If nonresident individuals, estates, and trusts are partners in an upper-tier partnership that invests in a lower-tier fund trading securities solely for its own account, is that trading income treated as New York source income - even if the upper-tier partnership also invests in another lower-tier entity that does business in New York?

Plain-English summary

McDermott, Will & Emery asked the Department, on behalf of an investment adviser's client structure, how New York would source income flowing through a "master-feeder" hedge fund arrangement combined with a new operating lending business. Each Master Fund (a Delaware LLC taxed as a partnership) traded stocks and securities solely for its own account and was not a dealer or market-maker. Domestic Feeders (also Delaware LLCs taxed as partnerships, and the "upper tier" partnership for this analysis) invested in the Master Funds, and their own partners were U.S. resident individuals, estates and trusts - some of them nonresidents of New York. The Domestic Feeders were also considering becoming limited partners in a new entity, New LP, which would run an active loan-origination business based in Texas but expected to generate at least some income sourced to New York.

The Department walked through the layered statutory scheme: partnerships aren't taxed as entities under Tax Law § 601(f); a partner's items retain their federal character under § 617(b); a nonresident partner's New York source income is limited to items connected with New York sources under §§ 631 and 632(a); and § 631(d) provides that a nonresident (other than a dealer) isn't treated as carrying on a business in New York solely because of purchasing and selling property, or stock options, for its own account. The tiered-partnership regulation, 20 NYCRR 137.6, ties these together for multi-layer structures: an upper-tier partner's distributive share of an item attributable to a lower-tier partnership keeps the source and character it had at the lower tier, unaffected by passing through the upper tier.

Applying that framework, the Department found the Master Funds' securities trading fell within the § 631(d) own-account safe harbor (as in Kenneth S. Davidson Partners, TSB-A-88(11)I, and Paul E. Singer, TSB-A-92(2)I), so that income is not New York source income - and stays that way as it flows through the Domestic Feeders to nonresident individual, estate, and trust partners. By contrast, New LP's loan-origination business was assumed to generate some New York source trade-or-business income under § 631(b)(1), and that character likewise carries through to the nonresident partners' distributive shares. Critically, the Department held these two income streams don't contaminate each other: following Paul E. Singer, having some New York-source New LP income flow through a Domestic Feeder does not convert the same Domestic Feeder's separate distributive share of Master Fund trading income into New York source income.

The opinion added one more wrinkle: if a Domestic Feeder itself is carrying on a business in New York and uses its Master Fund interest in that business, gain from disposing of that Master Fund interest would be swept into the Domestic Feeder's New York business income under § 631(b)(1) - a different rule than the trading-income analysis, citing Ronald van der Horst, TSB-A-00(5)I.

What this means for you

Nonresident investors in tiered fund structures

If you're a nonresident individual, estate, or trust holding an interest in an upper-tier feeder partnership, your share of income the lower-tier fund earns from trading securities solely for its own account is not New York source income, even if that feeder also invests in a different lower-tier entity that does business in New York. The two income streams are analyzed separately.

Fund sponsors and administrators structuring master-feeder vehicles

Adding a New York-connected operating business (like a loan-origination entity) alongside a pure trading fund within the same feeder doesn't automatically taint the trading fund's income with New York source status. Each lower-tier partnership's activities are tested independently under Tax Law § 631(d) and the tiered-partnership regulation, 20 NYCRR 137.6.

Accountants and tax professionals

Watch for the exception: if the upper-tier partnership itself conducts a New York business and uses its interest in the trading fund as part of that business, gain on disposing of that interest can become New York source income under § 631(b)(1) - separate from the ordinary trading-income analysis.

Common questions

Q: Does investing in a New York lending business through the same feeder taint the feeder's securities-trading income?
A: No. The Department held that a Domestic Feeder's distributive share of a New York-source lending business (New LP) does not change the treatment of its separate distributive share of a Master Fund's own-account trading income - the two are analyzed independently.

