Opinion
Docket No. 013905-2010
07-20-2015
Re: MCI Communication Services, Inc. v. Director, Division of Taxation
Michael James Guerriero, Esq. Day Pitney LLP One Jefferson Road Parsippany, New Jersey 07054-2891 Jill C. McNally Deputy Attorney General Division of Law R.J. Hughes Justice Complex P.O. Box 106 25 Market Street Trenton, New Jersey 08625-0106
NOT FOR PUBLICATION WITHOUT APPROVAL OF THE TAX COURT COMMITTEE ON OPINIONS
NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE TAX COURT COMMITTEE ON OPINIONS
Michael James Guerriero, Esq.
Day Pitney LLP
One Jefferson Road
Parsippany, New Jersey 07054-2891
Jill C. McNally
Deputy Attorney General
Division of Law
R.J. Hughes Justice Complex
P.O. Box 106
25 Market Street
Trenton, New Jersey 08625-0106
Dear Counsel:
This letter constitutes the court's opinion with respect to the parties' cross-motions for summary judgment. The issue presented is whether under the New Jersey Corporation Business Tax Act a taxpayer is permitted to "adjust" its Entire Net Income to reverse the effect of the reduction in tax attributes required by Internal Revenue Code §108(b).
For the following reasons, plaintiff's motion is denied and defendant's motion is granted.
I. Facts
In July, 2002, Worldcom, Inc. filed a Petition for Reorganization pursuant to Title 11 of the U.S. Bankruptcy Code on behalf of itself and its subsidiaries. Upon emerging from bankruptcy in April, 2004, Worldcom, Inc. merged into MCI, Inc. ("MCI") which became the surviving entity. As a result of the Title 11 reorganization of Worldcom, Inc. and its subsequent merger into MCI, a substantial amount of the debt of MCI and its affiliated companies was cancelled.
Bankruptcy reorganization is more commonly referred to as Chapter 11, however, Internal Revenue Code §108(a) uses the phrase Title 11 of the U.S. Bankruptcy Code. The court will therefore utilize the phrase Title 11 throughout this opinion.
During the 2005 tax year, MCI Communication Services, Inc. ("plaintiff"), was a domestic corporation authorized to do business in the State of New Jersey and was a wholly owned subsidiary of MCI. For tax year 2005, plaintiff consented to file consolidated returns for federal income tax purposes with the group consisting of MCI and its affiliates.
As provided for by the Internal Revenue Code (IRC), the income from the cancellation of indebtedness (CODI) resulting from the Title 11 bankruptcy was excluded from the income of the members of the MCI Group. Also as provide for by the IRC, the members of the MCI Group were required to reduce certain of their tax attributes by the aggregate amount of their excluded CODI. Since Worldcom, Inc. had limited tax attributes, the IRC required that "lower tier" members of the group, such as plaintiff, take into account a portion of the CODI of "upper tier" members and to reduce their tax attributes with respect to the "pushed-down" CODI.
As a result of the application of federal income tax provisions, plaintiff was required to reduce its tax attributes by $3,584,207,381, the majority of which was the result of CODI pushed down to it from its upper tier affiliates. For tax year 2005, plaintiff recognized income in the amount of $271,144,051 solely as a result of the pushed down CODI.
Plaintiff filed its 2005 NJ Corporation Business Tax (CBT) return reporting a refund due of $1,142,454.00. On Schedule A, line 33(b) of the CBT return under "other deductions and additions," plaintiff reported a deduction of $271,132,237. An attachment to the return stated that the deduction consisted of "Excess Capital Loss Limitation" of $11,814 and "Reversal of Federal Attribute Reduction Turn" in the amount of ($271,144,051).
The Division disallowed the deduction of $271,144,051 and issued a Final Determination on July 24, 2007 which plaintiff appealed in a timely filed protest. Thereafter a Final Determination upholding the July 24, 2007 determination was issued and plaintiff timely filed the instant complaint in the Tax Court.
