THE BRITISH LAND CASE: WILL THE EXCEPTION WORK AGAIN?

By Arthur S. Hirshfield, CPA, Bronx Community College

The New York State Court of Appeals has held that a nondomiciliary corporation was not required to apportion the gain realized on the sale of an out-of-state property using the New York statutory apportionment formula since to do so results in an unconstitutional tax on extraterritorial values [In the Matter of British Land (Maryland), Inc. v. Tax Appeals Tribunal of the State of New York, NYS Ct. of Appeals, No. 21, 2/16/95].

Background

British Land (Maryland), Inc. (hereafter the "taxpayer") was formed as a subsidiary of British Land Company, an international real estate investment firm. Shortly after its incorporation, the taxpayer purchased the capital stock of a Maryland company that owned an office building in Baltimore. Several years later, the taxpayer bought the fee interest in the land on which the office building was located (hereafter the "Maryland property"). Soon after purchasing the Maryland property, the taxpayer determined that the property should be sold. Before a sale could be completed, the taxpayer entered the real estate market in New York, acquiring an office building in New York City (hereafter the "New York property"). The Maryland property was ultimately sold in 1984, producing a $13 million capital gain.

Noting the taxpayer's unitary relationship of the New York and Maryland business activities, the New York State Department of Taxation and Finance ("the Department") issued a deficiency assessment against the taxpayer based on the apportioned gain on the sale of the Maryland property. Since the cost of the New York property was considerably greater than the Maryland property, the New York apportionment percentage was significant. The New York statutory three-factor apportionment formula (double the gross receipts, payroll, and tangible asset value) resulted in allocating and assessing tax on 64% of the capital gain related to the sale of the Maryland property to New York. The Administrative Law Judge, the New York Tax Appeals Tribunal, and the New York Appellate Division all affirmed the Department's assessment.

Analysis

The New York Court of Appeals reversed the decision and remanded the case back to the Tax Appeals Tribunal to redetermine the allocation percentage to reflect the taxpayer's business activities in the state. The Court of Appeals found that the gain on the Maryland property was in large part attributable to factors present in states other than New York and that distortion resulting from property values was evident.

The Court of Appeals agreed with the intermediate courts that the taxpayer cannot use separate geographical accounting to establish the taxation of extraterritorial income. The Court of Appeals, nevertheless, concluded that the apportionment formula as applied to the taxpayer's unitary business was unconstitutional because the factors that were mainly responsible for the appreciation in the value of the Maryland property had no link to New York.

Specifically, the Court of Appeals held that the following factors were responsible for the appreciation in value of the Maryland property that gave rise to the gain: improved economic climate in the foreign state's location, sound management, improvement and renovation of the property out of state, and the commencement of activities to sell the out-of-state property before acquiring the property in New York State.

Further, the Court of Appeals found proof of extraterritorial taxation due to the property factor. The taxpayer's only assets were the New York and Maryland properties. The New York property was a recent acquisition at a much greater cost than the Maryland property. The Court of Appeals concluded that the extremely marked differences in value inevitably had a distortive effect on the application of the statutory apportionment formula.

Observations

It is important to recognize that a nondomiciliary corporation which seeks to set aside a state allocation formula for the recognition of income has the considerable burden of presenting strong evidence to support its position. It should also be noted that the Court of Appeals considered apportionment distortion results as a consequence of the timing of the sale of the Maryland property. The decision to sell was made prior to the initiation of New York business activities. Moreover, the Court's reliance on apportionment factor distortion as a consequence of property value differences may not in and of itself, given the other circumstances present in British Land, be persuasive to show the needed level of unconstitutionality for a distortion claim.

The author wishes to thank Jerry Gattegno of Deloitte & Touche LLP and Corey Rosenthal of Ernst & Young LLP for providing him with the background materials essential for preparing this article.

NEW JERSEY GROSS INCOME CREDIT FOR TAXES PAID TO OTHER JURISDICTIONS

By Robert A. Reitman, CPA, Frank & Zimmerman & Company, LLP

The Spring 1995 issue of New Jersey State Tax News contains two discussions concerning New York taxes used in computing the credit for taxes paid to other jurisdictions for New Jersey gross income tax purposes.

The first discussion identifies the treatment of New York City Unincorporated Business Tax (UBT) for New Jersey residents who are subject to that tax. The New Jersey Division of Taxation (the Division) previously determined that the UBT is not a tax on an individual's income but a tax imposed on the unincorporated business. Therefore, the UBT cannot be used in the calculation of credit for taxes paid to another jurisdiction. (See New Jersey State Tax News July/August 1990.)

However, on the New York State nonresident income tax return, a New Jersey resident subject to the UBT must add the UBT paid to line 22, "New York State Additions," in the "Federal Amount" column. The Division has concluded that the amount of UBT added back may be used in the numerator of the credit calculation for taxes paid to other jurisdictions (New York State) on the New Jersey resident income tax return.

If a deduction of New York City UBT was taken to compute New Jersey Gross Income, that amount must be added back to recompute New Jersey taxable income, which results in a revised New Jersey tax.

The Numerator Is at Issue

The second discussion concerns the New Jersey Tax Court CaseÑDavid R. Allen v. Director, Division of Taxation, Tax Court 004866-93, decided November 30, 1994 [1994 WL 774013 (N.J. Tax)]. At issue was the numerator of the ratio used in computing the credit for taxes paid to other jurisdictions. The taxpayers had New York source income in 1990 of wages, capital gains, and other income. Their income subject to tax in New York State included a rental loss of $5,744. The taxpayers' New Jersey Gross Income consisted of wages, interest, dividends, capital gains, and other income. Their net capital gains for New Jersey purposes reflected the deduction of capital losses of $21,237 from capital gains. In dispute were the utilization of offsetting deductions, one allowable in New York but not in New Jersey (the $5,744 rental loss) and the other allowable in New Jersey but not New York (the $21,237 capital loss), for purposes of arriving at the New Jersey resident credit amount.

The Division argued that the numerator used to compute income subject to tax by other jurisdictions should include the taxpayers' capital loss and the rental loss incurred in New York even though this loss is not allowed on the taxpayers' New Jersey tax return. The taxpayers argued that in order to avoid double taxation, the numerator should include a deduction of the amount of the capital loss, the larger of the deductions, not taxed by New Jersey.

The Tax Court entered summary judgment for the taxpayer. The Tax Court maintained that the purpose of the credit provision is the avoidance of double taxation. To that end the two deductions of income that are not common to New York and New Jersey should reduce the numerator of the credit ratio by the greater of the two offsetting amounts, not by their sum. In arriving at its decision, the Tax Court rejected the Division's position that the calculation of the numerator of the credit ratio should be determined by utilizing categories of income and deductions. The Division is appealing this decision. *

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SEPTEMBER 1995 / THE CPA JOURNAL