If a corporation with deferred installment-sale gain on New York real estate transfers the remaining notes to an affiliate before the gain is fully recognized, must it accelerate the deferred gain into New York entire net income right away?

Plain-English summary

Corporation X, a New York corporation that files a federal consolidated return with its parent Corporation Y, stopped operating and sold its operating assets in 1991. Its remaining assets include two purchase-money notes from a 1982 installment sale of New York City real property -- no gain was recognized at the time of sale, but substantial gain will be recognized when the notes mature in 1992 and 1997. Ernst & Young, on behalf of the petitioner, asked how two proposed restructurings would affect New York's treatment of that deferred gain:

• Scenario 1 -- Corporation X dividends the notes to a newly formed non-New York holding company (included in Y's federal consolidated return), raising questions about whether Corporation X must currently recognize the full deferred gain, whether the IRC section 311 gain enters entire net income, and whether the new holding company gets New York nexus merely by owning the notes.
• Scenario 2 -- Corporation X instead sells the notes to an affiliate, Corporation A, deferring the resulting gain for federal purposes under the consolidated-return rules.

The Department's answer: in both scenarios, Corporation X computes entire net income starting from federal taxable income as if it had filed a separate federal return (following Leonard Koval, CPA, TSB-A-84(2)C) -- so the section 311 gain (dividend scenario) or sale gain (sale scenario) enters that starting point even though federal consolidated-return rules defer it. Beyond that, Tax Law section 208.9(d) and Regulations section 3-2.7 give the Commissioner discretion to reassign which year an item of income belongs in "whenever necessary... to properly reflect entire net income" -- illustrated by regulatory examples where a corporation selling New York real estate on an installment basis and later terminating its New York taxable status must include the full deferred profit in the year its status ends. The Department indicated it would exercise that discretion in a similar situation to require the full 1982 gain into the year Corporation X transfers the notes. But it stressed that discretion is exercised only as to an actual taxpayer on actual facts -- not a hypothetical one -- so whether the Commissioner will actually do so here is a factual question an advisory opinion cannot resolve in advance. On the nexus question in Scenario 1, mere ownership of the notes by the new holding company, without more, is not enough by itself to create New York nexus.

What this means for you

Corporations with deferred installment-sale gain

If you're holding installment notes from a New York property sale with gain deferred, transferring those notes to an affiliate -- whether by dividend or sale -- can trigger the Commissioner's discretionary authority to accelerate the deferred gain into your entire net income for the transfer year, even if the transaction is tax-deferred federally under consolidated-return rules.

Accountants and tax professionals

The core mechanic: entire net income for a group member filing a federal consolidated return is computed on a separate-return basis (Koval), so intercompany deferral doesn't carry over to New York. Layered on top is the Commissioner's section 208.9(d)/Regulations 3-2.7 discretion to reassign timing to prevent distortion -- a fact-specific inquiry the Department won't pre-clear in an advisory opinion.

Holding companies acquiring notes secured by New York property

Simply owning notes from a New York real estate sale isn't itself enough to create New York nexus -- nexus still requires doing business, employing capital, or owning/leasing property/maintaining an office in New York in a more substantive sense.

Common questions

Q: Does transferring installment notes to an affiliate always accelerate the deferred gain for New York?
A: Not automatically, but the Commissioner has discretion under section 208.9(d) to require it where necessary to prevent distortion of entire net income -- and the Department signaled it would likely use that discretion on facts like these.

Q: Will the Department confirm exercise of that discretion in advance for a specific taxpayer?
A: No -- whether the Commissioner will actually exercise the discretion in a particular case is a factual matter that can't be determined in an advisory opinion; the opinion only applies statutes/regulations to the facts presented.

Q: Does mere ownership of notes secured by New York property create nexus for the owner?
A: No, not by itself -- nexus requires doing business, employing capital, owning/leasing property, or maintaining an office in New York in a more substantial sense.

Citations and references

Statutes and regulations:

• Tax Law section 209.1 (franchise tax through the date the franchise ceases)
• Tax Law section 208.9 (entire net income) and section 208.9(d) (Commissioner's discretion to reassign timing)
• Business Corporation Franchise Tax Regulations section 3-2.7 (examples 2 and 3, installment-sale acceleration)
• IRC section 311 (gain on distribution of appreciated property)

Prior opinion cited in the ruling:

• Leonard Koval, CPA, TSB-A-84(2)C

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1992.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a92_2c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-92 (2) C
Corporation Tax
January 31, 1992

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C910912A

On September 12, 1991, a Petition for Advisory Opinion was received from Kenneth T.
Zemsky, Ernst & Young, 277 Park Avenue, New York, New York 10172.
The issue raised by Petitioner, Kenneth T. Zemsky, is how to compute entire net income with
respect to the rules relating to acceleration of deferred gain under two proposed scenarios.
Corporation X is a New York corporation and is owned by Corporation Y, a non-taxpayer.
For federal income tax purposes, Corporation X and Corporation Y file on a consolidated basis.
During 1991, Corporation X stopped its operations and sold its operating assets. Corporation X will
have a net operating loss for 1991.
Corporation X's remaining assets include two purchase money notes originating from the sale
of real property in New York City in 1982. The property was used in Corporation X's operations.
The sale was essentially treated as an installment sale with no recognized gain in 1982, but
substantial gains will be recognized when the notes mature in 1992 and 1997. The 1992 maturing
note may be redeemed in 1991.
Corporation X also owns two parcels of land, one of which is located in New York State.
Scenario #1: A non-New York holding company is established between Corporation X and
Corporation Y and is included in Corporation Y's federal consolidated return. Corporation X will
dividend the notes to the new holding company.
Questions:
1.

