Robert R. Burton et al., Appellants,v.New York State Department of Taxation and Finance et al., Respondents.BriefN.Y.June 4, 2015APL-2014-46 To be argued by: JUDITH N. VALE 15 minutes requested Supreme Court, Albany County, Index No. 3207/13 State of New York Court of Appeals ROBERT R. BURTON and JENNIFER R. BURTON, et al., Plaintiffs-Appellants, -against- NEW YORK STATE DEPARTMENT OF TAXATION AND FINANCE, et al., Defendants-Respondents. BRIEF FOR RESPONDENTS BARBARA D. UNDERWOOD Solicitor General CECELIA C. CHANG Special Counsel to the Solicitor General JUDITH N. VALE Assistant Solicitor General of Counsel ERIC T. SCHNEIDERMAN Attorney General of the State of New York Attorney for Respondents 120 Broadway New York, New York 10271 (212) 416-6274 (212) 416-8962 (facsimile) Dated: October 20, 2014 i TABLE OF CONTENTS Page TABLE OF AUTHORITIES ............................................................ iii PRELIMINARY STATEMENT ........................................................ 1 ISSUES PRESENTED ..................................................................... 3 STATEMENT OF THE CASE ......................................................... 3 A. Constitutional Background ............................................ 3 B. Statutory Background .................................................. 10 C. Facts and Procedural History ...................................... 13 1. Plaintiffs’ sale of JBS pursuant to a voluntary deemed asset-sale election ................... 13 2. The curative 2010 amendments ........................... 16 3. Plaintiffs’ refund demands and lawsuit ............... 18 4. Proceedings below ................................................. 19 ARGUMENT ................................................................................. 20 POINT I - SECTION 3 HAS NO BEARING ON TAXATION OF INCOME FROM SALES TRANSACTIONS .................................................... 20 A. Section 3 Relates Only to Property Taxes on Intangible Assets Maintained in New York. ..... 21 B. The Legislature’s Policy Decisions Do Not Create Any Constitutional Prohibition Against Taxation of Income from Sales Transactions. ...................................................... 27 ii TABLE OF CONTENTS (cont'd) Page POINT II - PLAINTIFFS’ ASSET-SALE GAINS WOULD NOT BE PROTECTED BY ANY CONSTITUTIONAL BAR ON TAXING STOCK-SALE INCOME, EVEN IF SUCH A BAR EXISTED ........................................................ 33 CONCLUSION ............................................................................... 40 iii TABLE OF AUTHORITIES Cases Page(s) 595 Invs. Ltd. P’ship v. Biderman, 140 Misc. 2d 441 (Sup. Ct. N.Y. County 1988) .......................... 25 Adler v. Deegan, 251 N.Y. 467 ............................................................................... 21 Ampco Printing-Advertisers’ Offset Corp. v. City of N.Y., 14 N.Y.2d 11 (1964) ........................................................... passim Bordeleau v. State, 18 N.Y.3d 305 (2011) ................................................................. 20 Foss v. City of Rochester, 65 N.Y.2d 247 (1985) ................................................................. 28 Franklin Soc’y for Home Bldg. & Sav. v. Bennett, 282 N.Y. 79 (1939) ............................................................... 20, 25 Gen. Mills Inc. v. Comm’r of Revenue, 440 Mass. 154 (2003) ................................................................. 38 Matter of Guardian Life Ins. Co. of Am. v. Chapman, 302 N.Y. 226 (1951) ............................................................... 9, 23 Matter of Tamagni v. Tax Appeals Tribunal of the State of N.Y., 230 A.D.2d 417 (3d Dep’t 1997) ................................. 9, 23, 25, 26 Matter of Tamagni v. Tax Appeals Tribunal of the State of N.Y., 91 N.Y.2d 530 (1998) ................................................................... 9 O’Kane v. State, 172 Misc. 829 (Ct. Cl. 1939) ......................................................... 9 Prince v. State Dep’t of Revenue, 55 So. 3d 273, 278 (Ala. Civ. App. 2010) ................................... 38 iv TABLE OF AUTHORITIES (cont’d) Cases Page(s) Simon v. City of N.Y., 22 Misc. 2d 718 (Sup. Ct. N.Y. County 1960) ............................ 23 State Tax Comm’n of Utah v. Aldrich, 316 U.S. 174 (1942) ...................................................................... 6 Travis v. Yale & Towne Mfg. Co., 252 U.S. 60 (1920) ...................................................................... 28 United States v. Carlton, 512 U.S. 26 (1994) ...................................................................... 38 Woodside Savings & Loan Ass’n v. Gallman, 73 Misc. 2d 357 (Sup. Ct. N.Y. County 1972), aff’d, 34 N.Y.2d 674 (1974) .................................................... 9, 23 Constitutional Provisions N.Y. Const. art. 16 .................................................................. 1, 5, 21 State Laws Ch. 627, 1919 N.Y. Laws 1639 ....................................................... 28 Tax Law § 210 .................................................................................................... 36 § 617 ........................................................................................ 10, 11, 17 § 631 .................................................................................. 11, 12, 28, 30 § 632 .................................................................................. 10, 11, 15, 17 § 660 ........................................................................................ 10, 15, 17 20 N.Y.C.R.R. § 4-2.2 ............................................................................... 11 v TABLE OF AUTHORITIES (cont’d) Federal Laws Page(s) 26 U.S.C. §§ 1361-1379 .............................................................................. 10 § 1366 ......................................................................................... 10 Technical Corrections Act of 1982, Pub. L. No. 97-448 § 306, 96 Stat 2365 (1983) ......................................................... 34 26 C.F.R. § 1.338(h)(10)-1 .............................................................. 15 Miscellaneous Authorities 98 N.Y. Jur. 2d Taxation & Assessment § 29 .................................. 7 2 Revised Record, N.Y. State Const. Conv. 749 (1938) ............. 4, 22 Byron F. Egan, Asset Acquisitions: Assuming and Avoiding Liabilities, 116 Penn. St. L. Rev. 913 (2012) ............................. 15 Company Overview of JBS Sports, Inc., Bloomberg Businessweek (Oct. 16, 2014), available at http://investing.businessweek.com/research/stocks/private /snapshot.asp?privcapId=35128954. ......................................... 13 Dep’t of Taxation & Fin. Recommendation (Apr. 12, 1960), reprinted in Bill Jacket for ch. 563 (1960) ................................ 29 Joseph R. Gomez, Tax Aspects of Mergers and Acquisitions for the Corporate Lawyer, 5 J. Small & Emerging Bus. L. 321 (Fall 2001) ........................................................................... 14 Office of Tax Policy Analysis Technical Services Division, Summary of Corporation Tax Legislative Changes Enacted in 2006 (Jan. 30, 2007), available at http://www.tax.ny.gov/pdf/memos/corporation/m07_3c.pdf ...... 36 vi TABLE OF AUTHORITIES (cont’d) Miscellaneous Authorities Page(s) State of N.Y. Temporary State Commission on the Constitutional Convention, State Finance: Report 8 (March 24, 1967) ............................................................................. 8, 25 PRELIMINARY STATEMENT In this direct constitutional appeal, plaintiffs seek to avoid payment of any New York income tax on their more than $80 million sale of JBS Sports, Inc., a sports media company that conducted more than thirteen percent of its business in this State. Plaintiffs demand complete tax immunity based on the theory that article 16, section 3 (“Section 3”) of the New York Constitution bars the Legislature from taxing nonresidents’ income from the sale of intangible property such as stock. This Court should affirm the grant of summary judgment to defendants by Supreme Court, Albany County (Lynch, J.). As the text, history, and purpose of Section 3 make clear: Section 3 was addressed only to the direct taxation of intangible property “solely because of the ownership or possession” of the property. N.Y. Const. art. 16, § 3. Section 3 expressly authorizes taxation of the “income” earned from the sale of intangible property like stock—whether the income is earned by residents or nonresidents like plaintiffs. For decades, New York has collected taxes from both resident and nonresident individuals and 2 corporations based on certain stock sales and other transactions involving intangible property. While the Legislature has chosen, as a matter of policy, not to tax nonresidents to the full extent permitted by the Constitution, there is no constitutional bar to the Legislature making a different policy choice—plaintiffs’ essential complaint here. Plaintiffs’ claim of tax immunity not only fails on the law; it also fails based on the specific nature of plaintiffs’ sale transaction. Even if Section 3 limited taxation of nonresidents’ income from sales of intangible assets, which it does not, plaintiffs could not invoke that provision because they elected to treat their sale transaction as a deemed sale of corporate assets for tax purposes. Because the Legislature indisputably may tax gains from corporate assets used to do business in New York, and because there is no evidence that Section 3 was meant to shield parties from taxation when they elect asset-sale treatment, plaintiffs’ claim fails even under their own erroneous constitutional theory. 