Is a U.S. corporation's Subpart F income from its foreign subsidiaries treated as a 'dividend' for New York's Article 9-A and Article 33 franchise taxes, and if so, how much of it can be excluded from entire net income?

Plain-English summary

American International Group (AIG), an insurance holding company with foreign subsidiaries and branches operating worldwide, asked a foundational question: under the federal "Subpart F" rules, a U.S. shareholder of a controlled foreign corporation (one where U.S. shareholders own more than 50% of the voting stock or value) must include its pro-rata share of the foreign corporation's Subpart F income in its own federal taxable income each year -- whether or not that income is actually distributed. AIG argued this deemed inclusion should be treated as a "dividend" for New York's Article 9-A (general corporate franchise tax) and Article 33 (insurance corporation franchise tax) purposes, which would let AIG exclude some or all of it from its entire net income under the dividends-received modifications those statutes provide.

The Department agreed, for several converging reasons. Federally, Subpart F income is measured by the foreign corporation's earnings and profits (the same measure used to define a dividend under IRC § 316), a foreign tax credit is available for it "as if" it were a dividend, and once actually distributed it is NOT treated as a second, separate dividend (since it was already taxed as if distributed). The Department had already adopted this position internally in a 1966 policy memorandum and a 1978 memorandum for Article 32 (bank franchise tax) purposes. Courts in Massachusetts and Pennsylvania, ruling on similar state dividends-received deductions, had reached the same conclusion -- reasoning that failing to treat Subpart F income as a dividend would permanently deny the taxpayer any dividends-received benefit, since the income could never again be "received" as an actual dividend without double-counting.

Having established that Subpart F income is a deemed dividend, the Department then applied Article 9-A's and Article 33's ordinary dividend rules to determine how much can be excluded from entire net income. Both statutes turn the answer on whether the controlled foreign corporation is a "subsidiary" -- meaning the taxpayer owns more than 50% of its voting stock, based on actual beneficial ownership rather than mere record title. If it is a subsidiary, the deemed dividend counts as subsidiary-capital income and 100% of it can be excluded from entire net income. If the taxpayer owns 50% or less of the CFC's voting stock, the Subpart F deemed dividend is instead treated as an ordinary dividend, of which only 50% can be excluded (with a special share-based limitation for life insurance companies under Article 33, tied to IRC § 812(a)(1)). Because Article 33's dividend and subsidiary-capital provisions are "substantially identical" to Article 9-A's (by an express 1974 statutory directive that the two articles be read in pari materia), the Department applied the identical analysis and reached the identical conclusion under both articles.

What this means for you

U.S. corporations with controlled foreign corporations (CFCs)

If your company must include Subpart F income from a CFC on its federal return, that same income is treated as a deemed dividend for New York Article 9-A or Article 33 purposes -- meaning it's eligible for the same dividends-received exclusion as an actual dividend, not treated as ordinary business income by default.

Determining the exclusion percentage

The key threshold is ownership: more than 50% direct voting-stock ownership (based on actual beneficial ownership, which can require a full factual showing if record title and beneficial ownership diverge) gets a 100% exclusion as subsidiary-capital income; 50% or less gets only a 50% exclusion as an ordinary dividend.

Multi-tier corporate structures

This ruling's ownership test is framed around the taxpayer's DIRECT ownership of the specific CFC generating the Subpart F income. A later 1988 follow-up ruling to AIG (TSB-A-88(7)C) addressed what happens when the Subpart F income actually comes from a SECOND-TIER CFC the taxpayer doesn't directly own -- and a 1992 modification to both this ruling and that one (TSB-A-87(23.1)C/TSB-A-88(7.1)C) changed the answer for tax years 1992 and later. If your CFC structure has multiple tiers, don't rely on this 1987 ruling alone -- check the later modification.

