When a securities broker-dealer invests customer funds in repurchase agreements (repos) with banks, is that investment "investment capital" under New York's franchise tax, or something else — and does it matter whether the repo is really a purchase of securities versus a secured loan?

Subject

Whether an investment in a repurchase agreement by a corporation subject to Article 9-A tax is considered "investment capital" under section 208.5 of the Tax Law.

Plain-English summary

First Albany Corporation, an NYSE member firm, was required by SEC rules to deposit excess customer credit balances into a "Special Reserve Account" that could only be invested in U.S. government-backed debt securities, including repurchase agreements ("repos") secured by such securities. First Albany invested those customer funds in repos with various New York banks — agreements where First Albany's money is exchanged for government securities, with the bank agreeing to buy them back (repurchase them) after a short period (24 hours to 5 days), paying interest along the way. First Albany reported these on its books as "Segregated Securities" and argued the arrangement should count as "investment capital," making the interest earned tax-favored "investment income" under Article 9-A.

The Department's answer turned on a threshold question that repo transactions can present either way: is a repo, in substance, a genuine purchase of the underlying government securities (with the taxpayer as true owner, bearing the risk of profit and loss), or is it, in substance, a secured loan collateralized by those securities (with the taxpayer merely as a lender holding collateral)? The Department adopted the reasoning of an Illinois appellate case (Andras v. Illinois Dept. of Revenue) and a related New York Technical Services Bureau memorandum: courts look at factors like whether either party can force the other to buy/sell back, whether there's a default remedy, whether a fixed interest rate applies regardless of the securities' actual market value, and — most importantly — whether the "purchaser" bears real ownership risk (the right to freely dispose of the securities and the exposure to market gains/losses). If First Albany truly owned the securities during the repo term, they can be investment capital (if they meet section 208.5's other requirements). If instead First Albany was really just a secured lender, the resulting debt instrument could be investment capital only if it independently qualifies under section 208.5 and 20 NYCRR § 3-4.2 — otherwise it's business or subsidiary capital instead. Because this purchase-vs-loan characterization is a fact question that varies by the terms of each specific repo, the Department could not resolve it in the abstract and left it to be determined based on the actual agreements, in the context of an ongoing audit.

What this means for you

Broker-dealers and financial firms investing customer funds in repos

Whether your repo investments count as tax-favored "investment capital" isn't automatic — it depends on the specific terms of each agreement and whether you genuinely bear the economic risk of owning the underlying securities during the repo term, versus simply holding them as loan collateral. Review your repo agreements for the classic purchase-vs-loan indicators: mutual buy-back/resell rights, default remedies, fixed interest independent of market value, and who bears gain/loss risk.

Accountants preparing Article 9-A returns for firms with repo investments

Don't assume repo income automatically qualifies as investment income under section 208.6. Apply the purchase-vs-loan framework from Andras v. Illinois Dept. of Revenue (adopted here) and the related May 4, 1988 Opinion of Counsel reprinted in TSB-M-88(5)I — even though that memo addressed a regulated investment company for personal income tax purposes, the Department confirmed the same rationale applies to Article 9-A corporate taxpayers.

Businesses generally holding repos as short-term cash investments

The same purchase-vs-loan analysis likely applies to any corporation's repo holdings when classifying them for New York franchise tax capital categories, not just broker-dealers — check the terms of your specific agreements rather than assuming a blanket answer.

Common questions

Q: Are all repurchase agreements automatically "investment capital"?
A: No. It depends on whether the repo is, in economic substance, a genuine purchase of the securities (true ownership, real risk of gain/loss) or a secured loan — a fact question turning on the specific agreement's terms.

Q: What factors indicate a repo is really a loan rather than a purchase?
A: Mutual rights to force a resale/repurchase, specific default remedies, a fixed interest rate regardless of the securities' market value, sale of identical securities back and forth, and the "purchaser" bearing none of the risk of loss on the securities.

Q: Can another broker-dealer rely on this ruling?
A: No. This advisory opinion binds the Department only for the taxpayer and facts presented, and cannot be relied on by anyone else — and even here, the Department did not resolve the ultimate factual classification, leaving it to audit.

