[00:00:00] Speaker 02:
8, Ginsburg versus United States.

[00:00:39] Speaker 02:
We're ready, Mr. Jacobs, whenever you are.

[00:00:50] Speaker 00:
Please proceed.

[00:00:51] Speaker 00:
May it please the court, Tim Jacobs, for plaintiffs.

[00:00:55] Speaker 00:
This case presents a simple fact pattern and may be resolved on the basis of longstanding federal income tax principles under the recovery of capital doctrine.

[00:01:05] Speaker 02:
Can I ask you just as a preliminary matter?

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I know, I think there's something in the record here that this particular situation under New York law, there's since been amendments of this particular way of doing tax credits no longer exists on the books.

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There have been a number of amendments to New York law in the original, I think, version.

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It covered both site preparation costs and tangible property costs, which would be the building.

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New York has since limited parts or portions of the credit to, I guess, cut down on the number of credits for tangible property.

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The other amendment that they made is the revenue, revenue concerns caused them to defer some of the payments and we see that happening in this case.

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Whereas generally when you have filed the tax returns or the folks, the taxpayers here file their tax returns

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They should have been entitled to receive the credit at that point in time, but New York basically deferred the payments for some years.

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Does the Brownfield program still exist?

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It does.

[00:02:13] Speaker 04:
It does.

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Where did the Court of Federal Claims find a conspiracy involving the labels used by the Ginsburg and New York?

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The court's terminology was that both New York and the Ginsburgs had been manipulated, which I found to be a pretty strong word.

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I'm reading from your break, 21, 22.

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That is, the CFC was convinced that the labels used by the Ginsburgs in their motion papers and New York in its statutes to describe the payment somehow evinced a conspiracy between those parties to manipulate

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the federal income taxation laws.

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I seem to remember from taking the bar in 1977 that a conspiracy is an agreement among two or more persons committed an unlawful act or a lawful act in furtherance thereof or with some act.

[00:03:14] Speaker 00:
Right, Your Honor, and where the... Where did you get a conspiracy?

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Where the court of federal claims drew that was from actually the Sunoco case, that there was manipulation, that New York had set up the program

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basically has a reimbursable credit in order to somehow create a tax payment.

[00:03:35] Speaker 04:
So where do you get, you say that the court found a conspiracy.

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Where is the conspiracy found in the court's decision?

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Well, I'm using the word manipulate in that reference.

[00:03:49] Speaker 02:
Well, the sentence, the reference by the court is thus to call this payment a refund

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would allow plaintiffs in the state of New York to manipulate federal income tax law.

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Do you think he's suggesting a legal conspiracy by that?

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Or you're offended by that?

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Well, I don't think there's anything.

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I mean, I think the issue here is the judge, Judge Hodges, seemed to believe that the refundable, the fact that this is refundable credit was a problem.

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that it was designed in some form or fashion.

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New York to shift the burden to the United States.

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Right.

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And that's where I'm saying it is suggested there was some conspiracy.

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My terminology, manipulate, is a pretty strong term.

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And here it's used at both the taxpayers and the state.

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Can you manipulate the tax laws in a lawful fashion?

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I thought that's what they were designed for.

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Well, I'm sorry for the...

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using that terminology.

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Again, I think the plaintiffs here manipulating the tax code is something that is strong, that strong terminology when it says both New York and the taxpayers on that.

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Let's just talk about that question.

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You say this is a refund, but it's not a refund in the way, don't you accept that most people usually think of a refund for

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taxes for money you've already paid.

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You get a refund for paid taxes.

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Right.

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That's the traditional sense.

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Refundable credits, however, are used at the federal level all the time.

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You have to earn income tax credit.

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You get the American Opportunity Credit.

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You've got the Affordable Care Act credit.

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All of those are refundable credits, meaning that there is a portion of it that's applied to the tax liability.

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And there's a portion of it that's refundable.

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It is designed in a way that effectively... So in this instance, let's say you have a piece of property in New York under the laws that exist.

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And it's got some pollution problems.

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And in order to prevent that pollution from leaching out, you put down a foundation, which you might need for the building anyway.

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But that foundation blocks the pollution.

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And as a result, the state of New York says, OK, Brownfield, you're entitled to a credit on this.

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And the state refunds some of your taxes.

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Let's say that the foundation costs $2 million.

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And they refund $500,000 that you paid in New York taxes.

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So that other million and a half the feds are going to pay.

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That's your position.

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It's not our position.

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In substance, what this credit is, is a reimbursement of capital expenditures.

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Our position is, under well-established federal income tax law, the recovery of capital doctrine.

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That's it.