II. Legal Issues and Analysis
A. Summary Judgment
Summary judgment should be granted where "the pleadings, depositions, answers to interrogatories and admissions on file, together with the affidavits, if any, show there is no genuine issue as to any material fact challenged and the moving party is entitled to a judgment or order as a matter of law." R. 4:46-2(c). In Brill v. Guardian Life Ins. Co., 142 N.J. 520, 523 (1995), our Supreme Court established the standard for summary judgment as follows:
[W]hen deciding a motion for summary judgment under Rule 4:46-2, the determination whether there exists a genuine issue with respect to a material fact challenged requires the motion judge to consider whether the competent evidential materials presented, when viewed in the light most favorable to the non-moving party in consideration of the applicable evidentiary standard, are sufficient to permit a rational factfinder to resolve the alleged disputed issue in favor of the non-moving party.
"The express import of the Brill decision was to 'encourage trial courts not to refrain from granting summary judgment when the proper circumstances present themselves.'" Township of Howell v. Monmouth Cnty Bd. of Taxation, 18 N.J. Tax 149, 153 (Tax 1999) (quoting Brill, supra, 142 N.J. at 541).
The court concludes that there is no genuine dispute with respect to any of the material facts in this matter. The issues presented are purely questions of statutory application and I find that it is ripe for summary judgment.
B. Standard of Review
The review of this matter begins with the presumption that determinations made by the Director are valid. See Campo Jersey, Inc. v. Director, Div. of Taxation, 390 N.J. Super. 366, 383 (App. Div. 2007), certif. denied, 190 N.J. 395 (2007); L&L Oil Service, Inc. v. Director, Div. of Taxation, 340 N.J. Super. 173, 183 (App. Div. 2001); Atlantic City Transp. Co. v. Director, Div. of Taxation, 12 N.J. 130, 146 (1953). "New Jersey Courts generally defer to the interpretation that an agency gives to a statute [when] that agency is charged with enforc[ement.]" Koch v. Director, Div. of Taxation, 157 N.J. 1, 8 (1999) (citing Smith v. Director, Div. of Taxation 108 N.J. 19, 25 (1987)). Determinations by the Director are afforded a presumption of correctness because "[c]ourts have recognized the Director's expertise in the highly specialized and technical area of taxation." Aetna Burglar & Fire Alarm Co. v. Director, Div. of Taxation, 16 N.J. Tax 584, 589 (Tax 1997) (citing Metromedia, Inc. v. Director, Div. of Taxation, 97 N.J. 313, 327 (1984). The Supreme Court has directed courts to accord "great respect" to the Director's application of tax statutes, "so long as it is not plainly unreasonable." Metromedia, supra, 97 N.J. at 327. However, where the interpretation of an administrative agency is plainly at odds with a statute, that interpretation will not be upheld. See Oberhand v. Director, Div. of Taxation, 193 N.J. 558, 568 (2008) (citing GE Solid State v. Director, Div. of Taxation, 132 N.J. 298, 306 (1993).
C. Discussion
1. General Principles of the CBT
The CBT requires that all non-exempt domestic and foreign corporations pay an annual franchise tax for the privilege of having or exercising its corporate franchise in New Jersey, or for the privilege of deriving receipts from sources within the State or for the privilege of engaging in contacts within the State or for the privilege of doing business, employing capital or owning capital or property, or maintaining an office in New Jersey. N.J.S.A. 54:10A-2.
The franchise tax on a corporation which is not a New Jersey S Corporation is the greater of an alternative minimum assessment (which is not at issue in this matter) or a percentage of the Corporation's "Entire Net Income." N.J.S.A. 54:10A-5. Entire Net Income is the:
total net income from all sources, whether within or without the United States, and shall include the gain derived from the employment of capital or labor, or from both combined, as well as profit gained through a sale or conversion of capital assets. For the purpose of this act, the amount of a taxpayer's entire net income shall be deemed prima facie to be equal in amount to the taxable income, before net operating loss deduction and special deductions, which the taxpayer is required to report, or, if the taxpayer is classified as a partnership for federal tax purposes, would otherwise be required to report, to the United States Treasury Department for the purpose of computing its federal income tax . . .
[N .J.S.A. 54:10A-4(k)]
Thereafter various deductions and additions as are specified by statute are permitted or required as the case may be. See, N.J.S.A. 54:10A-4(k)(2)(A) through (J) and N.J.S.A. 54:10A-4.1 through 4.5.
2. Federal Taxable Income and Entire Net Income
For federal income tax purposes, generally "Gross Income" includes income from the discharge of indebtedness. 26 U.S.C.A. §61(a)(12). However, the gross income of a taxpayer does not include any of the CODI otherwise includable in income where "the discharge occurs in a title 11 case." 26 U.S.C.A. §108(a)(1)(A). If IRC §108(a) applies to exclude CODI, IRC §108(b)(1) then applies to require the reduction of certain tax attributes of the discharged taxpayer to the extent of the CODI excluded under IRC §108(a)(1)(A). 26 U.S.C.A. §108(b)(1) .
Specifically, IRC §108(b)(1) requires that the amount excluded from gross income pursuant to IRC §108(a) "shall be applied to reduce the tax attributes of the taxpayer as provided in [IRC §108(b)(2)]." IRC §108(b)(2) requires a reduction in the following tax attributes in the following order: Net Operating Losses, General Business credits allowable under IRC §38, minimum tax credit allowable under IRC §53(b), capital losses, basis reduction, passive activity losses and credit carryovers and foreign tax credit carryovers. Under IRC §108(b)(5) the taxpayer may elect to apply its required reductions first against basis in depreciable property.
Ultimately, then, the discharged taxpayer takes the excluded CODI into income through the reduction of its tax attributes, whether by the reduction of net operating losses, tax credits, or basis of assets which would otherwise generate deductions, including depreciation deductions, or reduced gain on sale.
As noted above, plaintiff was a member of the MCI Group which consented to file consolidated returns with respect to federal income tax pursuant to IRC §1501 . IRC §1502 grants authority to the Secretary of the Treasury to "prescribe such regulations as he may deem necessary in order that the tax liability of any affiliated group of corporations making a consolidated return and of each corporation in the group, . . . may be returned, determined, computed, assessed collected, and adjusted in such manner as clearly to reflect the income-tax liability . . . in order to prevent avoidance of such tax liability." 26 U.S.C.A. §1502. In accordance with that authorization, Temporary Treasury Regulation §1.1502-28T was adopted to set forth "rules for the application of section 108(a) and the reduction of tax attributes pursuant to section 108(b) when a member of the group realizes discharge of indebtedness income that is excluded from gross income under section 108(a) (excluded COD income)." Temp. Treas. Reg. §1.1502-28T(a). According to plaintiff, "since WorldcomMCI had very limited tax attributes, the federal consolidated return regulations required Worldcom, Inc. to 'push down' the CODI that exceeded its tax attributes to subsidiary members in the MCI Group to offset tax attributes at the subsidiary level until the full amount of the CODI had been absorbed or there were not attributes left to absorb."
IRC §1501 provides in part "An affiliated group of corporations shall, subject to the provisions of this chapter, have the privilege of making a consolidated return with respect to the income tax imposed by chapter 1 for the taxable year in lieu of separate returns. The making of a consolidated return shall be upon the condition that all corporations which at any time during the taxable year have been members of the affiliated group consent to all the consolidated return regulations prescribed under section 1502 prior to the last day prescribed by law for the filing of such return. The making of a consolidated return shall be considered as such consent." 26 U.S.C.A. §1501.
Final Regulations were adopted March 22, 2005 applicable to discharges that occur after March 21, 2005, with certain exceptions and elections available. Treas. Reg. §1.1502-28(d).
