State & Local Tax Alert

Transcription

1 State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP New Jersey Tax Court Finds Out-of-State Corporate Limited Partner Has Nexus for CBT Purposes On October 4, 2017, the New Jersey Tax Court ruled that an out-of-state corporate limited partner had nexus with New Jersey for Corporation Business Tax (CBT) purposes by virtue of its interests in two partnerships doing business in New Jersey. 1 Specifically, the Court found that there was no credible basis to determine that the taxpayer played a distinctly separate role as a passive investor in the partnerships. Background During the tax years at issue, the taxpayer, Preserve II, Inc. (Preserve), a foreign corporation based outside New Jersey, served as a 99 percent limited partner with a $9,900 capital contribution in each of two foreign limited partnerships, Pulte Homes of NJ, L.P. (Pulte Homes) and Pulte Communities of NJ, L.P. (Pulte Communities). The remaining 1 percent general partnership interests in Pulte Homes and Pulte Communities were held by Pulte Home Corporation of the Delaware Valley and Preserve I, Inc., respectively. 2 Preserve, Pulte Home Corporation of the Delaware Valley and Preserve I, Inc. were all wholly owned by the same entity, Pulte Home Corporation (PHC), also based outside New Jersey. Pulte Homes and Pulte Communities were engaged in the business of developing, building, and selling residential homes in New Jersey and were part of a corporate family which included a national residential real estate developer and builder. The ultimate corporate parent served as a publicly held holding company incorporated in Michigan. 3 The partnership agreements for Pulte Homes and Pulte Communities provided that the general partners had full, exclusive, and absolute power to manage and control each partnership, including its property assets and business. All of the decision-making authority was exclusively entrusted to the general partners. Pursuant to the agreements, Preserve had no voice or participation in the management of the [p]artnership business, and could not sign or act on behalf of, nor bind the partnership. However, all of Release date October 30, 2017 States New Jersey Issue/Topic Corporation Business Tax Contact details Frank Schaefer Iselin T E frank.schaefer@us.gt.com Bridget McCann Iselin T E bridget.mccann@us.gt.com Jamie C. Yesnowitz Washington, DC T E jamie.yesnowitz@us.gt.com Chuck Jones Chicago T E chuck.jones@us.gt.com Lori Stolly Cincinnati T E lori.stolly@us.gt.com Priya D. Nair Washington, DC T E priya.nair@us.gt.com 1 Preserve II, Inc. v. Division of Taxation, New Jersey Tax Court, Nos , , , Oct. 4, Each general partner held a $100 capital contribution in each partnership. 3 Notably, the corporate parent s forms 10-K filed with the SEC did not identify either Preserve, or the two general partners, as holding companies. Further, the Forms 10-K noted that all subsidiaries and operating units operate independently with respect to daily operations..

2 Grant Thornton LLP - 2 Preserve s corporate officers also served as officers and/or directors of the two general partners. As the partnerships were doing business in New Jersey, their general partners filed appropriate returns and paid CBT with respect to their 1 percent shares in each partnership. In addition, for the tax years, Preserve initially did not dispute that it had nexus with New Jersey and voluntarily filed CBT returns, paying tax on its share of partnership income. Its balance sheet for each year reported zero liabilities. Notably, Preserve filed as an investment company 4 and was consequently subject to CBT on only a portion of its income. The Director of the Division of Taxation began an audit of Preserve in Pursuant to the decision in BIS LP, Inc. v. Director, Division of Taxation, 5 Preserve subsequently claimed that it lacked any nexus or connection with New Jersey for the tax years and requested a refund of the CBT paid. The Division disagreed and not only denied the refunds, but also imposed CBT assessments against the partnerships under N.J. Rev. Stat. Sec. 54:10A-15.7 and 54:10A-15.11, which require a partnership to withhold tax on income distributed to non-resident corporate partners which have not consented to New Jersey s jurisdiction to tax them. Also, the Division assessed interest and both underpayment and amnesty penalties. Tax Court Decision The central issue that the Tax Court addressed was whether Preserve had nexus for CBT purposes. The Division asserted nexus based on the fact that Preserve was authorized to do business in New Jersey and that it had a unitary relationship with the two partnerships. Preserve disagreed and argued that: (i) a certificate of authority to do business cannot create nexus for CBT purposes; (ii) it did not have nexus because it was not unitary with either partnership and, as a limited partner, it was prohibited from managing and controlling the partnerships business; and (iii) the assessments against the partnerships lacked any presumptive correctness because they contradicted the Division s determination that Preserve was unitary with the partnerships for CBT nexus purposes. Alternatively, Preserve argued that if it had CBT nexus, it was entitled to apply investment company status as its sole activity consisted of holding limited partnership interests in each partnership. 4 N.J. REV. STAT. 54:10A-4(f). For investment companies, tax liability is limited to a measurement of 40 percent of entire net income and 40 percent of entire net worth. N.J. REV. STAT. 54:10A- 5(d). 5 Docket No. A T2 (N.J. Super. Ct. App. Div. 2011). In that case, the Court found that a taxpayer, whose only connection with New Jersey was a 99 percent limited partnership interest in a partnership doing business in New Jersey, did not have New Jersey CBT nexus. In that instance, the corporation had no control over the partnership s business and no other physical contacts in New Jersey. The Court found that the partner was not integrally related to the partnership since it was not in the same line of business, but served as a holding company implemented to limit liability at that level.