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That portion is a recovery of capital by definition, which is not taxable.

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It is a reduction in the basis of the property.

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And to your honors... So what happens to the million and a half?

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The million and a half stays invested and there's a reduction of basis.

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It works exactly like the federal income tax code, which if you're looking at capital accounts, tax law section 21 of the New York law follows.

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It's charged with a capital account for the site preparation component.

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It is cost based.

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So we're only talking about the half million that New York gives you back.

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Right.

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The half million is the refundable portion, which is a reduction of basis.

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It is not taxable income for federal income tax purposes.

[00:07:52] Speaker 02:
Because?

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Because of the recovery of capital doctrine.

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It is similar to... Is there some way you cannot spend that money?

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You can spend the money at that point in time like any other recovery of capital.

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For example, the government uses the sales scenario.

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I buy stock two years ago.

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I sell the stock today.

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My basis in that was, let's say, $80.

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Today, I'm selling it for $100.

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I'm pocketing $100.

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I have that in my pocket.

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I could use that for whatever I want.

[00:08:30] Speaker 02:
Yeah, but there's no sale.

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And there's only $20 of gain.

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There's no sale.

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There's nothing on the record to evidence that there's any contemplation of a sale.

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But the recovery of capital doctrine is not limited to sales.

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Where the court of federal claims went wrong is it said that the recovery of capital doctrine is limited to sale of goods.

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And the government acknowledges, it is brief, that that's not correct, that what the court of federal claims really meant was it was a sale of capital assets.

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Well, they're both wrong because recovery of capital doctrine applies in any number of instances as a fundamental income tax principle

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It applies to insurance recoveries.

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It applies to settlements that damages claims, contractor payments, gambling winnings.

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This court in California in Hawaii in sugary refinery company said it applies to tax refunds for recovery of capital doctrine.

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That's not a sale either.

[00:09:27] Speaker 04:
Well, hang on.

[00:09:32] Speaker 04:
You're confusing me because I asked you if there's any restriction and you said no.

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on how they can spend the money.

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But in the blue brief at 25, you argued that the Ginsburg don't have complete dominion and control over the Brownfield credits.

[00:09:46] Speaker 00:
They don't.

[00:09:46] Speaker 00:
They don't.

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I'm saying as a general matter, when you have a recovery of capital, it doesn't matter if you don't have complete dominion.

[00:09:54] Speaker 00:
No, no.

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Because you can use in the stock.

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No, no.

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We're talking apples and oranges.

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Well, I'm saying to answer your question, there were considerable restrictions.

[00:10:03] Speaker 00:
You answered my question.

[00:10:04] Speaker 04:
You said they could spend the money any way they wanted.

[00:10:07] Speaker 00:
They can't, in a general sense.

[00:10:09] Speaker 00:
I said, it doesn't matter for recovery of capital purposes.

[00:10:11] Speaker 00:
What I would say here, the credit, sure, they can spend that.

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They may have to repay it, though.

[00:10:17] Speaker 00:
There is the restrictions here.

[00:10:19] Speaker 00:
Unlike the off-the-shelf credit that I think Your Honor referred to earlier, this is not off-the-shelf.

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There is a Brownfield clean-up agreement with the state, with enforceable obligations.

[00:10:29] Speaker 02:
Right, so they can recoup the payment.

[00:10:31] Speaker 02:
So is there any limitation or restriction beyond?

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recouping the payment as their fraud or something like that.

[00:10:38] Speaker 00:
There is, and I think the government even says for good cause, which is quite broad.

[00:10:43] Speaker 02:
Which is sort of not in the nature of fraud necessarily, but if you're not doing what the commitment with the state was in order for you to get that benefit, anything beyond that in terms of... So there's an environmental easement, Your Honor, that has to be filed and is recorded.

[00:10:59] Speaker 00:
The environmental easement and the agreement are not even mentioned in the opinion, but if

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If there's a violation or any of the protocols, and that environmental easement, by the way, is in perpetuity, that is on this property.

[00:11:10] Speaker 02:
Right, but if there's a violation of what the agreement or the understanding was between the owners and the state, that's the circumstance.

[00:11:19] Speaker 02:
I'm asking if there's any other restriction on your use of the funds.

[00:11:25] Speaker 00:
Just like any other recovery of capital, once I've received... Can you answer my question?

[00:11:30] Speaker 02:
They can explain it, but is there any restriction beyond some recoupment of payment if there's a violation in what the understanding was of the party?

[00:11:39] Speaker 00:
There are restrictions in this case.

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I'm saying that my art position is that is not relevant because under Glenshaw Glass, which the government is relying upon, there is the first requirement is the accession of wealth.

