Can the distortion requirement for filing a combined report be satisfied by substantial intercorporate transactions among two or more corporations, and does one member's lack of federal income preclude a distortion finding?

Plain-English summary

Schroder & Co. Inc. asked whether the distortion requirement for filing a combined report (20 NYCRR 6-2.3) can be satisfied by substantial intercorporate transactions among two or more corporations. A combined report has three requirements -- stock ownership, a unitary business, and distortion if the corporations report separately. The distortion element is presumed when there are substantial intercorporate transactions among the group.

The regulation lists qualifying intercorporate transactions (manufacturing or acquiring goods/property or performing services for other group members; selling goods acquired from members; financing members' sales; performing related customer services with common facilities and employees), while incidental service functions (accounting, legal, personnel) don't count. The presumption can be met where as little as 50% of a corporation's receipts or expenses come from qualifying activities with one other member or a combinable group -- it need not transact with every member.

Applying this, the Department said that the fact that one member (Lewco) generally has no federal taxable income or loss does not preclude a finding that separate reporting distorts the group's New York activities, business, income, or capital. However, whether Schroder and Lewco actually meet the distortion requirement is a question of fact that cannot be determined in an advisory opinion.

What this means for you

Substantial intercorporate transactions presume distortion

When group members have substantial qualifying intercorporate transactions, separate reporting is presumed to distort, supporting a combined report.

The 50% threshold and a combinable group

The presumption can be met where as little as half of a corporation's receipts or expenses are from qualifying activities with one other member or a combinable group -- not with every member.

A member with no federal income still counts

A member's lack of federal taxable income or loss does not, by itself, prevent a distortion finding.

Common questions

Q: Can two corporations alone meet the distortion test? A: Yes. Substantial intercorporate transactions can exist between as few as two corporations (or with a combinable group).

Q: Do accounting and legal services count?
A: No. Incidental service functions like accounting, legal, and personnel services are not counted.

Q: Does the opinion decide that Schroder must file combined? A: No. Whether the distortion requirement is met is a question of fact outside an advisory opinion.

Citations and references

Statutes, regulations, and authorities:

• Tax Law section 211.4 (combined reports)
• 20 NYCRR 6-2.1 (requirements for a combined report)
• 20 NYCRR 6-2.2 (corporations includable in a combined report)
• 20 NYCRR 6-2.3 (distortion requirement; substantial intercorporate transactions)
• Schroder & Co. Inc., TSB-A-97(28)C (Dec. 4, 1997)

Date note: the scraper's date heuristic initially picked up the Petition-received date (October 20, 1997) rather than the document's actual DATED sign-off. Corrected issued_date to December 4, 1997, matching the "DATED:" line in the original text below.

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_28c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-97(28)C
Corporation Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C971020B

On October 20, 1997, a Petition for Advisory Opinion was received from Schroder & Co. Inc., Equitable Center, 787 Seventh Avenue, New York, New York 10019-6016. The issue raised by Petitioner,Schroder & Co. Inc., 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. Petitioner, 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. Petitioner owns 80 percent of the voting stock of Lewco Securities Corp. ("Lewco"), another New York taxpayer. Lewco acts as a clearing broker for Petitioner 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, Lewco processes and settles the securities transactions of Petitioner and its other owners (the "patrons") in exchange for fees. Fees charged by Lewco generally approximate its cost of providing clearing services to Petitioner and its other patrons, rather than an arm's length charge. In fact, amounts charged to Petitioner and its other patrons for services provided by Lewco are sometimes less than cost because Lewco 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 Petitioner and its other patrons. Lewco derives more than 50 percent of its receipts from the fees which it charges for services provided to Petitioner. As a cooperative, Lewco distributes the taxable income which it earns in the conduct of its cooperative business to Petitioner and its other patrons in proportion to their volume of business with Lewco. Lewco is allowed to deduct these distributions ("patronage dividends"), and as a consequence, Lewco 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

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Corporation Tax

of earnings derived from patronage-related activities must be made pursuant to a pre-existing obligation of the 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 Petitioner and Lewco 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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Corporation Tax

(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 Petitioner and Lewco 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 Lewco does not generally have

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TSB-A-97(28)C
Corporation Tax

federal taxable income or loss would not preclude the finding of distortion of the activities, business, income or capital between Petitioner and Lewco pursuant to section 6-2.3 of the Article 9-A Regulations. However, the question of whether Petitioner and Lewco 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: December 4, 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.