New Jersey

Subscribe to New Jersey

The New Jersey Tax Court denied a holding company’s motion for partial summary judgment seeking a determination that the taxpayer lacked nexus with New Jersey and would not be required to file corporation business tax returns. The taxpayer’s only connection to the state of New Jersey was the receipt of royalties from an affiliate doing business in New Jersey. The taxpayer argued that its facts were distinguishable from those in Lanco, Inc. v. Dir., Div. of Taxation, 188 N.J. 380 (2006), in which the New Jersey Supreme Court held that an out-of-state company lacking a physical presence in New Jersey was deemed to be doing business in the state by receiving state-sourced royalty income. The court acknowledged that the taxpayer’s facts appeared to be distinguishable from the facts in Lanco, but noted that the facts regarding the taxpayer’s activities in the state were not sufficiently developed in the motion and that discovery was still incomplete and pending. As a result, the court denied the taxpayer’s motion but left open the question of whether the taxpayer had sufficient contact with the state to satisfy the Due Process and Commerce Clauses of the U.S. Constitution. Crown Packaging Technology, Inc. v. Dir., Div. of Taxation, Dkt. No. 003249-2012 (N.J. Tax Ct. Feb. 26, 2019).

The New Jersey Tax Court ruled that a corporation was entitled to apportion its corporate income based on a “regular place of business” outside of New Jersey. This now-repealed apportionment requirement was the source of several New Jersey Tax Court cases. For tax years beginning before July 1, 2010, N.J. Rev. Stat. § 54:10A-6 provided that corporations must maintain a regular place of business outside of New Jersey as a prerequisite to apportion its income. The court rejected the New Jersey Division of Taxation’s interpretation of its regulation, N.J.A.C. 18:7-7.2. Notably, the court disagreed with the Division’s contention that all of the regulation’s factors for finding a regular place of business must be met. And, the court also rejected the Division’s position that an employee’s employer is determined based on which entity is paying the employee, rather than which entity directs and controls the employee. (ADP Vehicle Registration, Inc. v. Division of Taxation, Dkt No. 014946-2014 (N.J. Tax Ct. Dec. 11, 2018)).

The New Jersey Tax Court rejected a taxpayer’s due process claim finding that the Division of Taxation properly issued the notice of assessment. The taxpayer made three arguments: (1) that the Division issued the assessment in the name of the predecessor corporation instead of the successor corporation, (2) that the assessment was addressed to the wrong zip code, and (3) that the taxpayer’s third-party mailroom routed the assessment to the wrong location. In addressing each of these claims, the court reasoned that the taxpayer’s officer executed prior statute waivers in the name of the predecessor corporation and that the assessment was delivered to the proper address where agents of the taxpayer accepted and signed the mail return receipt card. Although there was evidence that the taxpayer’s mailroom routed the assessment to a different location, the court found that the taxpayer’s neglect was not excusable and that it was responsible for its organization’s failure to take prompt action to respond to the assessment. (Merrill Lynch Credit Corporation v. Division of Taxation, Dkt. No: 004230-2017 (NJ Tax Ct. Sep. 28, 2018) WL 4718875).

The New Jersey Tax Court rejected the Division of Taxation’s application of a five-factor alternative apportionment formula as invalid rulemaking under New Jersey’s Administrative Procedures Act (APA). The Tax Court previously determined that an application of the statutory apportionment formula in effect prior to 2011 for companies without a “regular place of business” outside New Jersey did not fairly reflect the taxpayer’s in-state business activities and remanded the case to the Division so that other apportionment methods could be considered. The Division then proposed a modified five-factor formula. The Tax Court found that while the five-factor formula could be an acceptable exercise of the Division’s discretionary authority to adjust the taxpayer’s apportionment formula, it nevertheless constituted an impermissible “de facto rule-making” in violation of the APA.

Canon Fin. Servs., Inc. v. Director, Div. of Taxation, No. 000404-2014 (N.J. Tax Ct. Dec. 5, 2018).

On December 21, the New Jersey Division of Taxation released Technical Bulletin TB-85, which addresses how the Division will expect taxpayers to calculate the amount of so-called global intangible low-taxed income (GILTI) and foreign derived intangible income (FDII) that are taxable for New Jersey corporation business tax (CBT) purposes.

