United States: New Jersey Tax Court Holds Out-Of-State Corporate Limited Partner Has Nexus For CBT Purposes

The New Jersey Tax Court has held that an out-of-state corporate limited partner in a New Jersey limited partnership that owned and operated numerous supermarkets in the state had nexus for purposes of the New Jersey corporation business tax (CBT) because both entities were in the same line of business and interdependent with each other.¹ Specifically, the Tax Court determined that the limited partner had nexus because both entities were parties to the same New Jersey-governed cash management agreement (CMA); had common agents, managers, officers and directors based in New Jersey upon whom they depended to operate their stores; and shared a principal place of business in New Jersey.

Background

Village Super Market, Inc. ("INC") was a New Jersey corporation that owned and operated 25 supermarkets in New Jersey and one supermarket in Pennsylvania. In 1999, INC reorganized its business into separate legal entities to conduct its New Jersey and Pennsylvania operations. INC formed the taxpayer, Village Super Market of PA, Inc. ("PA"), as a wholly-owned subsidiary to own and operate the supermarket in Pennsylvania. PA filed a New Jersey business registration form indicating that it was doing business in the state. INC also formed a New Jersey limited partnership, Village Super Market of NJ, LP ("LP"), to operate the 25 supermarkets in New Jersey. PA held a 99 percent limited partnership interest in LP and INC held a one percent general partnership interest.² PA's limited partnership interest in LP was its most substantial asset and largest source of income. As LP's general partner, INC appointed LP's officers. PA and LP each had a board of directors comprised of INC employees, officers and shareholders. Also, they both had the same primary place of business in New Jersey.

As part of the reorganization, both PA and LP entered into separate administrative service agreements³ and adopted a CMA⁴ with INC. The Tax Court noted that the day-to-day operations of the stores did not change since the 1999 reorganization and all stores continued to operate under the same name. Also, the leadership of INC, PA and LP was interrelated. The division of the stores into districts was structured in the same manner as before the reorganization. PA's store was located in the same district as some of LP's New Jersey stores. Furthermore, INC was a shareholder of a large food cooperative, Wakefern, which owned the ShopRite name used by the supermarkets and provided many services and most of the merchandise to the stores. Because only Wakefern shareholders could operate a store under the ShopRite name and INC was the only entity with shareholder status, INC was the conduit between PA and LP and the Wakefern cooperative.

The New Jersey Division of Taxation audited LP for the period of January 1, 2003 through March 31, 2006. After examining whether the distributive share of partnership income was properly reported on INC and PA's returns, the Division concluded that PA should have filed a New Jersey CBT return on the basis that PA had nexus with New Jersey. In doing so, the Division issued a formal notice that PA owed CBT for the period commencing November 1, 1999. Following PA's protest, the Division's Conference and Appeals Branch issued a final determination upholding the determination that PA was subject to the CBT. PA subsequently filed a complaint in Tax Court.

Taxpayer Had Nexus with New Jersey

The Tax Court agreed with the Division that PA had nexus with New Jersey for purposes of the CBT. The power of a state to tax an out-of-state entity is found in the Due Process Clause of the U.S. Constitution. There must a "minimal connection" or "nexus" between the interstate activities and the taxing states and "a rational relationship between the income attributed to the [s]tate and the intrastate values of the enterprise."⁵ Nexus can be established through a transaction-based analysis or a presence-based analysis. In a transaction-based analysis, there must be a connection between the entity and the activity being conducted in the taxing state. Therefore, a passive investor in an unrelated business enterprise would not have transactional nexus.⁶ For presence-based nexus, the corporation must have minimum contacts with the taxing state.⁷

In addition to satisfying the Due Process test, a tax on interstate activity also must satisfy the Commerce Clause of the U.S. Constitution and meet the following requirements: (i) be applied to an activity with a substantial nexus with the taxing state; (ii) be fairly apportioned; (iii) not discriminate against interstate commerce; and (iv) be fairly related to the services provided by the state.⁸

The New Jersey CBT is imposed on corporations "for the privilege of having or exercising its corporate franchise in [New Jersey], or for the privilege of doing business, employing or owning capital or property, or maintaining an office, in [New Jersey]."⁹ An analysis of the specific facts of a case must be performed to determine whether an out-of-state corporation is subject to the CBT.¹⁰ New Jersey regulations provide guidance on the imposition of the CBT on out-of-state limited partners with investments in New Jersey.¹¹ The Tax Court explained that the Director's nexus determinations are presumptively correct and PA had the burden of overcoming this presumption. PA argued that its limited partnership interest in LP was not enough to subject PA to the CBT because it was strictly a passive investor. In support of its argument, PA asserted that it was similar to the taxpayer in a recent case, BIS LP, Inc. v. Director, Division of Taxation,¹² in which the Tax Court determined a limited partnership interest in a limited partnership was insufficient to create nexus with New Jersey. However, the Tax Court found that BIS, which was subsequently affirmed by the Appellate Division, did not support PA's argument because the corporate taxpayer serving as limited partner in BIS was not in the same line of business as the limited partnership. Also, the lines that divided the corporate taxpayer and the limited partnership in BIS were clean and precise. In BIS, there was no substantial overlapping of officers or the sharing of offices, operational facilities, technology or knowhow. In the instant case, the Tax Court found that PA's interactions with LP and INC established sufficient minimum contacts to meet the requirement of presence-based nexus with New Jersey. PA's interstate activities could be summarized in the following three areas: (i) physical presence in New Jersey;¹³ (ii) contractual presence through the CMA;¹⁴ and (iii) "correlating business interests."¹⁵ Also, the argument that PA was a separate, distinct and independent business from LP or INC was not supported by the facts. The Tax Court could not find any difference in the operations of the supermarkets before or after the 1999 reorganization. All of the entities were involved in the supermarket business and their activities were interrelated and interdependent.

