New Jersey Tax Court rules foreign source income not includible in CBT base

Frank Schaefer
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Bridget McCann
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Taryn Ruane
New York – Manhattan
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Jamie C. Yesnowitz
Washington, DC
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Chuck Jones
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Lori Stolly
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Priya D. Nair
Washington, DC
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On November 28, 2017, the New Jersey Tax Court held that the New Jersey Division of Taxation was unable to impose the Corporation Business Tax (CBT) on the portion of a foreign corporation’s income that was not subject to federal income tax.1 Specifically, a taxpayer filing federal Form 1120-F is not required to include worldwide income in computing its CBT liability.

Background The taxpayer, Infosys Limited of India (Infosys), is an India-based multinational corporation engaged in providing services and support in technology, business consulting, information technology, software engineering, and outsourcing. Infosys operates 33 branches worldwide, including one in the United States, and is treated as a foreign corporation for federal income tax purposes.2 Infosys reported and paid in a timely manner both federal income tax (Federal Form 1120-F) and New Jersey CBT (NJ Form CBT-100) for the four fiscal tax years from April 1, 2007 through March 31, 2011.

During the course of a 2011 IRS audit, Infosys realized that it had made a consistent error in preparing its originally filed CBT returns for its 2008-2011 fiscal years. Specifically, Infosys erroneously reflected its worldwide income on Line 33b of Form CBT-100, including it in entire net income (ENI) before the net operating loss deduction and dividend exclusion. Instead, an amount equal to federal taxable income before the net operating loss deduction and special deductions (as reported on Line 29 of its federal Form 1120-F) should have been included.

In June 2012, Infosys filed amended CBT returns with the Division correcting this error and requested a refund of tax, including interest.3 The Division denied the requested refunds and Infosys timely filed a complaint with the New Jersey Tax Court, resulting in this determination.

Tax Court Decision The New Jersey CBT requires that all non-exempt domestic and foreign corporations pay an annual franchise tax for the privilege of having or exercising a corporate franchise in New Jersey, or for the privilege of deriving receipts from sources within New Jersey, or for the privilege of doing business, employing capital or owning capital or property, or maintaining an office in New Jersey.4 The franchise tax is generally based on the greater of an alternative minimum assessment or a percentage of the corporation’s ENI, which is a measure of federal taxable income.5 The sole issue in this case was the statutory computation of ENI. Infosys maintained that N.J. Rev. Stat. Sec. 54:10A-4(k) clearly adopts federal taxable income (Form 1120-F, Line 29) as the starting point for determining ENI, subject only to specifically enumerated and inapplicable adjustments.6 The Director argued that the statute is not absolute and allows for the addition of worldwide income to the taxpayer’s federal tax base in computing ENI.

N.J. Rev. Stat. Sec. 54:10a-4(k) defines ENI as “total net income from all sources, whether within or without the United States, and shall include the gain derived from the employment of capital or labor, or from both combined, as well as profit gained through a sale or conversion of capital assets.” Further, ENI is “to be equal in amount to the taxable income, before net operating loss deduction and special deductions, which the taxpayer is required to report . . . to the United States Treasury Department for the purpose of computing its federal income tax . . ..”7 After referencing the federal amounts, New Jersey statutes provide that ENI “shall be determined without the exclusion, deduction or credit of . . .” and lists many exceptions to the statutes defining federal taxable income.8 Notably absent from the list of amounts required to be added back is worldwide income excluded from the federal taxable income computation.

In support of its statutory interpretation, the Director argued that the first sentence of the statute defining ENI supported its position that worldwide income should be added back to the federal tax base when calculating CBT. Notably, the Director had unsuccessfully relied upon this argument in another case involving relatively similar facts.9 In ruling for the taxpayer, that Court concluded that the statute “unequivocally coupled a corporation’s ENI for CBT purposes to its federal taxable income, with limited exceptions.”10 Citing the language and analysis from the prior decision, the Court found that the controlling statutory language establishes ENI to be equivalent to taxable income before NOL deductions and special deductions, reported for purposes of computing federal taxable income. Also, the Court rejected the Director’s argument that because ENI is considered an exclusion under federal law, and not a deduction, worldwide income should be included in ENI for CBT purposes. It found no statutory difference between exclusions and deductions.

