It’s Not the Eggnog – New Jersey Proposes to Specially Allocate GILTI Based on GDP

On December 21, the New Jersey Division of Taxation released Technical Bulletin TB-85, which addresses how the Division will expect taxpayers to calculate the amount of so-called global intangible low-taxed income (GILTI) and foreign derived intangible income (FDII) that are taxable for New Jersey corporation business tax (CBT) purposes.

Background: GILTI and FDII under Federal Tax Law

The Federal Tax Cuts and Jobs Act (TCJA) created a new category of income under Internal Revenue Code (IRC) section 951A, known as GILTI.  This provision imposes a tax on U.S. shareholders based on income from controlled foreign corporations (CFCs), to the extent that this income is in excess of a nominal 10% return on the tangible assets of the CFCs.  GILTI is taxed at the regular federal tax rates, but a deduction is generally allowed for 50% of the amount of GILTI included in a taxpayer’s federal gross income under IRC section 250(a)(1)(B). Additionally, foreign tax credits are available to offset the federal income tax imposed on GILTI, with credits limited to 80% of the amount of foreign taxes paid.

The TCJA also identified a new category of income, FDII, which calculates an amount similar to GILTI (i.e., a proxy for intangible income based on an assumed 10% return on tangible depreciable asset basis) and multiplies that amount by the fraction of the income earned in the United States that is attributable to property sold or licensed to a non-U.S. person for foreign use or to services provided outside the United States.  Under IRC section 250(a)(1)(A), taxpayers are generally permitted a deduction from income equal to 37.5% of FDII.

New Jersey Treatment of GILTI and FDII

New Jersey Legislation

New Jersey legislation has confirmed that a corporate taxpayer must include the amount of GILTI calculated under IRC section 951A in its taxable income base for CBT purposes, but also may take the deductions related to both GILTI and FDII under IRC section 250(a).  New Jersey law does not provide for any offset of CBT with foreign tax credits.

In a signing statement released in conjunction with October amendments to the CBT, Governor Murphy acknowledged that taxing GILTI “may disproportionately impact certain New Jersey taxpayers.”  Governor Murphy added that he had been assured that the Division “maintains the discretion under existing law to provide relief to individual CBT taxpayers when appropriate to ensure the taxpayer’s CBT obligation fairly reflects its liability”—leaving many to believe that a corporation taxable in New Jersey would be able to request some form of individualized alternative apportionment relief based on its specific circumstances.  Thereafter, Director John Ficara called apportionment relief a “big issue” and said that the Division would provide its “factor relief approach” in public guidance.

The Technical Bulletin

Although Governor Murphy’s signing statement suggested that the Division would take an individualized approach to provide companies with apportionment relief, the Technical Bulletin instead states that all corporations filing a CBT-100 (the general return for most CBT filers) or BFC-1 (the return for banking and financial corporations) will be expected to calculate the amounts of GILTI and FDII taxable for CBT purposes “based on a separate special accounting method.”  Specifically, taxable GILTI and FDII (net of the deductions under IRC section 250(a)) will be calculated using an allocation ratio that is separate from a taxpayer’s generally applicable CBT ratio, and which is “equal to the ratio of New Jersey’s gross domestic product (GDP) over the total GDP of every U.S. state (and the District of Columbia) in which the taxpayer has economic nexus.”  Thus, a taxpayer will have two apportionment factors—one applicable to its entire net income base, and one applicable to its taxable GILTI and FDII.

As an example, the Technical Bulletin states that because the current New Jersey GDP ratio is approximately 3.1%, and corporations currently receive a deduction of 50% of the GILTI inclusion, a corporation with nexus in all states and the District of Columbia would pay CBT on approximately 1.6% of its gross income calculated under IRC section 951A.  The Technical Bulletin’s example does not take FDII into consideration.

Taxable GILTI and FDII will be calculated on a new Schedule A-6.

Potential Considerations

Below is a summary of some of the issues raised by the Technical Bulletin.

