Broadband subsidies could be subject to federal corporate income tax

Broadband subsidies provided under programs established by the American Rescue Plan Act (ARPA) and the Infrastructure Investment and Jobs Act (IIJA) may be subject to federal corporate income tax, which would require companies receiving subsidies to return 21% to the federal government. government.

While the IRS has in the past declared a tax “safe harbour” for certain broadband grants (specifically, the BTOP and BIP grants, in 2010), this may now be more difficult in due to legislative changes enacted as part of the 2017 Tax Cuts and Jobs Act, as described below.

If not conclusively resolved, the taxation issue could significantly mitigate the positive impact of broadband subsidies provided under ARPA and IIJA, including the massive injection of 42 billion dollars to come under the BEAD program. Entities expecting to receive grant funds should budget for the tax bill, which may necessitate a reduction in the scope of their project. Entities may also consider structuring a project so that grant funds are received by tax-exempt entities.

This blog post provides a high-level overview of these issues. Please note that the following is a very simplified discussion provided for general information purposes only. It is not intended to be used as legal advice and should not be treated as such, particularly with respect to the tax status of an individual entity.

1. In general, federal grants are taxable.

As a starting point, the receipt of a government grant by a business is generally not excluded from gross business income under the Internal Revenue Code and is therefore taxable.[1] “A federal grant is normally taxable unless otherwise specified in the legislation authorizing the grant.”[2] (A government loan, on the other hand, is not taxable, as it must be repaid.)

2. “Contributions of non-shareholders to the capital” (Brown Shoe Co., Inc. v. Commissioner).

While the general rule states that a federal grant is taxable income, a doctrine first enunciated in 1950 provided a basis for arguing that a federal grant can be excluded from gross income. In the case of 1950 Brown Shoe Co., Inc. v. Commissioner, the United States Supreme Court has viewed the tax treatment of cash and property received by a shoe company from community groups as an inducement to locate the company’s facilities in the community.[3] The Court held that income received by the shoe business from community groups represented “capital contributions” by non-shareholders and could therefore be excluded from income. The Court’s reasoning emphasized that contributions to the shoe business by the community were made for community benefit, not in exchange for direct service, “their only expectation being that such contributions might prove beneficial to the community as a whole”.[4]

3. IRC section 118.

In 1954, Congress enacted Section 118 of the IRC, which directly dealt with non-stockholder contributions to capital and essentially codified the Brown Shoe Co. holding. The general rule in Section 118 was that the gross income of a company did not include any contribution to its capital. As a 2018 publication by Deloitte note, Section 118 “went on to say that a capital contribution did not include any contribution in favor of construction or any other contribution from a customer or potential customer, which means that such amounts were taxable and included in gross income. This meant that other capital contributions from non-shareholders could be excluded from a company’s gross income.[5]

4. BTOP and BIP 2010 grant programs: IRS Rev. proc. 2010-34.

In the American Recovery and Reinvestment Act of 2009, Congress created two major broadband subsidy programs: the $4 billion Broadband Technology Opportunity Program (BTOP) administered by the NTIA and the $2.5 Billion Broadband Initiatives (BIP) administered by the US Department of Agriculture. Utilities service. The BTOP and BIP programs presented the same tax problem now before us: would grant recipient companies be required to report grant funds as gross income?

In 2010, the IRS declared that BTOP and BIP grant funds did not need to be reported as gross income.[6] In doing so, the IRS relied entirely on the aforementioned Section 118. The IRS said, “Section 118(a) of the Code provides that in the case of a corporation, the gross income does not include a contribution to the capital of the taxpayer. Section 1.118-1 of the Income Tax Regulations provides that Section 118 applies to capital contributions made by a person other than a shareholder, for example, property contributed to a company by a unit government with the aim of allowing the company to expand its facilities.”[7] On this basis, the IRS said it would not challenge a corporate taxpayer’s exclusion of the BTOP and BIP grant funds from gross income.

Based on the IRS’ 2010 determination, one would reasonably assume that broadband subsidies provided through the ARPA and IIJA programs could be safely classified as non-taxable income, as the IRS has no perhaps updating its determination from 2010 (which specifically dealt with BTOP and BIP) to apply for the new subsidy programs. Unfortunately, a legislative change in 2017 complicated the situation.

5. The Tax Cuts and Jobs Act 2017.

The Tax Cuts and Jobs Act of 2017 (TCJA) significantly amended Section 118 of the IRC.[8] More relevant for our purposes, the TCJA added an exception to the definition of “taxpayer capital contribution” so that the term no longer includes “any contribution by a government entity or civic group…”.[9] As the Deloitte journal notes, “[t]a TCJA left unchanged the general rule in Section 118 that capital contributions are not included in gross income. What has changed is the addition of language to Section 118 that makes the proceeds of a grant from government entities or civic groups to a corporation taxable upon receipt as gross income…” .[10]

In short, the legislative changes passed in 2017 appear to undo the reasoning used by the IRS in 2010 to allow BTOP and BIP grant funds to be tax-exempt.

6. What now?

As explained above, broadband grant funds received by companies under ARPA (for example, as a subrecipient of a project funded under the Coronavirus State and Local Fiscal Recovery Fund ), or under future IIJA programs (including the BEAD program) may well be “gross income” subject to tax at the rate of 21%. Such an outcome would be clearly contrary to the objectives of ARPA and the ‘IIJA and hamper national efforts to deploy much-needed broadband infrastructure.

Prompt action by the IRS would fix the problem, but after the 2017 TCJA, it’s unclear if and how the IRS would be able to do so. If the IRS is unable to resolve the issue, congressional action may ultimately be required.

FOOTNOTES

[1] Internal Revenue Service, “CARES Act Coronavirus Relief Fund frequently asked questions», consulted on 03/01/2022.

[2] Internal Revenue Service, Publication 937 Business Reporting, IRS Pub. 937, 1989 WL 508466 (1989).

[3] Brown Shoe Co., Inc. v. Internal Revenue Commissioner, 339 US 583 (1950).

[4] ID., at 591; see, for example, United States v. Chicago, Burlington and Quincy Railroad Co., 412 US 401 (1973).

[5] Deloitte,”Impacts of Tax Reform on Section 118», Journal of Multistate Taxation and Incentives, Vol. 28, No. 6, September 2018.

[6] Internal Revenue Service Rev. proc. 2010-34.

[7] Identifier.

[8] To see James Adkinson, “State and local location incentives: reminder that the rules have changed», The tax advisor, June 1, 2019.

[9] 26 USC § 118(b).

[10] Deloitte, above.

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