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Owners win on utilities taxes.

Owners do not have to pay New York City utility taxes on 100 percent of the monies collected and paid to Con Edison, a State Supreme Court judge ruled last week.

The city's Department of Finance had claimed that where electrical payments are included in the tenant's rent, taxes should be paid on a percentage of the money collected and attributable to common areas. The case had been remanded from the Appellate Division on the profit issue, but the owner will probably appeal on the basis that the tax should not apply at all.

Melvyn Kaufman, who along with brother Robert, owned the subject building, 5 Hanover Square, and controlled 127 John Street at the time, said "We won a nice decision that is a major decision for the industry."

Owners already pay commercial rent tax on rental amounts that include electrical payments, but around 1989, the Finance Dept. began trying to collect utility taxes on the electrical payments as well.

As tax collections and city revenue dropped drastically after the stock market crash of 1987, the city aggressively went after building owners for these taxes when it realized there was a potential source of revenue that was going untaxed.

Since these payments had never been requested before, owners had never filed utility tax returns. Therefore, said Robert J. Ward, a partner with Mayer Brown & Platt, who tried the case for Sage Realty, Kaufman's management company, there was no statute of limitations, and the city began claiming taxes going back over 15 years for most office buildings.

Eventually, after the Real Estate Board of New York (REBNY) stepped in, the city agreed to limit the retroactivity to five years and to waive penalties but not interest, as was described in REW on Dec. 1, 1993.

Most owners had filed administrative protests, but in 1990, the Kaufmans, after being assessed utility tax of $47,572.07 on the subject buildings based on calculations in rent inclusion clauses, filed this declaratory judgement action, Sage Realty Corporation, Robert Kaufman, Melvyn Kaufman and 127 John Street Associates vs. Carol O'Cleireacain as Commissioner of Finance, the City of New York and Consolidated Edison.

The administrative protests have been stayed, Ward believes, pending the outcome of this case. But the city also tried to cut deals, he said, with those owners that agreed not to wait out the Sage case.

This case was originally lost in the Supreme Court when the court decided the owner had to pay taxes on the profit.

After a 1991 re-argument, the plaintiffs contended that the charges for electricity in the rent inclusion clauses are not identifiable and have nothing to do with the actual amount of consumption. At that time, State Supreme Court Justice Alice Schlesinger ruled that this was a factual issue to be resolved at trial.

She also ruled, and was later affirmed by the Appellate Division, First Department, that the plaintiffs are vendors of utility services, and are liable for the utility tax with respect to electricity furnished to non-metered commercial tenants.

But the Appellate Division said "the utility tax is to be imposed on the profits received from the re-distribution of electricity," and the owner "is able to deduct the cost of the electricity, upon which the vendor utility has already paid a utility tax."

The Appellate Division remanded the case back to the Supreme Court for the trial to determine the profit, and this decision reflects that trial outcome.

In a portion of the decision signed last week, Judge Marylin G. Diamond wrote, "In view of the testimony adduced by both sides, it is clear that rent inclusion clauses are a valid measure of a tenant's consumption of electricity."

But owners have to pass along the money collected - which includes utility taxes - to Con Edison, which then pays the State the tax. Ward explained the city's position was that it could tax the electricity paid by tenants towards common areas - which it decided amounted to 48 percent of the building - as the owner's profit.

Diamond continued, that in light of the First Department Appellate Division's earlier decision on Sage, "...there is no basis to permit the City to exclude common areas as a deduction," and that "plaintiffs are entitled to deduct the full amount of the utility costs upon which the utility has paid a utility tax from the rent inclusion amounts... What the City has done is to create a net profit by arbitrarily excluding the common areas."

The court also stated that "the City's application of a 52 percent deduction is neither rational nor reasonable."

What the court has held is that even if the utility tax applies, the city will have to give owners a deduction for 100 percent of the amount they have to pay to Con Ed.

"The Supreme Court has now found in favor of Sage Realty and against the city," said Ward, "and says the owner was entitled to deduct 100 percent of the cost of the electricity instead of 52 percent that the city had said, which was the tenant area. This is a very big and very far-reaching decision."

The court, however, was only requested to rule on the profit issue, and not on applicability, and so that is still a bone of contention that will be fought by owners.

Based on the 100 percent deduction, Justice Diamond ruled no tax was owed on 5 Hanover Square, where Con Edison payments exceeded income, but ruled $70,986 was received in profit at 127 John Street, on which tax is owed at 3 percent, amounting to about $1,600.

Ward said they will probably contest the decision on the basis of applicability. "We do not believe that the utility tax applies to non-submetered amounts one bit," he explained. "So that's an issue that we may appeal. I don't think it's over."

The City's Assistant Corporation Counsel, Frances Henn, said she will be meeting soon with her client - the Dept. of Finance - to see how they will proceed.

"The decision affirmed that the services were taxable under the utility tax," she said. "But the function of how the taxes are computed will be different in each particular case. The court didn't say there wasn't a tax due, just how you compute."

REBNY President Steven Spinola hailed the ruling as a great decision. "The decision wasn't based on whether you had to pay the tax, but what you had to pay," he said. "You get X from the tenants, you give X to Con Ed, and whatever the difference, if there is a profit, that's what you pay on. It's a very small number, rather than what the city wanted, which was on about half of the entire amount paid. We've been talking to the city about eliminating this tax," he added, "because it amounts to pennies."

Attorney Richard A. Shapiro, a partner with Wien Malkin & Bettex, fought and settled a similar case against New York State when it went after his client, the Empire State Building owners, around the same time.

"I'm so surprised," he said of the Sage decision, which has been awaited for about 17 months. "The court is saying that the tax is applicable on profit, which we don't believe is the case. We continue to think it's an incorrect decision," he added, agreeing with Ward.

"The city has long taken the position that unless charges are subject to a meter, it's subject to the commercial rent tax," explained Shapiro. "We're continuing to test the validity of the utility tax, certainly in the city, and there are some proceedings in place and hopefully it's not over."
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Author:Weiss, Lois
Publication:Real Estate Weekly
Date:Oct 23, 1996
Previous Article:Manhattan office market overview.
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