Tax Abatements on Hold - Legislation Proposed
April 24, 2003
Tax abatements granted under the Long Term Tax Exemption Law, N.J.S.A. 40A:20-1 et seq. (the “Long Term Law”) and its predecessor, the Fox-Lance Act, N.J.S.A. 40:55C-40 et seq. have been a driving force for redevelopment of urban areas generally and the Jersey City waterfront in particular. The success of the program is attested to by the fact that upon completion of projects now under construction, Jersey City’s central business district, measured by Class A office space, will be among the largest in the nation.
However, a recent Tax Court decision has jeopardized existing abatements and pending abatement applications. In response, legislation has been introduced which will address the issues raised in the recent decision and in earlier cases.
The case in question is Town of Secaucus v. City of Jersey City, decided December 5, 2002 by Judge Harold Kuskin. The case involves the largest completed office building in New Jersey, 101 Hudson Street, Jersey City (hereafter, the case is referred to as “101 Hudson Decision”).
Before discussing the case, a little history is in order. Tax abatements are based on a provision in the New Jersey Constitution which authorizes exemptions from taxation “in whole or in part, for a limited period of time during which the profits of and dividends payable by any private corporation enjoying such tax exemption shall be limited by law.” N.J. Const. Art. VIII, Section 3, para 1. The Long Term Law, consistent with the New Jersey Constitution, provides for tax abatements to be granted to urban renewal entities whose profits must be limited. N.J.S.A. 40A:20-9a. When the net profits of an urban renewal entity exceed the allowable net profits for a fiscal year, the urban renewal entity must pay the excess net profits to the municipality as an additional service charge. N.J.S.A. 40A:20-15.
For a variety of reasons, Hudson County municipalities which have not been the subject of intensive, tax-abated redevelopment filed numerous lawsuits against Jersey City and developers of tax-abated projects in Jersey City, challenging the abatements on a variety of grounds. In Secaucus v. Jersey City and TPI Urban Renewal, 19 N.J. Tax 10 (Tax Ct. 2002) (the “TPI Decision”), also decided by Judge Kuskin, the court upheld Secaucus’s challenge on several grounds, including deviation from certain certification requirements in the law and the fact that the amount of the abatement exceeded the statutory maximum. Notably, however, Judge Kuskin did not invalidate the abatement on the ground that the multi-tiered ownership structure of the project did not conform with the statutory requirements.
Judge Kuskin’s ruling in the TPI Decision with regard to the deal structure was important because most projects enjoying tax abatements are structured similarly. Often, the urban renewal entity which receives the tax abatement leases the land on which the project is built from an affiliated company. The urban renewal entity then subleases the completed project to an affiliated operating company, which either uses the project or enters into sub-subleases with third parties. The rent payments to and by the urban renewal entity are in amounts which insure that the profit limitations in the law are not exceeded.
In light of the TPI Decision, Judge Kuskin’s 101 Hudson Decision with regard to the deal structure is somewhat surprising. In particular, and this is the heart of the problem, Judge Kuskin has ruled in the 101 Hudson Decision that the deal structure has to be collapsed for the purpose of calculating whether or not excess profits have been received by the urban renewal entity. As in the case of TPI, the deal structure in 101 Hudson isolates the urban renewal entity from the operating income derived from the building constructed as a result of the abatement. The land is owned by Hudson Associates. Hudson Associates ground leases it to Hudson Urban Renewal, the recipient of the tax abatement. Hudson Urban Renewal master leases the project to Hudson Leasing Associates. Hudson Leasing Associates subleases the office space in the building. The rent payable by Hudson Leasing Associates to Hudson Urban Renewal is limited to an amount which will not cause Hudson Urban Renewal to be required to pay excess profits to Jersey City under the formula set forth in the Long Term Law.
Secaucus repeated the argument which had been unsuccessful in the TPI Decision that the Urban Renewal Entity is not enjoying the abatement as required by law, as a result of the deal structure. In fact, plaintiff apparently argued that the TPI Decision was either erroneous or a result of a misunderstanding of Secaucus’s contentions. In reply, Judge Kuskin notes that he re-examined the TPI Decision and applicable statutes, concludes that he understood plaintiff’s arguments and correctly ruled that the deal structure was not prohibited as provided in the TPI Decision or by the structure in place with regard to 101 Hudson.
