In Bank of America Consumer Card Holdings,¹ the New Jersey Tax Court (Court) held that a credit card bank's receipts from interest on purchases not paid within a grace period, interchange which occurs on all transactions, and service fees are allocated to New Jersey and, as such, are subject to the New Jersey Corporate Business Tax (CBT). While the interest and interchange are both fully allocable to New Jersey, the service fees are only 50% allocable to the state as the 25-50-25% regulation that specifically allocates certain services fee applies.

The taxpayers, Bank of America Consumer Card Holdings and related entities (collectively, BOA), are in the credit card account business, and derive income from interest, interchange and services fees charged to card holders. BOA concedes that it has nexus with New Jersey and agrees that the double-weighted sales factor apportionment applies. For tax years 2002-2008 BOA filed amended returns seeking a $42 million refund, arguing that none of the income earned or derived from New Jersey cardholder accounts should be allocated to the state. The New Jersey Division of Taxation (Division) rejected BOA's refund claims.

Background

In 2002 the CBT was overhauled and the Corporate Income Tax (CIT) was repealed. A key change to the CBT expanded its scope to apply not only to the privilege of doing business in New Jersey but also to the privilege of deriving receipts from sources within New Jersey (i.e., the standard under the former CIT, which was imposed on taxpayers not subject to the CBT). Further, the 2002 amendments made clear that the CBT applies "if the taxpayer's business activity in this State is sufficient to give this State jurisdiction to impose the tax under the [US] Constitution … ," and adopted a throwout rule, which was repealed in 2010.

Interest receipts

BOA earned interest income when credit card holders (i.e., customers that used their cards to make purchases) failed to pay the amount advanced within the designated grace period. A number of such card holders were in New Jersey. At issue, is how this interest income should be sourced. The Court found that BOA "[did] not clearly set forth what sort of sourcing would be appropriate" and "assumed" that BOA was arguing that the interest income should be sourced to where it conducts its operations. The Court rejected this argument, reasoning that while BOA's argument seems to find the body of case law on interest allocation under the former CIT inapplicable to the current CBT, and found instead that "it is entirely appropriate" to review how the New Jersey Supreme Court (NJSC) dealt with this issue under the former CIT as the current CBT "is essentially a continuation of the taxation scheme of the now repealed CIT … ."

Turning to CIT cases² on point, the Court said the taxpayers in the Avco case raised the same argument that is before this court — i.e., the taxable situs of an intangible is the domicile of the creditor and, therefore, the taxpayer earned no income in New Jersey. The argument in both cases "rests on the maxim" that the movables follow the person. In Avco, however, the NJSC "put [] aside traditional concepts relating to intangibles" and instead held that "the real source of [the taxpayer's] income is not a piece of paper, but the New Jersey borrowers." Moreover, the NJSC held that, absent legislative intent that the maxim the movable follow the person be construed to be part of the CIT, interest income received from New Jersey borrowers is derived from sources within New Jersey and, thus, subject to the CIT.

Moreover, in 1984, while Avco was pending before the NJSC, the Division issued a regulation,³ which is still in effect, that provides in part that the "taxable situs [of an intangible] is New Jersey to the extent that the intangible has been integrated with a business carried on in this State." Included in the regulation is a comment that is directly on point, and states that interest income from lending money to New Jersey residents is income derived from sources within New Jersey and, as such, is earned in the State and includible in the numerator of the receipts fraction. The Court found this comment to be "more than a mere comment," but rather an embedded example that "defines the mechanic of how the regulation is to be implemented."

Based on the regulation and the CIT ruling in Avco, the Court concluded that interest income from New Jersey borrowers is allocated to numerator of the receipts factor of the allocation formula.

Interchange fees

The second issue before the Court is whether interchange resulting from credit card transactions of New Jersey customers is properly allocated to New Jersey and, if so, how much of it is allocated to the state. The Court's first step in resolving this issue was to determine whether the interchange constitutes a fee for a service or is instead, treated as interest. Citing the US Tax Court's ruling in Capital One Financial Corp.,⁴ the Court determined that the interchange is original issue discount (OID) which is economically equivalent to interest. Further, the Court explained that under the CBT, BOA, in calculating its net income for CBT purposes, must use the same method of accounting it used in calculating its federal net income tax.⁵

For federal income tax purposes, BOA is treating the interchange as OID. Under this accounting method, the interchange is not fully realized as income in the year in which a particular purchase is made but is instead spread out over the likely number of years it will take the cardholder to pay off the portion of the balance attributed to the purchase. For CBT purposes, however, BOA wanted to treat the interchange as a fee. Under New Jersey law, if the interchange is interest it would be fully allocable to New Jersey but only partially allocable to New Jersey if it is treated as a fee. This proposed treatment the Court found "runs counter to the assertions necessary for taxpayers to enjoy the tax treatment received under federal law." The interchange is either a service fee or OID/interest; it cannot be treated as both.

The Court, in finding that the interchange constituted interest, did not choose to rely wholly on the fact that BOA treats the interchange as OID/interest for federal income tax purposes. The Court explained that OID typically arises when debt is purchased for cash for less than face value. Moreover, the interchange is not a fee because it does not compensate the cardholder for specifically stated services, rather it compensates the credit card issuer for costs associated with lending money to credit card holders (e.g., fraud risks, financial carrying costs, processing costs), the income from which is generally treated as interest.

