When a New York bank computes the IBF modification for its international banking facility, does it need to first add back interbranch income and expenses between the IBF and its foreign branches that got washed out (netted to zero) in federal taxable income?

Subject

Whether a New York banking corporation, using the "IBF modification" under Tax Law § 1453(f), may adjust federal taxable income to reflect income and expenses from interbranch transactions between its New York international banking facility (IBF) and its foreign branches that are included in computing IBF eligible net income.

Plain-English summary

This bank had a New York International Banking Facility (IBF) — a special vehicle New York created in 1978 to let banks make loans to and take deposits from foreign customers largely free of state tax, competing with offshore banking centers. The bank's foreign branches funded its IBF's loans to foreign borrowers. For federal tax purposes, an IBF isn't treated as a separate entity from the rest of the bank, so when the IBF "borrows" from a foreign branch or "lends" to one, the interest expense on one side exactly offsets the interest income on the other — the transaction washes out and never shows up as a net number in federal taxable income.

That created a problem when applying New York's IBF modification, which lets a bank deduct the exempt "eligible net income" of its IBF from entire net income. The IBF modification calculation is supposed to include interbranch income and expenses (per the statute's definition of eligible income) — but if those amounts already washed out of federal taxable income before the modification is applied, subtracting the IBF modification would improperly shrink the entire net income attributable to the bank's other, non-exempt activities. That result would go beyond what the Legislature intended: the exemption was meant to shelter genuine IBF international lending, not siphon revenue from the bank's ordinary domestic/other business, and the Legislature specifically built in a "floor amount" safeguard to protect existing revenue from business already conducted through New York branches.

The Department ruled the bank must first restore (add back) the interbranch income and expenses between the IBF and its foreign branches to federal taxable income, before applying the IBF modification — so entire net income properly reflects those interbranch amounts going into the calculation, and the resulting IBF modification deduction is computed correctly rather than double-counting an exemption that was never really available for the bank's non-IBF income.

What this means for you

Banks operating a New York IBF with foreign-branch funding

If your IBF's loans are funded through interbranch transactions with foreign branches, don't rely on federal taxable income "as filed" when applying the section 1453(f) IBF modification — those interbranch amounts likely washed to zero federally and must be restored first. Skipping that step understates entire net income and overstates the exempt IBF deduction.

Accountants preparing Article 32 bank franchise returns

The mechanics: start from federal taxable income (§ 1453(a)), then modify it to recognize interbranch IBF/foreign-branch income and expenses not otherwise reflected (this ruling's holding), then apply the IBF modification itself (§ 1453(f)), further reduced by the ineligible funding amount (§ 1453(f)(5), 20 NYCRR § 18-3.10) and the floor amount (§ 1453(f)(6), 20 NYCRR § 18-3.11). This ruling follows the same approach the Department took for alien banks in Hessische Landesbank-Girozentrale, TSB-A-88(12)C.

Note on this opinion's later modification

The Department modified this opinion's conclusion on November 9, 1990 (TSB-A-89(15.1)C) — but only to clarify that a domestic bank using the IBF modification (like this one) does not need to make the further Hessische Landesbank-Girozentrale-style adjustment that applies specifically to alien (foreign) banks. The core holding here — that interbranch income/expenses must be restored before applying the IBF modification — remains intact.

Common questions

Q: Why does an interbranch transaction between an IBF and a foreign branch "wash" federally?
A: Because an IBF isn't recognized as a separate legal entity for federal income tax purposes — the interest expense on one side of an interbranch loan exactly equals the interest income on the other, so both net out of federal taxable income.

Q: Does restoring interbranch income mean the bank loses the IBF's tax exemption?
A: No. The exempt eligible net income of the IBF is still deducted through the modification — this ruling only ensures the modification is computed off the correct, complete entire-net-income base, so the exemption doesn't inadvertently reduce tax on the bank's other, non-IBF business.

Q: Can another bank rely on this ruling?
A: No. This advisory opinion binds the Department only for the taxpayer and facts presented, and cannot be relied on by anyone else. See also its later modification, TSB-A-89(15.1)C, for the domestic-vs-alien-bank distinction.

