Goldman Sachs Petershill Fund Offshore Holdings (Delaware) Corp. New York City owes general corporation tax on its capital gains from the sale of its stake in a hedge fund manager, Claren Road Asset Management LLC, in 2010.
The New York City Tax Appeals Tribunal ruled that the Petershill Fund’s capital gain was due to the “capital appreciation” of Claren’s city business and thus had a connection to the city. (Affair of Goldman Sachs Petershill Fund Offshore Holdings (Delaware) Corp., TAT (E) 16-9 (GC), New York City Tax App. Trib. (March 12, 2021).
The Petershill Fund is owned by two limited partnerships, Petershill Offshore LP and Petershill PMD QP Offshore LP, both offshore companies. The investment strategy of offshore companies is to buy holdings in alternative investment management companies. The offshore companies formed the Petershill Fund and the fund formed the Petershill US IM Master Fund LP, a limited partnership (Master Fund). The Petershill Fund held 88.91% of the shares in the master fund. Goldman Sachs Group, Inc. owned 9.66% of these shares.
In 2008, the Master Fund acquired a 9.9% stake in Claren Road Asset Management, LLC. The Master Fund was never an executive member of Claren. Claren and the Master Fund were treated as partnerships for tax purposes. The Fund has recognized and paid general corporate income tax (GCT) on its portion of Claren’s income, deductions, gains and losses. The master fund’s share of Clarens income flowed into the fund from the master fund. Other than the Master Fund’s investment in Claren, neither the Fund nor the Master Fund had any business activities in New York City.
In 2010, the Master Fund sold its stake in Claren to The Carlyle Group, an independent buyer. The fund reported a capital gain on the sale of Claren of $ 54.7 million on its federal income tax return. The Fund has excluded capital gain in determining its total net income. The New York Treasury Department alleged a lack of GCT. The deficiency was due to the fact that the Fund excluded capital gains from total net income.
An administrative judge (ALJ) confirmed the complaint. The ALJ concluded that the Fund was linked to the city by virtue of its partnership interest in a city company for which the Fund had paid GCT on its share of the partnership income for each year it owned Claren. The fund argued that there was a lack of adequate connections to the city. The fund has analogized its investment in Claren with company shares.
Doing business in town
The GCT is imposed on companies that “do business in the city”. When a partnership does business in the city, all of their corporate partners are subject to the GCT. The only exception to this rule for limited partnerships that are either “publicly traded limited partnerships” or “portfolio investment partnerships” does not apply to the Fund’s ownership of its interest in Claren.
The Fund, the court said, “by disclosing its GCT earnings … and reporting its share of Claren’s income in GCT earnings… is admitting that it has a connection to the city by virtue of its ownership of a partnership interest in Claren. ”
The Fund argued that its LLC stake in Claren was “virtually indistinguishable from owning shares in a company.” The court rejected claims that the Fund’s stake in Claren should be treated as an interest in a company. Claren has been properly characterized as a partnership for both federal income tax and GCT purposes. Claren was just a conduit for the income from his urban activities, all of which flowed to the partners. As a partner of Claren, the fund was treated for tax purposes as if it had participated in Claren’s business, which was entirely local to the city.
Black is distinguishable
In Swart v. Franchise Tax Board ruled the court that “passively holding” a 0.2% interest in a California limited company is not “doing business”. Swart seemed to attach a lot of weight to the de minimis character of a 0.2% stake, the court said. In contrast, the master fund’s 9.9% stake in Claren cannot be classified as de minimis. Additionally, “Doing business under the GCT is broader than the narrow definition of California law. The GCT definition was changed in 1990 so that in the context of business activities, limited partners of a partnership with business activities within the city are expressly included. “
Capital gain can be attributed to New York City
The Fund claimed that even if the Fund had a city connection in the sale of its partnership stake in Claren, the capital gain was not properly allocated to the city. However, the Fund did business in the city due to its limited partnership interest in Claren and paid the GCT on its portion of Claren’s income, deductions, profits and losses, which the Fund allocated 100% to the city. said the court. The question that remains is whether, as the fund claims, the capital gains should be distributed outside the city.
The core of the fund’s argument arises from the parties’ statement that neither the fund and Claren nor the master fund and Claren operate a unitary business. The Fund asked the court to “divide the proceeds from its stake in Claren” into: (1) the flow-through income from the Fund’s interest in Clarens business that the Fund treated as allocable, and (2) the capital gain from the sale of those shares which the Fund had treated as non-allocable.
In Allied-Signal, Inc. v. Treasury Commissioner, the court ruled that the city “may tax dividends and capital gains if the company in which the investment was held was doing business within the city.”
“Since we do not make a meaningful distinction between the dividend share of a partner in the income from a partnership and a distribution of income to shareholders of a corporation through dividends, both of which come from inner-city business activities, we come to the conclusion that all efforts to distribute Allocate the Fund’s share of Clarens income to which the [fund] paid GCT and its capital gain from the sale of its shares in Claren must fail at first sight, “said the court.
The Fund claimed that it was in a separate “investment business” in managing the investments of its stake in Claren. The Fund argued that the capital gain came from the Fund’s investment management business and not from Claren’s operations and therefore the capital gain could not be allocated by the city on a one-stop-shop basis.
The parties have agreed that the fund and Claren will not operate a single business. “We do not interpret the provision to mean that we must treat the income the Fund has generated from Claren’s business differently from the capital gain the Fund has made [fund] derived from the sale of this business, ”said the court.
Both the distributing portion of the fund’s income from Claren and the capital gain had to be treated as part of the single business of Claren and were imputable to the city according to the single business principle. The capital gain was entirely attributable to the value of Claren at the time of sale, which in turn was entirely attributable to the value of Claren’s business, which was entirely attributable to Claren’s business activities in the city and which the Fund owned 100% in the city.
“But there would be no profit for the value of Claren’s business at the time of sale.” The court rejected the Fund’s allegation that the capital gain was due to services the Fund provided in managing its investment in Claren in London, rather than the value of Claren’s business at the time of sale. As part of Allied-Signal, the Fund’s capital gain attributable to the “capital appreciation” of Claren’s city business is related to the city and is subject to the GCT.
The court upheld the ALJ’s decision and upheld the ministry’s notification.
This column does not necessarily represent the opinion of the Bureau of National Affairs, Inc. or its owners.
Information about the author
Robert Willens is President of Robert Willens LLC, New York City Tax and Consulting Firm, and Associate Professor of Finance at Columbia University Graduate School of Business.
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