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New Jersey Division of Taxation Adopts New CBT Regulations

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Home Perspectives New Jersey Division of Taxation Adopts New CBT Regulations
The New Jersey Division of Taxation (the “Division”) has issued new regulations for the state’s corporation business tax (“CBT”).1 The new regulations, which are effective immediately,2 provide long-awaited guidance on related-party addbacks, global intangible low-taxed income (“GILTI”), foreign-derived intangible income (“FDII”), and dividends. Although the Division has previously issued informal guidance through a number of Technical Bulletins,3 this is the first official guidance addressing New Jersey’s switch from separate-company to combined reporting, which became effective for the 2019 tax year.4

Interest and royalty addback

For CBT purposes, interest and royalties paid to related members are not deductible unless an exception applies.5 One such exception is the so-called “unreasonableness” exception.6 Historically, the Division has narrowly construed this exception, stating that it applies only to the extent that the related party paid CBT on the income stream.7 But a series of decisions by New Jersey’s courts have called this policy into question. Most recently, in Lorillard Tobacco Company v. Director, Division of Taxation,8 the court held that a taxpayer was entitled to deduct fully its related-party royalty expense where the affiliate paid at least some New Jersey tax on the income—in spite of any difference between their respective effective tax rates.9

Consistent with Lorillard, the Division’s new regulation no longer requires a taxpayer to consider the New Jersey effective tax rate of its affiliate in computing its addback exception.10

Instead, the regulation provides a number of factors to be considered in determining whether adding back interest expenses or costs and intangible expenses or costs would be unreasonable: unfair duplicative taxation; a technical failure to qualify the transactions under the statutory exceptions; an inability or impediment to meet the requirements due to legal or financial constraints; or the transaction is equivalent to an unrelated loan transaction.11

Of course, this change to the “unreasonableness” exception will have limited applicability going forward as a result of New Jersey’s switch to combined reporting. Intercompany interest and royalties between members of a combined group are eliminated under combination, rather than added back.12 So after the 2018 tax year, the Division’s new regulation will apply only to interest and royalties paid to affiliates outside the combined group.

In addition, the Division’s new regulations reflect statutory changes made to the “treaty” exception. Previously, a taxpayer would typically qualify for an addback exception if the affiliated payee was located in a foreign country with an income tax treaty with the United States. However, when the New Jersey Legislature enacted combined reporting, it also limited the treaty exception by requiring the affiliate to pay tax on the income stream at an effective tax rate within 3% of the taxpayer’s New Jersey effective tax rate.13