GOVERNMENT POLLUTION GRANT IS CONTRIBUTION TO CAPITAL.

Index Nos.: 0118.02-00

January 30, 1980

Refer Reply to: T:C:C:2:1

Y was incorporated in 1926 and since that time has been engaged in the production and sale or newsprint, pulp, and lumber, and in logging and power generation. Y's head office and production facilities are located in *** As part of an effort to encourage the construction of pollution control facilities and the modernization of plant facilities by private industry, M has provided a grant to Y of approximately $7 million ***. The grant provides, in part, that it is intended to insure Iong term stability of employment, viability of mill operations, and protection of the environment. The terms of the grant indicate that it is not being given in consideration for goods or services rendered, or as a subsidy paid for the purpose of inducing Y to limit production.

Section 118(a) of the Internal Revenue Code of 1954 ("Code") provides that, in the case of a corporation, gross income does not include any contribution to the capital of the taxpayer. Section 1.118 -- 1 of the Income Tax Regulations provides, in part, that property contributed to a corporation by a governmental unit or civic group for the purpose of inducing the corporation to locate in a particular community or to expand its operating facilities is a contribution to capital. The section also provides that property transferred toa corporation in consideration for goods or services rendered or as a subsidy paid to induce a corporation to limit production is not a contribution to capital. In Edwards v. Cuba Railroad Co., 268 U.S. 628 (1925), the Supreme Court of the United States held that governmental subsidies given to a corporation to promote construction of a railroad were not taxable income to the corporation because such subsidies were made in order to achieve a broad public benefit and to reimburse the corporation for capital expenditures. The Supreme Court has also held that where community groups contribute cash and property to a corporation and do not anticipate any direct benefit from such contributions, but expect only that the contributions will benefit the community at large, such contributions represent contributions to the capital of the corporation. See Brown Shoe Co., Inc. v. Commissioner, 339 U.S. 583 (1950), 1950 -- 1 C.B. 38. In the instant case, since M is providing the grant to Y in order to promote the general welfare, and not in consideration for goods or services rendered or as an inducement to limit production, we conclude that the grant is a contribution to the capital of Y.

Section 1.312 -- 6(b) provides, in part, that among the items entering into the computation of corporate earnings and profits are all income exempted by statute, income not taxable by the Federal Government under the Constitution, and all items includible in gross income under section 61 of the Code. Contributions to capital are not includible in a corporation's earnings and profits. See United National Corporation v. Commissioner, 143 F.2d 580 (9th Cir. 1944), rev'g 2 T.C. 111.

Section 362(c)(2) of the Code provides, in part, that the basis of any property acquired by a corporation with money received by the corporation as a capital contribution from a nonshareholder within 12 months from the date of such contribution shall be reduced by the amount of such contribution. The section also provides that any part of the contribution not expended during the 12 month period will cause the bases of the corporation's other assets to be reduced by the amount not expended.

Accordingly, for federal income tax purposes:

(I) The grant by M to Y qualifies as a contribution to the capital of Y pursuant to section 118 of the Code and the regulations thereunder and as such is not included in the gross income of Y.

(2) The grant by M to Y will not constitute income to Y within the meaning of section 61 of the Code.

(3) The grant by M to Y will not increase Y's earnings and profits for federal income tax purposes.

(4) The basis of property acquired with the grant will be reduced by the amount of the grant, to the extent such property was acquired within 12 months of receipt of the grant. The excess, if any, of the amount of the grant over the amount of the reduction described in the preceding sentence shall be applied to the reduction, on the last day of the 12 month period beginning on the day the grant is received, of the basis of other properties held by Y, in accordance with section 362(c)(2) of the Code and the regulations thereunder.

A copy of this ruling letter should be attached to the consolidated federal income tax return of X.

In accordance with each power of attorney on file, we are sending a copy of this letter to your authorized representative.

Sincerely yours,