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Stryker Corporation v. Director, Division of Taxation

4852-96, 1999 WL 1204553 (Tax Ct. 1999)

TAXATION; SUBSIDIARIES; DROP SHIPMENTS—Where a manufacturer drop ships products from New Jersey to points outside the state for a corporate subsidiary, the value of the shipments can be used in determining the manufacturer’s corporate taxes even though this would not be the case if the subsidiary were merely a division.

A taxpayer manufactured orthopedic hips and knees and sold them to a related company for resale to customers in the United States. It did not sell directly to customers, who placed orders directly with the sales company. Upon receipt of an order, the sales company processed it and then placed its order with the manufacturing company via an in-line computer. The sales company did not have any employees engaged in shipping, receiving, warehousing or distribution functions, all of which were performed by the manufacturing company. Thus, upon receipt of an order, the manufacturing company’s personnel would locate the ordered product from inventory, pack it, and ship the product to the sales company’s customer either within or outside of New Jersey. At least quarterly, personnel from the manufacturing company and the sales company would review the sales company’s receipts from sales in order to determine and implement a price and profit allocation, with a final reconciliation of the allocations being made at the close of each year. The New Jersey tax authorities audited the manufacturing company and determined that for purposes of the New Jersey Corporation Business Tax, the entire net income for sales to the sales company should be included in the numerator of the “receipts fraction,” which is used to determine the portion of the manufacturing company’s total receipts which is subject to New Jersey tax. When this matter arrived at the Tax Court, the taxing authority argued that the manufacturing company and the sales company should be treated as wholly independent entities for purposes of the issues before the Court. The manufacturing company however, contended that the shipment of orthopedic hips and knees its to its sales company’s customers outside of New Jersey were not includable in its receipts fraction because, although the parts were located in New Jersey “at the time of the receipt of or appropriation to the orders” from the sales company, the manufacturing company made no “shipments” of the products to points within New Jersey. It asserted that its physical proximity to the sales company, and their inter-relationships “in terms of allocation of expenses and administrative functions, do not affect the ‘destination’ of the merchandise.” The State, however, contended that the sales transaction between the two companies took place exclusively in New Jersey, and that the manufacturing company constructively shipped to the sales company the products ordered by the sales company. Under this theory, “constructive shipments occurred when [the manufacturing company] allocated specific merchandise to [a sales company’s] order, and then shipped merchandise on behalf of [the sales company].” Both the taxpayer and the taxing authority acknowledged that the taxing statute did not contemplate three-party drop-shipment transactions. The Court, however, considered itself required to interpret the statutory provisions, and apply them to the facts at hand, “in accordance with legislative intent.” The manufacturing company sought to have the court rely on administrative interpretations of statutes similar to the New Jersey statute in California, New York, and Pennsylvania. California adopted the Uniform Division of Income for Tax Purposes Act. That Act, with a wide variety of amendments, had been adopted in twenty-two states and the District of Columbia. Under the interpretation of those three states, a drop-shipment to a dealer’s out-of-state customer would be excluded from the numerator of the allocation fraction. With this as background, the Court looked at the New Jersey Sales and Use Tax Act, N.J.S. 54:32B-1 to -29. Under that statute, “[a]ny transfer of title or possession or both, exchange or barter, rental, lease, or license to use or consume, conditional or otherwise, in any manner or by any means whatsoever for a consideration, or any agreement therefore, including the rendering of any service, taxable under the act, for a consideration or any agreement therefor” constitutes a “sale.” Therefore, for sales tax purposes, mere transfer of title is sufficient to subject the transaction to tax. “Shipment” or transfer of possession is not required. Under N.J.S. 54:10A-6(B)(1), a “shipment” is made to a point in New Jersey only when actual transportation of merchandise and transfer of possession occurs. “The concepts of constructive delivery and constructive shipment asserted by [the Division of Taxation] are inconsistent with the actual physical transfer which the word ‘shipment,’ as used in this statute, implies.” Consequently, the Court held that the manufacturing company made no physical transfer to its sales company of the products which it sold to its sales company and then shipped to the sales company’s customers. Based on that analysis, therefore, the sales to the sales company would not have been includable in the numerator of the manufacturing company’s receipts fraction under subsection (B)(1).

But this did not end the issue. The Court then set out to determine whether exclusion of the receipts from subsection (B)(1) prevented taxation by New Jersey of those receipts, or whether another provision of N.J.S. 54:10A-6(B), particularly subsection (B)(6), was applicable to receipts. Here, the Tax Court felt that the out-of-state authority cited by the manufacturing company, which suggested that the statutory provisions similar to section (B)(1) were conclusive as to the taxability of receipts from certain tangible personal property were, in general, not binding on the Tax Court, nor were they instructive as to the proper interpretation of N.J.S. 54:10A-6(B). Here, the Court found that the Corporation Business Tax Act was of broad scope and that while the Act did not contemplate three-party drop-shipment transactions, it did not prohibit inclusion of the sales and the receipts fraction of the receipts generated by such transactions. Under subsection (B)(6), the place to or from which shipment is made is not relevant to the determination of whether receipts must be included in the numerator of the receipts fraction. “The issue is solely whether the receipt was ‘earned by the taxpayer within New Jersey.’” Here, the Court concluded that the law was applicable to the manufacturing company’s receipts from sales to its sales subsidiary involving direct shipments to the sales company’s out-of-state customers. The manufacturing company was located in New Jersey and sold merchandise located in New Jersey to a customer also located in New Jersey (its own sales company). The sales company made payments for the merchandise in New Jersey. The transactions resulted in receipts to the manufacturing company for New Jersey transactions. Therefore, the receipts were earned in New Jersey. The Court recognized that the manufacturing company could have established its sales company as a division and not as a separate subsidiary corporation. In such an event, the Division of Taxation acknowledged that receipts of sales made by the manufacturing company (through its sales division) and shipped to out-of-state customers would not have been includable in the numerator of the manufacturing company’s receipts fraction. But, having elected the existing corporate structure, the manufacturing company could not avoid its tax consequences. In reaching this conclusion, the Tax Court cited the New Jersey Supreme Court: “We are not told why [the taxpayer] employed subsidiaries. A probable motivation was tax advantage somewhere. The question is whether a state must adjust its tax laws to avoid a disadvantage a taxpayer may experience because of its decision to incorporate a part of its operation. As a general proposition, the answer must be that it is for the taxpayer to make its business decisions in the light of tax statutes, rather than the other way around.”


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