On Nov. 4, 2020, New Jersey Gov. Phil Murphy approved a Corporation Business Tax (CBT) technical corrections bill making legislative amendments intended to simplify and clarify various aspects of New Jersey’s 2018 CBT reform law (CBT Act).1 The bill makes important substantive changes to the CBT Act, addressing such provisions as the dividends received exclusion; net operating loss (NOL) deduction carryover utilization among combined group members; conformity to federal NOL rules; affiliated group elections; application of the minimum tax to taxable members of a combined group; and extension of the CBT return original due date by 30 days. Many changes are retroactive to tax periods ending on or after July 31, 2019, but various effective dates apply.
Background
On July 1, 2018, New Jersey enacted legislation making significant changes to the state’s CBT regime.2 The legislation imposed a temporary surtax on corporations; decoupled from certain Internal Revenue Code (IRC) provisions contained in the Tax Cuts and Jobs Act of 2017 (TCJA);3 and modified New Jersey’s dividends received exclusion and NOL deduction provisions. Most notably, for tax years ending on or after July 31, 2019, the legislation requires combined reporting for entities under combined ownership, engaged in a unitary business, and having at least one corporation subject to the CBT.4 In response to concerns about the specific application of the combined reporting provisions to CBT taxpayers, state legislators proposed a technical corrections bill after receiving extensive input from the business community and the New Jersey Division of Taxation (Division).
Substantive changes to the CBT Act
Dividends received exclusion
A key provision of the technical corrections bill addresses the “trapped dividend exclusion” scenario for certain combined group filers. Prior to the bill’s enactment, the CBT law was unclear as to the computation of the dividends received exclusion for combined group members. As interpreted by the Division, dividend income was apportioned on a separate company basis, using the apportionment formula of the group member receiving the dividend, rather than the formula of the entire combined group. This created an unintended “trapped dividend exclusion” for certain combined group filers, whereby dividends were unable to be subtracted from post-allocated income when a member of the combined group had a “zero” New Jersey allocation factor.
Under the new law, members of a combined group are treated as one taxpayer regarding dividends and deemed dividends that were received as part of the unitary business of the combined group.5 The bill further requires that both dividend income and the dividends received exclusion be apportioned using the combined group’s apportionment percentage.6 While the statutory change to the exclusion applies to tax years ending on or after July 31, 2020, the Division released a notice extending this relief to tax years ending on or after July 31, 2019.7 The notice also provides instructions on reporting the exclusion adjustment on Schedule R of the taxpayer’s 2019 CBT return. The guidance specifies that combined groups affected by the “trapped dividend exclusion” scenario may amend their 2019 CBT return to make the adjustment in the case that they have already filed their return.8
For tax periods ending on and after July 31, 2019, but before July 31, 2020, the bill provides that subsidiaries exclude dividends from entire net income (ENI) to the extent they received dividends from other subsidiaries, included those dividends in ENI, and paid tax on those dividends.9 Prospectively for tax periods ending on and after July 31, 2020, the bill repeals the dividends received exclusion for certain subsidiaries receiving dividends and deemed dividends from other subsidiaries, and replaces the exclusion with a credit to simplify the reduction of double taxation of tiered dividends.10
Affiliated group election
New Jersey allows combined return filers to make an affiliated group election utilizing the definition found in IRC Sec. 1504.11 Under the original CBT law, members of an affiliated group were limited to commonly owned entities organized in the United States. Effective for tax years ending on or after July 31, 2019, overseas companies having U.S. effectively connected income (ECI) are now included in the definition of an “affiliated group.”12 Specifically, the corrective legislation defines U.S. domestic corporations as: (i) business entities wherever incorporated or formed that are U.S. domestic corporations, are deemed to be, or are treated as U.S. domestic corporations under the provisions of the IRC; or (ii) any entities incorporated or formed under the laws of a foreign nation that are required to file federal tax returns if such entities have ECI within the meaning of the IRC.13
Common ownership is defined as more than 50% of the voting control of each member of an affiliated group that is directly or indirectly owned by a common owner(s), either corporate or non-corporate, whether or not the owner(s) are members of the affiliated group.14 The statutory change codifies the guidance previously released by the Division, which noted that foreign corporations treated as U.S. domestic corporations can be included in the combined group.15 The enacted language regarding common ownership is also consistent with the Division’s interpretation as outlined in the guidance.