However, Judge Kuskin further rules that the deal structure does not control the calculation of excess profits under the Long Term Law. He notes that the property owner, the urban renewal entity, and the sublessee have common ownership. He further holds that the Long Term Law requires the calculation of financial obligations of the urban renewal entity to be based on the revenue from the project. He adds that “the structure under which a project is owned and operated cannot be used to circumvent this requirement by diverting project income, and thus unlimited profits, from an urban renewal entity to a non-urban renewal entity in common ownership.”
Judge Kuskin’s decision means that deal structures intended to insolate urban renewal entities from excess profits will be disregarded, at least where there is common ownership among the entity owning the land, the urban renewal entity and the entity operating the project (many residential projects are structured by a two-tier structure, also intended to insolate the urban renewal entity from excess profits). Because of certain other rulings by Judge Kuskin related to laches, estoppel, and appeal periods, existing projects are subject to attack notwithstanding that they may have been approved without challenge some time in the past.
In direct response to the 101 Hudson Decision and other, related problems associated with tax abatements, Senate Bill 2402 was introduced March 10, 2003. It was adopted by the Senate on March 20, 2003. A similar bill is awaiting action in the Assembly.
The portion of the 101 Hudson Decision requiring the deal structure to be collapsed for the purpose of computing revenues and net profits is addressed in several ways in the proposed legislation. First, the proposed legislation addresses the expense side of the calculation by allowing capital costs of all entities whose revenue is included in the calculation of excess profits, amortized over the term of the tax abatement, to be deducted. Under the Long Term Law as it now exists, there is no provision for deducting capital costs of any party other than the urban renewal entity, and allowable capital costs must be amortized over the life of the improvements. Similarly, the proposed legislation allows deduction of all reasonable operating expenses of any entity whose revenue is included in the calculation of excess profits. Additionally, a new category of expense, namely debt service, can be deducted and has been broadly defined to include not only mortgage debt but also returns on institutional equity financing and related party debt. Expenses can also include environmental remediation costs.
Additionally, the proposed legislation addresses allowable net profits by increasing the allowable profit rate. Currently, the allowable profit rate is limited to 1.25 percent above the entity’s permanent mortgage interest rate. As proposed, the allowable profit rate is the greater of 12% per year or 1.25% over the urban renewal entity’s permanent mortgage financing rate.
As a result of these changes alone, projects should be able to proceed with tax abatements without the necessity of creating multi-tiered ownership structures solely to isolate the urban renewal entity from excess profits. Instead, it should be possible for an operating company to own the land included within a tax abatement area, build and lease a project or sell units in a project, without generating profits in excess of allowable net profits.
Additionally, the proposed legislation cures certain other problems related to the TPI Decision including providing a method by which tax abatements can be certified by the municipality and avoid technical challenges. Additionally, and importantly, the proposed legislation mandates that any legal challenge to a tax abatement be brought by prerogative writ within twenty days from adoption of an ordinance approving a financial agreement (being the agreement by which a tax abatement is granted). This is in direct response to Judge Kuskin’s decision that appeals of tax abatements which appeared to be barred because they were untimely, or by operation of laches or estoppel, will not be barred.
The proposed legislation also provides that all prior financial agreements are ratified and validated, excluding abatements under litigation commenced as of December 31, 2002. This provision will grandfather and protect preexisting abatements from further legal challenges.
The proposed legislation also permits transfer of the ownership interest in urban renewal entities. At present, such transfers are prohibited by the terms of many financial agreements and, arguably, are impermissible as a matter of law.
The Senate introduced and approved Senate Bill 2402 in a period of less than four months after the 101 Hudson Decision. Senate Bill 2402 passed by a 36-to-1 margin. If the proposed bill or a bill not substantially different becomes law, tax abatements will be revitalized and, with much of the existing uncertainty removed, can be expected to become an even more potent tool for redevelopment. In the interim, tax abatements are on hold.