Title: Columbus Div. of Income Tax v. New Plan Realty Trust

State: ohio

Issuer: Ohio Supreme Court

Document:

[Cite as Columbus Div. of Income Tax v. New Plan Realty Trust, 94 Ohio St.3d 193, 2002-
Ohio-479.] 
 
 
 
CITY OF COLUMBUS, DIVISION OF INCOME TAX, APPELLANT, v. NEW PLAN 
REALTY TRUST, APPELLEE. 
[Cite as Columbus Div. of Income Tax v. New Plan Realty Trust (2002), 94 
Ohio St.3d 193.] 
Taxation — Dividends paid by real estate investment trust to its shareholders 
are not tax deductible as “ordinary and necessary expenses” under 
Columbus City Code 361.09. 
(No. 00-1838 — Submitted October 31, 2001 — Decided February 6, 2002.) 
APPEAL from the Court of Appeals for Franklin County, No. 99AP-1350. 
__________________ 
SYLLABUS OF THE COURT 
Dividends paid by a real estate investment trust to its shareholders, while 
generally deductible for purposes of federal taxation under Section 856 et 
seq., Title 26, U.S.Code, are not tax deductible as “ordinary and necessary 
expenses” under Columbus City Code 361.09. 
__________________ 
 
ALICE ROBIE RESNICK, J.  The relevant facts in this case are undisputed.  
Defendant-appellee, New Plan Realty Trust (“New Plan”), is engaged in the 
business of owning, operating, and managing real estate investments throughout 
the United States.  For the tax year August 1, 1996 through July 31, 1997, New 
Plan elected and qualified to receive special federal income tax treatment as a real 
estate investment trust (“REIT”) under the Internal Revenue Code.  To qualify as 
a REIT in 1996, New Plan had to distribute at least ninety-five percent of its 
taxable income to its shareholders as dividends.  Former Section 857(a)(1)(A), 
Title 26, U.S.Code.  It was then allowed to deduct the paid dividends from its 
SUPREME COURT OF OHIO 
2 
taxable income for purposes of calculating its federal tax liability.  Section 
857(b)(2)(B), Title 26, U.S.Code. 
 
In 1996, New Plan owned rental property in the city of Columbus.  When 
New Plan filed its 1996 corporate tax return (form BR-25) with plaintiff-
appellant, City of Columbus, Division of Income Tax, it reported its taxable 
income and thus its net tax liability as “-0-.”  In so doing, New Plan adjusted its 
taxable income by subtracting the amount of dividends paid to its shareholders, as 
it did in its 1996 federal form 1120-REIT return. 
 
In a notice dated March 27, 1998, appellant informed New Plan that upon 
audit it was determined that New Plan owed $5,376.16 plus penalties and interest 
on its 1996 BR-25.  In particular, the notice explained that “[f]or city tax 
purposes, Dividends Paid are not deductible.” 
 
On May 18, 1998, New Plan wrote a letter to appellant requesting that the 
notice be canceled on the basis that New Plan’s “deduction for dividends paid to 
its shareholders is an ordinary and necessary expense of its business in accordance 
with its federal income tax classification and accounting system as [a REIT].” 
 
In a letter dated July 9, 1998, appellant responded as follows: 
 
“At issue is the deduction for dividends paid by a REIT to its shareholders.  
The City of Columbus taxes all entities (trusts, S corps and C corps) on their net 
profits prior to distribution to shareholders.  Although you are required to 
dividend 95% of the income under Internal Revenue Codes that has no impact on 
the City taxation.  Under the IRS code the shareholders would be required to 
report their dividends on their individual tax returns whereas the City does not 
require dividend income to be reported individually.  In addition, we do not 
consider the dividends to be an expense of the REIT but rather a distribution of 
income to shareholders.” 
 
On June 17, 1999, appellant instituted the present action in the Franklin 
County Municipal Court to recover the assessed 1996 tax plus interest and 
January Term, 2002 
3 
penalties.  Both parties filed motions for summary judgment, and the trial court 
granted summary judgment in favor of appellant. 
 
The court of appeals reversed the judgment of the trial court and held that 
a REIT is entitled to deduct the dividends it pays to its shareholders in calculating 
taxable income under the Columbus income tax ordinance.  The court of appeals 
reasoned: 
 
“The Columbus City Code directs the taxpayer to calculate its taxable 
income in the manner used to calculate net profits under the ‘accounting system 
used * * * for federal income tax purposes.’  The Columbus City Code is silent as 
to the definition of this phrase.  The term ‘accounting system,’ however, is broad 
enough to encompass more than the cash or accrual method of accounting, as 
appellee argues.  Resolving ambiguities in the taxpayer’s favor, this court 
concludes that, under the language of Columbus City Code 361.09, appellant is 
entitled to deduct from net profits the dividends it distributed to its shareholders 
because appellant is allowed to deduct paid dividends for federal taxation 
purposes.”  (Emphasis sic.) 
 
The cause is now before this court pursuant to the allowance of a 
discretionary appeal. 
 
The question for review is whether REITs are entitled to a deduction for 
paid dividends under the income tax provisions of the Columbus City Code. 
 