Background: GILTI and FDII under Federal Tax Law

The Federal Tax Cuts and Jobs Act (TCJA) created a new category of income under Internal Revenue Code (IRC) section 951A, known as GILTI.  This provision imposes a tax on U.S. shareholders based on income from controlled foreign corporations (CFCs), to the extent that this income is in excess of a nominal 10% return on the tangible assets of the CFCs.  GILTI is taxed at the regular federal tax rates, but a deduction is generally allowed for 50% of the amount of GILTI included in a taxpayer’s federal gross income under IRC section 250(a)(1)(B). Additionally, foreign tax credits are available to offset the federal income tax imposed on GILTI, with credits limited to 80% of the amount of foreign taxes paid.

The TCJA also identified a new category of income, FDII, which calculates an amount similar to GILTI (i.e., a proxy for intangible income based on an assumed 10% return on tangible depreciable asset basis) and multiplies that amount by the fraction of the income earned in the United States that is attributable to property sold or licensed to a non-U.S. person for foreign use or to services provided outside the United States.  Under IRC section 250(a)(1)(A), taxpayers are generally permitted a deduction from income equal to 37.5% of FDII.

New Jersey Treatment of GILTI and FDII

New Jersey Legislation

New Jersey legislation has confirmed that a corporate taxpayer must include the amount of GILTI calculated under IRC section 951A in its taxable income base for CBT purposes, but also may take the deductions related to both GILTI and FDII under IRC section 250(a).  New Jersey law does not provide for any offset of CBT with foreign tax credits.

In a signing statement released in conjunction with October amendments to the CBT, Governor Murphy acknowledged that taxing GILTI “may disproportionately impact certain New Jersey taxpayers.”  Governor Murphy added that he had been assured that the Division “maintains the discretion under existing law to provide relief to individual CBT taxpayers when appropriate to ensure the taxpayer’s CBT obligation fairly reflects its liability”—leaving many to believe that a corporation taxable in New Jersey would be able to request some form of individualized alternative apportionment relief based on its specific circumstances.  Thereafter, Director John Ficara called apportionment relief a “big issue” and said that the Division would provide its “factor relief approach” in public guidance.

The Technical Bulletin

Although Governor Murphy’s signing statement suggested that the Division would take an individualized approach to provide companies with apportionment relief, the Technical Bulletin instead states that all corporations filing a CBT-100 (the general return for most CBT filers) or BFC-1 (the return for banking and financial corporations) will be expected to calculate the amounts of GILTI and FDII taxable for CBT purposes “based on a separate special accounting method.”  Specifically, taxable GILTI and FDII (net of the deductions under IRC section 250(a)) will be calculated using an allocation ratio that is separate from a taxpayer’s generally applicable CBT ratio, and which is “equal to the ratio of New Jersey’s gross domestic product (GDP) over the total GDP of every U.S. state (and the District of Columbia) in which the taxpayer has economic nexus.”  Thus, a taxpayer will have two apportionment factors—one applicable to its entire net income base, and one applicable to its taxable GILTI and FDII.

As an example, the Technical Bulletin states that because the current New Jersey GDP ratio is approximately 3.1%, and corporations currently receive a deduction of 50% of the GILTI inclusion, a corporation with nexus in all states and the District of Columbia would pay CBT on approximately 1.6% of its gross income calculated under IRC section 951A.  The Technical Bulletin’s example does not take FDII into consideration.

Taxable GILTI and FDII will be calculated on a new Schedule A-6.

Potential Considerations

Below is a summary of some of the issues raised by the Technical Bulletin.

