Is a trade acceptance draft purchased by a company investment capital under section 208.5, or business capital, for Article 9-A?

Plain-English summary

Deloitte & Touche LLP asked whether a trade acceptance draft purchased by a company ("C") is investment capital under section 208.5 of the Tax Law. C is part of a corporate group that developed and patented a financing program letting suppliers offer credit to their commercial customers through pre-authorized debit drafts. Each draft specifies the amount due, the due date, and the buyer's bank-account information; acceptance confirms the goods/services were delivered and accepted and fixes a payment date. The draft is the payment instrument for the transaction.

The Department held the trade acceptance draft is investment capital:

• Section 208.5 defines investment capital as investments in stocks, bonds, and other securities, including "qualifying corporate debt instruments."
• A trade acceptance draft, when purchased by C, is a qualifying corporate debt instrument and does not constitute subsidiary capital in C's hands.
• Therefore it is investment capital under section 208.5, not business capital.
• Caveat: whether C actually holds the drafts for sale to customers in the regular course of business (which could change the character) is a factual matter not resolved in the opinion.

What this means for you

Trade acceptance drafts can be investment capital

A purchased trade acceptance draft -- a short-term debt instrument arising from a financing program -- can qualify as a "qualifying corporate debt instrument" and thus as investment capital under section 208.5, separating its income and value from the business-capital base.

The line is whether the paper is held for sale

The Department flagged that the conclusion assumes the holder is investing in the drafts, not dealing in them. If C holds the drafts for sale to customers in the ordinary course, the character could shift to business capital. That turns on the facts of how the program operates.

Classification drives allocation

Investment capital and investment income are allocated by the investment allocation percentage, distinct from business capital. Correctly classifying instruments like these affects both the capital base and how related income is allocated to New York.

Common questions

Q: Is a purchased trade acceptance draft investment capital or business capital?
A: It is investment capital under section 208.5, as a qualifying corporate debt instrument that is not subsidiary capital -- unless held for sale to customers.

Q: What would change the answer?
A: If the company holds the drafts for sale to customers in the regular course of business, the character could be business capital. That is a factual determination.

Q: Why does the classification matter?
A: Investment capital and its income are allocated using the investment allocation percentage, separate from the business-capital base, affecting the New York tax.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 208.5 (definition of investment capital)
- Tax Law section 208.6 (investment income)
- Tax Law section 208.7(a) (definition of business capital; cash election)
- 20 NYCRR 3-3.2 (investment capital; qualifying corporate debt instruments)
- Deloitte & Touche LLP, TSB-A-01(15)C (Jan. 22, 2001)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_2001.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a01_15c.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-01(15)C
Corporation Tax
January 22, 2001

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C000927A

On September 27, 2000, a Petition for Advisory Opinion was received from Deloitte &
Touche LLP, Two World Trade Center, New York, New York 10281.
The issue raised by Petitioner, Deloitte & Touche LLP, is whether a trade acceptance draft
constitutes investment capital under section 208.5 of the Tax Law when purchased by the company
designated as “C” below.
Petitioner submits the following facts as the basis for this Advisory Opinion.
H company is incorporated in Delaware and is publicly traded. H owns 100 percent of the
stock of a first-tier company, C, that owns 100 percent of the stock of two second-tier companies,
F and O. C, F and O are incorporated in Delaware. C is registered and doing business in New York,
New Jersey and Florida. F is registered and doing business in New York. O is registered and doing
business in New York.
H, working through C, F and O has developed and patented a proprietary financing program
(the “Program”) to allow participating buyers and suppliers to create between them an alternative
means of financing commercial purchases. The Program allows suppliers to offer credit terms to
their commercial customers through the use of pre-authorized debit drafts. Each draft specifies the
amount due, the due date, and the buyer’s bank account information. Acceptance of the draft
confirms that: (i) the goods or services have been delivered by the seller; (ii) the goods or services
were checked and accepted by the buyer; and (iii) establishes a specific payment date. The draft
itself constitutes the payment instrument for the transaction according to its terms, and is called a
“trade acceptance.” The draft is negotiable so that the seller may endorse it and transfer it to another
party.
There are three major steps involved in the Program.
(1) Enrollment of the buyer. This involves the buyer providing customary credit and business
information to allow O to evaluate the buyer’s credit worthiness. In addition, each buyer must
execute appropriate Buyer Agreements that set forth the basic terms and conditions of the Program.
(2) Enrollment of the seller. This involves the execution of a basic Letter of Understanding
between O and each seller that sets forth the basic terms of the Program. For the most part, this step
is purely administrative since the Program depends upon the credit worthiness of the buyer (being