Citations and references

Statutes and regulations:

• Tax Law § 208.5 (definition of "investment capital")
• Tax Law § 208.6 (definition of "investment income")
• 20 NYCRR § 3-4.2 (Business Corporation Franchise Tax Regulations, investment capital)
• Tax Law § 171(24); 20 NYCRR § 901.1(a) (advisory opinions limited to specified facts, cannot resolve disputed factual questions)
• Referenced authority: Andras v. Illinois Department of Revenue, 154 Ill. App. 3d 37 (1987); TSB-M-88(5)I (Opinion of Counsel, May 4, 1988)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1989.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a89_8c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-89(8)C
Corporation Tax
July 12, 1989

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C890321A

On February 18, 1982, a Petition for Advisory Opinion was received from First Albany
Corporation, 41 State Street, Albany, New York 12207.
The issue raised is whether an investment in a repurchase agreement by a corporation subject
to tax under Article 9-A is considered investment capital pursuant to section 208.5 of the Tax Law.
Facts
Petitioner, a New York corporation and a member of the New York Stock Exchange,
regularly invests customer monies in repurchase agreements.
Petitioner is required by the Securities and Exchange Commission to deposit excess
customer-related credit balances in a "Special Reserve Account for the exclusive benefit of
customers". The funds in this account may be invested only in debt securities guaranteed fully by
the U.S. Government (Treasury bills, bonds, notes or repurchase agreements secured by the same.)
The customer is paid interest at a rate determined at the end of each month, but his credit
balance is not evidenced by any specific security. Petitioner invests these monies in repurchase
agreements with various New York banking institutions. The repurchase agreement indicates that
the investment is made in U.S. treasury notes or other U.S. government security. The interest earned
is directly deposited into Petitioner's checking account or added to the next repurchase agreement
by the banking institution. Petitioner pays the customer a rate of interest anywhere from one-half
to two and one quarter percent below the amounts received on the repurchase agreement.
Additional factors are (1) Petitioner reports these investments on its books and in its financial
statements as "Segregated Securities" and (2) the repurchase agreements may be for a period of
anywhere between twenty-four hours and five days depending on the rate of interest at the time of
purchase.
Petitioner contends that the investments mentioned above constitute "investment capital" for
New York State franchise tax purposes and therefore, interest received on such investments is
"investment income" under Article 9-A.
Discussion
Section 208.5 of the Tax Law states that "[t]he term 'investment capital' means investments
in stocks, bonds and other securities, corporate and governmental, not held for sale to customers in
the regular course of business, exclusive of subsidiary capital and stock issued by the taxpayer.... "
TP-9 (9/88)

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Section 208.6 of the Tax Law states that "[t]he term 'investment income' means income,
including capital gains in excess of capital losses, from investment capital, to the extent included in
computing entire net income .... "
Technical Services Bureau Memorandum TSB-M-88(5)I reprinted, in its entirety, an Opinion
of Counsel dated May 4, 1988. In such opinion, Counsel discussed whether repos are secured loans
or, rather, are more properly treated as distinct purchases and (re)sales. Even though the Opinion
of Counsel pertained to a regulated investment company for personal income tax purposes, the
rationale used to characterize repurchase agreements is applicable to taxpayers under Article 9-A of
the Tax Law.
Such Opinion of Counsel states, in pertinent part:
Very recently, authorities in both Illinois and Virginia have considered sets
of facts and issues indistinguishable from those which you now present: the state
taxation of shareholders of a RIC that invests assets in Federal paper repos, first
"buying" the Federal obligations and then "reselling" them to the same party. See,
Andras v. Illinois Department of Revenue, 154 Ill. App. 3d 37, 106 Ill. Dec. 732, 506
N.E. 2d 439 (2d District 1987), lv. app. den., No. 63703 (Oct. 7, 1987, Illinois
Supreme Court), cert. den., 108 S. Ct. 1223 (Mar. 21, 1988); Illinois Department of
Revenue Information Bulletin, FY 87-25 (May 1987); Virginia Department of
Taxation, Ruling of the Commissioner (P.D. 87-186, July 7, 1987). See also,
Virginia Tax Bulletin 82-3 (April 1982).
The reasoning of the Illinois court in Andras is particularly instructive and
bears repeating here:
"Plaintiffs next argue that the Department incorrectly
classified the Trust's repurchase agreements as secured loans rather
than sales. The transactions are arranged as follows. The Trust [a
RIC] agrees to purchase certain U.S. Government securities from a
bank or other seller and simultaneously agrees to resell the same
securities to the same party on a certain, fixed date, which is generally
within a few days of the original sale date. The seller agrees to pay the
Trust interest at a fixed rate for the period between the original sale
and the repurchase. The record contains some representative
repurchase agreements supplied by the Trust. Some of the
agreements refer to the original purchase price as 'principal' and to the
government securities as 'collateral' ....
"In reviewing similar transactions involving municipal bonds,
Federal courts have consistently held that the Federal income tax
exemption provided for income received from State or municipal
obligations (26 U.S.C. sec. 103(a)(1954)) is available only to the
taxpayer who actually owns the securities -- i.e., the taxpayer who has

