INSIGHT: BrokerTec’s Relocation Grants Were Nontaxable Contributions to Capital

BrokerTec Holdings Inc. doesn’t owe tax on the $170 million in grants it and its affiliates received from the state of New Jersey to relocate from New York City to Jersey City.

The grants were nontaxable contributions to capital under the version of tax code Section 118 in effect at the time the grants were made. The grants weren’t a payment for a specific, quantifiable service, because New Jersey benefitted only indirectly, the U.S. Tax Court ruled in BrokerTec Holdings, Inc. v. Commissioner, T.C. Memo. 2019-32.

BrokerTec Holdings Inc.—now BrokerTec Global LLC, a subsidiary of TP ICAP Plc—was a voice and electronic broker-dealer operating out of offices in lower Manhattan. Garban Intercapital North America Inc. and First Broker Holdings Inc. were subsidiaries of BrokerTec. On Sept. 11, 2001, Garban had its offices in the World Trade Center. Garban’s offices were completely destroyed in the terrorist attack. Although First Broker’s offices were not damaged, the destruction in the area made it nearly impossible for First Broker’s employees to return to the office. Consequently, First Broker’s management concluded that the firm had to search for permanent office space elsewhere in New York or New Jersey.

The New Jersey Economic Development Authority (EDA) is an independent agency of the state of New Jersey. Its “mission is to develop New Jersey’s economy and revitalize its cities by inducing businesses” to move to, or remain in, New Jersey by providing financial and technical assistance. The EDA makes cash grants under the New Jersey Business Employment Incentive Program (BEIP). The EDA used BEIP grants to induce companies to locate in New Jersey. The state “provided larger grants to ‘targeted industries’ willing to locate their business facilities in ‘urban-aid municipalities.’” The amount of the grant awarded by the EDA was from 30 percent to 80 percent of the recipient’s employees’ state income tax withholdings.

Garban engaged a law firm, Stadtmauer, Bailkin, Biggins LLC, to assist it in applying for BEIP grants. The EDA staff decided that Garban was financially viable and the BEIP would be a material factor in Garban’s decision to locate in New Jersey. The EDA offered the company a BEIP grant for a 10-year period at the 80 percent level. Garban committed to employing 640 full-time workers in Jersey City for 15 years. Garban agreed that it could not move its New Jersey office during that period; and that it would not move its office to another state without the express written approval of the EDA.

Garban first received its BEIP grants in May 2004 after Garban made the capital outlays necessary to build its office. Garban received a total of $147 million from the BEIP. New Jersey placed no restrictions on Garban’s use of the money. In fact, Garban used all of its BEIP proceeds to acquire all of the stock of ICAP Holdings (USA) Inc. The EDA board approved a grant for First Broker on Nov. 13, 2001. Garban acquired First Broker on April 30, 2002. First Broker received BEIP grants each year from 2005 through 2014. BrokerTec excluded the BEIP payments from its gross income, asserting that they are nontaxable.

Section 118 Is Controlling

BrokerTec argued that it fell under tax code Section 118(a). Section 118, as it then existed, provided that in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer. The regulations provide that “Section 118 also applies to contributions to capital made by persons other than shareholders … However, the exclusion does not apply to any money or property transferred to the corporation in consideration for goods or services rendered.”

Note, Section 118(b) was amended by the Tax Cuts and Jobs Act and now provides that “any contribution by any governmental entity or civic group (other than a shareholder as such)” is not a contribution to capital excluded from gross income for the purposes of Section 118(a).

In United States v. Chi., Burlington & Quincy R. Co. the U.S. Supreme Court enumerated the identifying characteristics of a non-shareholder contribution to capital: (1) It 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 must result in benefit to the transferee in an amount commensurate with its value; and (5) the asset will be employed in, or contribute to, the production of additional income.

The key, the Tax Court noted, to determining whether payments from a non-shareholder are taxable to the recipient or non-taxable as a contribution to capital is the intent or motive of the transferor. Here, it was undisputed that the EDA’s purpose in making payments to BrokerTec’s affiliates was to induce them to establish their offices in a targeted area. We find, the court said, that the EDA’s intent and motivation for the grant was to provide a non-taxable contribution to capital. The statute enacting the BEIP stated that the purpose of the program was to “develop New Jersey’s economy and revitalize its cities by providing financial and technical assistance.” The facts of this case “fall squarely within the four corners” of Treasury Regulation Section 1.118-1.

The Internal Revenue Service objected that BrokerTec’s affiliates ultimately received $170 million in aid via BEIP grants while only expending some $40 million in moving to New Jersey. The IRS implied that this disparity was excessive. These facts, however, did not affect the court’s analysis. BrokerTec’s affiliates were required to establish facilities in New Jersey and to operate those facilities for a minimum period with an agreed number of employees. Had BrokerTec’s affiliates failed to do so, they would have forfeited their state aid.

The IRS raised one further objection. The agency argued that “New Jersey received direct and substantial benefits from having BEIP applicants commit to creating jobs in New Jersey for 15 years by creating tax revenues that it would not have otherwise received.” Thus, the IRS asserted that BrokerTec’s affiliates received the BEIP grant “as a direct payment for a specific, quantifiable service, i.e., New Jersey bought tax revenue.” The court noted that the goal of the BEIP was to develop New Jersey’s economy and revitalize its cities. While New Jersey may have benefited from the increased tax revenue of the new business brought to the state under the BEIP, that was merely an indirect benefit as contemplated by the legislative history. There was, here, no nexus between the services provided by BrokerTec’s affiliates and the aid provided by the donor. Therefore, the grant disbursements were contributions to capital pursuant to Section 118(a). The circumstances, the court observed, surrounding the payments are substantially similar to those in Commissioner v. Brown Shoe Co. and “manifest the definite purpose of enlarging the working capital” of BrokerTec’s affiliates.

The taxpayer, in Brown Shoe, received cash and other property from community groups to induce the taxpayer to locate or expand its factory within municipalities. The U.S. Supreme Court concluded that the assets transferred to the petitioner represented contributions to capital. “Since in this case there are neither customers nor payments for service, we may infer a different purpose for the transactions between petitioner and the community groups. The contributions were provided by citizens of the 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. Under these circumstances, the transfers manifested a definite purpose to enlarge the working capital of the company.”

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.