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On May 1, 2020, the New York Tax Appeals Tribunal held that an electricity generation company met the requirements to be classified as a qualified New York manufacturer (QNYM), and was therefore entitled to a $350,000 limitation in computing the capital base of its New York corporation franchise tax for the 2010 through 2012 tax years.1
In a case of statutory interpretation, the Tribunal reversed the determination of the Administrative Law Judge (ALJ),2
finding that the New York Department of Taxation and Finance (Department) could not incorporate into the QNYM statute an exclusion related to the generation of electricity when such exclusion was not in the plain language of the statute.
The petitioner, TransCanada Facility USA, Inc. (TransCanada) provides wholesale energy through two wholly-owned limited liability companies, TC Ravenswood LLC (Ravenswood) since 2008, and Coolidge Power LLC (Coolidge) since 2011. Both entities are disregarded for federal income tax and New York corporation franchise tax purposes. The Ravenswood facility generating station is located in Long Island City, New York, while the Coolidge facility is located outside the state. For the 2010 through 2012 tax years, TransCanada filed a general business corporation combined franchise tax return and MTA surcharge return that included the Ravenswood property. For each of those tax years, the combined group’s capital base yielded the highest tax of the four alternative tax bases.3
As such, TransCanada calculated tax on its combined capital base at the $350,000 cap on the ground that it met the requirements of a QNYM. For the tax years at issue, TransCanada paid $355,000 in corporation franchise tax, consisting of $350,000 in tax on the combined capital base and $5,000 of fixed dollar minimum tax attributable to the Ravenswood property. TransCanada also paid an MTA surcharge of $60,350 for each of the tax years at issue.
Under audit, the Department determined that the combined group did not meet the definition of a QNYM under New York tax law, and therefore disallowed the $350,000 cap on the tax computed on the combined group’s capital base. Accordingly, the Department recomputed the tax on the combined group’s capital base without the cap and issued a notice of deficiency with an additional aggregate liability of nearly $5 million in tax, interest and penalties for the tax years at issue. TransCanada appealed the determination to the Division of Tax Appeals’ ALJ unit, challenging the notice.
The ALJ considered whether TransCanada, an entity engaged in generating electricity, met the QNYM definition in order to take advantage of the $350,000 capital base tax liability cap. To be considered a QNYM for the tax years at issue, the taxpayer had to establish that: (i) it was a manufacturer principally engaged in the production of goods by manufacturing;4
(ii) it had property located in New York as described under a section of the tax law providing for the New York Investment Tax Credit (ITC);5
and (iii) either the adjusted basis of that property was at least equal to $1 million for federal income tax purposes, or all of its real and personal property was located in New York.6
The ALJ agreed with the petitioner that the statute should be construed against the state because it concerned the imposition of a tax. Similarly, the ALJ agreed that the petitioner was a manufacturer as defined under New York tax law, rejecting the Department’s argument that the production of goods by manufacturing or processing did not include electricity. However, the ALJ determined that TransCanada did not meet the definition of a qualified New York manufacturer because it did not have property as described in the ITC statute, as such statute provided that “goods shall not include electricity.”7
As TransCanada did not meet the property requirements to be a QNYM, the ALJ concluded that TransCanada was not entitled to the $350,000 liability cap under the capital base tax.
Both the Department and TransCanada filed exceptions to ALJ’s determination. On appeal to the Tribunal, TransCanada argued that the capital base tax is a tax imposition statute, meaning that any ambiguities should be resolved in favor of the petitioner instead of the Department. TransCanada also argued that it qualified as a manufacturer for purposes of the capital base of the corporation franchise tax, noting that the state legislature specifically excluded electricity generators from the definition of a “manufacturer” for purposes of the entire net income (ENI) base only. Finally, TransCanada asserted that the ITC limitation applied only for purposes of determining eligibility for the ITC and was not intended to limit it from being classified as a QNYM for purposes of the capital base cap.
In its exceptions filed with the Tribunal, the Department argued that the $350,000 capital base tax cap functioned no differently than a tax credit or exemption, meaning that the petitioner must show a clear entitlement to the statutory benefit. Next, the Department contended that a taxpayer principally engaged in the generation of electricity is not a manufacturer for purposes of the ITC limitation, and therefore could not be a manufacturer for purposes of the tax computed on the capital base. The Department asserted that the production of goods by manufacturing or processing does not include electricity, regardless of the ITC limitation language. Finally, the Department argued that even if considered a manufacturer, TransCanada did not qualify as a QNYM because it did not have New York property that qualified for the ITC. The Department asserted that the legislature’s lack of action to add an express exclusion for electricity generation for capital base purposes did not necessarily lead to a conclusion that electricity generators met the definition of a QNYM.
Capital base tax cap as a tax imposition statute
The Tribunal first analyzed whether the statute providing for a cap on the capital base tax for manufacturers functioned as a tax imposition to be construed in favor of TransCanada, or instead a tax exemption, exclusion, deduction or credit to be construed in favor of the Department. Reviewing the statutory language, the Tribunal noted that the tax law imposed a corporation franchise tax upon the petitioner’s capital base at various rates, subject to a $350,000 liability cap for QNYMs.8
Reading the provisions together, the Tribunal determined that both provisions provide for the imposition of a franchise tax. The Tribunal also reasoned that the liability cap is functionally distinct from an exclusion, exemption or deduction, as those terms are typically used in tax statutes. Rather, the Tribunal reasoned, the tax cap “merely defines the applicable tax that is imposed.” Concluding that the capital base tax cap is a tax imposition statute, the Tribunal determined that the Department had the burden to demonstrate that the liability cap did not apply to TransCanada.