The total CODI excluded from the income of the MCI Group resulting from the Title 11 bankruptcy was $25,144,516,691. Debt owed directly by plaintiff which was canceled as a result of its Title 11 bankruptcy amounted to $70,676,742. Plaintiff reduced its tax attributes by this amount as required by IRC §108(b). Furthermore, since plaintiff was a member of the MCI group filing a consolidated income tax return for federal tax purposes in tax year 2005, and because the tax attributes of upper tier members of the group were insufficient to fully absorb upper tier CODI, IRC §108(b) and Temp. Treas. Reg. §1502-28T worked to require plaintiff to further reduce its tax attributes for a portion of the unabsorbed upper tier CODI. The total of the CODI attributed to plaintiff from upper tier members was $3,584,207,381. Plaintiff contended that the result of the CODI attributed to it from upper tier members of the MCI group and the resulting reduction in tax attributes was an increase in its income in the amount of $271,144,051. The Director did not dispute this contention. However, the Director did dispute that such income should be treated any differently than the income recognized by plaintiff as a result of plaintiff's own CODI.
At oral argument, plaintiff conceded that the income generated by the reduction in tax attributes resulting from the plaintiff's own CODI was not at issue.
According to the exhibits submitted by plaintiff, these tax attribute reductions were as follows:
| Other current assets: | $ 19,584,254 |
| PPE: | 834,711,598 |
| Intangibles: | 71,460,803 |
| Other LT assets: | 28,037,941 |
| Third Party A/R | 52,439,604 |
| Intercompany A/R | 2,577,973,181 |
|---|---|
| Total | $3,584,207,381 |
Although the federal income tax provisions permit the filing of consolidated returns, New Jersey is a separate reporting state, requiring each entity in a corporate group that has activity in this State to file a separate corporate business tax return, except in certain specified situations not present in this matter. N.J.A.C. 18:7-11.15. Where the taxpayer is a member of a group which files a consolidated income tax return for federal income tax purposes, the taxpayer must complete and file its return under the NJ CBT Act and "must reflect its entire net income . . . as if it had filed its Federal return on its own separate basis." Ibid.
Plaintiff filed its 2005 CBT reporting at Schedule A, line 28, its "unconsolidated" Federal Taxable Income, before net operating loss deductions and special deductions, as $1,301,421,024. Similarly, the amount of Federal Taxable Income reported on the pro forma U.S. Corporation Income Tax Return submitted by plaintiff as an Exhibit in this matter was $1,301,421,024. The pro forma return reflected the adjustments required by both IRC §108(b) and Temp. Treas. Reg. §1502-28T. On its CBT return, plaintiff claimed a deduction of $271,144,051 to reverse the "federal attribute reduction turn", i.e. the amount of income recognized solely as a result of the reduction of tax attributes attributable to the CODI "pushed down" to plaintiff pursuant to Temp. Treas. Reg. §1502-28T. Specifically, plaintiff contended that the $271,144,051 is the income which should have been offset by the depreciation expense lost as a result of the CODI pushed down to it.
During oral argument plaintiff contended that reporting this amount on Schedule A, line 28 was an error and that, plaintiff should have adjusted its depreciation deduction on Schedule A, line 20a (depreciation from Federal Form 4562) to include the deductions lost as a result of IRC §108(b) and pushed down CODI which would have reduced its line 28 income. Plaintiff referenced no provision of the CBT which would support such an adjustment. The Form 4562 attached to plaintiff's pro forma federal return listed depreciation of $3,098,636 which was identical to the amount reported on Schedule A, line 20a.
As far as the court can determine the phrase "federal attribute reduction turn" was coined by the plaintiff for the purposes of filing its claim in this matter.
Plaintiff certified that this amount represented the reversal of the depreciation expense attributable to the pushed down CODI. Based on the evidence presented the court is unable to conclude that the entire amount claimed by plaintiff as its federal attribute reversal turn represents solely depreciation expense, however, this lack of clarity has no effect on the final outcome of this court's ruling.
There can be no argument that Entire Net Income for NJ CBT purposes is inextricably linked to federal taxable income. "The court is not permitted to ignore the unequivocal provisions of N.J.S.A. 54:10A-4(k) linking entire net income to federal taxable income with limited, express exceptions, [ ] or the established legal precedents recognizing that the Legislature coupled entire net income under the CBT to federal taxable income.[ ]" (Internal Citations omitted.) International Business Machines Corp. v. Director, Div. of Taxation, 26 N.J. Tax 102, 112 (Tax 2011). "If the statute is clear and unambiguous on its face and admits to only one interpretation, [courts should] delve no deeper than the act's literal terms to divine the Legislature's intent." (Alteration in the original) (Internal quotation marks and citations omitted.) Koch v. Director, Div. of Taxation, supra, 157 N.J. at 7. See also, Cohen v. Director, Div. of Taxation, ___ N.J. Tax ___ (App. Div. 2015) (slip op.) (where language of statute was clear as to definition of Accumulated Adjustment Account, no basis to deviate from statutory definition).
