On June 30, New Jersey Governor Chris Christie signed a constitutionally-mandated balanced state budget for FY 20151 and also signed legislation which makes various changes to the state's tax statutes.2 Specifically, the newly enacted legislation redefines "operational income," limits partners' ability to claim refunds for tax paid on their behalf by in-state partnerships, limits corporate use of net operating loss (NOL) deductions and carryovers after certain debts have been discharged, and establishes click-through sales and use tax nexus. Unless otherwise noted, the amendments are effective for privilege periods ending on or after July 1, 2014.
Operational Income
For businesses subject to New Jersey's corporation business tax (CBT), the classification of income as "operational" or "non-operational" determines whether such income will be allocated among multiple states or specifically assigned to a single state.3 Prior to amendment, "operational income" was defined as "income from tangible and intangible property if the acquisition, management, and disposition of the property constitutes integral parts of the taxpayer's regular trade or business operations and includes investment income serving an operational function."4 As amended, "operational income" is defined as "income from tangible and intangible property if the acquisition, management, or disposition of the property constitute an integral part of the taxpayer's regular trade or business operations and includes investment income serving an operational function."5 Thus, this amendment creates three separate and independent factors, only one of which needs to be satisfied in order to result in "operational income" apportionable to New Jersey for CBT purposes.
This statute was amended in response to the decision by the New Jersey Superior Court, Appellate Division in McKesson Water Products Co. v. Director of Revenue.6 In this case, the Court held that the gain derived from a deemed asset sale under Internal Revenue Code (IRC) Sec. 338(h)(10) was not subject to the CBT because it did not constitute "operational income" as defined in the statute. While the McKesson decision specifically concerned deemed asset sales under IRC Sec. 338(h)(10), the wording of the amendment applies to any transaction subject to an operational/non-operational analysis including actual asset sales, stock sales and various types of investment income.
Partnership Refunds
Partnerships doing business in New Jersey are required to pay tax on behalf of certain out-of-state partners.7 Those payments are then credited to the nonresident partners who can each seek a refund of any amount exceeding their own tax liability. The law is amended to restrict a nonresident partner's ability to obtain those refunds. Specifically, a nonresident partner is now required to file a New Jersey tax return reporting all income that is subject to New Jersey state tax in order to receive credit for the tax remitted by the partnership on the partner's behalf.8 The legislation further provides that a refund cannot be claimed by the partnership itself. Essentially, this new provision overturns the administrative portion of the Appellate Division's decision in BIS LP, Inc. v. Director, Division of Taxation9 by allowing nonresident partners to receive refunds of taxes paid on their behalf only when the nonresident partner is taxable in New Jersey and files a New Jersey return. However, the amendment does not address the substantive issue of nexus for corporate limited partners addressed in BIS.
