On October 11, 2016, the New Jersey Tax Court published its long-awaited decision concerning the sourcing of interest and other fees related to credit card transactions. The court ruled against the taxpayers and held that market sourcing applied—despite a statutory rule based on place of performance. The decision is likely to be appealed, but New Jersey-based taxpayers should consider filing refund claims in the meantime.
Potential Impact Beyond Financial Services Companies
The case involved several out-of-state financial services companies that issued consumer credit cards. The issue was how to apportion various receipts from New Jersey cardholders, including interest, service fees, and interchange fees (the 2% transaction fee retained by the issuing bank on the amount charged). For apportionment purposes, the court determined that interchange fees were the same as interest, and sourced both types of receipts based on the location of the borrower. Despite a lengthy 76-page opinion, the court provided relatively little analysis in reaching its conclusion. Rather, the court relied heavily on an example in the Division’s regulations that includes interest in the sales-fraction numerator to the extent paid by a New Jersey resident.
This ruling could have significance for more than just financial services companies. In applying market sourcing to interest, the court specifically rejected sourcing intangible receipts based on the taxpayer’s commercial domicile. This means that New Jersey-based companies may have a refund opportunity. New Jersey-based companies that currently include intangible receipts in their sales fraction numerator should consider sourcing those receipts based on payor location if it produces a better result.
Court Adopts Benefit-Received Test for Services
Perhaps the most surprising part of the opinion is the court’s treatment of service fees. The statute provides that service receipts are sourced to New Jersey only if the “services [are] performed within the State .…” N.J.S.A. 54:10A-6(B)(4). Because the taxpayers performed services outside New Jersey, they argued that their receipts should be included only in the sales fraction denominator. But, despite the plain statutory language, the court concluded that fees received by the taxpayers from New Jersey customers were earned entirely from New Jersey and, thus, includable in the sales fraction numerator. In light of technological advances, the court observed that services no longer have to be performed locally. Unlike services performed on a tangible object (such as a haircut or carwash), the court reasoned that the situs of services performed on an intangible (such as a financial transaction) is amorphous. Accordingly, the court concluded that service receipts from such transactions should be sourced “based upon where the benefit of the service is derived or earned, not necessarily where the service is technically performed.”1
Because the court’s conclusion contradicts the statutory rule based on location of performance, this decision is likely to be appealed. But again, the court’s decision provides a potential refund opportunity for companies performing services in New Jersey. Companies that perform services within New Jersey, and that have been including those services receipts in the numerator based on the statute, should file a refund claim to the extent their customers receive the benefit of those services outside the state.
- The court included only 50% of the service fees in the sales fraction numerator based on N.J.A.C. 18:7-8.10(c), which is the Division’s special apportionment regulation for certain electronic transactions. The regulation provides that 25% of the receipt is sourced to the state of origination, 50% to where the service is performed, and 25% to where the transaction terminates. Although the court ruled that the Division was bound by its regulation, the court stated that the Division could rescind the regulation going forward.
Client Alert 2016-269