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Accuzip, Inc. v. Director, Division of Taxation

25 N.J. Tax 158 (2009)

TAXATION — Federal law treats the sale of pre-written software as tangible copyrighted property even if the parties characterize their transaction as a license; therefore, absent some other consideration, the sale of such software is not considered as doing business in New Jersey for the purposes of the Corporation Business Tax.

A Nevada corporation with offices in California developed and sold computer mailing programs to customers nationwide. The programs were sold on computer disks with a licensing agreement attached. The company marketed its products by placing advertisements in national trade magazines and by maintaining a web page. Orders were placed via telephone, e-mail or fax to an employee in California. The products were shipped from the California office. Technical support was provided from the California office. The corporation did not own or rent any real property or have any employees in New Jersey. Between 1999 and 2001, it had 93 customers in New Jersey. This represented two percent of its total gross income. The New Jersey Tax Director (Director) found that the corporation was “doing business” in New Jersey for Corporation Business Tax (CBT) purposes because it retained title to licensed software in New Jersey. It required the corporation to pay taxes based on income.

A Colorado corporation with offices in Denver developed and copyrighted a desktop publishing computer program. The product was delivered throughout the world. It employed a sales representative for New York and New Jersey who solicited orders from resellers in his territory. He also conducted educational sessions where he informed resellers’ sales personnel of the benefits and features of the software programs so that they would be better able to sell more inventory to end users. He worked out of his personal residence in New Jersey. The Director determined that the corporation’s licensing of software to New Jersey customers, while retaining title to such software, constituted “doing business” in New Jersey. It required the corporation to file tax returns and pay taxes based on income.

Both corporations appealed the Director’s determination. The Tax Court reversed the determination with respect to the Nevada corporation and upheld the determination against the Colorado corporation [that it was doing business in New Jersey, but found that it was only subject to the minimum tax under the New Jersey Corporation Business Tax Act (Act)] . First, the Tax Court noted that a state does not violate the Commerce Clause if it only taxes an entity when the tax is: (a) applied to an activity with a substantial nexus with the taxing State; (b) is fairly apportioned; (c) does not discriminate against interstate commerce; and (d) and is fairly related to the services provided by the State. It held that the main issue in dispute was whether there was a substantial nexus between the corporations and New Jersey sufficient to impose a tax based on corporate income without violating the Commerce Clause. The Act provides that a foreign corporation is subject to tax if, among other factors, it is “doing business” or employing or owning property in New Jersey. The determination as to whether a corporation is doing business in New Jersey is fact sensitive. The Tax Court noted that the United States Supreme Court had held that physical presence is necessary to satisfy the substantial nexus standard in the sales and use tax context. Notwithstanding this holding, it noted that the New Jersey Supreme Court ruled that New Jersey may tax income generated in the state from intangible property and impose CBT liability even where the assessed corporation lacked a physical presence in the state.

The Tax Court rejected the Director’s argument that both corporations were similarly situated to a third corporation in an earlier case (which previously had been found to be subject to the CBT) because they all licensed intangible property, as evidenced through their licensing agreements.

First, it noted that the Director was incorrect in characterizing the software sold by the Nevada and Colorado corporations as intangible property. It stated that federal law treats the sale of pre-written software as tangible copyrighted property even if the parties characterized the transaction as a license. It thus determined that the fees were generated from the single sale of the pre-written computer software (and later updates) and not from any resale or royalty payments, as was the case with the company in the prior case. Second, it mentioned that these corporations were different from the other corporation because: (a) they were not affiliated with an entity that had a physical presence in New Jersey; (b) neither of the corporations’ intellectual property was displayed in New Jersey store locations to generate sales; and (c) neither of the corporations were holding companies solely created for the purpose of generating a tax benefit.

The Court also rejected the Director’s argument that the corporations owned property in New Jersey. It found that the licensing agreements put customers on notice that the corporations were not selling ownership of their intellectual property. Rather, it found that each software buyer received ownership of the physical property containing the intellectual property for its own use. It believed that if it had concluded that the corporations’ owned property in New Jersey, this outcome would lead to illogical results, i.e. if all of the customers moved to another state with their disks then, under the Director’s argument, the corporations would not own property in New Jersey and would potentially be liable for tax to another state. The Court concluded that this was surely not what the New Jersey Legislature intended when adopting the Act. Based on the fact that: (a) the Nevada corporation sold tangible property; (b) it did not own property in New Jersey; (c) the nature and extent of its activities, as well as the continuity, frequency, and regularity of those activities were diminimus; (d) the seat of management, offices, and other places of business were not located in New Jersey; and (e) had no agents, officers or employees in New Jersey, the Court determined that the Nevada corporation was not doing business in New Jersey and held there was no substantial nexus between the corporation and New Jersey for the Director to impose a tax based on its income.

While the Court also concluded that the Colorado corporation was selling tangible property and did not own property in the state, it noted that this particular corporation employed a regional sales representative in New Jersey. This representative traveled to stores in New Jersey that sold the corporation’s products, and held educational sessions in New Jersey. As such, this corporation was “doing business” in New Jersey pursuant to the Act. Nevertheless, the Court ruled that the Colorado corporation’s activities needed to be further examined to determine if they were “protected” and therefore subject only to a minimum tax, or “unprotected,” thus subjecting it to tax based on income. 15 U.S.C. Section 381 provides that no state may impose a net income tax on a person from interstate commerce if the only business activities in the State are the solicitation of orders for the sale of tangible personal property. Here, the Court found that the record demonstrated that: (x) all of the sales representative’s activity conducted in New Jersey furthered the solicitation of orders for the corporation’s product; (y) his education sessions were of a pre-sale nature and he was not educating an end user, but rather the retail seller; and (z) the sessions had no independent business function apart from the solicitation of orders. Accordingly, it ruled that the activities of the Colorado corporation fell within the protection of that federal law and subjected it only to the minimum tax pursuant to the New Jersey statute.

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