FRIED, FRANK, HARRIS, SHRIVER & JACOBSON (A PARTNERSHIP) – DETERMINATION – 05/12/00 In the Matter of FRIED, FRANK, HARRIS, SHRIVER & JACOBSON (A PARTNERSHIP) TAT(H) 97-16(CR) - DETERMINATION NEW YORK CITY TAX APPEALS TRIBUNAL ADMINISTRATIVE LAW JUDGE DIVISION COMMERCIAL RENT TAX – A RENT REBATE ATTRIBUTABLE TO A REAL ESTATE TAX REDUCTION MAY BE USED BY A TENANT TO REDUCE BASE RENT ONLY IN THE TAX YEAR IN WHICH THE RENT ATTRIBUTABLE TO THE REAL ESTATE TAX WAS ORIGINALLY PAID BY THE TENANT PURSUANT TO ITS LEASE WITH THE LANDLORD AND NOT IN THE YEAR IN WHICH THE REBATE WAS RECEIVED/PETITIONER WAS NOT DEPRIVED OF DUE PROCESS SINCE IT COULD HAVE FILED A PROTECTIVE REFUND CLAIM BASED ON THE LANDLORD'S CHALLENGE TO THE REAL ESTATE TAX/THE NEGLIGENCE PENALTY WAS ABATED BECAUSE PETITIONER'S ATTEMPTS TO COMPLY WITH THE CODE AND REGULATIONS WERE REASONABLE/THE SUBSTANTIAL UNDERSTATEMENT PENALTY WAS ABATED BECAUSE PETITIONER ADEQUATELY DISCLOSED ITS POSITION ON ITS RETURNS. MAY 12, 2000

NEW YORK CITY TAX APPEALS TRIBUNAL ADMINISTRATIVE LAW JUDGE DIVISION_ : In the Matter of the Petition : DETERMINATION : of : : TAT(H) 97-16(CR) FRIED, FRANK, HARRIS, SHRIVER : & JACOBSON (A PARTNERSHIP) : __________________________________: Schwartz, A.L.J.: Petitioner Fried, Frank, Harris, Shriver & Jacobson (a

Partnership), One New York Plaza, New York, New York 10004,

filed a Petition for redetermination of deficiencies of

Commercial Rent or Occupancy Tax (“CRT”) under Chapter 7 of

Title 11 of the Administrative Code (“Code”) of the City of New

York (“City”) for the period June 1, 1992 through May 31, 1995.

Pursuant to section 1-09(f) of the City Tax Appeals

Tribunal’s Rules of Practice and Procedure, Petitioner and the

Commissioner of Finance (“Respondent” or the “Commissioner”)

consented to have this matter determined on submission without

the need for an appearance at a hearing. On March 10, 1999, the

parties submitted a stipulation of facts with accompanying

exhibits. Petitioner filed a Memorandum of Law on April 23,

1999. Respondent filed a Brief on July 15, 1999. Petitioner

filed a Reply Memorandum of Law on October 1, 1999. Respondent

filed a Sur-Reply Brief on November 15, 1999. Petitioner

appeared pro se through John A. Borek, Esq. and Sandra M.

Lipsman, Esq., Of Counsel. Respondent was represented by Robert

J. Firestone, Esq., George P. Lynch, Esq. and Karen M. Griffin,

Esq., Assistant Corporation Counsels.

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ISSUES

I. Whether base rent for a tax year may be reduced by the

amount of a rent rebate received during that tax year which

related to a reduction of the landlord’s real estate taxes, and

thus Petitioner’s rent, for prior tax years.

II. Whether Petitioner was deprived of any meaningful op-

portunity to challenge the tax in violation of its Due Process

rights.

III. Whether penalties for negligent underpayment of tax

and for substantial understatement of tax liability were

properly imposed.

FINDINGS OF FACT

The facts set forth below are based on the stipulated facts

and exhibits submitted.

1. Since 1980, Petitioner has leased City office space

(the “Taxable Premises”) at One New York Plaza in Manhattan (the

“Building”) pursuant to a lease dated January 31, 1978 (the

“Lease”). Ownership of the Building changed hands in 1990.