Q: Why doesn't the Master Funds' trading count as "doing business" in New York?
A: Because Tax Law § 631(d) provides that a nonresident (other than a dealer) isn't deemed to carry on a business in New York solely by purchasing and selling property, or stock options, for its own account - and the Master Funds were not dealers or market-makers.

Q: How does income keep its "non-New York source" label as it passes through multiple partnership layers?
A: Under 20 NYCRR 137.6, when an upper-tier partnership is itself a partner in a lower-tier partnership, the source and character of an item attributable to the lower tier is fixed at the lower tier and doesn't change as it flows up to the upper-tier partner.

Q: Is there any scenario where Master Fund-related gain would become New York source income?
A: Yes - if a Domestic Feeder is itself carrying on a business in New York and employs its Master Fund ownership interest in that business, gain from disposing of that interest would be included in the Domestic Feeder's New York business income under § 631(b)(1), per Ronald van der Horst, TSB-A-00(5)I.

Q: Who does this ruling bind?
A: Only the petitioner, McDermott, Will & Emery, and its client structure as described, and only based on the facts submitted. Other taxpayers cannot rely on it.

Citations and references

• Tax Law § 601(f) - partnerships aren't taxed as entities; partners are liable individually
• Tax Law § 617(b) - a partnership item retains the same character for a partner as for federal purposes
• Tax Law § 631(b)(1) - New York source income includes items from a business, trade, profession or occupation carried on in New York
• Tax Law § 631(d) - a nonresident (other than a dealer) isn't carrying on business in New York solely by trading property or stock options for its own account
• Tax Law § 632(a) - a nonresident partner's New York source income is limited to the portion connected with New York sources
• Tax Law § 633(a) - a nonresident estate or trust sources income under the same rules as a nonresident individual
• 20 NYCRR 137.6 - in tiered partnerships, an item's source and character are fixed at the lower-tier partnership and carry through unchanged to the upper-tier partner
• Kenneth S. Davidson Partners, TSB-A-88(11)I (June 28, 1988) - trading options for own account isn't carrying on business in New York
• Paul E. Singer, TSB-A-92(2)I (June 4, 1992) - own-account trading income keeps its character through a tiered partnership arrangement
• Ronald van der Horst, TSB-A-00(5)I (September 6, 2000) - gain on disposing of a business-used partnership interest is included in New York business income

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2004.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a04_6i.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-04(6)I
Income Tax
October 25, 2004

Income Ta

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I040330D

On March 30, 2004, a Petition for Advisory Opinion was received from McDermott, Will
& Emery, c/o Arthur Rosen, Esq., 50 Rockefeller Plaza, New York, New York 10020.
The issue raised by Petitioner, McDermott, Will & Emery, is whether the portion of
nonresident partners’ distributive shares of partnership income (an upper tier partnership)
attributable to an investment in a lower tier partnership that trades in intangible personal property
solely for its own account will be New York source income when received by the nonresident
partners of the upper tier partnership who are individuals, estates and trusts.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner’s client (Investment Adviser) is a New York limited partnership. Investment
Adviser is owned by one general partner and two limited partners. The two limited partners are a
third party bank with a minority interest and an individual with a majority interest (hereinafter
referred to as Q). Investment Adviser’s general partner (with an ownership interest of less than
one percent) is an S corporation that is owned 100% by Q, who also owns a limited partnership
interest in Investment Adviser. Investment Adviser provides investment advisory services,
pursuant to investment advisory agreements, to investment funds that have been organized in a
master feeder structure described as follows.
Each investment fund (Master Fund) is a Delaware limited liability company (LLC) that
is classified as a partnership for federal income tax purposes (lower tier partnership). Each
Master Fund has two members that are treated as partners for federal income tax purposes. The
two partners are a domestic feeder fund (Domestic Feeder) and an offshore feeder fund (Offshore
Feeder). Each Master Fund, with the assistance of Investment Adviser, trades in stocks and
securities for its own account. In addition, one of the Master Funds has investments in other
Master Funds. None of the Master Funds is a dealer in stocks or securities or acts as a market­
maker in securities. Each Master Fund files a New York State partnership return.
The Offshore Feeders are characterized as non-United States corporations for federal
income tax purposes. The investors in the Offshore Feeders are non-United States persons and
United States tax exempt entities.
Each Domestic Feeder is a Delaware LLC that is classified as a partnership for federal
income tax purposes (upper tier partnership). The investors, i.e., partners, in the Domestic
Feeders are United States resident individuals and United States entities that are either estates or
trusts. Certain individuals and entities invest in more than one Domestic Feeder. Each Domestic
Feeder invests for its own account in a Master Fund, which in turn invests in stocks and other

