Sec. 3-3.2. Definition of investment capital

Tax Law, §§ 5; 208(5), (7) and (8-A)(a); and 210(2)

(a)

(1) The term investment capital means the taxpayer's investments in stocks, bonds and other securities issued by a corporation (except as provided in paragraph (2) of this subdivision) or by the United States, any state, territory or possession of the United States, the District of Columbia, or any foreign country, or any political subdivision or governmental instrumentality of any of the foregoing (see subdivisions [c]-[g] of this section). At the election of the taxpayer, cash on hand and cash on deposit may be treated on any report as either investment capital or business capital (see section 3-3.3 of this Subpart). In making the election, a taxpayer that is a partner in a partnership and is using the aggregate method pursuant to section 3-13.3 of this Part or that is a foreign corporate limited partner that has made an election with respect to such partnership pursuant to the provisions of section 3-13.5 of this Part takes into account its proportionate part (see section 3-13.3[a][2] of this Part) of partnership items which constitute cash on hand and cash on deposit. Any debt instrument, including a certificate of deposit, which is described in paragraph (2) or (3) of subdivision (c) of this section and is not described in paragraph (2) of this subdivision and which is payable by its terms on demand or within six months and one day from the date on which the debt was incurred is deemed to be cash on hand or on deposit. Any such debt instrument which is payable by its terms more than six months and one day from the date on which the debt was incurred is deemed to be cash on hand or on deposit on any day which is not more than six months and one day prior to its date of maturity. Cash also includes shares in a money market mutual fund. A money market mutual fund is a no-load, open-end investment company registered under the Federal Investment Company Act of 1940 which attempts to maintain a constant net asset value per share and holds itself out to be a “money market” fund. A taxpayer may not elect to treat part of its cash as investment capital and part as business capital. No election to treat cash as investment capital may be made where the taxpayer has no other investment capital.

Example 1:

On February 1, 1990, Corporation A, a calendar year taxpayer, purchased a certificate of deposit with a maturity date of January 31, 1991, which was a qualifying corporate debt instrument (as such term is defined in subdivision [d] of this section). On July 1, 1990, Corporation A purchased a four month qualifying corporate debt instrument on the day it was issued and renewed it, with the identical terms, on November 1, 1990. On August 1, 1990, Corporation A bought a qualifying corporate debt instrument, on the day it was issued, with a maturity of February 2, 1991. On September 1, 1990, the corporation bought a nine month qualifying corporate debt instrument which had been issued on January 1, 1990, and was due on October 1, 1990. For the taxable year ending December 31, 1990, the two four month debt instruments and the debt instrument due on February 2, 1991 are deemed to be cash. The renewal of the four month debt instrument purchased on July 1, 1990 is treated as the creation of a second, separate debt instrument, each of the two instruments being due within six months and one day of the date on which the debt was incurred. The debt instrument due on February 2, 1991 is deemed to be cash because it is due within six months and one day from the date on which it was purchased.

The nine-month debt instrument is deemed to be cash because each day on which the taxpayer owned it was a day not more than six months and one day prior to its maturity date.

The one year certificate of deposit is not deemed to be cash until July 30, 1990 (the first day not more than six months and one day prior to the maturity date of January 31, 1991) and thereafter.

(2) Investment capital does not include:

(i) stock issued by the taxpayer;

(ii) stocks, bonds or other securities constituting subsidiary capital;

(iii) securities of an individual, partnership, trust or other nongovernmental entity which is not a corporation within the definition contained in section 208.1 of the Tax Law (such as Federal National Mortgage Association and Government National Mortgage Association pass-through certificates);

(iv) stocks, bonds and other securities of a DISC, or any indebtedness from a DISC;

(v) regular interests and residual interests in a real estate mortgage investment conduit (REMIC), as defined in section 860D of the Internal Revenue Code;

(vi) futures contracts and forward contracts;