However, under Section 35.02 of the Lease, the new owner assumed

all the obligations of the previous owner. Petitioner also

sublet a portion of the Taxable Premises from another tenant in

the Building. The owner of the Building and Petitioner’s sub-

landlord are hereinafter referred to, collectively, as the

“Landlord.” From time to time during the term of the Lease,

Petitioner sublet portions of the Taxable Premises to a sub-

tenant.

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2. Section 3.01 of the Lease provided that rent was the

sum of: (a) a specified fixed amount each year, plus (b) amounts

based on increases in the Landlord’s Real Property Tax

(“Property Tax Escalations”) and certain operating costs.

3. Property Tax Escalations were included in the rent for

the period July 1, 1984 through June 30, 1992.

4. On the July 1984, January 1985, July 1985, January

1986, July 1986, December 1986, July 1987, January 1988, July

1988, January 1989, and July 1989 bills for charges relating to

Property Tax Escalations, the Landlord informed Petitioner that

it had instituted property tax reduction proceedings.

5. After eight years of litigation with the City regarding

property tax reductions, to which Petitioner was not a party or

a witness and was not, in any way, consulted or otherwise a

participant, the Landlord’s property taxes for the real estate

tax years ending June 30, 1985 through June 30, 1992 with

respect to the Building were reduced. Petitioner’s share of the

Landlord’s property tax reduction was $4,390,722 (including

$951,311 of interest), which amount was received by the Landlord

from the City during the period June 1, 1992 through May 31,

1993 (“FY93”). On or about January 1992, Petitioner became

aware of the decision retroactively reducing the assessed

valuation of the Building. Petitioner thereafter became aware

that the decision had been affirmed by the Appellate Division,

First Department.

6. Section 3.03 B of the Lease expressly provided in

relevant part that:

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[I]in the event that Landlord shall receive a refund of taxes as a result of a reduction in Taxes for any Tax Year. . . . Landlord shall credit Tenant’s Proportionate Share of the net amount of such refund (after deducting therefrom all expenses, including, but not limited to, the fees of attorneys and experts incurred by Landlord in connection therewith) against the next accruing installment or installments of Rent to become due and payable to Landlord from Tenant or, if no further installment of Rent is to become payable, shall remit such share, or the balance thereof not theretofore credited on account of Rent, to Tenant within thirty (30) days after the receipt of such refund,. . ..

. . .

[t]he expiration or termination of this Lease during any Tax Year shall not affect the rights or obligations of the parties under this Section 3.03 which shall survive any such expiration or termination, and Tenant shall remain liable for Tenant’s Proportionate Share of any such excess, and Landlord shall remain liable for the refund for such Tax Year, apportioned as of the date of expiration or termination, notwithstanding such expiration or termination.

7. Pursuant to Section 3.03 B of the Lease, the Landlord

paid a rent rebate of $3,849,204 to Petitioner in FY93,

reflecting Petitioner’s share of the Landlord’s property tax

reduction less Petitioner’s share of legal expenses as provided

for in Section 3.03 B, computed as follows:

Total rent rebate: $4,390,722 Legal expenses: __(541,518) Net rebate paid: $3,849,204

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8. A portion of the $3,849,204 rebate was attributable to

Petitioner’s sub-tenant. With a letter dated September 11,

1992, Petitioner paid $283,357 of the net rent rebate to its

sub-tenant pursuant to the rent escalation provisions of the

sub-tenant’s sublease.

9. The net rebate paid to Petitioner by Landlord was at-

tributable to tax and interest and was allocable between

Petitioner and its sub-tenant as follows:

Petitioner Sub-tenant Total Tax $2,671,592 $226,301 $2,897,893 Interest 894,255 57,056 951,311 Total $3,565,847 $283,357 $3,849,204

10. By letter dated July 13, 1992, Landlord first informed

Petitioner that a rebate of rent would be made during FY93 and

remitted the first two checks to Petitioner. The remainder of

the rebate in the form of additional checks was remitted to

Petitioner by August 31, 1992.

11. Pursuant to Code section 11-709, Petitioner timely

claimed, and thereafter received, CRT refunds for the period

June 1, 1991 through May 31, 1992 (“FY92”) by reason of its

reducing the base rent for FY92 by $387,542 of the rent rebate

received from the Landlord.1 Petitioner received CRT refunds

aggregating $23,253 (6% of $387,542).

12. During FY93, Petitioner timely filed its quarterly CRT

returns (Forms CR-Q) for the periods June 1, 1992 through August

31, 1992 (“1Q93”), September 1, 1992 through November 30, 1992

1 Although not explicitly stated in the stipulation of facts, it appears that $387,542 represented the portion of the Property Tax Escalation relating to FY92.

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(“2Q93”), and December 1, 1992 through February 28, 1993

(“3Q93”), as well as its annual CRT return (Form CR-A) for FY93.

13. Petitioner paid $48,494 with its Form CR-Q for 1Q93

and $60,498 with its Form CR-Q for 2Q93, for a total paid of

$108,992. On its Form CR-Q for 3Q93, Petitioner showed no tax

due and disclosed the fact that it had subtracted the rent

rebate in calculating its base rent for that quarter.

14. Petitioner requested a refund on a Form CR-A for FY93.

In an attachment to that form, Petitioner disclosed the fact

that it had subtracted the rent rebate in calculating the

aggregate base rent paid to the Landlord during FY93.

15. On October 22, 1993, the Department of Finance (the

“Department”) sent a Notice For Information to Petitioner

requesting “[a] detailed letter regarding the rent rebates or a

renegotiated lease agreement.”

16. In response to the October 22, 1993 Notice, Petitioner

sent a letter to Respondent dated November 18, 1993 amending the

request for refund contained in its CR-A for FY93, and providing

details regarding the rent rebates referenced in Petitioner’s

claim for refund (the “November 1993 Amendment”).

17. As detailed in the November 1993 Amendment, Petitioner

requested a refund in the amount of $20,138, calculated2 as

follows:

2 In initially calculating its CRT liability on its Form CR-A for FY93, Petitioner excluded the Landlord’s legal expense allocation ($541,518) that the Landlord had deducted from Petitioner’s share of the property tax reduction and included the interest ($951,311) which was included in the amount received by Petitioner from the Landlord that was attributable to both Petitioner’s share of the rent rebate ($894,255) and to its sub-tenant’s

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Rents reported on Form CR-A $4,306,469 Less: Net rebate excluding interest $2,671,5923 Legal expenses 541,5184 Reduced by amount attributable to FY92 (387,542)5 Net rent rebate (2,825,568) Base rent $1,480,901 CRT (6% of base rent) 88,854 Amount previously paid 108,992) Refund claimed $20,138 18. The Department issued a Notice of Disallowance dated

April 19, 1994 denying Petitioner’s refund request. Petitioner

did not file a Request for Conciliation Conference or a Petition

for Hearing in response to this Notice of Disallowance.

19. The Department conducted an audit of Petitioner’s CRT

returns for the period June 1, 1992 through May 31, 1995. In a

Notice of Determination dated December 3, 1996 the Department

asserted the following CRT deficiencies:

Tax Period Principal Interest6 Penalty Total

6/1/92 – 5/31/93 $204,475.78 $50,464.41 $64,062.25 $319,002.44 6/1/93 – 5/31/94 2,753.19 608.44 441.88 3,803.51 6/1/94 – 5/31/95 217.32 25.40 0.00 242.72 Total $207,446.29 $51,098.25 $64,504.13 $323,048.67

share ($57,056). As a result, Petitioner originally reported a net remaining rent rebate of $3,178,305, reported CRT for the year of $67,690 and claimed a refund of $41,302. 3 See, Finding of Fact 9, supra. 4 See, Finding of Fact 7, supra. 5 See, Finding of Fact 11, supra. 6 Computed to 9/20/96.

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20. The deficiency for FY93 arose, in part, because the

Department did not permit Petitioner to reduce its base rent for

FY93 by the $2,825,568 net rent rebate reported on Petitioner’s

FY93 CR-A as amended by the November 1993 Amendment. The

Department’s rationale was that a rent rebate received by a

tenant in a current year that related to a prior period may only

reduce CRT liability for that prior period, and may result in

the granting of a refund only if the statute of limitations for

a refund claim is still open. The auditor, however, did allow

the portion of the rent rebate applicable to the period June 1,

1992 through June 30, 1992 in the amount of $37,144.7

Although Respondent also disputed Petitioner’s right to

claim a reduction for the operation expense credits issued by

Landlord, he has subsequently abandoned this issue.

