Is a corporation whose only income is partnership distributive shares from financial activities a 'financial service company' under Connecticut's corporation business tax?

Plain-English summary

A corporation subject to Connecticut's corporation business tax is the general partner in several partnerships. It earns all of its gross income from its distributive shares of those partnerships, and the partnerships earn all of their income from "Financial Service Activities" as defined in Conn. Gen. Stat. § 12-218b(a)(6)(J)(i). Neither the corporation nor the partnerships is an insurance company or real estate broker. The corporation asked whether it is a "financial service company" — a classification that governs how a company apportions its net income for the corporation business tax.

DRS ruled yes. A "financial service company" is one that derives 50% or more of its gross income from listed financial sources or activities. The corporation itself doesn't directly conduct financial activities — its income arrives as partnership distributive shares. The key was Connecticut's adoption of the federal "conduit" treatment of partnerships:

• Connecticut defines "gross income" by reference to the Internal Revenue Code (Conn. Gen. Stat. § 12-213(a)(9)(A)), and the Connecticut Supreme Court has held (in Bell Atlantic NYNEX Mobile and Berkley v. Gavin) that the corporation business tax therefore incorporates the federal conduit treatment of partnership tax attributes.
• Under I.R.C. § 702(b)–(c), a partner's distributive share keeps the character it had at the partnership level — it's treated as if realized directly from the source the partnership realized it from.

Applying that, the corporation is treated as deriving its income directly from the partnerships' Financial Service Activities. Since all of its income comes that way, it easily meets the 50%-or-more test and is a financial service company under § 12-218b(a)(6)(J)(i). (A footnote adds that the same conclusion would hold if the corporation were a limited partner required or electing to apportion that income.)

What this means for you

Corporations that invest or operate through partnerships

The character of income you receive as a partnership distributive share carries through to you for Connecticut corporation-business-tax purposes. If your partnerships' income is financial in nature, that character follows into your hands — and can make you a "financial service company," which changes how you apportion your net income to Connecticut. Don't assume that holding financial activities one level down (in a partnership) insulates the corporate partner from the classification.

Financial-sector holding and management structures

Structuring financial operations under partnerships doesn't dilute the financial character of the income for this test. A corporate partner deriving 50%+ of its gross income (through distributive shares) from listed financial activities is a financial service company. Model the apportionment consequences before assuming a general vs. special apportionment rule applies.

Accountants and tax professionals

The holding rests on the conduit principle: Conn. Gen. Stat. § 12-213(a)(9)(A) ties "gross income" to the IRC, and Bell Atlantic NYNEX Mobile, Inc. v. Commissioner, 273 Conn. 240 (2005) (building on Berkley v. Gavin, 253 Conn. 761 (2000)) confirms the corporation business tax incorporates federal partnership conduit treatment. I.R.C. § 702(b)–(c) preserves the source and character of distributive-share income, so the partnerships' financial-activity income is tested at the corporate-partner level under § 12-218b(a)(6)(J)(i). The general partner's income is apportioned under § 12-218(h)(3); the footnote extends the result to a qualifying limited partner. (The published HTML copy did not include a signature date.)

Common questions

Q: What is a "financial service company" for Connecticut tax purposes?
A: Broadly, a company (other than an insurance company or real estate broker) that derives 50% or more of its gross income from a list of financial sources or activities in Conn. Gen. Stat. § 12-218b(a)(6). The classification affects how the company apportions its net income.

Q: The corporation only holds partnership interests — how is it a financial service company?
A: Because Connecticut's corporation business tax incorporates the federal conduit treatment of partnerships. The financial character of the partnerships' income carries through to the corporate partner's distributive shares, so the corporation is treated as deriving that income directly from financial activities.

Q: Does it matter that it's a general partner?
A: The ruling addresses a general partner, whose net income (including distributive shares) is apportioned under § 12-218(h)(3). A footnote says the same analysis applies to a limited partner required or electing to apportion that income.