(vii) stocks, bonds and other securities held by the taxpayer for sale to customers in the regular course of its business and, in the case of a taxpayer that is a partner in a partnership using the aggregate method pursuant to section 3-13.3 of this Part or that is a foreign corporate limited partner that has made an election with respect to such partnership pursuant to the provisions of section 3-13.5 of this Part, its proportionate part (see section 3-13.3[a][2] of this Part) of such items which are held by such partnership for sale to customers in the regular course of the partnership's business; and

(viii) repurchase agreements and securities lending agreements described in subdivision (g) of this section, including, in the case of a taxpayer that is a partner in a partnership that uses the aggregate method pursuant to section 3-13.3 of this Part or is a foreign corporate limited partner that has made an election with respect to such partnership pursuant to the provisions of section 3-13.5 of this Part, where such partnership is a registered securities broker or dealer as described in section 210.3(a)(9)(B) of the Tax Law, its proportionate part (see section 3-13.3[a][2] of this Part) of such items which are held by such partnership.

(b) The amount of investment capital is determined as set forth in subdivision (b) of section 3-3.4 of this Part.

(c) For purposes of paragraph (1) of subdivision (a) of this section, the phrase stocks, bonds and other securities means:

(1) stocks and similar corporate equity instruments, such as business trust certificates, and units in a publicly traded partnership included in the definition of “corporation” contained in section 208.1 of the Tax Law;

(2) debt instruments issued by the United States, any state, territory or possession of the United States, the District of Columbia, or any foreign country, or any political subdivision or governmental instrumentality of any of the foregoing;

(3) qualifying corporate debt instruments (see subdivision [d] of this section);

(4) options on any item described in paragraph (1), (2), or (3) of this subdivision and not described in paragraph (2) of subdivision (a) of this section, or on a stock or bond index, or on a futures contract on such an index, unless the options are purchased primarily to diminish the taxpayer's risk of loss from holding one or more positions in assets which constitute business or subsidiary capital; and

(5) stock rights and stock warrants not in the possession of the issuer thereof. Provided, however, debt instruments described in paragraph (2) or (3) of this subdivision which are deemed to be cash pursuant to paragraph (1) of subdivision (a) of this section do not constitute stocks, bonds or other securities.

(d) Qualifying corporate debt instruments.

(1) The term qualifying corporate debt instruments means all debt instruments issued by a corporation other than the following:

(i) instruments issued by the taxpayer or a DISC;

(ii) instruments which constitute subsidiary capital in the hands of the taxpayer;

(iii) instruments acquired by the taxpayer for services rendered or for the sale, rental or other transfer of property, where the obligor is the recipient of the services or property; however, where a taxpayer sells or otherwise transfers property which is investment capital in the hands of such taxpayer ( e.g., stock) and receives in return a corporate obligation issued by the recipient of such property, such corporate obligation, if it is not otherwise excluded from the category of investment capital, would constitute investment capital in the hands of the taxpayer;

(iv) instruments acquired for funds if:

(a) the obligor is the recipient of such funds;

(b) the taxpayer is principally engaged in the business of lending funds; and

(c) the obligation is acquired in the regular course of the taxpayer's business of lending funds;

(v) accepted drafts (such as banker's acceptances and trade acceptances) where the taxpayer is the drawer of the draft;

(vi) instruments issued by a corporation which is a member of an affiliated group which includes the taxpayer; and

(vii) accounts receivable, including those held by a factor.

(2) Terms used in this subdivision shall have the meanings prescribed as follows:

(i) Affiliated group. The term affiliated group means a corporation or corporations and the common parent of such corporation or corporations. The common parent of a corporation or corporations means an individual, corporation, partnership, trust or estate who or which owns or controls, either directly or indirectly, at least 80 percent of the voting stock of such corporation or of each of such corporations. An affiliated group also includes all other corporations at least 80 percent of the voting stock of which is owned or controlled, either directly or indirectly, by one or more of the corporations included in the affiliated group, or by such common parent and one or more of the corporations included in the affiliated group.