Application of minimum tax and CBT rates
Prior to the bill’s enactment, New Jersey’s $2,000 minimum tax was imposed on each member of a combined group. Effective for tax periods ending on or after July 31, 2019, the legislation clarifies that the minimum tax applies only to taxable members of a New Jersey combined group, or group members having nexus with New Jersey.16 This clarification codifies a Division bulletin specifying that the minimum tax is imposed only on taxable members of the combined group.17
In line with U.S. Supreme Court jurisprudence on the unitary business principle and combined groups, the bill clarifies that income from the separate activities of a combined group member will be taxed only if the member has nexus with New Jersey.18 Additionally, the CBT rate applies to taxable net income plus the non-operational income specifically assigned by statute to New Jersey.19
NOL carryforwards
Retroactive to tax years ending on and after Dec. 31, 2019, the bill ensures that the joint NOL carryover transfer program for new or expanding emerging technology and biotechnology companies continues under the CBT Act by clarifying the proper calculation of unused prior NOL conversion (PNOL) carryovers and NOL carryovers.20 Additionally, the bill allows emerging technology and biotechnology companies to sell PNOL carryovers to other members of their combined group as long as the sale is made “at arm’s length price at the same rate as though the sale was to an unrelated taxpayer.”21
Specific to mergers and acquisitions, a taxable member of a combined group that departs the group may take its share of a combined NOL carryforward upon leaving the group.22 Additionally, the survival of NOL carryforwards under a merger between two combined group members now applies to mergers occurring between parties that would have been combined group members within one tax period of the merger, unless there is an unforeseen delay in finalizing the merger or acquisition due to obtaining required approvals from federal or state regulatory agencies.23 This provision does not apply to merger agreements in effect before the legislation’s effective date.
For tax periods beginning on or after Jan. 1, 2020, the IRC provisions governing the transfer of federal NOLs and NOL carryovers apply to CBT NOL carryovers.24 This adoption applies to mergers, acquisitions, reorganizations, spin-offs, split-offs, dissolution, bankruptcy, or any form of cessation of a business, or any other provision that limits or reduces federal NOLs and NOL carryovers.25 To the extent consistent with the CBT law, federal rules regarding consolidated return NOLs and NOL carryovers apply to CBT NOL carryover provisions as though the combined group filed a federal consolidated return, regardless of how the group filed for federal income tax purposes.26
Combined group changes
Retroactive to tax periods ending on and after July 31, 2019, the definition of “taxpayer” is amended to include “any combined group filing a mandatory or elective New Jersey combined return.”27 The bill further clarifies that a New Jersey S corporation is only included as taxable member of a combined group if the S corporation elects to be included and taxed at the same rate as the other members of the combined group.28 A New Jersey S corporation that does not elect to be included in the combined group is required to file a separate return.29
Other technical changes
CBT return filing
In addition to substantive changes described above, the bill makes several corrections and clarifications to the CBT return filing process, some of which require further action from the Division. Most notably, for tax periods ending on and after July 31, 2020, the due date of the CBT return is extended to 30 days after the original due date of the taxpayer’s federal corporate income tax return.30 This measure codifies the Division’s administrative extension of the CBT return filing deadline in recent years to allow taxpayers additional time to prepare and file their CBT returns, considering recent federal tax changes resulting from the TCJA and the Coronavirus Aid, Relief and Economic Security (CARES) Act.31
