Denying an exception filed by the Department of Taxation and Finance, the New York State Tax Appeals Tribunal has upheld a claim for refund of qualified empire zone enterprise (“QEZE”) credits for real property taxes, finding that the company had a valid business purpose for its reorganization, consistent with the legislative intent in allowing such credits. Matter of Graphite Metallizing Holdings, Inc., DTA No. 822416 (N.Y.S. Tax App. Trib., July 7, 2011).
Facts. Back in 1998, a predecessor entity, Graphite Metallizing Corporation (“GMC 1”), received advice from its outside accounting firm that it should reorganize, in order to facilitate acquisitions and to help limit potential liabilities both for injuries resulting from its manufacturing process and for environmental issues arising from its use of a landfill. A holding company structure was recommended, in which the financial problems of one entity would not affect the others. At a stockholders’ meeting in June 1998, a resolution was approved authorizing the restructuring. No mention of tax credits or the QEZE program was made in the advice or in the minutes of the meeting authorizing the restructuring. Similar records of meetings held later in 1998, 1999, and 2000 also contained discussions of potential legal issues arising from GMC 1’s use of a landfill, and discussions of future acquisitions. In 1999, GMC 1 actually purchased a company located in Ohio, and in 2000 it attempted to purchase another target company but was outbid by a competitor.
In July 2002, GMC 1 did reorganize, pursuant to the 1998 authorization, and began operating as a holding company, eventually changing its name to Graphite Metallizing Holdings, Inc. (“GMH 1”), the petitioner in this case. The reorganization also resulted in the creation of a new subsidiary, which eventually changed its name to General Metallizing Corporation (“GMC 2”); GMC 2 conducted GMC 1’s former business activities, using the same assets, location, and workforce.
Meanwhile, during 2001 and 2002, GMH 1 (formerly GMC 1) also sought advice in connection with participating in the Empire Zone Program Act and obtaining Empire Zone Credits, and was advised to form new entities to operate in the Zone. At board meetings in 2002, participation in the Empire Zone benefits program was identified as a way to encourage the continuation of the company’s operations in Yonkers, rather than seeking alternative sites in other locations, including Ohio, where its subsidiary was already operating. Documents also discussed the need to obtain QEZE certifications before the “restrictions associated with the definition of a new business” took effect in 2002. (Emphasis in original.) Application was made for inclusion in the Empire Zone, and in December 2002, GMC 2 was notified it was certified eligible to received benefits, retroactive to July 31, 2002. During the 2001-2002 period, the outside advisors who were consulted did not discuss environmental concerns or protection from liabilities as purposes for the restructuring, and presented documents to the company related to a “QEZE Tax Credit Restructuring Planning Strategy.”
GMH 1 applied for real property tax credits pursuant to its certification. The credits were allowed for 2003 and 2004, but denied for 2005, due to changes in the QEZE statute, which, for years beginning on or after January 2005, required demonstration of a business purpose for restructuring when a newly created business was operating the same business previously operated by an affiliate.
The business purpose requirement. As discussed in the February 2011 issue of New York Tax Insights, QEZE tax credits and exemptions are linked to job creation, and the level of benefits is, in very general terms, determined by a comparison of the number of jobs in a base period to the number of jobs in a particular subsequent period. To obtain greater benefits, a business would have had to either increase its employment level to twice its base year employment level, or qualify as a “new business” so that, with a base period employment level of zero, the addition of even one job would result in its entitlement to 100% of the available benefits. The possibility of an existing business simply forming a new entity and continuing the same business — referred to as “shirt changing” — had been identified as a potential problem under the old law, and the statute was amended in 2002 to provide that a corporation or partnership will not be treated as a new business if it was similar in operation and ownership to an existing entity and was not formed for a valid business purpose as defined in the statute. Tax Law former § 14(j)(4)(B). A valid business purpose must “alone or in combination constitute the primary motivation for some business activity . . . which . . . changes in a meaningful way, apart from tax effects, the economic position of the taxpayer.” Tax Law § 208(9)(o)(1)(D).
The business purpose requirement for QEZE benefits was enacted on May 22, 2002, and was made applicable to entities created on or after August 1, 2002. The change resulted in a significant increase in the number of businesses being set up between May 22 and August 1, and therefore the legislature added an additional requirement that successor businesses first certified as eligible to receive QEZE benefits prior to August 1, 2002, had to meet the business purpose test to retain those benefits for tax periods beginning on or after January 1, 2005.