21. On or about February 27, 1997, Petitioner filed a

Petition requesting a redetermination of the deficiency asserted

for FY93. Petitioner is not challenging the deficiency asserted

for June 1, 1993 through May 31, 1994 (“FY94”), or the

deficiency asserted for June 1, 1994 through May 31, 1995

(“FY95”). FY93 is the only tax year at issue.

22. Respondent no longer disputes the accuracy of the

amounts reported by Petitioner on its Forms CR-Q for 1Q93, 2Q93

and 3Q93 and Form CR-A for FY93 as amended by the November 1993

Amendment other than Petitioner’s right to claim a reduction for

a rent rebate in calculating those amounts.

7 Under the doctrine of equitable recoupment, when the City has opened, through an audit, a tax year in which a claim for a refund would ordinarily be time-barred, the time barred refund claim will be permitted as a set-off against any deficiency arising during the audit period if the time-barred

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Respondent now asserts that Petitioner is liable for CRT in

the principal amount of $193,544, plus a ten percent penalty for

substantial understatement of liability pursuant to Code section

11-715(j) in the amount of $19,057 (sic), and penalties for

negligent underpayment of five percent pursuant to Code section

11-715(d)(1) in the amount of $9,677 and fifty percent of the

total interest pursuant to Code section 11-715(d)(2) which has

yet to be calculated.

23. The Department has not published procedures for filing

refund claims that are contingent upon the occurrence of a

future event (“Protective Refund Claims”). However, taxpayers

have filed such claims with respect to both income and excise

taxes, including the CRT, and the Department has established

internal procedures for processing such claims. These

procedures involve setting up a file for each Protective Refund

Claim and holding it in abeyance until the event that caused the

need for the claim has been concluded and the taxpayer provides

the Department with the relevant information necessary to

substantiate the claimed refund.

STATEMENT OF POSITIONS

Petitioner asserts that the rent it actually paid during

FY93 consisted of those amounts remitted to the Landlord less

the amount of the rent rebate paid to it by the Landlord that

was required to be credited against its rent for FY93 under the

Lease. Respondent counters that as the rent rebates related to

overpayments of rent in prior periods, Petitioner should have

amount is for the same tax, in the same audit period, and arises from the same transaction addressed under audit.

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taken those rebates in account by timely filing refund claims

for those prior periods.

Petitioner counters that no refunds would have been

available because the CRT paid in the prior periods was not

erroneous when paid. Petitioner further contends that because

of the eighteen-month statute of limitations on refund claims,

under Code section 11-709.a Respondent’s position would deprive

it of any meaningful opportunity to challenge CRT paid on rent

that was rebated. Respondent replies that Petitioner had the

remedy of filing Protective Refund Claims to keep the statute of

limitations open.

Petitioner also asserts that Respondent had no basis for

imposing penalties. Petitioner contends that the substantial

understatement penalty was improper because there was

substantial authority for Petitioner’s position, it was

adequately disclosed on the returns, and Petitioner acted in

good faith. Respondent’s briefs do not address the issue of

penalties.

CONCLUSIONS OF LAW

Deductibility of rebate

Under section 11-702 of the Code, the CRT is imposed on

“base rent.” Base rent is defined, in relevant part, in Code

section 11-701.7 as “[t]he rent paid for each taxable premises

by a tenant to his or her landlord for a period . . ..”

[Emphasis added.] Rent is defined in Code section 11-701.6 as:

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[t]he consideration paid or required to be paid by a tenant for the use or occupancy of premises, valued in money, whether received in money or otherwise, including all credits and property or services of any kind . . .. [Emphasis added.]

The Code thus distinguishes between rent, which can be either an

amount paid or an amount accrued but not paid in a particular

year, and base rent (upon which the CRT is imposed) which is the

amount actually paid in a particular year.

In FY93, Petitioner remitted to Landlord the amount of rent

provided in Section 3.01 of the Lease and also received a series

of checks representing a rebate resulting from a reduction in

Landlord’s real property tax for prior periods. Section 3.03 B

of the Lease provides that rent rebates due to property tax

reductions shall be credited against the next installment or

installments of rent to become due to Landlord. Had Landlord8

followed the Lease, instead of exchanging checks, Petitioner

would have been required to remit only the net amount to

Landlord. Petitioner asserts that base rent should therefore be

deemed to be the amount of rent provided for in Section 3.01 of

the Lease less the amount of the rent rebate.