3 ISSUES PRESENTED 1. Whether Section 3 is irrelevant to plaintiffs’ sale transaction because it addresses only direct property taxes levied on intangible assets held in New York and does not contain any limitation on taxation of income from sales transactions? 2. Whether any limitation on taxation of nonresidents’ income from the sale of intangible assets would be inapplicable to plaintiffs’ income here because they elected to treat the transaction not as a sale of intangible assets but as a sale of corporate assets used to do business in New York? STATEMENT OF THE CASE A. Constitutional Background Section 3 of article 16 of the New York State Constitution is primarily addressed to a now largely outdated system of taxation based on the physical location of property. The provision first appeared in the 1938 Constitution. At that time, many States had been attempting to tax intangible forms of property (like stocks or bonds) in the same manner as real property by assessing taxes based solely on ownership of stocks or bonds according to the 4 value of the stocks or bonds (i.e. “ad valorem” taxes). (R. 222.) See also 2 Revised Record, N.Y. State Const. Conv. 749 (1938) (“1938 Convention Record”). Because intangible property was taxed on the same model as real property, intangible property taxes were viewed as a form of location-based tax—making it important (under then-existing law) to determine the proper legal situs of the intangible property for tax-jurisdiction purposes. (R. 222 (noting that New York stopped levying ad valorem taxes on intangibles because “of the impossibility of taxing intangible personal property the same as real estate”).) Physical presence in the state was one easy way to determine situs. For example, States could impose an ad valorem tax on actual stock certificates or bonds (or other physical representations of intangibles) kept within the State. But parties could then move their intangible assets to avoid the tax, and States that attempted to impose such taxes began experiencing a severe “flow of intangible wealth to other states.” (R. 223.) Section 3 was added to the Constitution in 1938 to address this narrow problem alone: the outflow of intangible assets, which 5 threatened New York’s status as the nation’s major financial center. The plain language of Section 3 ensures that all individuals—whether or not they reside in New York—can store certificates evidencing ownership of intangible property, such as stock or bonds, within the State without subjecting the property to property taxes based solely on the physical location or existence of intangible assets, however that location might be defined. Specifically, Section 3 provides that: Moneys, credits, securities and other intangible personal property within the [S]tate not employed in carrying on any business therein by the owner shall be deemed to be located at the domicile of the owner for purposes of taxation . . . . Intangible personal property shall not be taxed ad valorem nor shall any excise tax be levied solely because of the ownership or possession thereof, except that the income therefrom may be taken into consideration in computing any excise tax measured by income generally. N.Y. Const. art. 16, § 3. The record of the 1938 constitutional convention, at which Section 3 was proposed and debated, makes clear that the provision’s two sentences together protect against ad valorem and similar location-based taxes on intangible assets merely by virtue of their location (or the location of certificates) in New York. (R. 6 222-224.) The first sentence advances this goal by writing into the state Constitution a then-existing, and now largely outdated, property-situs rule that intangible assets are considered to be physically “located” in the domicile state of the owner.1 As a result, nonresidents were assured that New York’s already- existing situs rule for property-based taxes would not change. (R. 226 (explaining that Section 3 “shall not in any way affect the present law”).) Section 3’s second sentence further addressed the wealth-flight problem by prohibiting all state taxation assessed solely based on the physical ownership, possession, or presence of intangibles in New York, whether such property is owned by residents or nonresidents. (R. 222.) See Ampco Printing-Advertisers’ 1 The property-situs rule had its origins in Supreme Court due-process case law concerned with avoiding double taxation of property. Although New York retains the situs principle for taxes measured by an intangible’s physical location, the underlying due process rationale for the rule was overturned by the Supreme Court in State Tax Comm’n of Utah v. Aldrich, 316 U.S. 174 (1942), a case that ushered in a more modern era of taxation that is less concerned with “taxation by more than one state,” id. at 176, 181-82 (quotation marks omitted); see also id. at 197-98 & n.21 (Jackson, J., dissenting) (explaining that States had relied on prior situs rule, including New York by adding Section 3 to the New York Constitution). 7 Offset Corp. v. City of N.Y., 14 N.Y.2d 11, 22 (1964). This clause thus “close[d] the door on [an] obsolete method of taxation” and provided “further assurance to the people of the whole United States that if they send intangibles into [New York] they are not going to be subjected to ad valorem taxation.” (R. 222-223.) Section 3’s text and history make equally clear that the provision is limited to location-based taxes of this form and does not in any way prevent distinct forms of taxation measured by the use of intangible assets or the generation of income from intangible property. (R. 224.) See also 98 N.Y. Jur. 2d Taxation & Assessment § 29. Section 3 expressly permits taxation based on the income from intangible assets. And the convention record explains that New York ended its attempts at ad valorem taxation of intangibles when it instead “adopted the income tax” in 1919. (R. 223.) Rather than contemplating any limitation on the collection of income-based or transaction-based taxes, the delegates repeatedly emphasized that by encouraging the retention of intangibles in New York, the State would be able to increase its collection of taxes based on the sale of stocks and bonds and other 8 income generated from intangible property. The delegates to the 1938 constitutional convention thus projected that Section 3 would create new and “very splendid [tax] revenue” streams when intangible property is sold or transferred. (R. 224.) For example, when asked if Section 3 would prevent stock-transfer taxes, one committee member explained: “if [New York] can increase this intangible wealth from the other states [it] will be able to impose the transfer taxes which will bring [the State] substantial revenues.” (R. 223.) Decades of subsequent history and tax practice further establish that Section 3 relates only to property-related and not income- or transactional-based taxes. Just thirty years after Section 3’s enactment, a commission preparing for the next constitutional convention in 1967 explained that Section 3 protects residents and nonresidents from ad valorem and similar taxation on intangibles, State of N.Y. Temporary State Commission on the Constitutional Convention, State Finance: Report 8, at 62-63 (March 24, 1967) (“1967 Report”), but does not limit taxation of “income from such [intangible] property,” id. at 37 (emphasis added). 9 Moreover, in keeping with this established and uniform understanding of Section 3, New York courts have upheld a long history of taxes on income from intangible assets, including taxes on transfers of stock, see O’Kane v. State, 172 Misc. 829, 831 (Ct. Cl. 1939), and franchise taxes based on income derived from intangible property, see, e.g., Matter of Guardian Life Ins. Co. of Am. v. Chapman, 302 N.Y. 226, 238-39 (1951); Woodside Savings & Loan Ass’n v. Gallman, 73 Misc. 2d 357, 360 (Sup. Ct. N.Y. County 1972), aff’d, 34 N.Y.2d 674 (1974). Likewise, this Court has upheld an income tax on intangibles owned by individuals domiciled in another state—whose intangibles thus had a physical “situs” elsewhere— because they were statutory residents in New York. See Matter of Tamagni v. Tax Appeals Tribunal of the State of N.Y., 91 N.Y.2d 530, 532-33, 545 (1998); Matter of Tamagni v. Tax Appeals Tribunal of the State of N.Y., 230 A.D.2d 417, 421 (3d Dep’t 1997). 