The New York City Tax Appeals Tribunal has held that lease payments made to the Port Authority after the destruction of the World Trade Center on September 11, 2001, were not subject to commercial rent tax (“CRT”) because there were no “premises” after the total destruction of the buildings. Matter of 1 World Trade Center LLC, et al. TAT (E) 07-34(CR), et al. (N.Y.C. Tax App. Trib., Oct. 12, 2011).

Background

In July 2001, two months before the terrorist attack on the World Trade Center, the lessees entered into four nearly identical 99-year leases with the Port Authority, each relating to one of four buildings at the World Trade Center (“WTC”) site, including the “Twin Towers.” The premises were defined in the leases as consisting of the buildings only, and did not include the underlying land. Pursuant to the leases, the tenants made initial rental payments of approximately $491 million in July 2001. In addition to these initial rent payments, the lessees began to make monthly lease payments.

Until the destruction of the WTC on September 11, 2001, the lessees operated the buildings, collected rent from their subtenants, and properly deducted those amounts from their taxable base rent in calculating the CRT due. After the buildings were destroyed, the lessees continued to make rent payments, but no longer collected rent from their subtenants.

Except for a nine-month period after September 11 during which the City of New York took control of the WTC site, the Port Authority retained control over the site during the tax years in issue. In July 2002, the lessees and the Port Authority entered into an “Interim Access Agreement” giving the Port Authority control over the site at least through 2003; the agreement also gave the lessees certain access to the premises for pre-construction work in rebuilding. In December 2003, the parties entered into a new agreement identifying five new sites where five new buildings might be built, none of which was on the original Twin Tower footprints.

CRT Returns and Audit

The commercial rent tax is imposed on “base rent” paid by a tenant of certain taxable commercial premises in New York City, generally premises in Manhattan south of 96th Street. Base rent is reduced by subtenant rentals received or due from a tenant’s subtenants with respect to the premises. Taxable premises are defined as real property, and structures thereon, occupied or intended to be occupied in order to carry on a trade, business, or other commercial activity. Admin. Code §§ 11–701.4 and 11–701.5.

The lessees filed CRT returns for the tax year June 1, 2001 – May 31, 2002 (which included the period before September 11), and reported the $491 million in initial rent payments as taxable “base rent,” as well as the monthly rental payments thereafter, less the rental payments they received from subtenants, although it appears from the decision that CRT was not paid on the $491 million. On the annual CRT returns filed for the next three tax years (through May 31, 2005), the lessees reported as base rent the monthly rental payments they continued to make to the Port Authority, but subtracted as “subtenant rents” business interruption insurance payments they received from their insurer for the loss of subtenant rental income. As a result, the returns for those years showed no CRT liability for those years.

On audit, the Department of Finance (“Department”) disallowed the deductions for business interruption insurance proceeds as subtenant deductions, and assessed tax, interest, and penalties. In December 2009, after an administrative hearing, an Administrative Law Judge issued a determination concluding that no CRT was due post-September 11, and that the payments made to the Port Authority were not subject to the CRT because the lessees did not have the right to occupy specific space after the government takeover of the WTC site on September 11, 2001. The Department appealed.

City Tribunal Decision

The City Tribunal upheld the ALJ in concluding that no CRT was due on payments made after September 11, 2001. The Tribunal interpreted the term “premises” under the CRT law as requiring specified premises, and it found that no premises existed after September 11, 2001.

The City Tribunal rejected the Department’s argument that under the definition of “premises,” which includes not only real property but any structure thereon or space therein, the volume of space previously occupied by the buildings continued to exist and constituted taxable premises: “After September 11, 2001, the location and nature of the Premises covered by the Leases were thrown into sufficient doubt that we cannot conclude that there were identifiable premises covered by the Leases after that date for purposes of the CRT.” Accordingly, the Tribunal held that there were no identifiable premises covered by the leases after September 11, 2001, so no CRT was due on rent payments made after that date.

However, for the initial rent payments in the amount of $491 million made in July, 2001, the Tribunal rejected the lessees’ attempt to prorate those payments over the lease term, and to deduct business interruption proceeds as subtenant rents from the prorated amounts. The Tribunal held that (i) business interruption proceeds are not deductible as subtenant rents for CRT purposes, and (ii) the lessees’ contention that the initial rent payments should be prorated over the 99-year lease was unsupported by anything in the record or the leases, noting that in fact the initial rent payments were attributed to the first quarter of the year on the lessees’ annual CRT return for the tax year ending May 31, 2002.

The Tribunal therefore affirmed the ALJ’s cancellation of the CRT deficiencies attributable to the period beginning September 11, 2001, and modified the ALJ’s decision for the period through September 10, 2001, holding that CRT remained due on the initial rent payments and monthly rent payments made before September 11, less any actual subtenant rents received during that period.

Interestingly, in a separate opinion, concurring in part and dissenting in part, one Commissioner agreed that there were no taxable “premises” for CRT purposes during the period during which the City had complete control – between September 11, 2001 and July 1, 2002 -- and for the period beginning when the lessees executed the agreement of December 1, 2003, which established that no buildings would be constructed in the Twin Towers’ footprints, but that for the period of July 1, 2002 until December 1, 2003, the lessees had well-defined taxable premises located on the original Twin Towers’ footprints that were subject to CRT on the rent paid during that period.

Additional Insights. Needless to say, the unique circumstances concerning the destruction of the World Trade Center, coupled with the complex lease agreement and subsequent modifications, made this a case of first impression. The City Tribunal properly rejected the Department’s position that the continued lease payments were made for the taxpayers’ occupancy rights with respect to “the original volume of space” formerly occupied by the World Trade Center buildings. The CRT tax law applies to identifiable premises, and not to “volumes of space.”

The Department’s curious reliance on Matter of Debenham’s, Inc., 92 A.D.2d 829 (1st Dep’t 1983), appeal after remand 117 A.D.2d 344 (1st Dep’t 1986), in which payments made for the right to operate shoe concessions within a number of the landlord’s department stores, but not in a specific location within the stores, seems far removed from the circumstances where the leased premises are totally destroyed. Indeed, the Department’s position that the tax applies to the right to occupy an unspecified “volume of space” would have expanded the scope of the commercial rent tax far beyond anything previously contemplated. Assuming the threshold for taxability were met, would license fees paid to the City of New York for the right to operate buses on Manhattan streets constitute a taxable lease of a “volume of space”? Would the operator of a street parade or fair on Manhattan streets also be subject to the commercial rent tax on payments it makes to the City for the right to operate the parade or fair on a specified route or block, representing a “volume of space”? Under the City Tribunal’s decision, the answers to such questions should not be in doubt.