When an insurance holding company's Subpart F income is deemed a dividend, is the 50% of that deemed dividend included in New York entire net income treated as investment income (from investment capital) or as business income?

Plain-English summary

American International Group, Inc. (AIG), an insurance holding company, had earlier been told (TSB-A-87(23)C) that its federal Subpart F income from controlled foreign corporations (CFCs) is treated as a "deemed dividend" for New York Article 9-A purposes -- 100% deductible if attributable to majority-owned subsidiary capital, or 50% deductible otherwise. AIG's follow-up question: is the remaining, taxable 50% "investment income" (from investment capital, allocated favorably under § 210.3(b)) or ordinary business income?

The Department rejected AIG's broader argument that all Subpart F deemed dividends must be investment income (since dividends can only come from stock investments). Subpart F income isn't a real dividend at all -- it's undistributed income merely "deemed" a dividend by statute for deduction purposes. Investment income specifically requires income "from investment capital" (§ 208.6), and investment capital means stock the taxpayer itself owns (§ 208.5). So the taxable 50% is investment income only where AIG has a direct stock investment (not exceeding 50% ownership) in the specific CFC generating the Subpart F income. But where the deemed dividend comes from a CFC in which AIG has no direct stock investment at all -- a second-tier CFC owned by AIG's own CFC -- that deemed dividend isn't derived from AIG's investment capital and must instead be classified as ordinary business income. That business income counts in the denominator of the receipts factor as "other business receipts," but since it isn't earned within New York, none of it lands in the numerator either.

What this means for you

Multinational holding companies with tiered CFC structures

The character of taxable Subpart F deemed-dividend income for New York purposes depends on exactly which tier of your CFC structure generated it, and whether you personally (not through an intermediate CFC) hold the stock. Don't assume all Subpart F inclusions get uniform investment-income treatment -- trace each dollar to the specific CFC and your direct ownership stake in it.

Accountants and tax professionals

Important update: this ruling was later modified by TSB-A-87(23.1)C/TSB-A-88(7.1)C (Nov. 2, 1992), effective for taxable years beginning on or after January 1, 1992. That modification changes the treatment of second-tier and lower-tier CFC Subpart F income specifically -- it's now deemed to flow up through the tier structure and take on the character of the taxpayer's ownership in the FIRST-TIER CFC, rather than being automatically business income as this 1988 opinion held. For pre-1992 tax years, this opinion's original business-income treatment of unowned second-tier CFC income should still control.

Common questions

Q: Does this ruling still reflect current Department policy?
A: Only for tax years before 1992. The Department significantly revised the second-tier CFC treatment in a 1992 modification (TSB-A-87(23.1)C/88(7.1)C) -- check that later ruling for taxable years 1992 and after.

Q: Is Subpart F income a real dividend for New York purposes?
A: No -- the Department explicitly rejected that characterization. It's undistributed income that's merely deemed a dividend by statute for purposes of specific deduction provisions.

Q: Can another multinational holding company rely on this ruling today?
A: No. It binds the Department only for AIG's facts, and in any event the second-tier CFC holding here was superseded by the 1992 modification for later tax years.

Citations and references

Statutes:

• Tax Law § 208.5 (investment capital); § 208.6 (investment income); § 208.8 (business income)
• Tax Law § 208.9(a)(1), (2) (subsidiary/other dividend deductions)
• Tax Law § 210.3(b) (investment income allocation)
• IRC § 957, § 958 (CFC definition; constructive ownership)
• Related opinions: TSB-A-87(23)C (Subpart F as deemed dividend); TSB-A-87(23.1)C/TSB-A-88(7.1)C (1992 modification)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1988.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a88_7c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-88 (7)C
Corporation Tax
March 18, 1988

