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United Parcel Service General Services Co. v. Director, Division of Taxation

25 N.J. Tax 1 (2009)

TAXATION; COMMERCIAL BUSINESS TAX — When no one factor is decisive, the income taxation test as to whether monetary transfers from one corporation to a related corporation constitutes a loan depends mostly on the intent of the parties because internal corporate accounting records have little significance and the economic reality of a transaction should be considered as if independently unrelated entities were involved.

A parent corporation transferred all cash deposited in the bank accounts of its numerous subsidiaries into its own account on a daily basis. It then used the funds that had been “swept” into its account to pay expenses of the subsidiary corporations. The funds provided by the parent for payment of a particular subsidiary’s expenses may have been less than, equal to, or more than the cash swept into the parent’s account from that subsidiary. None of the subsidiaries was able to obtain the cash not used to pay their expenses or receive any amounts earned by the parent corporation from its investments of the cash. The subsidiaries reported the sweeps in their respective New Jersey Commercial Business Tax (CBT) returns as “loans” to the parent corporation. The subsidiaries did not report any interest income with respect to the loan amounts. Because the subsidiaries did not report interest income in connection with the loans to their parent corporation, the Director of the Division of Taxation, following a routine audit of past tax filings, imputed interest between the parent corporation and certain of its subsidiaries and allocated to New Jersey certain receipts of each of these entities for the tax years in question, together with interest and amnesty penalties (even though the applicable amnesty periods had already expired). The imputation of interest involved application and interpretation of the New Jersey Corporation Business Tax Act which authorizes the Director to make adjustments in order to correct distortions in a corporation’s reporting, on its CBT returns, of its entire net income and authorizes the Director to include, as net income, a corporation’s “fair profits” resulting from transactions with related corporations. The parent corporation claimed that a centralized cash management system was common in large corporate structures and that such a system did not involve loans. It stated that there were no loan documentation, repayment schedules, due dates or collateral, and no interest payments were required from or made to it. Finally, the corporation’s airline subsidiary refused to provide the Director with certain information as to the “cost and value” of its aircraft alleging that this information would not accurately reflect the “cost and value” of the aircraft and would not provide a reasonable basis for determining revenue generation. The Director made a determination of the airline’s revenues based on the only information it had available reflecting the differences in size among the aircraft. The corporation and several of its subsidiaries challenged the CBT assessments imposed by the Director by filing an action in the Tax Court.

First, as to the imputation of interest issue, the Court noted that no reported New Jersey decision had yet addressed the tax consequences of the cash management system used by the parent corporation. Reviewing case law from other jurisdictions, it found the following common themes emerged with respect to determining whether monetary transfers from one corporation to related corporations constituted loans: (a) the most important consideration is the intent of the parties; (b) no one of the various factors used to identify a loan was decisive; (c) internal corporate accounting records have little significance; and (d) the economic reality of the transaction should be considered as if independent unrelated entities were involved. After applying these themes to the facts presented here, the Court concluded that the Director reasonably determined that the monetary transfers made pursuant to the parent corporation’s cash management system were loans for which interest should be imputed. It noted that funds transferred from the subsidiary to the parent would constitute, for tax purposes, either contributions to capital, dividends, payments for goods or services, or loans. Transfers of funds between independent corporations could not be treated as “in the nature of equity,” when, as a result of the transfers, the transferors received no equity interest in the transferee. Moreover, the parties presented no proofs as to whether the transfers could have constituted dividends or payment for goods or services, and none of the parties contended that the transfers were dividends or payment for goods or services. The Tax Court held that the parent’s decision to create a corporate structure, with one parent and numerous wholly-owned subsidiaries, constituted a business decision producing binding tax consequences on the corporate entities. It ruled that the subsidiaries could not be treated as divisions of the parent for the purposes of the tax consequences of the cash management system and as independent corporations for all other purposes. The Court also noted that the subsidiaries reported the cash sweeps as loans on their CBT returns when they could have reported them differently. It stated that a taxpayer is generally not allowed to argue that the substance of a transaction was other than the form it chose. Otherwise, post-transaction tax-planning would be encouraged and a monumental administrative burden would be imposed on the government.

Second, as to the allocation of revenue to New Jersey, the Court found that the corporation provided sufficient evidence to support its contention that the Director erred in allocating all revenues earned by the corporation’s data processing unit to New Jersey. It found that some of these revenues were generated by services performed in, or provided from, another state, and that those revenues attributable to another state must be excluded from the revenue allocated to New Jersey. However, since all the revenue that was generated from equipment performing the data processing, and the personnel necessary to operate, maintain, and repair the equipment were located in New Jersey, such equipment was subject to the New Jersey tax. The Court believed it was irrelevant that some of the users having equipment necessary to access the information generated in New Jersey were located outside the State.

Third, the Court held that since the parent corporation elected to withhold certain cost and value information requested by the State’s auditor they placed themselves in a position to be subject to whatever reasonable determination the Director made based on the limited information the corporation chose to provide. It stated that, if it ruled otherwise, it would encourage all taxpayers to withhold information during the audit process and then challenge the Director’s determinations in appeals using the very information withheld during the audit. It also rejected the corporation’s assertion that its refusal was warranted because of its concerns about the confidential nature of the cost and value information. The Court held that such confidentiality concerns were groundless as they ignore New Jersey’s statutory and regulatory requirements that tax information be kept confidential.

Fourth, the Court declared that the Director had discretion, but was not mandated, to waive the payment of all or any part of any penalty if the taxpayer’s failure to pay tax when due “is explained to the satisfaction of the [D]irector[.]” The Court held that the Director’s refusal to waive late payment penalties was manifestly unreasonable with respect to the taxes due based on interest imputed in connection with the corporation’s cash management system since there were genuine issues of fact and law that existed concerning this issue, i.e. the case law related to this issue could have been interpreted to suggest that the cash management system may not have generated loans.

Lastly, the Court refused to impose an amnesty penalty on the corporation. The Amnesty penalty is imposed if a taxpayer failed to pay any State tax during the “amnesty period” set forth under the statute. Although the statutory provisions expressly precluded waiver or abatement of the penalty, the Court agreed with the corporation that, based on the legislative history of the statutes, the penalty should be waived. The applicable legislative history stated that the amnesty penalties were not to be applied to deficiencies assessed pursuant to a question of law or fact uncovered through routine audits of taxpayers otherwise in compliance with the filing and payment requirements of the state, as was the case here. Further, the corporation contended that the penalty should not apply because the Director notified the corporation of the deficiency after the amnesty periods had expired. The Court mentioned that, had the Director made a showing that the taxpayer intentionally understated its tax obligation or otherwise filed the returns in bad faith, it might have reached a different conclusion.

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