10 B. Statutory Background The underlying tax scheme at issue in this appeal concerns the taxation of income from S corporations. An S corporation is a special form of corporation that is permitted to avoid paying corporate-level income tax by passing income, gains, and losses directly to shareholders, who are then responsible for paying individual federal and state income tax on the corporation’s flow- through earnings. (R. 53-54); see 26 U.S.C. §§ 1361-1379; Tax Law § 660(a). Because gains flow from the corporation to shareholders, both federal and state law assess taxes on pass-through income based on the income’s character when earned by the corporation. (R. 54); 26 U.S.C. § 1366(b); Tax Law §§ 617(a), 632(e)(2). New York’s tax treatment of S-corporation pass-through earnings conforms to federal law. To achieve parallel state and federal tax treatment, Tax Law § 660 provides that New York S- corporation shareholders must report for state income-tax purposes the same “S corporation items of income, loss, deduction and reductions . . . which are taken into account for federal income tax purposes.” Tax Law § 660(a). (See R. 54.) As a result, the 11 amount of pass-through income taxed by the State is based on the amount of flow-through income taxed under federal law, with “[e]ach item” of pass-through gain retaining “the same character” for state income tax purposes as it had “for federal income tax purposes.” Tax Law §§ 617(b), 632(e)(2). (See R. 54.) New York’s statutory income-source rules then determine the proportion of federal pass-through gain subject to state income tax. While resident New York shareholders owe state taxes on all pass-through earnings, see Tax Law § 617(a), nonresident shareholders—like plaintiffs in this case—pay state income taxes proportional to the underlying percentage of corporate pass- through gains “derived from or connected with New York sources.” Id. § 632(a)(2); see also id. § 631(a)(1)(B). Department of Taxation and Finance (DTF) regulations determine the percentage of the S corporation’s overall business derived from New York, see id. § 632(a)(1); 20 N.Y.C.R.R. § 4-2.2, and this percentage is applied to nonresident shareholders’ federal pass-through earnings to calculate their state income tax (R. 54). 12 In addition to paying proportionate state income tax on their S-corporation pass-through gains, nonresidents must also pay taxes on other income that they derive from New York sources. Tax Law § 631(b). Nonresidents’ earnings from intangible personal property, including “dividends, interests, and gains from the disposition of intangible property,” are taxable New York source income when the intangible property is employed in a business carried on in the State. Id. § 631(b)(2). These statutory income-source rules apply to income from intangible assets whether or not those assets are maintained inside or outside of New York, and do not relate to taxation of intangibles based on their physical location or mere presence within the State. 13 C. Facts and Procedural History 1. Plaintiffs’ sale of JBS pursuant to a voluntary deemed asset-sale election Plaintiffs are nonresidents of New York who were previously the owners and shareholders of JBS, a Tennessee corporation that provides sports media services. (R. 17.) Company Overview of JBS Sports, Inc., Bloomberg Businessweek (Oct. 16, 2014).2 While plaintiffs owned JBS, the corporation conducted substantial business in New York, earning more than thirteen percent of its total income from New York sources. (R. 19.) Because JBS elected to be treated as an S corporation for federal and New York tax purposes (R. 6, 17), plaintiffs were responsible for paying individual federal and state income tax on their pro-rata shares of JBS’s pass-through income and gains. In July 2007, plaintiffs sold JBS to Yahoo! Inc. for more than $88 million.3 (R. 6, 17-18.) Both plaintiffs and Yahoo! jointly took a 2 Available at http://investing.businessweek.com/research/sto cks/private/snapshot.asp?privcapId=35128954. 3 The total sale price for the JBS transaction was more than $88 million. (R. 17-18.) Plaintiffs’ received more than $80 million (continued on next page) 14 federal election under IRC § 338(h)(10) to treat a stock-sale transaction as a sale of JBS’s corporate assets—a “deemed asset sale”—for tax purposes. (R. 17-18, 54-55.) By taking this § 338(h)(10) deemed asset-sale election, plaintiffs and Yahoo! were able to qualify their transaction for significant federal and state tax benefits available only for asset sales. (R. 6, 54-55.) Specifically, asset-sale treatment allowed Yahoo! to “step up” to fair market value the taxable basis of the JBS assets that Yahoo! acquired, which results in future reduced tax liabilities.4 (R. 6, 54-55.) See generally Joseph R. Gomez, Tax Aspects of Mergers and Acquisitions for the Corporate Lawyer, 5 J. Small & Emerging Bus. L. 321, 329 (Fall 2001). But because this asset-sale treatment can also trigger negative federal and state tax consequences for selling shareholders like plaintiffs, of this gain (R. 18), with one shareholder who is not a party to this lawsuit receiving the additional sale proceeds (R. 17 n.1). 4 The step-up adjustment provides S-corporation purchasers like Yahoo! with future enhanced tax deductions for asset depreciation and lower taxable gains on subsequent asset sales. 15 the deemed asset-sale election had to be jointly agreed to by plaintiffs and Yahoo!.5 See 26 C.F.R. § 1.338(h)(10)-1(c)(3). As plaintiffs themselves explained, JBS’s “deemed asset sale resulted in federal taxable gain to the JBS shareholders of $88,364,074.00,” with each plaintiff recognizing their pro-rata share of JBS’s flow-through income. (R. 17-18.) Because JBS was an S corporation, the “amount and character” of its asset-sale gain passed through to plaintiffs, who were required to pay federal and state income tax on the more than $80 million in asset-sale earnings they received. 26 C.F.R. § 1.338(h)(10)-1(d)(5); Tax Law §§ 632(a)(1)-(2), (e), 660(a). For federal tax purposes, JBS reported its $88 million in deemed asset-sale gains as well as the pro-rata share of this corporate income that passed through to each plaintiff. (R. 18.) Despite paying federal income tax on these asset-sale gains (R. 18- 5 Selling shareholders will often agree to the deemed asset- sale election if the purchasers’ tax benefits outweigh the tax costs, allowing the purchaser to compensate the shareholder for any tax consequences through an increased sale price. See Byron F. Egan, Asset Acquisitions: Assuming and Avoiding Liabilities, 116 Penn. St. L. Rev. 913, 928 (2012). 16 19, 189), plaintiffs failed to report or to pay any New York state income tax on the multi-million dollar sale. (R. 19, 189.) 2. The curative 2010 amendments In 2010, the Legislature acted to cure two erroneous administrative decisions that threatened to create tax loopholes and undermine longstanding New York tax law with respect to parallel treatment of pass-through gains. Because plaintiffs in this case do not challenge the curative purposes of the 2010 amendments or the constitutionality of applying the amendments retroactively to plaintiffs,6 only a brief description of the amendments is provided below for background.7 The Legislature enacted the 2010 amendments to correct mistaken administrative rulings in Matter of Baum and Matter of 6 Although plaintiffs originally asserted that retroactive application of the 2010 amendments to the JBS transaction violated due process, they withdrew this claim before Supreme Court (R. 7, 235), and have not attempted to renew it on appeal. 7 A full explanation of the events leading up to the curative 2010 amendments and their curative goals is provided in the brief being filed today in this Court in Caprio v. Dep’t of Taxation & Finance, APL-2014-177. 17 Mintz. In Baum, the Tax Appeals Tribunal erroneously refused to treat a § 338(h)(10) deemed asset sale as an asset sale for New York tax purposes. (R. 37-38, 86-92.) In Mintz, an Administrative Law Judge committed a similar error with respect to an actual asset sale that used installment reporting, a different tax election not at issue in this appeal. (R. 37-38, 93-98.) Both administrative rulings departed from the foundational parallel-treatment rules and policy, embodied in the Tax Law, which require parallel treatment of S-corporation income for federal and state tax purposes. See Tax Law §§ 617(b), 632(e)(2), 660(a). To avoid the legal confusion, unfairness, and unexpected tax losses that would result if the two erroneous rulings were allowed to stand for still-open tax years, the Legislature made curative amendments to the Tax Law. (R. 34, 37-38, 50.) Among other changes, the Legislature amended Tax Law § 632 to provide that “any gain recognized on the deemed asset sale for federal income tax purposes will be treated as New York source income” from an asset sale subject to state income tax. (R. 34.) To fully cure the negative consequences of Baum and Mintz, the Legislature made 18 the 2010 amendments retroactive to still-open tax years for which the statute of limitations period had not run. (R. 35.) 