COURT OF APPEALS AFFIRMS REVOCATION OF TAX EXEMPTION FOR PUBLIC PARKING FACILITIES

By Michael J. Hilkin

Reversing a decision by the Appellate Division, the Court of Appeals has held in a 5-2 decision that a charitable organization is not entitled to a continued exemption from real property taxes for the public parking facilities it owns and operates. Matter of Greater Jamaica Dev. Corp. v. New York City Tax Commission, N.Y. Decision No. 108 (July 1, 2015).

Facts. Greater Jamaica Development Corporation ("GJDC") was formed in 1967 as a charitable not-for-profit corporation with a mission to promote the development of the business district of Jamaica, Queens. In 1998, it created Jamaica First Parking, LLC ("JFP") to acquire, develop, and operate parking facilities in Jamaica on a nonprofit basis. JFP operated five facilities, four of which had formerly been operated by the New York City Department of Transportation, and the fifth of which was built on vacant land purchased from the City with monies received from the operation of the other four parking facilities. The parking facilities offered below-market rate parking accessible to local retail stores, state and federal office buildings, and religious organizations.

In 2001, the IRS concluded that (1) JFP was a disregarded entity for federal income tax purposes, and (2) JFP's activities would not adversely impact GJDC's federal tax-exempt status because JFP's operation of the parking facilities was "substantially related" to GJDC's charitable purposes and would "lessen the burdens of government." Further, in 2007, the New York City Department of Finance ("Department") granted real property tax exemptions for the five parking facilities pursuant to RPTL § 420-a, which allows a property tax exemption for property owned by entities organized or conducted for charitable purposes when the primary use of such property is for such purposes. However, in February 2011, the Department revoked the property tax exemption prospectively on the grounds that the operation of parking facilities was not a charitable activity as contemplated by RPTL § 420-a.

GJDC and JFP challenged the revocation, and the trial court ruled in the Department's favor. However, as discussed in the January 2014 issue of New York Tax Insights, the Appellate Division, Second Department, reversed on the basis that when an exemption has been granted, the Department has the burden to establish "revocation of the tax exemption on the grounds that petitioners' activity did not conform to a charitable purpose within the meaning of RPTL 420-a," and that the Department had not met its burden.

The Court of Appeals Decision. The Court of Appeals concluded that the property was not exempt. It found that while the taxing authority seeking to revoke a previously granted property tax exemption carries the initial burden of establishing that a property is not exempt from taxation, the Department satisfied this initial burden simply by demonstrating the grounds outlined in the exemption revocation letter provided by the Department. Such grounds included that JFP's parking facilities were not used for a charitable purpose or a purpose incidental to a charitable purpose, but instead were used for economic development, and that JFP collected monies exceeding the costs of the parking facilities and used its excess proceeds to fund other operations, such as the purchase of land for a fifth parking facility. The majority was also persuaded by an affirmation submitted by the New York City Assistant Corporation Counsel, who claimed that the factual allegations in GJDC and JFP's court petition challenging the exemption revocation established that the parking facilities were not entitled to exemption because JFP was created for the sole purposes of acquiring, owning, developing, and operating public parking facilities to promote GJDC's purpose of promoting commerce and business growth in Jamaica.

After finding that the Department had sustained its initial burden, the Court determined that GJDC and JFP failed to carry the burden of showing that the use of JFP's parking lots carried out GJDC and JFP's exempt charitable purpose. The majority determined that evidence of GJDC's and JFP's federal income tax-exempt status was insufficient to establish that the parking facilities were entitled to exemption from real property taxes under RPTL § 420-a, reasoning that the IRS's determination for federal income tax purposes requires "an analysis of the organization and its operation as a whole," while RPTL § 420-a requires both that real property (1) be owned by an entity organized for charitable purposes and (2) be used for carrying out such charitable purposes. While agreeing that GJDC and JFP were entities organized and operated for charitable purposes, the majority concluded that they failed to demonstrate that the use of their public parking facilities was consistent with their charitable purposes.

The Court called the operation of parking facilities that enable visitors to frequent local businesses in downtown Jamaica "laudable," but nonetheless concluded such activities were not charitable because they fulfilled the "primary purpose of economic development," focusing on the fact that the economic benefit conveyed by the below-market rate parking provided by JFP inures to the benefit of private enterprise. The majority also rejected the argument that the parking facilities fulfilled a "charitable" purpose by lessening the burden on local government—even though federal Treasury Regulations specifically identify such a purpose as charitable for federal income tax purposes.