3 Grant Thornton LLP - 3 Nexus Determination The New Jersey CBT is imposed on a corporation for the privilege of having or exercising its corporate franchise in [New Jersey], or for the privilege of deriving receipts from sources within [New Jersey], or for the privilege of engaging in contacts within [New Jersey], or for the privilege of doing business, employing or owning capital or property, or maintaining an office, in [New Jersey]. 6 New Jersey law and regulations assert nexus to the extent permissible by the federal Constitution and statutes of the United States. 7 Pursuant to administrative regulations, an analysis of the specific facts of a case must be performed to determine whether an out-of-state corporation is subject to the CBT. 8 New Jersey regulations provide guidance on the imposition of the CBT on out-of-state limited partners with investments in New Jersey. 9 Specifically, an actual or deemed foreign corporate general partner is subject to the CBT simply as a result of its status as a partner. 10 However, if a foreign corporation is a limited partner and its only connection to New Jersey is its ownership of one or more limited partnership interests in partnerships doing business in the state, and is otherwise not subject to the CBT, then the ownership of the limited partnership interest does not make the corporation taxable. 11 Instead, a foreign corporate limited partner of a partnership doing business in New Jersey is taxed under the CBT if: (i) it is also a general partner; (ii) it takes an active part in the control of the partnership business; or (iii) it meets the criteria of a corporation doing business under N.J. Admin Code tit. 18, Sec The taxpayer is required to prove to the Director that a limited partner does not meet the requirements to be subject to the CBT. 13 Preserve did not dispute that it had New Jersey sourced income for the tax years at issue. Both partnerships did business in New Jersey and derived related income. Since Preserve clearly derived income from New Jersey sources, the Court found that it met the definition of doing business in New Jersey, as defined in N.J. Admin Code tit. 18, Sec and was properly subject to the CBT. The Court rejected Preserve s claim that the assessments were voidable since they were erroneously grounded on a finding that Preserve had authority to do business in New Jersey. 14 Further, the Court rejected Preserve s request to invalidate related regulations N.J. REV. STAT. 54:10A-2. 7 N.J. REV. STAT. 54:10A-2; N.J. ADMIN. CODE tit. 18, 7-1.6(b). 8 N.J. ADMIN. CODE tit. 18, 7-1.9(b). 9 N.J. ADMIN. CODE tit. 18, 7-1.6(a); 7-1.9(a), (b); 7-7.6(c). 10 N.J. ADMIN. CODE tit. 18, 7-7.6(a). 11 N.J. ADMIN. CODE tit. 18, 7-7.6(b). 12 N.J. ADMIN. CODE tit. 18, 7-7.6(c). 13 N.J. ADMIN. CODE tit. 18, 7-7.6(e). 14 Notably, Preserve s originally filed tax returns for the tax years listed different dates on which it began to do business in New Jersey. The state issued a Certificate of Authority for Preserve in late December Preserve had argued that it did not have authority to do business in New Jersey prior to that date. 15 Preserve had maintained that N.J. ADMIN. CODE tit. 18, and Example 3 of N.J. ADMIN. CODE tit. 18, 7-1.8(a) (which provided that CBT is imposed upon a foreign corporation regardless of whether it has formally qualified or is authorized to do business in New Jersey) should be voided as exceeding the statutory authority of N.J. REV. STAT. 54:10A-2.

4 Grant Thornton LLP - 4 Preserve next argued that its limited partnership interests were not enough to create nexus for CBT purposes because it was strictly a passive investor. In support of its argument, Preserve relied upon the decision in BIS LP, Inc. v. Director, Division of Taxation. 16 In that case, the Court found that a taxpayer, whose only connection with New Jersey was a 99 percent limited partnership interest in a partnership doing business in New Jersey, did not have New Jersey CBT nexus. The Court pointed instead to its more recent decision in Village Super Market of PA, Inc. v. Director, Division of Taxation, 17 in which it concluded that the taxpayer had sufficient minimum contacts to meet the requirement of presence based nexus with New Jersey due to various factors. Specifically, the Court applied a transactional nexus analysis, similar to that used in Village Super Market, in which there must be a connection between the foreign entity and the activity being conducted in the taxing state, to the facts at hand. First, the Court rejected Preserve s argument that it was merely a limited partner in the partnerships pursuant to the terms of its partnership agreement. In rejecting the elevation of form over substance, the Court considered the facts and circumstances of Preserve s business purpose, its involvement in the partnership s businesses, and the shared relationships between Preserve, its partnerships and their common parent corporation. Notably, the Court found no evidence to show that only the general partners performed all operations, management, and control for the partnerships while the limited partners were absolute passive investors. 18 Instead, the Court found the lines between the partnerships, the general partner, Preserve, and the common parent corporation to be completely blurred, rather than sharp and distinct as outlined in the partnership agreements. As the facts did not credibly establish a distinction as to Preserve s limited partner status, the Court could not conclude that Preserve did nothing in either partnership besides receive its share of pass-through income. Distinguishing the decision from BIS, the Court noted that in that case there was neither an allegation, an issue, nor discussion, thus, no finding, of a limited partner being a deemed general partner. Because the Court found that Preserve itself was subject to the CBT for the years at issue and was, therefore, a resident corporate partner, the assessments against the partnerships were cancelled, along with related interest and penalties. Qualification as Investment Partnership Effective August 7, 2006, the Division amended its regulations so that the direct investment in a non-publicly-traded pass-through entity would not be considered qualified investment activities for an entity to meet the definition of investment company. 19 Prior decisions had considered the propriety of whether this change could be 16 Docket No. A T2 (N.J. Super. Ct. App. Div. 2011). 17 No , New Jersey Tax Court, Oct. 23, The facts of the case indicate that Preserve, the partnerships and their general partners, as well as their common parent corporation all shared a common benefit plan and medical benefits, accounting and tax preparation service, and common policies and procedures regarding home building operations. Also, no entity had an outside bank account and key personnel were unaware of Preserve s existence. 19 N.J. ADMIN. CODE tit. 18, (b).