TransCanada as a manufacturer
The next issue concerned whether TransCanada qualified as a “manufacturer” as defined under New York tax law. The version of the tax law in effect during the tax years at issue defined a “manufacturer” as a taxpayer “principally engaged in the production of goods by manufacturing, processing…” and other activities.9
The Department contended that the generation of electricity did not qualify as the production of goods by manufacturing or processing due to the legislature’s definition used in the ITC statute.10
Engaging in statutory construction, the Tribunal determined that the legislature did not intend to explicitly exclude electricity or the generation of electricity from the definition of “manufacturer” for purposes of the capital base tax cap. While agreeing that the term “goods” did not include electricity for purposes of determining the eligibility of property for the ITC, the Tribunal noted that the legislature did not make any corresponding changes to the capital base provision of the former tax law. As such, the Tribunal agreed with the ALJ that the clear and unambiguous language of the capital base tax cap confirmed the conclusion that TransCanada is considered a manufacturer as defined under the tax law. The Tribunal concluded that the exclusion of electricity generators from the manufacturer definition under the ENI tax cap and the absence of similar language under the capital base tax cap indicated a legislative intent to exclude electricity generators only from the benefit of the ENI cap.
TransCanada as a QNYM
Having concluded that TransCanada qualified as a manufacturer, the Tribunal then considered the issue of whether TransCanada was a QNYM entitled to the $350,000 capital base cap. The Tribunal’s analysis focused on the question of whether the petitioner’s New York property was of the kind described in the ITC statute. The Tribunal agreed with TransCanada that the ITC limitation applied only for purposes of determining eligibility for the ITC, and was not intended to limit TransCanada’s classification as a QNYM for purposes of the capital base tax cap.
Consulting the legislative history of the ITC limitation sentence, the Tribunal explained that the provision was enacted to exclude property used in the generation of electricity from eligibility for the ITC, and that nothing in the legislative history suggested that the legislature intended the limitation sentence to apply to subjects other than eligibility for the ITC. Had the legislature intended to exclude electricity generators from the definition of a QNYM, the Tribunal reasoned, it would have referred more broadly to the ITC subdivision in general (rather than through a specific reference within the ITC subdivision), or simply would have required the property of a QNYM to be eligible for the ITC. Noting that the legislature expressly excluded electricity generators from the definition of a manufacturer for purposes of the ENI base, but failed to do the same when drafting the statute for purposes of the capital base, the Tribunal concluded that the legislature had done so deliberately. Under the Department’s interpretation, the Tribunal noted, the exclusionary language in the ENI section would be rendered superfluous.
The Tribunal also referenced several attempts by the legislature to amend the tax law to exclude electricity generation as a qualifying activity for purposes of the capital tax base cap, none of which were ultimately enacted into law. Taking the above factors into account, the Tribunal concluded that TransCanada met its burden to show that it was a QNYM entitled to the $350,000 capital base tax cap under the tax law during the years in question. Accordingly, the Tribunal reversed the ALJ’s determination and canceled the Department’s notice of deficiency.
A taxpayer-favorable decision, the TransCanada
case presents a unique fact pattern regarding the classification of taxpayers eligible for status as a QNYM and the corresponding tax benefits. Although the case concerned a liability cap to the capital base tax that is being phased out under the current version of the tax law, the statute defining the requirements for QNYM classification remains relevant under current law, given the fact that QNYMs continue to enjoy favorable tax treatment. Effective for tax years beginning in 2014, New York enacted a 0% tax rate on business income, and corresponding special rates on the capital base and fixed dollar minimum tax, available for QNYMs.11
As such, the Department continues to closely scrutinize corporations looking to benefit from QNYM status, even with the state’s elimination of the capital base tax by 2021.
decision may have potentially limited application to New York City corporation taxes, primarily because the City has instituted more restrictive requirements to meet the definition of a qualified New York City manufacturing corporation. For example, the City defines a “manufacturing corporation” as a corporation principally engaged in the manufacturing and sale of tangible personal property, and requires that “manufacturing” include the process of working raw materials into wares for suitable use.12
Electricity generators and producers of non-tangible goods are unlikely to qualify for New York City qualified manufacturer treatment under this definition.
Coinciding with the release of this decision, the Department recently released updated draft regulations pertaining to certain special entities that specifically address the corporation franchise tax treatment of QNYMs.13
The draft regulations set out to define a QNYM as a corporation or combined group “engaged in the production of tangible goods
” by manufacturing or processing,14
even though the statute merely requires that the taxpayer be engaged in the production of “goods” to be considered a QNYM. Accordingly, the draft regulations seek to specifically exclude the generation and distribution of electricity from the definition of manufacturing activities,15
along with the creation of digital products.16
The draft regulations also attempt to limit the scope of activities that qualify for companies engaging in contract manufacturing, whereby a company outsources certain aspects of the manufacturing process to a third party, while retaining control over the overall manufacturing process.17
Overall, the draft regulations would significantly limit the scope of manufacturing activities eligible for QNYM treatment by more narrowly interpreting the term “manufacturing” and creating exclusions that may exceed the authority of the QNYM statute. However, the draft regulations raise questions about whether the Department is contravening legislative intent regarding generators of electricity and other activities not explicitly excluded from the statutory definition of manufacturing. If finalized, the draft regulations would likely invite legal challenge.
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