The Tax Court held that cash grants received by a corporate taxpayer from New Jersey were nontaxable contributions to capital. According to the court, the state's intent when making the grants to the taxpayer was to bring in new jobs to a targeted area and to revitalize that area.
Facts: BrokerTec Holdings Inc. was the parent company of a consolidated group that included two financial services companies: Garban Intercapital North America Inc. and First Brokers Holdings Inc. On Sept. 11, 2001, when the World Trade Center in New York was destroyed by terrorists, Garban had offices in both of the center's towers, while First Brokers had offices near the center. The day after the attacks, both companies began looking for new permanent office space. Later in 2001, Garban and First Brokers each applied for cash grants from the New Jersey Economic Development Authority (EDA) under its Business Employment Incentive Program (BEIP), a program established to encourage companies to locate in New Jersey. Grant awards were based on the number of jobs to be created, the duration of those jobs, the amount invested by the applicant, and the long-term economic impact of the applicant on the economy of New Jersey. Both companies were awarded grants and negotiated the terms of a final agreement with the EDA.
From 2005 to 2014, Garban received grants totaling nearly $147.5 million, while First Brokers received over $22.2 million. All of the grant amounts were used to acquire 100% of the stock of ICAP Holdings (USA) Inc. as part of BrokerTec's plan to expand its business. From 2010 to 2013 on its consolidated tax return, BrokerTec excluded more than $55.6 million of grant payments from its gross income as nontaxable nonshareholder capital contributions. The IRS disallowed the exclusions and assessed deficiencies for those years. The taxpayer petitioned the Tax Court for relief.
Issues: Sec. 108 excludes from gross income contributions to capital to a corporation. As of Dec. 22, 2017, due to the law known as the Tax Cuts and Jobs Act of 2017, P.L. 115-97, contributions to capital no longer include "any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such)." Prior to Dec. 22, 2017, contributions to capital included contributions to a corporation by a governmental unit or by a civic group if the purpose of those contributions was to encourage the corporation to locate its business in a particular community, or to enable the corporation to expand its operating facilities.
When courts have determined the taxability of payments from a governmental entity or civic group to a corporation, they have examined whether the donor intended to make a nontaxable contribution to capital contributions. The Supreme Court has stated that nonshareholder capital contributions have the following characteristics: The contributions must become part of the transferee's permanent working capital, cannot be for services performed, must be bargained for, must result in a benefit to the transferee approximately equal to its value, and will be used to generate additional income. The IRS argued that the payments were not capital contributions because "the BEIP agreements do not provide that the Petitioner incur a specified amount of costs, or any cost at all, for capital assets or for any other type of asset."
Holding: The court rejected the government's argument, stating that it incorrectly focused on BrokerTec's use of the grant money rather than the EDA's motive for making the grants to BrokerTec. According to the court, the grants were capital contributions because their purpose was to encourage businesses to locate in New Jersey and thereby develop New Jersey's economy and revitalize its cities.
The IRS also argued the grants were excessive because BrokerTec's affiliates received grants totaling nearly $169.8 million but spent only about $40 million to relocate to New Jersey. The court conceded that the amounts might be excessive, but that didn't change the fact that to receive and keep any grant money, the companies had to build offices in New Jersey and operate those offices with a certain number of employees for the specified period.
Also, according to the court, the IRS conflated the terms "capital asset" and "working capital" in its analysis. But the court stated the two terms are not interchangeable because, for this purpose, courts have used the term "working capital" to describe the total amount invested into the business, a broader term than "capital asset," which refers to an asset such as a factory or machinery.
- BrokerTec Holdings, Inc., T.C. Memo. 2019-32
— By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.