  • Lack of Individualized Apportionment Relief:  While the Technical Bulletin suggests that all corporations will calculate the amount of GILTI subject to tax under a single approach, future guidance may be necessary to identify circumstances where, consistent with Governor Murphy’s signing statement, “individual CBT taxpayers” may request another approach to the taxation of GILTI.
    • Eversheds Sutherland Observation:  A taxpayer who is adversely affected by the separate allocation ratio outlined in the Technical Bulletin may have a constitutional argument that the use of U.S. (and U.S. state) GDP data is arbitrary and does not bear a rational relationship to the taxpayer’s activities in New Jersey.
      • Although the Division has taken the position that GILTI is a “hybrid of different income items that largely constitutes displaced U.S. income,” many taxpayers earn GILTI from non‑U.S. activities with little or no connection to New Jersey.  The allocation of GILTI based on U.S. (and U.S. state) GDP figures may not properly address issues of factor representation, and thus may cause unconstitutional distortion.
      • States generally apply the unitary business principle to require a taxpayer to apportion all of its unitary business income to the state using one single apportionment method for all of the activities of the unitary business.  To the extent that GILTI is earned from activities of a single unitary business, New Jersey’s requirement that a taxpayer allocate GILTI to the state using a separate and different allocation ratio may raise issues under the unitary business principle as outlined by the U.S. Supreme Court.
  • Calculation of the Allocation Ratio:  The amount of GILTI allocated to New Jersey will depend on the states in which a taxpayer has “economic nexus.”  However, New Jersey law does not provide a bright line economic nexus standard for CBT purposes, and the Technical Bulletin does not address how a taxpayer should determine whether or not it has economic nexus in a particular state.
    • Eversheds Sutherland Observation:  In Lorillard Licensing Company LLC v. Dir., Div. of Taxation, the New Jersey Superior Court, Appellate Division held that New Jersey’s economic nexus standard must be applied to determine whether a taxpayer is “subject to tax” in other jurisdictions for purposes of New Jersey’s (now repealed) Throw-Out Rule.  29 N.J. Tax 275 (App. Div. 2015), certif. denied, 226 N.J. 212 (2016).  Further, the court held that it is irrelevant whether the taxpayer actually filed returns in or paid tax to those other jurisdictions.  This judicial authority may be applicable when determining the states in which a taxpayer has economic nexus for purposes of calculating its GILTI allocation ratio.
  • Combined Reporting:  New Jersey has adopted a combined reporting regime for tax years ending on or after July 31, 2019.  The Technical Bulletin does not address whether an entity filing a combined return may calculate a single allocation ratio based on the total number of states in which any group member has economic nexus (or if each group member with GILTI will have to calculate an allocation ratio separately).
  • Winners and Losers:  New Jersey’s proposed approach, requiring all corporations to allocate GILTI using a ratio based on U.S. (and U.S. state) GDP, will have a disparate impact on taxpayers.  Under the Division’s approach, taxpayers with nexus in numerous states, but having a relatively higher “general” New Jersey apportionment factor, will be treated more favorably than taxpayers conducting business in a small number of states and having a relatively smaller “general” New Jersey apportionment factor.  For instance, based on U.S state GDP data, a taxpayer that is only conducting business in New Jersey, New York, and Connecticut would have a GILTI allocation ratio of approximately 24.7%.  However, it is possible that the taxpayer’s standard New Jersey apportionment factor is much less (or much higher) than 24.7%, depending on its business.
    • Eversheds Sutherland Observation:  Including a rule in future draft regulations to allow a taxpayer to use the lesser of its separately calculated GILTI allocation ratio or its standard New Jersey apportionment factor to allocate its GILTI inclusion would prevent this unfair result.

Conclusion

The Division intends to promulgate regulations addressing the allocation of GILTI and FDII consistent with the approach outlined in the Technical Bulletin.  Under New Jersey law, the Division will prepare draft regulations, and take comments on such draft regulations, prior to issuing regulations in final form.  As such, New Jersey taxpayers who are especially disadvantaged by New Jersey’s current approach to taxing GILTI and FDII may want to consider preparing comments, either now or shortly after draft regulations are released, outlining their concerns.

The New Jersey Tax Court rejected the taxpayer’s argument that the partnership filing fee, which requires a partnership with New Jersey source income to pay a per-partner fee of $150 (capped at $250,000), violated the Commerce Clause. The Tax Court held that the filing fee is not facially discriminatory because all partnerships must pay the fee regardless of the location of the partnership or partner, or the nature of the partnership’s business, provided the partnership earns New Jersey source income. The Tax Court also held that the plaintiff failed to prove that the filing fee, in practical effect, discriminates against interstate commerce. The Tax Court ruled that the filing fee did not “implicate or violate” the Commerce Clause because the fee is imposed to cover the government’s cost of processing and reviewing the New Jersey returns of partnerships and their partners, which, according to the Tax Court, is a purely intrastate activity.

Targa Resources Partners, L.P. v. Director, Division of Taxation, 010749-2015 (N.J. Tax 2018)

Ferrellgas Partners, L.P. v. Director, Division of Taxation, 007051-2014 (N.J. Tax 2018)

The New Jersey Tax Court upheld the New Jersey Division of Taxation’s use of the 25/50/25 sourcing rule for “certain services” against a provider of mass messaging services by fax, email and voice. Specifically, the court upheld the Division’s determination of a 76% receipts factor, which consisted of 25% for all transactions originating in New Jersey, 50% for all transactions performed in New Jersey, and 1% for the percentage of transactions that terminated in New Jersey. Because the court determined that the taxpayer performed its service entirely in New Jersey, it stated that a 100% receipts factor could also have been appropriate under a cost-of-performance sourcing method.

 

Xpedite Sys., Inc. v. Division of Taxation, No. 018847-2010