PLR 201144006: IRS treats a state economic-development grant as a capital contribution

Plain-English summary

A corporation asked whether a state economic-development grant used for construction, renovation, and business expansion was a nonshareholder contribution to capital. The IRS concluded that the grant was a contribution to capital under § 118(a) and was excludable from gross income under § 61. The ruling relied on the grant’s purpose of encouraging job-creating development and the absence of a direct payment for specific services. It did not address other Code or regulation provisions.

Ruling snapshot

• Question: Is the state grant a nonshareholder contribution to capital excludable from gross income?
• Outcome: approved
• Key authorities: IRC §§ 61, 118, and 362; Treas. Reg. § 1.118-1

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201144006
Third Party Communication: None
Release Date: 11/4/2011
Date of Communication: Not Applicable
Index Number: 118.00-00, 118.01-04
Person To Contact:
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Telephone Number:
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Refer Reply To:
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CC:PSI:B05
PLR-105704-11
In Re: Ruling Request
Date:
August 05, 2011

Taxpayer = ------------------------------------------------
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LLC 1 = --------------------------------------------------
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LLC 2 = --------------------------------------
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State = -------------------------------------------

Grant Program = ------------------------------------

Department = -------------------------------------------------------------------------

Date 1 = ------------------

Date 2 = -------------------

Date 3 = --------------------

Building = ----------------
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Addresses = ------------------------------------------------------------------------------------------
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a = ---------------
PLR-105704-11
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Dear ----------------:

This letter responds to a letter dated February 3, 2011, submitted on behalf of Taxpayer, requesting a ruling under section 118(a) of the Internal Revenue Code.

Taxpayer represents the following: Taxpayer is the parent corporation of an affiliated group of corporations that files a consolidated Federal income tax return, and is the single-member owner of LLC 1 (a disregarded entity for Federal income tax purposes). LLC 1 is the single-member owner of LLC 2 (a disregarded entity for Federal income tax purposes).

State established the Grant Program, run by Department, for the purpose of securing job-creating economic development opportunities, including the expansion or preservation of existing industry and the attraction of economic development prospects within State. Department and LLC 2 entered into a contract governing the terms and conditions of a grant under the Grant Program on Date 1. The terms and conditions included that LLC 2 use the grant for construction and renovation costs, engineering/architecture costs (subject to limitations) and for the purchase of office furniture, fixtures, machinery and equipment as part of LLC 2’s plan to centralize and expand its business operations at Addresses. LLC 2 could not use the grant for any other activities without first obtaining consent from Department.

On Date 2, LLC 2 submitted a payment request to Department requesting reimbursement of costs incurred in the construction of Building at one of the approved Addresses in the amount of a (which amount is equal to the full amount of the grant awarded). On Date 3, Department made the grant payment of a to LLC 2.

Taxpayer requests a ruling that the grant payment of a received from State, pursuant to the contract entered into between the parties, is a nonshareholder contribution to capital under section 118(a), which is excludable from Taxpayer’s gross income under section 61.

Section 61(a) provides that, except as otherwise provided in Subtitle A (Income Taxes), gross income means all income from whatever source derived.

Section 1.61-1(a) of the Income Tax Regulations provides that gross income means all income from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services.

The Supreme Court in Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955), held that gross income includes “instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”
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The Supreme Court in New Colonial Ice Co., Inc. v. Helvering, 292 U.S. 435, 440 (1934), held that “[w]hether and to what extent deductions shall be allowed depends on legislative grace; and only as there is clear provision therefor can any particular deduction be allowed.” “Obviously, therefore, a taxpayer seeking a deduction must be able to point to an applicable statute and show that he comes within its terms.” Id.

Section 118(a) provides that, in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer.

Section 1.118-1 provides the following:

In the case of a corporation, section 118 provides an exclusion from gross income with respect to any contribution of money or property to the capital of the taxpayer. Thus, if a corporation requires additional funds for conducting its business and obtains such funds through voluntary pro rata payments by its shareholders, the amounts so received being credited to its surplus account or to a special account, such amounts do not constitute income, although there is no increase in the outstanding shares of stock of the corporation. In such a case the payments are in the nature of assessments upon, and represent an additional price paid for, the shares of the stock held by the individual shareholders, and will be treated as an addition to and as a part of the operating capital of the company. Section 118 also applies to contributions to capital made by persons other than shareholders. For example, the exclusion applies to the value of land or other property contributed to a corporation by a governmental unit or by a civic group for the purpose of inducing the corporation to locate its business in a particular community, or for the purpose of enabling the corporation to expand its operating facilities. However, the exclusion does not apply to any money or property transferred to the corporation in consideration for goods or services rendered, or to subsidies paid for the purpose of inducing the taxpayer to limit production. See section 362 for the basis of property acquired by a corporation through a contribution to its capital by its stockholders or by nonstockholders. (Emphasis added.)

