In a decision issued this morning, a New Jersey appellate court ruled that the throwout rule does not apply to intangible holding companies.1 New Jersey courts have not been kind to the throwout rule. When it was first adopted in 2002, the Division of Taxation had hoped that throwout would generate additional revenue of up to $100 million per year.2 But the court’s decision effectively makes throwout inapplicable except for a very limited category of taxpayers. You can read the court’s decision here.
Until its repeal, effective in 2011,3 the throwout rule required a taxpayer to compute its sales-fraction denominator by excluding receipts that were sourced to a state in which the taxpayer was not “subject to a tax” based on income or business activity. The throwout rule was particularly problematic for IHCs. The New Jersey Supreme Court, in Lanco, Inc. v. Director,4 held that physical presence was not required for income tax nexus. As a result, IHCs that licensed intangibles to affiliates doing business in the state became subject to New Jersey’s corporate income tax. If the IHC wasn’t filing business activity returns in any other separate-company state, the Division took the position that the IHC’s double-weighted sales fraction was 100%. Many IHCs received assessments in the tens of millions of dollars.
One such IHC was Lorillard Licensing Company. Because of throwout, its annual tax liability jumped by nearly 600%. The Division audited Lorillard and issued an assessment of more than $24 million. While most IHCs settled their assessments for pennies on the dollar, Lorillard appealed its assessment to the New Jersey Tax Court.
Meanwhile, the New Jersey Supreme Court, in Whirlpool Properties Inc. v. Director,5 held that it was unconstitutional to apply throwout to receipts sourced to a state that had made a policy choice not to tax those receipts. By contrast, the court permitted throwout of receipts sourced to a state that didn’t impose tax because it lacked jurisdiction under the U.S. Constitution. The issue in Lorillard was whether New Jersey’s nexus standards, or those of the destination state, applied in determining whether a taxpayer was “subject to tax” for purposes of throwout.
Lorillard argued that under New Jersey’s broad economic nexus standard, it was subject to tax in every state. By definition, therefore, throwout couldn’t apply to any of Lorillard’s receipts—even if it didn’t file a separate-company return in any state except New Jersey. The Tax Court agreed and issued a 2013 ruling that throwout did not apply to Lorillard. The Division appealed this trial court decision to the New Jersey Appellate Division.
A three-judge panel of the Appellate Division heard oral argument September 21, 2015. At oral argument, the Division argued that Whirlpool had been wrongly decided and that another state’s mere ability to impose tax shouldn’t preclude New Jersey from applying throwout. But Judge Messano, in particular, seemed unconvinced by this. He also questioned whether throwout could ever be applied constitutionally—other than to remote sellers of tangible personal property that ship their products by common carrier.
Today’s decision reiterates that throwout applies only in very limited circumstances. Despite the Division’s long-standing polices, throwout should not apply to:
- Any receipts whatsoever from intangibles or performing services—regardless of where the receipts are sourced
- Receipts from tangible personal property sourced to states that don’t impose an income or business activity tax
- Receipts sourced to states in which the taxpayer is immune from tax under P.L. 86-272, 15 U.S.C. 381-384
- Intercompany receipts sourced to unitary-combined states that eliminate those receipts from the sales factor
The Division will likely appeal the Appellate Division’s decision to the New Jersey Supreme Court. Still, the decision is good news for taxpayers with pending appeals or audits. The general limitations period for filing refund claims is four years. But if you’ve signed a waiver or are currently being audited, your refund rights remain open.