5 Grant Thornton LLP - 5 effective on a retroactive basis to tax year and determined that the amendment was an invalid exercise of the Division s rule-making power. 21 Because of the findings as to the nature of Preserve s business, including the lack of any substantive distinction between Preserve and the corporate general partner with respect to the partnerships business operations, control, and management, the Court did not need to analyze the pertinent definition to conclude that Preserve did not qualify as an investment company. The Court abated underpayment penalties related to the investment company classification for tax years 2005 and 2006 because the amended regulation at issue was not yet promulgated when Preserve s initial CBT returns were filed. However, as the change became known in 2006, it declined to abate underpayment penalties for Also, amnesty penalties for years were abated as the taxpayer did not make a willful decision to underpay tax. Commentary This decision serves as a clear reminder that the determination of whether an out-of-state entity that holds a limited partnership interest in a New Jersey limited partnership has nexus with the state is extremely fact-dependent and closely mirrors the rationale applied in Village Super Market. The Tax Court distinguished both this case and Village Super Market from BIS based on the fact that the entities in BIS were separate and engaged in different lines of business. In contrast, the Tax Court viewed the activities at issue in both Village Super Market and the instant case as interrelated. Taxpayers should note that the Court spent a significant amount of time identifying pertinent facts, including interviewing several key employees and officers about the activities of each related entity. In addition, the Court went beyond the terms of the partnership agreements that nominally provided that Preserve had no managerial powers over the underlying partnerships. In situations where an out-of-state corporation owns a passive ownership interest in a pass-through entity doing business in New Jersey, the relationship between the corporation, the pass-through entity, and other related entities needs to be carefully examined in order to make a nexus determination. Notably, key facts in support of the determination should be clearly documented contemporaneously to avoid potential misunderstandings or misrepresentations upon audit. Taxpayers now have as a resource three different decisions with developed fact patterns demonstrating how to treat these types of arrangements, both for purposes of applying for potential CBT refunds and for prospective planning through restructuring. Taxpayers should be wary of submitting refund claims based on the holding in BIS unless they are certain that their facts clearly mirror those outlined in that decision. As for prospective planning in this area, some level of risk remains, as the Division could challenge such 20 BIS LP, Inc. 21 Manheim N.J. Inves. Inc. v. Director, Division of Taxation, 30 N.J. Tax 18 (Tax 2017). In this case, the Court simply ruled on the validity of the regulation. The decision did not find as to the limited partner s allegations that it was a mere passive investor and, thus, was automatically entitled to an investment company status.

6 Grant Thornton LLP - 6 planning either on a transaction-by-transaction basis (for example, by claiming a transaction does not have valid business purpose) or more holistically (through regulations or support of an amended statute that would diminish or eliminate any long-term New Jersey CBT benefit of such planning). The Tax Court s decision to cancel the imposition of interest and penalties related to the underlying partnerships (Pulte Homes and Pulte Communities) in light of finding Preserve a resident corporate partner may be of general interest to partnerships. The discussion in this case points out that each regular place of business of a partnership that is unitary with a corporate partner who is filing a return in this State is to be treated as a regular place of business of the corporate partner. Taxpayers simply viewing the instructions to Form NJ-1065E may not find this intuitive since they state that the cost [of the regular place of business] must be borne directly by the taxpayer and not be some related entity or person. Finally, corporations performing a New Jersey nexus analysis may wish to consider some of the language included in the decision. Specifically, they may find relevant the discussions regarding subjectivity to the CBT, derivation of income from New Jersey sources, the holding of a certificate of authority to do business in the state, and Example 3 of N.J. Admin Code tit. 18, Sec (a) which simply seeks imposition of the minimum tax. All could serve as informative to a broader group of taxpayers beyond partnerships. The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP. This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thornton or their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed.