Get out of town! Court Upholds New York City Tax Applying Corporate Dividend Allocation

On April 12, 2022, the Appeals Division, First Department, denied a taxpayer’s appeal to the New York City Tax Appeals Court and ruled that the court’s decision to uphold an assessment of tax on an out-of-state entity’s gain from the sale of a partnership interest was “rational”.[1]

The taxpayer was an investment vehicle that set up a master fund to invest in alternative investment management companies. It is important to note that the taxpayer had no property or payroll in the city and did not otherwise carry on business in the city. In 2008, the taxpayer’s main fund acquired an interest in an entity – Claren Road Asset Management, LLC – which conducted all of its business activities in New York. In 2010, the taxpayer’s master fund sold Claren, generating a capital gain of $54 million. New York City taxed the entire gain on the sale of Claren.

Litigation ensues and the parties stipulate that the taxpayer and Claren are not engaging in a unitary business. In 2018, a New York City administrative law judge upheld the tax, applying the investee allocation (i.e. the gain was allocated using the 100% allocation factor of Clarin). In 2021, the New York City Tax Appeals Tribunal upheld the ALJ’s decision, finding that the capital gain was indeed subject to New York City general corporation tax.

Applying a rational basis test to the Tribunal’s decision, the First Department’s Appellate Division explained: “[t]The Tribunal rationally determined that the claimant failed to demonstrate that the City impermissibly sought to impose GCT on income attributable to activities conducted outside its borders. Based on a 1991 Court of Appeal decision, Allied-Signal Inc. v. End Commissioner.79 NY2d 73 (1991), the Appeal Division observed that “[t]The connection between the City and the Claimant’s capital gain is Claren’s activities in the City, which generated the Claimant’s investment income (on which the Claimant paid taxes to the City).

Although the taxpayer argued that the capital gain was realized out of town because its Claren-related business was carried on (entirely) in London, it was still “rational for the Court to conclude that the capital was attributable to value of Claren on the date of its sale. (emphasis added). The decision ends with a quote from the 1940 Supreme Court opinion in Wisconsin v. JC Penney Co.311 U.S. 435 (1940): “The fact that a tax is contingent on events occurring without a state does not destroy the connection between such a tax and the transactions within a state for which the tax is an exaction.”

The decision does not otherwise provide an analysis of the myriad of constitutional issues that may arise from cross-border sales of partnership interests.

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