There is no question that there is no authorization for plaintiff's deduction of the "federal attribute reduction turn" in the CBT. Based solely on the plain language of the statute, plaintiff's argument would fail. However, plaintiff asserts that, but for the filing of a consolidated return with the other members of the MCI Group, plaintiff would not have been required to reduce its tax attributes by the amount of the CODI pushed down to it from upper tier members and its income would not have been increased by $271,144,051. Thus, plaintiff maintains, if it reflects its Entire Net Income "as if it had filed its Federal return on its own separate basis" as required by N.J.A.C. 18:7-11.15, the adjustments to basis for CODI of upper tier members would not have been made and its income would not have been increased as a result of those adjustments. Therefore plaintiff argues, plaintiff should calculate its Entire Net Income for CBT purposes as if the CODI of the upper tier members had not been attributed to it and the "federal attribute reduction turn" deduction reflects this calculation.
Plaintiff's argument is similar to that made in General Bldg. Products Corp. v. State, Div. of Taxation, 14 N.J. Tax 232 (Tax 1994), aff'd 15 N.J. Tax 213 (App. Div. 1995) where the question related to an election under IRC §338(h)(10) to treat the sale of the stock of a subsidiary corporation as a sale of the subsidiary's assets. For federal income tax purposes, if the IRC §338(h)(10) election was made, the parent corporation/seller recognized no gain or loss on the sale of the subsidiary's stock; the subsidiary was treated as having sold its assets to itself and was required to recognize gain or loss based on the difference between the purchase price paid to the parent for its stock and its adjusted basis in its assets; and the purchaser acquired the subsidiary and its assets with a stepped up basis for depreciation going forward equal to the amount of the purchase price. The issue before the court was whether the "deemed sale" of the subsidiary's assets to itself was a taxable event for the purposes of NJ CBT.
The plaintiff in General Building argued that the election was only available under federal law if the taxpayers were members of an affiliated group which filed consolidated returns and that since New Jersey did not permit consolidated returns, the effect of the federal statute could not be recognized in New Jersey. Id. at 245. In rejecting the plaintiff's argument, Judge Rimm stated:
New Jersey's prohibition against consolidated returns does not immunize [the New Jersey subsidiary] from state taxation of any gain realized as a result of the deemed sale of its assets. It merely requires that the tax consequences be independently reported . . .
The parties made the §338(h)(10) election and are bound to accept the consequences which flow from it under the Act. General Trading v. Director, Div. of Taxation, [ 83 N.J. 122 (1980)]; Rinier v. State of New Jersey, 273 N.J. Super. 135, (App. Div. 1994) (If an election is made to file a joint federal income tax return, a joint state income tax return must be filed under the New Jersey Gross Income Tax Act, N.J.S.A. 54A:1-1 to 10-12). In this case, because of New Jersey's prohibition of consolidated returns, one consequence of plaintiff's and U.S. Home's decision to make a §338(h)(10) election is that [the New Jersey subsidiary] must independently report the gain from the deemed sale. Any other result would deprive the State of New Jersey of taxes to which it is legitimately entitled.
[Id. at 248-249.]
As the Director notes, plaintiff consented to file federal income tax returns on a consolidated basis with the MCI Group. Thus, the director argues, they must accept the tax consequences of those business decisions, including the federal tax consequences of the reduction of the tax attributes caused by the upper tier members' CODI allocated to plaintiff. See General Trading Co., Inc. v. Director, Division of Taxation, 83 N.J. 122 (1980).
