Does a tax-free restructuring of a partnership's corporate partners (a section 351 transfer plus section 368(a)(1)(A) mergers) trigger recapture of the investment tax credit?

Plain-English summary

A limited partnership ("Partnership") owns investment-tax-credit (ITC) property placed in service in 1993; its two corporate partners (Partner I, 51%, and Partner II, 49%, both subsidiaries of Corporation I) each claimed their share of the credit under Tax Law section 210.12. They planned a tax-free restructuring: Partner I would form a subsidiary (Newco) and contribute a 1% Partnership interest to it (a section 351 transfer), then Partner I and Partner II would merge into their parent, Corporation I (section 368(a)(1)(A) reorganizations). The ITC property stays in the Partnership, in qualified use. Morrison & Foerster asked whether this triggers recapture of the ITC.

No. Under section 210.12(g), ITC is recaptured only if the property is disposed of or ceases to be in qualified use before the end of its useful life. The term "disposition" is read using federal precedent (IRC section 47), under which a tax-free section 351 contribution that meets the "mere change in form" conditions is not a disposition (Coats & Clark, Milton Roy; Rev. Rul. 77-361). And 20 NYCRR 5-2.8(c)(2)/(e) provide that a section 368(a)(1)(A) statutory merger -- a section 381(a) transfer -- is not a disposition. Because the property stays in the Partnership in qualified use, the restructuring does not require recapture -- provided the property remains in qualified use for its life or more than 12 consecutive years. (Corporate partners are deemed to buy their share of partnership ITC property under John J. Eagan, TSB-A-87(9)C.)

What this means for you

ITC recapture turns on a disposition or loss of qualified use

The credit is added back only if the property is sold, retired, or otherwise disposed of, or stops being used in a qualifying way, before the end of its useful life.

Section 351 transfers and section 368(a)(1)(A) mergers are not dispositions

A tax-free section 351 contribution that is a mere change in form, and a statutory merger under section 368(a)(1)(A) (a section 381(a) transfer), are excluded from the definition of disposition, so they do not trigger recapture as long as the property stays in qualified use.

Corporate partners claim and keep ITC on partnership property

A corporate partner is deemed to buy its allocable share of partnership property and may claim the ITC; restructuring the partners without moving the property out of qualified use does not cost them the credit (the recapture clock continues with the surviving corporation, counting both holding periods).

Common questions

Q: When is the New York investment tax credit recaptured?
A: Only when the qualified property is disposed of or ceases to be in qualified use before the end of its useful life; then the excess credit is added back.

Q: Do tax-free reorganizations cause ITC recapture?
A: No. Section 351 transfers and section 368(a)(1)(A) mergers are not dispositions under 20 NYCRR 5-2.8, so they do not trigger recapture if the property stays in qualified use.

Q: What if the property later leaves qualified use?
A: Recapture can still be required from the surviving corporation if the property is not kept in qualified use for its life or more than 12 consecutive years, counting both the transferor's and the acquirer's holding periods.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 210.12 / 210.12(g) (investment tax credit; recapture on disposition or disqualification)
- 20 NYCRR 5-2.8 (what is and is not a disposition; section 381(a) transfers)
- IRC sections 351, 368(a)(1)(A), 381(a), 47 (tax-free transfers and reorganizations; federal ITC recapture); IRC section 1.47-3(f)(1); Rev. Rul. 77-361
- Coats & Clark Inc., TSB-A-88(16)C; Milton Roy Company, TSB-A-93(7)C; John J. Eagan, TSB-A-87(9)C (corporate partner deemed to purchase partnership property); see also Enviro-Gro Technologies, TSB-A-97(9)C

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1996.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a96_27c.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-96 (27) C
Corporation Tax
December 19, 1996

Taxpayer Services Division
Technical Services Bureau

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C960718C

On July 18, 1996, a Petition for Advisory Opinion was received from Morrison & Foerster
LLP, 1290 Avenue of the Americas, New York, New York 10104.
The issue raised by Petitioner, Morrison & Foerster LLP, is whether recapture of investment
tax credit claimed under section 210.12 of the Tax Law is required by reason of a proposed
restructuring brought about by the tax-free mergers of the corporate partners of a partnership owning
qualified property.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Partnership
Partner I, owns a 51 percent general partnership interest in Partnership, a limited partnership.
The other 49 percent interest in Partnership is owned by Partner II, a limited partner. Partner I and
Partner II are wholly-owned subsidiaries of Corporation I, a corporation subject to taxation under
Article 9-A of the Tax Law.
In 1993, Partnership purchased and placed in service certain property that was eligible for
investment tax credit under section 210.12 of the Tax Law. Partner I and Partner II claimed 51
percent and 49 percent of the credit, respectively, based on their proportionate interests in
Partnership. Most of the property for which the investment tax credit was claimed is seven-year
property being depreciated pursuant to section 168 of the Internal Revenue Code ("IRC") over a
seven-year period.
Proposed Restructuring
Partner I and Partner II are contemplating a restructuring which will consist of the following
steps:
1. Partner I will form a new wholly-owned subsidiary ("Newco").
2. Partner I will transfer a one percent interest in Partnership to Newco.
3. Partner I and Partner II will merge into their parent, Corporation I. Pursuant to this merger,
all assets owned by Partner I and Partner II (the Partnership interests and Newco stock) will
be transferred to Corporation I.
At the conclusion of the restructuring, Corporation I will own 99 percent of Partnership, and
it will own 100 percent of the stock of Newco which will own the remaining one percent of
Partnership.

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At all times, Partnership will have at least two partners, and for purposes of the New York
State Partnership Law it will continue as a partnership. The property for which the investment tax
credit was claimed will not be transferred. The property will continue in qualified use and will
remain in Partnership's hands both before and after the contemplated restructuring. Partnership
interests in Partnership will be transferred when Newco is formed and when Partner I and Partner
II merge into Corporation I.
Petitioner states that this restructuring will be tax-free for federal income tax and New York
State franchise tax purposes. The formation of Newco and transfer to it of the one percent
Partnership interest will be tax-free under section 351 of the IRC, and the mergers of Partner I and
Partner II into Corporation I will be tax-free reorganizations described in section 368(a)(1)(A) of the
IRC.
Section 210.12 of the Tax Law allows an investment tax credit against the tax imposed under
Article 9-A of the Tax Law. For taxable years beginning after 1990, section 210.12 allows an
investment tax credit equal to five percent with respect to the first $350 million of the investment
credit base and four percent with respect to the investment credit base in excess of $350 million. The
investment credit base is the cost or other basis for federal income tax purposes of qualified tangible
personal property and other tangible property, including buildings and structural components of
buildings.
Under section 210.12(b) of the Tax Law and section 5-2.2 of the Business Corporation
Franchise Tax Regulations ("Article 9-A Regulations"), the term "qualified property" means tangible
personal property and other tangible property, including buildings and structural components of
buildings, which:
(1)

is acquired, constructed, reconstructed or erected by the taxpayer after
December 31, 1968;

(2)

is depreciable pursuant to section 167 of the Internal Revenue Code;

(3)

has a useful life of four years or more;

(4)

is acquired by the taxpayer by purchase as defined in section 179(d) of the
Internal Revenue Code;

(5)

has a situs in New York State; and

(6)

is principally used by the taxpayer in the production of goods by
manufacturing, processing, assembling, refining, mining, extracting, farming,
agriculture, horticulture, floriculture, viticulture or commercial fishing.

Section 210.12(g) of the Tax Law and section 5-2.8(a) of the Article 9-A 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

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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 Article 9-A 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;
(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.

Section 5-2.8(e) of the Article 9-A Regulations provides that
[f]or purposes of this section, a disposition does not occur where property is
transferred from a corporation as part of a transaction to which section 381(a) of the
Internal Revenue Code applies; e.g., ... a reorganization under ... section 368(a)(1)(A)
(statutory merger or consolidation) ... As there is no disposition in these cases, an add
back 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.

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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 Article 9-A Regulations.
Section 1-2.1 of the Article 9-A Regulations provides that, unless a different meaning is
clearly required, any term used in the Article 9-A Regulations shall presumably have the same
meaning as when used in a comparable context in the IRC and the corresponding regulations. The
language of section 210.12(g) of the Tax Law is parallel to that contained in section 47 of the IRC
prior to the enactment of the Revenue Reconciliation Act of 1990. 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 Article 9-A Regulations, it is appropriate
to apply precedent set under the IRC for federal income tax purposes.
Section 47 of the IRC, (prior to the enactment of the Revenue Reconciliation Act of 1990
applicable to property placed in service after December 31, 1990), 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 CB 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:
(1)

the section 38 property is retained as section 38 property in the same trade or
business;

(2)

the transferor of the section 38 property retains a substantial interest in such
trade or business;

(3)

substantially all the assets (whether or not section 38 property) necessary to
operate the trade or business are transferred to the transferee to whom the
section 38 property is transferred; and

(4)

the basis of the section 38 property in the hands of the transferee is
determined in whole or in part by reference to the basis of the section 38
property in the hands of the transferor.

It has been determined that where the conditions set forth in section 1.473(f)(1) of the federal
Income Tax Regulations are met, a transaction qualifying for nonrecognition treatment under section

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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, Rev Rul 77361,
1977-2 CB 6.)
A tax-free transfer pursuant to section 351 of the IRC, that for federal income tax purposes
does not require the recapture of the investment tax credit taken on section 38 of the IRC property,
does not constitute a "disposition" as contemplated in section 210.12(g) of the Tax Law. See Coats
& Clark Inc., Adv Op Comm T & F, August 11, 1988, TSB-A-88(16)C, and Milton Roy Company,
Adv Op Comm T F, February 10, 1993, TSB-A-93(7)C.
In John J. Eagan. Norris. McLaughlin & Marcus, Adv Op St Tax Comm, April 29, 1987,
TSB-A-87(9)C, it was held that where a partnership purchases tangible personal property that is
principally used by the partnership, the property is deemed to be purchased by each partner to the
extent of the partners's allocable or pro rata share of the partnership's property. Therefore, where the
property meets all of the requirements for qualifying for the investment tax credit, a corporate partner
of the partnership is allowed an investment tax credit, pursuant to section 210.12(a) of the Tax Law,
for its allocable share of the cost or other basis of such qualifying tangible personal property.
In this case, Partnership purchased and placed in service property that was eligible for
investment tax credit under section 210.12 of the Tax Law. Pursuant to John Eagan, supra, Partner
I and Partner II, as corporate partners, were deemed to have purchased the property. The property met
all of the requirements for qualifying for the investment tax credit, and Partner I and Partner II were
each allowed an investment tax credit, pursuant to section 210.12 of the Tax Law, for their allocable
share of the cost or other basis of the qualifying property. Since Partner I and Partner II have claimed
the investment tax credit, it must be determined whether a disposition of the qualifying property was
made by Partner I and Partner II.
Petitioner states that the formation of Newco by Partner I and the transfer to Newco by
Partner I of the one percent Partnership interest will be tax-free under section 351 of the IRC. It
appears that all of the conditions set forth in section 1.47-.3(f)(1) of the federal Income Tax
Regulations will be met. Accordingly, pursuant to section 5-2.8 of the Article 9-A Regulations and
Coats & Clark, supra, and Milton Roy, supra, it appears that this transaction is not considered a
"disposition" by Partner I as contemplated in section 210.12(g) of the Tax Law.
Petitioner also states that the mergers of Partner I and Partner II will be tax-free
reorganizations described in section 368(a)(1)(A) of the IRC. Pursuant to section 5-2.8(c)(2) and
(e) of the Article 9-A of the Regulations, a "disposition", as contemplated in section 210.12(g) of the
Tax Law, does not occur as a result of a reorganization that constitutes a statutory merger or
consolidation under section 368(a)(1)(A) of the IRC. Accordingly, it appears that Partner I and
Partner II will not dispose of the qualifying property when they are merged into their parent,
Corporation I under reorganizations that qualify as tax-free reorganizations described in section
368(a)(1)(A) of the IRC.

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Where there is no disposition of qualified property, a recapture of investment tax credit is not
required provided that the property continues in qualified use for its entire life or for more than 12
consecutive years. Therefore, it appears that the restructuring proposed in the facts of this case will
not require the recapture of a portion of the investment tax credit claimed by Partner I and Partner
II.

DATED: December 19, 1996

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

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