Net Operating Losses
The legislation enacts the requirement that any newly created NOL or carryovers to privilege periods ending after June 30, 2014 must be reduced by the amount that is excludable from federal taxable income as a discharge of indebtedness due to bankruptcy, insolvency, or qualified farm indebtedness as outlined in IRC. Sec. 108(a)(1)(A), (B), and (C).10
Click-Through Nexus
In an effort to even the playing field between online-only and brick-and-mortar retailers, the legislation expands the applicability of New Jersey's sales and use tax through the establishment of a rebuttable presumption of nexus for certain "click-through" activities. For taxable transactions occurring on or after July 1, 2014, the legislation amends the statutory definition of a "seller" required to charge and collect New Jersey tax to include out-of-state sellers who enter into agreements with independent contractors or other representatives with physical presence in New Jersey if those independent contractors or other representatives receive a commission or other compensation for directly or indirectly referring potential customers to the out-of-state seller via Internet link or otherwise.11 For this presumption of nexus to apply, the cumulative gross receipts from such "clickthrough" sales must be in excess of $10,000 during the preceding four calendar quarterly periods.12 If these requirements are met, the duty is imposed on the seller to collect and remit sales tax. To rebut this presumption, the out-of-state seller must prove that the independent contractor or representative did not engage in any solicitation in New Jersey on the seller's behalf that would establish nexus under the United States Constitution.13
Commentary
The turbulent political climate surrounding the new budget centered on Governor Christie's proposal to balance the state's FY 2015 budget in large part by substantially reducing the state's contributions to public employee pension programs. In response to his proposal, the Democratic majorities in both houses passed a budget bill that would have maintained the previously agreed-upon pension contributions and also introduced and passed bills that would have raised revenue needed for the pension contributions by adding a one-year, 15 percent surcharge to the CBT14 and by a temporary three-year increase in personal income tax rates for individuals with personal income over $1 million.15 Before signing the budget bill, Governor Christie vetoed the budgetary provisions pertaining to these tax increases which he said would "[inhibit] growth with crushing taxes" and reduced the state's pension contributions.16
The legislation is noteworthy as it provides remedies to the state's losses in two recent Appellate Division tax decisions. The statement accompanying the introduction of the legislation explains that it is meant to adjust the statutory definition of operational income under the CBT to "clarify" that the acquisition, management, or disposition of an asset may be independent factors in determining qualification as operational income, as opposed to requiring that all three factors be present. Taxpayers should be aware that for privilege periods ending on or after July 1, 2014, types of income classified as "non-operational" in prior tax periods may now be classified as "operational." Further, the legislature's use of the term "clarify" may be of concern since state tax agencies sometimes attempt to retroactively apply new legislation on the basis that it is "clarifying." Based on the Appellate Division's holding in McKesson and the effective dates in the legislation, any attempt by the New Jersey Division of Taxation to apply this change to income received in tax periods preceding the effective date should be viewed with a great deal of skepticism.
The legislation does not directly address another issue relating to IRC Sec. 338(h)(10) transactions that is sometimes raised on audit. Specifically, where a Sec. 338(h)(10) gain has been classified as non-operational, the Division has asserted that the amortization and/or depreciation deducted on the stepped-up basis of the assets should also be classified as non-operational and added back to the apportionable income base.
Due to the amendment of the partnership refund provisions, taxpayers should be aware that refund opportunities for nonresident partners may be affected. The legislation effectively removes the standing of the partnership that pays the tax to claim a refund on behalf of a nonresident partner. Both partnerships and nonresident partners should note this change to avoid running afoul of statute of limitation issues when making a claim for refund. As refunds accruing to prior tax periods will not be affected by the legislation, partnerships and their nonresident partners should examine whether any refund opportunities remain for open prior periods. Taxpayers, particularly those in tiered partnership structures, have previously experienced administrative complexities that required them to work with the Division to ensure proper application of partnership payments on behalf of nonresident partners. Perhaps the new law will help to remedy these situations.
The correction of the NOL "loophole" supersedes previous published guidance17 from the Division and brings the CBT into greater conformity with the corresponding federal provisions. Taxpayers had previously been advised that in computing entire net income for CBT purposes, New Jersey conformed to the federal exclusion of income from cancellation of debt. However, under New Jersey law18 the state NOL deduction had been calculated without regard to federal provisions requiring the reduction of tax attributes. New language added by the legislation19 adopts the federal treatment of NOLs in situations involving cancellation of indebtedness.
