Our finance subsidiary lends money to affiliated companies in the same corporate family to help fund their capital needs, evidenced by unsecured, non-negotiable intercompany notes that are never sold on any market or exchange. Does the interest we earn on those notes count as investment income from investment capital (potentially more favorably taxed) or as business income from business capital under New York's Article 9-A franchise tax?

Plain-English summary

Mobil International Finance Corp. was in the business of lending money to various companies within the Mobil corporate family to help finance their capital requirements. Those loans were evidenced by intercompany notes -- issued for a term of one year or more, unsecured, not sold in the open market or on any recognized exchange, and not negotiable instruments. Petitioner was under audit for 1975-1977 and raised the classification question for those years and subsequent ones: did the interest on these notes constitute "investment income" generated by "investment capital," or "business income" generated by "business capital," under Article 9-A?

Tax Law § 208.7 and 20 NYCRR § 3-4.3(a) define "business capital" as the total average fair market value of all of a taxpayer's assets, excluding treasury stock and assets constituting subsidiary or investment capital, less certain liabilities. Tax Law § 208.5 defines "investment capital" to include investments in "stocks, bonds and other securities, corporate and governmental." The regulations flesh out "other securities" (20 NYCRR § 3-4.2(c)) as instruments "of a like nature as stocks and bonds, which are customarily sold in the open market or on a recognized exchange, designed as a means of investment and issued for the purpose of financing corporate enterprises" -- language applicable to 1976-forward years but materially identical to the 1975 regulations.

Because one of the defining conditions for "other securities" is that the instrument be customarily sold in the open market or on a recognized exchange, and the Mobil intercompany notes were never sold on any market or exchange -- and were not even negotiable -- they could not qualify as "other securities" and therefore could not constitute investment capital. The Department held the notes were instead business capital, meaning the interest income they generated was business income for all of the years in question, both the years under audit and subsequent years.

What this means for you

Marketability and negotiability are the deciding factors for "investment capital" notes

If your corporation holds intercompany or related-party notes that are never sold on an open market or recognized exchange, and aren't negotiable, expect them to be classified as business capital rather than investment capital -- regardless of how bond-like or investment-like the note otherwise looks.

This classification question directly affects how you compute your Article 9-A tax base

Whether an asset is investment capital or business capital changes which components of Article 9-A's tax computation it falls into -- getting this wrong on intercompany financing notes is a common audit issue for corporate treasury/finance subsidiaries within larger groups.

Common questions

Q: Can we treat interest on non-negotiable, non-tradable intercompany notes as investment income for New York tax purposes?
A: No -- under this ruling, notes that aren't customarily sold on the open market or a recognized exchange (and especially non-negotiable ones) don't qualify as "other securities" and are treated as business capital, making the interest business income.

Q: Does the one-year-plus term of these notes matter to the classification?
A: The ruling doesn't rely on term length -- the dispositive facts were the notes' lack of open-market/exchange trading and lack of negotiability, not their maturity.

Citations and references

Statutes and guidance:

• Tax Law § 208.5
• Tax Law § 208.7
• 20 NYCRR § 3-4.2(c)
• 20 NYCRR § 3-4.3(a)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1980.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/h80_21c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-H-80(21)C
Corporation Tax
September 12, 1980

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C800620A

On June 20, 1980, a Petition for Advisory Opinion was filed by Mobil
International Finance Corp., P.O. Box 900, Dallas, Texas 75221.
The issue raised is whether the interest on certain intercompany notes held
by Petitioner constitutes investment income generated by investment capital or
business income generated by business capital, within the meaning of the
applicable provisions of Article 9-A of the Tax Law. Petitioner is presently
under audit with respect to calendar years 1975 through 1977 and raises this
issue with respect to both these and subsequent years.
Information contained in the petition, supplemented by a memorandum
prepared by the Advisory Opinion Unit of the Audit Division and acquiesced in by
Petitioner, reveals the following. Petitioner lends money to various companies
in the Mobil family in order to help such companies finance their capital
requirements. These loans are evidenced by the intercompany notes which
constitute the subject of this discussion. The notes are issued for a period of
one year or more, are unsecured, are not sold in the open market or on a
recognized exchange and are not negotiable instruments.
The term "business capital" is defined, in section 208.7 of the Tax Law and
section 3-4.3(a) of the Corporation Franchise Tax Regulations, as the total
average fair market value of all of the taxpayer's assets exclusive of treasury
stock, assets constituting subsidiary capital and investment capital, less
certain liabilities. 20 NYCRR 3-4.3(a).
The term "investment capital" is defined in section 208.5 of the Tax Law
to include "...investments in stocks, bonds and other securities, corporate and
governmental .... " Section 3-4.2(c) of the Corporation Franchise Tax Regulations
defines the term "other securities" to include corporate securities" . . .of a
like nature as stocks and bonds, which are customarily sold in the open market
or on a recognized exchange, designed as a means of investment and issued for the
purpose of financing corporate enterprises and providing a distribution of rights
in, or obligations of, such enterprises." 20 NYCRR 3-4.2(c). The foregoing is
applicable to taxable years beginning on or after January 1, 1976 but identical
language was contained in the regulations applicable to 1975.
As set forth above, one of the conditions which must be met in order for
obligations to be included in the category of "other securities" is that they be
customarily sold in the open market or on a recognized exchange. The notes at
issue are not sold in the open market or on a recognized exchange. Indeed, the
notes are not negotiable.
Accordingly, such notes are not "other securities" and do not constitute
investment capital within the meaning of the provisions the Tax Law and
regulations cited above. The notes constitute business capital, and the interest
income derived therefrom constitutes business income with respect to all of the
periods in question.
DATED:

September 9, 1980

JAMES H. TULLY., COMMISSIONER

s/LOUIS ETLINGER
Deputy Director
Technical Services Bureau
LOUIS M. JACOBSON, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR