A newly passed New Jersey law is interesting both for what it does and for what it does not do. Assembly bill 3486/Senate bill 2268, attempts to “clarify” four aspects of New Jersey law (retroactively for three of the four!). The four areas affected by the law change are: (1) the business/non-business income distinction (called “operational/non-operational income” in New Jersey); (2) a limited partner’s eligibility for a refund of Corporation Business Tax paid on its behalf by a limited partnership; (3) net operating losses involving certain amounts related to bankruptcies, insolvencies, and qualified farm indebtedness; and (4) click-through nexus for sales and use tax purposes.
Business/Non-Business Income Distinction
The distinction between business and non-business income (called “operational” and “non-operational” income in New Jersey) is critical as it determines whether certain income (such as gain from the sale of an asset) can be apportioned among the states or instead much be allocated to only one state. The law change expands the definition of “operational income” so that many more transactions will result in the generation of apportionable income. In fact, the law change is estimated to increase revenue by $25 million annually.
Historically, New Jersey’s definition of business (“operational”) income included gain from sale of property “if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations. . .” N.J.S.A. 54:10A-6.1(5)(a) (emphasis added). Use of the conjunction “and” caused New Jersey courts to determine that all three activities (“the acquisition, management, and disposition”) must each have been integral parts of the taxpayer’s regular trade or business in order for the gain from the asset to be apportionable business (“operational”) income. This could be overcome by demonstrating that one of the activities—usually the disposition of an asset—was not an integral part of a taxpayer’s regular trade or business.
The definition was changed, however, to replace the conjunctive “and” with the disjunctive “or” such that it will now read “the acquisition, management, and or disposition of the property constitute an integral parts of the taxpayer’s regular trade or business operations. . .” Thus, because engaging in any one (or more) of those three activities as part of a taxpayer’s regular trade or business is sufficient, many more transactions will generate apportionable business income.
This provision takes effect for tax years ending after July 1, 2014. This means that for a calendar year filer the provision takes effect retroactively for the tax year starting January 1, 2014, since the end of the year (December 1, 2014) is after July 1, 2014. Interestingly, while the legislation refers to this change as a “clarification,” the fact that it is anticipated to increase revenue by $25 million indicates that it is, indeed, a change of law, reiterating that for the test really is a conjunctive one for prior periods.
Overturning the Result of BIS LP v. Director
There has been (and continues to be) a substantial amount of litigation in New Jersey courts regarding tax payments and tax refunds related to limited partnerships and their out-of-state (“nonresident”) limited partners. In simplified terms, the historic regime has been that a limited partnership doing business in New Jersey is obligated to pay tax on behalf of certain out-of-state limited partners. The payments were immediately credited to the limited partner and the limited partner could seek a refund of amounts that reflected an overpayment compared to the limited partner’s actual liability. If the limited partner had no independent contacts with New Jersey and was not engaged in a unitary relationship with the limited partnership, it could be entitled to a full refund of amounts paid on its behalf. This could have the effect of 99 percent of a limited partnership’s income escaping New Jersey taxation altogether.
The law change adds the following restrictions:
only a nonresident partner who files a New Jersey tax return and reports income that is subject to tax in this State may apply the tax paid by the partnership and credited to the nonresident partner’s partnership account against the partner’s tax liability; and provided further that a partnership that pays tax pursuant to this section shall not be entitled to claim a refund of payments credited to any of its nonresident partners. [N.J.S.A. 54:10A-15.11(12)(b).]
In other words, an out-of-state limited partner may seek a refund of taxes paid on the partner’s behalf only if the partner itself is taxable in New Jersey. But, if the partner itself is taxable in New Jersey, there is a strong chance that it will not be eligible for a refund or at least not for a full refund. This law change effectively overturns the courts’ decisions in BIS LP, Inc., v. Director, Division of Taxation, 25 N.J. Tax 88 (Tax 2009), affirmed, 26 N.J. Tax 489 (App. Div. 2011), remanded 27 N.J. Tax 58 (Tax 2012), affirmed Dkt. A–1647–12T3 (App. Div. 2014), which allowed an out-of-state non-unitary limited partner to obtain a refund of the Corporation Business Tax paid on its behalf by a limited partnership.
This provision takes effect for tax years ending after July 1, 2014. This means that for a calendar year filer the provision takes effect retroactively for the tax year starting January 1, 2014, since the end of the year (December 1, 2014) is after July 1, 2014.
This change is expected to generate $40 million of revenue annually. Again, while the legislation refers to this as a “clarification,” the fact that it is anticipated to increase revenue by $40 million indicates that it is, indeed, a change of law. As a change, the Division of Taxation’s arguments in matters currently before the courts that take a similar position (i.e., that a refund is only available to partners that are themselves taxable) become suspect.
Limiting Net Operating Losses
The new law requires that any newly generated net operating losses and any previously generated net operating loss carryovers being utilized after the law’s effective date be reduced by any amount excluded from federal taxable income under IRC §§ 108(a)(1)(A), (B) or (C) for debt discharged on account of bankruptcy, insolvency, or qualified farm indebtedness.
This provision takes effect for tax years ending after July 1, 2014. This means that for a calendar year filer the provision takes effect retroactively for the tax year starting January 1, 2014, since the end of the year (December 1, 2014) is after July 1, 2014.
Adopting Click-Through Nexus
New Jersey has finally adopted a click-through nexus provision, similar to those in many other states, and substantially identical to New York’s provision. The definition of a seller—that is, one who is required to collect sales tax—will be expanded to include the presumption that an out-of-state seller of taxable goods or services that enters into an agreement with someone physically located in New Jersey, through which the representative is paid to refer customers to the out-of-state seller and where those referrals result in sales in excess of $10,000 during the preceding four quarterly periods, is a obligated to collect sales tax. The provision applies regardless of whether the payment is commission-based or something else. The presumption is rebuttable by demonstrating that the in-state representative did not solicit sales in New Jersey on behalf of the out-of-state seller. The altered definition of seller is effective for sales made starting July 1, 2014 and is forecast to increase tax revenue by $25 million.
Thus, like in many states, the relevant question is whether in-state representatives are actively soliciting sales or are merely advertising on the out-of-state seller’s behalf. If soliciting, then the seller must register for and collect sales tax; if advertising, then the representative’s activities will not cause the seller to be obligated to collect tax. But how does one demonstrate that a representative’s activities are mere advertising versus active solicitation? The best solution will be for the Division of Taxation to—in the very near future, since the law takes effect immediately—publish clear guidelines related to this distinction. In the meantime, sellers may want to refer to the guidelines provided by the New York State Department of Taxation and Finance related to its click-through law, although these may provide only limited guidance as New York includes some concessions that the Division of Taxation may choose not to make. For example, while both the New York and New Jersey statutes apply to agreements “for a commission or other consideration,” New York administrative guidance concludes that a per-click fee (that is, the seller pays the representative based on the number of internet hits generated by the representative regardless of whether the clicks result in sales) is indicative of advertising and not of solicitation.
Also helpful to sellers, New York’s guidance details the type of records a seller can maintain (and subsequently provide to the Department upon request) detailing that representatives’ activities were limited to advertising. These standards—while incredibly burdensome for sellers with many representatives—at least provide some clarity.
Given that the New York and New Jersey laws are substantially similar and are each equally limited by the U.S. Constitution, sellers should consider applying New York’s guidance at least until the Division of Taxation publishes guidance of its own.
