On August 27, 2018, New Jersey Governor Phil Murphy conditionally vetoed a bill related to the Corporate Business Tax (CBT), Assembly Bill 4262 (A4262 or the Bill). A4262, which was passed by the New Jersey Senate and Assembly on June 25, 2018, provides technical corrections and substantive changes to previously enacted Assembly Bill 4202 (A4202) (signed into law on July 1, 2018). A4202 itself made historic, substantial changes to the CBT. (See Tax Alert 2018-1342 discussing the many changes to the CBT brought about through enactment of A4202.). With his conditional veto of A4262, however, the Governor proposed technical corrections, as well as various new substantive changes that, if enacted, would replace certain key provisions of the already-enacted A4202.

The Governor's proposed changes are currently being considered by the Assembly and Senate, which can either approve the Governor's recommended changes "as is" or modify and resubmit the bill for further consideration by the Governor. Regardless of which course the Legislature chooses, the reapproved bill would then go back to the Governor for his consideration (i.e., approval, conditional veto or outright veto). This process is likely to occur over the next few weeks.

The technical corrections and substantive changes contained in the Bill are summarized below.

Technical corrections

The Governor's conditional veto of A4262 includes the following technical corrections and clarifications:

— The addback rules related to intercompany intangible and interest payments would not apply to the extent that the group members are included in the same New Jersey combined return.

— For purposes of calculating the taxpayer's New Jersey allocation, as applied to the portion of deemed dividends under IRC Section 965 (the Transition Tax) included in Entire Net Income (ENI), the average three-year formula would be amended to use recipient New Jersey allocation from the 2014 through 2016 tax years, instead of the 2015 through 2017 tax years.

— The lesser of the three-year New Jersey average allocation or 3.5% sourcing formula would apply to the includable Transition Tax amount for tax years 2017 and 2018, instead of only 2017.

— Pre-allocated net operating losses incurred before privilege periods ending July 31, 2019 (PNOLs) would be converted to post-allocated net operating losses by applying the taxpayer's business allocation factor from the last privilege period before the privilege period ending on or before July 31, 2019, to the accumulated PNOLs.

— The deferred tax asset (DTA) deduction provided to public companies due to the diminution of DTAs or increase in deferred tax liabilities (DTLs) from combined filing would apply to all taxpayers filing either using the water's-edge default or elective worldwide or affiliated group elective combined filing methods.

— An existing limitation on carrying forward PNOLs following a change of corporate ownership would apply to net operating losses (NOLs) incurred in privilege periods ending on or after July 31, 2019, except when the change in corporate ownership occurs among members of a New Jersey combined return.

— Combinable captive insurance companies would not be exempt from the CBT, but non-combinable captive insurance companies would be exempt.

— PNOLs and NOLs would qualify to be surrendered by new or expanding emerging technology or biotechnology companies.

— The rule requiring non-surviving corporations in a merger to relinquish NOL carryforwards would not apply to mergers within combined filing groups, regardless of whether the groups use a water's-edge, worldwide or affiliated group filing method.

— The combined filing rules would apply to privilege periods ending on or after July 31, 2019.

— The combined NOL carryforward rules would apply to privilege periods ending on or after July 31, 2019.

— The so-called surtaxes imposed in tax years 2018 and 2019 at the rate of 2.5% and in 2020 and 2021 at the rate of 1.5% would apply to allocate ENI of taxpayers with allocated ENI over $1 million.

Substantive changes

The Governor's conditional veto of the Bill proposes the following substantive changes:

— Reversing the change in NOL and dividend received deduction (DRD) ordering rules included in A4202, to once again require the application of NOLs to ENI before applying the DRD (any DRD amount resulting in an ENI amount below $0 could not be carried forward to future tax years)

— Expanding the definition of "combined group" to include "all business entities" in place of "corporations"

— Authorizing the Director of the Division of Taxation (DOT) to write regulations to include or exclude business entities from the combined group

— Applying the "Finnigan" method to all combined filing options, requiring the sales factor for taxable members of combined groups to include receipts from New Jersey sales of both taxable members and a fraction of the sales of non-taxable members in the numerator (the fraction of the receipts from New Jersey sales of non-taxable members would be attributed to taxable members pro rata, based upon the taxable members' relative proportion of total combined group New Jersey allocation)

— Authorizing the Director to write regulations related to the appointment of a managerial member of a combined group outside of the procedures provided for in the Bill "to prevent undue harm to the members of the combined group" and extending that regulatory authority to allow the Director to determine the combined group's privilege period using the privilege period of members besides the managerial member

— Revising New Jersey's new water's-edge combined filing rules as follows:

— Limiting inclusion of foreign combined group members that earn more than 20% of their income from payments that are made by New Jersey combined groups members and relate to intangible property or related services, to the extent the foreign combined group members' income and allocation factors relate to those payments

— Expanding the water's-edge combined group to include domestic international sales corporations, foreign sales corporations and export trade corporations, to the extent of effectively connected income (ECI)

— Requiring inclusion of controlled foreign corporations, as defined in IRC Section 957, to the extent of income defined in IRC Section 952 (including lower-tier subsidiary distributions of previously taxed income), determined without regard to federal treaties, and allocation factors related to that income, unless the income was subject to at least 90% of the federal corporate income tax rate of 21% (i.e., 18.9%)

— Requiring inclusion of combined group members doing business in a jurisdiction determined by the Director to be a tax haven, to the extent of ECI, unless proven by a preponderance of evidence that the member is incorporated in a tax haven for a legitimate business purpose

— Defining a "tax haven" as a jurisdiction that: (1) has no or only a nominal effective tax rate on relevant income; (2) has anti-information sharing laws or practices related to taxpayer information; (3) has a tax regime lacking transparency; (4) facilitates the establishment of foreign-owned entities without the need for substantive presence or impact on the local economy; (5) excludes local residents from tax benefits, or excludes tax regime beneficiaries from participating in the local market; and (6) has a tax regime determined to be favorable to tax avoidance via various factors, including having a significant untaxed financial or other services sector relative to its economy (does not include a jurisdiction with a comprehensive income tax treaty with the United States)

— Prohibiting taxpayers that do not renew either worldwide or affiliated group filing elections in the year of expiration from making an election for the following three tax years

— Requiring the managerial member of a combined group to inform the Director within 120 days of any change in ownership of an elective combined filing group

— Applying the minimum tax of $2,000 to each member of a combined group

— Authorizing the Director to require inclusion of ENI and allocation factors of entities otherwise not part of the combined unitary business in a combined return in order to reflect proper allocation of income of a unitary business

— Amending the effective dates of the Bill's provisions as follows:

— Would apply provisions related to DRD changes to tax years beginning on or after January 1, 2017

— Would apply provisions related to combined filing and market sourcing to tax years ending on or after July 31, 2019

— Would apply all other provisions to tax years beginning on or after January 1, 2018

— Limiting the imposition of tax on the sale or assignment of tax credit transfer certificates to tax credits awarded after July 1, 2018, regardless of when the credits are sold or assigned

Implications

The Governor's proposed amendments to A4262, if adopted, would add an additional layer of complexity to the already complex changes instituted by A4202 on July 1, 2018. These amendments, which are intended as additional revenue raisers, will likely affect all taxpayers that must file New Jersey CBT returns. Many of the changes made to the combined reporting regime will be unique and differ markedly from the approaches other states have followed with respect to water's-edge reporting and there is little analogy a taxpayer can make to the manner in which other states have approached these issues.

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