On November 24, 2008, by a count of 39 to 0, the New Jersey Senate voted to eliminate the Throw Out Rule effective for privilege periods beginning on or after July 1, 2010. Previously, the Assembly also unanimously voted to eliminate the Rule. Fiscal estimates anticipate that this change will reduce New Jersey revenue by $89 million per year.
The “regular place of business” requirement for apportionment was also eliminated with the same effective date.
New Jersey Governor John S. Corzine has yet to sign the bill into law, but his signature is expected without delay as he has publicly shown his support for these changes.
Throw Out Rule Overview
The Throw Out Rule (N.J.S.A. 54:10A-6(B)) requires that a corporation increase its double-weighted sales factor based on sales that are assigned to jurisdictions where the corporation is not subject to a net income tax. The numerator of the sales factor (New Jersey receipts) is not affected by the Rule, but the sales factor denominator, which would normally include all receipts, is reduced by “throwing out” all receipts that would be assigned to jurisdictions where the corporation was not subject to a net income tax. By reducing the denominator while leaving the numerator unchanged, the sales factor increases. As the sales factor is double-weighted, the effect of its increase is even more significant.
The Throw Out Rule was, and continues to be, the subject of much criticism. Numerous taxpayers are challenging the validity of the Rule as facially violating the U.S. Constitution’s Commerce Clause, Due Process Clause, Supremacy Clause and Equal Protection Clause. Some taxpayers are also challenging the validity of the Rule on an as-applied basis.
Early versions of the legislation eliminating the Throw Out Rule reflected an effective date of July 1, 2008. However, the Division of Taxation, which supported the elimination of the Throw Out Rule, urged that the date be moved to July 1, 2010. Many of the voluntary disclosure agreements entered into by corporations seeking discretionary relief from the Throw Out Rule expire in 2010.
The elimination of the Throw Out Rule does not affect prior years or pending litigation. Currently several corporations are challenging the facial constitutionality of the Throw Out Rule before the Appellate Division of the Superior Court.
Regular Place of Business Overview
New Jersey requires a corporation to maintain a regular place of business outside of New Jersey in order to be allowed to apportion its income (N.J.S.A. 54:10A-6). This requirement was recently criticized by Presiding Judge Joseph C. Small of the Tax Court as being out-of-date and in need of a legislative fix in New Jersey Natural Gas Co. v. Director, Division of Taxation, 24 N.J. Tax 59 (2008).
Once the regular place of business requirement is eliminated, all corporations will be allowed to apportion their income for New Jersey Corporation Business Tax purposes. This approach is much more in line with the Division of Taxation’s economic nexus policy, which contends that a company is doing business anywhere it makes sales.