The New Jersey Division of Taxation (Division) quietly issued special regulations addressing the inclusion and apportionment of global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII) for purposes of the Corporation Business Tax (CBT).

Taking advantage of special authority granted by the New Jersey Legislature in conjunction with 2018 amendments to the CBT,¹ the Division issued the regulations without complying with the notice and comment requirements of New Jersey’s Administrative Procedure Act (APA).² The regulations are effective beginning April 8, 2020 and expire on October 5, 2020, by which time it is expected that the Division will promulgate replacement regulations consistent with the APA’s procedures.

For the most part, the regulations track the Division’s recent guidance posted on its website on the treatment of GILTI and FDII. The regulations also provide new guidance on the circumstances when a taxpayer may have to include net GILTI or FDII amounts in the numerator of the New Jersey allocation factor.

GILTI and FDII under Federal Tax Law

GILTI is a new category of income subject to tax under 2017’s Tax Cuts and Jobs Act (TCJA).³ GILTI is an approximation of a US shareholder’s allocable share of amounts earned by controlled foreign corporations (CFCs) outside the US in excess of a 10% return on the US shareholder’s aggregate share of the CFCs’ depreciable tangible property.

GILTI is subject to tax at regular US tax rates, but a federal tax deduction is allowed for up to 50% of the amount of GILTI included in a US shareholder’s federal gross income under IRC § 250(a)(1)(B).

Income classified as FDII, on the other hand, was subject to taxation prior to the TCJA. FDII represents the category of income earned in the US that is attributable to property sold or licensed to a non-US person for foreign use or to services provided outside the US. The TCJA merely defined FDII as that specific category of income for purposes of providing taxpayers a deduction. That deduction, in IRC § 250(a)(1)(A), permits domestic corporations to deduct 37.5% of their FDII from taxable income.

Initial New Jersey Guidance on the TCJA

For New Jersey CBT purposes a corporate taxpayer must include the amount of GILTI calculated under IRC § 951A in its taxable income base, but also may take the deductions related to both GILTI and FDII under IRC § 250(a).⁴

In response to the TCJA, the Division published, repealed, and revised several technical bulletins addressing GILTI and FDII.⁵ Initially, the Division was widely criticized for taking the position that taxpayers with GILTI and FDII must separately allocate this income using a special accounting method based on the ratio of New Jersey’s gross domestic product (GDP) over the total GDP of every US state in which the taxpayer has economic nexus.⁶

The Division quickly responded to criticism of the special GDP allocation method and revised its guidance to require that taxpayers include the net GILTI and FDII in the denominator of the allocation factor. However, the Division did not give up on the notion that some GILTI and FDII may be included in the numerator of the New Jersey allocation factor, stating, “the net amount of GILTI and the net FDII income amounts are included in the numerator (if applicable).”⁷

The Division’s suggestion that GILTI must be included in the numerator made New Jersey an outlier among the states and sparked immediate questions from taxpayers. Backtracking again, the Division issued the following statement in a revised technical bulletin:

Barring an unusual set of facts and circumstances, the net GILTI will be included in the denominator only, for most taxpayers. Outside of hypothetical scenarios, the Division is not aware of any real-life situations that would require the net GILTI related amounts to be included in the numerator of the allocation factor. If a situation arises in which the net GILTI is included in the numerator based on the taxpayer’s unique facts and circumstances, the taxpayer is not precluded from requesting discretionary relief under NJAC 18:7-8.3 and NJAC 18:7-10.1.⁸

Thus, as recently as October of 2019, the Division indicated that it was unaware of “real-life situations” that would require the inclusion of GILTI in the numerator.⁹ The new regulations, however, revive the notion that such situations may exist based on the application of New Jersey’s existing statutory and regulatory sourcing provisions, stating:

The net GILTI (that is, the GILTI reduced by the I.R.C. § 250(a) GILTI deduction) and net FDII (that is, the receipts attributable to the FDII reduced by the I.R.C. § 250(a) FDII deduction) are only included in the numerator of the allocation factor if, based on NJSA 54:10A-6 and 54:10A-6.1 and NJAC 18:7-8.1 through 8.17, such amounts would be considered to be a New Jersey receipt; otherwise net GILTI (that is, the GILTI reduced by the I.R.C. § 250(a) GILTI deduction) and net FDII (that is, the receipts attributable to the FDII reduced by the I.R.C. § 250(a) FDII deduction) are only included in the denominator of the allocation factor.¹⁰

The regulations go one step further and suggest, through examples, that the Division has thought of at least two “real-life situations” that would require the net GILTI amounts, as well as FDII, to be included in the numerator of the allocation factor.

Regulatory Examples Contemplate New Jersey Sourced Receipts from GILTI and FDII

In what is sure to inspire controversy, the Division has promulgated two examples of how a taxpayer with GILTI and FDII must source these amounts to the numerator of the New Jersey allocation factor: one example applicable to separate return taxpayers and one example applicable to taxpayers complying with New Jersey’s new combined reporting regime that generally went into effect for the 2019 tax year.¹¹

Separate Return Example

The separate return example describes a situation where the taxpayer (B) exports goods to customers in foreign nations.¹² Some of B’s export contracts stipulate that the foreign customer will take possession of the goods in B’s New Jersey warehouse before the goods are exported. Separately B earns GILTI from two CFCs and also earns FDII. The example provides that the CFCs are “integrated in B’s worldwide business,” but there is no stated connection between B’s sales involving the New Jersey warehouse and the CFCs’ activities. One CFC (Shell) derives receipts from US sources, including New Jersey sources, although it does not have income effectively connected to a business in the US within the meaning of the IRC.

