United States

New Jersey: Tax Court Addresses Sourcing Receipts from Mortgage Activities

Mar 28, 2016
From KPMG TaxWatch

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Recently, the New Jersey Tax court addressed whether certain receipts from acquiring, servicing, and selling mortgages and mortgage-backed securities were included in a taxpayer’s New Jersey sales factor numerator. The taxpayer, a multistate bank headquartered in Michigan, originated mortgage loans from retail loan centers in New Jersey. It also purchased mortgages originated by independent mortgage brokers and lenders as part of its wholesale loan business. The “vast majority” of the loans originated or acquired by the taxpayer were sold to Government Sponsored Entities (GSEs) in exchange for mortgage-backed securities that were then sold to broker-dealers. After the taxpayer sold a loan, it typically retained the rights to service the loan. However, occasionally it packaged the servicing rights and sold them to another provider. On returns filed as part of a Voluntary Disclosure Agreement, the taxpayer included in its New Jersey receipts factor numerator only interest income earned on loans originated at in-state retail locations. On audit, the Division of Taxation determined that all types of receipts (interest, mortgage servicing fees, loan origination fees, proceeds from the sale of servicing rights, and the gross proceeds from sales of mortgages) associated with loans secured by New Jersey real property should have been included in the numerator. The taxpayer disagreed with the assessment, and the matter eventually came before the tax court.

Under a New Jersey regulation, intangible income not apportioned under other provisions of the law is included in the numerator of the receipts factor if the taxable situs of the intangible is in New Jersey. An intangible has a taxable situs in New Jersey if it is integrated with a business carried out in the state. The Director asserted that all of the taxpayer’s various revenue streams were considered income from intangibles (i.e., the loans) and that all income associated with loans secured by New Jersey real property should have been included in the numerator because the loans were integrated with the taxpayer’s New Jersey business. The taxpayer, on the other hand, argued that income associated with wholesale loans— the loans acquired from other lenders or brokers was not integrated with its business carried on in New Jersey. The tax court, relying in part on earlier New Jersey cases, disagreed with the taxpayer’s position. Notably, the taxpayer had account representatives resident in New Jersey who worked with the local brokers and lenders from whom the taxpayer purchased loans. Furthermore, the court noted that the taxpayer’s activities associated with originating and acquiring loans were essentially the same, other than processing the original loan application. In the court’s view, the distinction the taxpayer attempted to draw between the origination of loans to New Jersey borrowers, and the purchase of mortgage loans from other New Jersey mortgage lenders, was of no consequence. The court concluded that the interest income and gross proceeds from the sales of mortgage-backed securities associated with loans secured by New Jersey real property were New Jersey receipts. Rejecting the taxpayer’s position that originating loans was akin to performing a service, the court likewise held that origination fees for loans secured by New Jersey real property were New Jersey receipts. However, receipts from servicing mortgages were attributed out of state where the servicing occurred and income from selling the right to service loans was likewise not sourced to New Jersey. In the court’s view, the right to service a loan arose only after the loan was sold and therefore these receipts were not associated with a New Jersey sitused intangible (i.e., the original loan secured by New Jersey property). The court also held that the throwout rule did not apply and that the Director did not err when it imposed underpayment penalties. Post-amnesty penalties, however, were abated because the final assessment was issued after the amnesty period ended. Please contact Jim Venere at 973-912-6349 with questions on Flagstar Bank v. New Jersey Division of Taxation.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

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.