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Corporation Tax
July 12, 1989
the right to dispose of them and who bears the risk of a profit or loss.
(See American National Bank v. United States (5th Cir. 1970), 421
F. 2d 442, 451, and cases cited therein.). . . If the Trust is not the true
owner of these securities, but is merely loaning the sellers the
securities, purchase price and there by earning otherwise taxable
interest income, we conclude that it may not shelter that income from
State taxation by allowing the borrowers to secure the loans with tax­
exempt Federal securities.
"In determining whether or not a repurchase transaction is
actually a loan, Federal courts consider the entire transaction, and
look to the following specific factors, which, if present, tend to
indicate that the transaction is a loan: (1) whether the seller could
require the purchaser to resell the securities; (2) whether the
purchaser could require the seller to repurchase them;(3) whether the
agreement provides either party a specific remedy in the event that the
other defaults; (4) whether the seller agreed to pay interest at a
stipulated rate between the sale and resale; and (5) whether the
amount advanced does not necessarily equal the fair market value of
the securities sold. (See Citizens National Bank v. United States
(1977), 551 F. 2d 832, 842, 213 Ct. Cl. 236.) Other indications of a
loan are: (6) whether the identical securities are bought and sold, and
(7) whether the purchaser may sell the securities for the seller's
account in the event of a default. See I.R.S. Rev. Rul. 74-27 1974-1
C.B. 24). See also, I.R.S. Rev. rul. 82-144 (1982-2 C.B. 34)
(transaction held to be purchase where the purchaser could sell the
securities at will); I.R.S. Rev. Rul. 77-59 (1977-1 C.B. 196)
(transaction was found to be loan only and the purchaser's assets were
found not to be the securities themselves, but the seller's obligation
to repay the funds loaned). Here the Trust and the sellers
affirmatively agreed to a repurchase transaction involving the same
securities at the time of the sale, and either could therefore properly
require the other to perform. And while the agreements do not
expressly provide mutual remedies in the event of a default, plaintiffs
have stated that the Trust is authorized to sell the securities if the
seller defaults. There is no indication that a default sale would relieve
the seller of the obligation to pay the agreed amount, and we therefore
perceive that such a default sale would only act as a credit against any
amount still owed by the seller under the original agreement. In
addition, all of the sample agreements clearly set a specific rate of
interest.
"The Department has not argued that the sale amounts do not
accurately reflect the value of the securities, and we will therefore
assume that they do. The evidence nevertheless clearly indicates

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that the Trust accepted none of the risks of ownership, and we
therefore conclude that the transactions were secured loans rather than
sales. See American National Bank v. United States (5th Cir. 1970),
421 F. 2d 442, 451 ..... We therefore affirm the circuit court's
conclusion that income derived by the Trust from these repurchase
agreements is not tax-exempt.
"The decision of the circuit court is. . . remanded with
directions to permit taxpayers to deduct from their gross income that
proportion of the dividends they received from the Trust that is
attributable to U.S. Government securities, but not the amount
attributable to income from repurchase agreements."
Andras v. Illinois Department of Revenue, supra, 506 N.E. 2d at 443-444.
It is my opinion that both the rationale and conclusion reached in Andras,
concerning the repo issue, are sound and should be followed for the matter at hand.
Note, also, that the Virginia Department of Taxation has taken a position
which accords with that expressed in Andras. Responding to inquiries from several
mutual funds, a recent Ruling of the Commissioner (P.D. 87-186, July 7, 1987)
stated, in relevant part:
"You also requested a ruling regarding the taxability, for
Virginia individual income tax purposes, of the interest and dividends
paid to Virginia residents from [a] mutual fund. This fund may invest
only in marketable securities issued or guaranteed by the United
States Government, by various agencies of the United States
Government and by various instrumentalities which have been
established or sponsored by the United States Government ('U.S.
Government Securities'). It is the present policy of this fund to invest
100% of its assets in overnight repurchase agreements with
government securities dealers recognized by the Federal Reserve
Board or with member banks of the Federal Reserve System. The
agreements are collateralized by U.S. Government Securities.
"Section 630-2-322(C)(2)(d) of the Virginia Individual
Income Tax Regulations provides:
'Repurchase agreements are usually
obligations issued by financial institutions which are
secured by U.S. obligations exempt from Virginia
income taxation . . . . In such cases the interest paid
by the financial institutions to purchasers of
repurchase agreements does not qualify for the

