly provides assistance to its customers after its products have been delivered, either by email or electronic “chat” that customers initiate by clicking on an icon on the corporation’s website. For example, the corporation regularly advises customers on how to use products after the products have been delivered. Since this activity does not constitute, and is not entirely ancillary to, the solicitation of orders for sales of tangible personal property, the corporation is not exempt from tax under this section

Example 10: A foreign corporation places Internet “cookies” onto the computers or other electronic devices of is customers. These cookies gather customer search information that will be used to adjust production schedules and inventory amounts, develop new products, or identify new items to offer for sale. Since this activity does not constitute, and is not entirely ancillary to, the solicitation of orders for sales of tangible personal property, the corporation is not exempt from tax under article 9-A under this section.

We expect the Tax Department will not have to look too far for comments on the new P.L. 86-272 regulations.

Short Period Reports

Section 6-1.2 of previously-released versions of the draft regulations included a list of scenarios when a corporation would be required to file a short period report. These included “a taxpayer that changes its accounting period for Federal income tax purposes; a taxpayer that becomes part of or ceases to be part of a Federal consolidated group during the year; or a taxpayer that changes from one Federal consolidated group to another Federal consolidated group during the year.” The new draft regulations confirm that a short period report is not required when one of these scenarios occurs but the corporation remains in the same New York State combined report both before and after the change.

MTA Surcharge Property Factor Computation

For corporations operating within the Metropolitan Commuter Transportation District (MCTD), an additional surcharge applies on top of the state’s general corporation tax. The tax surcharge is imposed on a tax base that is apportioned to the MCTD using a three-factor apportionment formula (property; payroll; and income). The new draft regulations indicate that under the property factor, which includes real and tangible personal property located within the MCTD, the “underlying asset of a capital lease between the surcharge taxpayer and another party (the lessor) is considered owned by the surcharge taxpayer.” Depending on where the underlying asset is located, this change has the potential to either increase or decrease a surcharge taxpayer’s MCTD apportionment percentage.

Special Entities

The new draft regulations propose two changes to the treatment of certain special entities.

The first change adds a new section related to certain foreign limited corporate partners (Section 10-2.6), providing that a non-unitary foreign limited corporate partner may be able to “elect to compute its tax bases by taking into account only its distributive share of each partnership item of receipts, income, gain, loss and deduction (including any modifications relating thereto) and its proportionate part of each partnership asset and liability, and each partnership activity…whether or not such share is actually distributed.” The new section includes additional guidance for making the separate accounting election and instructions for limited partners needing to aggregate income, capital, and receipts from multiple limited partnerships.

The second proposal adds a new subpart (Subpart 10-6) that addresses the tax computation for residual interest holders of a real estate mortgage investment conduit (REMIC). The new draft regulations specifically address the computation of the business income base in situations where the federal taxable income limit to excess inclusion (EI) found under IRC section 860E both does and does not apply to a holder of a residual interest in a REMIC (certain modifications are required when the EI limit applies); the computation of the capital base of a holder of a residual interest in a REMIC; instructions for combined groups that include a holder of a residual interest in a REMIC; along with new examples interpreting the guidance under Subpart 10-6.

New Net Operating Loss Examples

Finally, the new draft regulations also include a pair of new net operating loss examples. First, in the unabsorbed net operating loss (UNOL) examples—which deal with net operating loss (NOL) carryover amounts and the amount of the UNOL for a corporation or combined group—a new Example 5 addresses losses earned in Separate Return Limitation Years (SRLYs). Second, in the NOL examples, a new Example 9 addresses NOL calculations when a corporation without any NOLs available for its own use acquires a separate corporation with existing NOLs that are subject to IRC section 382 limitations.

If any of the state’s new proposed changes seem problematic, or desirable for that matter, we encourage effected taxpayers and practitioners to speak up and take advantage of the Tax Department’s offer to submit comments before the June 30 deadline.

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