United States: New Jersey Division Of Taxation Addresses Sourcing Of Income From Gift Card Sales

On June 29, the New Jersey Division of Taxation issued a letter ruling addressing the application of the Corporation Business Tax (CBT) to the sourcing of income from a taxpayer's sales of stored value cards, gift cards, and gift certificates to retailers.¹ The redemption fees attributable to a consumer's redemption of gift cards in stores located in New Jersey, and the income recognized from dormant gift cards and deferred unredeemed gift cards, which were activated in New Jersey, were sourced to the numerator of the CBT sales factor. The taxpayer's investment income was sourced to its commercial domicile in New Jersey, since the cash on hand for the investment was managed from the taxpayer's New Jersey office.

Facts

The taxpayer was incorporated in Florida, with an office location and business operations in New Jersey. The taxpayer was engaged in the business of issuing and selling stored value cards, gift cards, gift certificates and similar items (collectively referenced in the letter ruling as "Gift Cards") to a group of affiliated national retailers. The Gift Cards could be loaded and reloaded with monetary value and redeemed by owners of the cards for merchandise or services purchased at various store locations of the affiliated retailers. Under the agreement between the taxpayer and the affiliated retailers, the Gift Cards were sold at the retailers' store locations throughout the United States. When a consumer purchased a Gift Card at a store location, the taxpayer would pay the appropriate retailer a commission to activate the Gift Card.

The taxpayer also sold Gift Cards to unrelated third parties, including business-to business customers and aggregators. Business-to-business customers purchased Gift Cards in bulk for their own use, such as fundraising activities or reward programs. Consumers who ultimately obtained Gift Cards from business-to-business customers redeemed them at store locations of the Retail Affiliates. Gift Cards sold to aggregators, on the other hand, were distributed to third-party retailers nationwide (including supermarkets and drug stores) for ultimate sale to consumers. When a consumer purchased a Gift Card from a third-party retailer, the Gift Card was activated by the third party retailer and the aggregator remitted the value of the Gift Card to the taxpayer, net of an agreed fee. The end consumer then redeemed the Gift Cards at a location of the affiliated retailer.

The taxpayer utilized a third-party financial company, which for a fee, managed the activations, reporting and card production activity. While the taxpayer itself maintained records of the Gift Card redemptions that took place at the retail affiliates' store locations on a state-by-state basis, the taxpayer did not have the ability to track all activations on a state-by-state basis.

When a Gift Card was activated, the taxpayer recorded a cash asset and a corresponding liability. Upon redemption of a Gift Card, the taxpayer reimbursed affiliated retailers for the amount of the redemption and received a redemption fee from the retailers for each redemption transaction.

The activation and redemption of the Gift Card by the end consumer did not produce taxable income to the taxpayer. However, the redemption fees paid by the affiliated retailers to the taxpayer constituted taxable income to the taxpayer. In addition to the redemption fees, the taxpayer recognized income from "breakage" payments resulting from dormant Gift Cards that were not legally subject to escheat, and also from any Gift Card balances that were unredeemed after one year (under the IRS advance payment deferral rule).² Finally, the taxpayer recognized additional income from the investment of cash on hand. Accordingly, the taxpayer generated three separate income streams as a result of its activities involving Gift Cards. The taxpayer requested guidance on how each of these streams of income should be sourced for purposes of the New Jersey CBT sales factor.³

Discussion

The Division addressed these issues by explaining the business allocation formula under the CBT. The CBT sales factor is determined by including receipts from sales attributable to New Jersey in the numerator and including the total amount of receipts everywhere in the denominator. The Division implicitly concluded that the taxpayer's income streams all constituted intangible income. The Division explained that intangible income is sourced to New Jersey when it is generated from markets or customers located in New Jersey. The regulations state that the "taxable situs of an intangible is the commercial domicile of the owner or creditor unless the intangible has been integrated with a business carried on in this State."⁴ The Division found that the redemption fees and the breakage payments and deferred unredeemed Gift Card balances were integrated with the business that the taxpayer conducted in New Jersey.

