R.J. Reynolds Tobacco Co. v. City of New York Dept. of Finance
| Decision Date | 18 December 1995 |
| Citation | 643 N.Y.S.2d 865,169 Misc.2d 674 |
| Parties | R.J. REYNOLDS TOBACCO CO., Plaintiff, v. CITY OF NEW YORK DEPARTMENT OF FINANCE et al., Defendants. |
| Court | New York Supreme Court |
Morrison & Foerster, New York City (Arthur Rosen and Judith E. Lansky, of counsel), for plaintiff.
Paul A. Crotty, Corporation Counsel of New York City (George P. Lynch and Amy F. Nogid, of counsel), for defendants.
In this motion, plaintiff R.J. Reynolds Tobacco Company ("RJR") asks that this court (1) declare New York City Administrative Code §§ 11-602.8(a)(10), 11-602.8(j), and 11-602.8(b)(11) unconstitutional under the United States' Constitution's Commerce Clause, U.S. CONST. art. 1, § 8, cl. 3; (2) find that a Notice of Determination issued by defendant City of New York Department of Finance against RJR ("the Notice") is void; and (3) permanently enjoin defendants City of New York Department of Finance and Marc V. Shaw, Commissioner of the City of New York Department of Finance (collectively referred to as "the City") from enforcing New York City Administrative Code §§ 11-602.8(a)(10), 11-602.8(j), and 11-602.8(b)(11) and from enforcing the Notice. Currently, RJR moves for summary judgment. For the reasons below, I grant RJR's motion.
Under Section 167 of the Internal Revenue Code, a taxpayer can take a depreciation deduction for property used in its business or "held for the production of income" if that property is subject to exhaustion, wear and tear, decline from natural causes, decay, or obsolescence. 26 U.S.C. § 167(a) (1988 & Supp.1995). In general, the taxpayer can depreciate only the cost of the property minus a reasonable estimate of the property's salvage value. S.Rep. No. 144, 97th Cong., 1st Sess. 39, reprinted in 1981 U.S.CODE CONG. & AD.NEWS 105, 145. The taxpayer divides the deduction over the course of the estimated useful life of the property.
Section 167 once offered taxpayers the option of selecting its method of depreciation. The two depreciation schemes relevant to this action are the straight line method and the declining balance method. Using the straight line method, a taxpayer first subtracts the property's salvage value and then divides its deductions equally over the useful life of the property. 1 In this, the original method for depreciating property, the deductions were evenly divided to effectuate the goal of "allow[ing] taxpayers to match accurately, for tax accounting purposes, the cost of an asset to the income stream that the asset produced." Simon v. Commissioner, 68 F.3d 41, 44 (2d Cir.1995).
If the property had a useful life of three years or more, the taxpayer was able to use the declining balancing method. Under this method, the taxpayer could take depreciation deductions at an accelerated rate not exceeding twice the rate appropriate under the straight line method. Although the asset cannot be depreciated below its reasonable salvage value, the taxpayer can determine its annual depreciation allowances without taking the salvage value into account. Treas.Reg. (26 CFR) § 1.167(b)(2) ( T.D. 6712, 29 FR 3653 (1964)). 2 Using the declining balance method, which is "designed to encourage investment in depreciable assets," a taxpayer can recover as much as 40% of its investment during the first quarter of the property's useful life. M. ROSE & J. CHOMMIE, FEDERAL INCOME TAXATION (3d ed. 1988).
In 1981, Congress passed the Economic Recovery Tax Act of 1981 (ERTA), P.L. 97-34, 95 Stat. 172 (1981) (). ERTA "provide[d] the largest tax reduction in history," S.Rep. No. 97-144 at 2, 97th Cong., 1st Sess. 49, reprinted in 1981 U.S.CODE CONG. & AD.NEWS at 108, in order to stimulate economic growth in the United States. Simon, 68 F.3d at 45; Collins Music Co., Inc. v. United States, 21 F.3d 1330 1332 (4th Cir.1994). Among other things, Congress determined that the existing rules governing depreciation allowances did "not provide the investment stimulus that [was] essential for economic expansion." S.Rep. No. 97-144 at 47, 97th Cong., 1st Sess. 39, reprinted in 1981 U.S.CODE CONG. & AD.NEWS at 152. Therefore, ERTA devised an accelerated system of depreciation for property used in business, called the accelerated cost recovery system ("ACRS"). Id. at 6, 1981 U.S.CODE CONG. & AD.NEWS at 112; see Collins Music Co., 21 F.3d at 1332. The current version of this system, as revised by the Tax Reform Act of 1986, largely replaces Section 167 for property placed in service after 1981. 26 U.S.C. § 168 (Supp.1995). Under the ACRS, taxpayers depreciate tangible property not excepted from this provision by using the declining balance method until the straight line method will yield a larger depreciation allowance. 26 U.S.C. § 168(a), (b) (Supp.1995). At that point, the taxpayer switches to the straight line method. Id. In addition, the salvage value of the property is $0. 26 U.S.C. § 168(b)(4)(Supp.1995). Finally, 26 §§ 168 sets forth timetables for determining useful life which accelerate the rate of depreciation. 3 Taxpayers must depreciate using the ACRS unless they explicitly opt out of it. Collins Music Co, Inc., 21 F.3d at 1332 (citations omitted). 4
Title 11, Chapter 6, Subchapter 2 of the New York Administrative Code discusses New York City's general corporation tax. Pursuant to New York City Administrative Code § 11-603.1, "every domestic or foreign corporation [that does business, employs capital, or owns or leases property "in the city in a corporate or organized capacity"] ... shall annually pay a tax, upon the basis of its entire net income, or upon such other basis as may be applicable...." New York City Administrative Code § 11-604.1(E) provides that the corporate taxpayer is taxed on a portion of its entire net income ("ENI"). Section 11-602.8 of the Administrative Code explains that the taxpayer determines its ENI by computing its federal taxable income and making certain adjustments, including deductions.