Q: Does this ruling apply to my company?
A: Not automatically. A Connecticut Ruling binds DRS only for the taxpayer and facts it addressed. A different income mix or entity structure could change the classification.

Citations and references

Statutes:

• Conn. Gen. Stat. § 12-218b (apportionment of the net income of a financial service company); § 12-218b(a)(6)(J)(i) (definition of "financial service company")
• Conn. Gen. Stat. § 12-213(a)(9)(A) (defines "gross income" as gross income under the Internal Revenue Code)
• Conn. Gen. Stat. § 12-218(h)(3) (apportionment of a general partner's net income, including partnership distributive shares)

Federal law and cases:

• I.R.C. § 61(a)(13) (gross income includes distributive share of partnership gross income); § 702(b)–(c) (character and inclusion of distributive share)
• Bell Atlantic NYNEX Mobile, Inc. v. Commissioner, 273 Conn. 240 (2005); Berkley v. Gavin, 253 Conn. 761 (2000) (incorporation of federal partnership conduit treatment)

Source

• Landing page: Connecticut DRS Rulings
• Ruling: Ruling 2015-1

Original ruling text

Ruling No. 2015-1, Corporation Business Tax Financial Service Company

Facts

Corporation is subject to the corporation business tax and is a partner in multiple entities that are treated
as partnerships for federal income tax purposes (“Partnerships”).  Corporation is the general partner of each of
the Partnerships. [1]   Corporation derives all of its gross income from
its distributive shares of gross income from the Partnerships.  The Partnerships derive all of their gross
income from sources and activities described in Conn. Gen. Stat. § 12-218b(a)(6)(J)(i)
(“Financial Service Activities”).
Corporation and the Partnerships are not insurance companies or real
estate brokers.

Issue

Whether Corporation is
classified as a financial service company under Conn. Gen. Stat. §
12-218b(a)(6)(J)(i) due to the fact that its distributive shares of the Partnerships’
gross income, which the Partnerships derive entirely from Financial Service
Activities, comprise all of Corporation’s gross income.

Ruling

Corporation
is classified as a financial service company under Conn. Gen. Stat. §
12-218b(a)(6)(J)(i) due to the fact that its distributive shares of the Partnerships’
gross income, which the Partnerships derive entirely from Financial Service
Activities, comprise all of Corporation’s gross income.

Relevant
Law

Conn. Gen. Stat. §
12-218b provides for the apportionment of the net income of a financial service
company.

Conn. Gen. Stat. § 12-218b(a)(6)
sets forth the definition of “financial service company” and provides, in
pertinent part, that said term includes:

Any company, other than an insurance
company or a real estate broker, which derives fifty per cent or more of its
gross income from one of more of the following sources or activities: Loans;
letters of credit and acceptance of drafts; underwriting, purchase, placement,
sale or brokerage of securities, commodities contracts or other financial
instruments or contracts on its own account or for the account of others;
exchanges, exchange clearinghouses and other services allied with the exchange
of securities or commodities contracts; investment advisory or management
services; investment banking services, corporate trust and escrow services;
securities information processing; securities and financial rating agency
services; transfer agent, clearing agent, securities custodial and depository
services; securities exchange or quotation services; any of the services
described in subsection (f) of section 12-218; any of the services described in
subsection (g) of section 12-218; management, distribution or administrative
services to or on behalf of an investment entity; management, distribution or
administrative services to or on behalf of pension funds or retirement
accounts; leasing or acting as an agent, broker or adviser in connection with
leasing real and personal property that is the functional equivalent of an
extension of credit and that transfers substantially all of the benefits and
risks incident to the ownership of property, including any direct financing
lease or leverage lease that meets the criteria of Financial Accounting
Standards Board Statement No. 13, “Accounting for Leases” or any other lease
that is accounted for as a financing by a lessor under generally accepted
accounting principles; activities of a Morris plan company; credit card
activities; third party insurance administration services, claim administration
services, claim adjusting services, premium billing and collection services, or
employee benefit plan administration services; insurance underwriting or policy
issuance services; actuarial services; trust company services; financial
planning services; insurance brokerage services; or risk management services.

