New Jersey Tax Court Rejects State’s Attempt to Add Back Foreign Source Income

The Tax Court determined that the Department of Revenue had overstepped its bounds when using a regulation to justify the inclusion of worldwide income in a taxpayer’s entire net income.

By Alissa Graffius, SALT senior associate

Recently, the New Jersey Tax Court issued an opinion ruling that New Jersey cannot impose corporate business tax (CBT) on a non-U.S. company’s foreign-source income if that income is not included as taxable income for federal income tax purposes. [1]

Infosys Limited of India, Inc. (“Infosys”) was headquartered and incorporated in India but had branch operations in New Jersey. For its fiscal years ending in 2008-2011, Infosys filed its Form 1120-F with the IRS and reported federal taxable income (FTI) on line 29. The FTI it reported was calculated in accordance with a pre-filing agreement with the IRS and pursuant to the U.S.-India tax treaty. For the same period, Infosys filed a New Jersey CBT return.

During an IRS audit, Infosys realized that on the CBT return it mistakenly reported worldwide income instead of FTI from line 29 of Form 1120-F (which is only its U.S.-source income). Thus, Infosys amended its CBT returns, resulting in a $5.8 million overpayment. Infosys filed for a refund, and New Jersey denied the refund, claiming that worldwide income is the correct tax base. Infosys then lost its administrative appeal, resulting in this appeal to the New Jersey Tax Court.

For CBT purposes, the starting point for the tax calculation is referred to as entire net income (ENI). ENI is defined as “total net income from all sources, whether within or without the United States” which “shall be deemed…to be equal in amount to the taxable income, before net operating loss deduction and special deductions, which the taxpayer is required to report…to the United States Treasury Department for purposes of computing its federal income tax…” [2] However, there is a regulation (not a statute) that requires a taxpayer to add to federal taxable income “all income from sources outside the United States which has not been included in computing Federal taxable income.” [3]

Based on the statute and a prior Tax Court ruling, the Tax Court concluded that the state could not require Infosys to include its worldwide income for CBT purposes. [4] The Tax Court stated that the plain language of the statute limited ENI to FTI. It emphasized that the New Jersey legislature could have amended the statute to include language that would allow for New Jersey to include worldwide income in its ENI, and that the lack of such an amendment provides further support to the legislature’s intent to match ENI with FTI.

The state argued that the regulation required Infosys to add back its worldwide income to FTI for purposes of computing its ENI. However, the Tax Court ruled that the regulation exceeded the authority of the statute. Since the statute limited ENI to FTI subject to certain modifications, none of which added back worldwide income, the state’s regulation may not create such a rule, and is therefore invalid to that extent. In other words, the state’s executive branch (i.e., the Division of Taxation) is permitted only to enforce the laws as written by the legislature and to not create legislation through regulation.

This case is significant for a couple of reasons. First, any taxpayer that had previously included worldwide income for CBT purposes may be entitled to a refund. Second, when attempting to understand a state’s tax rules, regulations can be very helpful in clarifying and interpreting unclear statutes. However, when a Department of Revenue (DOR) regulation sets forth an obligation or requirement that is not provided for in the statute, the DOR may have exceeded its authority, and the regulation may be invalid. Therefore, taxpayers should not blindly follow a state’s regulation.

We constantly monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Alissa Graffius at alissa.graffius@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the January 2018 SALT Newsletter.

[1] Infosys Limited of Indian Inc. v. Director, Division of Taxation, Tax Court of New Jersey Docket No. 012060-2016 (Nov. 28, 2017).

[2] N.J. Rev. Stat. § 54:10A-4(k).

[3] N.J. Admin Code 18:7-5.2(a)(1)(xi).

[4] International Business Machines Corp. v. Director, Division of Taxation, 26 N.J. Tax 102 (Tax 2011).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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