The essence of Petitioner’s argument is that base rent is

that amount that had to be paid to Landlord to avoid eviction.

8 Respondent notes that because the Building had changed hands during the years at issue, the rent for FY93 was paid to the Landlord at that time while the rebate was received from an entity that had been the Landlord during a prior period. However, since the successor Landlord had assumed all the prior Landlord’s obligations under the Lease, the successor Landlord would have been required to give Petitioner credit for the rent rebate and would have been reimbursed by the prior Landlord. Accordingly, the fact that there were two different Landlords involved in these transactions does not effect the outcome of this matter.

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In support of its position, Petitioner cites Mobil Oil Corp. v.

Finance Adm’r. of City of N.Y., 58 N.Y.2d 95, 98 (1983), in

which the Court of Appeals held that amounts paid by a tenant to

its landlord for cleaning services constituted base rent as the

parties agreed on an aggregate amount as rent and, in exchange,

the landlord agreed to provide tenant with space and a variety

of services including cleaning. The Court noted that had the

tenant failed to pay the entire amount it would have been

subject to eviction.

Leaving aside the fact that Petitioner and Landlord

exchanged checks rather than netting the rebate credit against

the current rent,9 the difficulty with Petitioner’s analysis is

its understanding of the word “paid.” Code section 11-701.6

indicates that rent can be “paid” in money, property, services,

credits, etc. Had Petitioner paid its rent in part by the

application of a credit to which it was entitled because of the

Landlord’s property tax refund for a prior period, that is no

different from purchasing one item in a store, returning it for

a store credit, and subsequently using that credit to purchase

another item. There is no question but that the second item

would have been “paid” with the credit.

Petitioner asserts that “it is Respondent’s own practice to

calculate CRT on the basis of the consideration that actually

changes hands in the tax year, regardless of whether components

of that consideration are attributable to periods outside the

9 Although Petitioner did not, in fact, remit only the net amount of the rent, the Appeals Division of this Tribunal has indicated that they “do not advocate slavish adherence to . . . [the] doctrine that a taxpayer is always bound by the form of its transaction.” Admar Research, Inc., TAT(E) 94-137 (CR) (NYC Tax Appeals Tribunal, March 2, 1999).

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tax year.”10 To that end, Petitioner cites City Fin. Admin.

Bull. Vol. 2, No. 1 (Dec. 1970), reprinted in 5 New York Tax

Analysis, at XI-4211 (CCH 1997) [“A commercial tenant’s payment

in the current year of his share of the building’s increased

real estate taxes for a prior year, where the tenant continues

to occupy the business space, is reportable for commercial rent

tax purposes in the year of payment, and not in the year to

which the increase relates”]; J. Henry Schroeder Bank & Trust

Co.,11 TAT(H) 93-117, (NYC Tax Appeals Tribunal, August 31, 1995)

[Respondent asserted, and the Administrative Law Judge (“ALJ”)

held, that building maintenance escalation charges paid during

the tax years which were attributable to periods outside the tax

years were includible in base rent for the year in which paid];

In re J.C. Penney Co., Inc., FHD (218)–CR-12/88(0-0-0)

[Respondent stipulated that amounts paid in a subsequent period

attributable to escalations during a prior period are taxable

when paid]; and N.Y City Fin. Admin. Bull. Vol. 2, No. 3 (July

1971), reprinted in New York Tax Analysis, supra, at XI-4216

[“Despite his continuing legal obligation to pay rent, a tenant

who is not financially able to pay rent on leased premises is

not subject to the tax; in such case only the rent actually paid

enters into the computation of the tax due”]. However, the

authorities Petitioner cites merely indicate that, as required

by statute, the CRT is due only if and when rent is actually

paid. They do not discuss the proper treatment of rent paid in

one tax period that is rebated in a subsequent tax period.

Section 11-703(a) of the Code provides that it is presumed

that all rent paid or required to be paid by Petitioner is base

10 Petitioner’s Brief at 10.

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rent until the contrary is established and that the burden of

proving that presumptive base rent is not included in the

computation of tax is on Petitioner. Petitioner has not met its

burden of establishing that the rent paid by Petitioner should

be reduced by the amount of the rebate in determining base rent.