The legislation also requires taxpayers to include portions of their federal corporate income tax return as an attachment to their CBT return.32 The Division is directed to issue regulations describing which federal return portions are required and which are optional.33 Further, the bill requires the Division to create a simplified standardized return for combined groups, banking corporations, financial business corporations, and separate return filers applicable to tax periods ending on and after July 31, 2021.34 However, the bill maintains the New Jersey S corporation return for New Jersey S corporations that file separate returns.35 The standardized return will be made available on the Division’s website along with the accompanying forms and schedules for each type of taxpayer.36
From a reporting perspective, the bill requires members of a combined group to notify the Division when a combined group member dissolves; a merger occurs; a member withdraws from the group, ceases doing business or is acquired by a third party outside the group; or additional members enter the group and must be included.37 The Division is directed to issue specific forms enabling taxpayers to comply with these additional notice requirements.38 Importantly, notification is required by the annual return filing due date instead of 90 days after the event occurrence, as was required under prior law.39
Real estate transfer taxes and bulk sales
Under existing law, a realty transfer fee and a controlling interest transfer tax are imposed for the transfer of real property between taxpayers, even between members of a combined group as part of a unitary business. Under the new law, intercompany transfers of real property between combined group members executed on or after Jan. 1, 2021, will be excluded from the state’s realty transfer fee and controlling interest transfer tax.40 Similarly, intercompany transfers between combined group members entered into on or after Jan. 1, 2021, are excluded from the state’s bulk sale notification and escrow requirements.41 These provisions extend the unitary treatment of a combined group to New Jersey taxes other than the CBT.
Penalty relief
Finally, the bill clarifies that penalties or interest for underpayments of estimated taxes will not apply if additional tax liabilities are created as a result of the bill’s enactment, retroactive to privilege periods ending on or after July 31, 2020.42 Penalties will not apply if additional estimated payments are made by the later of the second estimated tax payment after the enactment of the bill, or the second estimated payment due after Jan. 1, 2021. The penalty relief provisions apply to taxpayers whose first privilege period affected by the bill’s enactment begins before Jan. 1, 2021.
Commentary
The CBT technical corrections bill represents the culmination of extensive collaboration between the New Jersey legislature, the Division, and the business community to clarify and simplify various substantive and technical aspects of the CBT reform law in order to resolve the practical difficulties faced by CBT taxpayers transitioning to unitary combined reporting. Certain changes, including the dividends received exclusion adjustments and affiliated group election changes, are retroactive to tax periods ending on and after July 31, 2019, which likely impacted filing positions on 2019 CBT returns with an extended due date of Nov. 16, 2020.43 The law’s inclusion of a combined group in the definition of a “taxpayer” also means that CBT liability computations will be completed for the entire combined group instead of for each individual member, thereby reducing the length and complexity of the CBT return for larger combined groups going forward.
The bill’s treatment of a combined group as one “taxpayer” does not appear to change the receipts allocation methods for combined groups filing on a water’s-edge basis or electing to file on a worldwide basis.44 Under New Jersey law, both return filing options use the Joyce method for purposes of allocating income, meaning that only the New Jersey sourced receipts from combined group members having nexus with New Jersey are included in the numerator of the combined group’s allocation factor.45 In contrast, CBT filers making the affiliated group election are required to follow the Finnigan method, which includes all New Jersey receipts derived from all combined group members in the allocation factor numerator.46 Given the Division’s position that the protections of Public Law 86-272 do not apply if another member of a combined group has New Jersey nexus,47 it is uncertain what impact the legislation will have on the application of Joyce to group members protected by P.L. 86-272.