Because the interchange is treated as OID/interest, the Court determined that the interchange was properly allocable to New Jersey.

Allocation of fees

The last issue considered by the Court was the proper allocation of services fee receipts (e.g., late fees, return check fees, over-the-limit fees, non-sufficient funds fees, annual fees) to New Jersey under the CBT. For the tax years at issue, New Jersey used a double weighted receipts factor apportionment formula, with the receipts factor including sales for both "services performed within the state"⁶ (Subsection 4) and "all other business receipts … earned in the state"⁷ (Subsection 6). A regulation⁸ adopted by the Division specifically allocated certain services fees from transactions having a connection to New Jersey based on the following: (1) allocate 25% of such fees to the state of origination, (2) allocate 50% of such fees to the state in which the service is performed, and (3) allocate 25% of such fees to the state in which the transaction terminates. (hereafter the 25-50-25 allocation rule).

The Court rejected BOA's argument that the services fees should be completely excluded from the numerator of the allocation fraction since the fees in question were for services performed outside New Jersey, reasoning that this argument ignores Subsection 6's inclusion of "all other business receipts … earned within the state." Under BOA's position, if services fees are excluded under Subsection 4, the same services fees cannot be included as being earned in the state under Subsection 6. Citing the NJSC's ruling in Stryker Corp.⁹ in which the NJSC rejected the application of ejusdem generis to the CBT receipts allocation provision and held that even though the activities were addressed by a specific subsection, the catch-all, loophole closing provision of Subsection 6 would still apply to include the receipts, holding that "in interpreting the CBT, the ancient maxims of construction are not applied unless specifically indicated by the Legislature."

After concluding that Subsection 6's catchall provisions "sweeps in all business receipts earned within the state," the Court next determined whether the services fee receipts from BOA's New Jersey customers are earned in New Jersey. The Court found that without the underlying credit card accounts the services fees would not arise, and since the benefit of the services fees (which is "part and parcel of having the credit card account") is being derived by the New Jersey customer of BOA, the fees are earned in New Jersey. The Court noted that the "revenue being derived here is not from the service provided by any late fee or other fee, but by the service of lending money to the customer."

In regard to sourcing the receipts, the Court citing Mayer & Schweitzer,¹⁰ determined that this case demonstrates that under New Jersey law receipts from intangibles are taxed at the location of the customer. The Court also determined that the impact of the Legislature's amendment of the CBT law to apply to the fullest extent allowed under the Constitution "is that the CBT is to be broadly and liberally read in favor of taxation. This clearly abrogates the maxim that the tax statutes are to be narrowly read when it comes to interpreting the CBT."

Ultimately, the Court found that under the Subsection 6 catch-all provision, 100% of the fee receipts are attributable to New Jersey; however, the Court found the Division is bound by the 25-50-25 allocation rule applies. Thus, only 50% of the services fee income is allocable to New Jersey.

Constitutional issues

The Court also determined that the CBT does not violate the Constitution and that the CBT is fairly apportioned. The Court reasoned that the CBT is internally consistent as it only taxes income generated by New Jersey cardholders. Thus, if the CBT were in effect in every state, each state would only tax income generated by cardholders in each respective state and would not result in double taxation. The Court also found the CBT externally consistent, reasoning that the double weighted receipts factor is more likely to reflect the BOA's net income derived from New Jersey. Further, application of the CBT does not discriminate against out-of-state businesses and it is fairly related to BOA's generation of income in the state.

Implications

BOA has 45 days from the date of the Order to appeal this decision, which as a Tax Court decision, is only precedential to the named taxpayer. Taxpayers should consider the revenue streams discussed in the case to determine whether they have sourced their receipts consistently with the Court's findings and, if not, whether they have potential exposure or refund opportunities.

———————————————

———————————————
ENDNOTES

¹ Bank of America Consumer Card Holdings v. New Jersey Division of Taxation, No. 012945-2011 (N.J. Tax Ct. Oct. 6, 2016) (consolidated with four other cases).

² Avco Fin. Serv. Consumer Disc. One, Inc. v. Director, Div. of Taxation, 100 N.J. 27 (1985); Tuition Plan v. Director, Div. of Taxation, 4 N.J. Tax 470 (Tax 1982); CIT Fin. Servs. Consumer Disc. Co. v. Director, Div. of Taxation, 4 N.J. Tax 568 (Tax 1982).

³ N.J.A.C. 18:7-8.12(e).

⁴ Capital One Fin. Corp. v. Comm'r, 659 F.3d 316 (4th Cir. 2011).

⁵ N.J.S.A. 54:10A-4(k).

⁶ N.J.S.A. 54:10A-6(B)(4).

⁷ N.J.S.A. 54:10A-6(B)(6).

⁸ N.J.A.C. 18:7-8.10(e).

⁹ Stryker Corp. v. Dir., Division of Taxation, 168 N.J. 138 (2001).

¹⁰ Mayer & Schweitzer, Inc. v. Director, Div. of Taxation, 20 N.J. Tax 217 (Tax 2002).