Would Corporation X be required to currently recognize the entire gain from the
installment sale?

2.

If no, would Corporation X be required to include the section 311 of the Internal
Revenue Code (hereinafter "IRC") gain in entire net income?

3.

Would ownership of the notes result in the new holding company having nexus in
New York State?

TP-9 (9/88)

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Corporation Tax
January 31, 1992

Section 209.1 of the Tax Law provides that the franchise tax is imposed for all or any part
of each taxable year during which a taxpayer exercises its corporate franchise. Accordingly, every
taxpayer is required to pay a tax measured by its entire net income base (or other applicable basis)
up to the date on which it ceases to possess a franchise.
Section 208.9 of the Tax Law defines entire net income as total net income from all sources
which shall be presumably the same as the entire taxable income which the taxpayer is required to
report to the United States Treasury Department and is adjusted as required by sections 208.9 and
210.3 of the Tax Law. Where a corporation participates in the filing of a consolidated return for
federal income tax purposes, but files a separate return for New York franchise tax purposes, federal
taxable income is computed as if the corporation had filed a separate federal return (See: Leonard
Koval, CPA, Adv Op St Tax Comm, March 16, 1984, TSB-A-84(2)C.)
Section 208.9(d) of the Tax Law and section 3-2.7 of the Business Corporation Franchise Tax
Regulations (hereinafter "Regulations") promulgated thereunder, provides that the Commissioner
of Taxation and Finance may, whenever necessary in order to properly reflect the entire net income
of a taxpayer, determine the year or period in which any item of income or deduction shall be
included, without regard to the method of accounting employed by the taxpayer. Examples 2 and 3
of section 3-2.7 of the Regulations provides:
Example 2:

A foreign corporation sells its New York State real estate on an installment
basis, and terminates its taxable status in New York State in the year of the
sale. The full profit on the sale must be included in entire net income in the
year of the sale.

Example 3:

A foreign corporation sells its New York State real estate on an installment
basis, and terminates its taxable status in New York State in a subsequent
taxable year prior to the receipt of all of its installment payments. The full
profit or the remaining profit on the sale must be included in entire net
income in the year it terminates its taxable status in New York State.

Herein, after Corporation X dividends the notes to the new holding company, Corporation
X will not be dissolved and will continue to be a taxpayer under Article 9-A of the Tax Law. As in
Koval, supra., when Corporation X computes its entire net income, its starting point is federal
taxable income computed as if Corporation X had filed a separate return for federal income tax
purposes.
With respect to questions i and 2, for the taxable year Corporation X dividends the notes to
the new holding company, the amount of the gain computed pursuant to section 311 of the IRC will
be included in the starting point for computing entire net income. Pursuant to section 208.9(d) of the
Tax Law and section 3-2.7 of the Regulations, the Commissioner of Taxation and Finance, in similar
situations, would exercise his authority and require that the full profit from the sale, in 1982,

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Corporation Tax
January 31, 1992

of the real property located in New York City be included in Corporation X's entire net income for
the taxable year in which Corporation X dividends the notes to the new holding company.
However, the Commissioner of Taxation and Finance would exercise such authority,
pursuant to section 208.9(d) of the Tax Law, only with respect to an actual taxpayer, not a
hypothetical corporation or taxpayer. Further, the determination of whether the Commissioner of
Taxation and Finance would exercise his authority in a particular situation is a factual matter not
susceptible of determination in an Advisory Opinion. An Advisory Opinion merely sets forth the
applicability of pertinent statutory and regulatory provision to "a specified set of facts." Tax Law,
section 171, subd. twenty-fourth; 20 NYCRR 901.1(a).
With respect to question 3, a foreign corporation is taxable in New York State for taxable
years in which it is doing business, employing capital, owning or leasing property in New York State
or maintaining an office in New York State. The mere ownership of notes acquired as a dividend
from Corporation X, is not sufficient to make the new holding company subject to franchise tax
under Article 9-A of the Tax Law.
Scenario #2: Corporation A, a subsidiary of Corporation Y, is included in Corporation Y's federal
consolidated return. Corporation X sells the notes to Corporation A. Corporation X will realize a
gain upon completing this sale. The gain from this sale is deferred for federal income tax purposes.
Question:
When computing entire net income, does Corporation X recognize the gain in the year of the
sale?
As in Scenario 1, Corporation X computes its entire net income by starting with federal
taxable income computed as if Corporation X had filed a separate federal return. When computing
the federal proforma return, the gain on the sale of the notes to Corporation A will be recognized in
the taxable year of such sale, even though such gain is deferred for federal income tax purposes
because of the filing of a federal consolidated return. As in Scenario 1, pursuant to section 208.9(d)
of the Tax Law and section 3-2.7 of the Regulations, the Commissioner of Taxation and Finance
would exercise his authority in a similar situation and require that the full profit from the sale, in
1982, of the real property located in New York City be included in Corporation X's entire net income
for the taxable year in which Corporation X sells the notes to Corporation A.

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Corporation Tax
January 31, 1992

Again, the Commissioner of Taxation and Finance would exercise such authority pursuant
to section 208.9(d) of the Tax Law only with respect to an actual taxpayer and the determination of
whether the Commissioner of Taxation and Finance would exercise his authority in a particular
situation is a factual matter not susceptible of determination in an Advisory Opinion.

DATED: January 31, 1992

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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