The Superior Court of New Jersey, Appellate Division, recently ruled that the New Jersey Division of Taxation’s application of the state’s now repealed throw-out rule to an intellectual property holding company was unconstitutional. See Lorillard Licensing Company LLC v. Director, Division of Taxation, Superior Court of New Jersey, Appellate Division, Docket No. A-2033-13T1.

The Facts

From 2002 through 2010, New Jersey law required multi-state taxpayers to apportion income to New Jersey using a three factor formula that weighed sales, property and payroll. The sales factor generally equaled New Jersey sales over total sales. The throw-out rule dictated that the sales factor equaled New Jersey sales over total taxed sales. Sales that were not taxed by any state were removed from the denominator of the sales factor, thus increasing the fraction.

Lorillard licensed intellectual property and received royalty payments from its wholly owned subsidiary, which made sales in all 50 states. Lorillard was formed in North Carolina and had no physical presence in New Jersey during the years at issue. New Jersey assessed Lorillard $24,251,739 in corporate business tax for tax years 1999 through 2004. Lorillard paid almost $6 million of the assessment based on its interpretation of the throw-out rule. The Division of Taxation argued that Lorillard sales that were not taxed in other states should not be included in the denominator. The Superior Court held against the Division of Taxation, affirming the lower court’s decision.

The Ruling

Based on New Jersey precedent, the court reasoned that the throw-out rule only removes sales from the denominator if the sales were not taxed by another state as the taxpayer did not have the “requisite constitutional contacts with the state or because of congressional action.” Whirlpool Props. Inc. v. Dir., Div. of Taxation. The court further reasoned that Lorillard had sufficient constitutional contacts with the other states based on its subsidiary’s actions. Specifically, the court cited to Lanco, Inc. v. Dir., Div. of Taxation, which held that “a state has the authority to tax a trademark holding company with no physical presence in the state based on the company’s receipt of royalty payments from sales in the state by a trademark licensee.” Whether or not the other states actually taxed Lorillard was irrelevant.

Although the throw-out rule was repealed effective July 2010, taxpayers whose four year statute of limitations for corporate business tax is still open may consider pursuing a refund claim.

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