(ii) Principally engaged in the business of lending funds. A taxpayer is principally engaged in the business of lending funds, for purposes of this subdivision, if during the taxable year more than 50 percent of its gross receipts consist of interest from loans made by the taxpayer and net gain from the sale or redemption of notes or other evidences of indebtedness arising from such loans. A taxpayer that is a partner in a partnership and is using the aggregate method pursuant to section 3-13.3 of this Part determines whether more than 50 percent of its gross receipts consist of interest from loans made by the taxpayer and net gain from the sale or redemption of notes or other evidences of indebtedness arising from such loans by dividing (A) the sum of the taxpayer's own gross receipts consisting of interest from such loans and such net gain plus its distributive share of the partnership's gross receipts consisting of interest from loans made by the partnership and such net gain arising from loans made by the partnership by (B) the sum of the taxpayer's own gross receipts and its distributive share of the partnership's gross receipts. A taxpayer that is a partner in a partnership for which an election has been made with respect to such partnership pursuant to the provisions of section 3-13.5 of this Part makes such determination by dividing (A) its distributive share of the partnership's gross receipts consisting of interest from loans made by the partnership and such net gain arising from loans made by the partnership by (B) its distributive share of the partnership's gross receipts. For purposes of this subparagraph, receipts do not include return of principal or nonrecurring, extraordinary items.

(e) For purposes of this section, the term instrument includes stock and debt which is held in book entry form.

(f) Repurchase agreements.

(1) Repurchase agreement is a term used to describe a transaction in which one party (the seller/borrower) in formal terms sells securities to a second party (the purchaser/lender) and simultaneously contracts to repurchase the same or substantially identical securities at a later time. Depending upon the nature of the agreement, in some instances the purchaser/lender will have in fact purchased the securities, whereas in other instances the transfer of funds to the seller/borrower will in fact constitute a loan. Where the purchaser/lender is a taxpayer it is necessary to determine whether the result of such a transaction is the holding by the purchaser/lender of investment capital. If the purchaser/lender, as a result of the repurchase agreement, owns the securities, and the securities are encompassed within the definition of investment capital contained in subdivision (a) of this section, such securities will constitute investment capital in the hands of the purchaser/lender. If the purchaser/lender has not acquired ownership of the securities, then it is a lender of funds and has acquired a debt instrument issued by the seller/borrower. Unless such debt instrument constitutes cash pursuant to paragraph (1) of subdivision (a) of this section, where such debt instrument is encompassed within the definition of investment capital contained in subdivisions (a) and (c) of this section, such instrument will constitute investment capital in the hands of the purchaser/lender. Otherwise, it will constitute either business capital or subsidiary capital. Provided, however, a repurchase agreement described in subdivision (g) of this section does not constitute investment capital, or cash on hand or cash on deposit pursuant to paragraph (a)(1) of this section.

(2) In a repurchase transaction the question of whether the purchaser/lender is the owner of the securities, rather than the owner of debt issued by the seller/borrower, turns on whether such purchaser/lender has acquired the economic benefits and burdens of ownership of the securities. The purchaser/lender is the owner of the securities if it: (A) has the right freely to dispose of or pledge the securities to a third party; and (B) has acquired the opportunity for profit and bears the risk of loss deriving from changes in the market value of the securities. These two factors must be simultaneously present in order for a transfer of ownership to be recognized. The absence of either of these factors would render the transaction a loan. In such event the purchaser/lender would be viewed as having acquired debt of the seller/borrower, collateralized by the securities. Where there is ambiguity as to the existence of either or both of the two factors, recourse may be had to an examination of various other features of the transaction. Features which are consistent with a characterization of the transaction as a loan, but which are not in and of themselves dispositive, are:

(i) a requirement that the same or identical securities be resold or returned;

