ARTICLE | October 26, 2023
Authored by RSM US LLP
New York State Division of Tax Appeals decision provides helpful guidance on sourcing of broker-dealer and other financial service receipts
A New York State Administrative Law Judge (ALJ) recently required census-based sourcing for a broker-dealer and other financial receipts in Jefferies Group LLC & Subsidiaries. While addressing state law before comprehensive tax reform in 2015, taxpayers may still be able to take advantage of the decision under current law, especially considering the state’s long-anticipated corporate regulations are nearing promulgation.
New York decision sheds light on broker-dealer and financial service industry
Broker-dealer sourcing provisions
The ALJ decision, which is not precedential, involves tax years prior to the enactment of New York State corporate tax reform (generally 2015 and earlier) and its move to towards customer/market-based sourcing. Prior to reform, several industries, including registered broker/dealers, were required to source specific categories of receipts using customer location. Specifically, New York Tax Law Sec. 210(3)(a)(9) required broker/dealers to source revenue based on the address of the customer 'responsible for paying' the revenues.
The taxpayer and its combined group members included an investment bank, a securities firm and a registered broker-dealer. The taxpayer filed several groups of amended returns arguing that its various financial receipts from institutional intermediaries such as registered investment advisors (RIAs) and nonregistered investment advisors, pension funds, hedge funds, investment vehicles and other intermediaries should be sourced based on the location of the underlying investors, and the relative U.S. census data should be used to reasonably approximate the location of the investors. The New York Department of Tax and Finance argued that receipts from intermediaries located in New York were sourced to New York, regardless of the location of the underlying investors. The taxpayer presented convincing testimony and evidence that the location of the underlying investors, 6.48% based on the New York census, fairly approximated the relative customers responsible for paying the revenues. The department, by contrast, argued that the statute required the use of the address of the intermediary, which would result in New York receipts in excess of 20%.
The ALJ agreed that the relevant statute did not authorize the use of the location of the underlying investors. However, the ALJ directed the state to apply its discretionary authority in using the investor-based approach. The ALJ was not persuaded by the department’s concerns that this would effectuate an industry-wide change in the applicable method used by similarly-situated taxpayers.
Other issues addressed
The ALJ also ruled in favor of the taxpayer with respect to its election to treat cash as investment under the former New York corporate tax regime, as well as the application of the former Financial Services Investment Tax Credit. The ALJ’s decision is notable for ruling that the department’s attempt to apply an investment required to the cash election was inappropriate under the statute. The ALJ also disregarded guidance provided by the department that went beyond the requirements in the Financial Services Investment Tax Credit provision.
Potential application to post-reform years
Although the decision addressed law prior to the comprehensive tax reform in 2015, the guidance provided by the ALJ may still have long-lasting implications on the application of the state’s corporate tax regime, including the possibility of taxpayers asserting similar positions under current law consistent with the decision. Specifically, the decision may provide guidance regarding the following topics contained in the draft regulations:
- Sourcing of brokerage commissions – The draft regulations, section 4-2.13, continues to use a sourcing rule similar to the one at issue in the decision, i.e., based on the mailing address of the customer responsible for paying the commissions. An example provides that such receipts should be sourced based on the location of the investment advisor. Taxpayers should consider whether the ALJ’s decision would support using a census-based approach.
- Sourcing of asset management receipts – The draft regulations, section 4-4.4, provides investor-based sourcing for asset manager services similar to the ultimate finding in the decision. Taxpayers wishing to use a census-based approach should consider whether the decision supports this position.
- Reasonable approximation – The decision uses the concept of ‘reasonable approximation,’ a concept used for sourcing services under the draft regulations and the model regulations used by several states. The decision provides guidance on the use of reasonable approximation concepts for the financial service industry.
- Discretionary powers – The ALJ decision provides guidance for situations where the department may be compelled to use its discretionary powers when the statute is distortive. The draft regulations include a number of instances where the department is authorized to broadly apply discretionary powers.
The ALJ’s decision provides a thorough and helpful framework for evaluating the application of corporate sourcing rules to brokerage commissions and other financial receipts. Taxpayers should consider whether the application of census-based sourcing concepts would 1) necessitate the amendment of previously filed returns and 2) require an impact analysis on tax provisions.
Taxpayers with questions about this decision, New York’s corporate tax regime, or the draft corporate regulations should reach out to their New York state and local tax adviser with questions.
This article was written by Amanda Pucciarelli, Harlan Kwiatek , Robert Zonenshein, Mo Bell-Jacobs and originally appeared on 2023-10-26.
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