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New Jersey adopts federal foreign income deduction

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On Oct. 4, 2018, New Jersey enacted legislation amending the state’s Corporation Business Tax (CBT).1 Many of these changes are technical corrections in response to the major tax reform legislation, A.B. 4202, which was enacted on July 1, 2018.2 However, the recent legislation includes some significant substantive changes. New Jersey adopts the foreign income deduction provided by Internal Revenue Code (IRC) Sec. 250. The legislation changes the effective date of the provisions in A.B. 4202 enacting mandatory unitary combined reporting and market-based sourcing from tax years beginning on or after January 1, 2019 to tax years ending on or after July 31, 2019. The legislation also makes substantive amendments to combined reporting, the new CBT surtax, the dividends received deduction (DRD), and the net operating loss (NOL) deduction. For Gross Income Tax (GIT) purposes, the legislation excludes gains or income from the sale of certain economic development tax credits.

Foreign income deduction Federal tax reform legislation, commonly known as the Tax Cuts and Jobs Act (TCJA),3 enacted late in 2017, imposes federal income tax on global intangible low-taxed income (GILTI) earned by controlled foreign corporations.4 Specifically, the tax is imposed on foreign intangible income to the extent it exceeds a 10% rate of return on invested foreign assets. IRC Sec. 250 provides a deduction equal to 50% of the GILTI inclusion and a portion of foreign derived intangible income (FDII). For tax years beginning on or after Jan. 1, 2018, the recent New Jersey legislation adds a new statutory section providing a CBT deduction equal to the federal deduction taken under IRC Sec. 250.5

Combined Reporting and Market-Based Sourcing A.B. 4202 provided major tax reform by enacting mandatory unitary combined reporting and market-based sourcing for sales of services.6 These provisions originally were scheduled to apply to tax years beginning on or after Jan. 1, 2019.7 As amended, these provisions now apply to tax years ending on or after July 31, 2019.8

The legislation clarifies that the related-party addback provisions do not apply to transactions between related members included in a combined group reported on a New Jersey combined return.9

For tax years ending on and after July 31, 2019, the minimum tax for each member of a combined group filing a mandatory or elective New Jersey combined return is $2,000 for the group’s tax year.10 Under existing law, the minimum tax is $2,000 for a member of an affiliated or controlled group that has payroll of $5 million or more for the tax year. The minimum tax provision would appear to include combined members that by themselves may not have independent New Jersey nexus.

New Jersey law is amended to provide that a combinable captive insurance company is not exempt from CBT.11 However, a captive insurance company that does not meet the definition of a combinable captive insurance company is excluded from the mandatory combined reporting statute and exempt from CBT.

CBT surtax Under A.B. 4202, an additional “surtax” is imposed on corporations subject to CBT for their next four tax years.12 Corporations with more than $1 million of allocated net income will pay a surtax of 2.5% for tax years beginning in 2018 or 2019, and a surtax of 1.5% for tax years beginning in 2020 or 2021. The recent legislation clarifies that the surtax is imposed on “allocated taxable net income” rather than “allocated net income.”13 For tax years ending before July 31, 2019, “allocated taxable net income” means allocated entire net income. For tax years ending on and after July 31, 2019, allocated taxable net income means taxable net income as defined in N.J. Rev. Stat. Sec. 54:10A-4(w).14 These changes ensure that the effect of NOLs is included in the surtax calculation. Also, “taxpayer” is clarified to mean any business entity subject to CBT.15

Dividends received deduction The recent legislation amends the DRD provisions. For tax years beginning (previously, ending) on or before Dec. 31, 2016, New Jersey allowed a 100 percent DRD for dividends paid by 80% or more owned subsidiaries.16 For subsequent tax years, the DRD is permanently reduced to 95% and covers both dividends paid and those “deemed paid.”17 For tax years beginning after 2016 and before 2019, deemed dividends are specially allocated by either the three-year average of the taxpayer’s 2014- 2016 (previously, 2015-2017) allocation factors or 3.5%, whichever is lower.18

Net operating losses A.B. 4202 significantly changed the computation and carryover of NOLs in New Jersey. As previously amended, the only NOL carryover deduction for losses incurred in tax years beginning prior to Jan. 1, 2018 was the prior net operating loss conversion carryover (PNOLCC) which recomputes NOLs from such earlier years on a post-allocation basis.19 The recent legislation changes this provision to losses incurred in tax years ending prior to July 31, 2019 (i.e. pre-combined reporting periods). Under existing law, for tax years beginning on or after January 1, 2018, NOLs are computed on a post-allocation basis.20 As recently amended, this provision applies to NOLs for tax years ending on or after July 31, 2019.

