Yesterday, the Tax Court of New Jersey issued two decisions that reverse longstanding Division of Taxation (Division) policies concerning royalty addback and nexus for the corporation business tax (CBT).

Lorillard Tobacco Company v. Director, Division of Taxation

For purposes of computing the CBT base, the general rule is that related-party royalty expenses must be added back.1 In Lorillard Tobacco Company,2 the taxpayer paid royalties to a subsidiary that was filing returns and paying CBT to New Jersey on the income stream. The taxpayer claimed a complete addback exception based on the so-called “unreasonable exception,” which provides that addback is not required if the taxpayer can prove by clear and convincing evidence that denying a deduction would be unreasonable. The Division’s policy, however, is to narrowly construe this exception.3 The Division’s regulation provides that the unreasonable exception applies only to “the extent that the payee pays tax to New Jersey on the income stream.”4 And under the Division’s tax return instructions, the value of the exception is capped at the amount of CBT paid by the affiliated licensor on the royalty stream.

In effect, if the affiliated licensor’s New Jersey apportionment is less than the licensee’s New Jersey apportionment, the Division has historically allowed the licensor to claim only a partial addback exception.