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C871123A

On November 23, 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, for purposes of the corporate franchise tax imposed under Article
9-A of the Tax Law, Subpart F income that is attributable to the "50 percent of dividends other than
from subsidiaries" that is included in entire net income is investment income earned from investment
capital.
On September 9, 1987, the Commissioner of Taxation and Finance issued to Petitioner an
Advisory Opinion stating that Subpart F income is deemed to be a dividend for purposes of Articles
9-A and 33 of the Tax Law (TSB-A-87(23)C). Under Article 9-A, if the Subpart F income is
attributable to subsidiary capital, 100 percent of the dividend is deducted from the taxpayer's federal
taxable income pursuant to section 208.9(a)(1) of the Tax Law. If the Subpart F income is not
attributable to subsidiary capital, 50 percent of such dividend may be deducted from the taxpayer's
federal taxable income pursuant to section 208.9(a)(2) of the Tax Law. Petitioner now questions the
treatment of the 50 percent of the dividend that is included in Petitioner's entire net income.
Petitioner is a holding company which, through its direct and indirect subsidiaries, is
primarily engaged in a wide range of insurance and insurance related activities in the United States
and overseas. Petitioner's foreign operations in many cases are conducted by its controlled foreign
corporations as that term is defined by Internal Revenue Code section 957. Pursuant to the federal
Subpart F income rules, Petitioner is required to report as taxable income certain of the earnings of
its controlled foreign corporations. Internal Revenue Code section 958 provides that in determining
controlled foreign corporation status, constructive ownership rules apply. Thus, Petitioner reports
as Subpart F income the earnings of directly owned controlled foreign companies and earnings of
controlled foreign corporations that are directly owned by other controlled foreign corporations.
For federal income tax purposes, Petitioner reports Subpart F income from corporations in
which it has an indirect investment in addition to the Subpart F income from corporations in which
it has a direct investment. The amount reported is in proportion to Petitioner's ownership of each
corporation.

RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

FRANK J. PUCCIA, DIRECTOR

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER

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TSB-A-88 (7)C
Corporation Tax
March 18, 1988

Petitioner contends that the Commissioner of Taxation and Finance recognizes that Subpart
F income is in essence dividend income and that can only result from an investment in stock.
Petitioner states that it is not a dealer in securities and its controlled foreign corporations are
not held for sale to customers in the regular course of business. Therefore, Petitioner contends that
the stock of the companies are either subsidiary or investment capital. Third-tier companies and
companies whose ownership by Petitioner does not exceed 50% have been determined not to be
subsidiaries by the Commissioner. Thus, Petitioner feels that the stock of these companies must
necessarily represent investment capital of Petitioner and the Subpart F income is investment income
apportioned to New York pursuant to Section 210.3(b).
Petitioner errs in its contention that dividend income can only result from an investment in
stock. In the case of Subpart F income, such income is undistributed and is not a dividend, as the
term "dividend" is commonly defined. Subpart F income is income that is "deemed" (treated as) a
dividend for purposes of the deductions allowed by sections 208.9(a)(1) and (2) of the Tax Law.
Entire net income consists of investment income and business income. Business Income is
defined in section 208.8 of the Tax Law as entire net income minus investment income. Investment
income is defined in section 208.6 of the Tax Law as income from investment capital, to the extent
included in computing entire net income, less certain deductions.
Investment capital, is defined in section 208.5 of the Tax Law as 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, less certain deductions.
The statute clearly states that investment income is derived from investment capital.
Accordingly, Petitioner may include as investment income, Subpart F income that is deemed a
dividend but only to the extent that Petitioner has an investment, but not more than 50 percent, in
the stock of the corporation generating the Subpart F income.
When Petitioner receives Subpart F income that is deemed a dividend from a corporation in
whose stock Petitioner does not have an investment (e.g., second-tier corporation), such income is
not derived from investment capital and, thus, cannot be investment income. Accordingly, such
deemed dividend must be business income.

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TSB-A-88 (7)C
Corporation Tax
March 18, 1988

It should be noted that when Petitioner computes the receipts factor of its business allocation
percentage, the amount of Subpart F income that is deemed a dividend and which constitutes
business income is included in the denominator of the factor as "other business receipts". However,
since the Subpart F income that is deemed a dividend is not earned within New York State, the
amount of such dividend is not included in the numerator of the factor.

DATED: March 18, 1988

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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