The New Jersey throwout wins are more nationally relevant than ever, even though New Jersey repealed the throwout provision in its Corporation Business Tax Act nearly a decade ago. "Throwout" takes its name from the requirement that receipts be removed from (or "thrown out" of) a company's sales factor denominator for income tax apportionment purposes if those receipts are not subject to tax in the state to which they are sourced. Throwing out receipts attributable to other states reduces the denominator of a company's sales factor, resulting in an increase in the amount of the company's income that is apportioned to and taxed by the state requiring throwout. Other states, blinded by the prospect of revenue, have not been as enlightened as the New Jersey Legislature, which understood that the right thing to do was to leave throwout in the state tax trash bin. Nonetheless, New Jersey courts have provided a framework for evaluating--and beating back--the constitutionality of other states' throwout provisions.
Parameters Set by New Jersey Courts
New Jersey's throwout provision made headlines twice with wins by our firm, Morrison & Foerster, in 2011 and 2014. The New Jersey Supreme Court agreed with us in 2011 and rejected the New Jersey Division of Taxation's approach to throwout, which excluded all receipts from the sales factor denominator that were not actually taxed in another jurisdiction, even when nontaxation resulted from nothing more than the other jurisdiction's policy choice. In Whirlpool Properties, Inc. v. Director, Division of Taxation, the New Jersey Supreme Court limited the application of throwout, ruling that it is constitutional only if it is limited to throwing out receipts that are not taxed by another state because either 1) the company lacks the requisite constitutional contacts with that state to be subject to tax there or 2) the company is protected from taxation due to congressional action, such as P.L. 86-272. (1) The Whirlpool court held that New Jersey's throwout provision is not constitutional if receipts are thrown out because the other state simply chooses not to impose an income tax. (2) The court reasoned that "although a lack of jurisdiction is rationally related to how much business a taxpayer does in a state, a state's legislative tax system is not. Whether another state chooses to tax a receipt has no bearing on how much income is attributable to New Jersey." (3)
The Whirlpool court did not address whether another state's constitutional jurisdiction to tax for throwout purposes should be based on that other state's understanding of its constitutional jurisdiction to tax or based on New Jersey's understanding. This question was particularly relevant because, in 2006, the New Jersey Supreme Court determined that New Jersey "constitutionally may apply the Corporation Business Tax notwithstanding a taxpayer's lack of a physical presence in New Jersey." (4) The New Jersey Division of Taxation applied Whirlpool by asserting New Jersey's own expansive view of its constitutional jurisdiction to tax a person, but also asserting that its own expansive view was not the relevant standard for determining whether another state had the constitutional jurisdiction to tax the same person for purposes of throwout. As one constitutional scholar noted, "[t]he court properly gave this response the summary dismissal it deserved." (5)
In Lorillard Licensing Co. v. Director, Division of Taxation, the Tax Court of New Jersey agreed with us in 2014 and ruled that the Division's interpretation of the throwout provision "tests the limits of [the Director's] credibility" when the Division argued that the same presence that made a company constitutionally subjectable to tax in New Jersey did not also make that company constitutionally subjectable to tax in other states. (6) The Tax Court of New Jersey and, on appeal, the Superior Court of New Jersey Appellate Division both soundly rejected the Division's position. (7) The courts held that, because there is only one U.S. Constitution, if a company is sufficiently present to be constitutionally subjectable to tax in New Jersey, that same presence must be sufficient in every other state. (8) Accordingly, the courts held that New Jersey's own nonphysical-presence nexus standard, which the courts found to be the same as the U.S. constitutional standard, is the standard that must be applied to determine whether a company was subject to tax in other states. (9) Notably, it is irrelevant in which states the company actually paid tax. (10) It is abundantly clear that taxability in another state has no bearing on the level of activity attributable to the taxing state.
These New Jersey wins have two clear take-aways. First, application of throwout is limited to receipts sourced to jurisdictions that either do not have constitutional jurisdiction to tax the company or jurisdictions that are barred from taxing...