Further, the Director argued that the previous decision was undercut by a more recent case in which a taxpayer forced an examination of the same New Jersey CBT statute in an attempt to adjust its federal basis in sold property for purposes of reducing the gain realized from the sale.11 In that decision, the taxpayer was seemingly allowed to deviate from basing its tax on the amount included on federal line 28 (Form 1120) in computing ENI without an “expressly enumerated” adjustment. In that case, the Court relied upon legislative intent to determine that only an entity’s actual economic gains from the sale of property, and not artificial gains resulting from unused depreciation deductions were properly subject to tax. Distinguishing the instant case from that decision, the Court noted that the prior decision focused not on the federal taxable income referenced in the statute, but rather on the more narrow language regarding the taxation of the sale of assets. Thus, the Court found both decisions “distinguishable and reconcilable.”

Based on its analysis, the Court concluded that the clear intent of the legislature was to pair ENI to federal taxable income with enumerated exceptions. Accordingly, the Court ruled that Infosys’s tax base should match its federal taxable income as included on Line 29 of its 1120-F, and the Director should issue the requested refund.12

Commentary The Tax Court’s decision provides some degree of clarity for certain taxpayers required to file New Jersey CBT returns. Specifically, it both solidifies the starting point for computing taxable income for foreign corporations and respects the federal treaty protections afforded by the U.S.-India Treaty. It also distinguishes between situations in which the starting point for the CBT base cannot be disturbed, versus situations in which adjustments to the CBT base can be made.

Based on this conclusion, foreign taxpayers should become more comfortable relying upon Form 1120-F, line 29 as the starting point in computing ENI for CBT purposes. The Court has now twice rejected the Director’sattempts to require the inclusion of worldwide income in that computation, noting the lack of legislative authority. Interestingly, in this decision, the Court heavily relies on the language and reasoning included in its earlier IBM13 decision, frequently citing both in its analysis. It should be noted that with the advent of federal tax reform and a new regime set to take place that encompasses substantial changes to the treatment of income arising from foreign sources, the issue of how New Jersey (and other states) may attempt to include worldwide income in the tax base will become more commonplace.

1 Infosys Limited of India Inc. v. Director, Division of Taxation, New Jersey Tax Court, Dkt. No. 012060-2016, Nov. 28, 2017.
2 Notably, the U.S. and India have entered into a treaty, Convention for the Avoidance of Double Taxation (U.S.-India Treaty). The treaty limits the U.S.’s right to tax an Indian entity’s business profits to include only profits attributable to business in the U.S. conducted through a permanent establishment.
3 The amended returns also included federal Revenue Agent’s Report (RAR) adjustments for Infosys’s fiscal years ending in 2008 and 2009.
4 N.J. REV. STAT. § 54:10a-2
5 N.J. REV. STAT. § 54:10a-5.
6 Notably, line 29 of federal Form 1120-F does not include worldwide income.
7 N.J. REV. STAT. § 54:10A-4(k)(2).
8 N.J. REV. STAT. § 54:10A-4(k)(2)(A)–(J).
9 International Business Machines Corp. v. Director, Division of Taxation, New Jersey Tax Court, Dkt. Nos. 011630-2008, 011795-2009, Jan. 26, 2011.
10 Id.
11 Toyota Motor Credit Corp. v. Director, Division of Taxation, New Jersey Tax Court, Dkt. No. 002021-2010, Aug. 1, 2014; aff’d., Appellate Division, Superior Court of New Jersey, Dkt. No. A-5189-14T3, Oct. 23, 2017.
12 The Court also rejected the Director’s argument that he should be able to pierce the protection provided to the taxpayer through the US-India treaty.
13 International Business Machines Corp. v. Director, Division of Taxation, New Jersey Tax Court, Dkt. Nos. 011630-2008, 011795-2009, Jan. 26, 2011.

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