Last week, in Schweitzer-Mauduit International Inc. v. Director, Div. of Taxation, Docket No. 007376-2005 (N.J. Tax 2012), the New Jersey Tax Court rejected nearly all of a taxpayer's claims for a sales and use tax refund. The court ruled that the taxpayer was not entitled to the manufacturing exemption for certain items used in its paper manufacturing business. The court also ruled that certain purchases did not qualify as nontaxable capital improvements. For the most part, the taxpayer was denied relief on evidentiary grounds. Nonetheless, the court's decision is still significant—especially for taxpayers with pending audits—because of its discussion about the following issues:

No projection of refunds. The taxpayer's appeal involved both an assessment appeal and a refund claim. Although the court denied substantially all of the taxpayer's requested relief, it agreed that the taxpayer had erroneously paid tax of $98.35 on certain parts for manufacturing equipment. Since the overpayment was included in the sample month selected by the auditor to compute the Division of Taxation's projected assessment, the taxpayer asserted that it should be able to similarly project its refund. The projection factor for the assessment was 42 months, so the projected refund would have been worth $4,131.70.

The court, however, refused to project the refund. There is virtually no authority or guidance in New Jersey on audit projections. The only guidance is in the Division's Field Audit Manual, but that guidance is very limited. Therefore, the court's analysis on projections may be the most significant aspect of its decision. The court concluded that the Division had broad discretion to use sampling methods to calculate assessments, but denied the taxpayer the same right to project overpayments. This seems inconsistent with the principles in the Taxpayer Bill of Rights, P.L. 1992, c.175, which guarantees "consistent treatment for assessments and refunds." See N.J. Division of Taxation, Publication ANJ-1 (December 2004). Therefore, despite the Tax Court's decision, taxpayers should continue to press the Division of Taxation to project overpayments in the same manner as underpayments.

Guidance on manufacturing exemption. In rejecting the taxpayer's claims, the court afforded great weight to how the taxpayer treated the disputed items for federal and accounting purposes. The manufacturing exemption doesn't apply to parts with a useful life of less than one year. N.J.S.A. 54:32B-8.13. Also, in determining whether the installation of tangible property results in a capital improvement, how the property is accounted for and depreciated is relevant under the regulation. N.J.A.C. 18:24-4.6. In Schweitzer-Mauduit, the taxpayer's accounting treatment was not consistent with its position for New Jersey sales tax purposes and the taxpayer was unable to overcome the statutory presumption of taxability. Taxpayers should be mindful, therefore, that how an item is treated for accounting and federal tax purposes can have New Jersey sales tax implications.

Importance of raising issues at administrative level. The Tax Court prohibited the taxpayer from raising new issues at trial. The court noted that there was "no evidence that any of the new claims for exempt treatment had been raised with [the hearing officer] during the course of the administrative protest." The court's ruling is consistent with United Parcel Services General Services Co. v. Director, Div. of Taxation, 25 N.J. Tax 1 (N.J. Tax 2009). In that case, the court held that a taxpayer couldn't rely on information at trial if it wasn't provided during the audit process. This reinforces the importance of raising all issues and documentation before getting to court. Otherwise, a taxpayer may be precluded from raising those issues later.

Client Alert 2012-045