SALT Blawg – State and Local Tax Blog
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Recently the New Jersey Division of Taxation ("Division") proposed amendments to a corporate business tax rule relating to foreign businesses' responsibilities to file and pay New Jersey's Corporation Business Tax ("CBT"). The proposed amendments are an attempt to clarify changes wrought by the Business Tax Reform Act ("Act"). Enacted July 2, 2002, the Act made numerous amendments to the CBT. Those amendments explicitly established that foreign corporations must pay CBT "for the privilege of deriving receipts from sources within this State, or for the privilege of engaging in contacts within this State."
Subsequent to the enactment of the Act, the New Jersey Supreme Court upheld the imposition of CBT against a corporation that lacked physical presence in the State, but derived income through a licensing agreement of its trademarks with a company in the State. Lanco Inc. v. Director, 188 N.J. 380 (2006). During 1992, the United States Supreme Court determined that, in the context of sales and use taxes, an entity must be physically present within the taxing jurisdiction in order to establish the requisite "substantial nexus." See Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Since the Court's decision in Quill, a split of authority emerged as to whether the Court's holding was limited to sales and use taxes. In Lanco, the New Jersey Supreme Court held that the Quill decision was limited to sales and use taxes, and thus established that the Division could constitutionally apply the CBT tax despite the taxpayer's lack of physical presence in the State.
Based upon the 2002 amendments made by the Act and the Lanco decision, the Division proposed amendments to N.J.A.C. 18:7-1.8(a) to make explicit that, despite not having any physical presence in New Jersey, corporations domiciled outside New Jersey, performing services in New Jersey and receiving income from New Jersey are required to file CBT returns and to pay CBT to New Jersey.
The proposed amendment is also directed specifically towards financial business corporations, banking corporations, credit card companies, or similar businesses performing similar services in New Jersey and domiciled outside of New Jersey ("Financial Businesses"). The Act, as amended, requires that Financial Businesses, which solicit business in New Jersey or receive gross receipts from sources within the State, file a CBT return and pay the applicable CBT to New Jersey.
During 2009, in a consolidated decision, the New Jersey Tax Court held in favor of the taxpayers and declined to extend Lanco's economic-nexus standard to sales of canned software. AccuZIP, Inc. v. Director, Div. of Taxation, N.J. Tax Court Docket No. 005744-2003 (Aug. 13, 2009); Quark, Inc. v. Director, Div. of Taxation, N.J. Tax Court Docket No. 004692-2002 (Aug. 13, 2009). The taxpayers in both cases transferred software on tangible media under a licensing agreement. Both were incorporated and headquartered outside of New Jersey. AccuZIP maintained no employees within the State, while Quark employed one individual who worked from his home. Based upon these facts the Court rejected the concept of economic nexus, distinguished Lanco and held that AccuZIP had insufficient contacts with New Jersey to satisfy the requirement of substantial nexus. Conversely, because Quark had an employee within the state, the court found that Quark was conducting business within the State. However, the court also found that Quark was only subject to the minimum tax because the activities of its New Jersey employee merely helped generate sales orders and therefore were protected by Public Law 86-272.
The AccuZIP court distinguished Lanco by differentiating between tangible and intangible property. According to the court, in AccuZIP the companies sold tangible copyrighted property in the form of CD-ROMs containing prewritten computer software. Conversely, in Lanco, the company generated income from the use in New Jersey of their intangible personal property in the form of trademarks and trade names.
Proposed Amendment: N.J.A.C. 18:7-1.8, announcing the promulgation of the regulation, relies upon Lanco as the determining case law basis for the amendment, without even citing AccuZIP and the court's distinguishing views on the tax implications of licensing agreements involving tangible or intangible property. As such, a reading of AccuZIP might call into question the validity of the regulation.