The New Jersey Tax Court Considers Application of the Business Allocation Formula of the Corporation Business Tax Act to a Foreign Corporation’s Sale-Leaseback Transaction
In a recent summary judgment opinion, the Tax Court of New Jersey considered the effect of the Corporation Business Tax Act N.J.S.A. 54:10A-1 (“CBT”) on a foreign business corporation which entered into a sale-leaseback transaction with the New Jersey Transit Corporation (“NJ Transit”). In General Foods Credit Invs. #3 Corp. v. Director, Div. of Taxation, 2017 N.J. Tax LEXIS 3 (Tax Ct. Feb. 22, 2017) [Subsequently approved for publication in the New Jersey Tax Court Reports], NJ Transit sold a fleet of buses (the “Assets”) to the Plaintiff, a Delaware Corporation. The Plaintiff in turn, leased the Assets back to NJ Transit for use as public transportation in New Jersey. The sole purpose of the transaction was to transfer the federal tax benefits (deductions for depreciation and amortization) to Plaintiff, while allowing NJ Transit to have operational control over the Assets. As a public entity, NJ Transit pays no federal tax and had no use for the tax benefits.
Although such transactions are not disallowed, ultimately, based upon the specific facts of the transaction at issue, the Internal Revenue Service (“IRS”) determined that Plaintiff had not acquired and retained the attributes of a traditional owner over the Assets. As a result, the IRS disallowed the interest, depreciation and amortization expenses that Plaintiff had claimed on federal tax returns in connection with the transaction. Plaintiff appealed that decision to the United States Court of Appeals for the Second Circuit, which affirmed the decision, after which Plaintiff entered into a binding Closing Agreement with the IRS. As required by N.J.S.A. 54:10A-13 of the CBT, Plaintiff notified the Director of the Division of Taxation of the State of New Jersey of the IRS adjustments. In amending its New Jersey tax returns to reflect the IRS’s determination that Plaintiff had not obtained an ownership interest in the assets, Plaintiff’s New Jersey tax burden was reduced, as its business allocation fractions under the CBT (explained further below) decreased. The Director disagreed, accepting the Plaintiff’s increased income due to the changes to the federal returns, but rejecting Plaintiff’s proposed adjustments to its business allocation formulas. The Director asserted that the assets were properly included in the property allocation fraction and thus income derived from the property should be included in the business allocation fraction. The disagreement led to the matter before the Tax Court.
In reaching its decision on Plaintiff’s summary judgment motion, the Tax Court reviewed the operation of the CBT with respect to foreign corporations. The CBT imposes an annual franchise tax on a domestic corporation for the privilege of doing business within the state, and on a foreign corporation for the privilege of having or exercising its corporate franchise in this State, or for the privilege of doing business, employing or owning capital or property, maintaining an office, deriving receipts, or engaging in contracts in New Jersey. The tax applies to all domestic and foreign corporations having a taxable status unless exempt. The income-based tax is measured by the corporation’s entire net income. As the Court acknowledged, however, New Jersey is constrained by the Constitution to tax only that portion of corporate income “that has a sufficient nexus to the State and is fairly attributable to the taxpayer’s economic activity here.” The portion of a foreign entity’s income subject to the CBT is determined by multiplying the entity’s entire net income by an allocation fraction pursuant to N.J.S.A. 54:10A-4(b). For the tax years relevant to the matter at issue, the allocation fraction was equal to the average of four fractions: a property fraction, a payroll fraction, and a receipts (or sales) fraction which was considered twice. [Note that the CBT apportionment formula changed as a result of legislative action in 2011 – the tax years at issue in this case were 2007-2009]. Each fraction is derived based upon a corporation’s property or activity that is located in or fairly attributable to New Jersey divided by the value of the property or activity from all sources within or without the State of New Jersey.
In determining whether the assets at issue in this matter were subject to the property (or sales) fractions, the Court noted that it was not constrained by the IRS determination and reviewed the New Jersey Supreme Court’s decision in Reuben H. Donnelley Corp. v. Director, Div. of Taxation, 128 N.J. 218 (1992). In that matter, the Court determined that certain assets included in equipment leases which were approved by Congress under the Economic Recovery Tax Act (“ERTA”), while permitted under the federal tax code, were not to be included under the property allocation fraction for purposes of the CBT as the entity was not the true owner of the property at issue. In the present matter, while the transaction between Plaintiff and NJ Transit was a sale-leaseback transaction that was not identical to the transaction in Donnelley, the Court found the Donnelley decision persuasive. As the purpose of the transaction was to transfer the tax benefits without any intention of using the Assets for Plaintiff’s business purposes, they were not Plaintiff’s property for purposes of its business allocation fraction under the CBT. Accordingly, Plaintiff’s treatment of the change was proper and summary judgment was granted in Plaintiff’s favor.
The attorneys at Sandelands Eyet LLP have significant experience representing clients before the Internal Revenue Service and state taxing authorities in tax controversies including examinations/audits, administrative appeals, United States Tax Court litigation, federal voluntary disclosures, multistate voluntary disclosures, and collections matters. Every tax controversy matter in New Jersey is complicated and fact specific. We encourage you to contact us to discuss your particular situation.