In a decision involving two consolidated cases, the New Jersey Tax Court held in favor of the taxpayers and declined to extend Lanco's economic-nexus standard to sales of canned software. Quark, Inc. v. Director, Div. of Taxation, N.J. Tax Court Docket No. 004692-2002 (Aug. 13, 2009); AccuZIP, Inc. v. Director, Div. of Taxation, N.J. Tax Court Docket No. 005744-2003 (Aug. 13, 2009). The decision and transcripts of the oral arguments, as well as other information and articles concerning New Jersey's nexus policies, are available at: www.reedsmith.com/njnexus.cfm.
The cases involved two unrelated software vendors: Quark and AccuZIP. Both companies were headquartered outside New Jersey and sold canned software to New Jersey customers, either directly or to distributors who then resold the software to New Jersey end-users. Each purchaser's use of the software was subject to a licensing agreement, but Quark and AccuZIP received only a single lump-sum payment from the sale of the software, rather than periodic royalties. AccuZIP had no physical presence whatsoever in New Jersey; Quark had a regional sales manager in New Jersey for at least some of the years at issue.
Both companies made relatively modest sales into New Jersey (for example, between 1999 and 2001, AccuZIP had only 93 customers in New Jersey and $65,000 of New Jersey receipts). Nonetheless, the Division of Taxation asserted corporation business tax (income tax) nexus. The Division argued that Quark and AccuZIP each had nexus because each company licensed intangible property used in New Jersey. In support of this argument, the Division relied on the New Jersey Supreme Court's decision in Lanco, which held that physical presence is not required for income tax nexus where a taxpayer licenses intangibles used in New Jersey. Lanco, Inc. v. Director, Div. of Taxation, 188 N.J. 380 (N.J. 2006), cert. denied, 551 U.S. 1131 (2007).
The Tax Court rejected the Division's argument. The court acknowledged that New Jersey courts have "take[n], as a given" that the state may tax income generated by intangible property even where the taxpayer lacks physical presence in the state. But the court distinguished Quark and AccuZIP's situation from that of Lanco. Specifically, the court noted that:
- Quark and AccuZIP were selling tangible copyrighted property in the form of CD-ROMs rather than an intangible
- Their fees were generated from the single sale of tangible property, not from royalty payments
- Their income was not derived from the use of their intangible personal property in New Jersey
- They were not affiliated with a corporation that had a physical presence in New Jersey
- Quark and AccuZIP were actual operating companies, not holding companies created for the purpose of generating a tax benefit
Accordingly, the court held that AccuZIP was not doing business in New Jersey and lacked substantial nexus with New Jersey. By contrast, the court determined that Quark was doing business in the state because it had physical presence (a sales manager) in the state. But Quark was subject only to the minimum tax because it was immune from income tax under P.L. 86-272.
Decision May Thwart Division's Attempts to Expand Lanco
The Division, citing Tax Comm'r v. MBNA Am. Bank, N.A., 640 S.E.2d 226, 238 (W.Va. 2006), cert. denied 551 U.S. 1141 (2007), urged the court to adopt a "significant economic presence test" to determine whether substantial nexus exists for Commerce Clause purposes. This would have been consistent with the Division's recent audit policies. For example, the Division has asserted nexus over: companies that license patents (even to non-affiliates or to licensees that conduct manufacturing activity using the patented process outside the state); companies that perform corporate treasury functions for New Jersey-based affiliates; and out-of-state credit card companies. (Interestingly, only months after it had submitted briefs in the Quark and AccuZIP cases, the Division ruled that it was not following MBNA and that a credit card company would not be subject to nexus even if it received interest from New Jersey customers.)
In its decision, however, the court rejected the "significant economic presence test" applied in MBNA, noting that it has not been adopted by New Jersey and thus is not controlling. The court's decision calls into question whether Lanco's economic nexus standard can be applied other than to intangible holding companies that license trademarks to affiliates. In distinguishing Lanco, the court acknowledged the lack of tax planning and noted that Quark and AccuZIP were not licensing intangibles to affiliates.
In summary, the court declined to extend Lanco's economic nexus standard beyond the facts in that case. Clearly, Lanco still applies to intercompany trademark licensing arrangements. But Quark and AccuZip limit the Division's authority to apply Lanco to other situations. Taxpayers who paid corporation business tax in such situations—despite having no physical presence in New Jersey should consider filing refund claims.