3. Plaintiffs’ refund demands and lawsuit After an audit, DTF assessed New York income tax on plaintiffs’ pass-through asset-sale gains from the JBS transaction in proportion to the amount of income JBS had derived from New York sources. The total amount of income tax assessed for all plaintiffs was approximately $167,000 (R. 19.) Plaintiffs initially signed consent forms agreeing to the amounts owed (R. 128-134), and paid the state taxes (R. 20). However, more than a year later, plaintiffs demanded refunds of the New York state income taxes they had previously paid, suddenly claiming that their deemed asset-sale income was actually “gain from the sale of shares of [JBS] stock” and that taxation of such income violated Section 3. (See, e.g., R. 136.) After DTF rejected plaintiffs’ refund demands (R. 180-186), plaintiffs filed this declaratory-judgment lawsuit— arguing that assessment of the disputed income taxes violated Section 3’s prohibitions on taxation of intangible property (R. 20). 19 4. Proceedings below In a Decision, Order, and Judgment dated January 6, 2014, Supreme Court, Albany County granted summary judgment to defendants and dismissed plaintiffs’ complaint. (R. 5-10.) The court concluded that taxation of plaintiffs’ asset-sale earnings could not violate Section 3 because Section 3 addresses intangible property and plaintiffs had earned pass-through income from a deemed sale of JBS’s corporate assets. (R. 8-9.) Supreme Court explained that plaintiffs’ insistence that they had recognized stock-sale gains for state tax purposes “ignore[d] their direct election to treat the transaction as an asset sale.” (R. 8-9.) Plaintiffs took a direct appeal to this Court pursuant to C.P.L.R. 5601(b)(2), asserting that their appeal is limited to challenging the constitutionality of the 2010 amendments under Section 3. (R. 271-272.) On May 7, 2014, this Court retained jurisdiction over the appeal. 20 ARGUMENT POINT I SECTION 3 HAS NO BEARING ON TAXATION OF INCOME FROM SALES TRANSACTIONS Plaintiffs’ appeal is based on a fundamental misreading of Section 3 as providing special income-tax immunity to nonresidents for gains earned from the sale of intangible assets such as stock. Plaintiffs’ theory of special immunity has no grounding in the history or text of Section 3, and would instead represent a monumental shift in tax policy never intended or even contemplated by the section’s drafters. The Legislature’s decision to tax income derived from a deemed sale of assets used to do substantial business in New York “enjoy[s] a strong presumption of constitutionality.” Bordeleau v. State, 18 N.Y.3d 305, 313 (2011). In determining whether plaintiffs have carried their heavy burden of proving otherwise, Section 3’s meaning and effect must be interpreted in light of its history and intended purposes. See Ampco, 14 N.Y.2d at 22-23 (interpreting Section 3 based on its purposes as explained in constitutional convention record); Franklin Soc’y for Home Bldg. & Sav. v. Bennett, 21 282 N.Y. 79, 87 (1939) (interpreting Section 3 as limited to its history and purposes); Adler v. Deegan, 251 N.Y. 467, 472-73 (giving “limited meaning” to constitutional text based on history). Here, both the plain language and historical context of Section 3 point in one direction. Section 3 prevents only location- based taxes on the theoretical presence of intangible assets in the State, while expressly allowing income or transactional taxes to be levied when such intangible property is sold or transferred. Because the tax at issue here is based on the income from the sale of JBS’s corporate assets, and not on the maintenance of intangible assets inside New York, Section 3 is irrelevant here. A. Section 3 Relates Only to Property Taxes on Intangible Assets Maintained in New York. Section 3 prohibits specific types of property taxes not at issue in this case. By its plain terms, Section 3 addresses the physical “location” of intangible assets for jurisdictional purposes and prohibits only certain taxes based “solely” on the value, ownership, or possession of intangible property maintained in the State. N.Y. Const. art. 16, § 3; see Ampco, 14 N.Y.2d at 21-24. The 22 provision is thus directed at taxes on intangible property measured by the physical location of intangibles, such as general property or estate taxes. (R. 222-224.) It does not in any way limit nonlocation-based forms of taxation on the use of or income from intangible property. (R. 224 (explaining that intangible property may be taxed “when it is used”).) To the contrary, taxes measured by income derived from intangibles are expressly contemplated and encouraged by Section 3. See, supra, at 7-8. This narrow textual focus on taxation of intangible assets stored inside New York is reinforced by Section 3’s history and purposes. As this Court has noted, the drafters of Section 3 made clear that the provision is designed to assure that taxpayers “could keep their money and securities in New York without any fear” of “ad valorem taxation.” Ampco, 14 N.Y.2d at 22-23 (quotation marks and brackets omitted). By thus encouraging residents and nonresidents to retain “cash balances” or “shares of stock” in the State’s financial institutions (1938 Convention Record at 749), the delegates aimed to “maintain the financial supremacy of New York City” and to expand the State’s tax base when such intangible assets 23 are sold or “put to use in the flow of trade and commerce,” Simon v. City of N.Y., 22 Misc. 2d 718, 718-21 (Sup. Ct. N.Y. County 1960). Here, plaintiffs were not taxed based on the physical location or existence of an intangible asset—and Section 3 is thus completely inapplicable. Plaintiffs instead paid taxes on the amount of their pass-through income from a deemed sale of corporate assets used to do substantial business in New York. Such a tax on sale earnings is “not based merely upon ownership or possession” of any intangible asset in the State “regardless of whether the property is used or not.” Ampco, 14 N.Y.2d at 22. Rather, such a tax is “based on the income generated” by the S corporation’s deemed asset sale and passed directly to its shareholders, which “does not offend” Section 3’s prohibition against ad valorem and similar location-based taxes. Matter of Tamagni, 230 A.D.2d at 421; see also Chapman, 302 N.Y. at 238- 39 (tax “measured by [insurance] premium income” is “not, in any sense,” an ad valorem tax); Woodside, 73 Misc. 2d at 360 (tax based on “interest or dividend” income is not an ad valorem tax and is permitted under Section 3). 24 Plaintiffs claim that the income from this sale is constitutionally immune from taxation because it arises from the sale of intangibles, but they are mistaken. As a preliminary matter, plaintiffs elected to treat this transaction as a sale of corporate assets and not as a sale of JBS stock, and therefore they cannot make a claim based on a constitutional protection for intangibles. See, infra, at __. In any event, Section 3 does not protect nonresidents’ income arising from the sale of stock, as plaintiffs claim (Pls.-Appellants’ Br. (“Br.”) at 6, 13-14). To the contrary, the only time that Section 3 mentions “income” is to expressly allow taxation based on gains generated from intangible assets. (R. 222-224.) Indeed, the drafters of Section 3 specifically intended this provision to expand rather than to limit the tax base by encouraging residents and nonresidents to maintain intangible property within the State that would produce additional tax revenues when transferred or sold. (R. 222-224); see also 1967 Report at 61-63. Plaintiffs’ alternate theory contravenes not only the text and intended purposes of Section 3, but also decades of historic tax 25 practice. The Temporary State Commission’s report for the 1967 constitutional convention emphasizes that although Section 3 protects both residents and nonresidents from ad valorem and similar taxation, the Legislature remains free to tax income generated from intangibles. 1967 Report at 37, 61-63. And for over eighty years, the courts have universally rejected arguments, like plaintiffs’ assertion here, that Section 3 provides anyone, whether a resident or nonresident, with complete tax immunity when intangible assets are sold or otherwise used in commerce. See, e.g., Ampco, 14 N.Y.2d at 22; Franklin, 282 N.Y. at 85-87; Matter of Tamagni, 230 A.D.2d at 421; 595 Invs. Ltd. P’ship v. Biderman, 140 Misc. 2d 441, 446-47 (Sup. Ct. N.Y. County 1988). By contrast, plaintiffs do not point to a single case since Section 3’s enactment holding otherwise, despite the fact that the State has proportionally taxed nonresidents’ S-corporation pass-through income for more than fifty years. Plaintiffs’ exclusive reliance on the first sentence of Section 3 (Br. at 13-14, 16-17), which does not prohibit any taxes at all, is misplaced. Logically, “it does not follow from the first sentence of 26 [Section 3], which provides that the situs of intangibles” maintained in New York is “the domicile of the owner,” that “income from intangibles” owned by a nondomiciliary “cannot be taxed in New York” when such income has a sufficient nexus to this State. Matter of Tamagni, 230 A.D.2d at 421. “Nor does the legislative history support [such a] conclusion.” Id. Rather, Section 3’s declarative statement regarding the situs of intangible assets codified a then-existing but now largely outdated rule used