As the U.S. Supreme Court demonstrates continued reluctance to hear state nexus cases,20 other states may pass similar legislation expanding their own nexus standards to encompass sales revenue procured through Internet sales. It seems likely that New Jersey's "click-through" provision will withstand judicial scrutiny as it is similar to the New York legislation which has survived legal challenge.21 Issues will remain as to the meaning of "indirect" referrals and whether in-state independent contractors and other representatives are actively soliciting sales or simply advertising. Understandably, the Division has yet to provide guidance in these areas. However, based on the many similarities between the sales and use tax statutes in New York and New Jersey, it may be useful to consult New York's published guidance.22
For planning purposes, it is important to note that the legislation was signed into law on June 30, 2014. As a result, for calendar year taxpayers' financial statements, the legislative changes are considered to be a second quarter event. Also, because the income tax provisions are effective for privilege periods ending on or after July 1, 2014, the changes may apply retroactively. For example, for a calendar year taxpayer, the new definition of "operational income" will be effective for the full tax year beginning on January 1, 2014 because the year-end date of December 31, 2014 is after the July 1, 2014 effective date.
Several provisions that were excluded from the final version of the legislation also should be noted. The highly contentious 75 percent wholesale tax on e-cigarettes and related gear that was originally proposed by Governor Christie in his budget summary is absent from the legislation.23 Due to heavy lobbying from a coalition of 50 independent e-cigarette retailers and the majority Democrats' concessions to gain bipartisan support, no taxes on electronic cigarettes were included in the bill. Also, statutory changes to equalize sales tax rates on purchases by businesses and individuals in the state's Urban Enterprise Zones as mentioned in Governor Christie's original budget message,24 were neither introduced nor acted upon by the legislature.
In reviewing the new tax provisions enacted by the New Jersey legislature taxpayers should note that while the language of these statutory changes is generally quite simple, their application may be far more complex and will likely require a detailed analysis based on each taxpayer's situation.
Footnotes
1. S.B. 2015, Laws 2014. Note that the suspension of all payments from the state's Business Employment Incentive Program (BEIP) for one year remains in the final budget.
2. A.B. 3486, Laws 2014. In the week preceding the budgetary deadline, the legislation was introduced by Democratic leadership in both houses, quickly passed and then forwarded to the governor for signature. While the Office of Legislative Services estimates that the law changes will raise revenues by $110 million in FY 2015, apparently these new provisions, which were initially proposed by the governor in his February budget address, are not viewed as tax increases but rather as "loophole closers."
3. N.J. REV. STAT. § 54:10A-6.1.
4. N.J. REV. STAT. § 54:10A-6.1(a) (emphasis added).
5. Id.
6. 974 A.2d 443 (N.J. Super. Ct. App. Div. 2009).
7. N.J. REV. STAT. § 54:10A-15.11.
8. N.J. REV. STAT. § 54:10A-15.11(b).
9. New Jersey Superior Court, Appellate Division, No. A-1647-12T3, April 11, 2014. In this case, the Appellate Division held that a nonresident limited partner could receive a refund of the CBT paid on its behalf by a limited partnership taxable in the state. For further discussion of this case, see GT SALT Alert: New Jersey Appellate Division Holds Limited Corporate Partner Entitled to CBT Refund of Tax Paid by Related Entity.
10. N.J. REV. STAT. § 54:10A-4(k)(6)(F).
11. N.J. REV. STAT. § 54:32B-2(i)(1)(C).
12. Id.
13. Id.
14. A.B. 3484, Laws 2014.
15. A.B. 3485, Laws 2014.
16. Letter from New Jersey Governor Chris Christie to New Jersey General Assembly, June 30, 2014.
17. State Tax News, New Jersey Division of Taxation, Winter 1996.
18. N.J. REV. STAT. § 54:10A-4(k)(6).
19. N.J. REV. STAT. § 54:10A-4(k)(6)(F).
21. See GT SALT Alert: New York State Court of Appeals Holds Click-Through Nexus Statute is Facially Constitutional.
22. See TSB-M-08(3)S, New York State Department of Taxation and Finance, May 8, 2008; TSB-M- 08(3.1)S, New York State Department of Taxation and Finance, June 30, 2008.
23. For further information, see The Governor's FY 2015 Budget Summary, page 24, at http://www.state.nj.us/treasury/omb/publications/15bib/BIB.pdf.
24. Id. at 32.
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