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securities. None of the Domestic Feeders “makes a market” in securities or otherwise acts as a
dealer in securities. Each Domestic Feeder files a New York State partnership return and reports
its distributive share of the lower tier Master Fund’s items of income, gain, loss, and deduction.
The Domestic Feeders are contemplating investing, by becoming a limited partner, in a
new entity that will be organized as a limited partnership (New LP) (a lower tier partnership.) In
making their investments from time to time in New LP, the Domestic Feeders may utilize a
portion of the income they earn from (or distributions they receive as return of capital related to)
their investments in the Master Funds. Similarly, the Domestic Feeders may utilize a portion of
the income they earn from (or distributions they receive as return of capital related to) their
investments in New LP to make other investments from time to time in the Master Funds. The
Domestic Feeders will have no management or other control over the operation or activities of
New LP.
New LP will conduct an active loan origination business, based in Texas. The general
partner (New GP) of New LP will be a corporation which is wholly- owned by Investment
Adviser. Certain of Investment Adviser’s management personnel will serve on the board of
directors of New GP. New GP will employ personnel and establish an office in Texas to carry
out the activities of New LP. New GP will retain Investment Adviser to provide certain
administrative and support services. Additionally, Investment Adviser, as an ultimate owner,
will have oversight over the risks incurred by and the operations of New GP.
Initially, it is contemplated that the business of New LP will consist of the following two
types of lending activities:

1. The provision of senior and mezzanine financing (loans) to commercial and industrial
   borrowers, primarily corporations. Such loans are expected to be provided to borrowers that
   have exhausted other sources of financing. The borrowers would not be related to New LP.
   New GP, on behalf of New LP, will be responsible for the negotiation and administration of the
   loans. New LP will earn both fees and interest income on such loans. In addition, in connection
   with providing such loans, New LP may receive certain equity interests in the borrowing entity,
   including options and warrants to acquire the common stock of the borrower.
2. The provision of mortgage loans secured by real property to entities or individuals.
   The borrowers would not be related to New LP. Some of the borrowing entities or individuals
   will be referred to New LP by an unrelated third party (referring party) pursuant to a contractual
   arrangement with such referring party. New GP, on behalf of New LP, will negotiate the loans
   and conduct the necessary due diligence before any such mortgage loan is funded. In addition,
   New GP will administer such mortgage loans on behalf of New LP.

