When a corporation sells the stock of its foreign subsidiaries to a sibling company (an affiliate under common ownership, but not a direct parent-subsidiary relationship) as part of an internal reorganization, is the amount received includible in its New York entire net income?

Plain-English summary

Chemco International, Inc. ("Petitioner") and Chemical International Finance Limited ("CIF") are SIBLING corporations -- both are wholly owned subsidiaries of Chemical Bank, which is itself wholly owned by Chemical New York Corporation. CNYC, Chemical Bank, CIF, and Petitioner all file a single CONSOLIDATED federal income tax return together, but Petitioner and CIF each file SEPARATE New York Article 9-A franchise tax returns.

Both Petitioner and CIF separately own stock in various foreign subsidiaries, including several U.K. corporations. To get favorable "group relief" treatment for U.K. corporate income tax purposes, Petitioner planned a three-step reorganization: (1) sell all of its U.K. subsidiary stock to CIF for cash equal to fair market value; (2) form a new U.K. holding company ("Newco"), wholly owned by CIF; and (3) CIF contributes all the U.K. subsidiary stock to Newco in exchange for Newco stock. Only the FIRST step -- Petitioner's sale of stock to CIF -- was the subject of this Petition.

For federal tax purposes, because CIF and Petitioner are commonly controlled siblings, IRC section 318's constructive ownership rules treat Petitioner's stock sale to CIF as a distribution in redemption of CIF stock -- which under IRC section 301 splits into a dividend portion and/or a capital-gain portion, both of which would normally be included in gross income. However, because everyone involved files a CONSOLIDATED federal return, the consolidated-return regulations (26 CFR § 1.1502-14(a)) eliminate that dividend income and defer recognition of any gain, making the first step tax-FREE for federal purposes.

The New York question was different, since Petitioner files SEPARATELY for Article 9-A purposes. Under longstanding Department practice, a corporation that's part of a federal consolidated group but files separately for New York computes its entire net income as if it had filed a separate federal return -- meaning BOTH the dividend and gain components of the IRC section 301 distribution would ordinarily be included in Petitioner's hypothetical separate federal taxable income, the starting point for New York entire net income. But Tax Law section 208.9(a)(1) specifically excludes "income, gains and losses from subsidiary capital" from entire net income, and "subsidiary capital" (§ 208.4) includes investments in the stock of a "subsidiary" (§ 208.3: a corporation more than 50% voting-stock owned by the taxpayer) -- which describes exactly what Petitioner is selling here (its own wholly owned U.K. subsidiaries). Since the income, in substance, derives from Petitioner's disposition of stock it owns in its own subsidiaries (and IRC section 318 treats it as arising from ownership/redemption of shares in a wholly owned corporation), the Department held the entire receipt -- both dividend and gain components -- is excluded from Petitioner's New York entire net income as income from subsidiary capital.

What this means for you

Multi-tier corporate groups restructuring foreign holdings

An intercompany stock sale between sibling corporations, even one that federal tax rules recharacterize as a stock redemption under IRC section 301/318, can still qualify for New York's subsidiary capital exclusion if the underlying substance is a sale of stock in your OWN subsidiary -- regardless of how the transaction is federally recharacterized for dividend/gain purposes.

Corporations filing separately for New York while part of a federal consolidated group

Remember that filing separately for Article 9-A means recomputing your entire net income as if you'd filed a standalone federal return -- consolidated-return eliminations that shelter income at the federal group level (like the section 1.1502-14(a) elimination here) don't automatically apply to your New York computation. You need an independent New York exclusion (like the subsidiary capital rule) to get the same tax-free result at the state level.

Accountants structuring multi-step group reorganizations

This Opinion addressed only the FIRST of a three-step reorganization (the stock sale to CIF). If your client's transaction involves multiple steps, consider whether each step needs its own separate Advisory Opinion request, since the Department here explicitly limited its ruling to the step actually presented.

Common questions

Q: Does selling subsidiary stock to a sibling company avoid New York tax the same way a federal consolidated return would?
A: Not automatically -- a corporation filing separately for New York must independently qualify for a New York exclusion (like the subsidiary capital rule here) rather than relying on federal consolidated-return eliminations.

Q: What is "subsidiary capital" under New York law?
A: Under Tax Law § 208.4, it includes a taxpayer's investments in the stock of its "subsidiaries" -- corporations more than 50% voting-stock owned by the taxpayer (§ 208.3). Income, gains, and losses attributable to subsidiary capital are excluded from entire net income under § 208.9(a)(1).

Q: Does it matter that federal tax rules characterized this as a stock redemption rather than an ordinary sale?
A: Not for the New York result here -- the Department looked to the substance (a sale of stock in Petitioner's own wholly owned subsidiaries) rather than the federal recharacterization, and applied the subsidiary capital exclusion regardless.

Q: Can another corporate group rely on this Opinion?
A: No. It binds the Department only as to Chemco International's own facts (and only the first step of its reorganization) and cannot be relied upon by other taxpayers, even in a similar multi-tier restructuring.