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That's where the recovery of capital doctrine comes in.

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And we don't satisfy, that requirement's not satisfied.

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We win on that basis under that requirement.

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Complete dominion is the lack of restrictions.

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That's the third requirement under Glenshow Glass, which says that the taxpayer must have complete dominion over the income.

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And our answer to that here in this case is the taxpayer doesn't have complete dominion.

[00:12:18] Speaker 04:
You're using my example of putting down the foundation.

[00:12:23] Speaker 04:
Right.

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My vision of that is,

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If the taxpayer used substandard concrete in that foundation and it crumbled away, that would fall not under fraud, but it would fall under the other provisions.

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The environmental easement is the enforceability toll.

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And in that circumstance, Your Honor, there is a certificate of completion.

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They yank that.

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And guess what happens?

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The state will say repay the credit.

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And there's a case called Bailey that's in the tax court that involves

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an easement very similar to this that deals with that third requirement under Glenshaw glass.

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The tax court there said the taxpayer did not have complete dominion over the facade, therefore not taxable.

[00:13:09] Speaker 00:
And our case here is much stronger.

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So there's a presumption of regularity if they're not.

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Once they've been approved, once the site permits have been issued and then the certificate of completion and so on,

[00:13:24] Speaker 04:
There's a presumption that they've been properly inspected and that the building proceeds.

[00:13:30] Speaker 00:
At that point in time, there's an initial certificate of completion that gives the tax division in New York the authority to issue the tax credit.

[00:13:42] Speaker 00:
Now, as we've seen, that somehow as New York changed its law, it got deferred and deferred and deferred so that even that is subject to restrictions.

[00:13:54] Speaker 02:
Good morning, Your Honors.

[00:14:07] Speaker 01:
Douglas Rennie for the United States.

[00:14:09] Speaker 04:
What constitutes good cause for revocation?

[00:14:12] Speaker 01:
Your Honor, that's unclear.

[00:14:14] Speaker 01:
It doesn't appear to be defined in the New York State statutes.

[00:14:19] Speaker 01:
Your honor, the issue in this case is whether a $1.8 million state subsidy payment, which is characterized as a tax refund, but bears no relation to any taxes previously paid.

[00:14:28] Speaker 04:
Let me follow up on you, please.

[00:14:30] Speaker 04:
Yes.

[00:14:32] Speaker 04:
If good cause is broad enough to include situations over which the Ginsburgs may not have control, storm, you know,

[00:14:47] Speaker 04:
hundred years, two hundred years storms in six months, washing away the concrete.

[00:14:55] Speaker 04:
Why do they have sufficient guarantees that they'll be allowed to keep the money for purposes of complete dominion?

[00:15:02] Speaker 01:
Your Honor, I think the answer to that is because even if the state commences some process to try to recoup the money, that

[00:15:16] Speaker 01:
means that that would almost certainly happen in a subsequent tax year.

[00:15:22] Speaker 01:
So the fact is they're receiving the income now.

[00:15:25] Speaker 01:
They would probably have a corresponding deduction in a future year if they had to pay it back.

[00:15:30] Speaker 01:
But for the time being, they can spend that money however they want.

[00:15:34] Speaker 04:
In the red break at 4 and 5, you cite the 2007 version of the New York environmental conservation law.

[00:15:41] Speaker 04:
Yes.

[00:15:41] Speaker 04:
But the 2005 version of the tax law.

[00:15:45] Speaker 04:
Are there any material differences between 2005 and 2007?

[00:15:49] Speaker 01:
I don't believe so, Your Honor, and I believe the reason we were citing those versions is because that was the relevant year for McKinney's to issue the relevant volume for those two different laws.

[00:16:05] Speaker 01:
Those are copies of those editions that are in the record for those years.

[00:16:11] Speaker 02:
But can I just go back to Judge Wallach's first initial question, which was, if something were to happen next year or in two years from now, and New York, and let's assume legally, can recoup the payment that they made, but your friends walked away with much smaller portion of it, is there clearly a means in the tax law that they can then recoup the taxes paid on the amount that has since been

[00:16:37] Speaker 01:
Yes, Your Honor.

[00:16:39] Speaker 01:
They would get a corresponding deduction for that in a future year.

[00:16:42] Speaker 01:
And that's, in essence, the tax benefit rule.

[00:16:44] Speaker 01:
It's the converse of that.

[00:16:46] Speaker 01:
Because they then had to pay it back, they would be able to take that deduction.

[00:16:54] Speaker 01:
Your Honor, the main argument here as to why this is not income appears to be the return of capital doctrine that the taxpayers are relying on.