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New GP, on behalf of new LP, will consult with Investment Adviser management
personnel in connection with approving the loans described above, assessing the risk profile and
exposure related to such loans, and certain other incidental activities. New LP may make loans
of either of the two types described above to borrowers secured by assets located in numerous
jurisdictions, including New York. For purposes of this Advisory Opinion, it is assumed that at
least a portion of the income generated by New LP will be considered trade or business income
from New York sources.
Certain of the same management personnel of Investment Adviser who are involved with
New LP will also be involved in advising the Master Funds with regard to investments, and may
act as managing directors of the Managing Entity for either Domestic Feeder or Offshore Feeder
or one or more of the Master Funds. The Managing Entity is a limited liability corporation with
two members. The majority member is Q. The minority member is an S corporation that is
owned 100% by Q. Q is the same person who owns a limited partnership interest in Investment
Adviser. While the Master Funds may invest in certain mortgage related securities, the Master
Funds will not be directly involved in New LP’s business activities and will not invest directly in
New LP. One of the Master Funds owns all of the stock of a corporation that owns two loans but
does not intend to pursue an active lending business. From time to time, such Master Fund may
receive dividend income from this wholly-owned corporate subsidiary.
Investment Adviser and Managing Entity will typically be compensated by the various
feeder entities for their services to the Master Funds, New LP, and the feeder entities. The
compensation is based both on a monthly percentage of net assets and the positive annual
performance of each entity. Such amounts are likely to be paid with funds distributed to the
feeder entities by the Master Funds and New LP. It is anticipated that Investment Adviser will,
in turn, allocate appropriate compensation to its subsidiary, New GP, for its services to New LP,
as described above.
Applicable law and regulations
Section 601(f) of the Tax Law provides:
Partners and partnerships. A partnership as such shall not be subject to tax under
this article. Persons carrying on business as partners shall be liable for tax under this
article only in their separate or individual capacities. As used in this article, the term
“partnership” shall include, unless a different meaning is clearly required, a subchapter K
limited liability company. The term “subchapter K limited liability company” shall mean
a limited liability company classified as a partnership for federal income tax purposes.
The term “limited liability company” means a domestic limited liability company or a
foreign limited liability company, as defined in section one hundred two of the limited
liability company law, a limited liability investment company formed pursuant to section

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five hundred seven of the banking law, or a limited liability trust company formed
pursuant to section one hundred two-a of the banking law.
Section 617(b) of the Tax Law provides, in part:
Character of items. Each item of partnership . . . income, gain, loss, or deduction
shall have the same character for a partner . . . under this article as for federal income tax
purposes. Where an item is not characterized for federal income tax purposes, it shall
have the same character for a partner . . . as if realized directly from the source from
which realized by the partnership . . . or incurred in the same manner as incurred by the
partnership. . . .
Section 631 of the Tax Law provides, in part:
(a) General. The New York source income of a nonresident individual shall be the
sum of the following: (1) The net amount of items of income, gain, loss and deduction
entering into his federal adjusted gross income, as defined in the laws of the United States
for the taxable year, derived from or connected with New York sources, including: (A)
his distributive share of partnership income, gain, loss and deduction, determined under
section six hundred thirty-two, and
*

*

*

(2) The portion of the modifications described in subsections (b) and (c) of
section six hundred twelve which relate to income derived from New York
sources (including any modifications attributable to him as a partner. . . .
(b) Income and deductions from New York sources.
(1) Items of income, gain, loss and deduction derived from or connected
with New York sources shall be those items attributable to:
*

*

*

(B) a business, trade, profession or occupation carried on in this state; or
*

*

*

(2) Income from intangible personal property, including annuities, dividends,
interest, and gains from the disposition of intangible personal property, shall constitute
income derived from New York sources only to the extent that such income is from

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property employed in a business, trade, profession, or occupation carried on in this
state….
*

*

*

(d) Purchase and sale for own account. A nonresident, other than a dealer holding
property primarily for sale to customers in the ordinary course of his trade or business,
shall not be deemed to carry on a business, trade, profession or occupation in this state
solely by reason of the purchase and sale of property or the purchase, sale or writing of
stock option contracts, or both, for his own account.
Section 632 of the Tax Law pertains, in part, to nonresident partners and provides, in
part:
(a) Portion derived from New York sources.
(1) In determining New York source income of a nonresident partner of any
partnership, there shall be included only the portion derived from or connected with
New York sources of such partner's distributive share of items of partnership income,
gain, loss and deduction entering into his federal adjusted gross income, as such portion
shall be determined under regulations of the [Commissioner of Taxation and Finance]
consistent with the applicable rules of section six hundred thirty-one.
*

*

*

(e) Application of rules for resident partners . . . to nonresident partners. . . .
(1) A nonresident partner's distributive share . . . of items shall be determined
under subsection (a) of section six hundred seventeen.
(2) The character of partnership . . . items for a nonresident partner . . . shall be
determined under subsection (b) of section six hundred seventeen.
Section 633(a) of the Tax Law provides, in part:
(a) General. The New York source income of a nonresident estate or trust shall be
the sum of the following:
(1) The net amount of items of income, gain, loss and deduction entering into
federal adjusted gross income, as determined under paragraph four of subsection (e) of
section six hundred one, derived from or connected with New York sources. Such

