Shifting of income between parent and subsidiary companies for the purpose of avoiding taxation has been a consistent concern for state departments of revenue. States have enacted a variety of rules to ensure that the entities involved file and pay taxes accurately. In Spring Licensing Group, Inc. v. New Jersey Director, Div. of Taxn., Dkt. No. 010001-2010 (Aug. 14, 2015), the New Jersey Tax Court issued an unpublished ruling clarifying the state’s laws regarding related party intangible expenses.
Since 2002, New Jersey required the addition to federal taxable income of related party intangible expenses. Under N.J. Rev. Stat. § 54:10A-4.4(b), taxpayers must add back otherwise deductible interest expenses and costs and intangible expenses and costs directly or indirectly paid, accrued or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with, one or more related members. Alabama, Connecticut and Georgia are among the states with similar provisions for the modification of federal taxable income to add back related party intangible expenses.
The court noted in Spring Licensing that the “statute was enacted to prevent tax avoidance from income shifting amongst members of a corporation by denying an otherwise allowable deduction for expenses paid to a related member.” However, the court went on to state that the addback does not absolve the payee entity from its duty to file a tax return in New Jersey and report allocable income.
Spring, a company incorporated in South Carolina, licenses trademarks which it owns. The company argued that it should not be subject to New Jersey’s corporation business tax because, after the addback, tax had already been paid by their related entity in New Jersey on the royalty payments made for the intangible property licensed. However, as the New Jersey Division of Taxation noted in the Bloomberg BNA Survey of State Tax Departments, collecting royalty income from intangible property is doing business in New Jersey and creates nexus with the state that subjects a corporation to the corporation business tax.
The New Jersey Department of Taxation argued in the case that it did not matter that the parent company had added back the related party intangible expenses, so long as Spring had nexus with the state it must file a return and report allocable income. Furthermore, the department argued that the taxpayer in this case had failed to take advantage of available relief provisions, and had not proven that the department’s requirement that they file and be taxed on allocable income was unreasonable.
The court agreed with the Department, saying that Spring was subject to the corporation business tax and must file a return and be taxed on its income from the licensing of intangible property. The court took particular note of the relief provisions in the statute, saying that while the taxpayer is required to file and pay taxes on this income, there was still relief available. While the licensing company will have to be taxed, the parent company that originally added back the expenses for the licensed intangible property could apply for a refund to prevent double taxation on that money.
The full text of the case is available here: https://www.judiciary.state.nj.us/taxcourt/tax_unpublished/10001-10opn.pdf
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Should states require filing and taxation for entities whose only contact with the state is licensing intangible property to related entities?
For more information about this and other state tax issues, sign up for a free trial of the Bloomberg BNA Premier State Tax Library.
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