A Puerto Rico-chartered bank's HOME OFFICE (not its New York branch) holds U.S. government securities, and federal law (IRC section 882(e)) forces the bank to treat that interest as U.S.-trade-or-business income purely because it also has a U.S. branch -- does that federal rule pull the interest income into New York's bank franchise tax base too, and if so, how much of it is New York's share?

Plain-English summary

Banco Popular de Puerto Rico is a foreign banking corporation organized under Puerto Rico law, with branch offices in Puerto Rico, New York, and California during the taxable years at issue (1975-1980). Its Puerto Rico HOME office held U.S. government securities as part of its investment portfolio -- acquired, held, and recorded entirely by the Puerto Rico branch or its correspondent banks, with the New York and California branches having no role in purchasing, funding, maintaining, or even knowing about these transactions. The interest income wasn't itself connected to any U.S. trade or business.

Ordinarily that would keep the interest outside U.S. effectively-connected income. But IRC section 882(e) contains a special rule: a bank organized in a U.S. possession that ALSO has interest income from U.S. obligations not otherwise effectively connected to a U.S. trade or business must nonetheless TREAT that interest as effectively connected income -- apparently because the bank's mere presence via a U.S. branch triggers the rule, regardless of whether that branch actually touches the securities. This forced the interest into Banco Popular's federal taxable income.

Since Article 32's entire net income computation starts from federal taxable income (section 1453(a)) and has no modification specifically excluding IRC section 882(e) interest, the Department held New York must include this interest income in entire net income too -- federal treatment carries through by default whenever no New York-specific modification exists. The harder question was HOW MUCH of that interest is New York's share, since the income isn't recorded on any U.S. branch's books at all (it's booked in Puerto Rico). Because Petitioner stated it allocated its overall entire net income using SEPARATE ACCOUNTING, the Department nonetheless devised a special two-step formula specifically for this un-booked interest: first, to the extent traceable to obligations held to meet reserve requirements, multiply by a ratio of New York reserve-subject deposits to total reserve-subject deposits; second, apply the remaining amount by the ratio of New York gross income (excluding this interest) to total gross income (excluding this interest).

This allocation methodology did not survive. In a subsequent reexamination, the Department ANNULLED this formula entirely and substituted a different result -- see the companion modified opinion, TSB-A-86(5.1)C, issued three months later, which instead allows the interest to be allocated under the bank's existing separate-accounting method, and since the interest is recorded on the Puerto Rico branch's books rather than any U.S. branch, that means it can be allocated entirely OUTSIDE New York State. Taxpayers relying on this original ruling should consult the modified opinion, which controls.

What this means for you

Puerto Rico or other U.S.-possession banks with New York branches

IRC section 882(e)'s special rule can pull your home office's otherwise-unconnected U.S. obligation interest into your federal (and therefore New York) taxable income merely because you also maintain a U.S. branch -- even if that branch has zero involvement with the securities. Don't assume geographic separation of the investment activity protects it from New York inclusion.

Reading superseded advisory opinions

This ruling illustrates why it's essential to check whether a later modified opinion has changed an earlier one's conclusion -- the Department's FIRST answer on how to allocate this interest (a bespoke reserve/gross-income formula) was completely different from its SECOND answer (ordinary separate accounting, entirely excluding the interest from New York). Only the modified opinion is the operative guidance.

Common questions

Q: Why would U.S. Treasury interest earned entirely outside New York end up in New York's tax base at all?
A: Because IRC section 882(e) forces a possession-organized bank with a U.S. branch to treat such interest as federally effectively-connected income, and Article 32 has no New York-specific modification excluding it -- so it flows into entire net income by default.

Q: Does this ruling's allocation formula still apply?
A: No -- it was annulled and replaced by the modified opinion, TSB-A-86(5.1)C, three months later.

Q: Can another Puerto Rico or possession-organized bank rely on this specific ruling?
A: No. It binds the Department only for this petitioner's specific facts and, in any event, its allocation conclusion was itself later superseded.

Citations and references

Statutes and regulations:

• Tax Law § 1453(a), § 1454(a), § 1455(a)
• Internal Revenue Code § 882(e)
• Part 35, Tax on State Banks, other Financial Corporations and National Banking Associations regulations (Articles 9-B/9-C)

Related rulings:

• TSB-A-86(5.1)C -- the modified opinion that annulled and replaced this ruling's allocation methodology

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1986.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a86_5c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-86 (5) C
Corporation Tax
January 30, 1986

STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. C850520A

On May 20, 1985, a Petition for Advisory Opinion was received from Banco Popular de
Puerto Rico, Box 2708, G.P.O., San Juan, Puerto Rico 00936.
The issue raised is whether, for taxable years 1975 through 1980, New York State has the
authority to tax net U.S. source interest income earned on U.S. government obligations acquired by
the foreign office of a banking corporation organized under the laws of a U.S. possession merely
because that bank has an operating branch in New York State and the Internal Revenue Code
requires that the interest from such securities be included in U.S. Federal taxable income pursuant
to section 882(e) of the Internal Revenue Code.
Petitioner is a foreign banking corporation organized under the laws of Puerto Rico, a U.S.
possession. For the taxable years at issue, Petitioner maintained banking branch offices in Puerto
Rico, New York and California. Petitioner's offices in Puerto Rico had U.S. obligations as part of
its investment portfolio. Such obligations were acquired by the home office and the physical
securities were held at the Petitioner's offices in Puerto Rico or at correspondent banks. The New
York and California branches did not purchase, fund or maintain the securities and did not know
when the home office purchased or sold the securities. The interest income from such securities was
recorded in the accounts of the Puerto Rican branches. The interest income from such securities was
not effectively connected with the conduct of a trade or business within the U.S.
Pursuant to section 882(e) of the Internal Revenue Code, a bank organized in a U.S.
possession that receives interest income from U.S. obligations which is not effectively connected
with the conduct of a trade or business within the U.S. must treat such interest income as income
which is effectively connected with the conduct of a trade or business within the U.S. Thus,
Petitioner's interest income from U.S. obligations is included in Federal taxable income.
For the taxable years at issue, section 1455(a) of Article 32 of the Tax Law provided that the
basic tax was 12 percent of the taxpayer's entire net income, or portion thereof allocated to New
York State, for the taxable year.
Since the enactment of Article 32 entire net income has been defined in section 1453(a) as
"total net income from all sources which shall be the same as the entire taxable income which the
taxpayer is required to report to the United States treasury department, except as hereinafter
provided." For the taxable years at issue, section 1453(b) through (h) of Article 32 provided for the
modifications required by section 1453(a). However, there is no modification to exempt interest
income from U.S. obligations which is treated as income effectively connected with the conduct of
a trade or business within the U.S. pursuant to section 882(e) of the Internal Revenue Code.

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

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

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TSB-A-86 (5) C
Corporation Tax
January 30, 1986
For the taxable years at issue, the only regulations promulgated in accordance with section
1453 of Article 32 pertain to the modification for international banking facilities which is not herein
at issue.
The regulations promulgated in accordance with Articles 9-B and 9-C of the Tax Law, the
predecessors to Article 32, apply only to the extent that such regulations conform with the provisions
of Article 32 and only in the absence of regulations promulgated in accordance with Article 32. In
a letter to Commerce Clearing House, Inc., dated February 26, 1973, the Director of the Corporation
Tax Bureau made the following statement:
"Inasmuch as the provisions of Article 32 conform with Articles 9-B and 9-C,
except in areas of privilege period and Federal conformity, regulations issued under
Articles 9-B and 9-C remain applicable except when they are in conflict with the
provisions of Article 32. Federal taxable income is the starting point in computing
entire net income and therefore Federal regulations applicable to such computation
will be followed."
Therefore, a taxpayer that has interest income from U.S. obligations that is included in
Federal taxable income pursuant to section 882(e) of the Internal Revenue Code must include such
interest income in entire net income.
For the taxable years at issue, section 1454(a) of Article 32 provided that when entire net
income is derived from business carried on both within and without New York State, such entire net
income may be allocated within and without New York State under the rules and regulations
prescribed by the Tax Commission. However, for the taxable years at issue, there were no
regulations promulgated in accordance with section 1454 of Article 32 regarding allocation methods.
Therefore, the allocation methods described in Part 35 of the Tax on State Banks, other Financial
Corporations and National Banking Associations regulations issued under Articles 9-B and 9-C
remain applicable. Petitioner states that for the taxable years at issue it allocates entire net income
within and without New York State by using the principles of separate accounting.
Since interest income from U.S. obligations that is treated as income which is effectively
connected with the conduct of a trade or business within the U.S. pursuant to section 882(e) of the
Internal Revenue Code is not recorded on the books or records of the branches within the U.S., the
portion of such interest income that is attributable to New York State is determined as follows:
1.

To the extent that it is possible to determine the amount of such interest
income from U.S. obligations that were used to meet Federal and State
reserve requirements, multiply the amount of such interest income by a
fraction the numerator of which is the amount of deposits within New York
State for the taxable year that were subject to reserves and the denominator
of which is the amount of total deposits for the taxable year that were subject
to reserves.

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TSB-A-86 (5) C
Corporation Tax
January 30, 1986
2.

Multiply the remaining amount of such interest income by a fraction the
numerator of which is gross income (excluding such interest income) within
New York State for the taxable year that was included in the computation of
entire net income and the denominator of which is total gross income
(excluding such interest income) for the taxable year that was included in the
computation of entire net income.

Accordingly, when computing its tax under Article 32 of the Tax Law for taxable years 1975
through 1980, Petitioner must include in entire net income the interest income from U.S. obligations
that is treated as income effectively connected with the conduct of a trade or business within the U.S.
pursuant to section 882(e) of the Internal Revenue Code. However, since Petitioner states that it
allocates entire net income within and without New York State by the principles of separate
accounting such interest income is allocated within New York State by the method stated herein.

DATED: January 30, 1986

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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