New York Tax Appeals Tribunal requires broker-dealer receipts to be sourced to intermediaries and not to investors

In brief

What happened?

The New York State Tax Appeals Tribunal on February 20 reversed, in part, an administrative law judge determination and required a taxpayer to source brokerage commissions, gross income from principal transactions, and management fees to the location of institutional intermediaries (i.e., pension funds, hedge funds, mutual funds, and other similar financial intermediaries) and not to the underlying investors.

Why does it matter?

Because the taxpayer has four months to appeal the Tribunal’s decision it is not currently binding law. While the case deals with the New York State corporate tax law in effect for pre-2015 years, the broker-dealer customer sourcing statute is substantially similar for New York State and City corporate tax purposes for years starting in or after 2015 (however, the rules for sourcing gains from principal transactions changed, and the post-2015 statute provides that broker-dealers should source 8% of certain qualifying receipts where customer location cannot be determined). The pre-2015 New York State corporate broker-dealer sourcing statute is also substantially similar to the current New York City (NYC)  unincorporated business tax (UBT) statute’s broker-dealer sourcing rule. Therefore, the outcome of this case may impact other broker-dealer taxpayers subject to the corporate tax or the NYC UBT.

Actions to consider

Similarly situated broker-dealer taxpayers, whether subject to the corporate tax or the NYC UBT, should review their current methods for sourcing receipts to analyze the potential impact of this decision.  

[In the matter of Petitions of Jefferies Group LLC & Subsidiaries, Tax Appeals Tribunal Nos. 829218, 829219, 2/20/2025]

Tax Appeals Tribunal decision

In determining whether the brokerage commissions, gross income from principal transactions, and management fees should be sourced based on the location of the underlying investors of the institutional intermediaries or to the location of the intermediaries themselves, the Tax Appeals Tribunal (tribunal) concluded that the receipts should be sourced to the location of the intermediaries and not on a look-through basis to the location of the underlying investors.

The tribunal’s analysis centered on the interpretation and application of New York Tax Law former Section 210 (3)(a)(9). First, the tribunal emphasized the customer-based sourcing rules outlined in the statute, which dictate that certain categories of receipts, such as brokerage commissions, management fees, margin interest, and gross income from principal transactions, should be sourced based on the mailing addresses of the customers responsible for payment, as recorded in the taxpayer's records. The tribunal noted that the main issue is to determine who is “the customer responsible for paying” the taxpayer. The tribunal referenced a definition in a federal rule intended to implement a section of the USA PATRIOT Act that was adopted by the Department of Treasury and the Securities and Exchange Commission (SEC), which does not require a broker-dealer to look through an intermediary to the underlying beneficial owners but defined a “customer” generally as “a person that opens a new account.” Based on this federal definition, the tribunal disagreed with the taxpayer that its customers were the underlying investors.

The tribunal determined that the division's method of sourcing receipts to the locations of the institutional intermediaries was not distortive and did not warrant the use of discretionary authority. The taxpayer presented expert witness testimony to show that the division’s method of sourcing the receipts based on intermediary location grossly overstated the taxpayer’s sales factor. The tribunal disagreed with the taxpayer’s expert’s recommendation to use U.S. Census data and held that a look-through methodology was not permitted for purposes of the broker-dealer sourcing statute.

Additionally, the tribunal addressed the taxpayer’s constitutional challenge, asserting that the division's method of sourcing receipts did not violate the Commerce Clause or the Due Process Clause of the US Constitution. Unlike the ALJ, the tribunal found no unconstitutional distortion in sourcing receipts to the taxpayer's branch or office that generated the transactions.

With respect to the taxpayer's election to treat the net income from its cash collateral used in securities borrowing and securities lending transactions, interest rate swap transactions, and certain cash on deposit as investment capital, the tribunal agreed with the ALJ’s finding that the division’s denial of the election was improper.

Finally, with regards to the taxpayer’s claimed investment tax credits and employment incentive credits, the division cited a G-Notice that detailed analysis related to another taxpayer, which stated that the electronic trading business unit's activities did not meet the criteria for ITC eligibility. However, the tribunal concluded that the disallowance was deemed improper, as it contradicted the plain language of the relevant tax law.