New Jersey rules on application of P.L. 86-272

The New Jersey Tax Court recently held that a wholesale produce distributor’s activities in the state were insufficient to impose the Corporation Business Tax (CBT) for most of the tax years at issue under the protection provided by Public Law (P.L.) 86-272, but the distributor’s activities in the state exceeded the protection for one of the contested tax years.¹ Specifically, the distributor’s activity of accepting produce returned prior to acceptance by the customer was protected under P.L. 86-272. Although the distributor’s conduct of sending trucks into the state for returns of accepted produce was not a protected activity, the conduct was de minimis and insufficient to warrant imposition of the CBT. However, the distributor’s activities of occasionally sending trucks into the state to obtain produce from a related entity and deliver the produce to a warehouse in Pennsylvania, combined with regularly sending trucks into the state to pick up produce rejected after delivery, exceeded P.L. 86-272 protection for one of the tax years at issue.

Background

The distributor is a business that purchases and sells fresh fruit and vegetables to large chain supermarkets, smaller grocery stores and restaurants. During the tax year ending January 2002 through the tax year ending January 2008 that were at issue, the distributor did not have any office locations, real property or inventory in New Jersey. The distributor serviced customers in New Jersey by receiving and processing orders at its Pennsylvania headquarters. The orders were fulfilled at the distributor’s Philadelphia warehouse and shipped to customers in New Jersey. While most of the produce was delivered by third-party carrier trucks, the distributor shipped between 11% and 14% of the produce into New Jersey on its own trucks during its 2004-2007 fiscal years.

A related entity grew produce in New Jersey and sold its produce to the distributor.² During most of the tax years at issue, third-party trucks picked up the produce in New Jersey and delivered it to the distributor’s Pennsylvania facility. For the tax year ending January 2007, however, the distributor used its own trucks on a systematic basis to pick up produce from the related entity in New Jersey and transport the produce to its facility in Pennsylvania.

Under the federal Perishable Agricultural Commodities Act of 1930 (PACA),³ a produce wholesaler must accept the return of rejected produce within a reasonable time, not to exceed 24 hours of delivery. Pursuant to this law, if the distributor’s customer rejected the produce at delivery, the produce was returned on the truck which delivered it to the customer. During the relevant tax years, only between 0.7% and 1% of the produce was rejected on delivery and returned to the distributor. In most cases, dissatisfied customers received a credit without the return of the produce.

In 2006, the New Jersey Division of Taxation conducted a truck stop of one of the distributor’s drivers. As a result of this stop, a jeopardy assessment was issued for failure to file New Jersey CBT returns. While the distributor’s protest of the jeopardy assessment was pending, the distributor sought relief under the 2009 amnesty program and filed returns for the relevant tax years. The Division issued a final determination in 2014 that assessed CBT, interest and penalties of $1,444,374 for the tax years at issue. The distributor appealed this final determination to the New Jersey Tax Court.

Taxation of foreign corporations

New Jersey law requires domestic and foreign corporations to pay an annual franchise tax for the privilege of conducting certain business activities in the state.⁴ Under the U.S. Constitution, a state only may tax an out-of-state corporation’s income to the extent it is fairly allocable to the state.⁵ In light of this limitation, a New Jersey CBT regulation limits the imposition of tax on foreign corporations to the extent they are doing business in the state.⁶ Under federal law, P.L. 86-272,⁷ states are prohibited from imposing an income tax on foreign corporations when that corporation’s activities are limited to “mere solicitation of orders” for the sale of tangible personal property if approval and shipment of orders occurs outside the taxing state.

Application of P.L. 86-272 protection

The New Jersey Tax Court determined that P.L. 86-272 protection from the CBT applied to the distributor for most of the contested tax years. In reaching its decision, the Tax Court reviewed the U.S. Supreme Court’s landmark decision in Wisconsin Department of Revenue v. William Wrigley, Jr., Co.⁸ which explains the application of P.L. 86-272. In Wrigley, the Court determined that “solicitation” includes “not just explicit verbal requests for orders but also any speech or conduct that implicitly invites an order.”⁹ The activity may be “entirely ancillary to requests for purchases” but must not be an activity that would be conducted beyond making sales.¹⁰

The Tax Court thoroughly considered the distributor’s activity of accepting returns of produce. In Chester A. Asher, Inc. v. Director, Division of Taxation,¹¹ the New Jersey Tax Court held that the activities of the distributor’s drivers in accepting “occasionally” returned products and collecting payment from some customers was not protected activity. In the instant case, the Division argued that the distributor’s occasional acceptance of returned produce was unprotected activity. The distributor argued that this activity was protected because it is required by federal law to accept returns of produce. In Heublein, Inc. v. South Carolina Tax Commission,¹² the U.S. Supreme Court held that a company’s activities to comply with the South Carolina Beverage Control Act were not protected because P.L. 86-272 does not apply to activities required by a state regulatory scheme that serves a legitimate state purpose other than imposing an income tax. In Pomco Graphics, Inc. v. Director, Division of Taxation,¹³ the New Jersey Tax Court held that a company’s purchase of a license that was required to conduct sales with casinos was protected activity under P.L. 86-272 because it was ancillary to the solicitation of orders. The company argued that Pomco applied to protect its conduct of accepting rejected produce, but the Division contended that Pomco did not apply because the requirement to accept the produce was imposed by federal rather than state law.

Produce rejected prior to acceptance

After considering the federal and New Jersey decisions discussed above, the Tax Court found that to the extent the produce is rejected prior to acceptance, under PACA, the distributor must accept the return of the rejected produce. Regardless of whether the requirement is imposed by state or federal law, accepting the return of rejected produce upon delivery is ancillary to the sale. The Tax Court determined that these returns were protected activity under P.L. 86-272.

