Fall out from New Jersey's throwout rule.

• Author: Friedman, Jeffrey

Introduction

The New Jersey Division of Taxation (the "Division") continues to enforce a controversial apportionment rule that the New Jersey Supreme Court ruled is unconstitutional in some circumstances. (1) The now repealed "Throwout Rule" codified at N.J. Stat. Ann. [section] 54:10A-6(B), was in effect for tax periods beginning January 1, 2002 until June 30, 2010. (2) The Throwout Rule increased the New Jersey apportionment percentage for multistate taxpayers by requiring the removal from the sales factor denominator of those sales sourced to a state in which the taxpayer was not filing a tax return. (3)

While the Throwout Rule may be gone, it is not forgotten (at least, not yet). Many taxpayers continue to struggle with the application of the Throwout Rule, regardless of its repeal. For example, numerous entities including certain holding companies historically have not filed New Jersey Corporate Business Tax ("CBT") returns under the assumption their activities in the state did not create nexus. Because they never filed New Jersey income tax returns, the statute of limitations for years extending back to the periods when the Throwout Rule was still in force remain open for assessment by the Division.

This article describes the constitutional challenges to the Throwout Rule, the New Jersey Supreme Court's permitted application of the Throwout Rule, and issues to consider in resolving disputes with New Jersey regarding the Throwout Rule. We conclude that the Division must apply an economic presence nexus standard for purposes of applying the Throwout Rule, which effectively renders the Throwout Rule inconsequential for multistate companies with economic presence nexus in other states.

New Jersey Apportionment Provisions

Traditionally, states apply an apportionment formula to attribute a multistate taxpayer's income to the various states in which the taxpayer conducts business. Each state's apportionment formula provides it with the means for determining that portion of a taxpayer's net income attributable to the state. At the core of each state's apportionment formula is a comparison of the taxpayer's in-state activities to its out-of-state activities. (4)

On occasion, taxpayers source receipts to a state that is not permitted, or chooses not, to impose a corporate tax on the taxpayer. For example, the dormant Commerce Clause of the U.S. Constitution and Pub. L. No. 86-272 (5) may limit the ability of states to impose corporate income tax on an out-of-state taxpayer. To combat perceived windfalls to corporate taxpayers that result from sourcing receipts to "no-tax" states, states have employed tactics, (6) including the Throwout Rule. (7)

New Jersey's Throwout Rule

New Jersey's Throwout Rule was effective for tax years beginning on or after January 1, 2002 through June 30, 2010. During that time, New Jersey applied a three-factor apportionment formula, with a double-weighted sales factory New Jersey's sales factor is calculated by dividing sales sourced to New Jersey by "all sales." (9) However, the Throwout Rule limits the amount of sales included in New Jersey's sales factor denominator. Specifically, the Throwout Rule provides:

[I]f receipts would be assigned to a state, a possession or territory of the United States or the District of Columbia or to any foreign country in which the taxpayer is not subject to a tax on or measured by profits or income, or business presence or business activity, then the receipts shall be excluded from the denominator of the sales fraction. (10) The practical impact of the Throwout Rule is that "[b]y throwing out receipts from the denominator, the sales fraction always increases, causing the apportionment formula and the taxpayer's resultant CBT [Corporation Business Tax] liability to New Jersey to increase." (11)

The Throwout Rule's Purpose: Loophole Closing, Revenue Raising, or Both?

A stated purpose of the Throwout Rule was to close "tax loopholes [that] allow multi-state corporations to transfer their profits out of [New Jersey] ... thus avoiding [] New Jersey taxation." (12) Both the New Jersey Assembly Budget Committee and the Senate Budget and Appropriations Committee provided the same explanation for the need to enact the Throwout Rule:

The more goods that are shipped out of New Jersey, the lower [the sales factor] is. Some of those sales are made in states where the corporation is not subject to tax because the corporation has no operations in those states. These sales are typically referred to as "nowhere sales" because they result in income being assigned so that it is taxed nowhere. [This] bill closes this loophole by...