Notably, a dissenting opinion strongly took issue with the majority's conclusions. The dissent stated that no change in facts or law predicated the change in the tax exemption for JFP's parking facilities, and that the Department's explanation for revoking the exemption was that the Department made a "mistake" and "erroneously awarded" the exemption "in the first instance." The dissent then classified the taxing authority's revocation of the exemption as a "flip-flop," and stated that a taxing authority should be required to show "some objective indication" other than a "mere change of heart" for revoking a previously issued exemption.

Additional Insights

It had been well established under New York law that when a taxing authority has granted a property tax exemption and later attempts to revoke it, the burden of proof is on the taxing authority. See, e.g., Matter of New York Botanical Garden v. Assessors of the Town of Washington, 55 N.Y.2d 328 (1982). In this case, however, the burden on the taxing authority appears to have been easy to meet. As discussed in the dissent, no facts or law changed between the time the Department granted an exemption for JFP's parking facilities in 2007 and revoked such exemption in 2011. Instead, it appears that the Department reexamined the facts surrounding JFP's parking facilities and reached a different legal conclusion—or, in the words of the dissent, had a "change of heart"—and the majority agreed with the Department's revised reasoning.

STATE AND CITY TAX DEPARTMENTS ISSUE GUIDANCE ON INVESTMENT CAPITAL IDENTIFICATION REQUIREMENTS

By Irwin M. Slomka

The New York State Tax Department (for Article 9-A) and New York City Tax Department (for the new Subchapter 3-A tax) have issued memorandums containing guidance as to how stock must be "clearly identified" in order to qualify as investment capital.

Technical Memorandum, TSB-M-15(4)C, (5)I, "Investment Capital Identification Requirements for Article 9-A Taxpayers," (N.Y.S. Dep't of Taxation & Fin., July 7, 2015); Finance Memorandum, "Investment Capital Identification Requirements for the Corporate Tax of 2015," (N.Y.C. Dep't of Fin., July 17, 2015).

Under last year's New York State corporate tax reform legislation, the definition of "investment capital" was narrowed, and investment income was made entirely exempt from Article 9-A tax. This past spring, significant "technical" changes were made to the definition of investment capital, resulting in a new five-part test. Among other things, in order to qualify as investment capital, the stock must be held for investment for more than one year, and, for stock acquired after 2014, the stock must have never been held for sale to customers in the regular course of the taxpayer's business. The five-part test also applies to the new Subchapter 3-A tax that replaces the New York City general corporation tax for most corporations.

One important new criterion under the new law is that before the close of the day on which the stock is acquired, the stock must be "clearly identified" in the taxpayer's records as stock held for investment (as required for securities dealers under IRC § 1236(a), whether or not the taxpayer is a dealer).

The memorandums provide that for securities dealers subject to IRC § 1236, in order to qualify as investment capital, the stock must be timely identified in the corporation's records as being held for investment under IRC § 1236(a)(1). That federal identification will be determinative in qualifying as investment capital, and a separate New York identification will not be accepted by the Department. It will not be sufficient for a securities dealer to merely identify the stock as being held for investment under IRC § 475 (relating to mark to market accounting for securities dealers).

For non-dealers, in order to be "clearly identified," the stock must be recorded, by the close of the day it is acquired, in a separate account maintained solely for investment capital purposes. The investment account must disclose, among other things, the CUSIP number for the stock, the date of purchase, the number of shares purchased, and the purchase price. The investment account can be maintained in the taxpayer's books of account for recordkeeping purposes only, or it may be a separate depository account maintained by a clearing company as nominee for the taxpayer. For stock acquired by non-dealers before October 1, 2015, a transition rule permits the taxpayer to make the necessary identification before October 1, 2015 (the transition rule does not apply to securities dealers).

The pronouncements also address the identification requirements where stock is owned by a partnership. If a corporate partner in such a partnership follows the aggregate method of taxation, then the partnership itself must follow the identification rule, even though it is not the actual "taxpayer."

Additional Insights

The 2015 "technical" changes regarding investment capital were quite substantive, and they impose significant recordkeeping requirements on both dealers and non-dealers in order to treat stock as investment capital. The apparent thrust of the 2015 legislation was to provide a bright-line test for whether stock qualifies as investment capital, particularly for securities dealers, where the failure to designate the stock as an investment for purposes of IRC § 1236(a)(1) will now be determinative. It is likely that many dealer firms currently do not make an IRC § 1236(a)(1) election for stock but will now have to do so in order to obtain investment capital treatment. The absence of a transition rule for dealers means that such firms run the risk that previously purchased stock can never qualify as investment capital if they did not make an IRC § 1236(a)(1) identification.

