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State and Local Tax

New Jersey Adopts Combined Return Regulations

by David Engel

Effective September 19, 2022, the New Jersey Division of Taxation has adopted new regulations in connection with combined returns.

Definitions relevant to combined returns.

N.J. Admin. Code § 18:7-21.1 provides the definitions that are relevant to combined returns. (N.J. Admin. Code § 18:7-21.1, et. seq., effective 09/19/2022.)

Common ownership testN.J. Rev. Stat. § 54:10A-4(aa) provides that common ownership” means that more than 50% of the voting control of each member of a combined group is directly or indirectly owned by a common owner or owners, either corporate or non-corporate, whether or not the owner or owners are members of the combined group. Whether voting control is indirectly owned is determined in accordance with IRC § 318. N.J. Admin. Code § 18:7-21.1 (4) provides guidance as to when the common ownership test is met under the above mentioned section. The regulation states that If the same person (and/or any related persons) holds directly or indirectly more than 50% of the voting control of a corporation (a parent corporation), that person is considered to hold indirectly any stock or other interest in ownership or control in a lower-tier corporation (a subsidiary corporation) that is directly or indirectly held by the parent corporation. For example, if Corporation A, a widely-held, publicly traded corporation, owns 51% of the stock of Corporation B; Corporation B owns 51% of Corporation C; and Corporation C owns 60% of Corporation D. Corporations A, B, C, and D are all treated as commonly owned or under common ownership, and subject to inclusion in a combined group. In another example, it is explained that if Foreign corporation (F) owns 100% of the stock of Corporation A (organized in the United States) and of Corporation B (also organized in the United States). Corporations A and B each directly or indirectly own various corporate subsidiaries in separate chains leading up to Corporations A and B, where the voting control of each subsidiary is more than 50% owned by a higher-tier corporation in the chain. Corporations A and B, and all of their respective direct and indirect subsidiaries, are treated as commonly owned or under common ownership, and subject to inclusion in a single combined group.

Unitary business.

N.J. Rev. Stat. § 54:10A-4(gg) provides that the term unitary business refers to a single economic enterprise that is made up either of separate parts of a single business entity or of a group of business entities under common ownership and that the term unitary business will be construed to the broadest extent permitted under the Constitution of the United States. N.J. Admin. Code § 18:7-21.2(a) provides that a unitary business is characterized by significant flows of value evidenced by factors, such as functional integration, centralization of management, and economies of scale. These factors provide evidence of whether the business activities operate as an integrated whole or exhibit substantial mutual interdependence and that if the entities meet either the “Interdependence of Functions Test” or the “Unity of Use and Management Test,” the entities are part of a unitary business.

Interdependence of functions test: N.J. Admin. Code § 18:7-21.2(b) provides that any of the following circumstances demonstrate that an interdependence of functions may exist: (1) businesses in the same line of business; (2) businesses are different steps of a vertically structured business; (3) centralized management as may be evidenced by executive-level policy made by a central person, board, or committee and not by each entity in areas such as, but not limited to, purchasing, accounting, finance, tax compliance, legal services, human resources, health and retirement plans, product lines, capital investment, and marketing; (4) goods or services, or both, are not supplied at arm’s-length prices between, or among, entities although existence of arm’s-length pricing between entities, however, does not indicate lack of unity; (5) a discount, cost-saving, or other benefit can result from joint purchases, leaseholds, or other forms of joint, shared, or common activities between or among entities; (6) whether the joint, shared, or common activity is directly beneficial to, related to, or reasonably necessary to the income-producing activities of the unitary business; (7) transfers or sharing of technical information or intellectual property, such as patents, copyrights, trademarks and service marks, trade secrets, processes or formulas, know-how, research, or development, provide evidence of a unitary relationship when the information or property transferred or shared is significant to the business’ operations; (8) significant common or intercompany financing, including the guarantee by, or the pledging of the credit of, one or more business entities for the benefit of another business entity or entities, if the financing activity serves an operational purpose; (9) significant sales, exchanges, or transfers of products, services, and/or intangibles between corporations related by common ownership; and (10) exercise of control.

Unity of use test:  N.J. Admin. Code § 18:7-21.2(c) provides that unity of use means there is functional integration among the entities and is evidenced generally by shared support functions. Unity of operations is evidenced, generally, by centralized management or utilization of centralized policies. These unities exist if each entity that is to be included in the unitary business benefits or receives goods, services, support, guidance, or direction arising from the actions of common staff resources or common executive resources, personnel, third-party providers, or operations under the direction of such common resources including common employees, common accounting; common cash management; common legal support and common offices.