to determine the physical location of intangibles for the purpose of levying ad valorem and similar property-based taxes. See, supra, at 3-7. As the drafters of Section 3 explained, the “underlying purpose” of Section 3’s “first sentence” was to ensure that nonresidents would not be “subjected to taxation merely by sending [intangibles] here and leaving [them] here.” (R. 222.) This sentence thus served as the foundational predicate for the general prohibitions on ad valorem and other location-oriented taxes that follow. Indeed, nothing in Section 3 remotely suggests that this situs rule silently created expansive prohibitions against income 27 taxes on nonresidents that do not appear in the Constitution. Just the opposite—the history and purposes of Section 3 demonstrate that it was designed to cement the State’s already-completed move away from “obsolete,” location-based methods of taxation and towards more modern systems of income- and transaction-based taxation for intangible property. (R. 222-224.) And Section 3’s drafters not only expected but intended this transition to expand, rather than to contract, New York’s income-tax base. (R. 222-224.) A contrary reading of Section 3 as prohibiting income or transactional taxes on intangibles would create a whole new category of tax prohibitions that simply “could not have entered into the mind of anyone at the [1938] convention.” Ampco, 14 N.Y.2d at 23. Accordingly, plaintiffs’ constitutional claim should be rejected. B. The Legislature’s Policy Decisions Do Not Create Any Constitutional Prohibition Against Taxation of Income from Sales Transactions. Because plaintiffs cannot point to any language in the Constitution that prevents taxation of gains from corporate asset sales or even from sales of intangible assets, they instead cite to statutes setting forth rules regarding taxation of nonresidents’ 28 income (Br. at 6-13), thereby fundamentally confusing the issue presented in this appeal. Plaintiffs cannot create new constitutional provisions out of whole cloth by simply inserting the text of statutory income-source rules into Section 3, which does not address income at all. The Legislature has nearly unfettered authority to set tax policy within the outer bounds of Section 3 and other constitutional limitations. Foss v. City of Rochester, 65 N.Y.2d 247, 257 (1985). Although Section 3 allows the Legislature to tax nonresidents’ income from sales of intangible assets, see supra, at 3-9, 21-27, the Legislature chose as a general matter not to tax nonresidents’ gains from intangible assets located within or outside of New York unless the assets were employed in a business carried on in the State.8 Tax Law § 631(b)(2). But this 8 The Legislature has chosen not to tax nonresidents’ income from certain intangible assets since it first adopted the income tax in 1919, well before Section 3’s enactment. See Ch. 627, § 1, 1919 N.Y. Laws 1639, 1642-43. This policy choice was designed “to preserve the pre-eminence of New York City as a financial center,” Travis v. Yale & Towne Mfg. Co., 252 U.S. 60, 81 (1920), and was continued through Tax Law § 631 when the income tax code was reorganized (continued on next page) 29 discretionary decision to assess taxes of narrower scope than the full extent permitted by Section 3 does not mean that the Legislature’s policy choice represents Section 3’s constitutional limit. Rather, the Legislature remains free under Section 3 to tax nonresidents’ income from sales of intangible property or to determine that certain gains are not considered to be derived from intangible assets at all, so long as the Legislature does not tax intangible property held in the State based merely on the property’s value or presence in New York. Most tax statutes do not reflect the full breadth of the Legislature’s constitutional taxing authority. Plaintiffs’ contrary constitutional theory would freeze into place past legislative policy choices as controlling constitutional mandates. That result would fatally undermine the Legislature’s ability to craft and change tax policy regarding nonresidents’ earnings from businesses or in 1960 to conform New York’s income tax treatment to that of federal law, see Dep’t of Taxation & Fin. Recommendation (Apr. 12, 1960), reprinted in Bill Jacket for ch. 563 (1960), at 73. Nothing in the legislative history of the income-tax recodification suggests that the Legislature adopted Tax Law § 631 based on any perceived constitutional limitations imposed by Section 3. 30 properties that derive substantial privileges from New York.9 The curative 2010 amendments are not the only instance where the Legislature has determined that a nonresidents’ sale of an intangible asset results in taxable New York source income. For example, to prevent the use of shell entities, certain sales by nonresidents of their interests in partnerships or S corporations owning real property in New York are treated as sales of real property rather than as sales of intangible ownership interests. Tax Law § 631(b)(1)(A)(1). Likewise, nonresidents’ gains from the sale of shares in New York cooperative housing corporations produce taxable New York source income despite technically being income from a sale of stock. Id. § 631(b)(1)(E). Nothing in Section 3 suggests that the Legislature is barred from making the policy decision that 9 The same counsel that represents plaintiffs in this case has recently filed another declaratory-judgment action claiming that Section 3 bars the Legislature from taxing a nonresident’s pass- through gains from a New York S corporation’s sale of its interest in a New York limited liability company. See Affirmation of B. McCann ¶¶ 3, 12, 18, Redford v. N.Y. State Dep’t of Taxation & Fin., Index No. 3974-14 (Sup. Ct. N.Y. County) (Sept. 18, 2014). 31 these or similar sales of intangible assets produce income sufficiently connected to New York to warrant state taxation. Indeed, plaintiffs’ conflation of constitutional and statutory limits contradicts Section 3 itself, which expressly allows the Legislature to tax nonresidents’ income from intangible assets brought in to New York even though such assets retain their “situs” in the owners’ domicile. Under plaintiffs’ view, Section 3 would somehow prohibit the very income taxes that it expressly allows because, based on a statute, the Constitution purportedly “prohibits the taxation of income from intangible property owned by a nonresident.” Br. at 6, 13. While the Legislature may choose—by statute—to limit the collection of income taxes from nonresidents, its choices do not expand the coverage of Section 3, so as to cement particular legislative policy choices as enduring constitutional limits. No different result is suggested by the various regulations, DTF technical service memoranda, and other documents to which plaintiffs point. Br. at 14-15 (citing R. 204-220). These materials analyze the statutory income-source rules that apply to S- 32 corporation shareholders or partners rather than Section 3’s constitutional limitation on ad valorem or similar taxation of assets maintained in New York.10 (See R. 204-205 (memorandum discussing DTF interpretation of Tax Law § 631(b)’s partnership income rules); R. 206-210 (memorandum discussing Tax Law provisions regarding personal income, estate, gift, and generation- skipping transfer taxes); R. 211-220 (DTF letter and administrative ruling regarding Tax Law § 631(b)’s partnership income rules as related to ownership of real property in New York). Accordingly, these documents are irrelevant, and plaintiffs’ claim should be rejected. 10 Only one of plaintiffs’ cited documents even mentions Section 3 at all, and it does so merely to provide “general” background for its discussion of various statutory income-source rules. (See R. 206-210.) 