Can the distortion requirement for filing a New York combined report be met when one of the corporations is a Subchapter T cooperative that generally reports no federal taxable income?

Plain-English summary

Coopers & Lybrand, LLP asked, on behalf of an investment-banking group, whether the distortion requirement for filing a New York combined report (20 NYCRR 6-2.3) can be met when one of the corporations -- a clearing broker ("Corporation Y") -- is taxed federally as a Subchapter T cooperative and, because it deducts patronage dividends, generally reports no federal taxable income or loss. Corporation Y derives more than 50% of its receipts from clearing fees charged to its affiliate ("Corporation X").

It is not precluded. A group that meets the stock-ownership and unitary-business tests may be required or permitted to file a combined report if separate reporting distorts the group's New York activities, and distortion is presumed when there are substantial intercorporate transactions (as little as 50% of a corporation's receipts or expenses from qualifying activities with another member). The fact that Corporation Y generally has no federal taxable income or loss does not preclude a finding of distortion between it and Corporation X.

But whether distortion actually exists is a question of fact that an advisory opinion cannot decide (Tax Law section 171, Twenty-fourth).

What this means for you

Combined reporting turns on three tests: ownership, unitary business, and distortion

A group may be required or allowed to file a combined report only if the capital-stock/control test and the unitary-business test are met and separate reporting would distort the group's New York activities, business, income, or capital.

Distortion is presumed from substantial intercorporate transactions

Distortion is presumed when at least 50% of a corporation's receipts or expenses come from qualifying activities (making/selling goods, financing sales, or performing services) with another member or a combinable group. Incidental accounting, legal, and personnel services do not count.

A no-income cooperative member doesn't block distortion

A member taxed as a Subchapter T cooperative that deducts patronage dividends and reports no federal taxable income or loss can still be part of a distortion finding; its lack of federal income does not preclude combination. Whether distortion exists remains a fact question.

Common questions

Q: When can a group of corporations file a New York combined report?
A: When the stock-ownership/control test and the unitary-business test are met and separate reporting distorts the group's New York activities -- distortion being presumed where there are substantial intercorporate transactions.

Q: Does a cooperative member with no taxable income prevent a combined report?
A: No. The Department says a member's status as a Subchapter T cooperative that generally reports no federal income or loss does not preclude a finding of distortion between it and an affiliate.

Q: Did this opinion decide that a combined report was required here?
A: No. Whether the distortion requirement is actually satisfied is a question of fact that cannot be determined in an advisory opinion.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 171 (Twenty-fourth) (advisory opinions limited to a stated set of facts)
- Tax Law section 211 (combined reports)
- 20 NYCRR 6-2.1 (combined report standards; separate-entity rule)
- 20 NYCRR 6-2.3 (distortion presumed from substantial intercorporate transactions; 50% test)
- IRC sections 1381-1388 (Subchapter T cooperatives; patronage dividends deduction)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1997.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a97_15c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-97(15)C
Corporation Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C970321B

On March 21, 1997, a Petition for Advisory Opinion was received from
Coopers & Lybrand, LLP, 1301 Avenue of the Americas, New York, New York 10019­
6013.
The issue raised by Petitioner, Coopers & Lybrand, LLP, is whether the
"distortion" requirement of section 6-2.3 of the Business Corporation Franchise
Tax Regulations ("Article 9-A Regulations"), may be satisfied by two or more
corporations seeking to file combined reports where one of the corporations is
taxed as a "cooperative" under Subchapter T of the Internal Revenue Code ("IRC").
Petitioner submits the following facts as the basis for this Advisory
Opinion.
Corporation X, a New York taxpayer, is an investment banking firm which is
involved in all major areas of investment banking, securities sales and trading,
securities research, investment advising, money management and risk arbitrage.
Its principal activity is that of a full-service broker-dealer providing a wide
range of financial services to retail and institutional clients, including
securities and options brokerage, investment banking and investment advisory
services. It also trades in corporate, government, municipal and federal agency
securities for its own account.
Corporation X owns 80 percent of the voting stock of Corporation Y, another
New York taxpayer. Corporation Y acts as a clearing broker for Corporation X and
other broker-dealers and is treated for federal income tax purposes as a non­
exempt cooperative under Subchapter T (sections 1381-1388) of the IRC. As a
clearing broker, Corporation Y processes and settles the securities transactions
of Corporation X and its other owners (the "patrons") in exchange for fees. Fees
charged by Corporation Y generally approximate its cost of providing clearing
services to Corporation X and its other patrons, rather than an arm's length
charge. In fact, amounts charged to Corporation X and its other patrons for
services provided by Corporation Y are sometimes less than cost because
Corporation Y engages in certain other income-producing activities related to its
cooperative business, the income from which is used to offset the cost of the
services provided to Corporation X and its other patrons. Corporation Y derives
more than 50 percent of its receipts from the fees which it charges for services
provided to Corporation X.
As a cooperative, Corporation Y distributes the taxable income which it
earns in the conduct of its cooperative business to Corporation X and its other
patrons in proportion to their volume of business with Corporation Y.
Corporation Y is allowed to deduct these distributions ("patronage dividends"),
and as a consequence, Corporation Y generally does not report federal taxable
income or loss. Petitioner states that to qualify as patronage dividends under
section 1388(a) of the IRC, distributions of earnings derived from patronage­
related activities must be made pursuant to a pre-existing obligation of the