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the party obligated to pay the drafts) rather than the seller who will sell the drafts to either C or a
third party.
(3) After both parties have enrolled in the Program, the seller will prepare the drafts
applicable to the particular commercial transaction and forward them to the buyer. If the
merchandise or services are acceptable, the buyer signs the draft and returns it to the seller in
payment for the goods or services. The draft cannot be used as payment for purchases by any of the
buyer’s subsidiaries, parent company, affiliates or employees. The drafts are negotiable instruments
as defined by the Uniform Commercial Code and can be transferred by the endorsement of the seller
or any subsequent holder of the drafts.
As a participant in this program, a seller has the option of either holding the draft until its due
date and collecting cash from the buyer or selling the draft as a negotiable security at the time of
issuance by the buyer to an unrelated third party. If the supplier chooses, it may sell the draft to C,
although C is not obligated to purchase such draft. If C chooses to purchase the draft, specific terms
are provided to suppliers in writing in a bill of sale for each purchase transaction. Terms are either
accepted in full, or may be rejected by the supplier for any reason. C becomes a holder in due
course.
Generally, C will pay the seller the full-face amount of the draft purchased, less C’s fees,
charges and agreed upon discounts. In certain cases, valuation and related payments may be less
than the full face value of the purchased draft depending upon the evaluation of the seller’s customer,
the industry in which the seller or buyer operate, the product or service sold and any other factors
that may have an impact on the value of the draft. Drafts offered for sale must have been issued and
delivered to the seller by the buyer as payment for the actual sale of goods and/or services in a bona
fide contemporaneous commercial transaction entered into in the ordinary course of business
between two unrelated parties at arm’s length. The drafts cannot represent sales of goods and/or
services to any of the supplier’s subsidiaries, parent company, affiliates or employees. None of the
drafts represent payment for products or services purchased from H, C, F or O.
After the purchase of the draft by C, C either holds the draft to maturity and collects cash
from the issuing buyer, or resells the draft to other investors. One purchaser of the drafts is F, a 100
percent owned subsidiary of C. C sells the drafts to F and unrelated purchasers at an arm’s length
discounted net asset value and earns a one percent investment transaction fee. In the case of F, the
purchased drafts are then bundled and used as collateral for third party financing. The funds received
from the third party lenders are used by F to purchase the drafts from C.
Petitioner states that C is not in the business of lending funds for purposes of section
3-3.2(d)(1)(iv) of the Business Corporation Franchise Tax Regulations (“Article 9-A Regulations”).