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determination of source shall be made in accordance with the applicable rules of section
six hundred thirty-one as in the case of a nonresident individual.
Section 137.6 of the Personal Income Tax Regulations provides:
Tiered partnerships. Where a nonresident partner is a member in a partnership,
and such partnership (hereinafter referred to as the "upper tier partnership") is a partner in
another partnership (hereinafter referred to as the "lower tier partnership"), the source and
character of such nonresident partner's distributive share of each partnership item of the
upper tier partnership which is attributable to the lower tier partnership retains the source
and character determined at the level of the lower tier partnership using the provisions of
sections 137.1 and 137.5 of this Part. Such source and character are not changed by
reason of the fact that such item flows through the upper tier partnership to such
nonresident partner.
Opinion
Each Master Fund and Domestic Feeder is classified as a partnership for federal income
tax purposes and each member of each Master Fund and Domestic Feeder is treated as a partner.
Under section 601(f) of the Tax Law each Master Fund and Domestic Feeder is classified as a
partnership and is not subject to New York State personal income tax. However, the individuals,
estates and trusts that are members of each Domestic Feeder are carrying on business as partners
and are liable for income tax in their separate or individual capacities.
Under section 632(a)(1) of the Tax Law, the New York source income of a nonresident
partner of any partnership includes only the portion derived from or connected with New York
sources of such partner's distributive share of items of partnership income, gain, loss and
deduction entering into the individual's federal adjusted gross income. The determination of
such portion shall be consistent with section 631 of the Tax Law.
Pursuant to section 631(b) of the Tax Law, items of income, gain, loss and deduction
derived from or connected with New York sources include those items attributable to a business,
trade, profession or occupation carried on in New York State. However, pursuant to section
631(d) of the Tax Law, a nonresident, other than a dealer holding property primarily for sale to
customers in the ordinary course of the individual's trade or business, shall not be deemed to
carry on a business, trade, profession or occupation in this State solely by reason of the purchase
and sale of property or the purchase, sale or writing of stock option contracts, or both, for the
individual's own account.

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Section 633 of the Tax Law provides that nonresident estates and trusts determine New
York source income in accordance with the applicable rules of section 631 of the Tax Law, as in
the case of a nonresident individual.
In Kenneth S. Davidson Partners, Adv Op Comm T&F, June 28, 1988, TSB-A-88(11)I, it
was held that the purchase and sale by the partnership of options on indexes, foreign currencies,
debt obligations and futures contracts and the exercise, closing out or expiration of such options
solely for its own account did not constitute the carrying on of a business, trade, profession or
occupation in New York State. However, the opinion noted that the partnership would not be
considered to be solely trading for its own account if it engaged in certain other activities such as
market making activities.
In Paul E. Singer, Adv Op Comm T&F, June 4, 1992, TSB-A-92(2)I, it was held that a
partnership with two general partners, a nonresident individual and a limited partnership,
engaged in trading securities for its own account was not carrying on a trade or business in
New York. The income attributable to the partnership was not New York source income under
section 631 of the Tax Law, and did not change its character despite the existence of a tiered
partnership arrangement where the partnership’s income was funneled through the limited
partnership before its ultimate distribution, or deemed distribution, to the individual.
In the present case, each Master Fund invests in stocks and other securities for its own
account, but is not a dealer in stocks or securities and does not act as a market maker in
securities. The Master Funds may invest in certain mortgage-related securities, but Petitioner
states that the Master Funds will not be directly involved in New LP’s business activities and
will not invest directly in New LP. Investment Adviser provides investment advisory services to
the Master Funds pursuant to investment advisory agreements. It appears that the Master Funds
are investing in stocks and other securities solely for their own account within the meaning of
section 631(d) of the Tax Law and as contemplated in Davidson Partners, supra, and, therefore,
the Master Funds will not be deemed to be carrying on a business, trade, profession or
occupation in New York State because of such activity.
New LP will conduct an active loan origination business, a portion of the income from
which is assumed in this Advisory Opinion to be New York source income from a trade or
business carried on in New York within the meaning of section 631(b)(2) of the Tax Law.
Investment Adviser will provide investment advisory services to New LP and New GP, which is
Investment Adviser’s wholly owned subsidiary. Certain of Investment Adviser’s management
personnel will serve on the board of directors of New GP, and it will have oversight over the
risks incurred by and the operations of New GP. New LP will consult with Investment Adviser
management personnel in connection with approving loans, assessing the risk profile and
exposure related to such loans, and certain other incidental activities.

