The Tax Court in Brokertec Holdings, Inc. v. Commissioner
) held that cash grants to a corporation from a state economic development program qualified as nontaxable contributions to capital under Section 118.
, a corporation (Garban) was a financial services company and the common parent of a consolidated group. Garban had offices in both towers of the World Trade Center in New York City and was displaced after Sept. 11, 2001. During its search for new office space, Garban applied for a grant under a New Jersey discretionary aid program that offered financial incentives to attract businesses to move to the state.
Specifically, the program awarded cash grants determined by the board of a New Jersey agency and was based on criteria including: (i) number of eligible employees; (ii) expected duration of the employee positions; (iii) type of contribution the business could make to long-term growth of the New Jersey economy; (iv) the amount of other assistance that the business would receive; and (v) the total dollar investment the business was making in the project. The typical amount of a grant was 30%to 80% of employee state income tax withholdings, but the grant was only based on withholding tax paid by the employees and was not a rebate of tax paid. On Nov. 8, 2001, Garban was informed that it was approved for a grant over a 10-year period at the 80% level. Garban also acquired another company on April 30, 2002, which was also approved to receive a grant under the program.
New Jersey ultimately awarded Garban $169,780,735 in grants through the program with no restrictions on the use of money. Garban used approximately $40 million to move to New Jersey and spent the remaining amount to acquire the stock of another company. Garban filed its tax returns with a position that a portion of the grants qualified to be tax-free contributions to capital under Section 118. The IRS challenged that position, objecting on grounds that Garban used only $40 million of the total grants to move to New Jersey.
Prior to the Tax Cuts and Jobs Act, Section 118(a) provided that a corporation does not include a contribution to its capital in its gross income. Furthermore, Treas. Reg. Sec. 1.118-1 provided that Section 118 even applied to a contribution to capital made by a nonshareholder. For example, property contributed to a corporation by a governmental unit for the purposes of enabling the corporation to expand its operating facilities could have qualified as a contribution to capital under Treas. Reg. Sec. 1.118-1, and would not be included in the gross income of such corporation. There is an abundance of case law related to contributions to capital, including, as cited by the Tax Court in Brokertec, Commissioner v. McKay Products Corp
., (178 F.2d 639 (3rd Cir. 1949)) and Brown Shoe Co. v. Commissioner
(339 U.S. 583 (1950)). In Brown Shoe, the taxpayer received cash and property from community groups to induce it to locate its operations to certain municipalities. The Supreme Court held that such cash and property qualified as contributions to capital.
, the Tax Court held that the grants qualified as contributions to capital under the former version of Section 118(a) because they were substantially similar to the facts in Brown Shoe.
Partner, Washington National Tax Office
+1 202 521 1532
Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.