[00:17:05] Speaker 01:
Your Honor,

[00:17:06] Speaker 01:
There is no precedent for applying this doctrine in this type of instance.

[00:17:11] Speaker 01:
Where it is relevant in terms of a capital asset, like a building here, is when there's a sale.

[00:17:18] Speaker 01:
And as Your Honors appear to perceive that there is no sale here, the return of capital doctrine just doesn't apply.

[00:17:24] Speaker 01:
And there is no general principle that you don't have to pay tax until you recover your initial investment.

[00:17:31] Speaker 01:
Now, one of the examples that came up was stock.

[00:17:35] Speaker 03:
which I think makes a good point because... Can we determine that there's not a return of capital because the Ginsburg capital is still producing wealth for them through the property?

[00:17:48] Speaker 01:
That's correct, Your Honor, and they would recover their capital when they sell it.

[00:17:53] Speaker 01:
At the time, currently, they're receiving

[00:17:57] Speaker 01:
rental payments, maybe other fees, any other type of money that they take in at this time, they have to pay taxes on.

[00:18:04] Speaker 03:
And in fact, the basis of that property hasn't been reduced yet.

[00:18:08] Speaker 01:
Right.

[00:18:09] Speaker 01:
Right.

[00:18:10] Speaker 01:
I think they have attempted to account for it in that manner, but their accounting does not control for federal tax purposes.

[00:18:21] Speaker 01:
So it should not be reduced.

[00:18:22] Speaker 01:
That's our position.

[00:18:26] Speaker 01:
Going back to the stock example, that would be another issue where you receive a dividend that doesn't reduce your basis.

[00:18:33] Speaker 01:
You have to pay tax on it when that happens, just as they would with rents or anything else in this example.

[00:18:44] Speaker 01:
And a contrary result would essentially allow states and private parties to redefine the scope of income to the detriment of the federal tax system, which I believe your honors will point out.

[00:18:56] Speaker 02:
Well, except if one person is living in New York and the other isn't, clearly they're not going to have a large state tax liability.

[00:19:07] Speaker 02:
So very likely, but obviously New York didn't think of it this way, which is we want to give benefit to people who are really doing a lot of business in New York.

[00:19:17] Speaker 02:
But as far as the federal fisc, why are we distinguishing between people who live in one state and people who live in the same state?

[00:19:27] Speaker 02:
Essentially, the distinction is just for those who have a hefty state tax bill and those who don't.

[00:19:33] Speaker 02:
Otherwise, they forfeited as the Ginsburg did in this case.

[00:19:37] Speaker 01:
You mean in terms of the tax credit being refundable, Your Honor?

[00:19:42] Speaker 02:
Yes.

[00:19:42] Speaker 02:
I mean, the amount that's left, you're not saying it's not subject to tax if it's just offset their state tax payment, right?

[00:19:54] Speaker 02:
Right.

[00:19:54] Speaker 02:
So the only reason it ends up being federal

[00:19:57] Speaker 02:
taxable under the federal code is because they didn't have enough offset.

[00:20:03] Speaker 01:
Because it becomes paid out.

[00:20:04] Speaker 01:
Although if you're in a difference, say it's not a refundable credit, then generally speaking, it can be carried forward to future years, which is probably the way it would work in a different state system.

[00:20:15] Speaker 01:
But our position is essentially, it doesn't really matter what state it is.

[00:20:20] Speaker 01:
If a state is coming up with this type of system,

[00:20:25] Speaker 01:
If you want to do it as a tax credit and you don't want them to have to pay federal taxes on it, then it should be a non-refundable state credit.

[00:20:35] Speaker 01:
But there are different ways to subsidize different projects.

[00:20:38] Speaker 02:
I'm sure this is going on.

[00:20:40] Speaker 02:
Some variation of this goes on all around the country.

[00:20:42] Speaker 02:
Are you specifically aware of states other than New York who have had similar situation?

[00:20:50] Speaker 02:
I mean, it's kind of odd that this is like an issue that hasn't been decided yet.

[00:20:54] Speaker 02:
And one of the things that may explain this is that this is a very unusual thing to refund it in cash.

[00:21:02] Speaker 01:
It is somewhat unusual, Your Honor.

[00:21:04] Speaker 01:
I can't recall a specific example of a different state having this type of refundable tax credit.

[00:21:15] Speaker 01:
There may have been a reference somewhere in some guidance in one of the briefs that had to do with a

[00:21:24] Speaker 01:
a Michigan tax credit.

[00:21:29] Speaker 02:
You referred us, as I mentioned to your friend, that there have been changes in the scope of this.

[00:21:35] Speaker 02:
Does it still remain in terms of providing this payment of funds?