Common questions

Q: Does this mean all Subpart F income is completely tax-free in New York? A: No -- it means Subpart F income is treated as a dividend eligible for the same partial or full exclusion that actual dividends get, not that it's automatically 100% excluded. The exclusion percentage (100% vs. 50%) depends on whether the CFC is a majority-owned subsidiary.

Q: How is "beneficial ownership" of a CFC determined if record title doesn't match actual ownership? A: The taxpayer must submit a full and complete statement of all relevant facts; mere registration of stock in the taxpayer's name isn't sufficient by itself if it isn't the actual beneficial owner, and vice versa.

Q: Does this ruling still reflect current law for AIG's or similar multi-tier CFC structures? A: Not entirely -- see TSB-A-87(23.1)C/TSB-A-88(7.1)C (1992), which modified both this ruling and TSB-A-88(7)C for tax years 1992 and later, in a case involving lower-tier CFC income flowing up an ownership chain.

Q: Can another company rely on this specific ruling?
A: No. It binds the Department only for this petitioner's facts and can't be relied upon by other taxpayers, though its general "Subpart F = deemed dividend" holding reflects a Department-wide policy position dating to 1966.

Citations and references

Statutes and regulations:

• Tax Law § 208.9(a)(1)-(2) (Article 9-A dividend/subsidiary-capital exclusions); § 208.3, § 208.4 (subsidiary definitions)
• Business Corporation Franchise Tax Regulations § 3-6.2 (beneficial ownership test)
• Tax Law § 1501, § 1503(b)(1)(A)-(B), § 1500(g)-(h) (Article 33 parallel provisions); Laws of 1974, ch. 649, § 12 (in pari materia directive)
• IRC §§ 951, 952(c), 959(d), 960, 316 (Subpart F and dividend mechanics)
• Dow Chemical Co. v. Commissioner of Revenue (Mass. 1979); Commonwealth v. Emhart Corp. (Pa. 1970); Albert L. Dougherty, 60 TC 917 (1973)
• Matter of Sears Industries, TSB-H-85(33)C; Matter of Armour & Company, TSB-H-85(12)C; Matter of Texas Instruments Inc., TSB-H-80(23)C

Related opinions:

• TSB-A-88(7)C (Mar. 1988) -- follow-up addressing second-tier CFC Subpart F income
• TSB-A-87(23.1)C/TSB-A-88(7.1)C (Nov. 1992) -- modifies both this ruling and TSB-A-88(7)C for tax years 1992+

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1987.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a87_23c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-87 (23) C
Corporation Tax
September 9, 1987

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C870408B

On April 8, 1987, a Petition for Advisory Opinion was received from American International Group, Inc., 70 Pine Street, 24th Floor, New York, New York 10270. The issue raised is whether Subpart F income constitutes a dividend for purposes of Article 9-A and Article 33 of the Tax Law. If Subpart F income does constitute a dividend and it is attributable to an investment which qualifies as subsidiary capital, may it be excluded from entire net income. Additionally, if it is attributable to an investment that does not qualify as subsidiary capital, may 50 percent of it be excluded from entire net income. Petitioner is a holding company which, through its subsidiaries, is primarily engaged in a wide range of insurance and insurance related activities in the United States and overseas. Petitioner's foreign operations are conducted by foreign subsidiaries and through branch operations of domestic subsidiaries. Some of Petitioner's foreign subsidiaries are owned by Article 9-A subsidiaries and others by Article 33 subsidiaries. These corporations are required, in some instances, to include Subpart F income in their gross income in determining the amounts of their federal taxable income. The Subpart F rules of the Internal Revenue Code provide, in effect, that if a foreign corporation is a controlled foreign corporation (more than 50 percent of its voting stock or its value is owned by a United States shareholder), the United States shareholder must include in its income its pro-rata share of the foreign corporation's Subpart F income, which is defined in section 951 of the Internal Revenue Code. Petitioner contends that for all practical purposes, Subpart F income is treated as a dividend for federal income tax purposes. For instance, the amount of Subpart F income includible by the United States shareholder is measured by the foreign corporation's earnings and profits. Section 316 of the Internal Revenue Code defines a dividend as a distribution to shareholders out of earnings and profits. In addition, section 960 of the Internal Revenue Code allows the United States shareholder of a controlled foreign corporation to claim a foreign tax credit for taxes paid by the foreign corporation to foreign jurisdictions in connection with its Subpart F income "in the same manner as if the amount so included (in the gross income of the United States shareholder) were a dividend paid by such foreign corporation . . ." (Emphasis added) Subpart F income is included in federal taxable income even if it is not distributed to the shareholder and is reported in Schedule C of Form 1120 as a dividend. As it is includible in the shareholder's income even if it is not distributed, section 959(d) of the Internal Revenue Code provides that when such amounts are distributed they shall not be treated as a dividend. Article 9-A Article 9-A of the Tax Law imposes a franchise tax on business corporations, which is RODERICK G. W. CHU, COMMISSIONER TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