Citations and references

Statutes and regulations:

• Tax Law § 1453(a) (entire net income starts from federal taxable income)
• Tax Law § 1453(f) (IBF modification: adjusted eligible net income deduction, its computation and limits)
• Tax Law § 1453(f)(5)-(6) (ineligible funding amount and floor amount limitations)
• 20 NYCRR § 18-3 (Franchise Tax on Banking Corporations Regulations, IBF separate accounting)
• 20 NYCRR § 18-3.10, § 18-3.11 (ineligible funding amount, floor amount)
• Referenced prior opinion: Hessische Landesbank-Girozentrale, TSB-A-88(12)C (May 16, 1988)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1989.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a89_15c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-89(15)C
Corporation Tax
December 18, 1989

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C890606A

On June 6, 1989, a Petition for Advisory Opinion was received from Philip L. Krevitsky,
C.P.A., 277 Park Avenue, New York, New York 10172.
The issue raised by Petitioner, Philip L. Krevitsky, C.P.A., pertains to Article 32 of the Tax
Law for taxable years ended 1985 and after. The question is whether a New York banking
corporation, utilizing the "IBF modification" pursuant to section 1453(f) of the Tax Law, may adjust
federal taxable income to reflect the income and expenses attributable to interbranch transactions
between its New York international banking facility (hereinafter "IBF") and its foreign branches that
are included in the computation of the IBF eligible net income.
A New York commercial bank (hereinafter "bank") has an IBF in New York and files its
returns on a calendar year basis. For taxable years ended 1985 and after, the bank's foreign branches
were the IBF's primary source of funds for making loans to third party foreign persons.
The bank contends that, for federal income tax purposes, the bank reflects interbranch income
and expenses at gross when reporting federal taxable income and, as a result, corresponding
interbranch transactions between the IBF and foreign branches are offset or wash. The bank asserts
that the net effect of reporting interbranch transactions at gross, is equivalent to excluding income
and expenses attributable to transactions between its IBF and its foreign branches, since the IBF is
not recognized as a separate legal entity for federal income tax purposes.
The bank also contends that when it utilizes the IBF modification to arrive at entire net
income, a distortive result is produced when gross income and gross expenses attributable to
interbranch transactions between its IBF and its foreign branches wash in the calculation of federal
taxable income. Therefore, the bank argues that before the IBF modification is made to arrive at
entire net income, federal taxable income must be modified to restore the income and expenses
included in the calculation of IBF eligible net income when such income and expenses have
otherwise been offset or in effect eliminated in such federal taxable income.
Pursuant to section 1453(a) of the Tax Law, the starting point for computing entire net
income is federal taxable income. For federal income tax purposes, an IBF is not recognized as a
separate legal entity. Therefore, for federal income tax purposes, when the taxpayer's IBF borrows
money from a foreign branch of the taxpayer, the interest expense of the IBF equals the interest
income of the foreign branch. The same is true when the IBF lends money to a foreign branch of the
taxpayer, the interest income of the IBF equals the interest expense of the foreign branch. As a
result, interbranch transactions are offset or a wash.
TP-9 (9/88)

-2­
TSB-A-89(15)C
Corporation Tax
December 18, 1989
When computing entire net income for taxable years 1985 and after, federal taxable income
must be modified as required by sections 1453(b) through (k).
Section 1453(f) provides a modification for the adjusted eligible net income of an IBF. For
taxable years 1985 and after, section 1453(f) provides, in pertinent part:
[p]rovided the taxpayer has not made an election ... there shall
be allowed as a deduction in determining entire net income, to the
extent not deductible in determining federal taxable income, the
adjusted eligible net income of an international banking facility...
Section 1453(f) further provides, in pertinent part:
(1) The eligible net income of an international banking facility shall
be the amount remaining after subtracting from the eligible gross
income the applicable expenses.
(2) Eligible gross income shall be the gross income derived by an
international banking facility from:
(A) making, arranging for, placing or servicing loans to
foreign persons...
(B) making or placing deposits with foreign persons which are
banks or foreign branches of banks (including foreign subsidiaries or
foreign branches of the taxpayer) or with other international banking
facilities; or
(C) entering into foreign exchange trading or hedging
transactions related to any of the transactions described in this
paragraph.
(3) Applicable expenses shall be any expenses or other deductions
attributable, directly or indirectly, to the eligible gross income
described in paragraph two of this subsection.
(4) Adjusted eligible net income shall be determined by subtracting
from eligible net income the ineligible funding amount, and by
subtracting from the amount remaining the floor amount.
. . .