Produce rejected following acceptance

The Tax Court held that the activity of regularly retrieving produce on the distributor’s trucks which was accepted by the buyer is not required by PACA, and not protected by P.L. 86-272 as ancillary to the sale. During the tax years under review, less than 5% of the packages of produce shipped into New Jersey were rejected. Only 1% or less of the produce was returned on the distributor’s trucks. Also, the majority of the packages returned on the distributor’s trucks was rejected prior to acceptance, and the activities were therefore protected under P.L. 86-272. Thus, the return of produce on the distributor’s trucks following acceptance was de minimis. Furthermore, the distributor’s practice of sending its trucks into New Jersey to retrieve returned produce after its acceptance was not sufficiently systematic to show that the activity constituted a non-trivial connection to New Jersey. Therefore, the returns following acceptance did not subject the distributor to New Jersey CBT.

Other activities

The Tax Court determined that the distributor engaged in other activity in New Jersey that was not ancillary to the sale of its produce. During 2006, the distributor used its trucks to pick up produce from a related entity in New Jersey. According to the Tax Court, this conduct was regular and systematic. Combined with the systematic but de minimis conduct of sending trucks to New Jersey to pick up produce returned following acceptance, this conducted was not protected by P.L. 86-272.

The Division’s other arguments contending that the distributor was subject to New Jersey CBT were unsuccessful. The Tax Court held that the distributor did not have an ownership interest in the pallets used to deliver the produce to its customers. Furthermore, the Tax Court determined that the distributor did not have a seat on the New Jersey produce auction or maintain an office in the state. The distributor’s employee obtained data from the auction and shared this information with its sales team. The Tax Court concluded that merely gathering information from sources in the state, without a presence in the state, is not unprotected conduct.

Income from one year subject to tax

The Tax Court concluded that the distributor had sufficient conduct in New Jersey beyond mere solicitation of sales that subjected it to CBT for the tax year beginning Feb. 1, 2006, and ending Jan. 31, 2007. However, the Tax Court held that the distributor did not engage in unprotected conduct during the other tax years at issue.

Penalties

The distributor was subject to the underpayment penalty for its tax year ending January 2007. According to the Tax Court, the distributor should have realized that its action of sending trucks into New Jersey to haul produce from its related entity to the warehouse in Pennsylvania was not protected activity. The distributor also argued that the tax amnesty penalty should not be assessed because the amount paid with the returns filed under appeal was based on reasonable cause. Because the return filed under the amnesty program for the tax year ending January 2007 did not accurately reflect the distributor’s liability, the distributor was subject to the amnesty penalty.

Commentary

Similar to a recent decision by the Maryland Court of Special Appeals,¹⁴ the New Jersey Tax Court’s decision provides clarity on what activities are considered to be protected by P.L. 86-272 in the state. The distributor was able to successfully argue that P.L. 86-272 protected it from New Jersey CBT for most of the years at issue. Because the P.L. 86-272 determinations usually are very fact-specific, this decision provides a useful illustration of the analysis performed by the Tax Court. This case is particularly interesting because many of the activities engaged in by the distributor were performed (at least in the distributor’s view) as a means to comply with federal law. While the Tax Court did not necessarily agree with the characterization that the distributor’s activities were mandated by federal requirements, the distributor’s activities in New Jersey under PACA were still protected because they were ancillary to the sale. This decision should be useful for companies that conduct activities in a state pursuant to federal law that are ancillary to solicitation, as well as companies that are uncertain as to whether some of their non-protected activities qualify as de minimis.

The imposition of New Jersey CBT for the tax year ending January 2007 appeared inevitable as the distributor actively used its trucks to haul produce from its related entity in New Jersey to its warehouse in Pennsylvania.¹⁵ For the tax year ending January 2007, the Tax Court considered these transportation activities in conjunction with the taxpayer’s de minimis activities for returns following a customer’s acceptance which occurred over the course of the tax years at issue. Thus, the de minimis activities were relevant in determining that the distributor did not have P.L. 86-272 protection for the tax year ending January 2007.

1 Procacci Brothers Sales Corp. v. Director, Division of Taxation, New Jersey Tax Court, Dkt. No. 015626-2014, May 25, 2021.
2 The Tax Court opinion provides that the New Jersey produce supplier was an entity related to the distributor, but it does not further explain the relationship.
3 7 U.S.C. §§ 499a–499t.
4 N.J. REV. STAT. § 54:10A-2.
5 Complete Auto Transit v. Brady, 430 U.S. 274, 279 (1977).
6 N.J. ADMIN. CODE § 18:7-1.6(a). Another regulation specifies the activities that are considered in determining whether a corporation is doing business in the state. N.J. ADMIN. CODE § 18:7-1.9(b).
7 Pub. L. No. 86-272, 73 Stat. 555 (1959), 15 U.S.C. § 381.
8 505 U.S. 214 (1992).
9 Id. at 223.
10 Id. at 228-230.
11 22 N.J. Tax 582 (Tax 2006).
12 409 U.S. 275 (1972).
13 13 N.J. Tax 578 (Tax 1993).
14 Blue Buffalo Co. v. Comptroller of the Treasury, 221 A.3d 1130 (Md. Ct. Spec. App. 2019), affirming Maryland Tax Court, No. 16-IN-00-0364 (Aug. 30, 2017). For further discussion of this case, see GT SALT Alert: Maryland Court interprets scope of P.L. 86-272.
15 The Tax Court did not explain the relationship between the New Jersey produce supplier and the distributor. Please note that New Jersey adopted mandatory unitary combined reporting for tax years ending on and after July 31, 2019. Under the new combined reporting regime, the P.L. 86-272 analysis could differ if the entities are unitary and treated as one taxpayer.

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