Taxpayer Wins New York Bank Tax Case: Division of Tax Appeals Determines that Department Violated its Own Published Guidance

In a recent decision, the New York State Division of Tax Appeals soundly rejected a determination by the New York State Department of Taxation and Finance (the "Department") that it could treat a banking corporation's international banking facility ("IBF") as having ineligible gross income in order to allow the use of scaling ratios to compute the bank's allocation factors.1 In rejecting the Department's position, the Administrative Law Judge ("ALJ") ruled that, under the formula allocation method elected by the taxpayer, the IBF's interbranch transactions and transactions that produced non-effectively connected income were to be disregarded entirely in computing the taxpayer's allocation factors. Moreover, in attempting to apply scaling ratios, the Department was found to have violated the Tax Law, regulations and its own published guidance.

UniCredit Elects the IBF Formula Allocation Method

During the years in question, UniCredit S.p.A. ("UniCredit") was a foreign bank headquartered in Italy. It conducted business in New York as a U.S. branch and was subject to the franchise tax on banking corporations under Article 32 of the Tax Law. The New York branch maintained an IBF, which was a separate set of asset and liability accounts segregated on the books and records of UniCredit.

Under Tax Law § 1455(a), a banking corporation doing business within and outside of New York must pay bank tax on its allocated entire net income. To determine the portion of entire net income allocable to the state, a banking corporation must multiply its entire net income by its income allocation percentage (the "ENI Allocation Percentage").2 The ENI Allocation Percentage consists of a payroll factor, a receipts factor, and a deposits factor, the latter two of which are double weighted.3

A banking corporation that has established an IBF may elect one of two methods to calculate its ENI Allocation Percentage. Under the first method (the "modification method"), the taxpayer computes its entire net income by deducting the adjusted eligible net income of its IBF from its federal taxable income (which is the starting point for entire net income).4 Under the second method (the "formula allocation method"), the taxpayer modifies its ENI Allocation Percentage by excluding the payroll expenses, receipts and deposits of the IBF that are attributable to the production of eligible gross income from the numerators of the fractions composing the ENI Allocation Percentage.5

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