A subsidiary sweeps its excess cash to its parent each month, and the parent issues a single renewable 'Floating Rate Note' evidencing the cumulative amount owed, canceling and reissuing the note each month as the balance changes. The note has a stated principal, a variable interest rate, and a stated maturity decades away, but has never been sold or traded, isn't part of a series, and isn't supported by a trust indenture. Does this note count as a 'bond' -- and therefore INVESTMENT capital -- under Tax Law section 208.5, or is it business capital?

Plain-English summary

SouthWestern Publishing Company routinely transferred its excess month-end cash to its parent corporation as part of an intercompany cash-management arrangement. In exchange, the parent issued Petitioner a "Floating Rate Note" evidencing the cumulative amount owed -- but rather than issuing a new instrument for each transfer, the parent canceled the prior month's note and reissued a fresh one reflecting the new running balance, every month. The notes were unsecured, stated a maturity date of December 31, 1999, and paid interest at a rate tied to prevailing short-term market rates rather than a fixed percentage. Petitioner argued these notes were "bonds" under Tax Law § 208.5 and should be classified as investment capital (generally a more favorable classification than business capital for franchise tax purposes).

Article 9-A divides a taxpayer's capital into three categories -- subsidiary capital, investment capital, and business capital -- each separately defined in Tax Law § 208. Investment capital under § 208.5 covers "stocks, bonds and other securities" not held for sale to customers. The Department agreed the notes broadly fit a dictionary definition of "bond" (a written promise to pay a fixed sum with stated interest), citing Black's Law Dictionary and Cass v. Realty Securities Co. But it held that fitting the dictionary definition of "bond" doesn't end the inquiry -- § 208.5's own phrase "stocks, bonds and OTHER SECURITIES" signals that only bonds which also qualify as securities count. Under 20 NYCRR § 3-4.2(c), that means instruments customarily sold in the open market or on a recognized exchange, designed as a means of investment.

The notes flunked essentially every hallmark of a marketable bond: they were never sold on any market or exchange; they weren't issued in standard marketable denominations (one sample note was for $16,778,810 -- far outside typical bond denominations like $1,000); they weren't backed by a trust indenture protecting bondholders; they weren't part of a numbered series, but existed only as a single, constantly-renewed instrument; and critically, they weren't negotiable under the Uniform Commercial Code -- they weren't payable "to order or to bearer" as UCC § 3-104(1) requires, and because the interest rate floated with market conditions rather than being fixed, they didn't even promise a "sum certain." Because the notes lacked the marketability and negotiability that distinguish genuine bonds and securities from ordinary intercompany debt instruments, the Department classified them as business capital, not investment capital.

What this means for you

An intercompany note labeled a "bond" isn't automatically investment capital

If your corporate group formalizes routine cash-sweep or intercompany-loan balances with a note that LOOKS like a bond on its face (stated principal, interest rate, maturity date), that alone doesn't secure favorable investment-capital treatment -- the instrument also needs the marketability characteristics of an actual security.

Look for the specific hallmarks the Department checks: marketability, denomination, indenture, series issuance, negotiability

A genuine investment-capital "bond" or "other security" is expected to be tradeable on an open market or exchange, issued in standard marketable denominations, backed by a trust indenture, issued as part of a series, and negotiable under UCC rules. Missing most or all of these, as here, points toward business capital instead.

A floating interest rate can itself defeat negotiability

Because a negotiable instrument under the UCC must promise a "sum certain," an instrument whose interest rate floats with market conditions -- rather than being fixed -- may fail the negotiability test on that basis alone, independent of any of the other bond characteristics.

Common questions

Q: If our intercompany note states a fixed principal amount and an interest rate, does that make it a "bond" for investment-capital purposes?
A: Not necessarily -- stating a principal and interest rate satisfies a broad dictionary definition of "bond," but Tax Law § 208.5 requires the instrument to also be a marketable "security," which requires far more (open-market tradability, standard denominations, an indenture, series issuance, and negotiability).

