Aug 31, 2015
From KPMG TaxWatch
The New Jersey Tax Court recently addressed whether the adoption of New Jersey’s related party expense disallowance statute in 2002 exempted the recipient of royalty income from filing a Corporation Business Tax (CBT) return. The taxpayer, an intangible holding company with no employees or property in New Jersey, earned royalty income from licensing intangibles to related parties. For the 2000 and 2001 tax years, the taxpayer filed and paid CBT on its royalty income. In 2002, as part of a business tax reform package, the New Jersey Legislature adopted a related party expense disallowance statute requiring taxpayers to add back certain expenses, including royalties, paid to a related party. Royalties were not required to be added back if one of the statutory exceptions was met. On its 2002 CBT return, the taxpayer filed a zero CBT return marked as “Final” requesting a refund of estimated payments. The return noted that the taxpayer’s royalty income, going forward, would be reported by its affiliate. On its New Jersey returns, the affiliate added back the royalty payments made to the taxpayer (i.e., the affiliate did not attempt to qualify for one of the statutory exceptions to the addback rules). The Division of Taxation disagreed with the taxpayer’s position that it was not required to file if the affiliate added back the royalty payments. After several years—during which time the Lanco economic nexus case was finalized—the matter came before the tax court on a motion for summary judgment.
Before the tax court, the taxpayer argued that the Division was imposing duplicative taxes by requiring it to pay CBT on royalties that were added back in computing its affiliate’s CBT. The Division, on the other hand, argued that under Lanco, the taxpayer was required to file and pay CBT and any duplicative taxation was the result of the affiliate not claiming an exception to the add back requirement or the taxpayer or affiliate not seeking some other means of relief, such as alternative apportionment. The tax court first determined that under Lanco, the taxpayer was subject to CBT on its royalty income. Furthermore, when the legislature enacted the related party expense disallowance legislation, which was intended to effectuate certain loophole closers, it did not limit the scope of entities subject to the CBT. The taxpayer relied primarily on dicta regarding the use of an addback provision for capturing royalty income paid to an entity without physical presence in New Jersey from the tax court’s opinion in Lanco as support for its position. However, the court concluded that the language relied on by the taxpayer simply affirmed the Lanco court’s view that denying a payor a deduction for royalties would allow New Jersey to capture the CBT that the intangible holding company previously avoided. However, in the court’s view, this language did not “sanction the out-of-state related member’s entity refusal to file CBT returns.” With respect to the issue of taxation of the royalty income at both the payor and payee level, the court noted that there were mechanisms in place (exceptions to the addback requirements, requesting alternative apportionment) to prevent double taxation and that nothing in the instant case had prevented the taxpayer’s affiliate from claiming an exception to the royalty addback requirement. The court also observed that the taxpayer’s argument presumed that the taxpayer had only royalty income received from one New Jersey-based related member. From year to year this may not necessarily be the case, which, the court pointed out, would lead to odd results and was not likely how the legislature intended to close loopholes. As such, the court concluded that the taxpayer was required under New Jersey law to file returns and pay CBT, effectively saying that potential double taxation issues are best dealt with at the payor level. Please contact Jim Venere at 973- 912- 6349 with questions on Spring Licensing Group, Inc. v. Director, Division of Taxation.
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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.