Sale of Partnership Interest is Taxable under New York City’s General Corporation Tax

The New York City Tax Tribunal sided with the City in ruling that the sale of a partnership interest by a corporation located outside New York should be included in income reported to the City based on the aggregate theory of partnerships, and that the City was not bound by federal principles (at that time) to the contrary.

On June 26, 2020, the New York City Tax Appeals Tribunal (Tribunal) issued a determination in which it concluded that a corporation’s share of capital gain from the sale of a limited partnership interest was includable in income for New York City General Corporation Tax (GCT) purposes.[1]

The Taxpayer is a corporation with its sole place of business located in New Jersey.[2]  For many years, it owned a 50% interest in a partnership (Seller) that owned, respectively, a 14.167%, 25%, and 0.01% limited partnership interest in three partnerships engaged in the real estate business in New York City (NYC).  Neither the Seller nor the Taxpayer were involved in the management or operation of the operating real estate partnerships; they were purely passive investors, and it was stipulated by the parties that the Taxpayer was not conducting a unitary business with the partnerships. In addition, the Taxpayer’s only connection to NYC is through its indirect ownership of these operating partnerships.

In 2012, the Seller sold its 14.167% limited partnership interest in one of the partnerships and passed through 50% of the capital gain to the Taxpayer, which equaled approximately $15,000,000.  The Taxpayer reported the gain on its federal income tax return as well as on its GCT return, but then excluded the gain on its GCT return as a deduction to federal taxable income in computing its entire net income (ENI) for GCT purposes, noting on an attached rider that the deduction represents “Gain on the sale of a partnership interest – not used in trade or business in NY.”  On audit, NYC added the gain back into income.

The starting point for computing ENI under the GCT is federal taxable income.[3] Therefore, the capital gain is included initially under Internal Revenue Code (IRC) § 741, which provides that the gain or loss from the sale of a partnership interest is recognized by the partner.

However, the Taxpayer argues that under federal conformity for years prior to the Tax Cuts and Jobs Act (TCJA), the IRC applied an entity approach, rather than an aggregate approach, to the sale of the interest.[4] Under the entity approach, the partner is treated as if it owned and sold a partnership interest, an intangible asset, as opposed to owning and selling a proportionate sale of the partnership assets (i.e., the aggregate approach).  Accordingly, Taxpayer maintains that its sale of the partnership interest is not sourced to NYC because that intangible asset was not used in a trade or business, and therefore should be sourced to the Taxpayer’s domicile in New Jersey.

The Tribunal disagreed and instead adopted the City’s argument that although the City adopts federal income as the starting point for calculating ENI, there nothing in the City’s rules that requires that it follow federal principles from a sourcing perspective or that permits the exclusion of the gain from ENI.

It is worth noting that NYC (and New York State) does not follow traditional state corporate tax concepts of “business income” and “nonbusiness income.” In another jurisdiction, the Taxpayer may have been able to argue successfully that its partnership interest is a purely passive investment that produces non-business income and that the gain from its sale of that interest should be sourced entirely to its state of commercial domicile rather than being treated as business income subject to apportionment among the states.

However, in light of the changes made by the TCJA to IRC § 864(c), it will be interesting to see whether states take note and enact rules that specifically treat the sale of a partnership interest by a nonresident individual or a foreign corporation as a sale of its proportionate share of partnership assets.  Aprio’s SALT team has experience assisting businesses that engage in a significant/nonrecurring transaction (i.e., the sale of a business or division) with issues related to business/nonbusiness income and sourcing of income to identify opportunities to minimize their multi-state income tax liability. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Kristen Mantilla, SALT Associate at kristen.mantilla@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the September 2020 SALT Newsletter.

[1] In the Matter of Mars Holdings, Inc. (TAT (H) 16-14 (GC))

[2] The Taxpayer files as an S-corporation for federal income tax purposes, but New York City does not conform to the S-election and instead treats all corporations as taxpayers under the GCT.

[3] NYC Admin. Code § 11-602.1.

[4] See Grecian Magnesite Min., Indus. & Shipping Co., SA v Commr. of Internal Revenue Serv. 926 F3d 819 (DC Cir 2019), affirming 149 T.C. 63 (2017).  The TCJA overruled this case by adding IRC § 864(c)(8), which now treats the sale of a partnership interest by a nonresident alien individual or a foreign corporation as if the seller sold a proportionate sale of the partnership assets.