In particular, the bill makes significant changes to New Jersey NOL carryover provisions, including the application of federal consolidated NOL and NOL carryover rules to New Jersey NOL provisions, to the extent they are consistent with CBT rules. This adoption is significant for purposes of mergers, acquisitions and other transactions affecting the composition of a combined group, given that New Jersey tax law generally limited NOL carryovers to the corporation incurring the loss under Richard’s Auto City v. Division and the regulation interpreted in that case.48 In contrast, the new law presumably applies the NOL carryover limitation rules under Sec. 381 and the successor rules on the carryover of NOLs and other federal tax attribute rules under Sec. 382, meaning that NOL carryovers may survive a merger or acquisition if the target entity remains part of the combined group for at least one year. However, the conformity to federal NOL carryover rules apparently does not apply to PNOL carryovers incurred prior to the change to combined reporting or NOL carryovers transferred to fiscal year taxpayers with a tax year beginning prior to January 1, 2020. The Division has indicated that it plans to issue further guidance detailing which federal provisions are inconsistent with the CBT law and therefore inapplicable for New Jersey NOL purposes.
Another business-friendly provision of the bill allows emerging technology and biotechnology companies to sell their PNOL carryovers to other members of their combined group at an arm’s-length price, as though the sale were made to an unrelated party. As the new law does not define what constitutes an “arm’s-length price,” the question becomes how such pricing will be substantiated, whether by an appraisal, a comparison to similar sales that have been made public, or otherwise. To address this issue, the Division plans to issue additional guidance in the coming months detailing how arm’s-length pricing may be adequately substantiated.
In addition to the taxpayer-favorable provisions impacting the CBT, the bill contains several provisions that benefit combined group members engaging in certain intercompany transactions, including the transfer of real property. Specifically, the realty transfer fee, controlling interest transfer tax, and bulk-sale reporting requirements will not apply to intercompany transfers of real property between combined group members that are part of a unitary business, beginning in 2021. These favorable provisions align with the unitary business concept that combined group members are now treated as one taxpayer for New Jersey tax purposes. While many provisions of the technical corrections legislation are subject to interpretation and will require further clarification from the Division in the form of regulations and other guidance, it is important to note that there are significant substantive and technical changes affecting CBT taxpayers that are largely effective beginning with the 2019 tax period. Given the various combined reporting provisions impacted by the bill, taxpayers should evaluate the effect of the legislation on their New Jersey filing position and determine any resulting positive or negative tax impact.
1 P.L. 2020, c. 118 (A. 4809), Laws 2020.
2 P.L. 2018, c. 48; P.L. 2018, c. 131, Laws 2018. For a detailed discussion of New Jersey’s 2018 tax overhaul, see GT SALT Alert: New Jersey Enacts Major Legislation Adopting Mandatory Combined Reporting, Market-Based Sourcing.
3 P.L. 115-97 (2017).
4 N.J. REV. STAT. §§ 54:10A-4(z); 54:10A-4.6.
5 P.L. 2020, c. 118, § 3, amending N.J. REV. STAT. § 54:10A-4(k)(5)(E).
6 Id.
7 Notice: CBT-100U Schedule R, New Jersey Division of Taxation, Nov. 5, 2020, published at https://www.state.nj.us/treasury/taxation/cbt/scheduleRnotice.shtml.
8 The notice requires the managerial member of the combined group to amend the group’s CBT return.
9 P.L. 2020, c. 118, § 3, amending N.J. REV. STAT. § 54:10A-4(k)(5)(D).
10 P.L. 2020, c. 118, § 15.
11 N.J. REV. STAT. § 54:10A-4.11.
12 P.L. 2020, c. 118, § 3, amending N.J. REV. STAT. § 54:10A-4(x).
13 Id.
14 Id.
15 N.J. Technical Bulletin TB-89(R), Combined Group Filing Methods, New Jersey Division of Taxation, revised June 28, 2019.
16 P.L. 2020, c. 118, § 9, amending N.J. REV. STAT. § 54:10A-5(e).
17 N.J. Technical Bulletin TB-86(R), Included and Excluded Business Entities in a Combined Group and the Minimum Tax of a Taxpayer that is a Member of a Combined Group, New Jersey Division of Taxation, revised Dec. 16, 2019.