33 POINT II PLAINTIFFS’ ASSET-SALE GAINS WOULD NOT BE PROTECTED BY ANY CONSTITUTIONAL BAR ON TAXING STOCK-SALE INCOME, EVEN IF SUCH A BAR EXISTED Plaintiffs’ constitutional claim fails at the outset because Section 3 does not prohibit taxation of income from any type of sale transaction. See supra, at 21-32. But plaintiffs’ claim would also fail even if Section 3 somehow limited taxation of nonresidents’ stock-sale income, because plaintiffs chose to treat the sale of JBS as a sale of corporate assets rather than as a sale of stock by using a particular form of transaction that did not exist in 1938, when Section 3 was added to the state Constitution. See supra at 13-18. Nothing in Section 3’s language or history suggests that New York is barred from taxing a transaction based on the particular transaction form and tax treatment parties voluntarily elect. At bottom, plaintiffs ask this Court to extend further an implied protection for stock-sale gains purportedly lurking in Section 3’s property-situs rule to bar taxation of income from a transaction that has both the economic substance and tax benefits of a 34 corporate asset sale. But such a far-reaching interpretation of Section 3 would be even more unmoored from the provision’s historic context and purposes. Section 3’s drafters simply could not have intended or even contemplated that a theoretical protection for income from intangible assets would also apply to deemed asset-sale gains earned pursuant to § 338(h)(10), a federal tax election that did not exist until almost fifty years after Section 3 was added to the state Constitution. See Technical Corrections Act of 1982, Pub. L. No. 97-448, § 306, 96 Stat 2365, 2400 (1983). Because plaintiffs’ theory stretches Section 3 beyond recognition, this Court should reject it. Tellingly, plaintiffs do not contest that New York may constitutionally assess proportional income taxes on corporate asset-sale gains passed through to S-corporation shareholders. Instead, plaintiffs attempt to shoehorn their deemed asset-sale gains into their erroneous constitutional theory by insisting that they recognized stock-sale gains on the JBS transaction for state tax purposes. Br. at 12-13, 17. But plaintiffs’ contention simply “ignores their direct election to treat the [JBS] transaction as an 35 asset sale.” (R. 8.) As an S corporation, JBS was a “conduit” through which corporate gains passed directly to plaintiffs, and plaintiffs were responsible for paying federal and state income taxes on this flow-through income. Br. at 9, 11. (See R. 53-54). Because plaintiffs and Yahoo! jointly chose to take a deemed asset-sale election, thereby qualifying their transaction for the step-up tax benefits of asset-sale treatment, JBS was treated as having sold its assets and passed its earnings to plaintiffs. (R. 17- 18; see also R. 53-54.) Plaintiffs thus received taxable gains from the sale of JBS’s corporate assets; at no point did they recognize income from a sale of their JBS stock. See, supra, at 13-18. Accordingly, plaintiffs’ asset-sale earnings would not qualify for a constitutional protection for stock-sale income, even if such a protection actually existed. To avoid asset-sale treatment of their JBS-sale gains, plaintiffs assert (Br. at 12, 17-19) that New York law does not recognize the § 338(h)(10) deemed asset-sale treatment that they 36 admit applies under federal law (R. 17-18).11 But plaintiffs’ arguments about the correct interpretation of the Tax Law are irrelevant to their constitutional claim in light of the curative 2010 amendments. Plaintiffs do not dispute that the amendments require plaintiffs’ federal deemed asset-sale earnings to be treated as New York asset-sale gains. And plaintiffs do not contest retroactive application of the 2010 amendments to the JBS transaction. As a result, there can be no dispute here that New York recognizes the § 338(h)(10) deemed asset-sale election and, accordingly, considers plaintiffs’ income to be from a corporate asset sale and not a stock sale.12 11 Plaintiffs assert in their brief that they reported “gain from the sale of [their] stock” on their federal tax returns. Br. at 4. But this contention directly contradicts plaintiffs’ factual pleadings in their own complaint, which states that JBS recognized and plaintiffs reported “deemed asset sale” income for federal tax purposes. (R. 18.) 12 Matter of Baum, on which plaintiffs rely (Br. at 18) is inapposite. The curative 2010 amendments expressly overruled Baum because the Legislature found that Baum had incorrectly interpreted prior New York law. (R. 34, 37-38.) Indeed, Baum was fundamentally flawed because the Tax Appeals Tribunal relied on a corporate-level income tax on S corporations (R. 91) that was eliminated in 2006, see Tax Law § 210(1)(g)(1); Office of Tax Policy (continued on next page) 37 In any event, plaintiffs’ contention (Br. at 12, 17) that their deemed asset-sale election triggered “fictitious” asset-sale treatment only for federal tax purposes is meritless. As the Legislature reaffirmed in enacting the curative 2010 amendments, New York “had always . . . considered” § 338(h)(10) deemed asset sales to produce asset-sale earnings taxable in New York, in accordance with the foundational principle of conformity between federal and state tax treatment of S-corporation pass-through earnings. (R. 37-38; see R. 34.) Allowing sellers to avoid this asset- sale treatment that they chose would undo the purpose of the deemed asset-sale election and threaten to deprive purchasers of the state step-up benefits available only for asset sales. Plaintiffs are essentially claiming that the deemed asset-sale election applies only for the tax benefits of an asset sale but not for the tax liabilities of asset-sale treatment. See Br. at 12, 17. But there is no logical reason why the Legislature would allow Analysis Technical Services Division, Summary of Corporation Tax Legislative Changes Enacted in 2006, at 4 (Jan. 30, 2007), available at http://www.tax.ny.gov/pdf/memos/corporation/ m07_3c.pdf. 38 plaintiffs “to treat the sale as an asset sale for federal tax purposes, yet claim it was a stock sale on a state return in order to obtain tax benefits where they suit [plaintiffs] in either system.” Prince v. State Dep’t of Revenue, 55 So. 3d 273, 278 (Ala. Civ. App. 2010). Such an anomalous result would be inconsistent with federal law, which holds selling shareholders to the negative tax results of a § 338(h)(10) deemed asset-sale election (see Br. at 12 (noting that asset-sale treatment can trigger higher federal tax rates)), and would have no grounding in tax policy. Put simply, the deemed asset sale under § 338(h)(10) is not simply “fictitious”; it has “nonfictional consequences” that apply under both federal and state law. Gen. Mills Inc. v. Comm’r of Revenue, 440 Mass. 154, 170-71 (2003) (applying state asset-sale treatment to deemed asset-sale election). Finally, plaintiffs’ arguments (Br. at 19-23) regarding a “waiver” of or “condition” on a right to be free from taxation are misplaced. Plaintiffs have no right under Section 3 to complete immunity from taxation of their $80 million in sale gains. See, supra, at 21-32. Nor do plaintiffs have any right to a particular tax treatment or benefit under the tax code. See United States v. 39 Carlton, 512 U.S. 26, 33 (1994). And the State did not ask or induce plaintiffs to relinquish anything. Rather, plaintiffs and Yahoo! made their own business decision to select asset-sale treatment for their transaction, and New York has simply taxed the JBS sale in accordance with that choice. Plaintiffs cannot now manufacture a constitutional claim to escape the consequences of their own deemed asset-sale election by claiming that they did not understand New York tax law.13 See Br. at 20-21. 13 Plaintiffs’ assertion (Br. at 20-21) that the amendments “change[d]” the law is irrelevant because plaintiffs do not contest retroactive application of the curative 2010 amendments to the JBS sale (R. 7, 235). In any event, the Legislature expressly found that the 2010 amendments did not change prior tax practice and instead reaffirmed pre-existing New York law. (R. 34, 37-38.) 40 CONCLUSION For the reasons set forth above, this Court should affirm the judgment of Supreme Court. Dated: New York, NY October 20, 2014 BARBARA D. UNDERWOOD Solicitor General CECELIA C. CHANG Special Counsel to the Solicitor General JUDITH VALE Assistant Solicitor General of Counsel Respectfully submitted, ERIC T. SCHNEIDERMAN Attorney General of the State of New York Attorney for Respondents By: ____________________________ JUDITH VALE Assistant Solicitor General 120 Broadway New York, NY 10271 (212) 416-6274 Reproduced on Recycled Paper Addendum 8 STATE FINANCE STATE OF NEW YORK TEMPORARY STATE COMMISSION ON THE CONSTITUTIONAL CONVENTION IATE OF NEW YORK ORARY STATE COMMISSION ON THE ONSTITUTIONAL CONVENTION TATE FINANCE ln.rch 24 19 7 Rockefeller PltntJ, Room }IOI, w Yori:, 1 • l' . 10020 TIER OF TRANSMITIAL 111 lhr lldr•µ,1111'. /n lfu• / 1/1,j ( ,1nBl1/11li11111d Im'• 11/1n 11 tillfi 1111· l1111/if1• of \111!1 fl{ Xr·w )111Tlr : ·1 hl' l'1·111p,,1-;11 y .' tal C:1 1111ni. ion 011 il1l' C:o11- lll'11111,tl c :1111 y(·111i r 111 \ll lllllih ii . rqmtl Oii 1-1. 111 ' 11111·. Thi~ 1q11111 t '"lllillt' · Liu • 1 r11i-1i1111 i1 11.d pnl\ 1 111 11~,11 li11g \ ';11 irn1~ .i~1·•· 1. I. of \1;111 · fi11a11cc~ ;1s wcU 1hr• i mplitalion~ fnt le lt·1:d .1111 a11d 1111 prilili1 ht11 I Ill' . 1111 '.!I, 1%7 Re: 111•11£1111 11l1111itt1>cl , .'ol , Pi l C:rn hin r : l1r11r111011 "F. •r la1 whid1 i111pn s, rn11i1111c: OI' rc,· i~' tat Lh , t.ax :i nu 1h 11hj ec1 10 wlti.ch il i, 10 h appli I, 1111. l 111, l b ufli it> nl Lu [ r 1 an ' oLh r law 1 > lix such r:t, In :i1ncnc!t:d form, thi 0 now Oll'Litul · Artid.c Lil, linn cordiu~ t judicial intcrprcLal io11 , thi~ prn i ·ion shonld 11 or u·u d a · r quiring 1.h aL 11..ic revcnu ' from ead1 iax be a11111 a ~peri fi c o bj· L or puq os . Tl1 · Lill.II s ha c l'11led 1ha1 r i111 Ill or this Jll' \' i)tiOll W:t IO 1 making- il more under 1antlahl ' 1 tht a ml 1 m 'Lnb .r of Lhe L. ,~i;, l a111rc. A110Lh ·r 18·1{i 1m1cmln1t1H r ·111;1ins io i1 origimil lo :\11i1 I I It, Seu ion 2:1. l.1 11i;11llb1es a 1h rcc-lif1h. quoru1n 1111 o rll vot<" ' 'on the final passage, in ei ther hou. c of Lh l ·gi I 11 au • <1 L whi Ii i111pns s. <'0 111i11u s. or r '' iv" a 1;.u·" as 11 II rt.ain 01h r ri11 antia l mall ,.,, ;\ 1901 a1H •111lnw111 dded 10 1h prohihiLion again , 1 I 01· I .ti bills " 1'ht: g ra111 i11K It) t111~ p eno 11 , a · ~ociation, fhnt porntii u, au ' xc111ptio11 from 1:L..:a 1io11 011 real 11· pCJ· onal p1 111 his claLL~ is now in .