Accordingly, the rebate may not be used to reduce base rent in

the year the rebate was received and may be used only to reduce

base rent for the year to which the rebate relates. Any other

conclusion would deprive of any remedy those taxpayers who, by

the time they receive their rebates, were no longer leasing the

same premises from the same landlord. In such instances if rent

rebates only reduced base rent for the year in which the rebate

was received, as Petitioner asserts, those taxpayers would be

wholly unable to obtain a CRT refund.

Due Process

To satisfy the Due Process Clause of the United States

Constitution, the City “must provide taxpayers with, not only a

fair opportunity to challenge the accuracy and legal validity of

their tax obligation, but also a ‘clear and certain remedy.’”

McKesson Corp. v. Division of Alcoholic Beverages & Tobacco, 496

U.S. 18, 38 (1990). Petitioner contends that if it is not

permitted to reduce the amount of base rent for FY93 by the rent

rebate, it will be deprived of Due Process because it would not

have had any meaningful opportunity to challenge the overpayment

of CRT on the rebated rent. Such an opportunity and remedy was

provided, however, by Code section 11-709.a, which provides in

relevant part that:

11 Petitioner cited this ALJ determination to show Respondent’s practice and not for its holding.

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the commissioner of finance shall refund or credit, without interest, any tax, penalty or interest erroneously, illegally or unconstitutionally collected or paid, if written application to the commissioner of finance for such refund shall be made within eighteen months from the date fixed by this chapter for filing a return on which such payment was based or within six months of the payment thereof, whichever of such periods expire the later. [Emphasis added.]

Petitioner contends that it would not have been entitled to

a refund and thus relief for the prior periods under this

provision because, at the time the CRT was originally paid, it

was not “erroneously, illegally or unconstitutionally collected

or paid.” Respondent agrees that the CRT at issue was not

illegally or unconstitutionally collected or paid but argues

that it was “erroneously paid” and that, assuming the statute of

limitations were still open, a refund could be issued.

Petitioner relies on two cases to support its position that

the CRT originally reported was not erroneously paid. In the

first case, Con Edison Co. of New York, Inc. v. State Tax.

Comm’n, 101 Misc. 2d 868, 422 N.Y.S.2d 294 (Sup. Ct. Albany

Cty., 1979), the taxpayer, with the knowledge and approval of

the New York State Department of Taxation and Finance, changed

the timing of the payment of sales and use tax on taxable

inventory items. Prior to this change such taxes had been paid

when those items were purchased. After the change, tax was paid

as items were withdrawn from inventory. As a result of this

change, the taxpayer continued to have items in inventory on

which taxes had been previously paid but would, under the new

system, again be subject to tax when the items were removed from

inventory. To avoid such double taxation, relying upon its

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understanding that it had the approval of the state tax

authorities, the taxpayer claimed a credit for the taxes

previously paid on the first return of those taxes it filed

using the new system.

The state tax authorities denied the credit on the ground

that the taxpayer should have timely requested a refund.

However, the Court allowed the credit because it found that when

they were paid, the taxes were not “erroneously, illegally or

unconstitutionally collected or paid, but . . . were

unquestionably due and owing.” Con Edison differs from this

case as the original tax liability reported was never in

dispute. At the time the taxes were paid, they were clearly

due. Nor did the change subsequently make the earlier payment

of those taxes erroneous. It was a change in the taxpayer’s

timing of payments that might have resulted in double taxation.

Thus the credit rather than a refund was the appropriate remedy.

In the second case cited by Petitioner, 1400 Broadway

Assoc., TAT(H) 93-300 (NYC Tax Appeals Tribunal, May 12, 1995),

the taxpayer, which used the accrual method of accounting,

sought to reduce its gross operating income for City Utility Tax

(“UT”) purposes by claiming bad debt deductions for

uncollectible electrical charges that had been included in gross

operating income in a prior period. It was not disputed that

under the accrual method of accounting the income had been

properly included in that prior period (when the receivables

were not worthless) and that the bad debts were properly

deducted in the current year (when the receivables became

worthless). At issue in 1400 Broadway was whether the bad debt

deduction was an “expense” which is not allowable under Code

section 11-1101.5 of the UT. The Department argued that the

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taxpayer should have claimed a refund for the years in which the

uncollectible amounts had originally been included in income.

