NY TSB-A-94(5)C Corporation Tax 1994-03-08

For Article 9-A, can a corporation's loan to a partnership be classified as investment capital, with the interest treated as investment income?

Short answer: No. Friendly Home Parties, a New York S corporation, made a $3.5 million demand loan to a partnership (owned by individuals who hold 70% of the corporation) and receives 7% interest, taking back an instrument; it is not principally engaged in lending. Investment capital under section 208.5 means investments in stocks, bonds and other securities that are corporate or governmental. A loan to a partnership is not an investment in a corporate or governmental security, so it is not investment capital, and the interest on it is not investment income under section 208.6. The loan and its interest fall into business capital and business income instead.

Disclaimer: This is an official New York State Department of Taxation and Finance Advisory Opinion (TSB-A), issued by the Office of Counsel at a taxpayer's request. It is limited to the facts set forth in it and binds the Department only with respect to the petitioner to whom it was issued, and only if that petitioner fully and accurately described all relevant facts; another taxpayer cannot rely on it. It reflects the law, regulations, and Department policy in effect when issued and may since have changed. Taxpayer-identifying details are redacted. New York State and local sales taxes are administered centrally by the Department. This summary is informational only and is not legal or tax advice. Consult a licensed New York tax professional about your specific situation.

About this page: The plain-English summary, reader guidance, and Q&A below were written by Ezel based on the official state tax ruling. The original ruling (linked at the bottom of this page, or PDF in the sidebar) is the authoritative source for any reliance.

View original ruling (PDF)

Plain-English summary

Friendly Home Parties, Inc., a New York S corporation, made a $3.5 million demand loan to a partnership -- one owned by individuals who together hold a 70% interest in Friendly Home Parties -- and receives 7% annual interest, taking back an instrument for the funds. Friendly Home Parties is not principally engaged in lending, and has other funds invested in cash equivalents. It asked whether, for Article 9-A, that loan to the partnership is investment capital, with the interest treated as investment income.

No. Section 208.5 defines investment capital as "investments in stocks, bonds and other securities, corporate and governmental," not held for sale to customers, excluding subsidiary capital and the taxpayer's own stock. A loan to a partnership -- evidenced by an instrument issued by the partnership -- is not an investment in a corporate or governmental security. So it is not investment capital under section 208.5, and the interest on it is not investment income under section 208.6. The loan is business capital and the interest is business income -- they enter the business allocation rather than the investment allocation.

What this means for you

Investment capital is limited to corporate and governmental securities

Section 208.5 reaches stocks, bonds, and other securities that are corporate or governmental. Instruments that are neither -- like a partnership's debt -- do not qualify.

A loan to a partnership is business capital, not investment capital

Because partnership debt is not a corporate or governmental security, a corporation's loan to a partnership is business capital, and the interest is business income, not investment income.

Not-principally-lending does not convert it to investment capital

It did not matter that the lender was not in the lending business; the classification turns on the nature of the instrument, not the lender's main activity.

Common questions

Q: My corporation loaned money to a partnership. Is that investment capital?
A: No. A loan to a partnership is not a corporate or governmental security, so it is not investment capital under section 208.5.

Q: Is the interest investment income?
A: No. Because the loan is not investment capital, the interest is business income, not investment income under section 208.6.

Q: Would it matter if I were in the lending business?
A: The classification here turns on the nature of the instrument (partnership debt), not on whether you are principally engaged in lending.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 208.5 (investment capital -- investments in stocks, bonds and other corporate or governmental securities)
- Tax Law section 208.6 (investment income from investment capital)
- 20 NYCRR 3-4.2 (investment capital regulation)

Source

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-94 (5) C
Corporation Tax
March 8, 1994

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C931217A

On December 17, 1993, a Petition for Advisory Opinion was received from Friendly Home
Parties, Inc., 25 Corporate Circle, Albany, New York 12203.
The issue raised by Petitioner, Friendly Home Parties, Inc., is whether for purposes of Article
9-A of the Tax Law, a loan from Petitioner to a partnership can be classified as investment capital
under section 3-4.2 of the Business Corporation Franchise Tax Regulations (hereinafter
"Regulations") and the income from such loan treated as investment income.
Petitioner is a New York S corporation and the partnership is owned by individuals who
collectively own a 70 percent interest in Petitioner. As an investment, Petitioner made a demand
loan of $3,500,000 to the partnership and receives interest at a seven percent annual rate of return.
An instrument was acquired by Petitioner in exchange for the funds. Petitioner is not principally
engaged in the business of lending funds. Petitioner has a substantial amount of other funds invested
in cash and cash equivalents for a stated return.
Section 208.5 of the Tax Law defines the term "investment capital" 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 and stock issued by the taxpayer, provided,
however, that, in the discretion of the [Commissioner of Taxation and Finance], there shall be
deducted from investment capital any liabilities which are directly or indirectly attributable to
investment capital".
Section 208.6 of the Tax Law defines the term "investment income" as the sum of (a) income,
including capital gains in excess of capital losses, from investment capital and (b) the amounts
described in section 208.9(b)(12),(13) and (14) of the Tax Law to the extent included in computing
entire net income, less, (c) in the discretion of the commissioner, any deductions allowable in
computing entire net income which are directly or indirectly attributable to investment capital or
investment income, and (d) such portion of any net operating loss deduction allowable in computing
entire net income, as the investment income, before such deduction, bears to entire net income,
before such deduction, provided, however, that in no case shall investment income exceed entire net
income.
Section 3-4.2 of the Regulations defines the term "investment capital" as follows:
(a)(1) The term investment capital means the taxpayer's investments in stocks, bonds
and other securities issued by a corporation (except as provided in paragraph (2) of
this subdivision) or by the United States, any state, territory or possession of the
United States, the District of Columbia, or any foreign country, or any political
subdivision or governmental instrumentality of any of the foregoing (emphasis
added)

-2
TSB-A-94 (5) C
Corporation Tax
March 8, 1994
(2)
...

Investment capital does not include:

(iii) securities of an individual, partnership, trust or other nongovernmental
entity which is not a corporation within the definition contained in section 208.1 of
the Tax Law ... (emphasis added)
...
(c) For purposes of paragraph (1) of subdivision (a) of this section, the phrase stocks,
bonds and other securities, means:
(1) stocks and similar corporate equity instruments, such as business trust certificates,
and units in a publicly traded partnership included in the definition of "corporation"
contained in section 208.1 of the Tax Law;
(2) debt instruments issued by the United States, any state, territory or possession of
the United States, the District of Columbia, or any foreign country, or any political
subdivision or governmental instrumentality of any of the foregoing;
(3) qualifying corporate debt instruments ...
(4) options on any item described in paragraph (1), (2), or (3) of this subdivision and
not described in paragraph (2) of subdivision (a) of this section, or on a stock or bond
index, or on a futures contract on such an index, unless the options are purchased
primarily to diminish the taxpayer's risk of loss from holding one or more positions
in assets which constitute business or subsidiary capital; and
(5) stock rights and stock warrants not in the possession of the issuer thereof.
Accordingly, a loan to a partnership is not investment capital pursuant to section 208.5 of the
Tax Law and section 3-4.2(a)(1) and (2) of the Regulations.
Therefore, where Petitioner makes a loan of $3,500,000 to a partnership and acquires an
instrument issued by the partnership in exchange for the funds, such loan does not constitute
investment capital pursuant to section 208.5 of the tax Law and section 3-4.2 of the Regulations, and
the interest income attributable to such loan does not constitute investment income pursuant to
section 208.6 of the Tax Law.

DATED: March 8, 1994

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

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