You asked for a description of provisions of a recently enacted New Jersey business tax reform law that could be applied to the Connecticut corporation tax.

SUMMARY

On July 2, 2002, the New Jersey legislature enacted Assembly Bill 2501, the Business Tax Reform Act (P. L. 2002, c. 40). The new law extensively revised New Jersey's corporation business tax.

Among other things, the New Jersey act:

1. establishes a graduated alternative minimum assessment tied to a company's gross receipts or gross profits;

2. suspends net operating loss (NOL) deductions for two years;

3. establishes a $ 150 annual fee for each partner in multi-partner businesses not subject to the corporation tax;

4. establishes a "throwout rule" to increase the share of a multi-state corporation's taxable income apportioned to New Jersey;

5. limits the exclusion of dividends from taxable income;

6. restricts companies' ability to deduct interest, royalty, and certain other business expenses attributable to transactions with their affiliates;

7. extends the state's corporation tax to cover any company deriving income from New Jersey, not just those doing business in state;

8. requires companies to allocate all headquarters income unrelated to its business operations to the state where it is headquartered rather than apportioning it to all states where it operates;

9. eliminates a deduction for foreign taxes paid;

10. establishes withholding requirements before certain businesses not subject to the corporation tax may distribute income from the business to out-of-state owners;

11. increases the state's minimum corporation tax and establishes higher minimums for companies with large payrolls; and

12. establishes a reduced tax rate for business with net incomes under $ 50,000.

Connecticut's corporation tax has many of the same elements as New Jersey's and any or all of the 12 provisions listed above could be applied in Connecticut, if the General Assembly chose to do so. This report explains each of the above-listed provisions along with the comparable provision of the Connecticut corporation tax. Descriptions of the New Jersey act are taken from the New Jersey Assembly Budget Committee's explanation of Assembly bill 2501.

ALTERNATIVE MINIMUM ASSESSMENT

The New Jersey act requires companies to pay an alternative minimum assessment (AMA) based on a formula that uses gross receipts or gross profits allocated to the state. Companies with gross profits under $ 1 million or gross receipts under $ 2 million are exempt from the AMA, as are S corporations, professional corporations, pass-through entities, and corporations operating as cooperatives. The maximum AMA for affiliated groups of five or more taxpayers is $ 20 million. The new AMA expires on July 1, 2006.

Connecticut has several minimums included in its corporation tax. First, a company must calculate its tax using two different tax bases (net income and capital base) and pay whichever tax is higher (CGS § 12-219). The tax rate on net income is 7. 5% and the tax on the alternative capital base is 3. 1 mills per dollar of capital holdings. In 2002, the General Assembly also enacted a law that prohibits companies from using corporation tax credits to reduce their taxes by more than 70% compared what they would have been without the credits (PA 02-1, MSS). Finally, all companies must pay at least the minimum corporation tax of $ 250 per year, which under another 2002 law cannot be reduced through use of tax credits (CGS § 12-219, as amended by PA 02-1, MSS).

NET OPERATING LOSS (NOL) DEDUCTION

Both Connecticut and New Jersey allow companies to deduct net operating losses (the excess of allowable deductions over gross income for a taxable year) and thereby reduce their tax liability. New Jersey allows most companies to carry forward an NOL for seven years (14 years for qualifying high technology companies). Connecticut allows a five-year NOL carry forward for the 1999 and earlier income years and a 20-year NOL carry forward for income years starting on or after January 1, 2000, provided the company was subject to the corporation tax in the year the NOL occurred (CGS § 12-217(a)(4)).

New Jersey's act suspends that state's NOL deductions for 2002 and 2003 and extends the state's seven- and 14-year carryforwards by two years.

PARTNERSHIP FEE

In both Connecticut and New Jersey, certain types of businesses are not subject to the corporation tax. Instead, income from these businesses, which include limited liability partnerships, limited liability companies, and S corporations, is "passed through" to their owners and partners and taxed under the state personal income tax.

New Jersey's new law establishes a $ 150 processing fee on each partner of any such "pass-through entity" that (1) receives income from New Jersey sources and (2) has more than two partners or owners. It also imposes the same fee on each licensed professional in any pass-through professional corporation that has more than two licensed professionals. The maximum fee is $ 250,000 per entity per year.

