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International Schools Services, Inc. v. West Windsor Township

207 N.J. 3, 21 A.3d 1166 (2011)

TAXATION; EXEMPTION — A non-profit entity, otherwise qualified for a property tax exemption, is not qualified for such an exemption when it has become inseparably entangled with for-profit entities because the tax exemption would be an advantage for the for-profit entity at the expense of taxpayers.

A non-profit organization, with a tax-exempt status under Section 501(c)(3) of the Internal Revenue Service Code, owned and occupied property. It maintained numerous interrelationships with other non-profit and for-profit corporations. One was with a for-profit corporation that provided insurance and investment services to educational communities abroad. The non-profit organization provided start-up funding for this for-profit organization and extended it an unsecured line of credit. The for-profit corporation made interest payments, but not principal payments. In 2000, the for-profit corporation entered in an agreement with a financial services entity. It allowed the financial services entity to service the international educational community on behalf of the for-profit corporation. The for-profit corporation then began to lease office space from the non-profit organization at a below market rent. The president of the non-profit organization also served on the for-profit organization’s board and was its interim president for a brief period of time.

The non-profit organization filed a real estate tax appeal. Prior to the relevant tax years, the leasing arrangement had ended.

Another organization related to the non-profit organization was a for-profit New Jersey corporation that offered insurance products to the international educational community. This for-profit corporation was a joint creation of the first for-profit corporation with a 51% interest, and another financial group with a 49% interest. During the tax years at issue, the non-profit organization’s president served as Chairman of the Board of this for-profit corporation. It also leased office space from the non-profit organization. The rent was in the range of 1/3 to 1/4 of what the non-profit organization could charge on the open market. The for-profit corporation was also the only tenant not required to pay escalation charges for taxes, utilities, and insurance.

The property was exempt from taxation from 1990 through 2001 as to the portions of the non-profit organization’s property that it actually occupied. However, the exemption was denied for 2002 and 2003 after the municipality reviewed the activities at the property. The non-profit organization then appealed to the Tax Court which decided the matter by using the three-prong test from Paper Mill Playhouse v. Millburn Township. It found that the non-profit organization had not satisfied the first prong requiring that an entity seeking a tax exemption must be “organized exclusively for the moral and mental improvement of men, women, and children.”

The non-profit organization appealed and the Appellate Division reversed the decision. It found that the purpose of this particular non-profit organization was to aid and promote educational organizations abroad. Therefore, it satisfied the first prong of the Paper Mill Playhouse analysis. It remanded the case back to Tax Court to address the remaining prongs of the test.

On remand, the Tax Court held that the second prong of the Paper Mill Playhouse test was not satisfied. It found that the schools, not the non-profit organization, were performing the activities sufficient for tax exemption, and the non-profit organization was merely assisting them. The Tax Court also found that the third prong of the test was not met because the non-profit organization only operated and maintained the property for the purpose of making a profit. It focused on the rent charged to the two for-profit corporations, the unsecured loan to the first for-profit corporation, and that the non-profit organization had allowed the use of its name and reputation to promote profit making ventures.

The non-profit organization appealed again. This time, the Appellate Division disagreed with the Tax Court’s finding under the second prong of the Paper Mill Playhouse test. However, it agreed that the non-profit organization failed the third prong of the test, finding that the various subsidies provided to the for-profit corporations made the non-profit organization ineligible for a property tax exemption. The New Jersey Supreme Court then granted the non-profit organization’s petition for certification.

The New Jersey Supreme Court held that the municipality properly denied a property tax exemption to the non-profit entity for the tax years 2002 and 2003 because the commingling of efforts and the entanglement of activities and operations by the non-profit entity and its profit-making affiliates was significant and substantial, with the benefit in the form of direct and indirect subsidies flowing only one way, i.e. from the non-profit entity to the for-profit entities.

The Court held that N.J.S.A. 54:4-3.6, a statute granting exemption from property taxation, should be subject to strict construction and the party seeking exemption bears the burden of proving entitlement. The court in Paper Mill Playhouse listed three requirements that an entity must satisfy in order to obtain a property tax exemption under the statute. The requirements are: (1) it must be “organized exclusively for the moral and mental improvement of men, women, and children”; (2) its property must be actually and exclusively used for the tax-exempt purpose; and (3) its operation and the use of its property must not be conducted for profit

This test was altered by legislative action subsequent to the Paper Mill Playhouse decision. A legislative amendment eliminated the test’s second prong’s exclusivity requirement. The statute presently permits an exemption for property that is “actually used” in connection with tax-exempt functions.

The Legislature’s amendment of the statute to eliminate the “exclusivity-of-use” requirement meant that property of a non-profit exempt-entitled entity can be used for non-exempt purposes so long as the two purposes can be separately accounted for, and if the non exempt use is not granted the exemption. This amendment thus raised the question as to whether the Legislature’s elimination of the exclusivity requirement now allowed a non-profit entity to conduct for-profit activities in a commingled fashion on its owned and occupied property, not just to support for-profit activities of another entity, but also to support the for-profit activities of others. The Court reasoned that the Legislature did not intend to allow a non-profit entity to gain the benefits under the non-exclusivity clause of prong two and engage in for-profit activities that were not conducted to be separately accountable for taxing purposes. According to the Court, the legislative changes presumed an ability to identify, segregate, and measure any for-profit activity. Allowing a non-profit entity to claim an exemption when it has became inseparably entangled with for-profit entities would be an advantage for the for-profit entities at the expense of the taxpayers.

The Court reiterated that the claimant of an exemption has the burden to establish its right to the exemption. Here, according to the Court, the non-profit entity was found to be at fault for being unable to distinguish between its non-profit activities on its owned and occupied property and the activities on the property that were promoting the interests of the for-profit entities. The non-profit entity commingled its financing and operations with the for-profit entities. In reaching this conclusion, the Court looked at the below market rents, the unsecured loans that were not timely repaid, and other activities. Consequently, the Court held that the Appellate Division properly affirmed the denial of the tax exemptions for 2002 and 2003.

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