United States

New Jersey: Tax Court Invalidates a Regulation Addressing Investment Company Status

Mar 06, 2017
From KPMG TaxWatch

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The New Jersey Tax Court recently invalidated a regulation that excludes certain non-publicly traded pass-through ownership interests as a qualifying asset when determining New Jersey Investment Company status. Under New Jersey’s Corporation Business Tax Act, “investment companies,” as defined, are eligible for certain tax benefits. Notably, such corporations can elect to be taxed on 40 percent of their entire net income base. The statutory definition of an “investment company” generally looks at whether at least 90 percent of the corporation’s activities consist of owning qualified assets, such as “stocks, bonds notes, mortgages, debentures, patents, patent rights, and other securities for its own account …” In 2006, the Division of Taxation amended the investment company regulation to exclude from the qualifying investment asset test any “direct investment in a non-publicly traded pass-through entity if that entity would not satisfy the definition of investment company if it had been organized as a corporation.” This amendment essentially eliminated any investment in an operating partnership from the definition of “other securities.” Applying the revised regulatory definition, the Division of Taxation determined a taxpayer failed the qualified asset test and could not elect New Jersey investment company status.  The taxpayer argued that the regulation contravened the Legislature’s intent and subsequently filed suit.

Although the Division has a right to issue regulations for the interpretation and application of the CBT Act, the Division may not promulgate regulations that are inconsistent with the underlying statute. The Legislature, the court determined, intended to broadly define “investment company” and deliberately chose to allow companies to invest and reinvest in “other securities.” In determining what is and is not a “security” New Jersey courts have looked to the U.S. Supreme Court for guidance and, based on these authorities, the generally accepted meaning of security included an ownership interest in a pass-through entity when the limited partner did not exercise control over the partnership. As such, the 2006 amendment contravened this definition and exceeded the Division’s authority. In the court’s view, the taxpayer correctly observed that the decision to prohibit companies with direct investments in pass-through entities from qualifying as investment companies was a policy decision to be decided exclusively by the Legislature. However, the court next held that the issue of whether the taxpayer was an investment company was not ripe for summary judgment. Specifically, it was “material to ascertain” whether the taxpayer exercised control over the partnership to discern if the alleged passive partnership interest was an “other security,” which would qualify the taxpayer as an investment company. Please contact Jim Venere at 973-912-6349 with questions on Manheim NJ Investments, Inc. v. 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.