The court finds no appreciable difference between the matter before it and that before the court in General Building Products. As a member of the MCI group filing a consolidated return for federal income tax purposes, plaintiff consented to the filing of the consolidated return. See, 26 U.S.C.A. §1501. As a result, it was required to take into account the excess CODI from upper tier members of the group which increased its federal taxable income. Plaintiff must accept this consequence of its consent to file a consolidated return with the MCI Group. Ibid.
Plaintiff's argument that there are no provisions in the CBT or the regulations thereunder requiring it to reduce tax attributes in connection with CODI - pushed down or otherwise - is unavailing. It is precisely the absence of any provision in the CBT to reverse the IRC §108(b) adjustments in determining taxable income that requires they be taken into account in determining Entire Net Income under the NJ CBT. International Business Machine Corp. v. Director, supra 26 N.J. Tax 102. The court finds that under the CBT the definition of Entire Net Income as set forth in N.J.S.A. 54:10A-4(k) includes the effect of the reduction in tax attributes required to be made by plaintiff as a result of IRC §§108 and 1502.
The court also notes that Federal Income Tax Regulation §1.1502-12 provides that "[t]he separate taxable income of a corporation which files a consolidated return is computed in accordance with the provisions of the Code covering the determination of taxable income of separate corporations, subject to the following modifications." Treas. Reg. §1.1502-12. None of the cited modifications appear to exclude the basis adjustments required by IRC §108(b) and the IRC §1502 regulations. Accordingly, it appears that under federal law plaintiff would be required to calculate its separate taxable income with reference to the reductions in tax attributes associated with the CODI pushed down to it from its upper tier members and that plaintiff's separate Federal Taxable Income under federal law, and therefore its Entire Net Income under the NJ CBT Act, would include the IRC §108(b) reductions.
3. The Plaintiff's "Phantom Income" Argument
Plaintiff further argues that the disallowance of the deduction for Federal Attribute Reduction Turn "creates and taxes phantom income" which plaintiff asserts the court rejected in Toyota Motor Credit Corporation v. Director, Division of Taxation, 28 N.J. Tax 96 (Tax 2014). However, Toyota is distinctly different from the case at bar. In Toyota, the court held that despite the lack of an express statutory provision in the CBT authorizing a departure from the method of calculating depreciation, it was constrained by significant appellate precedents to apply the reasoning of Koch v. Director, supra 157 N.J. 1 and Moroney v. Director, Div. of Taxation, 376 N.J. Super 1 (App. Div. 2005) to a substantially similar NJ CBT Act matter. Toyota Motor Credit Corporation v. Director, supra, 28 N.J. Tax at 114.
In Koch, the taxpayer's federal adjusted basis in a partnership interest sold by him reflected losses which the taxpayer had previously utilized to offset individual federal taxable income. The taxpayer was unable to utilize some of those federally recognized losses to offset income taxable for New Jersey Gross Income Tax ("NJGIT") purposes. When the taxpayer sold his partnership interest he recalculated his adjusted basis for NJGIT purposes by adding back losses for which he had obtained no NJ tax benefit. Our Supreme Court ruled that for purposes of the NJGIT where a taxpayer's federal adjusted basis reflected losses allowed under federal income tax law which were not allowed under the NJGIT, the taxpayer was entitled to determine gain by increasing basis by the amount of the losses the taxpayer was unable to utilize under the NJGIT. The Court's reasoning was based on its interpretation of N.J.S.A. 54A:5-1(c), defining net gains for NJGIT purposes, and the concept that a taxpayer may not be taxed on the return of capital. The Supreme Court found that with respect to income under N.J.S.A. 54A:5-1(c), "the Legislature intended to tax only income and not a return of capital." Id. at 8 (citing Walsh v. State, Dept. of Treasure, Div. of Taxation, 10 N.J. Tax 447, 460 (1989).
In Moroney v. Director, supra, 376 N.J. Super. 1, the Appellate Division applied the holding in Koch to a NJGIT case involving depreciation adjustments to basis for federal income tax purposes for which the taxpayers obtained no NJGIT benefit. In that matter, the court held that in calculating gain on the sale of depreciable assets under the NJGIT, a taxpayer could increase basis by the amount of depreciation for which the taxpayer received no benefit under the NJGIT. In doing so, the court noted, "[b]ecause N.J.S.A. 54A:5-1(c) imposes a tax on net gain from the sale or disposition of property, this section of the [NJGIT] Act reflects an intent on the part of the Legislature to 'tax only those transactions from which an individual derives an economic gain." Id. at 6-7.
