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The North Carolina Department of Revenue has recently released a notice advising of a change to the allocation of North Carolina income tax credits through partnerships in transactions treated as disguised sales.

The NCDOR notice, dated September 10, 2018, but issued without an identifying number, notes that for state income tax purposes North Carolina generally follows the federal income tax treatment of partnerships.  Certain North Carolina code sections specifically reference certain federal partnership tax standards.  See e.g., N.C. Gen. Stat. section 105-269.15.

The NCDOR notice advises of NCDOR’s position that relevant statutes in N.C. Gen. Stat. Chapter 105 incorporate federal income tax consequences arising from disguised sale transactions.  Therefore, NCDOR has determined that a taxpayer cannot be allocated state income tax credits in a transaction treated as a disguised sale for federal income tax purposes.

The Fourth Circuit case of Virginia Historic Tax Credit Fund 2001, LP v. Commissioner, 639 F.3d 129 (4th Cir. 2011), treated certain state income tax credit syndications, principally involving a non-proportionate allocation of state income tax credits, as disguised sales. For example purposes only, a one percent (1%) state credit investor may be admitted as a member of a partnership or other pass-through tax entity, but be allocated a significantly higher percentage, up to 100%, of state income tax credits realized or received by the partnership or pass-through entity.  Under facts similar to the Tax Credit Fund case, such transaction would be treated for federal income tax purposes as a taxable disguised sale of the state tax credits by the investment partnership to the state credit investor, not as an allocation of the state tax credits by the investment partnership to the state credit investor partner.[1]  Under the recent NCDOR notice, NCDOR would not treat the disguised sale as a partnership allocation and would disallow the allocation of state tax credits to the state credit investor partner in such transaction.

The NCDOR notice did not include any language addressing whether NCDOR would apply the position announced in the notice retroactively or only prospectively.  However, the language of the NCDOR notice cold be read to imply that NCDOR may apply the position announced in the notice retroactively to part transactions that have already closed but are still within an open audit period.

Tax credit investment and syndications transactions require significant and careful legal and accounting analysis and consideration by counsel experienced in such transactions and the multiple issues and pitfalls involved in such transactions.  Hirschler’s Tax Credit Group regularly counsels owners, developers and investors in the complexities of credit projects, investments and syndication transactions, and would be happy to discuss your project with you.

[1] An analysis of the details and analysis involved in the Tax Credit Fund case  is beyond the scope of this article.

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Heather A. Scott

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