The New Jersey Tax Court determined that an intercompany payment as a result of a tax sharing agreement is not a tax that is required to be added back to compute entire net income.
Intercompany Tax Sharing Agreement
The taxpayer conducted business as the financing arm of a parent multinational automotive company, and both were required to file corporation tax returns in the majority of states, including separate New Jersey corporation business tax returns. In the combined reporting states, the parent company filed the group’s corporation business tax returns and paid the tax. In order to fairly apportion any tax liabilities, the parent company entered into a tax sharing agreement with its affiliates, including the taxpayer. The agreement required the parties to make intercompany payments to each other, based on the estimated tax liabilities and benefits amongst the affiliates arising from state combined tax returns. For two years, the taxpayer received more payments from its affiliates than it had paid under the agreement, resulting in negative net intercompany payments for those years. The following two years, the taxpayer paid more to its affiliates than it received under the agreement, resulting in positive net intercompany payments for those years. On its New Jersey corporation business tax returns, the taxpayer added to its federal taxable income all of the taxes that it paid directly to states. However, the taxpayer did not add back its intercompany payments, and treated the net intercompany payments as an ordinary and necessary business expense.
In a subsequent audit, the intercompany payment deductions were denied as an unsubstantiated expense, and the taxpayer’s entire net income was recomputed by adding the positive net intercompany payments but not the negative net intercompany payments. A 5% late penalty payment was also imposed on the additional tax asserted as due. The taxpayer appealed, contending that the plain language of the controlling statute on addbacks applies only to the payer of the tax. Since the parent paid the corporation business tax due in the combined reporting states, the taxpayer argued that the parent is the entity that is subject to the addback.
Intercompany Payments Not Subject to Addback
The Tax Court determined that an intercompany payment is not a tax, nor is it an accrued tax, which is a tax that has been incurred but not yet paid or payable. It further held that such intercompany payments were fundamentally nothing more than contractual obligations within the consolidated group to fairly apportion expenses undertaken or imposed on the parent. Therefore, the reference in the addback statute to “taxes paid or accrued” does not refer to the intercompany payments but rather to the tax liability itself, without regard to filing requirements of any given state or the entity making the actual payment of the tax. It concluded that the intercompany payments, although based on estimated tax payments, were irrelevant for the purpose of reporting tax liability.
Daimler Investments US Corp. v. Director, Division of Taxation, New Jersey Tax Court, No. 008165-2016, January 31, 2019, ¶402-240