The legislative history to section 118 indicates that the exclusion from gross income for nonshareholder contributions to capital of a corporation was intended to apply to those contributions that are neither gifts, because the contributor expects to derive indirect benefits, nor payments for future services, because the anticipated future benefits are too intangible. The legislative history also indicates that the provision was intended to codify existing law that had developed through administrative and court decisions on the subject. H.R. Rep. No. 1337, 83d Cong., 2d Sess. 17 (1954); S. Rep. No. 1622, 83d Cong., 2d Sess. 18-19 (1954).
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The legislative history of section 118 provides, in part, the following:

This [section 118] in effect places in the Code the court decisions on this subject. It deals with cases where a contribution is made to a corporation by a governmental unit, chamber of commerce, or other association of individuals having no proprietary interest in the corporation. In many such cases because the contributor expects to derive indirect benefits, the contribution cannot be called a gift; yet the anticipated future benefits may also be so intangible as to not warrant treating the contribution as a payment for future services. (Emphasis added.)

S. Rep. No. 1622, 83d Cong., 2d Sess. 18-19 (1954).

One of the court decisions on this subject referred to in the committee reports is Detroit Edison Co. v. Commissioner, 391 U.S. 98 (1943). The facts involved the payment of cash to the taxpayer by prospective customers to cover the estimated cost of construction of the extension of the taxpayer’s electric utility service facilities to the prospective customers. The taxpayer contended that the payments were gifts or contributions to capital. The Court disagreed, holding that “[t]he payments were to the customers the price of the service.” Id. at 103. The Court reasoned that “it overtaxes the imagination to regard the farmers and other customers who furnished these funds as makers either of donations or contributions to the Company. The transaction neither in form nor in substance bore such a semblance.” Id. at 102.

Another court decision on this subject is Brown Shoe Co., Inc. v. Commissioner, 339 U.S. 583 (1950). The facts involved the payment of cash and the transfer of other property to the taxpayer by certain community groups as an inducement to the location or expansion of the taxpayer’s factory operations in the communities. The taxpayer contended that the properties so acquired were gifts or contributions to capital. The Court agreed, holding that “the assets transferred to petitioner by the community groups represented ‘contributions to capital.’” Id. at 589. The Court reasoned that “[t]he contributions to petitioner were provided by citizens of the respective communities who neither sought nor could have anticipated any direct service or recompense whatever, their only expectation being that such contributions might prove advantageous to the community at large. Id. at 591.

In United States v. Chicago, Burlington & Quincy Railroad Co., 412 U.S. 401 (1973), the Court, in determining whether a taxpayer was entitled to depreciate the cost of certain facilities that had been funded by the federal government, held that the governmental subsidies were not contributions to the taxpayer’s capital. The Court recognized that the holding in Detroit Edison Co. had been qualified by its decision in Brown Shoe Co. The Court in Chicago, Burlington & Quincy Railroad Co. found that the distinguishing characteristic between those two cases was the differing purpose motivating the respective transfers. The Court stated that:
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It seems fair to say that neither in Detroit Edison nor in Brown Shoe did the Court focus upon the use to which the assets transferred were applied, or upon the economic and business consequences for the transferee corporation. Instead, the Court stressed the intent or motive of the transferor and determined the tax character of the transaction by that intent or motive. Thus, the decisional distinction between Detroit Edison and Brown Shoe rested upon the nature of the benefit to the transferor, rather than to the transferee, and upon whether that benefit was direct or indirect, specific or general, certain or speculative. These factors, of course, are simply indicia of the transferor’s intent of motive. Id. at 411.

The Court reconciles Detroit Edison and Brown Shoe on the ground that in the former the transferor intended no contribution to the transferee’s capital, whereas in the latter the transferors did have that intent. See Id. at 412.

In addition, the Court stated that other characteristics of a contribution to capital are implicit in the two cases that do focus upon the use to which the assets transferred were applied or upon the economic and business consequences for the transferee corporation. The Court listed the following characteristics of a nonshareholder contribution to capital:

[1] It certainly must become a permanent part of the transferee’s working capital structure. [2] It may not be compensation, such as a direct payment for a specific, quantifiable service provided for the transferor by the transferee. [3] It must be bargained for. [4] The asset transferred foreseeably must result in benefit to the transferee in an amount commensurate with its value. [5] And the asset ordinarily, if not always, will be employed in or contribute to the production of additional income and its value assured in that respect.

Id. at 413.

In the present case, all the requirements of Chicago, Burlington & Quincy Railroad, have been met. Accordingly, we conclude the grant payment of a received from State, pursuant to the contract entered into between the parties, is a nonshareholder contribution to capital under section 118(a), which is excludable from Taxpayer’s gross income under section 61.

No opinion is expressed or implied regarding the application of any other provisions of the Code or regulations.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.
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In accordance with the power of attorney on file, a copy of this letter is being sent to Taxpayer’s authorized representatives.

Sincerely yours,

NICOLE R. CIMINO
Senior Technician Reviewer, Branch 5
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

Enclosures (2): Copy of this letter Copy for section 6110 purposes

cc: