Does a tax-free restructuring of the corporate partners of a partnership that owns investment-tax-credit property trigger recapture of the credit?

Plain-English summary

Enviro-Gro Technologies, Inc. (EGT) and an affiliate (EGT II) are the corporate partners of NYOFCO, a New York general partnership that bought investment-tax-credit (ITC) property; each partner claimed its share of the credit under Tax Law section 210.12. They planned a tax-free restructuring: EGT would form a subsidiary and contribute a 1% NYOFCO interest to it (a section 351 transfer), then EGT and EGT II would merge into their parent (WWTI) in section 332 / 368(a)(1)(A) reorganizations. The ITC property would stay in NYOFCO. The question: does this trigger 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. A section 351 tax-free contribution is not a disposition (Coats & Clark), and 20 NYCRR 5-2.8(c)(2)/(e) provide that a complete liquidation under section 332 or a statutory merger under section 368(a)(1)(A) is not a disposition. Because the property stays in NYOFCO and continues in qualified use, the restructuring does not require recapture of the credit -- so long as the property remains in qualified use for its life or more than 12 consecutive years.

What this means for you

ITC recapture turns on a disposition or loss of qualified use

The investment tax 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.

Tax-free section 351 transfers and section 332/368 mergers are not dispositions

A section 351 contribution and a section 332 liquidation or section 368(a)(1)(A) statutory merger fall within section 381(a) and 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 the partnership's property

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

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 332/368(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)
- 20 NYCRR 5-2.8 (what is and is not a disposition; section 381(a) transfers)
- IRC sections 332, 351, 368(a)(1)(A), 381(a) (tax-free transfers and reorganizations)
- Coats & Clark Inc., TSB-A-88(16)C; Milton Roy, TSB-A-93(7)C; Morrison & Foerster, TSB-A-96(27)C
- John J. Eagan, TSB-A-87(9)C (corporate partner deemed to purchase partnership property)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1997.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a97_9c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-97(9)C
Corporation Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C961231A

On December 31, 1996, a Petition for Advisory Opinion was received from
Enviro-Gro Technologies, Inc., Tax Department, 3000 Butterfield Road, Oak Brook,
Illinois 60521.
The issue raised by Petitioner, Enviro-Gro Technologies, Inc., is whether
recapture of the investment tax credit claimed under section 210.12 of the Tax
Law is required by reason of the 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.
NYOFCO
Petitioner, a Delaware corporation ("EGT"), owns a 51 percent partnership
interest in New York Organic Fertilizer Company, a New York general partnership
("NYOFCO"). The other 49 percent of NYOFCO is owned by Enviro-Gro Technologies
II, Inc., a Delaware corporation ("EGT II"). EGT and EGT II are wholly-owned
subsidiaries of Wheelabrator Water Technologies, Inc., a Maryland corporation
("WWTI"), subject to taxation in New York under Article 9-A of the Tax Law.
In 1993, NYOFCO purchased and placed in service certain property that was
eligible for investment tax credit under section 210.12 of the Tax Law. EGT and
EGT II claimed 51 percent and 49 percent of the credit, respectively, based on
their proportionate interests in NYOFCO. 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
EGT and EGT II are contemplating a restructuring which will consist of the
following steps:
1. EGT will form a new wholly-owned subsidiary ("Newco").
2. EGT will transfer a one percent interest in NYOFCO to Newco.
3. EGT and EGT II will merge into their parent, WWTI. Pursuant to this
merger, all assets owned by EGT and EGT II (the NYOFCO interests and Newco
stock) will be transferred to WWTI.
At the conclusion of the restructuring, WWTI will own 99 percent of NYOFCO,
and it will own 100 percent of the stock of Newco, which will own the remaining
one percent of NYOFCO.

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TSB-A-97(9)C
Corporation Tax

At all times, NYOFCO 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 NYOFCO's hands
both before and after the contemplated restructuring. Partnership interests in
NYOFCO will be transferred when Newco is formed and when EGT and EGT II merge
into WWTI.
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 NYOFCO interest will be tax-free under section
351 of the IRC, and the mergers of EGT and EGT II into WWTI will be tax-free
transactions described in sections 332 and 368(a)(1)(A) of the IRC.
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 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.

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TSB-A-97(9)C
Corporation Tax

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 complete liquidation of a subsidiary under section 332 of the
Internal Revenue Code, or 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.
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. However, it has
been held that a tax-free transfer pursuant to section 351 of the IRC, that for
federal income tax purposes would 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; Milton Roy
Company, Adv Op Comm T F, February 10, 1993, TSB-A-93(7)C; and Morrison &
Foerster LLP, Adv Op Comm T & F, December 19, 1996, TSB-A-96(27)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 partner'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, NYOFCO 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, EGT and EGT 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 EGT and EGT 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 EGT and EGT II have
claimed the investment tax credit, it must be determined whether a disposition
of the qualifying property was made by EGT and EGT II.

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TSB-A-97(9)C
Corporation Tax

Petitioner states that the formation of Newco by EGT and the transfer to
Newco by EGT of the one percent NYOFCO interest will be tax-free under section
351 of the IRC.
Accordingly, pursuant to section 5-2.8 of the Article 9-A
Regulations and Coats & Clark, supra, Milton Roy, supra, and Morrison Foerster,
supra, it appears that this transaction is not considered a "disposition" by EGT
as contemplated in section 210.12(g) of the Tax Law.
Petitioner also states that the mergers of EGT and EGT II will be tax-free
reorganizations described in sections 332 and 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 complete liquidation of a subsidiary under section 332 of
the IRC or a reorganization that constitutes a statutory merger or consolidation
under section 368(a)(1)(A) of the IRC. Accordingly, it appears that EGT and EGT
II will not dispose of the qualifying property when they are merged into their
parent, WWTI, under reorganizations that qualify as tax-free reorganizations
described in sections 332 and 368(a)(1)(A) of the IRC.
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 EGT and EGT II.

DATED:

March 28, 1997

NOTE:

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

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