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The Domestic Feeders invest for their own account in one or more lower tier Master
Funds and are treated as partners in the Master Funds, and may become limited partners in lower
tier New LP. The Domestic Feeders are not dealers in stocks or securities and do not act as
market makers in securities. Investment Adviser provides investment advisory services to the
Domestic Feeders pursuant to investment advisory agreements. Certain of Investment Adviser’s
management personnel may act as directors of Managing Entity which provides management
services to such Domestic Feeders. However, Petitioner states that the Domestic Feeders will
have no management or other control over the operation or activities of New LP.
Nonresident individuals, estates and trusts are partners in the upper tier Domestic
Feeders. The upper tier nonresident partners’ distributive share of the items of income, gain, loss
and deduction of each Domestic Feeder includes the Domestic Feeder’s (a) distributive share of
the items of income, gain, loss and deduction generated by each lower tier Master Fund from
trading in stocks and other securities for its own account, and (b) if the Domestic Feeder is a
limited partner in New LP, the distributive share of the items of income, gain, loss and deduction
generated by the lower tier New LP from its loan origination business, and (c) if the Domestic
Feeder is carrying on a business, trade, profession or occupation in New York State, the
distributive share of the items of income, gain, loss and deduction generated by such activities.
Following Paul E. Singer, supra, the fact that a portion of the nonresident partners’ distributive
share of the items of income, gain, loss and deduction of a Domestic Feeder includes its
distributive share of items of income, gain, loss and deduction generated by New LP, which
conducts business in New York, will not change the treatment of the Domestic Feeder’s
distributive share of items of income, gain, loss and deduction generated by a Master Fund which
trades in stocks and other securities solely for its own account.
Under section 137.6 of the Personal Income Tax Regulations, and following Paul E.
Singer, supra, the nonresident partners’ distributive share of a Domestic Feeder’s distributive
share of items of income, gain, loss or deduction that is generated by a lower tier Master Fund
that trades in intangible personal property solely for its own account, will not be New York
source income under section 631(b)(2) of the Tax Law.
However, the nonresident partners’ distributive share of a Domestic Feeder’s distributive
share of items of income, gain, loss or deduction that is generated by lower tier New LP’s
business conducted in New York, will be New York source income under section 631(b)(1)(B)
of the Tax Law.
If a Domestic Feeder is carrying on a business, trade, profession or occupation in
New York State, and the Domestic Feeder employs its ownership interest in the Master Fund in
its business, trade, profession or occupation in New York, any items of income, gain or loss
generated by the sale or other disposition by the Domestic Feeder of its ownership interest in the
Master Fund would be included in the Domestic Feeder’s items of income, gain, loss or

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deduction from carrying on its business, trade, profession or occupation in New York. (See
Ronald van der Horst, Adv Op Comm T&F, September 6, 2000, TSB-A-00(5)I.) The
nonresident partners’ distributive share of a Domestic Feeder’s income generated by the
Domestic Feeder’s business, trade, profession or occupation carried on in New York would be
New York source income under section 631(b)(1)(B) of the Tax Law. This treatment of the
Domestic Feeder’s disposition of its ownership interest in the Master Fund does not affect the
treatment of the distributive share of items of income, gain, loss and deduction attributable to the
Master Fund as discussed above.

DATED: October 25, 2004

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.