Robert R. Burton v. New York State Department of Taxation and FinanceRobert R. Burton v. New York State Department of Taxation and Finance
POINTS OF COUNSEL
Eric T. Schneiderman, Attorney General, New York City (Judith N. Vale, Barbara D. Underwood and Cecelia C. Chang of counsel), for respondents. I.
RIVERA, J.
Plaintiffs, nonresident shareholders in an S corporation, challenge under
I.
The facts are not in dispute. Plaintiffs are several nonresident former owners and shareholders of JBS Sports, Inc., a Tennessee business organized as an S corporation for federal and New York State tax purposes. An S corporation is structured so that its corporate income, losses, deductions, and credits pass through to its shareholders, based on their individual percentage ownership in the corporation (
In 2007, plaintiffs sold their JBS stock to Yahoo, Inc., and JBS and Yahoo decided to treat this transaction as a “deemed
A deemed asset sale provides counterbalanced advantages and disadvantages for purchaser and seller. On one side of the equation, the deemed asset sale makes possible significant future tax benefits to the purchaser because the assets are treated as sold at fair market value and the assets obtain a “stepped up,” rather than a carryover, basis for the purchaser‘s future depreciation and amortization deductions (see 26 ALR6th 219, § 2;
As a result of the JBS stock transaction, JBS realized over $88 million in gains. The JBS earnings then passed through to plaintiffs as shareholders (see
Based on the results of a subsequent audit, defendant New York State Department of Taxation and Finance assessed $167,000 in state income taxes on plaintiffs’ JBS transaction gains, relying on
After defendant rejected the refund demands, plaintiffs filed the instant declaratory judgment action against defendant and the Commissioner of the New York State Department of Taxation and Finance, challenging the tax as unconstitutional.1 Supreme Court denied plaintiffs’ motion for summary judgment, granted defendants’ motion for summary judgment, and declared that the statute “is constitutional” (see Burton v New York State Dept. of Taxation & Fin., 43 Misc 3d 316, 319 [Sup Ct, Albany County 2014]). Supreme Court noted that plaintiffs could not complain because they had elected to treat the JBS transaction as a deemed asset sale under federal income tax law (see id. at 318-319). We retained jurisdiction over plaintiffs’ direct appeal under CPLR 5601 (b) (2),2 and now affirm.
II.
Plaintiffs allege that
Defendants respond that
As a preliminary matter, there is no question that New York State‘s Tax Law, including
Turning to the constitutionality of the assessment, we first recognize as a foundational tenet of our state tax law that New York seeks to achieve a certain amount of parallel treatment of state and federal taxation (see
“[I]f the shareholders of the S corporation have made an election under section 338(h)(10) of the Internal Revenue Code, then any gain recognized on the deemed asset sale for federal income tax purposes will be treated as New York source income allocated in a manner consistent with the applicable methods and rules for allocation under article nine-A of this chapter in the year that the shareholder made the section 338(h)(10) election” (
Tax Law § 632 [a] [2] [footnote omitted]).
In accordance with these provisions, defendants treated plaintiffs’ gains from the JBS deemed asset sale as New York-source income, and assessed taxes in proportion to the JBS income derived from New York sources, which defendants calculated to be 13% of its total corporate income (see
Plaintiffs claim that a constitutional bar to the tax is found in
“Moneys, credits, securities and other intangible personal property within the state 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, and, if held in trust, shall not be deemed to be located in this state for purposes of taxation because of the trustee being domiciled in this state, provided that if no other state has jurisdiction to subject such property held in trust to death taxation, it may be deemed prop-erty
having a taxable situs within this state for purposes of death 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. Undistributed profits shall not be taxed” ( NY Const, art XVI, § 3 [emphasis added]).
“In construing the language of the Constitution[,] as in construing the language of a statute, the courts . . . give to the language used its ordinary meaning” (Matter of Carey v Morton, 297 NY 361, 366 [1948], citing Matter of Sherrill v O‘Brien, 188 NY 185, 207 [1907]). As is obvious from the language of
This view is unsupported by the plain language of
The second sentence of section 3 is a specific interdiction on ad valorem taxes, which are taxes assessed based on ownership and imposed according to the property‘s value. When determining the coverage of this proscription, this Court has previously adopted the general understanding that “[a]n ad valorem property tax is always based upon ownership of property and is payable regardless of whether the property is used or not” (Ampco, 14 NY2d at 22, citing Matter of Guardian Life Ins. Co. of Am. v Chapman, 302 NY 226, 238-239 [1951], Powell v Gleason, 50 Ariz 542, 547-548, 74 P2d 47, 50 [1937], and City of Walla Walla v State, 197 Wash 357, 362, 85 P2d 676, 678 [1938]). The second sentence of section 3 also prohibits excise taxes “levied solely because of the ownership or possession [of the intangible property].” Together these clauses preclude taxation based on physical ownership, possession, or presence in New York State.