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Discussion
Section 208.7(a) of the Tax Law provides that the term “business capital” means all assets,
other than subsidiary capital, investment capital and stock issued by the taxpayer, less liabilities not
deducted from subsidiary or investment capital except that cash on hand and on deposit shall be
treated as investment capital or as business capital as the taxpayer may elect.
Section 208.4(a) of the Tax Law provides that the term “subsidiary capital” means
investments in the stock of subsidiaries and any indebtedness from subsidiaries, exclusive of
accounts receivable acquired in the ordinary course of trade or business for services rendered or for
sales of property held primarily for sale to customers, whether or not evidenced by written
instrument, on which interest is not claimed and deducted by the subsidiary for purposes of taxation
under Article 9-A, 32 or 33 of the Tax Law, provided, however, that, in the discretion of the
Commissioner of Taxation and Finance, there shall be deducted from subsidiary capital any
liabilities which are directly or indirectly attributable to subsidiary capital.
Section 208.5 of the Tax Law provides that the term “investment capital” means investments
in stocks, bonds and other securities, corporate and governmental, not held for sale to customers in
the regular course of business, exclusive of subsidiary capital and stock issued by the taxpayer,
provided, however, that, in the discretion of the Commissioner, there shall be deducted from
investment capital any liabilities which are directly or indirectly attributable to investment capital.
Section 3-3.2(c) of the Article 9-A Regulations provides that the phrase “stocks, bonds and
other securities” means, among other things, “qualifying corporate debt instruments.”
Section 3-3.2(d)(1) of the Article 9-A Regulations provides:
[t]he term “qualifying corporate debt instruments” means all debt instruments
issued by a corporation other than the following:
(i) instruments issued by the taxpayer or a DISC;
(ii) instruments which constitute subsidiary capital in the hands of the
taxpayer;
(iii) instruments acquired by the taxpayer for services rendered or for the sale,
rental or other transfer of property, where the obligor is the recipient of the services
or property; however, where a taxpayer sells or otherwise transfers property which
is investment capital in the hands of such taxpayer (e.g., stock) and receives in return
a corporate obligation issued by the recipient of such property, such corporate

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obligation, if it is not otherwise excluded from the category of investment capital,
would constitute investment capital in the hands of the taxpayer;
(iv) instruments acquired for funds if:
(a)

the obligor is the recipient of such funds;

(b)

the taxpayer is principally engaged in the business of
lending funds; and

(c)

the obligation is acquired in the regular course of the
taxpayer’s business of lending funds;

(v) accepted drafts (such as banker’s acceptances and trade acceptances)
where the taxpayer is the drawer of the draft;
(vi) instruments issued by a corporation which is a member of an affiliated
group which includes the taxpayer; and
(vii) accounts receivable, including those held by a factor.
Section 3-3.2(d)(2)(ii) of the Article 9-A Regulations states that:
[a] taxpayer is principally engaged in the business of lending funds, for
purposes of this subdivision, if during the taxable year more than 50 percent of its
gross receipts consist of interest from loans or net gain from the sale or redemption
of notes or other evidences of indebtedness arising from loans made by the taxpayer.
For purposes of the preceding sentence, receipts do not include return of principal or
nonrecurring, extraordinary items.
In this case, the trade acceptance draft, when purchased by C, is a qualifying corporate debt
instrument under section 3-3.2(d)(1) of the Article 9-A Regulations if the buyer of the goods or
services which signs the draft as the drawee is a corporation because:
(i) The draft is not issued by C.
(ii) The draft does not constitute subsidiary capital in the hands of C.
(iii) The draft is not acquired by C for services rendered or for the sale, rental
or other transfer of property.

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Corporation Tax
January 22, 2001

(iv) C is the purchaser of the draft from the seller of the goods or services.
C has not originated a loan with the buyer, the obligor of the draft. Petitioner states
that C is not principally engaged in the lending of funds.
(v) The drawer of the draft is the seller of the goods or services, not C.
(vi) A buyer of the goods or services is not a member of the affiliated group
of H, C, O and F.
(vii) The draft is not an account receivable.
Accordingly, the trade acceptance draft at issue, when purchased by C, is investment capital
if the draft is not held by C for sale to customers in the regular course of its business. If such draft
is held by C for sale to customers in the regular course of its business, such draft would constitute
business capital. The determination of whether C holds the trade acceptance drafts for sale to
customers in the regular course of its business is a question of fact not susceptible of determination
in an Advisory Opinion. (§171.Twenty-fourth; 20 NYCRR 2376.1(a).)

DATED: January 22, 2001

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist III
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.