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computed on the one of four alternative bases which yields the highest tax. One of the bases is measured by entire net income, which is the corporation's federal taxable income with certain modifications. The modification set forth in section 208.9(a)(1) of the Tax Law provides that entire net income shall not include income, gains and losses from subsidiary capital except for such amounts from a former DISC which are treated as business income under section 208.8-A of the Tax Law. Section 208.9(a)(2) of the Tax Law provides that entire net income shall not include 50 percent of dividends, other than from subsidiaries or treated as business income under section 208.8-A of the Tax Law. The provisions of Article 9-A of the Tax Law do not specifically provide that Subpart F income is to be treated as a dividend eligible for the dividends received exclusions provided in section 208.9(a)(1) and (2) of the Tax Law. However, in a memorandum dated January 18, 1966, E. A. Doran, Deputy Tax Commissioner, concluded that for franchise tax purposes, Subpart F income should be treated as a dividend. Also, Technical Services Bureau Memorandum, TSB-M-78(17)C, dated September 7, 1978 provides that Subpart F income is deemed to be a dividend for purposes of computing entire net income under Article 32 of the Tax Law. The United States Tax Court, in a leading Subpart F income case, expressly refers to the "increase in earnings invested in United States property" as "statutory constructive dividend doctrine". See, Albert L. Dougherty, 60 TC 917, 930 (1973). In addition, the Supreme Judicial Court of Massachusetts held that for purposes of the Massachusetts corporate excise tax, which grants a 100% deduction for dividends received, Subpart F income should be treated as a dividend. See, Dow Chemical Co. v. Commissioner of Revenue, 378 Mass 254, 391 NE2d 253 (1979). The summary of Dow's conclusion is as follows: "The corporate excise adopts the Federal definition of gross income but, to determine taxable net income, allows a deduction for 'dividends' included in net income for the taxable year .... [T]hat income is included in gross income only because it is treated federally as if it had been currently distributed; it should be similarly treated under State law and deductible as a dividend. Disallowance of a dividend deduction for undistributed Subpart F income would in fact prevent the taxpayer from ever receiving a deduction for that income since it could not be included in income when actually distributed; the disallowance would thus subvert the statutory purpose of preventing multiple taxation of corporate income." Id. In its in-depth analysis of the dividend issue, the Dow court employed the following rationale: "The Subpart F provisions of the Code describe a dividend which is deemed to have been distributed in the taxable year. Indeed, Subpart F income is included in gross income only because it is treated as a dividend. This is made

