GMG Knowledge Base

Salt Spotlight
03 Mar, 2014

New Jersey Tax Court Amplifies its Decision in Lorillard Licensing Co.

Posted by Grant McCarthy Group on Mar 3, 2014 2:42:00 PM

Knowledge Base

On January 14, 2014, the New Jersey Tax Court issued an amplification of its bench opinion granting summary judgment to the taxpayer in Lorillard Licensing Co., LLC v. Director, Div. of Taxation, Docket No. A-2033-13T1 (August 9, 2013).  The Court confirmed that the throw-out rule applies only if a state lacks jurisdiction to tax the taxpayer’s sales assigned to that state (determined by applying the economic nexus standards set forth in Lanco), and is not dependent on whether the taxpayer actually files returns and pays tax in that state.

Background

For periods beginning prior to July 1, 2010, New Jersey’s throw-out rule provided that, in calculating a taxpayer’s sales factor for apportionment purposes, receipts that would be assigned to a jurisdiction in which the taxpayer is not “subject to” an income tax should be excluded from the denominator of the sales fraction.  At issue in Lorillard was how to determine when a taxpayer is “subject to tax” in another jurisdiction for this purpose. 
Lorillard argued that it should not be required to exclude any receipts from its New Jersey denominator based on the New Jersey Supreme Court’s decisions in Lanco, Inc. v. Director, Div. of Taxation, 188 N.J. 380 (2006) and Whirlpool Properties, Inc. v. Director, Div. of Taxation, 208 NJ 141 (2011).  In Lanco, the Court determined that licensing intangibles to an affiliated licensee that used the intangibles in New Jersey to generate sales created sufficient constitutional economic nexus with the state for the company to be subject to income tax.  In Whirlpool, presented with a facial discrimination challenge of the throw-out rule under the U.S. Constitution’s Commerce Clause, the Court limited the application of the throw-out rule “to receipts that are not taxed because the other state lacks jurisdiction to tax.”
Because Lorillard licensed its intellectual property to a company that used the intangibles in every state, the company argued that under theLanco nexus standard the company had sufficient nexus to be subject to tax in every state.  Applying Whirlpool’s limiting interpretation of the throw-out rule, Lorillard concluded that the throw-out rule should not apply to its licensing receipts assignable to any state because those states had jurisdiction to tax the company under the nexus standard set forth inLanco.
The Division, on the other hand, took the position that Whirlpool only prevented the throw-out rule from excluding receipts assigned to states that did not impose an income-based tax.  According to the Division, any receipts assigned to states that did have an income tax but in which a company did not actually file returns and pay tax should be excluded from the denominator of the sales fraction under New Jersey’s throw-out rule.  The Division’s argument essentially created two different standards for being “subject to tax”: one to establish nexus under Lanco, and a separate one to identify excludable receipts under the throw-out rule.

The Court’s Reasoning

Granting summary judgment for the taxpayer, the Tax Court in Lorillard noted that the New Jersey Supreme Court’s holding in Whirlpool was unequivocal, limiting the application of the throw-out rule to “receipts that are not taxed because the other state lacks jurisdiction to tax.”  Rejecting the Division’s argument that being “subject to tax” for throw-out purposes differs from being subject to tax under Lanco, the Tax Court stated, “The Director tests the limits of his credibility by asserting that the same licensing agreement that makes Licensing subject to tax in New Jersey does not also make Licensing subject to tax elsewhere.”  Accordingly, the same nexus standard should be applied for determining whether a taxpayer has nexus in New Jersey and in applying the throw-out rule.
The Tax Court entered a Final Order and Final Judgment granting the taxpayer’s motion for summary judgment on November 15, 2013.  The Division filed a Notice of Appeal with the Superior Court, Appellate Division on December 30, 2013.

GMG Observations

While most of the discussion of Lorillard has focused on the potential throw-out of royalty receipts assignable to states in which a taxpayer does not file returns, the Tax Court’s reasoning implies a broader application.  For example, the Court’s decision may prevent the throw-out of receipts assignable to states in which a taxpayer files as part of a combined or consolidated return, provided the taxpayer has independent nexus in the state.  The Division’s practice in audits has been to throw out license receipts assignable to states in which such receipts are eliminated as part of a combined or consolidated return.  The Lorillarddecision may also apply in situations where receipts from interest or services have been excluded from a taxpayer’s New Jersey sales factor under the throw-out rule. 
GMG recommends that any company with open periods beginning before July 1, 2010 consider applying for refunds or appealing any assessment resulting from an adverse application of the State’s throw-out rule.