United States

New Jersey: Tax Court Rules in Favor of Taxpayer in Latest Throwout Dispute

Feb 13, 2017
From KPMG TaxWatch

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The New Jersey Tax Court recently held that certain receipts were not subject to New Jersey’s Throwout Rule. Recall, this now-repealed rule affected the computation of the New Jersey sales factor by excluding from the numerator and denominator receipts attributable to a state or foreign country “in which the taxpayer is not subject to a tax on or measured by profits or income, or business presence or business activity.” The constitutionality of the throwout rule has been the subject of much litigation. In Whirlpool Properties, Inc. v. Director, Div. of Taxation, the New Jersey Supreme Court held that the rule operated permissibly with respect to receipts attributed to states where the taxpayer was protected under Public Law 86-272, or simply did not have the requisite contacts to establish nexus. However, the rule was facially unconstitutional with respect to receipts attributable to states that could impose a tax but had declined to do so.

In the case at hand, a California-headquartered company filed corporate tax returns in six states, including New Jersey. The taxpayer had inventory in seven states, but did not file in two of these states. In addition to earning revenue from product sales, the taxpayer reported significant capital gains relating to the sale of a discrete business line. On audit, the New Jersey Division of Taxation removed or “threw out” of the denominator receipts attributable to all but the six states where the taxpayer filed returns. The taxpayer protested this treatment and the matter went before the tax court on a summary judgment motion. The tax court first ruled that the were “legitimate grounds” for reversing the Division’s determination that only receipts reported to the six states where the taxpayer actually filed returns should be included in the sales factor denominator. Notably, in several states where the taxpayer was protected under Public Law 86-272, its receipts were potentially subject to throwback and it had inventory in at least two states which gave the state a basis upon which it could impose tax. Furthermore, the court rejected the Division’s position that the capital gain should be thrown out of the receipts factor denominator because the gains were not subject to tax in another state- notably California where the taxpayer was headquartered. California, by regulation, permits exclusion from the sales factor of certain items such as capital gains “to avoid distortion.” The court agreed that this exclusion did not mean that such receipts were not “subject to tax.” The key inquiry is whether the other state has “the ability to tax, not actual taxation.” Please contact Jim Venere at 973.912.6349 with questions on Elan Pharmaceuticals, Inc.  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.