Our 'Edge Act' international banking subsidiary has only ever operated out of a single New York office and reported all of its income as New York income. Now that federal rules let us open branches in other states without adding capital, how do we apportion interest expense between the New York home office and the new out-of-state branches for New York tax purposes?

Plain-English summary

United California Bank International was a wholly owned "Edge Act" banking corporation -- organized and operated under Federal Reserve Board regulations -- and a 100% subsidiary of United California Bank. Its sole business location had always been 630 Fifth Avenue, New York, and since its formation it had reported its entire taxable income as attributable to New York. A recent amendment to the Federal Reserve regulations allowed Edge Act banking subsidiaries to open branches in more than one state without requiring an increase in capital, and Petitioner intended to open branches in Florida, Texas, and Illinois. Once those branches opened, Petitioner would be doing business in those states and would need to apportion its income for state tax purposes -- raising the question of how to divide interest expense between the New York home office and the new out-of-state branches.

20 NYCRR § 35.3 governs how banks apportion income between New York and other states. A corporation or association carrying on business at branches or agencies both within and outside New York, which keeps books of account for each branch or agency that -- in the Tax Commission's judgment -- actually reflect that branch's net income from New York business, must report its income on the basis of those books. If the books don't properly disclose each branch's net income, the regulation instead requires computing New York net income by deducting a proportionate share of total expenses (from business carried on by all branches, within and without New York) from New York gross income -- with that proportion set by the ratio of New York gross receipts to total (in-state plus out-of-state) gross receipts.

Applying this framework, the Department explained that if cash transferred to the new branches is based on a capital allocation, and the books and accounts genuinely attribute capital -- and, correspondingly, interest expense -- to each office, then tax returns filed on that separate-accounting basis would be acceptable, so long as the books actually reflect the business conducted within and without the state. If the books don't accurately reflect that division, Petitioner would instead have to use the gross-receipts-ratio method to compute its New York-apportioned net income and interest expense.

What this means for you

Keep books that actually track capital and expenses by branch if you want separate accounting

If your multistate bank or Edge Act subsidiary wants to apportion interest expense (and income generally) on a branch-by-branch, books-and-records basis rather than a formulaic ratio, your books need to genuinely reflect the capital allocated to, and net income generated by, each branch -- the Tax Commission will scrutinize whether the books are accurate, not just whether they exist.

The fallback gross-receipts ratio applies whenever books don't cleanly separate branches

If your accounting doesn't cleanly attribute capital and expenses to each branch, expect New York to fall back on 20 NYCRR § 35.3's formula: New York gross receipts divided by total gross receipts, applied against total expenses, to compute New York net income.

Common questions

Q: Can our bank always use its own books to apportion interest expense among branches instead of a formula? A: Only if those books actually reflect the real net income of each branch, in the Tax Commission's judgment -- otherwise the regulation requires the gross-receipts-ratio method instead.

Q: Does opening branches in other states automatically require a new capital allocation? A: Not under the Federal Reserve amendment described here -- Edge Act subsidiaries could open multistate branches without increasing capital, but New York tax apportionment still depends on how the books allocate capital and expenses among offices.

Citations and references

Statutes and guidance:

• 20 NYCRR § 35.3

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1981.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/h81_1c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-H-81(1)C
Corporation Tax
January 8, 1981

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C800418A

On April 18, 1980, a Petition for Advisory Opinion was received from United California Bank International, 630 Fifth Avenue, New York, New York 10020. On May 8, 1980 an amended petition was received from the Petitioner. The issue raised in the amended petition is the proper method of apportionment of interest expense between Petitioner's New York home office and branch offices which Petitioner proposes to form outside this State. United California Bank International is a corporation formed and operated as an "Edge Act" banking corporation under regulations of the Federal Reserve Board and is a 100% owned subsidiary of United California Bank. At present the sole business location of United California Bank International is 630 Fifth Avenue, New York, New York 10020. Since inception United California Bank International has reported its entire taxable income as being attributable to New York. A recent amendment to the Federal Reserve Regulations allows "Edge Act" banking subsidiaries to have branches in more than one state. The Regulations do not require an increase in capital when new branches are formed. United California Bank International intends to form branches in Florida, Texas and Illinois. Upon the formation of branches in other states the Corporation will be doing business in these states and will be required to divide its income for purposes of state taxes based on net income. Section 35.3 of the Regulations pertaining to the taxation of banks provides that a corporation or association carrying on business at branches or agencies both within and without the State, which keeps accounts of the income of each branch or agency which in the opinion of the State Tax Commission actually reflect the net income from business carried on within the State of each branch or agency, is required to report its income on the basis of the books maintained. 20 NYCRR35.3 In the event that the books do not properly disclose the net income of each branch or agency, net income from business carried on within the State is computed by deducting from gross income from business carried on by branches and agencies within the State a proportionate part of expenses from business carried on by branches and agencies within and without the State. Such proportion is the ratio of gross receipts from business carried on by branches and agencies within the state to gross receipts from business carried on by branches and agencies within and without the state. If cash is transferred to the branches based on an allocation of capital, the books and accounts would attribute capital to each office and tax returns filed on a separate accounting basis would, in effect, allocate the taxpayer's interest expense between the offices. Assuming that the books and accounts actually reflect the business carried on within and without the state, such tax

JAMES H. TULLY., COMMISSIONER

LOUIS M. JACOBSON, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

2
TSB-H-81(1)C
Corporation Tax
January 8, 1981

returns would be acceptable. If they do not, net income from business carried on within the state must be computed by the method outlined in the paragraph above.

DATED: October 6, 1980

s/LOUIS ETLINGER
Deputy Director
Technical Services Bureau