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plain by the text of Code 951.... Subpart F income is the amount 'which would have been distributed with respect to the stock,' and so forth ... In the legislative history, Subpart F income is described as a dividend to the United States shareholders, and it is on this basis that it is included in gross income. Other provisions of the Code conform in this understanding. Under 952(c), Subpart F income may not exceed "the earnings and profits" of the foreign corporation in that taxable year. The amount of Subpart F income must, under 951(a)(2)(B), be reduced by actual dividend distributions received by any person, other than the taxpayer, who had owned the taxpayer's stock during some part of the taxable year. And the foreign tax credit provisions, applicable to actual dividends, are applied in similar form to Subpart F income. 960... The view we take accords with Commonwealth v. Emhart Corp., 443 Pa. 397 (1970), cert. denied, 404 US 981 (1971), the only case cited in which the issue has been raised. There the taxpayer sought to deduct Subpart F income under a statutory provision authorizing a deduction for 'dividends received from any other corporation'.... The Commonwealth of Pennsylvania contended that the deduction should be limited to dividends 'received' and should not embrace deemed distributions not actually received by the taxpayer. In Emhart, as here, intercorporate dividends could not be deducted unless they were included in Federal gross income. The court noted that 'if a corporation fails to take the deduction in the year it included the dividend in its federal return, it is unclear whether the corporation can ever take advantage of the deduction in a later year, for while the corporation will have "received" the dividend, it will not have included that sum in its federal return--a prerequisite for the [State] deduction.' Id. at 408. The court found that failure to permit the deduction for Subpart F income could not be reconciled with the 'clear legislative determination that a corporation at some point is entitled to a deduction for dividends received from other corporations, presumably to avoid a double tax at the corporate level.' Id. To conclude, although the Commissioner properly required inclusion of Subpart F income in gross income, she erred in failing to allow a deduction under G.L. c. 63, 38(a)(1)." 378 Mass. at 267-272. (Footnotes omitted.) The reasoning adopted by the Massachusetts and Pennsylvania courts is persuasive for the instant dividend question. The rationale of Dow, Emhart and Dougherty support the policy of the Tax Department adopted in 1966, that is, to treat Subpart F income as a dividend under Article 9A.

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Accordingly, for purposes of Article 9-A of the Tax Law, it is appropriate, as shown above, to deem Subpart F income to be a dividend that is directly related to ownership of stock. For purposes of Article 9A of the Tax Law, the term "subsidiary" is defined in section 208.3 as "... a corporation of which over fifty per centum of the number of shares of stock entitling the holders thereof to vote for the election of directors or trustees is owned by the taxpayer". In addition, "subsidiary capital" is defined in section 208.4 as "... 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 articles nine-a, nine-b, nine-c, thirty-two or thirty-three of this chapter. ..." When determining whether a corporation is a subsidiary, guidance is given in section 3­ 6.2 of the Business Corporation Franchise Tax regulations which further defines the term "subsidiary" as follows: "(a) The term 'subsidiary' means a corporation which is controlled by the taxpayer, by reason of the taxpayer's ownership of more than 50 percent of the total number of the shares of stock of such corporation, issued and outstanding, which entitle the holder of the shares to vote at elections of its directors or trustees. The determination of whether or not particular shares of a corporation's stock entitles the holders of such shares to vote for the election of directors or trustees of the corporation depends on the actual legal situation with respect to voting rights, as it exists from time to time.

(b) The test of ownership is actual beneficial ownership, rather than mere record title as shown by the stock books of the issuing corporation. A corporation will not be considered to be a subsidiary because more than 50 percent of the shares of its voting stock is registered in the taxpayer's name, unless the taxpayer is the actual beneficial owner of such stock. However, a corporation will not be considered a subsidiary if more than 50 percent of the shares of its voting stock is not registered in the taxpayer's name, unless the taxpayer submits proof that it is the actual beneficial owner of such stock.