The ALJ held that the bad debt deduction was not an expense

within the meaning of Code section 11-1101.5 and was properly

deducted in the current year. The ALJ also noted that: “[s]ince

[the taxpayer’s] reporting of receipts on the accrual basis was

neither erroneous, illegal or unconstitutional, no refund is

permissible . . ..” Thus, in 1400 Broadway, the subsequent

event that generated the deduction, that the debts became

worthless, took place after the year in which the tax was paid

and did not make the original reporting erroneous.

Unlike the situations in Con Edison, supra, and 1400

Broadway, supra, here the original base rent reported was

erroneous since the rent paid was based on what was subsequently

determined to be an erroneous real property tax assessment.

Petitioner paid its CRT for the prior periods computed on that

erroneous base rent. As the rent rebate corrected the error in

the rent charged and paid, the tax should be corrected

accordingly. Accordingly, the threshold requirement in Code

section 11-709 that the original tax payment have been

erroneously paid is met here.

That Petitioner could have filed refund claims pursuant to

Code section 11-709.a is affirmed by the fact that Petitioner

did file refund claims for FY92 by reason of reducing the base

rent for FY92 by the portion of the rent rebate attributable to

that year’s real property taxes and that those refunds were paid

by the Department. Accordingly, Petitioner’s own conduct belies

its assertion that it would not be entitled to refunds for the

prior periods because of the “erroneously . . . collected or

paid” language in the refund provision.

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The problem with the refund procedure here is not one of

substance but of timeliness. At the time Petitioner received

the rent rebate, refunds for years prior to FY92 were barred by

the eighteen-month statute of limitations. Petitioner could not

have filed supportable refund claims for the prior periods while

the statute of limitations was still open because its right to

any CRT refunds was not yet fixed, since the Landlord’s real

property tax litigation fixing Petitioner’s entitlement to a

rebate had not yet concluded. This does not mean, however, that

Petitioner was without redress. While the statute of

limitations was open, Petitioner, having notice that the

litigation was in process, could have filed Protective Refund

Claims in order to keep the statute of limitations open until

the Landlord’s tax reduction proceedings were concluded.

Petitioner nevertheless asserts that it is a denial of Due

Process to now require that it have availed itself of an

undisclosed, undocumented and unsubstantiated procedure.12

As Petitioner asserts, there are no statutory provisions or

regulations or published instructions of any kind notifying the

public of the availability of a Protective Refund Claim under

any tax imposed by the Code. There are also no federal or state

statutory provisions or regulations dealing with Protective

Refund Claims as such. Accordingly, while this issue is one of

first impression under the Code, guidance can be gained from

federal and state case law which indicates that no specific

provision authorizing Protective Refund Claims are necessary to

provide Due Process.

12 Petitioner’s Brief at 18.

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The federal and state refund statutes, like the City

statute at issue here, merely set forth the time requirement for

filing a refund claim. See, e.g., IRC §6511; N.Y. Tax Law §687.

Nevertheless, a taxpayer’s obligation to file a Protective

Refund Claim to avert a statute of limitations bar is well

established in both federal and state decisions. See, e.g.,

Swietlik v. United States, 779 F.2d 1306 (7th Cir. 1985); In the

Matter of Bocklet, TSB-H-83(107)I, (State Tax Commission, May 6,

1983). In recognizing this remedy, courts have not only

rejected similar arguments that an adequate refund claim could

not be presented within the statutory period because neither the

existence nor the amount of the tax liability had been settled,

but have specifically held that where there is a potential that

a refund might be due, taxpayers must file protective claims to

avert the bar of limitations. Kellogg-Citizens Nat’l Bank of

Green Bay, Wisc. v. U.S., 330 F.2d 635, 639 (Ct. Cl. 1964).

Courts have required that such claims be filed even though

neither the Internal Revenue Code nor the Treasury regulations

promulgated thereunder explicitly set forth a taxpayer’s right

to file a protective claim. See, e.g., United States of America

v. Commercial National Bank of Peoria, et al., 874 F.2d. 1165

(7th Cir., 1989).