For non-dealers seeking investment capital treatment for stock acquired before October 1, 2015, it will be critical to comply with the new identification requirements for that stock before October 1, 2015, or else risk foregoing investment capital treatment. It seems clear that one important consequence of corporate tax reform—not fully apparent until the 2015 technical changes were enacted—is to severely limit the availability of investment capital treatment.

APPELLATE DIVISION AFFIRMS DENIAL OF INVESTMENT TAX CREDIT TO NUCLEAR POWER PLANT THAT PRODUCES STEAM AND WATER TO GENERATE ELECTRICITY

By Kara M. Kraman

In a unanimous decision, the Appellate Division has affirmed a New York State Tax Appeals Tribunal decision holding that certain assets used in the operation of a pair of nuclear power plants to produce steam used to generate electricity did not qualify for the investment tax credit ("ITC") for manufacturing under Article 9-A. Matter of Constellation Nuclear Power Plants LLC v. Tax Appeals Trib. of the State of N.Y., 2015 N.Y. Slip Op. 06183 (3d Dep't, July 16, 2015).

The taxpayer owned and operated two nuclear power plants in New York State. Equipment at both plants created steam from water, which was then used to generate electricity. The steam was then condensed back into water so the cycle could be repeated. Both plants used the steam to generate the electricity that they sold. Both of the plants sold only electricity and did not sell steam or water.

At issue was whether the taxpayer was entitled to an ITC for the specific equipment used solely to create steam and to condense it back into water. An ITC is allowed under Article 9-A for tangible personal property and other tangible property that is "principally used" by the taxpayer in the production of "goods" by manufacturing. Tax Law § 210(12)(b)(i)(A). Under the case law, "goods" constitute "tangible movable personal property having intrinsic value." Matter of Leisure Vue, Inc. v. Comm'r of Taxation & Fin., 172 A.D.2d 872 (3d Dep't, 1991). The term "goods" does not include electricity. Tax Law § 210(12)(b)(i)(A).

The taxpayer did not claim the ITC for equipment that was directly used to produce electricity. However, it did claim the ITC for the equipment engaged in producing steam from water and water from steam on the grounds that such equipment was not used to produce electricity, but rather to manufacture or process "goods" in the form of steam and water.

The Tribunal had rejected the taxpayer's argument, finding that the power plants utilized "unified, integrated processes that harnessed the energy from nuclear fission and produced electricity" and that "it is inappropriate to artificially divide a unitary process when the facts show that the parts and steps operate interdependently and indivisibly in accomplishing a singular task." Accordingly, the Tribunal determined that the equipment was principally used in the production of electricity and did not qualify for the ITC.

The Tribunal also rejected the taxpayer's argument that it was principally engaged in producing a "good," concluding that the taxpayer failed to carry its burden of establishing that either the water or steam was a "good" suitable for use.

Court Decision. On appeal, the Appellate Division, Third Department, affirmed the Tribunal's decision in its entirety. The court concluded that the equipment was principally used in the production of electricity because all of the disputed assets were necessary to the ultimate purpose of producing electricity, and that the water and steam were produced only to serve the purpose of manufacturing electricity. The Appellate Division distinguished its decision in Matter of Brooklyn Union Gas Company v. N.Y. State Tax Appeals Trib., 107 A.D.3d 1080 (3d Dep't, 2013), noting that, in that case, the individual analysis of certain component parts of a taxpayer's integrated gas delivery system was undertaken to determine whether those assets were used for the separate purpose of manufacturing rather than distribution, and that ultimately it was found that those parts were not used in manufacturing because they did not significantly change the nature of the gas delivered.

The Third Department also held that even when the equipment used to produce water and steam was viewed in isolation, the Tribunal correctly determined that such equipment was not engaged in manufacturing. The court noted that the equipment served to convert water into steam, and steam into water again, in an ongoing continuous cycle that made no permanent change in the water and yielded no final product. Accordingly, it concluded that such assets were not principally engaged in producing any tangible property other than electricity.

Additional Insights

Although the Appellate Division expressly rejected the idea that Brooklyn Union Gas "mandate[s] an assetby- asset approach," it also expressly rejected the idea that Brooklyn Union Gas mandates "any other specific form of inquiry as the prescribed method by which the Tribunal must determine eligibility for investment tax credits." This is significant because it suggests that there could be facts and circumstances under which an asset-by-asset approach would be appropriate in determining whether the ITC applies. However, to employ such an approach, a taxpayer would presumably need to at least be able to demonstrate that the equipment is used to manufacture a good that is itself eligible for the ITC, and that the good is not produced solely for the ultimate purpose of producing another good that is not eligible for the ITC.

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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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