Q: Does a floating interest rate tied to market conditions affect the classification?
A: Yes -- it undermines negotiability under the UCC, since a negotiable instrument must promise to pay a fixed "sum certain," which a floating-rate obligation does not.

Citations and references

Statutes and guidance:

• Tax Law § 208.5
• Tax Law § 208.4
• Tax Law § 208.7
• 20 NYCRR § 3-4.2(c)

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_35c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-H-81(35)C
Corporation Tax
June 18, 1981

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C800710A

On July 9, 1980 a Petition for Advisory Opinion was received from SouthWestern Publishing Company, 5101 Madison Road, Cincinnati, Ohio 45227.
The issue raised is the proper classification of certain written evidences
of indebtedness for purposes of the Franchise Tax on Business Corporations
imposed under Article 9-A of the Tax Law.
Petitioner is a corporate subsidiary. Loans from Petitioner to its parent
are generated when, at the end of each month, Petitioner's excess cash is
transferred to the parent. The parent issues to Petitioner a written evidence
of indebtedness (the nature of which is at issue herein but which will
hereinafter be denominated a "note") for the amount of such transferred funds to
date. That is, each month the previously issued note is cancelled and a new note
is issued in the amount of funds currently owed by the parent to Petitioner.
These notes, over a period of time, represent a constantly increasing debt. The
notes formalize a cash flow process whereby the parent gains the use of excess
funds generated by its subsidiary and puts such funds to various uses, such as
purchasing new acquisitions, reloaning money to other subsidiaries or financing
its own business functions. Through this cash flow process the parent reduces
its need for borrowing from outside sources.
The note issued by the parent is denominated on its face a "Floating Rate
Note" and is stated, also on its face, to be unsecured. It states the sum due
and sets forth a promise to pay the same on December 31, 1999, as well as "...to
pay interest monthly from date hereof, on the Balance or Principal remaining from
time to time unpaid, at a rate equal to the average rate earned on short term
investments or the average rate paid on short term borrowings." A sample note
submitted by Petitioner, dated April 30, 1977, states a sum due of $16,778,810.
The notes bear the signatures of the President and other officers of the parent
corporation, as well as the corporate seal of the parent corporation. The notes
have never been acquired in the open market and have never been sold by
Petitioner to its customers. The notes were not acquired for services rendered
or for the sale of property primarily held for sale to customers. Petitioner
contends that the notes constitute "bonds," within the meaning of section 208.5
of the Tax Law, and are thus "investment capital" for purposes of Article 9-A of
the Tax Law.
Article 9-A of the Tax Law divides a taxpayer's capital into three
categories, subsidiary capital, investment capital and business capital. Such
terms are defined in section 208, subdivisions 4, 5, and 7 of the Tax Law,
respectively. Petitioner asserts that the notes at issue represent investment
capital rather than business capital. The term "investment capital" is defined
as follows:
"The term 'investment capital' means investment 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 tax commission,
there shall be deducted from investment capital any liabilities payable by their
terms on demand or within one year from the date incurred, other than loans or
advances outstanding for more than a year as of any date during the year covered
by the report, which are attributable to investment capital .... "Tax Law, §208.5
JAMES H. TULLY., COMMISSIONER
TP-8 (4/80)

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

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TSB-H-81(35)C
Corporation Tax
June 18, 1981