Redemption Fees

With respect to the redemption fees earned by the taxpayer, the Division asserted that the taxpayer's sales of Gift Cards constituted a multistate business directly related and integrated with the Gift Card redemptions at the affiliated retailers' stores. Therefore, the taxpayer was required to source the income from redemption fees based on a "market sourcing" approach. Accordingly, the Division ruled that the fees attributable to redemptions that take place at stores located in New Jersey were to be sourced to the numerator of the CBT sales factor.

Breakage Payments and Deferred Unredeemed Gift Card Balances

Like the redemption fees, the Division ruled that the breakage payments and deferred unredeemed Gift Card balances should be sourced based on the "market sourcing" approach. The state-by-state redemption data available to the taxpayer could be used to allocate and source the breakage payments and deferred unredeemed balances since the taxpayer lacked state-by-state information with respect to activations. The Division essentially concluded that the redemption data was an accurate representation of the market for purposes of sourcing this income stream.

Miscellaneous Investment Income

While the market-based sourcing rules applied to both the redemption fees and the income unused or unredeemed Gift Cards, the Division held that these rules did not apply to the investment of cash on hand. The Division reiterated that the investment income, relating to a taxpayer's multistate trade or business, should be sourced to the commercial domicile of the owner or creditor unless the intangible is integrated with a business carried on outside the state. As the cash was managed from the taxpayer's New Jersey office, the Division ruled that the taxpayer's commercial domicile was New Jersey. The investment did not relate to the sale and redemption of the Gift Cards carried on throughout the United States. The Division also pointed out that the taxpayer's "Section 8" request that the investment income be allocated differently did not meet the requirements of a formal request for an adjustment in the allocation.⁵

Commentary

Given New Jersey's recent adoption of legislation that gradually phases in a single sales factor apportionment formula for purposes of the CBT between January 1, 2012 and January 1, 2014, guidance on how the Division treats particular income streams for purposes of the sales factor is extremely important.⁶ This is especially true for sales of items other than tangible personal property. Historically, the Division has not provided much guidance on the allocation of receipts from intangibles with the exception of its regulation covering "other receipts" that applies the "taxable situs" rule.⁷ This particular letter ruling has significant application for multistate retailers that may recognize significant amounts of revenue from intangible sources by relying upon gift cards as a means to maximize their businesses.

The implicit observation that redemption fees, breakage payments and deferred unredeemed gift card balances are intangibles for purposes of the CBT sales factor is not surprising. Given that characterization, it is logical that these intangibles should be sourced in a manner that takes into account the multistate nature of the taxpayer's business. Interestingly, the ruling permitted the use of state-by-state redemption data, in the absence of state-by-state activation data, to determine the sourcing of breakage payments and deferred unredeemed gift card balances. This approach recognizes that taxpayers may be limited in the amount of information they may have in determining where the activities of third parties or customers ultimately take place. The Division's allowance of a reasonable method of allocation will make it less burdensome for issuers of gift cards to accurately source these revenues.⁸

Footnotes

1 Letter Ruling 2012-5-CBT, State of New Jersey Division of Taxation, Regulatory Services Branch, June 29, 2012.

2 Pursuant to IRS Rev. Proc. 2004-34.

3 New Jersey apportions income by applying a three factor business allocation formula based on property, payroll, and double weighted sales. A single sales factor is being phased in between January 1, 2012 and January 1, 2014. See N.J. REV. STAT. § 54:10A-6.

4 N.J. ADMIN. CODE tit. 18, § 7-8.12(e).

5 "Section 8" refers to a taxpayer's ability to request alternative apportionment for purposes of the CBT pursuant to N.J. REV. STAT. § 54:10A-8. The proper format of a request for a different allocation method is laid out in N.J. ADMIN. CODE tit. 18, § 7-10.1.

6 New Jersey S.B. 2753, Laws 2011, effective April 28, 2011.

7 See N.J. ADMIN. CODE tit. 18, § 7-8.12(e).

8 For purposes of New Jersey's unclaimed property law, recently adopted legislation eventually will require issuers of stored value cards to obtain the address of the purchaser or owner of such cards. When this requirement is placed into effect, the information obtained may be helpful in determining where to source revenues from such cards for CBT purposes. See N.J. STAT. § 46:30B-42.1(c).

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