The relevant adjustment here is a depreciation deduction, discussed in the challenged Code provisions. Section 11-602.8(b)(11) of the Administrative Code ("Section B") states that in calculating its ENI the taxpayer shall not exclude from its income
for taxable years beginning after December thirty-first, nineteen hundred eighty-one, except with respect to ... recovery property placed in service in this state in taxable years beginning after December thirty-first, nineteen hundred eighty-four, the amount allowable as a deduction under section one hundred sixty-eight of the internal revenue code.
(emphasis supplied). 5 Section 11-602.8(j) of the Administrative Code ("Section J") states:
for taxable years beginning after December thirty-first, nineteen hundred eighty-one, except with respect to ... recovery property placed in service in this state in taxable years beginning after December thirty-first, nineteen hundred eighty-four, ... a taxpayer shall be allowed with respect to (recovery) property [a] ... deduction allowable under section one hundred sixty-seven of the internal revenue code.
(emphasis supplied); see also New York Administrative Code § 11-602.8(a)(10) (). The practical effect of the provisions is two-pronged. First, if a corporate taxpayer took accelerated depreciation deductions under Internal Revenue Code (26 USC) § 168 in calculating its federal taxable income, under Section 11-602(8)(b) the taxpayer must add that amount back in to its ENI if the deduction is for property placed in service outside of New York. Second, under Section 11-602(8)(j) the taxpayer can take a deduction for that property under Internal Revenue Code (26 USC) § 167. For property placed in service in New York, however, the taxpayer need not make this adjustment; instead, it can take the ACRS deduction in computing its local taxes. See New York Administrative Code § 11-602.8(b)(11), (j) ().
RJR is a business organized under New Jersey law; its principal place of business is Winston-Salem, North Carolina, and at least some of its property is placed in service outside of New York. Because RJR does business in New York City, it pays New York City taxes pursuant to the Administrative Code provisions discussed above. RJR completed its New York City tax returns in a timely fashion for the tax years ending December 31, 1987 and December 31, 1988. In computing its ENI for these returns, however, it used the ACRS system of depreciation set forth in 26 U.S.C. § 168 for property placed in service both within and without the State of New York.
The Department of Finance audited RJR's tax returns for the years in question. The Department of Finance recalculated RJR's ENI pursuant to the scheme discussed above, and found deficiencies. On September 29, 1993, the Department of Finance issued the Notice at the heart of this lawsuit, which alleges that RJR owes the City tax deficiencies of $281,970.70. This amount includes $168,156.00 in taxes owed, $96,999.10 in interest owed, and $16,815.60 in penalties.
Pursuant to New York Tax Law § 1138(a), plaintiff challenged the tax assessment by filing a Request for Conciliation Conference with the Department of Finance's Conciliations Bureau on December 15, 1993. At a conference held on February 22, 1994, a Conferee sustained the Notice as it related to RJR's depreciation deductions for property placed in service outside of New York. This resulted in a determination that RJR owes $105,064.00 in back taxes. The Conferee did not order that RJR pay penalties or interest. Subsequently, RJR filed this Article 78 proceeding.
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R.J. Reynolds Tobacco Co. v. City of New York Dept. of Finance
...of the depreciation deduction for Federal tax purposes, which is ably illustrated in the decision of the motion court (169 Misc.2d 674, 643 N.Y.S.2d 865), is not in dispute. Local taxing authorities, although imposing their own tax rates, often generally track the corporation's Federal tax ......