Similarly, in Toyota Motor Credit Corp. v. Director, supra, 26 N.J. Tax 96, the court permitted the taxpayer corporation to increase its basis by the amount of the so-called "bonus depreciation" allowed under federal law which was not permitted under the NJ CBT and for which the plaintiff had received no benefit, when calculating gain on sale. Thus, the Tax Court extended the application of Koch and Moroney, NJGIT cases, to sales of assets taxable under the CBT. In reaching the conclusion that Moroney and Koch were equally applicable to similar situations under the CBT, the court in Toyota specifically noted that:
[A] departure from federal basis was permitted in Moroney because the GIT Act "expresses an intent to tax only those transactions from which a [taxpayer] derives an economic gain." The CBT Act also expresses the intent to tax only the gain a taxpayer realized from the sale of property.
[Toyota Motor Credit Corporation v Director, supra, 28 N.J. Tax at 121 (Alteration in the original) (Internal citations omitted).]
Contrary to the plaintiff's argument, Toyota did not extend Koch to all circumstances involving federal depreciation deductions. The court in Toyota expressly noted that appellate courts had interpreted the NJGIT to "establish a broad principle that State tax policy prohibits the assessment of a tax on 'phantom income' resulting from depreciation deductions used by the taxpayer for federal purposes but which resulted in no New Jersey tax benefit." (Emphasis provided). Id. at 115-116. The court then extended the NJGIT treatment to a CBT matter noting the "strikingly similar" facts between the case before it and the facts in Moroney, Id. at 119.
In both Koch and Moroney, the courts were concerned with the gain on the sale of assets and the potential taxation of a return of capital. Those courts found that such a result was contrary to the intent of the Legislature which intended to only tax economic gain on the sale of assets. Koch, supra, 157 N.J. at 9; Moroney, supra, 376 N.J. Super. at 11. The lack of a sale or exchange in the matter before this court, distinguishes this case from that of Koch, Moroney and Toyota. See Waksal v. Director, Div. of Taxation, 215 N.J. 224, 238 (2013) (Absence of a sale, exchange or other disposition of property distinguishes deduction for non-business bad debt from Koch); Cohen v. Director, Div. of Taxation, supra, ___ N.J. Tax ___ (App. Div. 2015) (Koch does not support argument that losses may not reduce taxpayer's accumulated adjustment account in S Corporation below zero).
Furthermore, unlike the taxpayers in Moroney and Toyota, New Jersey has not denied plaintiff any deduction for depreciation allowable under federal law. To the contrary, New Jersey is according plaintiff the very same treatment as under federal law. The same depreciation permitted or denied under federal law and used to determine federal taxable income is being recognized in the calculation of Entire Net Income under the CBT. In actuality, IRC §108(b) does not require an adjustment to depreciation at all. Instead, it requires that a taxpayer reduce its tax attributes, only one of which is basis in depreciable assets. That the adjustment to basis required by federal tax law may affect depreciation otherwise allowable under the Internal Revenue Code is not at all similar to the circumstances before the courts in Koch, Moroney and Toyota. In those cases, there was an inequality of treatment between federal and New Jersey law, while in the matter before now before the court the same benefit (or lack thereof) accorded to plaintiff under federal law is identical to that being accorded plaintiff under New Jersey law.
The court rejects plaintiff's attempt to extend Toyota to all cases involving so-called "phantom income" simply because depreciation is a factor in the determination of Entire Net Income. Such an extension is neither warranted nor supported by the Toyota decision or its predecessors.