18 P.L. 2020, c. 118, § 9, amending N.J. REV. STAT. § 54:10A-5(c)(1).
19 Id.
20 P.L. 2020, c. 118, § 4, amending N.J. REV. STAT. § 54:10A-4.2(c).
21 P.L. 2020, c. 118, § 4, amending N.J. REV. STAT. § 54:10A-4.2(c); P.L. 2020, c. 118, § 1, amending N.J. REV. STAT. § 34:1B-7.42a(a), (b).
22 P.L. 2020, c. 118, § 6, amending N.J. REV. STAT. § 54:10A-4.6(h)(5).
23 P.L. 2020, c. 118, § 5, amending N.J. REV. STAT. § 54:10A-4.5(b).
24 P.L. 2020, c. 118, § 5, amending N.J. REV. STAT. § 54:10A-4.5(c).
25 Id.
26 P.L. 2020, c. 118, § 5, amending N.J. REV. STAT. § 54:10A-4.5(c); P.L. 2020, c. 118, § 6, amending N.J. REV. STAT. § 54:10A-4.6(m).
27 P.L. 2020, c. 118, § 3, amending N.J. REV. STAT. § 54:10A-4(h).
28 P.L. 2020, c. 118, § 3, amending N.J. REV. STAT. § 54:10A-4(ff). Unlike most states, New Jersey does not automatically recognize federal S corporation status, but instead requires federal S corporations to affirmatively elect Subchapter S status for New Jersey tax purposes. N.J. REV. STAT. § 54:10A-5.22. Otherwise, the corporation will be treated as a New Jersey C corporation and may be included in a combined group for CBT purposes.
29 Id.
30 P.L. 2020, c. 118, § 12, amending N.J. REV. STAT. § 54:10A-15(c).
31 P.L. 116-136 (2020).
32 P.L. 2020, c. 118, § 11, amending N.J. REV. STAT. § 54:10A-14(a).
33 Id.
34 P.L. 2020, c. 118, § 11, amending N.J. REV. STAT. § 54:10A-14(d).
35 Id.
36 Id.
37 P.L. 2020, c. 118, § 8, amending N.J. REV. STAT. § 54:10A-4.10(h).
38 Id.
39 Id.
40 P.L. 2020, c. 118, § 13, amending N.J. REV. STAT. § 54:15C-1(a)(6); P.L. 2020, c. 118, § 17, amending N.J. REV. STAT. § 46:15-10(r).
41 P.L. 2020, c. 118, § 14, amending N.J. REV. STAT. § 54:50-38(a)(2)(c).
42 P.L. 2020, c. 118, § 18.
43 However, for taxpayers that have already filed their 2019 CBT return, the Division’s guidance allows such taxpayers to amend their CBT return in order to make the dividend received exclusion adjustment on Schedule R of the return.
44 Elective worldwide group returns include all of the combined group’s worldwide income and allocation factors, regardless of source. Water’s-edge group returns, the default filing method for combined groups, include only entities having significant business operations within the U.S., with several inclusions and exceptions. N.J. REV. STAT. § 54:10A-4.11(a); N.J. Technical Bulletin TB-89(R), New Jersey Division of Taxation, revised June 28, 2019.
45 N.J. REV. STAT. § 54:10A-4.7(a); N.J. Technical Bulletin TB-89(R).
46 N.J. REV. STAT. § 54:10A-4.11(c); N.J. Technical Bulletin TB-89(R).
47 N.J. Technical Bulletin TB-89(R).
48 In Richard’s Auto City, Inc. v. Director, Division of Taxation, the New Jersey Supreme Court upheld a Division regulation (N.J. ADMIN. CODE § 18:7-5.13(b)) permitting NOLs to be carried over only by the corporation that sustained the loss if that corporation is also the surviving corporation following a statutory merger. 659 A.2d 1360 (N.J. 1995).
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