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cooperative to pay such amounts, and must be based on the quantity or value of
business done with or for each patron, not on the basis of relative
stockholdings.
Petitioner is not asking whether the distortion requirement is actually
satisfied, rather, the question focuses on whether a finding of distortion would
necessarily be precluded where one or more of the corporations seeking permission
to file a combined report is a cooperative and generally reports no federal
taxable income or loss.
It is assumed that Corporation X and Corporation Y
satisfy the stock ownership and unitary business requirements for filing a
combined report.
Section 6-2.1 of the Article 9-A Regulations provides that:
(a) Every corporation is a separate taxable entity and shall file
its own report.
However, the [Commissioner of Taxation and
Finance], in [his] discretion, may require a group of corporations
to file a combined report or may grant permission to a group of
corporations to file a combined report where:
(1) the requirement of stock ownership or
described in section 6-2.2(a) of this Part) is met;

control

(as

(2) the group of corporations is engaged in a unitary business
(as described in section 6-2.2(b) of this Part); and
(3) the other requirement set forth in section 6-2.3 ... of
this Part ... has been met.
(b) Each corporation in the combined report must compute and show
the tax which would have been required to be shown if filed on a
separate basis.
(c) The decision to permit or require a combined report will be
based on the facts in each case using the requirements set forth in
this Part.
Section 6-2.3 of the Article 9-A Regulations provides that:
(a) If the capital stock and unitary business requirements described
in section 6-2.2 of this Part have been met, the [Commissioner of
Taxation and Finance] may permit or require a group of taxpayers to
file a combined report if reporting on a separate basis distorts the
activities, business, income or capital in New York State of the
taxpayers.
The activities, business, income or capital of a
taxpayer will be presumed to be distorted when the taxpayer reports
on a separate basis if there are substantial intercorporate
transactions among the corporations.
...

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(c) In determining whether there are substantial intercorporate
transactions, the [Commissioner of Taxation and Finance] will
consider transactions directly connected with the business conducted
by the taxpayer, such as:
(1) manufacturing or acquiring goods or property or performing
services for other corporations in the group;
(2) selling goods acquired from other corporations in the
group;
(3) financing sales of other corporations in the group; or
(4) performing related
facilities and employees.

customer

services

using

common

Service functions will not be considered when they are
incidental to the business of the corporation providing such
service.
Service functions include, but are not limited to,
accounting, legal and personnel services.
The substantial
intercorporate transaction requirement may be met where as little as
50 percent of a corporation's receipts or expenses are from one or
more qualified activities described in this subdivision. It is not
necessary that there be substantial intercorporate transactions
between any one member with every other member of the group. It is,
however,
essential
that
each
corporation
have
substantial
intercorporate transactions with one other corporation or with a
combined or combinable group of corporations...
(d) If a taxpayer fails to meet the presumption of distortion
because it does not have substantial intercorporate transactions
with any corporation described in section 6-2.2 of this Part or with
a combined or combinable group of such corporations and if the
filing of a report on a separate basis nevertheless results in a
distortion of such taxpayer's activities, business, income or
capital in New York State then the [Commissioner of Taxation and
Finance] will permit or require the filing of a combined report. If
a taxpayer meets the presumption of distortion because it has
substantial intercorporate transactions with any corporation
described in section 6-2.2 of this Part or with a combined or
combinable group of such corporations and if the filing of a report
on a separate basis does not result in a distortion of such
taxpayer's activities, business, income or capital in New York
State, then the [Commissioner of Taxation and Finance] will not
permit or require the filing of a combined report....
In this case, it is assumed that Corporation X and Corporation Y meet the
stock ownership requirement and the unitary business requirement of section 6-2.1
of the Article 9-A Regulations. The third requirement set forth in section 6-2.3
of the Article 9-A Regulations discusses the distortion of activities, business,
income or capital in New York State of a group of taxpayers that may occur if
they report on a separate basis. The fact that Corporation Y does not generally

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have federal taxable income or loss would not preclude the finding of distortion
of the activities, business, income or capital between Corporation X and
Corporation Y pursuant to section 6-2.3 of the Article 9-A Regulations.
However, the question of whether Corporation X and Corporation Y meet the
distortion requirement set forth in section 6-2.3 of the Article 9-A Regulations
is a question of fact that is not susceptible of determination in an advisory
opinion. Tax Law, §171.Twenty-fourth; 20 NYCRR 2376.1(a).

DATED:

June 26, 1997

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

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