On February 6, 2017, the Tax Court of New Jersey granted partial summary judgment to the taxpayer in Elan Pharmaceuticals, Inc. v. Director, Division of Taxation. The court held that the New Jersey Division of Taxation (“Division”) improperly applied the state’s Throw-Out Rule by excluding receipts that were “subject to tax” in the originating state. The decision clarifies the scope of the Throw-Out Rule’s “subject to tax” language by finding that receipts may be “subject to tax” even when the destination state is precluded from taxing the sale under Public Law 86-272.
At issue in Elan was the interpretation of the “subject to tax” language in New Jersey’s Throw-Out Rule. The Throw-Out Rule was in effect in New Jersey from 2002 through 2010. It operated by modifying the denominator of the sales factor, which represents the entity’s total receipts, to exclude receipts that would be assigned to another state or country where the taxpayer is not “subject to tax.”
The New Jersey Supreme Court had previously held that throwing out receipts solely because another state declines to tax such receipts violates the “fair apportionment” prong of the Commerce Clause. Whirlpool Properties, Inc. v. Director, Division of Taxation, 208 N.J. 141 (2011). Thus, the court limited the Throw-Out Rule’s application to cases where the state cannot subject an entity to tax, whether due to constitutional limitations such as the absence of nexus with the state or due to congressional action such as Public Law 86-272. In Elan, the court narrowed the application further, holding that the Division may not throw out receipts that are immune from tax under Public Law 86-272 in the destination state if there are constitutional grounds for the receipts to be taxed in the originating state. The court noted that the “subject to tax” inquiry hinges on the “ability to tax, not actual taxation.”
Thus, the court concluded that the Division improperly applied the Throw-Out Rule to many of Elan’s receipts from sales to customers in other states. The court noted that Elan had property and payroll in numerous states, establishing sufficient nexus to tax Elan’s sales through a throwback rule. The court reasoned that, although Elan was not “subject to tax” in the destination states under Public Law 86-272, its receipts were “subject to tax” in the originating states because the originating states had the ability to constitutionally tax the receipts under a throwback rule. While the Elan decision does not expressly hold that the Division may never throw out Public Law 86-272 protected sales, it is difficult to imagine a situation where the originating jurisdiction lacks constitutional authority to tax the sales via throwback. Although this decision is not binding precedent, it demonstrates the court’s willingness, in applying the Throw-Out Rule, to conduct a factual inquiry into whether the taxpayer is “subject to tax” beyond the destination state.
Taxpayers with open years from 2002 through 2010 who voluntarily threw out Public Law 86-272 protected sales (or who were required to do so on audit) from the denominator of their New Jersey sales factor should consider whether claims for refund may be available.