The text of section 3 makes no mention and provides no language supporting extending the prohibition on ad valorem and ownership/property-based excise taxes to income taxes. There is simply no language in
The third sentence in section 3 declares that undistributed profits shall not be taxed. This prohibition, however, is not implicated by the facts and legal issues involved in this appeal, and the plaintiffs do not suggest that it supports their reading of the constitutional text.
At the time of section 3‘s adoption, the drafters intended to “write into the Constitution a well-settled rule of domicile with respect to taxation,” which generally treated the situs of intangible property as the owner‘s domicile (see 2 Rev Rec, 1938 NY Constitutional Convention at 1113). This rule, based on the doctrine of mobilia sequuntur personam, meaning the “movables follow the person,” (see Matter of Brown, 274 NY 10, 17 [1937], op mod on denial of rearg 274 NY 634 [1937], revd sub nom. Graves v Elliott, 307 US 383 [1939]), is unambiguously reflected in the first sentence of section 3.
The other concern addressed by the drafters in section 3 was the impact of taxation of securities and stocks based solely on presence in New York State. The drafters desired to attract and retain in the state monies and securities of nonresidents. In order to make the state attractive the drafters constitutionally prohibited taxation of intangibles “until [the holders] employ them in business in the State,” believing that this “tends to develop the financial supremacy of the City of New York” (see 2 Rev Rec, 1938 NY Constitutional Convention at 1113).
The drafters further prohibited ad valorem taxes of intangibles, seeking to ensure the end of those property taxes because that system had “utterly failed” (id.), leading to its replacement in 1919 with an income tax (see L 1919, ch 627). The drafters’ intent to attract stocks and securities is also evident from the prohibition on excise taxes solely based on possession and ownership. This prohibition was included to prohibit taxation based on presence in the state until such time as the property was employed in business, or was transferred.
In response to questions about the anticipated coverage of section 3 as applied to the stock transfer tax, the Chair of the Committee on Taxation, which sponsored section 3‘s addition to the Constitution in 1938, stated that
“[t]he stock transfer tax is an excise tax upon the
transfer, and those are the very taxes which I submit . . . we are going to reap the benefit from, because if we can increase this intangible wealth from the other states you will be able to impose the transfer taxes which will bring you substantial revenues that you never calculated” (see 2 Rev Rec, 1938 NY Constitutional Convention at 1114).
He further added,
“we want to make it impossible for the Legislature itself, or for the Legislature to delegate the right, to levy an excise tax on the mere possession of the property. In other words, the property may enjoy that privilege or it may be used for some purpose, and then you can levy an excise tax on it if and when it is used” (id. at 1115).
The interpretation advocated by plaintiffs is not merely rejected by this original history from the 1938 Constitutional Convention, but is also counter to the general understanding of section 3 publicized during the 1967 Constitutional Convention. According to the report on state finance submitted by the Temporary State Commission on the Constitutional Convention, section 3 was understood to provide that “[a]d valorem taxes or excises on the ownership or possession of intangible personal property are prohibited. However, income from such property may be taxed” (1967 Rep of Temp St Commn on Constitutional Convention, Rep No. 8, State Finance at 37 [emphasis omitted]).
The 1938 and 1967 Constitutional Convention Committee and Commission statements reveal that the intent of section 3 is to prohibit taxation of intangible assets based merely on their physical presence within the state, and to ensure a proscription on the ad valorem taxation system as applied to intangible personal property. This was necessary to encourage the importation and retention of nonresident wealth in the form of intangibles such as stocks. However, the prohibition does not eliminate all taxation, as illustrated by the excise tax and transfer tax explicitly referenced approvingly by the drafters, and as further recognized by the comprehensive review conducted by the 1968 Commission of section 3 and other provisions.
Here, defendants assessed an income tax on the gains realized by plaintiffs from the JBS deemed asset sale. It is not an
To the extent plaintiffs argue that the deemed asset sale is a fiction of federal law, suggesting there are no real consequences associated with such fiction, that is simply a convenient but inaccurate characterization of the JBS transaction. In reality “the [section 338 (h) (10)] ‘fiction‘. . . simply allowed the parties to change the means by which the gain was realized and by whom” (General Mills, Inc. v Commissioner of Revenue, 440 Mass 154, 170, 795 NE2d 552, 567 [2003]). Nothing changes the fact that plaintiffs sold something of value and reaped the benefits from that sale.
Accordingly, the order and judgment should be affirmed, with costs.
Chief Judge LIPPMAN and Judges READ, PIGOTT, ABDUS-SALAAM, STEIN and FAHEY concur.
Order and judgment affirmed, with costs.