Infosys Foreign Source Income Not Taxable, Again: N.J. Court

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Jennifer McLoughlin Washington Ryan C. Tuck Washington

By Jennifer McLoughlin

The New Jersey Tax Court didn’t find reason to reverse its earlier ruling that the state couldn’t impose a corporate business tax on foreign source income that isn’t taxable at the federal level.

In November 2017 opinion, the Tax Court awarded India tech giant Infosys a $5.83 million tax refund upon determining that the company’s entire net income for New Jersey Corporation Business Tax (CBT) purposes was equal to its federal taxable income—which didn’t include worldwide income. The refund reflected taxes that Infosys Ltd. of India Inc. paid on its foreign source income for tax years 2008 through 2011.

A March 19 opinion “amplified” the Tax Court’s earlier decision, rejecting the Division of Taxation’s argument that New Jersey law requires the add-back of foreign income exempted under federal law.

The Division of Taxation’s Director maintained that N.J.S.A. 54:10A-4(k)(2)(A) authorizes the state to add-back exemptions or deductions allowed under the Convention for the Avoidance of Double Taxation between the United States and India (U.S.-India Treaty). The New Jersey statute permits the add-back of “specific exemptions or credit allowed in any law of the United States imposing any tax on or measured by the income of corporations.” The director argued that under the U.S.-India Treaty, several sections of the Internal Revenue Code exempt Infosys’ foreign source income from federal taxation, and, therefore, the income is subject to the add-back statute.

However, the Tax Court was unconvinced that the New Jersey statutory scope captured Infosys’ foreign income.

Had the New Jersey Legislature “wished to provide for the add-back of foreign income excluded by treaties of the United States, it could have specifically done so,” Tax Court Judge Mary Siobhan Brennan wrote.

“The Legislature chose to equate CBT entire net income with ‘the taxable income, before net operating loss deduction and special deductions, which the taxpayer is required to report … to the United States Treasury Department for the purpose of computing its federal income tax’ subject only to specific add-back provisions,” Brennan said. “To interpret N.J.S.A. 54:10A-4(k)(2)(A) as broadly as is argued by the Director would be to undercut the Legislature’s clearly stated intent and render it meaningless when determining entire net income of foreign corporations.”

Treaty Not Law

The New Jersey Tax Court’s determination was premised on several observations:

  •  The U.S.-India Treaty isn’t a law of the United States. One IRC provision actually distinguishes “a treaty of the United States” from an “internal revenue law of the United States.”
  •  No judicial law supports the director’s position.
  •  Neither treaty protections nor IRC limitations on the scope of foreign entity taxation qualify as a “specific exemption or credit.” New Jersey law refers to a specific exemption as “a deduction when computing federal taxable income, not to foreign income that was never included in the federal tax base.”
Matthew Setzer, an associate in Reed Smith LLP’s State Tax Group, told Bloomberg Tax in a March 21 email that the New Jersey Tax Court’s refusal to adopt the Division of Taxation’s interpretation of N.J.S.A. 54:10A-4(k)(2)(A)—to the extent the court determined a treaty isn’t a United States law—shows that the Tax Court “will construe additions to income narrowly.”

However, there likely will be more litigation concerning the issue of “specific exemptions,” David Gutowski, a partner in Reed Smith LLP’s State Tax Group, told Bloomberg Tax.

“The taxpayer’s argument in Infosys was that a ‘specific exemption’ is a term of art that is limited to a specific dollar amount,” Gutowski said in a March 21 email. “The court found that federal limitations on taxing foreign-source income were not ‘specific exemptions.’ The court didn’t provide a detailed explanation for this, so we might see more litigation concerning the scope of the term ‘specific exemption’ in the future.”

Reassessing Refund

However, the Tax Court vacated the $5.83 million refund, instructing the director to calculate the refund due to Infosys by late July.

“The court accepts the Division’s argument that discovery and analysis has not been completed due to the early filing of the partial summary judgment motions,” Brennan wrote.

The Tax Court granted time for the Division of Taxation to conduct discovery and determine its position on the refund amount. If the parties can’t resolve the issue, the matter will proceed to the July 30 trial scheduled on remaining issues in the case.

“The court ruled that a taxpayer prevailing on a refund claim at Tax Court is entitled to a refund immediately—without having to wait for the appeal process to be completed,” Gutowski said. " To expedite any refund, the taxpayer will need to make sure the factual record has been fully developed. In fact, taxpayers may want to see if the Division will stipulate the amount of the refund in the event the taxpayer prevails.”

The case is Infosys Ltd. of India, Inc. v. Dir., Div. of Taxation , N.J. Tax Ct., No. 012060-2016, unpublished 3/19/18 .

To contact the reporter on this story: Jennifer McLoughlin in Washington at jmcloughlin@bloombergtax.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bloombergtax.com

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