In 2003 and 2004, Toyota Credit sold the leased vehicles. Because Toyota Credit’s tax basis in the vehicles had been reduced by depreciation deductions, it was less than the sale proceeds. So when Toyota Credit sold the vehicles, the depreciation recapture resulted in a significant gain for federal income tax purposes.

In support of Toyota Credit’s position, Reed Smith lawyers cited the CBT definition of entire net income, which imposes tax only on transactions that result in actual “gain,” “profit,” and “net income.” Reed Smith lawyers used New Jersey precedent prohibiting the assessment of New Jersey net income tax on “phantom income.” The Division argued unsuccessfully that the precedent was inapplicable since it involved only individual taxpayers. The Appellate Division agreed with the Tax Court that the prohibition of tax on “phantom income” applied equally to the net income tax imposed on corporate taxpayers. 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 for New Jersey purposes.

If you have questions about the court’s decision in Toyota Motor Credit Corporation, please contact one of the authors of this alert or the Reed Smith attorney with whom you usually work.

1. In this case, the New Jersey Supreme Court’s review is not “as of right.” See New Jersey Ct. R. 2:2–1. The New Jersey Supreme Court would have to grant a petition for certification from the Division. See New Jersey Ct. R. 2:12–3. The New Jersey Supreme Court grants petitions for certification under limited circumstances. See New Jersey Ct. R. 2:12–4.