Columbus City Code 361.16 defines “taxable income” as including “the 
net profits from the operation of a business, profession or other enterprise or 
activity.”  (Emphasis added.)  Columbus City Code 361.19(d) imposes a tax at the 
rate of two percent per annum “on the net profits of all corporations, estates, and 
trusts.”  (Emphasis added.) 
 
Columbus City Code 361.09 provides: 
 
“ ‘Net Profits’ means the net gain from the operation of a business, 
profession, or enterprise or other activity * * * after provision for all ordinary and 
SUPREME COURT OF OHIO 
4 
necessary expenses either paid or accrued in accordance with the accounting 
system used by the taxpayer for federal income tax purposes.”  (Emphasis added.) 
 
It is crystal clear that the only reduction in taxable income allowed to the 
corporate taxpayer under Columbus City Code 361.09 is for “ordinary and 
necessary expenses.”  The quoted language that follows this phrase cannot under 
any reasonable syntactical construction modify the phrase “net gain.”  Unless the 
Columbus ordinance is rewritten, taxable net profit for purposes of city taxation is 
whatever gain remains after subtracting ordinary and necessary expenses. 
 
However, New Plan somehow managed to convince the court of appeals 
to rewrite Section 361.09 to omit the phrase “ordinary and necessary expenses.”  
To comport with the court of appeals’ view, Columbus City Code 361.09 would 
have to be changed so as to define “net profits” as either (1) “undistributed gain,” 
(2) “net gain * * * after provision for all deductions allowed for federal income 
tax purposes,” or, as explained above, (3) “net gain * * * in accordance with the 
accounting system used by the taxpayer for federal income tax purposes,” after 
deleting the phrase “ordinary and necessary expenses either paid or accrued.”  
Otherwise, as it stands, “net profits” under Columbus City Code 361.09 is simply 
gain minus ordinary and necessary expenses. 
 
Paid dividends are not ordinary and necessary expenses.  An ordinary and 
necessary expense, whether claimed by an individual under Section 212 or by a 
business pursuant to Section 162, Title 26, U.S.Code, is a cost incurred in the 
production or maintenance of income.  See Natl. Can Corp. v. United States 
(N.D.Ill.1981), 520 F.Supp. 567, 579, affirmed (C.A.7, 1982), 687 F.2d 1107; 
Fischer v. United States (E.D.Wis.1971), 336 F.Supp. 428, 431-432, affirmed 
(C.A.7, 1973), 490 F.2d 218, 222; Estate of Walling v. Commr. of Internal 
Revenue (C.A.3, 1967), 373 F.2d 190, 193; N. Trust Co. v. Campbell (C.A.7, 
1954), 211 F.2d 251, 253. 
January Term, 2002 
5 
 
A paid dividend is not a cost incurred in the production or maintenance of 
income.  Quite the contrary, a dividend is a distribution of earnings and profit 
made by a corporation to its shareholders.  See Section 316(a), Title 26, 
U.S.Code.  In fact, this is precisely why claimed deductions for business expenses 
are denied where the expense is actually a disguised dividend.  See O.S.C. & 
Assoc., Inc. v. Commr. of Internal Revenue (C.A.9, 1999), 187 F.3d 1116; Petro-
Chem Mkg. Co., Inc. v. United States (1979), 221 Ct.Cl. 211, 602 F.2d 959; Nor-
Cal Adjusters v. Commr. of Internal Revenue (C.A.9, 1974), 503 F.2d 359, 362; 
Griffin & Co. v. United States (1968), 182 Ct.Cl. 436,  389 F.2d 802, 810; 
Northlich, Stolley, Inc. v. United States (1966), 177 Ct.Cl. 435, 368 F.2d 272, 278. 
 
Indeed, if paid dividends were considered ordinary and necessary 
expenses, there would have been no need for the enactment of the federal REIT 
provisions in the first place, since Section 162, Title 26, U.S.Code already 
provided for the deductibility of ordinary and necessary business expenses.  The 
REIT provisions are necessary to effectuate the deductibility of dividends by 
qualifying entities precisely because paid dividends are not otherwise tax 
deductible by the corporation as an ordinary and necessary expense. 
 
Therefore, we hold that dividends paid by a real estate investment trust to 
its shareholders, while generally deductible for purposes of federal taxation under 
Section 856 et seq., Title 26, U.S.Code, are not tax deductible as “ordinary and 
necessary expenses” under Columbus City Code 361.09. 
 
Accordingly, the judgment of the court of appeals is reversed, and the 
judgment of the trial court is reinstated. 
Judgment reversed. 
 
MOYER, C.J., DOUGLAS, COOK and LUNDBERG STRATTON, JJ., concur. 
 
F.E. SWEENEY and PFEIFER, JJ., dissent and would affirm the judgment of 
the court of appeals. 
__________________ 
SUPREME COURT OF OHIO 
6 
 
Janet E. Jackson, City Attorney, Stephen Porte and Jeffrey D. Porter, 
Assistant City Attorneys, for appellant. 
 
Chernesky, Heyman & Kress, P.L.L., Thomas P. Whelley II, Mark S. 
Feuer and Danyelle S.T. Coleman, for appellee. 
 
Barry M. Byron, Stephen L. Byron and John Gotherman, urging reversal 
for amicus curiae Ohio Municipal League. 
__________________