Unity upon acquisition: N.J. Admin. Code § 18:7-21.2(d)(2)  provides that when the common ownership standard is first met by reason of merger, acquisition, or business formation, it is presumed that a unitary business relationship exists. Unity is generally presumed for newly acquired or newly formed entities.

Holding company: N.J. Admin. Code § 18:7-21.2(d)(3) provides that when a parent holding company, that directly or indirectly controls one or more operating company subsidiaries engaged in a unitary business, is deemed to be engaged in a unitary business and includable in a combined report with the subsidiary or subsidiaries. An intermediate holding company is deemed to be engaged in a unitary business with the parent and subsidiary or subsidiaries and includable in a combined report with them.

Entities leaving the combined group: N.J. Admin. Code § 18:7-21.2(f) provides that if a member of a combined group is completely spun off from the group, that spun-off business entity and the combined group must show, to the Director’s satisfaction, that a unitary business relationship no longer exists.  N.J. Admin. Code Χ 18:7-21.2(g) provides that former members of a combined group will no longer be presumed unitary if sold to an unrelated third party. However, the Director may impose such conditions necessary to prevent the evasion of tax in either of the above circumstances.

Entities that may be included in combined return.

N.J. Admin. Code § 18:7-21.3 provides that entities that must be included in a combined return are: (1) corporations; (2) combinable captive insurance companies; (3) banking corporations and financial corporations; (4) limited liability companies (LLCs) (taxed as corporations); (5) foreign LLCs (taxed as corporations); (6) S corporations unless they have elected not to be included in a combined return; (7) casino licensees; (8) qualified S corporation subsidiaries that have not made an S corporation election; (9) New Jersey qualified S corporation subsidiaries that elect to be included in the combined group; (10) business entities treated as corporations for federal purposes; (11) professional corporations; (12) business entities incorporated under the laws of a foreign country that would be corporations if the entities had been incorporated under the laws of the United States; and (13) public utilities that are excluded from combined groups by N.J. Rev. Stat. 54:10A-4.6(k). N.J. Admin. Code § 18:7-21.3(b)  provides the following corporations are excluded: (1) corporations that are regulated, in whole or in part, by the Federal Energy Regulatory Commission, the New Jersey Board of Public Utilities, or similar regulatory body of another state, with respect to rates charged to customers for electric or gas services and water and wastewater services; (2) New Jersey S corporation that does not elect to be part of the combined group; (3) insurance companies other than combinable captive insurance companies; (4) disregarded entities; (5) entities treated as partnerships for federal tax purposes; and (6) exempt corporations.

Other regulations.

N.J. Admin. Code § 18:7-21.4 provides rules for mandatory combined reporting. N.J. Admin. Code § 18:7-21.5  provides rules for determining the managerial member of the combined group and the managerial member’s responsibilities. N.J. Admin. Code § 18:7-21.6 provides rules for filing combined returns and rules for making payments and assessments. N.J. Admin. Code §§ 18:7-21.7 and 18:7-21.8 provide rules for determining and reporting the income of a combined group for both U.S. and foreign entities. N.J. Admin. Code § 18:7-21.11 provides rules for net operating losses (NOLs). N.J. Admin. Code § 18:7-21.12 provides rules for the utilization of tax credits by members of the combined group. N.J. Admin. Code § 18:7-21.13 provides rules for calculating the allocation factor for a combined group.  N.J. Admin. Code § 18:7-21.15 provide that the default method is the water’s edge combined return. N.J. Admin. Code §§ 18:7-21.16 and 18:7-21.17  provide the rules for making a worldwide combined group return election or an affiliated group return election. N.J. Admin. Code § 18:7-21.18 provides rules for the net deferred tax liability deduction.  N.J. Admin. Code § 18:7-21.19 provides rules for application of the minimum tax. N.J. Admin. Code § 18:7-21.20 provides rules for the tax accounting methods of a combined group. N.J. Admin. Code §§ 18:7-21.23 and 18:7-21.24  give the Director the authority to adjust the makeup of the combined group to prevent tax avoidance. For example, if the Director determines that the member were not unitary and the principle purpose of including the members was to either shelter income, dilute the allocation factor of the combined group, improperly increase the combined group NOLs, or the inclusion was for the purpose of sharing tax credits that were not related to any function of the combined group, the Director may require decombination. N.J. Admin. Code § 18:7-21.25 provides rules for banking corporations and combined groups. N.J. Admin. Code § 18:7-21.26  lists the conditions for designating a managerial member by the Director. N.J. Admin. Code § 18:7-21.27 explains compliance with IRC § 1502. N.J. Admin. Code § 18:7-21.28 provides the allocation formula for freight companies. N.J. Admin. Code § 18:7-21.29 requires the members of a combined group to notify the Director of changes in the combined group.

 

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