If a company spins off a manufacturing division (including its New York plant) into a new wholly-owned subsidiary tax-free under IRC section 351, does it have to pay back the New York investment tax credit it already claimed on that plant?

Plain-English summary

Coats & Clark Inc., a Delaware corporation with divisions making yarns, thread, and tooling, had claimed New York's investment tax credit on its Dynacast tooling plant in Yorktown, New York. It planned to spin Dynacast off into a brand-new, wholly-owned subsidiary in a transaction that qualifies as tax-free under IRC section 351 -- operations at the Yorktown plant would continue unchanged, just under the new subsidiary's name. Coats & Clark asked whether this spin-off would count as a "disposition" of the credited property, which would force it to recapture (pay back) part of the investment tax credit.

The Department said no recapture is required. New York's investment-credit recapture regulation borrows its undefined term "disposition" from the parallel federal investment-credit-recapture statute (IRC § 47), and federal law has a specific carve-out: a transaction that qualifies as tax-free under IRC § 351 is treated as a mere change in the form of doing business (not a disposition triggering recapture) if the property stays in the same business, the transferor keeps a substantial interest, essentially all the operating assets move together, and the new entity takes a carryover basis. Coats & Clark's spin-off met all of those conditions, so New York followed the federal treatment and found no disposition -- as long as the new subsidiary keeps the Yorktown plant in qualified manufacturing use for its full useful life or at least 12 consecutive years.

What this means for you

Multi-division manufacturers restructuring into subsidiaries

Reorganizing a division that has taken New York investment tax credit into its own subsidiary doesn't automatically trigger a costly credit payback, provided the restructuring is a genuine tax-free IRC § 351 transaction and operations continue essentially unchanged in the new entity. The property must keep being used in the same qualified manufacturing activity for the credit's full holding-period requirements.

Accountants and tax professionals

New York explicitly imports the federal "mere change in form" test (Federal Income Tax Regulations § 1.47-3(f)(1), Rev. Rul. 77-361) via Regulations § 1-2.1's rule that undefined terms track comparable IRC usage. Note the ongoing condition: even without recapture at the time of the spin-off, the acquiring subsidiary must maintain qualified use for the property's full life or 12 years (§ 5-2.8(e)) — a later disqualifying event in the subsidiary's hands could still trigger recapture down the road, measured against the combined holding period of both corporations.

Common questions

Q: Does any transfer of credited property to a new subsidiary avoid recapture?
A: No -- only transfers meeting the federal "mere change in form" conditions: continued use in the same trade or business, the transferor retaining a substantial interest, essentially all necessary assets transferring together, and carryover basis in the new entity's hands.

Q: Can the new subsidiary claim its own, fresh investment tax credit on the transferred property?
A: Generally no -- because it takes over the property at the transferor's adjusted basis rather than acquiring it by purchase under IRC § 179(d)(2), the transfer typically doesn't qualify as a new purchase for credit purposes.

Q: Can another company relying on IRC section 351 for a similar spin-off count on this exact result?
A: No. This opinion binds the Department only for Coats & Clark on these facts; a company should confirm its own transaction satisfies all four "mere change in form" conditions before assuming no recapture applies.

Citations and references

Statutes and regulations:

• Tax Law § 210.12(g) (investment tax credit recapture on disposition)
• Tax Law § 210.12(a) (investment tax credit)
• Business Corporation Franchise Tax Regulations § 5-2.8(a), (c), (e)
• Business Corporation Franchise Tax Regulations § 1-2.1
• IRC § 351 (tax-free transfer to controlled corporation); IRC § 47 (federal ITC recapture)
• Federal Income Tax Regulations § 1.47-3(f)(1)
• Revenue Ruling 77-361, 1977-2 C.B. 6

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1988.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a88_16c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-88 (16)C
Corporation Tax
August 11, 1988

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C880601B

One June 1, 1988, a Petition for Advisory Opinion was received from Coats & Clark Inc.,
30 Patewood Drive, Greenville, South Carolina 29615.
The issue raised is whether the spin off of one of Petitioner's divisions into a new subsidiary,
pursuant to section 351 of the Internal Revenue Code, would be considered a disposition of
qualifying property under section 210.12(g) of the Tax Law and whether Petitioner would be
required to recapture the investment tax credit allowed under section 210.12(a) of the Tax Law.
Petitioner is a multi-state corporation organized under the laws of the State of Delaware and
is taxable under Article 9-A of the Tax Law. Petitioner has four divisions: Consumer Sewing,
Industrial, Craft and Yarns and Dynacast. The first three divisions are engaged in the manufacture
of yarns and threads. Dynacast is engaged in the manufacture of tooling and one of its five plants is
in Yorktown, New York.
In prior years, investment tax credit was taken on the Yorktown, New York manufacturing
facility. Petitioner will create a new subsidiary and spin off the Dynacast division into the new
subsidiary. This transaction is not considered a sale for federal income tax purposes but is a tax-free
transaction pursuant to section 351 of the Internal Revenue Code. After the transaction, all operations
of the Dynacast Division, including the New York operations, will continue as they were prior to the
section 351 transaction.
Section 351(a) of the Internal Revenue Code (hereinafter "IRC") states: "[n]o gain or loss
shall be recognized if property is transferred to a corporation by one or more persons solely in
exchange for stock or securities in such corporation and immediately after the exchange such person
or persons are in control (as defined in section 368(c)) of the corporation."
Section 210.12(g) of the Tax Law and section 5-2.8(a) of the Business Corporation Franchise
Tax Regulations (hereinafter "Regulations") provide that if property on which investment tax credit
has been claimed is disposed of or ceases to be in qualified use prior to the end of its useful life, the
difference between the credit taken and the credit allowed for actual use must be added back to the
tax otherwise due in the year of disposition or disqualification.
Section 5-2.8(c) of the Regulations provides that a disposition of qualified property
includes:
(1) a sale of the property;
(2) a liquidation other than as part of a statutory merger or consolidation;
(3) a legal dissolution of the taxpayer;
(4) a trade-in of the property;
TP-8 (3/83)