4. The Lack of a NJ Requirement to Reduce Tax Attributes
Finally plaintiff argues that there are no provisions in the CBT or the regulations promulgated thereunder requiring the reduction of tax attributes in connection with the discharge of indebtedness and, therefore, plaintiff should be permitted to adjust the IRC §108(b) tax attribute reductions occasioned by the allocation of upper tier members' CODI. The plaintiff maintains that the Director's position as stated in the Winter 1996 New Jersey State Tax News is controlling. In that publication, the Director stated:
The Division received an inquiry regarding the forgiveness of corporation debt of a corporation that is an S corporation for Federal purposes and a regular corporation of New Jersey purposes. Since the Company was insolvent at the time of the discharge, the amount of debt which would have been included in income was excluded for Federal purposes (IRC Section 108). Federal law also requires a reduction in certain tax attributes, in this case specifically the net operating loss. IRC section 108(b)(2)(A).
It is the position of the Division that income from cancellation of debt is excludable from New Jersey [CBT] to the same extent that it is excludable for Federal purposes.
The New Jersey net operating loss deduction is calculated independently of the Federal tax attributes. (N.J.S.A. 54:10A-4(k)(6)), and at the present time there is no provision to reduce tax attributes connected with discharge of indebtedness. Thus, New Jersey would not require the corporation to reduce New Jersey net operating loss with respect to discharge of indebtedness for corporation business tax purposes.
[New Jersey State Tax News, Corporation Business Tax - Forgiveness of Debt, Winter 1996, pg. 15. (Emphasis supplied)]
The reductions at issue in this matter relate to the tax basis of certain assets and not net operating losses (NOLs) as addressed in the referenced article. The distinction between the two tax attributes (basis v. NOL) is important. Entire net income, for purposes of the NJ CBT is defined as federal "taxable income, before net operating loss deduction". N.J.S.A. 54:10A-4(k) (Emphasis supplied). Thus, NOLs are, excluded from the determination of a taxpayer's Entire Net Income, whereas the tax effect of the reductions in basis required by IRC §108(b) are taken into account. The Director's clarification that New Jersey does not require any IRC §108(b) reduction in the tax attribute of NOL has no bearing on the effect of the federal requirement that taxable income be calculated with reference to all reductions in tax attributes required by IRC §108(b) .
For tax years after June 30, 2014, the CBT was amended to require a reduction in a taxpayer's NJ net operating losses by the amount of the CODI excluded under IRC §108(a). See N.J.S.A. 54:10A-4(k)(6)(F). --------
This is buttressed by the fact that there is no express provision in the CBT for the exclusion of cancelation of indebtedness income in a Title 11 bankruptcy case. Yet, since the calculation of Entire Net Income begins with the Federal Taxable Income of a taxpayer, the CODI otherwise taxable under IRC §61(a)(12) is excluded from Federal Taxable Income under IRC §108(a) and thus from CBT Entire Net Income. It follows that the adjustment to tax attributes under IRC §108(b) and their effect on Federal Taxable Income should also be taken into account, regardless of whether it is pushed down from an upper tier member, or is occasioned by the taxpayer's own CODI.
Finally, the court notes that at no time did plaintiff argue that the adjustment to basis required by IRC §108(b) as a result of the CODI attributable to plaintiff's own debt should be reversed. Clearly the Internal Revenue Code requires that plaintiff calculate its Federal Taxable Income by excluding the CODI directly attributable to plaintiff. Just as clearly, plaintiff's Federal Taxable Income must be calculated by taking into account the reduction in tax attributes associated with that CODI. If one follows plaintiff's argument to its logical conclusion, the Director's article in the State Tax News would be equally applicable to the reduction in tax attributes occasioned as a result of plaintiff's own CODI. Yet even plaintiff does not advance this argument.
The court is not persuaded that the Director's advice expressly addressing the treatment of NOLs under the CBT should be interpreted as applying to any other tax attribute affected by IRC §108(b).
II. Conclusion
For the foregoing reasons, the court finds that the final determination of the Director denying plaintiff's deduction for federal attribute reduction turn is correct and therefore affirmed. Plaintiff's motion for summary judgment is denied and the cross-motion of the Director is granted. Plaintiff's complaint is dismissed. Very truly yours, /s/
Kathi F. Fiamingo, J.T.C.