New developments prompt a new look at section 118 contributions to capital

Journal of Taxation

Volumn 108, Issue 1, 2008, Pages 24-32

  Schnee, Edward J ^a,b   Seago, W Eugene ^c,d  

^a Department of Accounting ^*

^b UNIVERSITY OF ALABAMA   (United States)

^c VIRGINIA POLYTECHNIC INSTITUTE AND STATE UNIVERSITY   (United States)

^d ABA Tax Section

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[No Author keywords available]

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EID: 38749119777     PISSN: 00224863     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (26)

1. TNT Doc 2007-2901. See generally "Lessee's Treatment of Construction Allowances for Short-Term Lease of Retail Space," 106 JTAX 307 (May 2007).
2. LMSB-04-1007-069, 10/5/07, TNT Doc 2007-23279. See "IRS Issues LMSB Directive on Abuse of Capital Contribution Provision," 2007 TNT 202-16.
3. "The subsidy payments taxed were not made for services rendered or to be rendered. They were not profits or gains from the use or operation of the railroad, and do not constitute income within the meaning of the Sixteenth Amendment."
4. Section 1012.
5. "The payments were to the customer the price of the service."
6. Levinson and Schifrin, "Regulatory and Tax Treatment of Electric Interconnection Facilities," 23 Energy L.J. 459 (2002).
7. GCM 38944, 12/27/82.
8. 1994 WL 1866000, 6/29/94.
9. 9H. Rep't No. 1337, 83rd Cong., 2d Sess. (1954) ("This in effect places in the code the court decisions on the subject").
10. S. Rep't No. 1622, 83d Cong., 2d Sess. (1954).
11. This reading would not include those transfers excluded under Section 118(c).
12. See note 8, supra, and the accompanying text.
13. As previously discussed, the heart of the Section 118 issue is "timing." If the utility was permitted to spread the income over future periods (the life of the facilities), the ruling would not have a substantial impact on the utility (because it received income before it was earned, or because the utility incurred an obligation to use the facilities for the customers' benefit).
14. See the heading "Real Estate Incentives" in the text, below.
15. The Ruling discusses the CB&Q tests but reaches its final conclusion based on payment for services.
16. A taxpayer cannot avoid the rules of Section 118(a), specifically the taxation of compensation, by disguising the transaction. this is illustrated by Rev. Rul. 81-83, 1981-1 CB 434. In this Ruling, a real estate developer built an extension of a company's water line to provide water and sewer services to the development. A transfer of the extension to the service provider in exchange for water services would have been taxable and not excluded under Section 118(a). Therefore, the developer transferred the extension in exchange for stock of the provider. The number of shares issued equaled the number of lots needing services. The developer sold the lots plus one share of stock to each purchaser. Without the stock the lot would not have received water service. The IRS concluded that the stock transfer for property was not a valid Section 1032 transaction because the developer did intend to or actually receive an equity interest in the provider. The IRS then examined the transaction under Section 118(a) and found it taxable income since it was a property transfer in exchange for services.
17. See Seago, "Non-Shareholder Contributions to Corporate Capital: Back to the Future," 26 J. Corp. Tax'n No. 4 (Winter 2000), page 327.
18. See IRS Industry Specialization Program Coordinated Issues, Retail Industry, "Tenant Allowances to Retail Store Operators," 10/7/96.
19. Section 110 (added to the Code in 1997) excludes a payment from a lessee's income if the lessee spends the payment (which may be cash or a reduction in rent) for an improvement to retail space on qualified real property rented under a short-term lease, and the improvements revert to the lessor.
20. Unlike Section 118, Section 110 is not limited to corporations.
21. Citing 4 Mertens, Law of Federal Income Taxation § 23.21(e), fn. 6 (rev. ed 1980), and McKee, Nelson, and Whitmire, Federal Taxation of Partnership and Partners, ¶ S9.08[2][w] (no edition or year specified). The GCM also refers to "Taxation of Nonshareholder Contributions to Capital," 82 Harv. L. Rev. 619 (1970), page 628, fn. 49, as allowing noncorporations to exclude contributions.
22. See Levinson and Schifrin, supra note 6.
23. 1998 IRS NSAR 6119, 1998 WL 1993295.
24. See LMSB-04-1007-069, supra note 2.
25. Some commentators argue that Glenshaw Glass Co., 348 U.S. 426, 47 AFTR 162 (1955), is not as broad as many interpret it to be. See, e.g., O'Hara, "Thinking Outside the Code," 2007 TNT 162-32. Given that the Supreme Court has specifically stated that Glenshaw Glass provides a very broad definition of income, it is likely that courts will reject such an approach. See Schleier, 515 U.S. 323, 75 AFTR2d 95-2675 (1995).
26. See Notice 87-82, 1987-2 CB 389, and Swig Investment Co., 98 F.3d 1359, 78 AFTR2d 96-6705 (CA-F.C., 1996).