Reversing the Tax Court, the Third Circuit held that cash grants New Jersey paid a financial services corporation to relocate in the state were taxable income rather than a contribution to the corporation's capital.
Facts: BrokerTec Holdings Inc. was the parent of two subsidiaries with offices that were destroyed or severely damaged in the Sept. 11, 2001, terrorist attacks on the World Trade Center in New York City. The companies applied to the New Jersey Economic Development Authority's Incentive Program for cash assistance to relocate their offices across the Hudson River in New Jersey. The program required the grants to be a material factor in an applicant's decision to relocate or expand its business in New Jersey, resulting in a net increase in employment in the state. It based the grant amount on the amount of state income taxes withheld from employees' wages in the new location, with additional amounts for targeted communities and industries.
BrokerTec certified it would employ 720 full-time workers at its new leased offices, to which it would make more than $47 million in improvements, and invest another $25 million in equipment and furnishings. But beyond creating and maintaining a minimum number of jobs, the Incentive Program did not require these investments.
Beginning in 2004, the company received approximately $170 million from the program. It excluded from taxable income of its consolidated group for tax years 2010 to 2013 about $56 million of that amount as nontaxable nonshareholder contributions to capital. The IRS determined the grants were taxable income and issued deficiency notices.
The Tax Court rejected the IRS's argument that the program did not require BrokerTec to make any specified investments in capital assets and therefore the payments were not contributions to capital. The court stated that the grants fell "squarely within the four corners" of Regs. Sec. 1.118-1, which provides as an example of a governmental grant that contributes to a corporation's capital one that is "for the purpose of inducing the corporation to locate its business in a particular community." Thus, the grants were contributions to BrokerTec's capital, the Tax Court held (BrokerTec Holdings, Inc., T.C. Memo. 2019-32; see "Tax Matters: State Cash Grants Were Nontaxable Contributions to Capital," JofA, Aug. 2019). The IRS appealed.
Issues: Sec. 118 generally excludes from gross income any contribution to the capital of a taxpayer. (The law known as the Tax Cuts and Jobs Act, P.L. 115-97, added to certain other exceptions from that exclusion any contribution by a nonshareholder governmental entity or civic group (Sec. 118(b)(2), effective for contributions made after Dec. 22, 2017).) The donor's intent has generally been held to be controlling.
The IRS argued that the Tax Court misapplied Regs. Sec. 1.118-1, and more than a relocation is required. Citing Chicago, Burlington & Quincy R.R. Co. (CB&Q), 412 U.S. 401 (1973), the Service contended that payments must also be restricted to use as capital rather than for expenses, such as wages or dividends. In this case, New Jersey placed no restriction on the use of the grant money, the IRS argued.
Holding: The Third Circuit agreed with the IRS. Payments "must become a permanent part of the transferee's working capital," the court said, quoting CB&Q (at 413). Based on the case law prior to CB&Q, the court found that when cash grants given as relocation inducements are unrestricted in their use, as they were in BrokerTec's case, they are not contributions to capital but supplement the transferee's income.
- BrokerTec Holdings, Inc., No. 19-2603 (3d Cir. 7/28/20)
— By Paul Bonner, a JofA senior editor.