For tax years ending on or after July 31, 2019, the recently enacted legislation adds a new NOL deduction provision when there is a change in ownership.21 When there is a change in 50% or more of the ownership of a corporation because of the redemption or sale of stock and the corporation changes the trade or business giving rise to the loss, no NOL sustained before the changes may be carried over to be deducted from income earned after the changes. The Director of the New Jersey Division of Taxation may disallow the carryover if the facts indicate that the corporation was acquired for the primary purpose of using its NOL carryover. This provision is nearly identical to that applicable to NOLs for earlier years.22 However, the new provision does not apply between members of a combined group reported on a New Jersey combined return.

Net worth computation The computation of “net worth” for CBT purposes is amended.23 The reduction from aggregate values for an investment in capital stock of one or more subsidiaries is changed from 100 percent to 50 percent.

Transfers of economic development tax credits For GIT purposes, “net gains or income” does not include gains or income derived from the sale or assignment of a tax credit transfer certificate for a tax credit approved by the New Jersey Economic Development Authority prior to July 1, 2018, regardless of when the sale or assignment occurs.24 This gain or income also is excluded from distributive shares of partnership income and the net pro rata share of S corporation income.25

Commentary In July 2018, New Jersey enacted major tax legislation that included fundamental changes such as mandatory unitary combined reporting and market-based sourcing for services, items that had been considered for years. The legislation also enacted a new CBT surtax and made complicated modifications to the DRD and NOL deductions. The recent legislation makes significant technical corrections and some substantive changes that will affect taxpayers with significant New Jersey activities. Some of the changes increase the complexity of the New Jersey tax reform legislation enacted earlier this year.

Interestingly, on Aug. 27, 2018, New Jersey Gov. Philip Murphy had conditionally vetoed an earlier CBT “follow-up” bill and returned it to the legislature with his recommended changes.26 Murphy had sought Finnigan27 rather than Joyce28 apportionment. He had recommended that certain income of controlled foreign corporations, members doing business in tax havens and effectively connected income all be included in combined reports and that the Director be given broad authority to determine the composition of a combined group and the computation of the tax due from its taxable members. These recommendations are not contained in the new legislation signed by the governor on Oct. 4, 2018.

One of the most noteworthy changes in the latest enacted bill is New Jersey’s express adoption of the foreign income deduction provided by the TCJA under IRC Sec. 250. States are taking different approaches concerning their treatment of GILTI and the deduction provided by IRC Sec. 250. Many of the states that have rolling IRC conformity have not expressly addressed the treatment of GILTI, but states such as Alabama and Connecticut have released administrative guidance on this topic. Some of the static conformity states that have enacted legislation advancing their IRC conformity date to include the TCJA have decoupled from the federal GILTI provisions.29 Thus, it is significant that New Jersey has enacted legislation expressly adopting GILTI and the IRC Sec. 250 deduction. Governor Murphy issued a statement upon signing the legislation that acknowledges there are “concerns” regarding the legislation’s treatment of GILTI and “newly taxing GILTI may disproportionately impact certain New Jersey taxpayers.”30 He instructed the Division of Taxation to “provide relief to individual CBT taxpayers when appropriate to ensure the taxpayer’s CBT obligation fairly reflects its liability,” leaving the door open to case-by-case determinations of whether to allow factor representation or other alternative apportionment relief with respect to the inclusion of GILTI. Also, the statement notes that as some neighboring states still are considering how they will treat GILTI, New Jersey will closely monitor how these states ultimately decide how to tax this item.

By changing the effective date for combined reporting and market-based sourcing from tax years beginning on or after Jan. 1, 2019, to tax years ending on or after July 31, 2019, the legislation is accelerating the effective date for certain fiscal year CBT filers. For example, a fiscal year filer with a tax year running from Aug. 1, 2018, through July 31, 2019, is now subject to the combined reporting and market-based sourcing provisions due to the recent legislation. Taxpayers need to carefully consider these effective date changes because they suddenly may be subject to combined reporting and market-based sourcing. At the same time, the effective date of the NOL amendments is postponed from tax years beginning on or after January 1, 2018 to tax years ending on or after July 31, 2019. The effective dates for the DRD amendments also have been changed.

The tax base of the new CBT surtax is amended to be allocated taxable net income for tax years ending on and after July 31, 2019. Because the surtax is now imposed on taxable net income, NOLs should be taken into consideration. The Division of Taxation recently issued guidance indicating that the surtax applies to all taxpayers with a CBT liability, but does not apply to public utilities or New Jersey S corporations.31

Taxpayers must evaluate the ASC 740 effects of A.B. 4202, which was enacted on July 1, 2018, and the recent legislation, which was enacted on Oct. 4, 2018. Because this legislation was enacted in different quarters, and the effective dates were changed for some key components, the ASC 740 reserve computations may be particularly complicated.
 