\ rtirlc Il l , SC"<:1io11 Ii . • \ Laxa1io11 ar1jcJc wa . lraft·d b • 1h tic 111 ·d th L:'lxing prJ\\' 'r ;111d r"g11l:11, ~L1 a. csMll m \\'ti rC'j 'l'I. 'U Ji 1 iJ 1 • vol ' I ~ I' ha I 't'a r !'I long W i lh I h 1h;n Crnl ' '<•n1io11. Fina l I " :r Tax:1tio11 ,\11 i le. w~1~ cvn~u· 111~ tt~tl nnd ;1prt• l!l3tl . It · k · ' p1ovi~in11 is tli e op ning dcd:-11 a1i1m LhaL 'th 1 n t'1xati.on shall never lw surr · nd~rcd. susp1;ndcd 1w ronLtarttil ... ,'\n r law hicll delegate th. 1ax i11g pow r .-ha ll spc.'Cff ' 1l1 t ol t.;Lx " wlti h ma • h imJ o. ·cl 1 h r 1111d "r ;u11l pro\!.id It i·evicw. " A I 1 hough lh i · prm· 1 ~11 'II i a Id 1 , s ·rl 10 1 h pow r 111 I. gi. !;11 ur<·, i11 1.., j it~ 111. in impac1 i · 011 111 • power of it i 1 1 Lo :ii g:rwern m ' lll s , r limi1 cd in 1lwi r taxirtg p wcr t tb1 M 1 of taxc~ ~p '1: ifi all dclcga1cd b . Lh Legi~l:111rrc. ln o •11'1 111 I .1 l,111 i1w, , i11 :" t' \\' \ 'nl'L I 111:1.11 " ihlv 111'1 '"11 :il pl np t:: rt It · Id II I i 11 'C ' \\' \ Il l k i, 1:1"·rl :11 1 l1v cl11111i1 ik nl 1 l.1t· fl\\ ' lll'I . lml ii 1rl 11 •1 ,1 ; 11 1 11:1 . j 11 11 , d 11 1i o 11 , i1 j , .~11 1 1 1 1 · 1 r 111 1·, r :ill' 1; 1-:: 11io11 i11 \I ll k_ 111/ 111 1..:_ 1/i /I' / 'r ' l' \IJ//fl / /'ro /w 1/\'. . Ir/ '11 /111 t ' !l l l:IXl'' 111 C' XI i'i ., Ii i r1\\ lll l ,l1 ip 111 fl" 'l ' " i1111 11 1 i11 1:111.14il1l1 · pl' I 011 :d 111 upt•rt\ :111· 11 l1 11vd . 11 111,1 ·11·1. i1u111111· 11111 11 '11il1 p1op11I~ 111;1\ Ii · 1:"t"rl . ·;. I 11r/1 ,/11 / 111/1 ii ./ '111/1/.1. 1'11t·r1 · i~ a11 .1li..rdu1t· 11111l1i l>i1in11 1111 ":111r11 1 .,r 111111 i, 11 il1111 ed 111·11f 1r- . I. /1 111111111 /11/111 11 l i:, 11 i11.1/ ~/ 11 / 1· (.'rn /1 11 111/111 11.1. \\hen· Iii<' -; 1:1 11:· I' p 11111 •11 •d l tJ 1.1' 11 :1Ll llJJ;t( llll p111 :i1i1111 , ii Ill:!~ 11!11 di~1 I i111i11 :11 1• i 11 I(' ' .1111 1 llll ' ll1111 I, 111 l.1, ;11i1111 1d' 'illl Ii I !1l '(Hl'l':11i1111 · .11lcf \ l : l h' l'rll " " ' 1' '1' 1( j, 111 !.! ,11 1i-1.1111 i:dll· , i111il .1 1 l111111i•Jll\ . 1'111· i 11l t lll 111 111 \i , iOL \ 11lij1TI lo 1: 1,:1 Il l fJ/1/1« : 11/ 'F.\ /.\'/) r .. \ l 'l ·. /Ul· .. \ '(.'F Ml PRESENT TAX SYSTEM 1 lw ,1. 1!! ·' , !1.1,11 l." ' " "t 1111 1· 1 1 1 :i ~ lw 1 l:1"if11·d 111111 111111 f' 'I 1 :il1·g1 11 i1 , ; ( J) iJ11 · p c- 1-;1111,ll i111otlll\ l.llo. , ( '..! ) l'XI j,, . ~ IHI I llll I 'I '" '"· (:: g 1·111•1.d l11h i 111· ' I.I l ' \ , :1111 ! J I) ""('' 1111 1 1 : 111~k1 I . I I 1.i ll!.;l '' R ONAL INCOME TAX I h 1' 1. 1, '' ·'' 11111mlut«tl 111 l'l l !J. ~i" 11 •: 1r~ alt1 ·1 iii · i111p11,i 111111 11· 111 d i1 iil11 :d i11. lllllt' l:i Ii~ I lw 1'1·dl'ra l ~1 11 1'1" 1111w11 1 . :-.nw :11i lll )' lll ' """ l n1 111 ol 1111· l ll ' l'~llll. il i11n11111 l a :-. . 1 llt' pi '''L 111 1.1 i, h ·1 it •d al ,i.;r:1d 11:i red r ;1L1:!> . 1:11'1 in,t:· a l 111·11 p1·1 I"' 1lu· 111,1 .:i 1.noo nl 1:1.\:i lck i 1 11 · 11 1 1 1 ~· . TllC'l't j ~ :1 !llW pn ((' Iii 11, , ln1 (• : 11 h :11 ldi1i1111:d ~:2. 1101111 { in1n111 c . 1\·itl 1 a 11wximu1n 1:1tc Ill r'"l 1t·111 0 11 1.":dl l1• i111u111L' i11 xn:s· nl ;::. 15. 100. Likt' the 11111111w ' ·" - tl1i, 11 ·11 . il l11w~ a per,1111<1 1 1·:-.. 'T'll !Jli o 11 ol' .'!iOll 11 1 " .I"' 11 . 11 11 1 l• 11 r ·: 11 l1 d1"p t'11dl•111 . Ii : d~o :dlow · i 11·1-11i11·d HI ln1 11 •1 r .1i 11 I·"'''· tt >1 1ll'i l>1Hi1J11,, i111c•rc ·,t p:1\1llC:lll' :111 I 1· 1u •11,1·, . 11111 .11 1 . d lu 1L111t1 · 1111 l ilt• i11~111:111<1 · 111 t·111 i11 111_., "I' ' '" l7 Th ' bu lf{ 1 i!> i1Hn1111 I 1 · wh n wxr·s . re L i d, c i ,J an I p< s ic d m11~idr Lh • g 1wr:d l1111d hcrau ~c 1he i1 u~ i.;. no t 11bj~1 l 10 1bc ' a111c 111!> crutin ) ~111d cnn 1r I as ::itT m hcr ' XP 111it 11 r wiLhi 11 th e bud~ tarv fnt 111 ·work. --If the p r i nci pie o c:inna 1 k in u j, ;dlrrmf'cl I'} th onslitut 111 thi~ ould I ad LO th ' wid e!ip1 cad dcniaml by va r io11. i111 r L gro11 LO ha · t. ~r xc. ·ar marked 1'111 their parti cu lar 1>111·po ·c and pr r.111 Thu · ~u Pl' >rt "' nl rn. 11 , programs cou Id <'X n I i- . SLll'e to h. sp ia l l "IXC • ·t a. i I ror Lhn. ' ft111uio11s. --Th • armarkirrg- or raxe · in vo l ve'~ the allocation of m ni cordi ng t ome r igid ;irr:rng m ' rH 1h ~11 111ay not rellect 11 11 e ·els o ( rl 1 ' pro~r:un t ha I :ir • 1 1 h ·11 ·Ii 1 ru111 · u ·h canrta r r '.\fur ·1)\1 1, need ancl ci rcut11 ~ t :111 r > d 1a 11 g m r 1im •: Ii ·ru· it \\'(ll l b impracl i a l LO freC'7C Lh c use of fund . \ ' f'I' a lo ng p riod Of I Ill ;1 • wou l I h:q p(•rr if . 1 ronstiu11ion a l nm11da1 to 1hi' ffec1. , . a ppr v • I. --The , nmtrki11g f li111d/ fJrnhi/Jitinp; fh c /11 ,•11tio11 of t1 ili.1't rib11t,.r/ profit ·: --Th x plicir -irn t 111 •111 of ·ud1 a provision in tJ1 o u lil 11 11 will bc:lp Lh Late re1a i11 1hc: 0 11 1J •11 ol 1hc bu ·incss communi R •1 ' n1ion of 1his clau in rh C Jll SLiLu lion 1 ill be witnes lo II 1a1 ,• rn111in11ing desire :ind i111 111io11 10 provi I a go u b 111 dima1 ._ Th ·liinina1iou of thi prnvisi 11 worrld ha a lelet ' 1 1 df ' t on h11~in ·· p.· •chology. lt .ould hav a harmful imp;1 ·1 " lht' r 'I 111io11 of existing firm, and the atlracli.nn 1 { 11 I ne II stare. -- udistr ibutcd prnfiL: ar P'" " ilir g logic a airu i.11ch • n la · ·ti b 1 an • orhcr tatc. ' H ta · i: L11a 1 ii would cliscoura~ 1 80 • ntion of profits for capital investments and thereby thwart eco- l mic development in the state. ·-Retention of this provision is necessary to safeguard the interests 1f persons who invest their capital in the state. Already the owners •I equity capital are subjected to double taxation. In the absence r the kind of consti tutional protection currently made available 1 them, stockholders could potentially have their incomes earned 1 m investment taxed a third time; they could be taxed on net •1ofi ts and on retained profits at the corporate level and on divi - 1 nds received at the personal level. Arguments against the retention of the clause in the Con- tilut ion prohibiting the taxation of undistributed profits: ·- ---This type of taxation has never been seriously considered in he state nor is it likely that the Legislature will seriously consider t in the fu ture. I t is widely recognized that retained corporate '.1rnings constitute a primary source of capital financing and con- tibu te importantly to the state's economic development. --There is no need for either consti tutional or statutory prn- rtion against the imposi tion of a tax on undistributed corporate 11ofi ts. There are compelling economic reasons why the state cannot riously consider such a possibility, the most significant one being I adverse effect on the location of industry. Corporations cannot -K:ape the imposition of federal taxes, unless they decide to move tn some other country. But they can largely escape a particular tax I• ded by one state by moving their base of operations to some other tate. Since New York can ill afford such a loss of firms, there is liule likelihood that it would contemplate a tax of this kind. b. Arguments in favor of prohibiting ad valorem taxation r excise taxation of in tangible personal property: ·--Retention of this provision will encourage modest and substan- tial owners of wealth to reside in the state. It is in the best in teres ts n! the state to retain this class of resident not only because of the 1.1xes he pays in to the state treasury (for example, personal income, Iles and a wide varie ty of consumer taxes), but also because of the timulus his expenditures will provide the economy of the state. ---In view of the rela tively high taxes already being paid on real property, this provision affords real property owners some protection f1om the payment of still higher taxes on their total assets. ---Past experience with the taxa tion of intangibles has been so un- uccessful that this kind of tax should be prohibited. Because in- tangibles can be hidden, it is easy to evade the tax. Accordingly this 61 t:i .· \ ill dis<'.ri iniint ' ag;1i 11st th 1111 . a ti ·tan t } xpcri 11 LC ' i1h a in qu iw l le a.·· " flt 11t pra<-'tic .. bouc L taxpa er. M au 1:i . u in a ngibl al ll rgum 11/.1 t1g11111.1l th · rt'l1 ·utw11 of the clatl5 in Ill t11.l io11 /1rohil;iti11J! ad 1 alor ·m tn11gib le /' -r.\'fJrl(I/ profu·rty: --\ hil it i~ 11'11 (' 11!;11 :I m nl i repon pt iwll horn --T tal weahl., a to pa · L:otirm: --Th I n •·t•11 •<>11 ti1111i nal p1r"i ion :1Jronl. nou-r 'id 1 ~ ura11 c that t.h ir r;tpita l p ~~~~ion :. will l' ' tnai11 intacL :rn I coura · 1h m 10 l e11n~ it in Lh 'UIL n ti po ·i1.. in vaul1 . . 11111 lo11g-1 enn u·u t. . --.If rh is prO\•i ·ion w •re cl let ·d , it L 11!d lea L to : ignifi ·ant 11 fi:ro, wea lth ou tsi de the ·ta lc ;111d 1.0 a n :ul {fol n Lit c111i11 ' Ill l f'W Yo rk a . the f-inan r ial c.-a pital 0£ the n Lil 11 withdr}11 a l of i111 a ngih l J r·sonal \ cahh ou ld be ;1ccomp;111 n d a lo . ot t'l'01111111i acli\ci1 which no w h Ip~ I I ro\ide cmpl 11 10 th Ii i.a nd!