The example first concludes that “[t]he portion of the net GILTI (that is, the GILTI reduced by the IRC § 250(a) GILTI deduction) attributable to New Jersey from receipts derived from non-effectively connected US source income would be included in B’s numerator.” The example also concludes that “[t]he portion of the net FDII (that is, the receipts attributable to the FDII reduced by the IRC § 250(a) FDII deduction) attributable to New Jersey receipts would be in B’s numerator.”¹³

The reference to “non-effectively connected U.S. source income” with respect to sourcing GILTI in the numerator suggests that a portion of the GILTI derived from Shell must be included in B’s numerator because Shell is the entity described as having New Jersey source income but no effectively connected income.

If that is the Division’s position (and it is not clear that it is), then the Division could have stated explicitly in the conclusion that a portion of the GILTI derived from Shell must be included in B’s numerator and the Division could have also explained how that portion would be calculated.

The example’s inclusion of B’s FDII in the New Jersey numerator is equally confusing. As FDII does not represent a new category of income or receipt, there is no need to provide separate, unique treatment of FDII in New Jersey’s allocation factor.

Finally, the example leaves the reader guessing as to the significance of B’s use of the New Jersey warehouse for exports. Under New Jersey’s destination sourcing rules for sales of tangible personal property, the sale of goods shipped to a non-New Jersey customer where possession is transferred in New Jersey results in a receipt allocable to New Jersey.¹⁴ Therefore, presumably the numerator of B’s allocation factor should already reflect these sales of goods exported from B’s warehouse.

Combined Return Example

In a second lengthy example that is perhaps even more difficult to follow, the Division describes the allocation of GILTI and FDII for six entities filing a combined return.¹⁵ Although not explicitly stated, since at least two of the entities are CFCs, it can be presumed that the entities elected to file as a worldwide group. In that situation, the Division acknowledges that the GILTI of the domestic parent company (Q) would be excluded from the combined group’s entire net income because the income and loss of the CFCs is included in the combined group’s entire net income already by virtue of the CFCs being members. In addition, the combined group denominator would not include the GILTI that Q was required to include in income for Federal purposes.

However, for purposes of computing each entity’s numerator,¹⁶ the example explains that if a CFC’s effectively connected income did not generate GILTI (which it could not because if it was effectively connected income it would be subject to federal income tax), the CFC’s New Jersey receipts would not be net of the IRC § 250(a) GILTI deduction. On the other hand, if the CFC’s “U.S. source income generated the GILTI, and that income was from New Jersey sources,” then the CFC’s numerator should include GILTI net of the I.R.C. 250(a) GILTI deduction. The Division provides no explanation or support for how a CFC could “generate” GILTI that is US and New Jersey source income.

The combined group example also suggests an additional tie to New Jersey because two group members (X and Y) have a joint New Jersey warehouse and have “FDII attributable receipts from sales to non-U.S. customers.” According to the example, “[b]ased on the terms of the export contracts and for insurance purposes, the customers take possession at X’s and Y’s joint New Jersey warehouse before the goods are exported to the customers’ respective home countries.” Consistent with the first example, it appears that the warehouse arrangement causes X and Y to have to include net New Jersey receipts “attributable to the FDII income” in their respective numerators, even though the group’s allocation factor should already include any New Jersey receipts based on destination sales.

The examples beg the question of why is the Division working so hard to find a basis to include GILTI in the numerator of the New Jersey allocation factor when the vast majority of states have shown no appetite to create additional state tax liability by sourcing GILTI to the numerator of the apportionment factor? The examples also fail to recognize that FDII does not create a new item of income and does not require special apportionment procedures.

Additional Regulatory Guidance

The special regulations also set forth several interpretations that the Division previously expressed in technical bulletins, including: (1) the availability of the “unreasonable exception” to New Jersey’s related party interest and intangibles addback requirements when the taxpayer includes GILTI in entire net income from a related party and expenses from the same related party would otherwise be required to be added back¹⁷ and (2) the temporary special allocation formula for the tax liability on the 5% of dividends paid or deemed paid by an 80% or more owned subsidiary for tax years beginning on and after January 1, 2017, and beginning before January 1, 2019.¹⁸

In addition, the special regulations updated portions of the existing rules on related party interest and intangibles addback requirements in NJAC 18:7-5.18 to reflect guidance in TAM 2011-13R (Feb. 24, 2016) and the analysis of the Tax Court of New Jersey in Morgan Stanley & Co. Inc. v. Dir., Div. of Taxation.¹⁹

Considerations

The regulations are effective April 8, 2020, but there is no reason to believe the Division will not apply the positions in the regulations to 2018 and 2019 CBT returns.

As the Division will be required to provide a review and comment period in order to keep the regulations from expiring on October 5, 2020, taxpayers have the opportunity to provide additional feedback to help steer the Division toward better policy on the apportionment of GILTI and FDII.

The notion of GILTI representing US or New Jersey source income is inconsistent with the intent of the TCJA in taxing GILTI in the first place. GILTI is income that prior to the TCJA was not subject to federal income tax because it was not US source income. The Division’s position shows that New Jersey is still clinging to the notion that GILTI represents “displaced” US income—and, as they see it, “displaced” New Jersey income.²⁰

With respect to FDII, the regulations create more confusion than guidance. Contrary to what the Division seems to understand, FDII was subject to federal and New Jersey taxation prior to the TCJA. If FDII constitutes New Jersey receipts, irrespective of being FDII, then those amounts would already be reflected in the taxpayer’s allocation factor regardless of New Jersey’s guidance. Unfortunately, the Division’s approach in the special regulations again raises more questions than answers.

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