NJ: Computation of Tax Add Back in Determining a Sub's Separate CBT Liability when Taxes Paid by Parent

The New Jersey Tax Court recently addressed whether a corporate business taxpayer filing a separate New Jersey return was required to add back amounts paid to its parent corporation under a tax-sharing agreement. The parent corporation paid taxes on behalf of the combined group in non-separate reporting states and was reimbursed by the various affiliates, including the taxpayer, under a tax-sharing agreement. Per the agreement, payments were computed using a formula that looked at the affiliate’s estimated federal taxable income multiplied by an effective tax rate. It was recognized that the intercompany payments under the agreement were not equal to the amount of tax the affiliate would have paid if it had filed a separate returns in the non-separate reporting states. Under New Jersey law, a Corporation Business Tax (CBT) taxpayer is required to add back taxes paid or accrued to a state that are imposed on or measured by profits or income or business presence or business activity.  In filing its New Jersey CBT returns, the taxpayer added back all of the income-based taxes it paid directly to separate reporting states. However, it did not add back the amounts paid to its parent under the tax sharing agreement that were used to compensate the parent for the taxes paid to the non-separate reporting states. Rather, these amounts were treated as ordinary and necessary business expenses and were deducted. After an audit, the Division took the position that these amounts were “taxes” required to be added back in computing New Jersey entire net income. The matter eventually made its way to the tax court.  

Before the tax court, the legal issue was whether the taxpayer was required to add back tax liabilities associated with the non-separate reporting jurisdictions when those payments were made by the parent on behalf of the combined group. The court agreed with the taxpayer’s position that the intercompany payments were not taxes nor were they indirect payments of taxes. Rather, the intercompany payments were an accounting mechanism employed by the parent to attempt to estimate and recoup the taxes paid by the parent on the taxpayer’s income in the combined and consolidated states. The court also concluded that the intercompany payments were not accrued taxes. Because the parent had paid all of the required taxes in the non-separate reporting states, those states did not have a legal claim against the taxpayer, and the taxes were not accrued. However, the court next looked at the legislative history behind the income tax addback statute and determined that the add back was essential to “formulating a snapshot of the allocable business activity or presence among the various states in which a taxpayer does business.”  Although, in non-seprate reporting states, the parent calculated and paid the applicable taxes, this did not mean that the subsidiary did not have any tax liability in those states. In fact, these states generally imposed joint and several liability for the payment of the tax.  The tax court determined the income tax addback must be calculated based on the taxpayer’s liability as calculated by its pro rata share of the parent’s total tax obligation in the non-separate reporting states. Because the parent had added back all of the state income taxes it paid to the non-separate reporting states, the tax court also noted that equity demanded that the taxpayer’s CBT liability be reduced by any overpayment of CBT made by the parent on the taxpayer’s behalf. Please contact Jim Venere at 973-912-6349 with questions on Daimler Investments US Corporation v. Director, Division of Taxation.