A recent series of New Jersey cases has considered the circumstances under which an out-of-state corporate partner holding a limited partnership interest in a partnership doing business in New Jersey will have sufficient nexus to subject it to the state's corporation business tax (CBT). The issue first came to the forefront in BIS LP, Inc. v. Director, Div. of Tax.,26 N.J. Tax 489 (N.J. Super. Ct. App. Div. 2011), aff'g 25 N.J. Tax 88 (N.J. Tax Ct. 2009)). Two subsequent decisions issued in BIS LP's wake substantially narrow its scope by shedding light on problematic fact patterns that will not pass muster under its holding.
BIS LP involved a taxpayer, BIS LP Inc., that was an out-of-state limited partner with a 99% limited partnership interest in BISYS Information Solutions LP (Solutions), a data processing company based in New Jersey. BIS was wholly owned by an out-of-state holding company, BISYS Inc., which also held the 1% general partner interest in Solutions. Under the limited partnership agreement, BIS did not have the right to manage Solutions or perform any acts on its behalf, and its only connection to New Jersey was its interest in Solutions. Specifically, BIS did not have a location, office, employee, agent, or any other physical presence in the state, and the partnership interest in Solutions was BIS's only asset and source of income.
The Director of the Division of Taxation held that BIS had a unitary business relationship with Solutions and thus had sufficient nexus with the state to be subject to the CBT. The Tax Court of New Jersey disagreed, and the Appellate Division of the New Jersey Superior Court affirmed, holding that BIS lacked nexus with New Jersey and did not owe CBT. In its decision, the appellate court focused on certain key findings to support its conclusion that the businesses were not unitary. Specifically, the court noted that, although the partnership interest was the source of BIS's income and was its only or most substantial asset, BIS and Solutions were not in the same line of business, had no "substantial" overlapping of officers, and had no sharing of offices, operational facilities, technology, or know-how.
Village Super Market of PA
In Village Super Market of PA, Inc. v. Director, Div. of Tax., No. 0210022010 (N.J. Tax Ct. 10/23/13), as part of a reorganization, a New Jersey corporation, Village Super Market Inc. (INC), formed a New Jersey limited partnership, Village Super Market of NJ LP (NJ LP), to operate 25 supermarkets in New Jersey. Village Super Market of PA Inc. (PA), a wholly owned subsidiary of INC, held a 99% limited partnership interest in NJ LP, and INC held a 1% general partnership interest. On audit, the Division of Taxation held that PA had nexus with New Jersey, thereby subjecting it to the state's CBT.
Applying a transaction-based nexus analysis, the state Tax Court upheld the Division of Taxation's finding of nexus, rejecting efforts by PA to align its facts to those contained in BIS LP and paint itself as no more than a "passive investor." In its decision, the state Tax Court carefully distinguished the facts at hand from BIS LP, noting that PA and NJ LP, unlike the entities in BIS LP, were not discrete and independent entities because they were both in the same line of business and shared the same New Jersey-based agents, managers, officers, and directors to run their stores. Furthermore, both PA and NJ LP were controlled by the same New Jersey-governed cash management agreements and shared the same principal place of business in New Jersey.
The state Tax Court also focused on the fact that, unlike in BIS LP, PA, NJ LP, and INC continued operations as they had prior to their reorganization, leading the court to conclude that the "formation of the separate business entities of PA and LP appear to simply be a guise created for the purpose of tax avoidance." The court noted that the entities were interrelated, with the tax returns being the only item separating the entities. Based on this analysis, the court held that PA was "completely distinguishable" from the taxpayer in BIS LP because the "lines between PA, INC, and NJ LP are blurred, not separate and distinct." With this language, the theme of "clean and precise" lines dividing entities emerged in Village Super Market as a key to a nexus analysis.
This theme became more firmly established in the most recent case to address this issue, Preserve II, Inc. v. Director, Div. of Tax., No. 010921-2013 (N.J. Tax Ct. 10/4/17). In this case, an out-of-state corporation, Preserve II Inc. (Preserve), served as a 99% limited partner in two partnerships doing business in New Jersey. Each partnership had a separate entity to hold the remaining 1% general partnership interest. Preserve and the two general partners all were wholly owned by the same out-of-state entity, Pulte Home Corp. (PHC).