While narrower definitions may be applicable within certain restricted
spheres of activity, taken in its broadest sense the term "bond" includes any
written instrument acknowledging a debt. The term "corporate bond" is defined
in Black's Law Dictionary (revised fourth edition) as "A written promise by a
corporation under seal to pay a fixed sum of money at some future time named,
with stated interest payable at some fixed time or intervals, given in return for
money or its equivalent received by the corporation, sometimes secured, and
sometimes not." So, too, it has been said that the "...distinguishing feature
of a bond is that it is an obligation to pay a fixed sum, with stated
interest...[which] may or may not be secured." Cass v. Realty Securities Co.,
148 App. Div. 96, aff'd 206 NY 649. While each of the notes at issue herein may
thus fairly be denominated a "bond", such determination does not conclude this
inquiry, for it is still necessary to determine whether these "bonds" are such
within the meaning and intent of section 208.5 of the Tax Law.
The Tax Law includes under the rubric of investment capital "...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 .... " Tax Law, §208.5. The use of the
phrase "stocks, bonds and other securities" indicates an intention to include as
investment capital only those "bonds" which are "securities."
The Franchise Tax Regulations contain no definitions for the terms "bonds"
and "securities". However, at 20 NYCRR 3-4.2(c) there is a description of the
types of securities which are includible as "other securities," within the
meaning of section 208.5 of the Tax Law. It is there provided, thus, in relevant
part, that such "other securities" "...are limited to securities issued by
governmental bodies and securities issued by corporations 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 . . . They do not include corporate
obligations not commonly known as securities . . . ."
This description of the types of securities which are includible in
investment capital as "other securities" is equally applicable in determining
which "bonds," assuming the same to be securities, are also so includible. An
examination of the notes at issue herein reveals that they do not satisfy the
applicable criteria and consequently do not constitute investment capital within
the meaning of section 208.5 of the Tax Law. Thus, bonds commonly sold in the
open market or on a recognized exchange and commonly used as a means of
investment are typically stated to represent a specified and unchanging debt; are
in denominations, such as $1,000, designed to enhance marketability; are
supported by an indenture (trust agreement), with a trustee to safeguard
bondholders' interests; are sold in the form of a series rather than a single
instrument; and, finally, are negotiable. The notes at issue are not only not
themselves sold in the open market or on a recognized exchange, they do not bear
any of the foregoing characteristics of bonds and other securities which are so
sold or commonly used as a means of investment. Thus, although on its face each
note states a specific sum due the holder, in actuality this represents a
transitory state of indebtedness from its parent corporation to Petitioner,
modified at the end of each month; the notes are in amounts (e.g., $16,778,810)
wholly atypical of bonds commonly traded; the notes, unlike such bonds, are not
supported by an indenture; the notes are not issued as part of a series but,
rather, appear only singly, the issuance of each note requiring the retirement
of its predecessor; and, finally, the notes are not negotiable. The notes are
not negotiable because, contrary to Section 3-104(1) of the Uniform Commercial
Code, the notes are not payable "to order or to bearer," and because they do not
constitute promises to pay "a sum certain," this last in that the interest is

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TSB-H-81(35)C
Corporation Tax
June 18, 1981

stated on the face of the instrument to be payable "...at a rate equal to the
average rate earned on short-term investments or the average rate paid on short­
term borrowings." Further, the notes are not negotiable as "securities," within
the meaning of Article 8 of the Uniform Commercial Code, because they do not meet
the requirements set forth in section 8-102 thereof. Thus, for example, each
note is not "either one of a class or series or by its terms...divisible into a
class or series of instruments...," nor is it "of a type commonly dealt in upon
securities exchanges or markets or commonly recognized in any area in which it
is issued or dealt in as a medium for investment."
The notes in question,
therefore, do not bear the quality of negotiability, which is characteristic of
the "bonds and other securities" treated in section 208.5 of the Tax Law.
The notes in question, thus, are not of a type commonly traded in the open
market or on a recognized exchange and, futhermore, are not of a type commonly
dealt in as a means of investment. Accordingly, the notes in question do not
constitute "bonds or other securities," within the meaning of section 208.5 of
the Tax Law, and are therefore properly classifiable as business capital rather
than investment capital under Article 9-A of the Tax Law.

DATED:

June 16, 1981

s/LOUIS ETLINGER
Deputy Director
Technical Services Bureau