New Jersey Throw-Out Rule Modified By Tax Court Case
New Jersey’s 2002 implementation of the “throw-out rule” represented an attempt to plug a perceived loophole in the Corporation Business Tax (“CBT”) rules regarding “no-where sales.” Although the rule was repealed for tax periods beginning after June 30, 2010, a new twist has just surfaced that may still impact open years. The New Jersey CBT statute of limitations for a refund is four years from the original due date of the return and does not include any extensions.
The throw-out rule modifies the New Jersey sales factor denominator by excluding sales assigned to a jurisdiction in which the taxpayer is not subject to a tax measured by profits or income. The term “dual nexus” standard has been used to describe the conflicting positions of New Jersey using one standard for subjecting foreign corporations to CBT and another standard when applying the throw-out rule. The New Jersey Supreme Court in the 2006 Lanco case ruled that the physical presence nexus was only a requirement in the context of establishing sales and use tax nexus following the U.S. Supreme Court 1992 Quill case, and therefore an economic presence nexus could be applied to determine whether a corporation is subject to the New Jersey CBT. The 2011 New Jersey Supreme Court in Whirlpool ruled that the throw-out rule was constitutional and could be applied to any destination state where the taxpayer lacked substantial nexus unless it was one of the few states that did not have an income tax.
Whirlpool Properties, Inc. (“WPI”), a Michigan-based trademark holdings company, was assessed New Jersey taxes based on the use of its trademarks in New Jersey using the affiliates’ sales factors because no New Jersey returns had been filed by WPI for 1996 through 2003. The pre-throw-out years’ apportionment was approximately 1.3% while 2002’s and 2003’s (the first throw-out years) apportionment percentages were roughly 30% and 42%, respectively. Whirlpool fought the assessments and the New Jersey Supreme Court ultimately ruled in 2011 that the throw-out rule was constitutional but it split the challenged throw-out sales into two groups:
- Sales not subject to an income tax due to a state not having established a constitutionally acceptable level of contact, i.e., following the Lanco case; or, because the state relied upon a Congressional definition of constitutional taxable business activity for sales of tangible personal property, i.e., P.L. 86-272.
- Sales not subject to an income tax because the destination state chose to not impose an income tax. These states were NV, SD, WA and WY.
A recent New Jersey Tax Court “Order Granting Partial Summary Judgment” (Lorillard Licensing Company, LLC), appears to have clarified the throw-out rule further by eliminating the dual nexus standard New Jersey previously applied.
Specifically, New Jersey applies an economic nexus standard adopted in Geoffrey and Lanco to determine if an entity is subject to the New Jersey corporation tax. Therefore, the Director must use the same standard when applying the New Jersey throw-out rule in determining whether an entity is taxable in another state even if that state hasn’t established an economic nexus rule. As a result, New Jersey’s throw-out rule has been rendered inapplicable to companies such as intangible holding companies. Thus, refunds may be available to companies that had a large amount of throw-out sales where the company was subject to an economic nexus standard.