According to the Tax Court, there was a rational relationship between the income attributed to New Jersey and values of the enterprise. The investment income from PA's limited partnership in LP had a rational relationship to New Jersey because of the overlap of officers and directors, the "commonality of the business enterprises"¹⁶ and their unification in INC's western district, and the execution of a joint CMA with LP and INC. The Tax Court concluded that PA was completely distinguishable from the corporate taxpayer in BIS. Rather than being separate and distinct, the lines between PA, INC and LP were blurred as all three entities were in the same line of business, interdependent upon one another, and were being operated in exactly the same manner that they were prior to the restructuring. Also, PA's identity and existence as a ShopRite operator in Pennsylvania and an investor in LP's ShopRite stores in New Jersey were dependent upon its relationship with Wakefern through shares of stock held by INC in New Jersey. Without this connection to New Jersey, PA's business model would cease to exist.¹⁷

Commentary

The determination of whether an out-of-state entity that holds a limited partnership interest in a New Jersey limited partnership has nexus with the state is extremely dependent on the facts of each case. The Tax Court found in the BIS case that a limited partnership interest was not sufficient to create nexus with New Jersey. However, the Tax Court distinguished BIS from the instant case because the entities in BIS were separate and engaged in different lines of business. In contrast, the Tax Court viewed the activities of PA, LP and INC as interrelated and comprising the operation of a single supermarket business. The Tax Court repeatedly noted that the business operations did not change following the corporate reorganization.

Therefore, in situations where an out-of-state corporation owns a passive ownership interest in a New Jersey pass-through entity, the relationship between the corporation, the pass-through entity, and other related entities needs to be carefully examined when making a nexus determination. If this decision stands, taxpayers will have two relatively distinct fact patterns to consider in determining how to treat these types of arrangements, both for purposes of applying for potential CBT refunds and for prospective planning through restructuring. While it may seem that a fact pattern closer in line to BIS than this decision would be helpful in pursuing a claim for refund, this decision may further embolden the Division to challenge all refund claims of this type. Even before this latest decision the Division had indicated that it would vigorously examine the interactions and interrelationships of taxpayers claiming refunds pursuant to BIS. As for prospective planning in this area, some level of risk remains in restructuring efforts, as the Division could challenge such planning either on a transaction-by-transaction basis (for example, by claiming a transaction does not have valid business purpose) or more holistically (through regulations or support of an amended statute that would diminish or eliminate any longterm New Jersey CBT benefit of such planning).

Footnotes

1 Village Super Market of PA, Inc. v. Director, Division of Taxation, New Jersey Tax Court, No. 021002- 2010, Oct. 23, 2013.

2 PA's limited partnership interest in LP gradually decreased to 94 percent in December 2001 and 83 percent in December 2007. INC's general partnership interest correspondingly increased.

3 Under these agreements, INC provided a variety of services such as accounting, payroll, tax return preparation and processing, and human resources.

4 As a result of entering into the CMA, all of PA and LP's cash was held by INC through a subsidiary loan for the stated purpose of efficiency and investment.

5 Exxon Corp. v. Wisconsin Department of Revenue, 447 U.S. 207 (1980) (citing Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425 (1980)).

6 See Allied-Signal Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992).

7 A court must examine factors such as whether the corporation has offices, employees, or real or tangible personal property in the state. See Lanco, Inc. v. Director, Division of Taxation, 879 A.2d 1234 (N.J. Super. Ct. App. Div. 2005), aff'd, 908 A.2d 176 (N.J. 2006), cert. denied, 551 U.S. 1131 (2007).

8 Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).

9 Stryker Corp. v. Director, Division of Taxation, 773 A.2d 674 (N.J. 2001) (citing Statement to Assembly Bill No. 395 of 1945 (Ch. 162, Laws 1945) (quoting N.J. REV. STAT. § 54:10A-2)).

10 N.J. ADMIN. CODE tit. 18, § 7-1.9(b).

11 N.J. ADMIN. CODE tit. 18, §§ 7-1.6(a); 7-1.9(a), (b); 7-7.6(c).

12 25 N.J. Tax 88 (Tax Ct. 2009), aff'd, 26 N.J. Tax 489 (App. Div. 2011), certif. granted, 27 N.J. Tax 58 (Tax Ct. 2012). For a discussion of the BIS case, see GT SALT Alert: New Jersey Tax Court Holds Out-of-State Corporate Limited Partner That Lacked Nexus Is Entitled to CBT Refund.

13 PA's official documents and business records were kept at INC's business offices in New Jersey. Also, PA's tax returns and bank statements used the New Jersey address. PA's New Jersey business registration form indicated that there were people working in New Jersey on PA's behalf. Finally, other than the store manager, all of PA's officers and directors worked out of the New Jersey office and only made occasional visits to the Pennsylvania store.

14 The CMA was governed by New Jersey law and was executed by and between PA, LP and INC. Under the CMA, all of PA's cash assets were held in New Jersey as a subsidiary loan to INC. The substantial interest income from these loans remained in New Jersey because it was added to the principal balance of the loan and not paid out to PA.

15 Presumably, the Tax Court was referring to the fact that PA, LP and INC were operating a common supermarket business using the ShopRite name. The Court highlighted that there was a sharing of the resources and information of all three entities. Also, there was a substantial overlap of the officers and directors of PA, LP and INC.

16 This phrase apparently refers to the fact that the three entities operated a common supermarket business under the ShopRite name.

17 Interestingly, the Tax Court did not analyze whether PA, INC and LP constituted a "unitary business," stating that such determination, while referenced in BIS, was "irrelevant to this court's determination of nexus."

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