New Jersey: Royalty add-backs; holding company must file tax return

New Jersey: Royalty add-backs; holding company returns

The New Jersey Tax Court held that an intangible holding company was not immune from filing corporation business tax return when an affiliate added back royalties. Accordingly, New Jersey’s related-party expense disallowance statute (enacted in 2002) does not exempt the recipient of royalty income from filing a corporation business tax return.

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The case is: Spring Licensing Group, Inc. v. Director, Division of Taxation. 

Background

The taxpayer, an intangible holding company with no employees or property in New Jersey, earned royalty income from licensing intangibles to related parties.  

For the 2000 and 2001 tax years, the taxpayer filed and paid corporation business tax (CBT) on its royalty income.

In 2002, as part of a business tax reform package, the New Jersey legislature adopted a related-party expense disallowance statute requiring taxpayers to add back certain expenses, including royalties, paid to a related party. Royalties were not required to be added back if one of the statutory exceptions was met.

On its 2002 CBT return, the taxpayer filed a “zero” CBT return marked as “final” and requested a refund of estimated payments. The return noted that the taxpayer’s royalty income, going forward, would be reported by its affiliate. On its New Jersey returns, the affiliate added back the royalty payments made to the taxpayer (i.e., the affiliate did not attempt to qualify for one of the statutory exceptions to the add-back rules).

The New Jersey Division of Taxation disagreed with the taxpayer’s position that it was not required to file if the affiliate added back the royalty payments.

After several years—during which time the Lanco economic nexus case was finalized—the case came before the state tax court on a motion for summary judgment.  

Court's decision

Before the state tax court, the taxpayer argued that the Division of Taxation was imposing duplicative taxes by requiring it to pay CBT on royalties that were added back in computing its affiliate’s CBT. The tax administration, on the other hand, argued that under Lanco, the taxpayer was required to file and pay CBT and any duplicative taxation was the result of the affiliate not claiming an exception to the add back requirement or the taxpayer or affiliate seeking some other means of relief, such as alternative apportionment. 

The state tax court first determined that under Lanco, the taxpayer was subject to CBT on its royalty income. When the legislature enacted the related-party expense disallowance legislation—intended to effectuate certain “loophole closers”—it did not limit the scope of entities subject to the CBT.

The taxpayer relied primarily on dicta regarding the use of an add-back provision for capturing royalty income paid to an entity without physical presence in New Jersey from the tax court’s opinion in Lanco as support for its position.

However, the court concluded that the language relied on by the taxpayer simply affirmed the Lanco court’s view that denying a payor a deduction for royalties would allow New Jersey to capture the CBT that the intangible holding company previously avoided. However, in the court’s view, this language did not “sanction the out-of-state related member’s entity refusal to file CBT returns.” 

With respect to the issue of taxation of the royalty income at both the payor and payee level, the court noted that there were mechanisms in place (exceptions to the add-back requirements, requesting alternative apportionment) to prevent double taxation and that nothing in the instant case had prevented the taxpayer’s affiliate from claiming an exception to the royalty add-back requirement.  The court also observed that the taxpayer’s argument presumed that the taxpayer had only royalty income received from one New Jersey-based related member.  From year to year, this would not necessarily be the case, which the court pointed out, would lead to odd results and was not likely how the legislature intended to close loopholes. 

As such, the court concluded that the taxpayer was required under New Jersey law to file returns and pay CBT, effectively finding that potential double taxation issues are best dealt with at the payor level.

 

For more information, contact a KPMG State and Local Tax professional:

Jim Venere | (973) 912-6349 

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