Relying on BIS LP, Preserve argued that its limited partnership interests were insufficient to create nexus because it was a passive investor as evidenced by its role as a limited partner set out in its partnership agreement. In a lengthy analysis, the state Tax Court rejected Preserve's argument, noting that it rested on the faulty notion of its form as a limited partner over the substance of the arrangement. Instead, the court applied a transaction-based nexus analysis that went beyond the terms of the partnership agreement that labeled Preserve as a limited partnership and looked to the underlying relationships between the entities, Preserve's business purpose, and its activities with the partnerships.
Based on this analysis, the court concluded that the lines between the partnerships, the general partner, Preserve, and PHC were "far from sharp and distinct and in fact were completely blurred." Specifically, Preserve was not a passive investor in an unrelated business, but instead was "as much of a general partner as the other corporate general partners." No evidence showed that the general partners performed all operations, management, and control for the partnerships while the limited partners were absolute passive "investors." In support of this, the court noted that the entities had overlapping key management personnel, each of whom was tasked with the goal of ensuring the success of the Pulte family's core business of homebuilding. This task ostensibly was a far cry from the business of passively investing in partnerships. Ironically, the testimony showed that "some individuals did not even know of Preserve's existence, the general partners' existence, or even the partnerships' existence." Because the facts did not show that Preserve's role was that of a limited partner, the state Tax Court upheld a finding of nexus, explaining that it could not conclude that Preserve only received its share of passthrough income in the partnerships.
Taken as a whole, these three cases serve as a valuable tool for taxpayers seeking guidance on when an out-of-state corporation owning a passive ownership interest in a passthrough entity doing business in New Jersey might be found to have nexus. When the New Jersey appellate court originally issued its 2011 taxpayer-favorable opinion in BIS LP, many taxpayers saw an opportunity to review their existing tax structures for potential CBT refund opportunities. The opinion was also seen as establishing a blueprint for taxpayers to use when planning an entity structure that could potentially reduce their CBT on a prospective basis.
However, the state Tax Court's subsequent decisions in Village Super Market and Preserve II not only placed restrictions on the scope of BIS LP, but also reflect an evolution in the Division of Taxation's approach to challenging those structures. As evidenced by the Division of Taxation's two subsequent wins, it is apparent that establishing a successful nexus finding rests on careful and detailed documentation and a close scrutiny of the facts. Notably, after BIS LP, the Division of Taxation even went so far as to informally indicate that it would look at the facts in each case and analyze the elements of a unitary business far more rigorously than it did in BIS LP.
Taxpayers should pay close attention to the significant amount of time the state Tax Court in Preserve II spent identifying pertinent facts, including interviewing several key employees and officers about the activities of each related entity. The court went beyond the terms of the partnership agreements that nominally provided that Preserve had no managerial powers over the underlying partnerships. Instead, the court closely examined the actual relationships between the corporation, the passthrough entity, and other related entities, and elevated substance over form in concluding that the corporate partner had nexus for CBT purposes.
While the three decisions definitely provide valuable guidance, this area of the law still appears to be somewhat unsettled. The common theme that runs through these three decisions is that of "blurred lines." At one end of the spectrum, the lines in BIS LP, according to the Village Super Market court, were "clear and distinct." In some sense, both Village Super Market and Preserve II can be seen as occupying the other end of the spectrum where the lines between the entities were so blurred that a finding of nexus was all but a foregone conclusion.
For example, in Village Super Market, the entities were both in the same line of business, had common officers, and continued operations as they had prior to their reorganization. In Preserve II, many employees were completely unaware of the existence of the separate entities. Ironically, in an area in which the court has highlighted the difference between the "clear and distinct line" versus "blurred line" situations, a "bright-line" test may be needed for taxpayers in close cases to truly have clarity in determining the extent to which corporate partner CBT nexus may exist.
Greg Fairbanks is a tax managing director with Grant Thornton LLP in Washington.
For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.