[00:21:40] Speaker 01:
I believe it is still a refundable credit, Your Honor.

[00:21:43] Speaker 01:
But as counsel said, I think they reduced the scope of the tangible property credit.

[00:21:49] Speaker 01:
It's my understanding.

[00:21:52] Speaker 01:
If Your Honors have no further questions, we will roll out.

[00:22:08] Speaker 00:
I'd like to respond, Your Honor, to Judge Raina's question earlier about still producing wealth and the fact that you can only recover the basis in the property at the time of sale.

[00:22:19] Speaker 00:
Well, that's actually not true.

[00:22:21] Speaker 00:
depreciation and amortization is an example of recovery of capital.

[00:22:26] Speaker 00:
There's a case called a nausea land company that deals with a situation where you would have an easement that might be taken to that property.

[00:22:33] Speaker 00:
There are multiple occasions where in this particular property, it is not unique that you have to wait to the end of the investment in order to recover capital.

[00:22:43] Speaker 00:
In fact, it's basic to the federal income tax system.

[00:22:46] Speaker 00:
You're recovering capital immediately on this property.

[00:22:49] Speaker 04:
When Merton's on the law of federal income taxation explains return of capital theory this way, when the purchaser's obligations are received as part of the consideration on a sale, but have no ascertainable fair market value at the time of their receipt, the seller may treat the full amount of the payments as they are received as a return of capital.

[00:23:14] Speaker 04:
Only those payments that are received after his entire basis has been recovered

[00:23:19] Speaker 04:
must be reported as income.

[00:23:21] Speaker 04:
Right.

[00:23:21] Speaker 04:
How does your return of capital theory fit into that example?

[00:23:25] Speaker 04:
What payment did you make to the state that is now being returned?

[00:23:29] Speaker 00:
Well, again, there are numerous examples.

[00:23:31] Speaker 00:
I mean, that's one example of a return of capital.

[00:23:33] Speaker 00:
A sale is.

[00:23:35] Speaker 00:
But in the sales situation, the government is suggesting that this is a third party's requirement.

[00:23:41] Speaker 00:
And I would point court to the general counsel memorandum in the Office of Chief Counsel, which says provided repayment has the effect,

[00:23:48] Speaker 00:
So far as its recipient is concerned of restoring in whole or a part, the original outlay, it may emanate from a third party and nonetheless be considered a return of capital.

[00:23:58] Speaker 00:
It does not matter here.

[00:24:00] Speaker 00:
I mean, this is the office of chief counsel that's general council member M37509 cited in our briefs.

[00:24:06] Speaker 00:
It doesn't matter that we made our original investment with, in this case, it would be the contractors and whoever we're paying out and that New York has agreed under an agreement to reimburse us.

[00:24:17] Speaker 00:
capital expenditures.

[00:24:19] Speaker 00:
And I would say, Your Honor, just to be clear, the government has admitted in their briefing papers down below that in reality the credit is designed to reimburse the taxpayers' capital expenditures.

[00:24:30] Speaker 00:
That is very important because that is a recovery of capital.

[00:24:35] Speaker 00:
And you get to recover that capital by reducing your basis in the property

[00:24:41] Speaker 00:
And in many cases, this is not an expense.

[00:24:44] Speaker 00:
The government misses the tax benefit rule.

[00:24:46] Speaker 03:
Is the basis in this property reduced?

[00:24:49] Speaker 03:
Was it reduced?

[00:24:50] Speaker 00:
It's reduced through a mechanism where, in this case, we will not get a windfall.

[00:24:56] Speaker 00:
The taxpayers will not get a windfall.

[00:24:57] Speaker 00:
Its depreciation allowances will get reduced because there was depreciation that would have been with the full basis.

[00:25:04] Speaker 00:
You have to reduce that depreciation allowances to account for the fact that here, this was a reimbursement of return of capital.

[00:25:11] Speaker 00:
And that's important because that happens at this point in time.

[00:25:15] Speaker 00:
When there's an ultimate sale down the road, the game will be bigger as a result of that.

[00:25:22] Speaker 00:
If I could, I know my time's.

[00:25:24] Speaker 02:
We have one quick point, sure.

[00:25:26] Speaker 00:
So the earlier questions, your honor had asked about examples.

[00:25:30] Speaker 00:
I would point out that the federal government has reimbursable credits, refundable credits like this.

[00:25:37] Speaker 00:
In fact, that's how New York structured this transaction.

[00:25:40] Speaker 00:
And there's the Sunoco case.

[00:25:42] Speaker 00:
Contrary to this case, the government's position with federal tax credits that are refundable is that they are not included in the tax weight.