At a Glance...
Yesterday, New Jersey Democratic Senate President Steve Sweeney introduced a corporation business tax ("CBT") bill that: raises the tax rate to 13% for certain corporations; levies new taxes on foreign earnings; and couples or decouples certain provisions of the CBT statute to the federal Tax Cuts and Jobs Act (P.L. 115–97) (the "TCJA"). A copy of the bill, S2746, will be available here. (An identical bill, sponsored by Assembly Budget Chair Eliana Pintor Marin, was introduced in the Assembly as A4202.)
Although Senator Sweeney estimated that the bill could generate over $800 million of additional revenue, this falls far short of the $1.5 billion of tax increases that Governor Murphy had called for in his original budget proposal. Under Governor Murphy's proposal, the bulk of the additional revenue would come from increasing the state sales tax rate and imposing a "millionaire's tax" on wealthy individuals. Only $110 million of additional revenue would come from the corporate income tax through the adoption of "water's edge" combined reporting and market sourcing for services. Senator Sweeney has been a vocal opponent of Murphy's proposed tax increases on individuals and favors more significant tax increases on corporations to fund looming expenses related to education, transportation, and state pensions.
It's unusual for there to be a budget impasse among members of the same party. Yet earlier this week, Governor Murphy stated that he would veto any proposed legislation that did not include his proposed plan to "modernize" New Jersey's CBT. (Combined reporting and market sourcing are conspicuously absent from S2746.) If the budget isn't finalized by June 30, New Jersey will be facing a potential government shutdown.
A summary of Senator Sweeney's proposed CBT amendments is provided below.
Response to Federal Tax Reform
- Tax on repatriated
earnings. The TCJA provides for a one-time tax under
I.R.C. § 965 on undistributed post-1986 earnings of foreign
subsidiaries owned by U.S. corporations. These deemed
dividends are treated as Subpart F income, and thus, are included
in the taxpayer's Line 28 taxable income. Under the
current CBT statute,1 a taxpayer is entitled to a 100%
dividends received deduction for actual or deemed dividends from an
80%-or-more owned subsidiary. Under current New Jersey law,
therefore, earnings of an 80%-or-more owned foreign subsidiary that
are deemed to be repatriated under I.R.C. § 965 would not be
subject to CBT. The proposed legislation would change this by
enacting a one-time 9% levy on any dividends included in the
taxpayer's federal Line 28 taxable income.2 The
proposal includes a provision that prohibits taxpayers from
deducting the one-time levy in computing their entire net income
for CBT purposes.
The levy applies not only to deemed dividends under I.R.C. § 965 but to any dividend received in the 2017 tax year. (It is necessary to apply the levy to all dividends to avoid a foreign commerce clause issue under Kraft.3) The levy is computed by apportioning a taxpayer's total dividends received to New Jersey using a standard "allocation factor" of roughly 3% (which reflects the ratio of New Jersey's gross domestic product to the total U.S. gross domestic product).4
This standard allocation factor may violate external consistency or otherwise be distortive for out-of-state taxpayers.
- Applying the interest deduction
limitation. Under I.R.C. § 163(j), as amended by the
TCJA, the deduction for business interest is limited to the sum of
the taxpayer's: (i) business interest income; (ii) 30% of
adjusted taxable income; and (iii) floor plan financing
interest. S2746 provides that this limitation shall apply in
computing entire net income for CBT purposes.
The proposed legislation further provides that the interest limitation must be applied on a "pro-rata basis to interest paid to both related and unrelated parties."5 But the bill does not specifically explain how a taxpayer should compute the limitation if it reports its federal income tax as part of a consolidated group.
In Notice 2018–28, the IRS stated that it intends to apply the business interest limitation rules at the level of the consolidated group. As a result, for purposes of the limitation, a consolidated group's taxable income will be its consolidated taxable income and intercompany obligations will be disregarded. Recently, the New Jersey appellate court held that federal consolidated return principles apply to the CBT even though it is computed on a separate-company basis.6 For CBT purposes, therefore, taxpayers may be able to take the position that the interest limitation should be computed on a consolidated basis rather than a separate-company basis.
Other Proposed Amendments
- Surtax for taxpayers with entire net income greater than $1 million. The proposed legislation includes a two-year surtax on corporate taxpayers with entire net income that exceeds $1 million.7 The surtax is 1.5% for taxpayers with entire net income in excess of $1 million; the surtax jumps to 4% for taxpayers with entire net income in excess of $25 million.8 The maximum combined corporate tax rate, therefore, is 13%, which would be the highest in the nation.
- Dividends Received Deduction limited. The bill reduces the dividends received deduction for dividends from 80%-or-more subsidiaries from 100% to 95%.9 New Jersey has very taxpayer-friendly case law, however, on the scope of the unitary business principle. So, despite the proposed legislation, taxpayers may be able to take the position that their dividends are nonunitary and thus excludable from the CBT tax base entirely.
- Taxation of worldwide
income. The New Jersey Tax Court, in Infosys Limited
of India Inc. v. Director, Division of Taxation,10
ruled that a foreign corporation was not subject to CBT on its
income unless it was included on Line 29 of its federal Form
1120–F. In other words, a foreign corporation is not
subject to New Jersey CBT on its foreign-source income or income
that is immune from federal income tax based on a treaty. The
Tax Court's decision is not yet final and is likely to be
appealed. In the meantime, the proposed legislation would
effectively overrule the Tax Court's decision and subject
foreign-source income to taxation.
Specifically, the proposed legislation broadens the definition of "entire net income" and makes any exclusions, exemptions, or deductions contained in a U.S. tax treaty inapplicable unless the treaty expressly applies to state taxes.11
- Expanded addback for related-party interest and royalties. Under the current CBT Act, interest and royalties paid to affiliates does not have to be added back if the affiliate is located in a foreign country with a tax treaty with the United States.12 S2746 effectively repeals this so-called "treaty exemption" by limiting it to treaties that contain an express exemption from U.S. state income tax.13
1 See N.J.S.A. 54:10A–4(k)(5).
2 See S2746, § 3.b.
3 See Kraft General Foods, Inc. v. Iowa Dept. of Rev. and Fin., 505 U.S. 71, 79 (1992) (stating that "the Foreign Commerce Clause recognizes that discriminatory treatment of foreign commerce may create problems"). Central to a Foreign Commerce Clause analysis is whether a state discriminates against foreign commerce in favor of domestic commerce.
4 See S2746, § 3.d.
5 See id. at § 4.4(k)(2)(K).
6 See MCI Communication Servs., Inc. v. Director, Division of Taxation, 2015 WL 4537743 (N.J. Tax July 20, 2015), aff'd Slip Op., Docket No. A–5735–14T3 (N.J. Super. Ct. App. Div. June 15, 2018). See our coverage of that case here.
7 See S2746, § 1.(1)–(2).
8 See id. at § 1.(1)–(2).
9 See S2746, § 4.4(k)(5)(B).
10 See Infosys Limited of India Inc. v. Director, Division of Taxation, 2017 WL 5907704 (Nov. 28, 2017), aff'd on reconsideration, 2018 WL 1385844 (N.J. Tax March 19, 2018). For our previous coverage of Infosys, see our alerts, here and here.
11 See S2746, § 4.4(k)(16); see also id. at § 4.4(k)(2)(A).
12 N.J.S.A. 54:10A–4(k)(2)(I).
13 See S2746, § 4.4(k)(2)(I).
This article is presented for informational purposes only and is not intended to constitute legal advice.