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Lanco, Inc. v. Director, Division of Taxation

379 N.J. Super. 562, 879 A.2d 1234 (App. Div. 2005)

TAXATION; INCOME TAX; LICENSE FEES—Unlike with sales and use taxes, a business, such as a trademark licensing company, does not need to have a physical presence in New Jersey to be subject to income taxation.

On an appeal from the Tax Court, the Appellate Division was presented with the question of “whether New Jersey may constitutionally subject a foreign corporation to the Corporation Business Tax, where the corporation has no physical presence in the state and derives income from a New Jersey source only pursuant to a license agreement with another corporation that conducts a retail business [in New Jersey].” In this case, a non-New Jersey corporation licensed intellectual property to a clothing retailer. Because it had “no real or personal property or personnel in the State,” the Tax Court held that, by reason of a lack of physical presence in New Jersey, “subjecting it to the tax would violate the Commerce Clause of the federal constitution.” The Director of the Division of Taxation appealed, arguing that the license company “derived receipts from sources in the State, thereby making it subject to the tax, and that ‘there [were] no constitutional impediments to application of the corporation business tax to [the licensing company] given its substantial nexus to New Jersey’ because there was no violation of the due process clause ... or the Commerce Clause.” This raised “a critical question [of] whether [a] taxpayer must have a physical presence in the state in order to constitute the required ‘substantial nexus’ necessary to satisfy the Commerce Clause.”

According to a standard established by the United States Supreme Court in Quill there is a “bright-line, physical-presence requirement ... [for imposition] of sales and use taxes.” Nonetheless, “[t]he Director argue[d] that ‘the rationale for abandoning a physical presence requirement for Due Process Clause purposes recognizes that businesses engage in significant levels of commercial activity in a state without ever ‘setting foot’ there, ‘and businesses foresee being subject to state tax laws as a result of commercial activity directed at a particular state.’” The director further argued that “[t]here is no principled reason why the Commerce Clause should require a corporation’s physical presence to justify State taxation ... provided the State can establish that the corporation derive[d] significant benefits from continued and deliberate economic activity in the taxing State.” Lastly, the Director also “emphasize[d] that Quill involved vendors whose only connection with customers was by common carrier or the United States mail, but here there [was] a long-term contractual relationship with a related corporation that operate[d] retail-clothing outlets throughout New Jersey.”

As further support for its arguments, the Director asserted that the agreement from the licensing company and its related retail affiliate “promote[d] increased retail purchases of merchandise at stores in New Jersey and that ‘growth in retail sales burdens [New Jersey] by increasing traffic, requiring police and fire protection and imposing demands on the labor pool.”

The Appellate Division agreed with the Director that “Quill does not apply to taxes other than sales and use taxes.” It also found that it had never “articulated the same physical-presence requirement” that had been established for sales and use taxes when addressing other taxes. The Court also looked at rulings in other states, finding that a measurable number of other states had declined to require a physical presence for income tax purposes. In sum, the Court was “satisfied that the physical presence requirement applicable to use and sales taxes [was] not applicable to income tax and that the New Jersey Business Corporation Tax may be constitutionally applied to income derived by [the licensing company] from licensing fees attributable to New Jersey.” Consequently, it reversed the decision of the Tax Court.


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