> ur Nt 0 \\' ' ork rcs idcnt.s in l>anks. 1 rukerag h· I law fi r ws <.i ml or her insLi1util)m i11voh·ed i11 1h man;1gem n1 f r personal wcalrh. 62 ----The prov1s1011 does not cost the state very much in terms of .1 x revenue. lf the state were to impose a tax on this class of 11 operty, it probably would not realize much revenue because of he outflo w of capital which would follow. A rgum ents against the retention of the clause in th e Constitu- rm de fin ing the location of certain intangible personal property for 11irposes of taxation : --By continuing this provision, the state is deprived of a potential mrce of revenue from the taxation of intangible personal property 11 ld in banks or trust funds . - Preferen tial trea tment o[ a particular class of citizens sharpens he rivalry among the various states for the development of " tax I.Ivens." Ultimately, this kind of com petition works to the detri- ucnt of all states and should be discouraged. ··--At a time when the state is constantly searching out new tax 1urces to finance the ever mounting demands made on it for public 1vices, it is inconsistent that this potential source of income should • automatically excluded . d . Argu ments in favor of prohibiting discrimination against lie-chartered banks in the rates or methods of taxation: - T he provision was included in the Constitution largely to pro- ' t sta te-chartered banks against discrimin atory taxation . This pro· I ion should remain intact because it affords such banks a much decl p rotection. Traditionally, banks have offered inviting targets 1 state and local governments seeking new sources of revenue. lince they are in greater need of protection from discriminatory ation than public utilities, insuran ce companies and other enter- 1ses which require a special franchise or license from the state order to operate. - Feder al sta tutes already protect the national banks from higher re and loca l taxes than those imposed on other moneyed capital, 111 there would be no comparable protection for state banks if this use were deleted. - State-chartered banks should continue to enjoy protection be- 1se it is in the best interests of New York as a financial center hf· imposition of disc.Timina tory taxes on state banks could have 1 mfu l consequences for th e economic well-being of the state. A rg1nnents aga inst t !t e retention of the clause in the Consl i- 1nn prohibiting; discrimination agains t slale-charlr'red banks in ra tes or m ethods of taxation: .. .Jf the state were to impose a discriminatory tax ag;1inst state- 63 REVISED RECORD OF THE OF THE STATE OF NEW YORK APRIL FIFTH TO ,AUGUST TWENTY-SIXTH 1938 VOLUME II ALBANY J.. B. LYON COMP ANY, PRINTERS 1938 ittee, of probably arter to working, of them excused 1s to be Comm1t- furt her the pur- tlrn fol- 11 be so ·n Cit ies Int. 480, 1, and I dered. :r. ,John July 8, he Com- further course, '.barge a ng. So, here are ittee on into the rules. ord and llECORD i-!7 nL: 1. it. a reL'>Or from lh ·owmitte f a pro[ o al wliich 'l'he Do yon wa11l it i·eacl 1ww ? . lr. not tlriuk it L nrt~c · ury lo u rearl. 'I he f'r si l(•nl: It will b> p1'i11l d. ThlJ!:l , in favor of re iv- 111:: t lP r1·1 ! rt au1l J rinLi11g il. :i~nif~· h.v .ft.dua A,ve_ ( 'la ru: of \.' 1• ) ' 0Htrary-mi11 I Pd, :\o. . 'n ord red. 'l'h • ' 1·1·Ptary : Rr ~Ir . .'uxr; Tli e C'nn1111 iltc<· 1 n '1'11xatio11 to wh1J1n wet" r·fc'lTrd n11:io11 . propo·t'tl n111•ndm nts to 11w ( 'oll: Lilut.iou relat.iv t taxation gave f'flrcful ('.Oii . icl<'rntion a nrl ti I ibl'ra- iuu In Uwm. l1 'lu ;1 pn!Jli ·Ji •;1,1·i11~ tbl'rrou and eon f rred wi th r ecoi;!nizrd :-1uLhnriti1'c' . : a r . uJI the ~0111111itke h~· tuirt en Jtfl1r111111 h· rnt • wiL!1 two oth ' !' lli l' lllhcr_ I 1· •.· nt· but not ,., tin!!, and n u '"'ntb:c vnf P:. duly tt>pot't tl R 1ww Jlrli ·l iu r l' fati1111 to lilxation ['11· i11s1•rlion in lit' ('r 11. litutit•n: 'f11 I' llO\ in~ ill" • lJ11• vnri 11 ·e •!,ion: th 'l' ol' with xp lana- l ion of th!! pru,·ision ·: 81·(·Jio11 J. 'J'ht• ptJ\\'\'1' Ill" laxali011 .' !t~tll lt('V~ r lw Sll lT 11 I l'C'd . . 11"-pcrnled 01· ·1111I1·a ·t d a l\' fl , •• 1•x ·•pl a. to . ce111·iti s issu d for pnhlit· JHJ1·posl' pur 1111111 to law. 11,\· law whi.<·h. tl I gat·e · l lH' taxintr pow ·r hull . p(•t•if'.v Iii 11nt11 re anrl . 11hje ·t o.f cMh ta - wlti ·Ii may be imp• d Ill 'l' under, a.11Cl provide for its l'l' \ ' j w. B crnptio11 · from trurnti n may b i.:nmt l,v for \" Ji •iou . •d11c·ali na l or 1·hru·irahlP purpo~ .• • !ltl(I 0 ''11 d I y uny c~nrporation or • :01·ial ion o r~ani;r, d r cond11 •lr.rl P. 1• !11- siwl. for 11 •or uwre of ·1u•h p111·p · "· and not op ntlinJ? for profi t. Tl1r L •:;!i:lul ur 11rn ~·, ltnwrv r. pr . <' rilic lim.itntion • 111 l ll Lh • P~".f'c11 ·io11 of . n ·It l'X'mpti011_ in the va rio11. r. untie" io r luti 11 t n 1 hp t,axabl • pi·op i·fy th r in . 'rh n1l1 ptio11 hy 11!1• I <'gi Jaturc• <1f 1h1• rl'c1>11t r> lit":• of U<'lr;-:atil1~ th 1axing powct· t . ·nh }i,•i. ion arnl fh rP. ·nlt-incr r xpcri 'lll' • of' taxpaye1 · in tlu' ity uf N"cw ork under flte lo •;J.J legi Jal ion eIIHl'tC' jlllT~llatt( fll lht> hr o.d grant r htXill;! pow r lo tl1nt m11nh•ipn li t~-, 11as l 11 ~'mu· 1 ~nm 1 11il t Pr to lh cmwl wiou that I h TJ Pg-i lill nre ,;h nld n lrnst sp i·ify l11 1101.ur au I ulijN•f I' rach In .· wlr i1·1J may be imposNl h~· Ilic ub liYL ion 1111 provide for it. arlmini t rati w~ un 111a~- he 11ni'f'1 r mit~' in t it<', bitr's Hxinir :y:tf'm aH l tJ1c a\" 1i1lan •r nf roin1wtil i 11 in tuxHtion tw n varinu" it.ic/: n ·11 ~l adnally o c11 1Trd I hrough th 7 NSTI1 TI AL NVEN'J'I ;1.i 11 elements T..iegislature. r«lc>t·al, Slate ·1 connection l'•~ absolutely !JO\\'Cl' with 'iri:umscribed npon taxable ·rid<' for the H.\' he altered for religious. h.>' organ iza~ •w·Ji purposes ill'e disch arg-- •rwis(• ha \ ' C to ~loual protec- ~"li"('t to that !1<1ir•e of their IHI'! ions in the I fo,; itations in 1'11pervision ·x of taxa~ (•I I-founded the assess- t the time Ii mandate tive system :rnents," Slate. ill tangible n i•a.rr:rin 0- 111•'1 t~ b~. taxation. va lorem x;•ise tax. nnt. No. No. 128. pN·sonal n.•r pro- fll)t em- d1·1•tnt>;v : Y. for , nn less RECORD ~· 9 Ll1e property has acquiretl a busines:> s ;tus in : .1othrr state ... . '' In thP nlSI' or !Ill' taxatio11 of forei:..ni ('.\ll'llu l'>di.i ,; s i11 ti1is State ti1e tax law lilJC«ifienll y provides that a· foreign ,;orpor pnrposrs of taxat'ion, sole ly by n•asoa of maintaining cash hala11e<•s in banks, 01· owning shares of sioek or securities kept in the State as pledged 1:ollatcral or drposited with banks in sa frkeeping or eustody aceo1mts. By embodying t his prineiple in the Constitution a guaranty 1,·jli be giYen to both lllllll"r>sid!'llt i11dividllah; and foreign cot·- porations that they eau kcC>p tlwir money and seenrities in the Siatc of l\ew York without any fear that t he establishctl lcgis- lnti\-n polil~.,- \\'il l he (d1<111ged. Tlrns eno1·rnous arnounh; of sud1 intangible personalty from all over the United States will be at.traetetl to this State, making for the eonscnation of the Jirnrncial center of the com1try here. Undoubtedly a very great part of stwh in11rng:ibles ownt'd by 11011n's ide11ts and fo1·eig11 corporations ·will fi ll(l its way into the lrnsiHess of the State and will be used in business transactions iu the State \vli r t·e it will be productive of business taxes. The Legislature lias wisely 1:011eluded, as indicated by ex- press statutory poliey, that the ad va lorcm taxation of intangi- ble personal property is impracticable. Out of the cxperienee with the General P roper ty Tax, the Securetl Debts Tax, the luvestment Tax, t he lVIonictl Capital Tax, the Tax Law, by :-;eetion 3 thereof, now peoYides that intangible personal prop- (•rty "shall not be liable to taxation loca lly for State or loeal purposes". In order to avert any possib le experimental return to outmoded, useless taxing methods with respect to intangi- bles, the committee believes that this principle slionlcl be em- bodied in the Constitution. Section 4. \¥here the :State has power to tax corporations iiworporatetl under the la-ws of the United States there shall ht~ no discrimination in th e rates and method of taxation be- tween sueh corporations and. other corporations exercising- sub- s1antially similar fuuetions and engaged in substantially sirni- lai· business within the State. The source of Otis sed ion is Mr. Fol1?er's proposal ( Int. No. 123, Pr. No. 124) , providing for th e equal taxation of '.\'at ional ba1 1ki11g assotiations aitd State ba 11ki1 w i11stitnt ions . Th e Rtate taxat ion of nat io11a l ba11ks is l'Ontrnlled b1· l•\•rl('i"ili sta tute. ·while the legislative poliey of K<•w Ym·t« has eon- ;.;istently been to treat both classes alike for tax pnrposrs, it now appears that sevrrnl states a1·e imposing- heavier tax('s 11po11 Stat(• ban ks than 11 po11 :'\a tio1w l ban king· assor·ia tions . from which the latter are protected by Federal statnte; thus Wt'ake11 i111-t t lw den·lnpnwnt of Stat(• bnnking- systems, as Rtate l1a11ks l'llll 1·P1Hlily hr COll\"t't"fril i11to National ban ki ng ass