From time to time, the Internal Revenue Service has

published Revenue Procedures or Revenue Rulings or Announcements

advising the public of the need to file Protective Refund Claims

in a variety of situations. See, e.g., Rev. Proc. 96-13, 1996-1

C.B. 616; Rev. Rul. 83-79, 1983-1 C.B. 346; Ann. 93-93, 1993-24

I.R.B. 66. However, these Internal Revenue Service pronounce-

ments do not create the right to file a Protective Refund Claim

but merely advise taxpayers of the need to file them in

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particular situations. It is not necessary that there be a

specific Internal Revenue Service pronouncement in order for a

taxpayer to file a federal Protective Refund Claim. See, e.g.,

Kellogg-Citizens, supra.

Petitioner was on notice that the Landlord’s real estate

tax assessment was being challenged prior to the time the

statute of limitations would have foreclosed the filing of

refund claims. Under these circumstances, Due Process was

provided by the refund claim provision of Code section 11-709.a.

In reaching this conclusion I am not unmindful that it may

create administrative complexities for both commercial tenants

and the Department. Real estate tax escalation clauses are a

common feature in commercial leases in the City and many

commercial landlords in the City routinely contest their real

property tax assessments. Accordingly, to prevent a statute of

limitations bar similar to that which occurred here prudent

tenants may routinely choose to file Protective Refund Claims.

While extending the Code section 11-709.a statute of limitations

for such refund claims would be less onerous for all concerned,

such relief was not requested and is not within the scope of my

authority.

Penalties

Code section 11-715(d) imposes a penalty for a deficiency

due to negligence or intentional disregard of the Code or

applicable rules or regulations. Although there are no City

rules or regulations defining negligence or intentional

disregard of the Code and rules or regulations, the federal

regulation related to a similar penalty under the Internal

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Revenue Code provides guidance. Treas. Reg. Section 1.6662-

3(b)(1) defines “negligence” to include:

any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return. “Negligence” also includes any failure by the taxpayer to keep adequate books and records or to substantiate items properly.

Petitioner made a reasonable attempt to comply with the tax

law in an area where there is no published authority. There is

no indication that Petitioner’s records were in any way

incomplete. Moreover, the returns were filed in a timely

manner. Under these circumstances, the negligence penalty was

inappropriate and is abated.

Code section 11-715(j) imposes a penalty for a substantial

understatement of tax. A substantial understatement of tax is

defined as an understatement that “exceeds the greater of ten

percent of the tax required to be shown on the final return for

the tax year or five thousand dollars.” This penalty, however,

does not apply to any portion of the understatement:

which is attributable to the tax treatment of any item by the taxpayer if there is or was substantial authority for such treatment, or any item with respect to which the relevant facts affecting the item’s tax treatment are adequately disclosed in the return or in a statement attached to the return.

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On its Form CR-Q for 3Q93 and on Form CR-A for FY93,

Petitioner subtracted the rent rebate in calculating base rent.

Both of these returns contain an attachment adequately

disclosing this fact and the fact that the rebate related to

rent escalations for the prior periods. Under these

circumstances, the substantial understatement penalty is

inappropriate and is abated.

ACCORDINGLY, IT IS CONCLUDED THAT:

A. A rent rebate attributable to a real estate tax

reduction may be used by a tenant to reduce Base Rent only in

the tax year in which the underlying real estate tax escalation

was paid by the tenant.

B. The applicable refund provision of the Code provided

Petitioner with Due Process as it could have filed a Protective

Refund Claim with respect to the tax paid on the rent

attributable to the real estate taxes being contested.

C. The negligence penalty is abated because Petitioner’s

attempts to comply with the Code and the applicable rules or

regulations thereunder were reasonable.

D. The substantial understatement penalty is abated

because Petitioner adequately disclosed the position it took on

the relevant returns.

The Petition of Fried, Frank, Harris, Shriver & Jacobson is

denied in part and granted in part. The Notice of Determination

dated December 3, 1996 is sustained except to the extent

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indicated in Finding of Fact 22 and the abatement of penalties

in Conclusions of Law C and D above.

Dated: May 12, 2000 New York, New York _______________________ MARLENE F. SCHWARTZ Administrative Law Judge