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Reuben H. Donnelley Corp. v. Director

Decided: June 22, 1992.


On certification to the Superior Court, Appellate Division.

Garibaldi, Wilentz, Clifford, Handler, Pollock, O'Hern, Stein


The opinion of the court was delivered by


This appeal presents the issue of whether a corporation may include safe-harbor-lease (SHL) property in the property fraction used to determine its business-allocation factor under the New Jersey Corporation Business Tax Act (the CBT Act) for the tax years 1983 and 1984. We conclude that it may not.


In 1981, Congress enacted the Economic Recovery Tax Act (ERTA), which granted additional depreciation under the Accelerated Cost Recovery System (ACRS) and tax credits for the purchase and leasing of certain machinery and other equipment. I.R.C. § 168(f)(8) (1981). Congress recognized that some companies that wished to purchase new equipment might not be able to take advantage of the tax benefits. That would be the case if the company had lost money or paid no taxes that year. As the Senate Finance Committee reported:

[We] recognize that some businesses may not be able to use completely the increased cost recovery allowance and the increased investment credits * * * [they] will provide the greatest benefit to the economy if * * * deductions and investment tax credits are more easily distributed throughout the corporate sector.

[S. Rep. No. 144, 97th Cong., 1st Sess. 61 (1981).]

To achieve the distribution of those tax benefits Congress permitted businesses to enter into safe-harbor leases. Those safe-harbor leases permitted a company needing equipment to buy and then sell the equipment to another company that could use the tax benefits. The second company would then lease the equipment back to the first. The safe-harbor lease was a net lease: the company employing the equipment loaned the funds to the second company for the "purchase," and in lieu of paying rent, reduced this debt on a regular basis. Usually the two companies exchanged no money except for the down payment.

The transaction took place solely on paper. The buyer-lessor entered into a safe-harbor lease solely to take advantage of its tax benefits. Prior to ERTA, the Internal Revenue Service (IRS) scrutinized leases to determine the underlying economic substance of the transactions. The IRS considered whether the lessor derived a profit or cash flow from the transaction itself or solely from the tax benefits of ownership, and whether the lessor held the burdens, benefits, and incidents of ownership.

In contrast, under ERTA, as long as the parties used the appropriate form for the transaction, that the lease had no economic substance aside from federal tax benefits was irrelevant. ERTA made actual ownership of the property unnecessary for federal tax purposes. The only requirement was that "all of the parties to the agreement characterize such an agreement as a lease and elect to have the provisions * * * apply." I.R.C. § 168(f)(8)(A). If the parties entered into a safe-harbor lease, "the lessor [would] be treated as the owner of the property." I.R.C. § 168(f)(8).


The taxpayer, The Reuben H. Donnelley Corporation (Donnelley), is a Delaware corporation that does business both within and outside New Jersey. In 1981, Donnelley entered into a number of equipment leases with several manufacturing companies that qualified as safe-harbor leases pursuant to I.R.C. § 168(f)(8). The lease transactions fully comported with ERTA and were entered into solely for federal-tax purposes. As a result of those transactions, Donnelley became the nominal owner-lessor of a large amount of property located outside New Jersey. Other than tax benefits, it did not receive any incidences of property ownership.

Although its ownership was for federal-tax purposes only, Donnelley included its SHL property in the property fraction used to calculate its New Jersey Corporation Business Tax (CBT) for the tax years 1981, 1983, and 1984. In auditing the corporation, the Director of the Division of Taxation (Director) allowed Donnelley to include its SHL property in its property fraction for the tax year 1981 but excluded it for the tax years 1983 and 1984. Those exclusions are at issue.

Donnelley filed a complaint in the Tax Court challenging the exclusion of the SHL property from the property fraction. In its complaint it also alleged that rental payments from the SHL property were includable in the receipts fraction, also used to calculate its CBT liability. It no longer takes that position.

The Tax Court upheld the Director's decision, finding that the 1982 amendments to the CBT Act reflected the Legislature's intent to uncouple state- and federal-tax treatment of safe-harbor leases. Although Congress allowed the form of those leases to govern their tax treatment, the New Jersey Legislature has always followed a policy that true ownership determines whether a corporation may include property in its allocation fraction. The 1982 amendments to the CBT reinforced that policy with respect to SHL property. The Tax Court therefore concluded that Donnelley, as a nominal owner of SHL property, could not include such property in its property fraction.

Moreover, the Tax Court found that the 1982 amendments specifically dictated that the Director exclude the SHL property. Accordingly, there was no need for the Director first to have adopted a formal regulation or otherwise comply with the Administrative Procedure Act.

The Appellate Division reversed, holding that the Legislature intended to include SHL property in the property fraction.

We granted certification, ...

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