On September, 9, 2020, the New Jersey Appellate Division ruled against the taxpayer in Preserve II, Inc. v. Director, Div. of Taxation, No. A-1331-17T3. On its face, the decision looks like a disappointing taxpayer loss because the court upheld the determination that a corporation was subject to the New Jersey Corporation Business Tax (CBT) based upon its limited partnership interest in a partnership conducting business in New Jersey.
However, for some taxpayers the court’s decision may not be all bad news. Although New Jersey statutes impose CBT on a corporation for the “privilege of deriving receipts” from sources within New Jersey, the appellate court did not uphold the nexus determination merely because the corporate partner derived income from the limited partnership’s activities in New Jersey. Instead, the court engaged in a separate inquiry to determine that additional factors created sufficient nexus to satisfy the constitutional limitations on state income taxation. According to the court, those factors arose from “blurred lines” between the foreign corporation and its affiliates that conducted business in New Jersey.
In 2002, the New Jersey legislature amended the CBT imposition statute to extend the reach of the CBT to corporations “for the privilege of deriving receipts” from “sources” within New Jersey.1 However, in practice, New Jersey auditors have tended to require something more than merely “deriving receipts” to support a nexus determination and have looked to additional factors, such as the presence of intangibles in New Jersey.
The 2017 Tax Court decision
In the decision below, the Tax Court upheld the Division of Taxation’s determination that Preserve II, Inc. (Preserve) was subject to New Jersey CBT in the years 2005-2007. Preserve was a foreign corporation that owned 99% limited partnership interests in two limited partnerships that conducted business in New Jersey. Preserve and the general partners in the partnerships were all owned entirely by the same parent company. All entities were part of the same corporate family of Pulte Group, Inc., a national residential real estate developer and builder.
The Tax Court opinion noted that it was undisputed that Preserve had New Jersey source income as a result of being a limited partner in two partnerships that did business in New Jersey.2 According to the Tax Court, “[i]t follows therefore that Preserve is undoubtedly subject to CBT for the ‘privilege of deriving receipts from’ New Jersey.”3 Stated another way, “Preserve is subject to the CBT simply by virtue of having unquestionably derived income from New Jersey sources.”4
Eversheds Sutherland Observation: It should be no surprise that the Division of Taxation was emboldened by the Tax Court’s opinion in Preserve. Beginning in 2017, corporations began seeing more nexus determinations based on “deriving receipts” from New Jersey sources. Most recently, in a 2019 technical bulletin, the Division stated “A member of a combined group can have nexus with New Jersey by deriving receipts from New Jersey.”5
The 2020 Appellate Court decision
On appeal, Preserve argued that the Tax Court erred when it held that the limited partner had “automatic economic nexus” upon its receipt of partnership income from New Jersey sources.6
In rejecting the taxpayer’s argument, the appellate court reframed the Tax Court’s nexus holding as one that was based not only on a finding of deriving receipts from New Jersey, but also on a finding of sufficient nexus to satisfy the requirements of the Constitution. According to the appellate court, the plain language of the CBT imposition statute means, “a foreign corporation shall pay the CBT for ‘the privilege of deriving receipts from sources within this State’ as long as such taxation falls within federal constitutional limits and no statutory exemption applies.”7
The appellate court further upheld the Tax Court’s constitutional nexus determination based on the blurring of lines between Preserve, the partnerships and the general partners. The appellate court quoted with approval the Tax Court’s constitutional analysis:
In sum, the record amply supports a finding that the lines between the partnerships, the general partner, Preserve and PHC were far from sharp and distinct and in fact were completely blurred. Preserve was not a mere passive investor, actively involved in an unrelated business, as was the finding for the foreign corporate limited partner in BIS. . . . Indeed, Preserve had no authority to make, sell, or diversify any investments let alone have its own independently held/operated external bank/financial account. The court concludes that under all of the facts, Preserve had nexus to New Jersey.8
Eversheds Sutherland Observation: While the Preserve II appellate decision could be helpful for any taxpayer that has received a nexus determination based solely on “deriving receipts” from New Jersey, mere affiliation and sharing of corporate functions with a New Jersey taxpayer should not necessarily satisfy the substantial nexus required under the Constitution for state income taxation.