(ii) an obligation on the part of the purchaser/lender, where it sells the securities upon the failure of the seller/borrower to “repurchase” the securities, to turn over to the seller/borrower the proceeds in excess of the amount due to the purchaser/lender from the seller/borrower, and a right on the part of the purchaser/lender to hold the seller/borrower liable for any deficiency arising from such sale;

(iii) an obligation on the part of the seller/borrower to pay interest at a stipulated rate;

(iv) a disparity at the time of the initial transaction between the fair market value of the securities and the amount paid or advanced by the purchaser/lender;

(v) a right on the part of the purchaser/lender to require additional collateral if the market value of the securities declines (e.g., a mark to market provision); and

(vi) failure to treat the transaction as a sale or exchange for Federal income tax purposes; e.g., with respect to the reporting of gain or loss on each of the two purported sales, or the claim by the seller/borrower of the Internal Revenue Code section 103(a) exclusion with respect to exempt interest, if any, earned on the securities during the period between the initial “sale” and the “repurchase”.

(g) Repurchase agreements and securities lending agreements held by registered securities brokers or dealers.

(1) Repurchase agreements. A repurchase agreement, as described in subdivision (f) of this section, that is held by a registered securities broker or dealer, as described in section 210.3(a)(9)(B) of the Tax Law, does not constitute cash on hand or cash on deposit pursuant to paragraph (a)(1) of this section and is not investment capital.

(2) Securities lending agreements.

(i) A securities lending agreement held by a registered securities broker or dealer, as described in section 210.3(a)(9)(B) of the Tax Law, does not constitute cash on hand or cash on deposit pursuant to paragraph (a)(1) of this section and is not investment capital.

(ii) Securities lending agreement is a term used to describe a transaction in which, by its terms, one party (the securities lender) transfers stock or other securities in exchange for a promise by a second party (the securities borrower) to return substantially identical or equivalent securities at a later time. The securities borrower provides the securities lender with collateral, which may be cash or noncash collateral, such as a letter of credit or government securities. Securities lending agreements are generally characterized by the following:

(a) the securities borrower has the right to transfer the securities to a third party;

(b) the securities borrower is required to pay the securities lender an amount equal to dividends and interest paid on the securities over the term of the transaction and a fee, which may be quoted as an annualized percentage of the value of the securities, commonly known as the "borrow fee";

(c) where the agreed form of collateral in the securities lending agreement is cash, the securities lender retains any earnings from the use of the cash collateral during the term of the agreement;

(d) upon termination of the agreement, the securities borrower receives compensation for the use of the collateral commonly known as the "rebate fee" or "cash collateral fee";

(e) the net of the rebate fee and the borrow fee ("the net rebate fee") is ordinarily exchanged between the securities borrower and the securities lender; and

(f) the rebate fee generally exceeds the borrow fee and the net amount is reported as interest income by the securities borrower and interest expense by the securities lender.

(h) The following example illustrates some of the provisions of this section.

Example 2:

Corporation A is a manufacturing corporation and a taxpayer. It owns 25 units of a publicly traded master limited partnership which falls within the definition of “corporation” contained in section 208.1 of the Tax Law, 10,000 shares of stock in Corporation B (Corporation B, a manufacturing firm, has 5,000,000 shares of stock issued and outstanding), a $1,000,000 Government National Mortgage Association (GNMA) pass-through certificate, a $1,000,000 Federal National Mortgage Association (FNMA) pass-through certificate and a $100,000 FNMA debenture. Corporation A's investment capital consists of the shares of stock in Corporation B, the units of the partnership, and the FNMA debenture. The units of the partnership constitute investment capital because they are issued by a partnership which because of its characteristics falls within the definition of “corporation” contained in section 208.1 of the Tax Law. The FNMA debenture constitutes investment capital because it is a qualifying corporate debt instrument issued by a corporation, FNMA. Although the FNMA and GNMA certificates are guaranteed by FNMA and GNMA, respectively, they do not constitute investment capital because they are issued by a trust and thus are not “corporate or governmental”.