The ALJ Determination. After an audit, the Department denied the use of the QEZE credits for 2005, and the company petitioned for review. At the hearing, the Department contended that GMH 1 had failed to demonstrate a business purpose for the restructuring, relying heavily on the documents created during the 2001- 2002 period, all referencing the ability to obtain QEZE credits through the creation of a new entity.
The Administrative Law Judge found that, while at the exact time of the restructuring the primary motivation may have been to obtain QEZE benefits, that was not the sole motivation, and that other purposes existed, including the facilitation of acquisitions of other companies, increasing sales volume and market share, and isolating business risks and potential liability.
The Department filed an exception, claiming that the ALJ had misinterpreted the business purpose test and had also erred in considering evidence of both activities prior to the July 31, 2002 restructuring, and those occurring after that decision. The Department also challenged the credibility of the taxpayer’s witnesses.
The Tribunal Agrees. The Tax Appeals Tribunal upheld the ALJ’s decision, finding that an analysis of the “subjective intent” of the taxpayer demonstrated the existence of purposes other than the QEZE savings, although that was clearly among the purposes. The Tribunal found that the particular business purpose analysis under the QEZE statute required that the primary motivation not be the tax benefits, and that the restructuring be consistent with the statutory intent to achieve economic revitalization through private investment and job creation. Relying on the evidence from 1998 through 2000, referencing the need to limit liabilities and facilitate acquisitions, the Tribunal concluded that GMH 1 had made the decision to reorganize prior to becoming aware of the QEZE tax benefits, and that meaningful economic change occurred, since in fact the business, which had been struggling, actually did become profitable. The Tribunal also found that the reorganization was consistent with the legislative intent of the Empire Zone program, since the new structure provided the company with an incentive to stay in Yonkers, and all it needed to do was what it had previously resolved to do for other reasons.
Finally, the Tribunal rejected the Department’s argument that the ALJ should not have considered evidence from periods prior to or after the actual restructuring. While contemporaneous documentation may bear “greater relevance than after-the-fact rationalizations,” the Tribunal found no support for the exclusion of evidence regarding the initial business decision, the subsequent deliberation, or the eventual activities that demonstrated successful execution of the plan.
Additional Insights. In this decision, the Tribunal provides important clarification of the breadth of the “business purpose” requirement in the QEZE statute, and guidance on what sort of evidence will be regarded as useful in establishing that purpose. Unlike the decision in Matter of Dunk & Bright Furniture Co., DTA Nos. 823026 & 822710 (N.Y.S. Div. of Tax App., Dec. 30, 2010), exception filed, in which an ALJ found the company had failed to demonstrate a business purpose unrelated to QEZE savings, here both the ALJ and the Tribunal found ample evidence of business purposes in addition to the savings available under the QEZE program. In Dunk & Bright, the ALJ noted that none of the non-tax business purposes offered as claimed motivations during the course of the tax proceeding had been previously documented, pursued, or implemented, and therefore he did not find persuasive the taxpayer’s claim that those were true purposes. Here, the clear documentation of the other business purposes at the time the restructuring decision was made was crucial, even though there was evidence that, later on, QEZE savings were also taken into consideration.
The argument made by the Department that the Tribunal should disregard evidence of the initial motivation and the later effectuation of the plan seems quite curious and, as the Tribunal noted, unsupported by case law. In fact, in the Dunk & Bright case, it appears it was the Department that made arguments based on the taxpayer’s having failed to take any of the steps purportedly available under the new business structure, and the ALJ relied, at least in part, on the absence of subsequent activities, noting that it was “difficult to accept the premise that any meaningful economic or other changes . . . resulted from the reorganization, given that none of the envisioned steps or activities available under the [new] business structure . . . were ever undertaken or carried out.”
The Tribunal also rejected the Department’s argument that the testimony of the witnesses should be deemed “irrelevant” because they were employed by GMC 2. This must come as a relief to many taxpayers challenging tax assessments, who would be left without much useful evidence if testimony of witnesses were to be regarded as “irrelevant” simply because those witnesses are employed by the taxpayer or its affiliates. It is hard to imagine how any tax case could proceed to trial under those circumstances.