Citations and references

Statutes, regulations, and rulings:

• Tax Law § 208.9(a)(1), § 208.3, § 208.4, § 208.9
• Internal Revenue Code § 301(c)(1), § 301(c)(3)(a), § 318
• 26 CFR § 1.1502-14(a)
• Rev. Rul. 70-496, 1970-2 C.B. 74
• Ruling of State Tax Commission, 1965 N.Y.T.B. v.3 p.6

Related rulings:

• TSB-A-84(2)C -- issued a few months earlier, states the general principle this ruling applies: a corporation filing separately for New York, though part of a federal consolidated group, recomputes its Federal taxable income as if it had filed its own standalone federal return

Date note: The document header reads "October 31, 1984," while the sign-off line reads "DATED: October 24, 1984" -- a seven-day gap consistent with internal signing before the header/publication date; issued_date uses the header date without correction.

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1984.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a84_14c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-84 (14) C
Corporation Tax
October 31, 1984

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C820825A

On August 25, 1982 a Petition for Advisory Opinion was received from Chemco
International, Inc., One World Trade Center, Suite 8321, New York, New York 10048.
At issue is whether an amount to be received by Petitioner from a sale of the stock of one of
its subsidiaries to an affiliated corporation, whose stock it does not own, would be includible in
Petitioner's entire net income for purposes of the Franchise Tax on Business Corporations imposed
under Article 9-A of the Tax Law.
Chemco International, Inc. (Petitioner) and Chemical International Finance Limited (CIF)
are wholly owned subsidiaries of Chemical Bank, a New York banking corporation. Chemical Bank,
in turn, is a wholly owned subsidiary of Chemical New York Corporation (CNYC), a Delaware
Corporation.
CNYC, Chemical Bank, CIF and Petitioner, together with other U. S. corporations, file a
consolidated Federal income tax return. CIF and Petitioner, however, each file separate franchise tax
returns under Article 9-A of the Tax Law.
CIF and Petitioner each own the stock of a number of foreign subsidiaries, including several
United Kingdom corporations. To obtain tax relief in computing the U. K. corporate income tax,
Petitioner proposes to form a single holding company to own the stock of all the U. K. subsidiaries.
This affiliated group would then be entitled to "group relief" for U. K. tax purposes.
To accomplish the reorganization, the following steps will be taken:
(1)

Petitioner will sell the stock of all of its U. K. subsidiaries to CIF for an amount of cash
equal to the fair market value of such stock;

(2)

a new U. K. holding company (Newco) will be formed, all the stock of which will be owned
by CIF; and

(3)

CIF will transfer the stock of all the U. K. subsidiaries to Newco in exchange for its
stock.

Only the first step is the subject of this Petition for Advisory Opinion.
Under Federal corporate distribution rules, Petitioner's receipt from the sale of the stock of
its U. K. subsidiaries to CIF constitutes a distribution in redemption of CIF stock, constituting either
dividends and/or gain. I.R.C. §§301-4, 318 (1983); Rev. Rul. 70-496, 1970-2 C.B. 74. The
regulations applicable to consolidated returns provide for the elimination of the dividend income

RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

-2­
TSB-A-84 (14) C
Corporation Tax
October 31, 1984

and further provide that any gain realized in such a transaction is not recognized. 26 CFR §1.1502­
14(a) Thus, for Federal income tax purposes the first step in the reorganization will be tax free.
For purposes of the Franchise Tax on Business Corporations imposed by Article 9-A of the
Tax Law, Petitioner will file a separate report. Section 208.9 of the Tax Law, in pertinent part,
provides that New York entire net income is presumably the same as Federal taxable income. In the
case of a corporation filing as part of a group reporting on a consolidated basis for Federal income
tax purposes, but separately for New York franchise tax purposes, "entire net income has been
construed to mean the amount of taxable income a corporation would have been required to report
for Federal income tax purposes if it were reporting separately for Federal purposes, subject to the
applicable modifications provided for in section 208." Ruling of State Tax Commission, 1965
N.Y.T.B. - v.3 p.6. One of such modifications excludes from entire net income "income, gains and
losses from subsidiary capital." Tax Law, §208.9(a)(1) The term subsidiary capital is defined as
including "investments in the stock of subsidiaries," (Tax Law, §208.4), while the term "subsidiary"
is defined as a corporation over 50% of the voting stock of which is owned by the taxpayer. Tax
Law, 9208.3.
In calculating Federal taxable income as if Petitioner had filed separately, "[t]hat portion of
the distribution [in the transaction described above] which is a dividend . . . shall be included in
gross income." I.R.C., §301(c)(1). Further, "that portion of the distribution which is not a dividend,
to the amount that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or
exchange of property." I.R.C., §301(c)(3)(a). Therefore, in determining Petitioner's New York entire
net income, both the dividend and gain portion of the receipt are included in Federal taxable income,
the starting point in determining entire net income. As previously noted, however, income, gains and
losses from subsidiary capital are specifically excluded from entire net income. Tax Law,
§208.9(a)(1). In the present case, the income in question will be derived in fact from Petitioner's sale
of its stock in its U. K. subsidiaries. Further, within the contemplation of the Internal Revenue Code
the income is treated as derived from ownership or redemption of shares in a corporation wholly
owned (pursuant to I.R.C., §318) by Petitioner. Accordingly, pursuant to section 208.9(a)(1) of the
Tax Law, this income derived from subsidiary capital should be excluded by Petitioner from the
computation of its entire net income for purposes of the Franchise Tax on Business Corporations
imposed under Article 9-A of the Tax Law.

DATED: October 24, 1984

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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