On April 8, 2020, the New Jersey Division of Taxation (DOT) filed special adoption regulations (SARs) relating to statutory changes to the Corporation Business Tax Act (CBTA) in 2018. These regulations cover: (1) a revised unreasonableness exception to the state's addback rules for interest and royalties paid to related parties; (2) the treatment of global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII); and (3) the treatment of previously taxed income (PTI) in the context of dividends received from subsidiaries.The SARs will expire on October 5, 2020, but are expected to be adopted as permanent regulations before expiring.

Background

On July 1, 2018, New Jersey enacted a tax reform bill,¹ which was amended in October 2018, ² making significant changes to the CBTA. The changes included (1) taxing new forms of income (such as GILTI); (2) imposing mandatory combined reporting on unitary groups of corporations; (3) sourcing service revenue for allocation (New Jersey's reference to apportionment principles) purposes on a market basis, and (4) imposing a temporary surtax on certain corporations. The amended reform bill authorized the DOT Director to issue temporary emergency regulations to implement the substantial changes to the CBTA brought about by the initial reform.

Under New Jersey law, the DOT Director may issue emergency regulations without undergoing the normal rule adoption process, including a public comments period. Emergency regulations are only effective for six months.

The DOT Director exercised his statutory authority to address several of the changes in the CBTA reform laws, while also addressing certain recent tax court decisions.

Matters addressed by the SARs

Previously taxed income

Perhaps the most materially different provision in the SARs from prior DOT guidance relates to the treatment of federal PTI for CBTA purposes. According to the SARs, the DOT will only extend PTI treatment to deemed and actual dividends to the extent that a taxpayer filed a New Jersey tax return, included the dividend in the ENI base, and paid greater than minimum tax during the previous tax period. See N.J.A.C. 18:7-5.20. Literal application of this provision would seemingly allow New Jersey to indirectly tax the same distribution twice. For example, in Year One, the deemed distribution might offset CBT losses (causing a loss of attributes); in Year 2, the receipt of the cash dividend could be taxed despite its federal PTI status. Taxpayers should be prepared to petition for relief if they fall into a double taxation situation.

Special allocation factor for certain dividends

The SARs address the appropriate allocation factor to apply to actual and deemed dividends taxed during privilege periods beginning on or after January 1, 2017, and those beginning before January 1, 2019. The SARs added N.J.A.C. 18:7-3.25, which apportions 5% of the residual dividends left after applying the 95% dividends received exclusion (available to distributions from 80%-or-greater owned subsidiaries) enacted as part of the tax reform bills. Under this regulation, a taxpayer will allocate the taxable portion of the dividends received by the lower of its three-year average allocation factor to New Jersey or 3.5%. For privilege periods beginning on January 1, 2019, the special allocation formula set forth in this regulation will not be available. This regulation seems to be a faithful interpretation of the CBTA changes made by the 2018 state tax reform bills.

Related-party expenses

The SARs also modify the rules for related-party interest and intangible property licensing transactions set forth in N.J.A.C. 18:7-5.18. These provisions have recently been the subject of significant litigation.³ The SARs alter the language of the existing regulation to change the so-called unreasonable exception to the related-party addback from a requirement (shall) to a permissive (may), seemingly to grant the DOT Director greater discretion to not allow the exception. The SARs also analyze the change in the treaty-nation addback exemption, which now requires taxpayers to provide documentation proving that such payments were taxed in the payee's home country at an effective tax rate within three percentage points of the New Jersey rate. The remainder of the change relates to some of the possible instances that might establish exceptions to the interest and intangible expense addback.⁴

The SARs also mention that, if a taxpayer claiming an unreasonable exception included GILTI in its entire net income (ENI) from a related party, the expenses from the same related party would otherwise have to be added back.

GILTI and FDII

The SARs further examine the treatment of GILTI and FDII, appearing to be consistent with previously issued DOT guidance. Of note, the SARs allow a combined group that includes GILTI from a foreign affiliate to apply the offsetting GILTI deduction provided in IRC Section 250(a) for CBTA purposes as well. In addition, the SARs make clear that GILTI is not included in the tax base if the foreign controlled corporation to which the GILTI is attributed is already included in the taxable income of the combined group. Finally, the SARs outline when GILTI and FDII may be included in the sales factor numerator of the taxpayer's or combined group's allocation factor (New Jersey's reference to apportionment).

Implications

The SARs codify a significant amount of guidance that the DOT has previously released through technical bulletins since 2018. While most of the guidance is consistent with the DOT's previous guidance, certain topics are new, including the possible inclusion of GILTI and FDII in the New Jersey sales factor numerator, the application of the IRC Section 250(a) deduction despite eliminating GILTI from the ENI base in certain circumstances, and limitations on federal PTI. Applying these new rules, particularly those on PTI treatment, may result in incongruous tax results, requiring taxpayers to seek specific relief in the event of a double taxation situation.

Although taxpayers are currently unable to submit public comments, a 60-day comment period will commence once the DOT submits the SARs as permanently promulgated regulations. Further, the DOT told EY that it would welcome comments on the regulations at any time, not just during the 60-day comment period.

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ENDNOTES

¹ L. 2018, c. 48.

² L. 2018, c. 131.

³ See Morgan Stanley & Co. Inc. v. Director, Div. of Taxation, 28 N.J. Tax 197 (Tax 2014); Kraft Foods Global, Inc. v. Director, Div. of Taxation, 29 N.J. Tax 224 (Tax 2016), aff'd 2018 WL 2247356 (App. Div. 2018), cert. denied 236 N.J. 230 (2018).

⁴ Some potential challenges may include claiming unfair duplicative taxation, a technical failure to qualify the transactions under the statutory exceptions, an inability or impediment to meet the requirements due to legal or financial constraints, or the transaction is equivalent to an unrelated loan transaction.