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TSB-A-88 (16)C
Corporation Tax
August 11, 1988
(5) a gift of the property;
(6) transfer upon foreclosure of a security interest in the property;
(7) retirement of the property before expiration of its useful life;
(8) condemnation of the property;
(9) loss of the property due to fire, theft, storm or other casualty; and
(10) transfer of the property to a corporation not taxable under Article 9-A.
However, the term "disposition" is not defined for purposes of section 210.12(g) of the Tax Law
or section 5-2.8 of the Regulations.
Section 1-2.1 of the Regulations provides that, unless a different meaning is clearly required,
any term used in the Regulations presumably has the same meaning as when used in a comparable
context in the IRC and the regulations promulgated thereunder. Herein, the language of section
210.12(g) of the Tax Law is parallel to that contained in section 47 of the IRC. Therefore, when
determining whether a transaction is a disposition requiring recapture of investment tax credit for
purposes of section 212.12(g) of the Tax Law and section 5-2.8 of the Regulations, it is appropriate
to apply precedent set under the IRC for federal income tax purposes.
Section 47 of the IRC provides for a recomputation of the investment credit allowed by
section 38 of the IRC when qualified property is disposed of or ceases to be section 38 property. In
general, property will be considered disposed of whenever it is sold, exchanged, transferred,
distributed, involuntarily converted, or disposed of by gift. (See S. Rep. No. 1881, 87th Cong., 2nd
Sess. 149 (1962, 1962-3 C.B. 707, 852-853.) However, not all dispositions result in recapture for
federal income tax purposes.
Section 1.47-3(f)(1) of the Federal Income Tax Regulations provides that the provisions of
section 47 of the IRC relating to disposition do not apply to section 38 property which is disposed
of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the
estimated useful life which was taken into account in computing the taxpayer's qualified investment
by reason of a mere change in the form of conducting the trade or business in which such section 38
property is used provided that certain conditions are satisfied. The conditions are as follows:
(a)

the section 38 property must be retained as section 38 property in the same trade or
business;
(b)
the transferor of the section 38 property must retain a substantial interest in such
trade or business;
(c)
substantially all the assets (whether or not section 38 property) necessary to operate
such trade or business must be transferred along with the section 38 property; and
(d)
the basis of the section 38 property in the hands of the transferee must be determined
in whole or in part by reference to the transferor's basis.

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Corporation Tax
August 11, 1988
It has been determined that where the conditions set forth in section 1.47-3(f)(1) of the
Federal Income Tax Regulations are met, a transaction qualifying for nonrecognition treatment under
section 351 of the IRC constitutes a mere change in the form of conducting the trade or business and
recapture of investment credit under section 47 of the IRC is not required. See Revenue Ruling 77­
361 (1977-2 C. B. 6).
Accordingly, it appears that when Petitioner spins off Dynacast into a new subsidiary
pursuant to section 351 of the IRC, such transaction for federal income tax purposes would be a mere
change in the form of conducting the trade or business and Petitioner would not be required to
recapture the investment credit taken on the section 38 property that is transferred. Therefore,
pursuant to section 1-2.1 of the Regulations, such transaction should not be considered a
"disposition" as contemplated in section 210.12(g) of the Tax Law.
Section 5-2.8(e) of the Regulations provides that where property is transferred from one
corporation to another corporation and there is no disposition of qualified property, an add back of
investment tax credit is not required provided that the property continues in qualified use and is
acquired by a corporation subject to tax under Article 9-A. Generally, in these cases, the acquiring
or surviving corporation cannot claim an investment tax credit because it takes over such property
at the adjusted basis of the transferor and the transfer therefore does not qualify as a purchase
pursuant to Internal Revenue Code, section 179(d)(2). If the property in the hands of the acquiring
corporation is not in qualified use for its entire life or for more than 12 consecutive years, a recovery
from the acquiring corporation is required. In measuring the period of qualified use, the period
during which the property was held by the transferor corporation and the acquiring corporation are
to be taken into account.
Accordingly, Petitioner would not be required to recapture investment tax credit allowed
under section 210.12(a) of the Tax Law as long as the qualifying property, in the hands of the
subsidiary, continues in qualified use for its entire life or more than 12 consecutive years.

DATED: August 11, 1988

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.