Earlier this week, the New Jersey Tax Court released a letter opinion in Whirlpool Properties Inc. v. Director,1 its latest decision involving throwout. The Division of Taxation had argued that there were unresolved factual issues and, as a result, that it would be premature for the court to address the underlying throwout issue. The court agreed, but the decision could come at a high price for the Division by putting New Jersey’s broad economic nexus standard at risk.
By way of background, the throwout rule was in effect for the 2002-2010 tax years. It required taxpayers to exclude receipts from their sales-fraction denominator if sourced to a state in which the taxpayer is "not subject to a tax." Whirlpool Properties was an intangible holding company that licensed trademarks to affiliates. The royalty was computed based on a percentage of the affiliate’s manufacturing costs. Whirlpool Properties did not have any physical presence in New Jersey and the affiliated licensee conducted its manufacturing activities outside the state. The Division asserted nexus over Whirlpool Properties based on Lanco Inc. v. Director,2 in which the New Jersey Supreme Court held that physical presence was not required for income-tax nexus. In computing the assessment, the Division applied the throwout rule to exclude all receipts except New Jersey receipts from the sales-fraction denominator.
Whirlpool Properties contested the Division’s application of throwout. By definition, throwout applies only to receipts sourced to states in which the taxpayer is not subject to tax. Whirlpool Properties argued that under New Jersey’s expansive nexus standards, it would be subject to tax in every state and that, as a result, throwout couldn’t apply. Another intangible holding company successfully made this argument before a different Tax Court judge in Lorillard Licensing Co. LLC v. Director, Div. of Taxation, N.J. Tax Court Docket No. 008772-2006. In that case, the court ruled that the Division could not apply throwout to an intangible holding company’s royalty receipts from affiliates. (For a link to our teleseminar on this case, please visit www.reedsmith.com/njtax.) Since then, the Division has sent strong signals to taxpayers that it is willing to resolve pending throwout claims through negotiated settlements.
The Whirlpool Properties court, however, did not address Lorillard and refused to rule on throwout. Instead, the court concluded that a trial would be necessary to address the threshold issue of whether Whirlpool Properties had nexus with New Jersey. Based on the factual record before it, the court stated that the Division "has not demonstrated that Whirlpool has a substantial nexus with New Jersey." Importantly, even though Whirlpool Properties was an intangible holding company that licensed trademarks to affiliates, the court reasoned that the Division "has been unable to point to even a single dollar of income Whirlpool received from New Jersey sources." At trial, the Division will have the opportunity to present additional evidence. But unless the Division can show that Whirlpool Properties had agents in the state or that a portion of the royalty was attributable to the affiliate’s New Jersey sales, it will be difficult for the Division to establish nexus.
The Whirlpool Properties decision is significant in that it represents yet another case in which the New Jersey courts have shown reluctance to extend economic nexus beyond the specific facts in Lanco. For example, in AccuZip, Inc. v. Director, Div. of Taxation,3 the Tax Court held that the Commerce Clause prohibited New Jersey from imposing income tax on a company that licensed canned software to New Jersey customers, but that had no physical presence in the state. If the Division proceeds to trial in Whirlpool Properties, it could put its economic nexus standard at further risk.
In the meantime, companies that lack physical presence in New Jersey should evaluate whether they can distinguish their situation from Lanco. In particular, companies that license patents or copyrights (rather than trademarks), or compute the royalty based on a flat fee or unit of production (rather than on a percentage of the affiliate’s sales), may be able to take the position that they do not have nexus with New Jersey. At a minimum, companies should raise the question of nexus to gain additional leverage in negotiating settlements involving throwout and other issues.
If you are interested in more information on the Whirlpool Properties decision, please contact one of the authors of this alert, or the Reed Smith attorney with whom you normally work. For more information on Reed Smith’s New Jersey tax practice, visit www.reedsmith.com/njtax.
- Docket No. 000066-2007 (Oct. 22, 2013).
- 188 N.J. 380 (2006).
- 25 N.J. Tax 158 (Tax 2009).
Client Alert 2013-287