NYS Issues Guidance Addressing Investment Capital Identification Requirements
The New York State (“NYS”) Department of Taxation and Finance recently issued TSB-M-15(4)C (“TSB”), which outlines procedures for the identification of assets as investment capital as required under NYS tax law. Specifically, NYS Tax Law Sec. 208.5 requires that in order to treat an investment in stock as “investment capital,” taxpayers are required to clearly identify, in the corporation’s records, that the stock is held for investment in the same manner as required under Internal Revenue Code (“IRC”) Section 1236(a)(1). This identification must occur before the close of the day on which the stock is acquired.
The guidance, issued July 7, 2015 and summarized below, sets forth the procedures for complying with the identification requirement. Taxpayers currently holding stock for investment purposes should carefully review these identification procedures, including the deadline to make the identification by October 1st of this year, in order to take advantage of the favorable tax treatment afforded to income from investment capital.
The 2014-15 and 2015-2016 NYS budget legislation made significant changes to the State (and City) corporate income tax, including changes to both the definition of investment capital and the taxation of investment income. Under prior law, investment capital included investments in stocks, bonds and other securities not held for sale to customers in the regular course of business, and income from such investments was taxed at a lower rate. Under the new law, the definition of investment capital is significantly narrowed, and the income from such investments is now exempt from tax (subject to a cap). These changes are effective for tax years beginning on or after January 1, 2015.
Under the new rules, in order to qualify as investment capital, taxpayers must satisfy a five part test. See the infographic below for these tests.
The TSB provides procedures for meeting the identification requirement set forth in Tax Law 208.5(a)(v), and differentiates between dealers in securities and non-dealers.
For corporations that are securities dealers subject to IRC section 1236, stock acquired before and after October 1, 2015 must be clearly identified in the corporation’s records as stock held for investment under IRC section 1236(a)(1) in order to satisfy the investment capital identification requirement. The presence or absence of the federal identification pursuant to IRC Sec. 1236 (which permits dealers to treat gain from the sale certain securities as capital gain if certain requirements are met) is determinative for purposes of treating an asset as investment capital. Identification of the stock as held for investment under IRC Sec. 475 is not sufficient.
For corporations that are not securities dealers, stock must be recorded as investment capital before the close of the day on which the stock was purchased in an account maintained for investment capital purposes only. Additionally, the account must be separate from any account maintained for stock held for sale to customers and must disclose the name of the stock, the CUSIP number of the stock (or CINS number for international securities), date of the purchase, the number of shares purchased and the purchase price of the stock. Moreover, if the stock is sold, the investment capital account must record the date of sale, the number of shares sold, and the sales price for that stock. Finally, the investment capital account must be set up in a manner that readily identifies the length of time the stock was owned by the corporation.
When stock is purchased by a corporation pursuant to an option, such stock will qualify as investment capital only if the corporation, before the close of the day on which the option was acquired, clearly identified the option in its records as held for investment.
Transitional Rules for Non-Dealers
The TSB also provides a transitional rule for non-dealers for stock acquired before October 1, 2015 that otherwise meets the definition of investment capital. Such stock must be clearly identified in the corporation’s records as stock held for investment before October 1, 2015 in order to satisfy the investment capital identification requirement. In addition, any stock acquired after October 1, 2015 pursuant to an option acquired prior to that date will be treated as investment capital only if the corporation clearly identified the option in its records as held for investment prior to October 1, 2015.
The TSB does not provide transitional rules for dealers, presumably because NYS assumes that such taxpayers are already in compliance with IRC Sec. 1236. However, many corporate taxpayers, including dealers, do not separately account for capital assets since there is no preferential tax treatment for capital gains. In addition, the TSB does not provide guidance for non-New York corporations with stock acquired for investment purposes that later become subject to New York franchise tax.
If a corporation is a partner in a partnership and the corporation is using the aggregate method to compute its tax, the corporation’s proportional ownership interest in the stock may qualify as investment capital if the partnership follows the procedures for identification of the stock as investment capital as set forth above. In addition, for combined taxpayers, each corporation included in the combined return must separately comply with the identification procedures. Finally, identification of stock in the manner set forth above will also satisfy New York City investment capital identification requirements.
The Department is in the process of drafting regulations that hopefully will clarify some of the issues involving the identification procedures. Updates relating to these new procedures can be found on the Department’s corporate tax reform website (http://www.tax.ny.gov/bus/ct/corp_tax_reform.htm).
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