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subtraction. Repurchase agreements issued following
current commercial practice will invariably be
regarded as obligations of the issuing financial
institution. However, if the purchaser is regarded as­
the true owner of the underlying exempt obligation,
the interest will qualify for the subtraction even
though collected by the seller and distributed to the
purchaser. Any claim of such ownership must be
substantiated, by a taxpayer claiming a subtraction.'
"Based upon the information that you have provided and upon
the above regulation section, such dividends paid by this fund would
currently be subject to the Virginia individual income tax."
I am aware of two state tax cases which, at first glance, might seem to hold
contrary to the Illinois and Virginia view. See, Matz v. Michigan Department of
Treasury, 155 Mich. App. 778, 401 N.W. 2d 62 (1986); In re Thomas C. Sawyer
Estate, No. S101-84 (Chittenden County, Vermont, Superior Court, Feb. 20, 1986),
aff'd, No. 86-177 (Dec. 11, 1987, Vermont Supreme Court). However, the concern
in Matz was with whether -- absent a statute on point -- dividends from a mutual fund
which admittedly owned Federal securities would retain their character attribute as
Federally exempt interest, essentially passed through from the mutual fund.
Although repos were involved, and the facts seem akin to those considered by the
above Illinois and Virginia authorities, Matz never considered the present issue of
whether the mutual fund indeed owned the Federal securities. The loan versus sale
issue was passed over without mention. Instead Matz took it for granted that the
mutual fund was, as stipulated, the true owner of the Federal securities. The same is
true of Sawyer. Thus, neither Matz nor Sawyer addressed the instant issue and do
not, in reality, hold contrary to either Andras or the Ruling of the Virginia Tax
Commissioner.
. . .I believe that the loan versus sale issue turns on whether the
purchaser/lender becomes endowed with the economic benefits and burdens of
ownership of the (Federal) securities. The chief indicia of such endowment, as
alluded to in Andras, are (1) the right freely to dispose of or pledge the securities to
a third party, and (2) the accrual to such party of the opportunity for profit and loss
deriving from changes in the market value of the securities ....
Conclusion
Herein, depending on the nature of the repurchase agreement, in some instances Petitioner
will have in fact purchased the securities, whereas in other instances the transfer of funds to
Petitioner will in fact constitute a loan which is collateralized by the securities. If, Petitioner, as a
result of the repurchase agreement, owns the securities, and if the securities qualify as securities
pursuant to the definition of investment capital contained in section 208.5 of the Tax Law,

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such securities will constitute investment capital. If Petitioner, as a result of the repurchase
agreement, has not acquired ownership of the securities, then it is a lender of funds and has acquired
a debt instrument collateralized by the securities. If such debt instrument comes within the ambit
of investment capital pursuant to section 208.5 of the Tax Law and section 3-4.2 of the Business
Corporation Franchise Tax Regulations, such debt instrument will constitute investment capital.
Otherwise, the purchased security or debt instrument will constitute either business capital or
subsidiary capital.
In conclusion, the determination of whether Petitioner's investment in a repurchase agreement
constitutes investment capital and, therefore, income from such agreement is investment income, is
a question of fact not susceptible of determination in an advisory opinion. An advisory opinion
merely sets forth the applicability of pertinent statutory and regulatory provisions to "a specified set
of facts." Tax Law, § 171, subd. twenty-fourth; 20 NYCRR 901.1(a). In as much as the question
presented herein arises within the context of an audit, the necessary factual determination will be
made within such context, in accordance with the principles outlined above.

DATED: July 12, 1989

s/FRANK J. PUCCIA
Director
Technical Services Bureau

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