-3­
TSB-A-89(15)C
Corporation Tax
December 18, 1989
(8) For the purposes of this subsection the term 'foreign person' means
. . .
(C) a foreign branch of a domestic corporation (including the
taxpayer),
. . .
Section 1453(f) was added by Chapter 288 of the Laws of 1978. Section one of such Chapter
states that "the legislature intends by the enactment of this act to permit the establishment of New
York based international banking facilities for the purpose of making loans to or accept [sic] deposits
from certain foreign customers, free from ... state ... taxes." Such section also states that:
provisions permit a domestic bank to make loans to and accept
deposits from specified foreign customers through their New York
based international banking facility under essentially the same
conditions which exist outside the United States where that business
is conducted now.
The legislature further intends ... to provide for the exemption of the income of an
international banking facility ... subject to a tax floor provision to maintain revenues from
international business which is currently conducted from New York sites and, therefore,
taxable ....
A memorandum of the Rules Committee regarding Chapter 288 of the Laws of 1978 (NY
Legislative Annual, 1978, p. 198), states that:
if the international banking facility should suffer a loss, the loss may
not be taken against the income of the taxpayer's other branches ....
A further limitation is placed on the amount of the exemption
to protect revenues currently derived from existing business with
foreign customers recorded on the books of the taxpayer's New York
branches. . . . The limitation is based on a floor amount ....
As shown above, the eligible activities of an IBF are exempt from the franchise tax.
However it was not intended that such exemption would reduce the tax revenue from the taxpayer's
other activities.
A bank computes its IBF modification using the principles of separate accounting, as required
by section 1453(f) of the Tax Law and Subpart 18-3 of the Franchise Tax on Banking Corporations
Regulations. When computing such IBF modification, an improper result is achieved if the bank's
entire net income does not include income and expenses attributable to interbranch transactions
between its New York IBF and its foreign branches, because the IBF modification does recognize
such transactions. The result would be an IBF modification for income and expenses that were not
included in the computation of entire net income before the IBF modification. That is, the IBF
modification would reduce the entire net income of the taxpayer's other activities, which, as shown
herein, was not the intent of the Legislature. Therefore, the bank's entire net income as

-4­
TSB-A-89(15)C
Corporation Tax
December 18, 1989
determined before the IBF modification is allowed must recognize the interbranch income and
expenses included in the computation of the IBF eligible net income. (Hessische Landesbank Girozentrale, Advisory Op Comm T & F, May 16, 1988, (TSB-A-88(12)C)).
Therefore for taxable years 1985 and after, the bank must compute entire net income pursuant
to section 1453(a) in accordance with the legislative intent outlined above. Before the IBF
modification is made, the bank must modify federal taxable income to recognize the income and
expenses included in the computation of the IBF eligible net income of its New York IBF when such
income and expenses are not otherwise included in such federal taxable income or in the other
modifications contained in section 1453. That is, the bank's entire net income must recognize the
income and expenses attributable to interbranch transactions between the New York IBF and the
bank's foreign branches. When computing the IBF modification pursuant to section 1453(f) for
taxable years ended 1985 and after, the bank includes income and expenses attributable to
interbranch transactions between the New York IBF and the bank's foreign branches in determining
the eligible net income of its New York IBF. It should be noted, that the eligible net income of the
New York IBF must be reduced by (1) the ineligible funding amount, computed pursuant to section
1453(f)(5) of the Tax Law and section 18-3.10 of the Franchise Tax on Banking Corporations
Regulations, and (2) the floor amount, computed pursuant to section 1453(f)(6) of the Tax Law and
section 18-3.11 of the Franchise Tax on Banking Corporations Regulations.

DATED: December 18, 1989

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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