• Lack of Individualized Apportionment Relief:  While the Technical Bulletin suggests that all corporations will calculate the amount of GILTI subject to tax under a single approach, future guidance may be necessary to identify circumstances where, consistent with Governor Murphy’s signing statement, “individual CBT taxpayers” may request another approach to the taxation of GILTI.
  • Eversheds Sutherland Observation:  A taxpayer who is adversely affected by the separate allocation ratio outlined in the Technical Bulletin may have a constitutional argument that the use of U.S. (and U.S. state) GDP data is arbitrary and does not bear a rational relationship to the taxpayer’s activities in New Jersey.
    • Although the Division has taken the position that GILTI is a “hybrid of different income items that largely constitutes displaced U.S. income,” many taxpayers earn GILTI from non‑U.S. activities with little or no connection to New Jersey.  The allocation of GILTI based on U.S. (and U.S. state) GDP figures may not properly address issues of factor representation, and thus may cause unconstitutional distortion.
    • States generally apply the unitary business principle to require a taxpayer to apportion all of its unitary business income to the state using one single apportionment method for all of the activities of the unitary business.  To the extent that GILTI is earned from activities of a single unitary business, New Jersey’s requirement that a taxpayer allocate GILTI to the state using a separate and different allocation ratio may raise issues under the unitary business principle as outlined by the U.S. Supreme Court.
• Calculation of the Allocation Ratio:  The amount of GILTI allocated to New Jersey will depend on the states in which a taxpayer has “economic nexus.”  However, New Jersey law does not provide a bright line economic nexus standard for CBT purposes, and the Technical Bulletin does not address how a taxpayer should determine whether or not it has economic nexus in a particular state.
  • Eversheds Sutherland Observation:  In Lorillard Licensing Company LLC v. Dir., Div. of Taxation, the New Jersey Superior Court, Appellate Division held that New Jersey’s economic nexus standard must be applied to determine whether a taxpayer is “subject to tax” in other jurisdictions for purposes of New Jersey’s (now repealed) Throw-Out Rule.  29 N.J. Tax 275 (App. Div. 2015), certif. denied, 226 N.J. 212 (2016).  Further, the court held that it is irrelevant whether the taxpayer actually filed returns in or paid tax to those other jurisdictions.  This judicial authority may be applicable when determining the states in which a taxpayer has economic nexus for purposes of calculating its GILTI allocation ratio.
• Combined Reporting:  New Jersey has adopted a combined reporting regime for tax years ending on or after July 31, 2019.  The Technical Bulletin does not address whether an entity filing a combined return may calculate a single allocation ratio based on the total number of states in which any group member has economic nexus (or if each group member with GILTI will have to calculate an allocation ratio separately).
• Winners and Losers:  New Jersey’s proposed approach, requiring all corporations to allocate GILTI using a ratio based on U.S. (and U.S. state) GDP, will have a disparate impact on taxpayers.  Under the Division’s approach, taxpayers with nexus in numerous states, but having a relatively higher “general” New Jersey apportionment factor, will be treated more favorably than taxpayers conducting business in a small number of states and having a relatively smaller “general” New Jersey apportionment factor.  For instance, based on U.S state GDP data, a taxpayer that is only conducting business in New Jersey, New York, and Connecticut would have a GILTI allocation ratio of approximately 24.7%.  However, it is possible that the taxpayer’s standard New Jersey apportionment factor is much less (or much higher) than 24.7%, depending on its business.
  • Eversheds Sutherland Observation:  Including a rule in future draft regulations to allow a taxpayer to use the lesser of its separately calculated GILTI allocation ratio or its standard New Jersey apportionment factor to allocate its GILTI inclusion would prevent this unfair result.

Conclusion

The Division intends to promulgate regulations addressing the allocation of GILTI and FDII consistent with the approach outlined in the Technical Bulletin.  Under New Jersey law, the Division will prepare draft regulations, and take comments on such draft regulations, prior to issuing regulations in final form.  As such, New Jersey taxpayers who are especially disadvantaged by New Jersey’s current approach to taxing GILTI and FDII may want to consider preparing comments, either now or shortly after draft regulations are released, outlining their concerns.