1 Ch. 131 (A.B. 4495), Laws 2018, effective immediately and retroactive to Jan. 1, 2018 unless otherwise noted.
2 Ch. 48 (A.B. 4202), Laws 2018. For a discussion of this legislation, see GT SALT Alert: New Jersey Enacts Major Legislation Adopting Mandatory Combined Reporting, Market-Based Sourcing.
3 P.L. 115-97. For a discussion of this Act, see GT Alert: Tax Reform Law Transforming Business and Tax Planning.
4 IRC Sec. 951A. This applies to tax years beginning on or after Jan. 1, 2018.
5 A.B. 4495, § 1. Note that in order to prevent a potential double deduction, the deduction only is allowed in computing entire net income to the extent the corresponding amounts of income have not been excluded or exempted under any CBT provision.
6 N.J. REV. STAT. §§ 54:10A-4.6; 54:10A-6(B)(4).
7 A.B. 4202, § 33.
8 A.B. 4495, § 9.
9 N.J. REV. STAT. § 54:10A-4(k)(2)(I).
10 N.J. REV. STAT. § 54:10A-5(e).
11 N.J. REV. STAT. § 54:10A-4(y). A “combinable captive insurance company” is an entity treated as an association taxable as a corporation under the IRC: (i) more than 50 % of the voting stock of which is owned or controlled by a single entity treated as an association taxable as a corporation under the IRC, and not exempt from federal income tax; (ii) licensed under New Jersey or another state’s law as a captive insurance company; (iii) whose business includes providing insurance or reinsurance covering the risks of its parent and/or members of its affiliated group; and (iv) 50% or less of whose gross receipts for the privilege period consist of premiums from arrangements that constitute insurance for federal income tax purposes.
12 N.J. REV. STAT. § 54:10A-5.41.
13 N.J. REV. STAT. § 54:10A-5.41.b.(2).
14 Under this statute, taxable net income means entire net income allocated to New Jersey as modified by subtracting any prior net operating loss conversion carryforward and any net operating loss.
15 N.J. REV. STAT. § 54:10A-5.41.b.(1).
16 N.J. REV. STAT. § 54:10A-4(k)(5)(A)(i).
17 N.J. REV. STAT. § 54:10A-4(k)(5)(A)(ii), (iii).
18 On Oct. 5, 2018, the New Jersey Division of Taxation released Form CBT-DIV 2017. The new form enables taxpayers to comply with the special dividend reporting and allocation provisions of N.J. REV. STAT. § 54:10A-4(k)(5)(A)(ii) without amending calendar 2017 or FY 2018 New Jersey returns that have already been filed. The new form should be filed by Jan. 31, 2019.
19 N.J. REV. STAT. § 54:10A-4(k)(6), (u).
20 N.J. REV. STAT. § 54:10A-4(v), (w).
21 N.J. REV. STAT. § 54:10A-4(v)(5).
22 N.J. REV. STAT. § 54:10A-4(k)(6)(D).
23 N.J. REV. STAT. § 54:10A-4(d).
24 N.J. REV. STAT. § 54:5-1.c.
25 N.J. REV. STAT. § 54:5-1.k, p.
26 A.B. 4262, conditionally vetoed on Aug. 27, 2018.
27 Finnigan is a California State Board of Equalization (SBE) decision, currently followed by several states, that held sales made to a taxing state’s customers by a unitary group member that is not subject to tax in the state are includible in the numerator of the group’s sales factor in the state, as long as at least one member of the unitary group is subject to tax in the taxing state. Appeal of Finnigan, Dkt. No. 88-SBE-022 (Cal. State Bd. of Equal. Aug. 25, 1988).
28 Many states, including states that have adopted the Uniform Division of Income for Tax Purposes Act follow the Joyce rule, an SBE decision, whereby sales made to the taxing state’s customers by a unitary group member that is not subject to tax in the state are not includible in the numerator of the group’s sales factor in the state, even though other members of the unitary group are subject to tax in the taxing state. Appeal of Joyce Inc., Dkt. No. 66-SBE-070 (Cal. State Bd. of Equal. Nov. 23, 1966).
29 For example, states such as Hawaii, North Carolina, South Carolina and Wisconsin have enacted legislation expressly decoupling from GILTI.
30 Governor’s Statement Upon Signing Assembly Bill No. 4495, Office of New Jersey Governor, Oct. 4, 2018.
31 30-Day Penalty Relief and Surtax Information for Corporations, New Jersey Division of Taxation, Oct. 18, 2018.




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