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(d) In any case where the record holder of shares of voting stock of a corporation is not the actual beneficial owner of the stock, or where the right to vote such stock is not possessed by the record holder or by the actual beneficial owner of the stock, a full and complete statement of all relevant facts must be submitted." The concept of beneficial ownership of stock does not apply to situations involving three or more tier corporate structures unless there has been some transfer of rights in the stock, for example, where there has been a transfer of stock without transfer of legal title or where the transferee of the stock is not yet the holder of record on the books of the corporation or where there has been a transfer to a trustee. See Matter of Sears Industries, Inc., State Tax Commission Decision, July 26, 1985, TSB-H-85(33)C; Matter of Armour & Company, State Tax Commission Decision, April 4, 1985, TSB-H-85(12)C; and Matter of Texas Instruments Incorporated, State Tax Commission Decision, June 27, 1980, TSB-H-80(23)C. Accordingly, in the instant case, if a taxpayer under Article 9-A of the Tax Law is the owner of more than 50 percent of the voting stock of a controlled foreign corporation, the Subpart F income should be considered as being in the nature of a dividend from subsidiary capital. In addition, when computing entire net income 100 percent of the dividend may be deducted from the taxpayer's federal taxable income pursuant to section 208.9(a)(1) of the Tax Law. If a taxpayer under Article 9-A of the Tax Law is the owner of less than a majority of the voting stock of a controlled foreign corporation, the Subpart F income cannot be considered to be attributable to a subsidiary of the taxpayer but should be treated as a dividend 50 percent of which may be deducted from the taxpayer's federal taxable income pursuant to section 208.9(a)(2) of the Tax Law. Article 33 Article 33 of the Tax Law was added by the Laws of 1974, Chapter 649, effective May 30, 1974. Section 12 of such Chapter provided that Article 33 "... shall be construed so that the provisions of such article which are the same as or are substantially identical with those in article nine-a of the tax law shall be regarded as being in pari materia and shall be construed in a like manner." Section 1501 of Article 33 of the Tax Law imposes a franchise tax on insurance corporations which is computed on the one of four alternative bases which yields the highest tax. One of the bases is measured by entire net income, which is the insurance corporation's federal taxable income with certain modifications. The modification set forth in section 1503(b)(1)(A) of the Tax Law provides that entire net income shall not include income, gains and losses from subsidiary capital. Section 1503(b)(1)(B) of the Tax Law provides that entire net income shall not include 50 percent of dividends other than from subsidiaries. For purposes of Article 33 of the Tax Law, the term "subsidiary" is defined in section 1500(g) as "... a corporation of which over fifty percent of the number of shares of stock entitling

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the holders thereof to vote for the election of directors or trustees is owned by the taxpayer." In addition, "subsidiary capital" is defined in section 1500(h) as "... 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 a written instrument, on which interest is not claimed and deducted by the subsidiary for purposes of taxation under any article of this chapter. ..." Since, under Article 33 of the Tax Law, the franchise tax base measured by entire net income and the pertinent dividend modifications and the definitions of subsidiary and subsidiary capital are substantially identical to those contained in Article 9-A, Article 33 shall be regarded as being in pari materia with Article 9-A with regards to Subpart F income. (Laws of 1974, Chapter 649, section 12). Therefore, it is appropriate that the conclusion under Article 33 be the same as under Article 9-A. Accordingly, for purposes of Article 33 of the Tax Law, Subpart F income is deemed to be a dividend. In addition, if a taxpayer, under Article 33 of the Tax Law, is the owner of more than 50 percent of the voting stock of a controlled foreign corporation, the Subpart F income should be considered as being in the nature of a dividend from subsidiary capital. When computing entire net income, 100 percent of the dividend may be deducted from the taxpayer's federal taxable income pursuant to section 1503(b)(1)(A) of the Tax Law. If a taxpayer, under Article 33 of the Tax Law, is the owner of less than a majority of the voting stock of a controlled foreign corporation, the Subpart F income cannot be considered to be attributable to a subsidiary of the taxpayer, but should be treated as a dividend, 50 percent of which may be deducted from the taxpayer's federal taxable income pursuant to section 1503(b)(1)(B) of the Tax Law. It should be noted, that in the case of a life insurance company, such 50 percent deduction applies only with respect to the life insurance company's share of such dividends, which share means the percentage determined under section 812(a)(1) of the Internal Revenue Code.

DATED: September 9, 1987

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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