On Friday, August 1, in a corporation business tax case handled by Reed Smith, the New Jersey Tax Court ruled that Toyota Motor Credit Corp. was entitled to recompute its tax by reducing gains on the sale of leased vehicles. The court addressed three separate issues in its decision and ruled in favor of the taxpayer on each issue. (A copy of the decision is available at the following link: NJ State Tax team.)
Regarding the main issue in the case, the court ruled that Toyota Credit was entitled to increase its tax basis in leased vehicles to the extent of prior-year depreciation deductions that hadn’t produced any tax benefit. In the years leading up to the tax years at issue, Toyota Credit had taken depreciation deductions on the leased vehicles. But those depreciation deductions hadn’t reduced Toyota Credit’s actual New Jersey tax liability. Toyota Credit had been in a loss situation, and the deductions merely compounded Toyota Credit’s net operating losses for those years. In 2003 and 2004, Toyota Credit sold the leased vehicles. Because the tax basis had been reduced by depreciation deductions, the tax basis of the vehicles was less than the sale proceeds. So when Toyota Credit sold the vehicles, the sales resulted in significant “gains.” But these gains essentially represented recapture of the depreciation deductions taken by Toyota Credit in the prior years. Normally, Toyota Credit could have just offset the gains with net operating losses. The problem was that in 2003 and 2004, New Jersey had suspended the deductibility of net operating losses. So Toyota Credit couldn’t carry over the prior-year losses to offset the gains.
In support of Toyota Credit’s position, Reed Smith lawyers cited appellate precedent prohibiting the assessment of New Jersey tax on “phantom income” resulting from unused depreciation deductions. The Division had strenuously argued that the precedent was inapplicable since it involved only individual taxpayers, but the Tax Court agreed that the prohibition should be extended to corporate taxpayers as well. This enabled Toyota Credit to increase its tax basis in the vehicles by the amount of the depreciation deductions that generated useless net operating losses, which reduced Toyota Credit’s gains.
Toyota Credit’s win in this case may be applicable to other states with NOL suspensions or caps, such as California and Pennsylvania.
The Tax Court also ruled in favor of Toyota Credit on two other issues. First, the court ruled that Toyota Credit’s interpretation of the bonus decoupling statute was correct and set aside the Division of Taxation’s regulation to the contrary as an “unreasonable exercise of the Director’s authority.” The Tax Court also ruled in favor of Toyota Credit on a throwout issue, holding that the Division improperly threw out sales into Nevada, South Dakota, and Wyoming because Toyota Credit had property or payroll in those states. The court’s decision is significant in that it represents the first taxpayer win in a throwout case outside the intangible holding company context.
If you are interested in more information on the Toyota Motor Credit decision, or New Jersey tax issues affecting leasing companies more generally, 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 NJ State Tax team.
About Reed Smith State Tax Reed Smith’s state and local tax practice is comprised of more than 30 lawyers across seven offices nationwide. The practice focuses on state and local audit defense and refund appeals (from the administrative level through the appellate courts), as well as planning and transactional matters involving income, franchise, unclaimed property, sales and use, and property tax issues. Click here to view our State Tax team.
Client Alert 2014-210