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Important Ruling on the Throw Out Rule

Author: Frank L. Brunetti|February 9, 2016

NJ Tax Court makes important ruling on the Throw Out Rule

Important Ruling on the Throw Out Rule

NJ Tax Court makes important ruling on the Throw Out Rule

Recently, the New Jersey Superior Court Appellate Division upheld a previous decision that intangible holding companies are not required to throw out any out-of-state receipts.

According to a Reed Smith report, the Court ruled in Lorillard Licensing Company LLC v Director, Div. of Taxation that the state’s economic nexus law is applicable in determining if a company is subject to state tax in other jurisdictions as part of New Jersey’s “Throw Out Rule.” In what was ruled as a favorable decision for taxpayers, the corporation was required to pay lower state taxes on a subsidiary company as New Jersey could not raise its apportionment percentage.

The state’s Throw Out Rule was originally part of the 2002 Business Tax Reform Act that called upon companies to calculate receipts into the corporation business tax apportionment formula.  In essence, the numerator is receipts from a state and the denominator is receipts from all states. One problem is that not all states have a corporate income tax. The Court states that “The Throw-Out Rule modifies the sales fraction into one that divides New Jersey receipts only by taxed receipts.”  If receipts are attributed to states where there is no corporation business tax, then the state tax apportionment percentage increases in New Jersey. Thus, by throwing out receipts from the denominator, the fraction increases the income that is subject to tax by New Jersey.

In a 2011 case, Whirlpool v. Director, the Appellate Court limited the application of the Throw Out Rule to operate constitutionally.  In that instance, the receipts that were thrown out were limited to receipts not taxed by another state because the taxpayer did not have the requisite level of contact with that state to permit it to exert taxing jurisdiction.

Lorillard disputed the application of the Throw Out Rule rule by the New Jersey Division of Taxation. The company argued that in the determination of whether receipts are applicable or were required to be discounted from the denominator, the same economic nexus rule in Lanco, Inc. v. Director, Division of Taxation should have been applicable in this case. Lanco imposed tax upon an out-of-state intangible holding company that received a royalty for use of the intangibles in the state, Therefore, since the company would be subject to tax in those other jurisdictions, the receipts would not need to be discarded.

Oppositely, the New Jersey Division of Taxation argued that the tax itself as well as the state’s ability to tax companies, should be the primary determination for the applicability of the Throw Out Rule. Further, the Division of Taxation believed that the licensing agreement did not subject the company to taxation in other jurisdictions.

The Tax Court ruled in favor of the company after it asserted that it was irrelevant if the corporation filed returns or paid taxes for those receipts in other jurisdictions. The Appellate Division then agreed with the Tax Court that the tax policies of other jurisdictions are not relevant. The only issue is whether another state could assert taxing jurisdiction in a manner that satisfied the Commerce Clause of the Constitution.

The Division of Taxation may take its appeal to the New Jersey Supreme Court. Its argument is that there is a constitutional question or that it has the discretion of the court to pursue an appeal based on the application of the Throw Out Rule. However, from a broader perspective, the decision may only resolve Throw Out issues for the determination of whether intangible holding companies have a nexus in the state because Lanco, Inc. v. Director, Division of Taxation only determined nexus for intangible holding companies with licensing agreements with in-state affiliates. On its face, the ruling does not address the application of the Throw Out Rule to traditionally operating businesses where Whirlpool remains relevant.

Important Ruling on the Throw Out Rule

Author: Frank L. Brunetti

Recently, the New Jersey Superior Court Appellate Division upheld a previous decision that intangible holding companies are not required to throw out any out-of-state receipts.

According to a Reed Smith report, the Court ruled in Lorillard Licensing Company LLC v Director, Div. of Taxation that the state’s economic nexus law is applicable in determining if a company is subject to state tax in other jurisdictions as part of New Jersey’s “Throw Out Rule.” In what was ruled as a favorable decision for taxpayers, the corporation was required to pay lower state taxes on a subsidiary company as New Jersey could not raise its apportionment percentage.

The state’s Throw Out Rule was originally part of the 2002 Business Tax Reform Act that called upon companies to calculate receipts into the corporation business tax apportionment formula.  In essence, the numerator is receipts from a state and the denominator is receipts from all states. One problem is that not all states have a corporate income tax. The Court states that “The Throw-Out Rule modifies the sales fraction into one that divides New Jersey receipts only by taxed receipts.”  If receipts are attributed to states where there is no corporation business tax, then the state tax apportionment percentage increases in New Jersey. Thus, by throwing out receipts from the denominator, the fraction increases the income that is subject to tax by New Jersey.

In a 2011 case, Whirlpool v. Director, the Appellate Court limited the application of the Throw Out Rule to operate constitutionally.  In that instance, the receipts that were thrown out were limited to receipts not taxed by another state because the taxpayer did not have the requisite level of contact with that state to permit it to exert taxing jurisdiction.

Lorillard disputed the application of the Throw Out Rule rule by the New Jersey Division of Taxation. The company argued that in the determination of whether receipts are applicable or were required to be discounted from the denominator, the same economic nexus rule in Lanco, Inc. v. Director, Division of Taxation should have been applicable in this case. Lanco imposed tax upon an out-of-state intangible holding company that received a royalty for use of the intangibles in the state, Therefore, since the company would be subject to tax in those other jurisdictions, the receipts would not need to be discarded.

Oppositely, the New Jersey Division of Taxation argued that the tax itself as well as the state’s ability to tax companies, should be the primary determination for the applicability of the Throw Out Rule. Further, the Division of Taxation believed that the licensing agreement did not subject the company to taxation in other jurisdictions.

The Tax Court ruled in favor of the company after it asserted that it was irrelevant if the corporation filed returns or paid taxes for those receipts in other jurisdictions. The Appellate Division then agreed with the Tax Court that the tax policies of other jurisdictions are not relevant. The only issue is whether another state could assert taxing jurisdiction in a manner that satisfied the Commerce Clause of the Constitution.

The Division of Taxation may take its appeal to the New Jersey Supreme Court. Its argument is that there is a constitutional question or that it has the discretion of the court to pursue an appeal based on the application of the Throw Out Rule. However, from a broader perspective, the decision may only resolve Throw Out issues for the determination of whether intangible holding companies have a nexus in the state because Lanco, Inc. v. Director, Division of Taxation only determined nexus for intangible holding companies with licensing agreements with in-state affiliates. On its face, the ruling does not address the application of the Throw Out Rule to traditionally operating businesses where Whirlpool remains relevant.

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