Detailed New Jersey Development
Recently, the Superior Court of New Jersey, Appellate Division, issued the latest ruling in the ongoing litigation in Lorillard Tobacco Co. v. Division of Taxation over the deductibility of royalty payments made to a related party. In a 2019 decision, the tax court held that a taxpayer was entitled to a full deduction for royalty payments made to a subsidiary under the unreasonable exception. The New Jersey tax return form for computing the addback amount (Schedule G-2) provides that unless the royalty recipient pays Corporation Business Tax (CBT) on the entire royalty deduction amount, the royalty payor will not receive a full deduction for the royalty payment. In the instant case, the subsidiary’s reported royalty income closely matched the taxpayer’s royalty deductions. However, because the parties had different apportionment percentages—notably, the subsidiary had a lower apportionment percentage—the Division of Taxation allowed only a partial deduction for the royalties. The taxpayer appealed to the tax court, arguing that it was entitled to full deduction. The tax court agreed, noting that it was not unusual for related taxpayers to have different apportionment percentages. The tax court also noted that the legislature’s purported concerns that led to the adoption of the addback statute should have been “allayed” given that the subsidiary was filing and paying CBT. The tax court granted the taxpayer’s summary judgment motion and ordered the refund.
On appeal, the Appellate Division ruled that the tax court erred when it granted summary judgment to Lorillard. Specifically, the Appellate Division concluded there was nothing unreasonable about allowing an exception only to the extent the related party paid New Jersey CBT on the royalty income. In the court’s view, “this was a balanced approach” that considered the need to close loopholes as well as avoid an unreasonable addback. The Appellate Division noted that the tax court appeared to put the burden on the Division of Taxation to establish that its position was reasonable, whereas the statute puts the burden on Lorillard to establish it was entitled to a further exception to the add back rules. Finally, the Appellate Division rejected the taxpayer’s argument that the Division of Taxation should have promulgated a regulation that incorporated the Schedule G-2 language. Rulemaking is generally not needed for an agency determination that is obviously inferable from the language of the statute. In the Appellate Division’s view, it could be reasonably inferred that not allowing an exception in an amount equal to the tax paid by a related party payee might be considered unreasonable. Because the lower court did not address the taxpayer’s constitutional claims, the case was remanded back to the tax court. Please contact Jim Venere at 973-912-6349 with questions on the decision.
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