Conn. Gen. Stat. §
12-218b(a)(6)(J)(i).

Conn. Gen. Stat. § 12-213(a)(9)(A)
defines gross income as “gross income, as defined in the Internal Revenue Code.”

With respect to Connecticut
tax statutes that refer to the Internal Revenue Code, the Connecticut Supreme
Court has stated:

We long have held that when our tax
statutes refer to the federal tax code, federal tax concepts are incorporated
into state law. . . .  Although this rule
does not require the wholesale incorporation of the entire body of federal tax
principles into our state income tax scheme, where a reference to the federal
tax code expressly is made in the language of a statute, and where
incorporation of federal tax principles makes sense in light of the statutory
language at issue, our prior cases uniformly have held that incorporation
should take place.

(Citations omitted;
internal quotation marks omitted.)  Berkley
v. Gavin , 253 Conn. 761, 773 (2000).

In accordance with its
decision in Berkley , the Connecticut Supreme Court has found that “the
corporation business tax incorporates the federal income tax concept of ‘gross
income’” and, therefore, the corporation business tax “incorporates the conduit
treatment of partnership tax attributes.”
Bell Atlantic NYNEX Mobil, Inc. v. Commissioner , 273 Conn. 240, 262
(2005).

Section 61(a)(13) of the
Internal Revenue Code provides that “gross income” includes income derived from
a “[d]istributive share of partnership gross income.”

Section 702(b) of the
Internal Revenue Code provides that “[t]he character of any item of income,
gain, loss, deduction, or credit included in a partner’s distributive share. .
. shall be determined as if such item were realized directly from the source
from which realized by the partnership, or incurred in the same manner as
incurred by the partnership.”

Section 702(c) of the
Internal Revenue Code provides that “[i]n any case where it is necessary to
determine the gross income of a partner for purposes of this title, such amount
shall include his distributive share of the gross income of the partnership.”

Discussion

The Connecticut Supreme
Court has found that the corporation business tax incorporates the federal
conduit treatment of partnerships through its adoption of the federal tax
definition of “gross income.”  See
Bell Atlantic , 273 Conn. at 262.  Based
upon this incorporation, in any case where it is necessary to determine the
gross income of Corporation for corporation business tax purposes, such as in
determining Corporation’s gross income pursuant to the financial service
company provisions under Conn. Gen. Stat. § 12-218b(a)(6)(J)(i), Corporation
must include its distributive shares of the Partnerships’ gross income in its
gross income.  See I.R.C. § 702(c).  Moreover, the character of Corporation’s
distributive shares of such gross income “shall be determined as if such item
were realized directly from the source from which realized by the
[Partnerships].”  I.R.C. § 702(b).

As stated above, Corporation
derives all of its gross income from its distributive shares of the
Partnerships’ gross income and the Partnerships derive all of their gross
income from Financial Service Activities.
As such, in accordance with the conduit treatment of partnerships that
is incorporated into the corporation business tax, Corporation derives all of
its gross income directly from Financial Service Activities.  Accordingly, as Corporation derives fifty per
cent or more of its gross income from Financial Service Activities, it is classified
as a financial service company under Conn. Gen. Stat. § 12-218b(a)(6)(J)(i).

[1] As Corporation is a general
partner in the Partnerships, its net income, including its distributive shares
of the Partnerships’ income, is subject to apportionment under the provisions
of the corporation business tax.  See
Conn. Gen. Stat. § 12-218(h)(3).  The
analysis and ruling contained herein would also apply if Corporation were a
limited partner in the Partnerships and Corporation elected or was required to apportion
its net income, including its distributive shares of the Partnership’s income,
under the provisions of the corporation business tax.  See Conn. Gen. Stat. §§ 12-218(h)(1)
and 12-218(h)(2).