United States

New Jersey: Taxpayer Did Not Own Assets Subject to a Sale/Leaseback Transaction

Mar 06, 2017
From KPMG TaxWatch

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Recently, the New Jersey Tax Court ruled that certain property was not “owned” by a taxpayer and was therefore not included in the taxpayer’s New Jersey property factor and rental income from the property was not included in the receipts factor. The taxpayer at issue and numerous of its affiliates entered into various sale/leaseback and lease/leaseback transactions, one of which was with the New Jersey Transit Authority. On its originally filed federal tax returns, the taxpayer claimed depreciation and amortization deductions on the assets subject to the New Jersey Transit sale-leaseback transaction and reported imputed rental income. The IRS later challenged the taxpayer’s treatment of similar transactions and ultimately prevailed. This prompted the taxpayer to enter into a closing agreement with the IRS. Under this agreement, the New Jersey Transit sales-leaseback transaction was recast as a loan and the IRS imputed Original Issue Discount (OID) income. As required, the taxpayer reported the IRS changes to the New Jersey Division of Taxation. In filing its amended New Jersey returns, the taxpayer added back the various depreciation and amortization deductions and also removed the leased assets from the property fraction, removed the imputed rental income from the receipts fraction, and reported the imputed OID income. Upon review of the amended returns, the New Jersey Division of Taxation accepted the increase to the taxpayer’s entire net income, but disallowed the adjustments made to the apportionment factors. The Division argued the taxpayer intended to enter into a lease arrangement, and should be bound by the terms and conditions of the lease agreements.

The New Jersey Tax Court determined that the relevant inquiry was not whether the parties intended to enter into a lease arrangement, but whether the taxpayer obtained sufficient benefits and burdens of owning the subject assets so that they should be included in the taxpayer’s apportionment factors. In an earlier New Jersey Supreme Court case, the court had held that assets obtained through a safe-harbor lease were excluded from the property factor because they were not “owned” by the taxpayer. Although the transaction at issue was not a safe harbor lease, the transactions shared certain characteristics—notably they both involved the transfer of tax benefits with no intention of the lessor ever using the assets for its business operations. The taxpayer, similar to the taxpayer in the safe-harbor lease case, retained none of the “incidents, benefits and burdens of ownership” of the assets. The court concluded that the taxpayer did not have sufficient ownership of the assets to warrant inclusion of the assets in the property fraction or the imputed rental income in the receipts fraction.  Please contact Jim Venere at 973-912-6349 with questions on General Food Credit Investors #3 v. Division of Taxation.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.