In 2002, the Connecticut legislature established a new tax on S corporations, limited partnerships, limited liability partnerships, and limited liability companies that are required to file their annual reports with the secretary of the state. The Connecticut tax is $ 250 per entity per year (PA 02-1, MSS).

THROWOUT RULE

Both Connecticut and New Jersey require multi-state corporations to apportion income to determine what percentage of the total is taxable in each state. Both states also use apportionment formulas that give the greatest weight to sales, requiring companies to allocate their income in whole or in part based on the ratio of their sales in Connecticut or New Jersey to their total nationwide sales. But many such companies make sales either to purchasers in states where they have no taxable nexus or to the U. S. government. These sales are called "nowhere sales" because they are not taxed by any state.

States can capture revenue from nowhere sales by establishing "throwout" or "throwback" rules. A "throwout rule" removes nowhere sales from the company's total sales. A "throwback rule" requires the company to add nowhere sales to its in-state sales. Either way, such rules increase the relative weight of in-state sales and thus the taxable income apportioned to the taxing state.

New Jersey's new law establishes a throwout rule for multi-state corporations operating in New Jersey. But it caps the additional tax liability attributable to the throwout at $ 5 million for any corporate group. It also allows each group to spread the additional liability proportionately among its affiliates.

Connecticut currently has no throwout or throwback rule (CGS §§ 12-218, 218a, 218b).

DIVIDEND EXCLUSION

New Jersey previously allowed corporations to exclude from taxable income 100% of any dividends received from companies in which they have at least an 80% ownership interest and 50% of all other dividends. The new act eliminates the exclusion for dividends from companies in which the corporation receiving the dividends has less than a 50% ownership.

Connecticut's dividend exclusion is more generous than either the current or former New Jersey one. Connecticut allows corporations to exclude 100% of dividends from companies in which they have at least a 20% ownership interest and 70% of dividends from any other company (CGS § 217(a)(1)(D)).

ROYALTIES AND INTEREST

Because certain expenses and payments among affiliated and related companies are deductible under state corporation tax laws, multi-state companies may structure certain transactions to import or export income between lower and higher tax states to minimize their overall tax liability. These transactions often involve payments of royalties, interest, or dividends among affiliated or related companies.

New Jersey's new act limits deductions for royalties and other so-called "intangible" expenses and costs paid between affiliated or related companies by establishing a general rule that disallows deductions for such expenses between related parties. The act allows the state tax director to allow deductions, either by regulation or on a case-by-case basis, (1) when a company can show that the transaction is not designed simply to avoid taxes, (2) if the interest or expense is directly or indirectly accrued or paid to a related company located in a foreign country covered by a comprehensive U. S. income tax treaty, or (3) if the taxpayer can show the arrangement involves an unrelated third party. New Jersey's law also disallows deductions for inter-affiliate interest payments unless the taxpayer can show (1) the principal purpose of the transaction is not tax avoidance, (2) the transaction is an arm's length one, (3) the transaction was already subject to taxes approximating New Jersey's, or (4) that the disallowance is unreasonable.

Connecticut also restricts deductions for royalty, intangible expense, and interest expense payments between affiliated companies. Connecticut law requires companies to add back such expenses in computing net taxable income unless (1) the company establishes by clear and convincing evidence, that the add-backs are unreasonable, (2) the company and the Department of Revenue Services (DRS) commissioner agree to an alternate form of apportionment: or (3) the company, establishes by a preponderance of evidence that (a) the affiliate paid the expenses to an unrelated third party in the same income year and (b) the transaction's principal purpose was not to avoid Connecticut taxes (CGS § 12-218c).

Connecticut law also authorizes the DRS commissioner to disallow a deduction or expense if he determines it had no valid business purpose (CGS § 12-226a). But the effect of this law was limited by a Connecticut Supreme Court ruling involving the Carpenter Technology Corporation which set up a Delaware subsidiary; capitalized it with $ 300,005,000; and, a few days later, borrowed all but $ 5,000 back. The company deducted the interest on the loan, saving $ 196,102 in Connecticut

corporation taxes for 1990 and 1991. When the DRS commissioner tried to adjust Carpenter's taxes on the grounds that the transaction was a sham one undertaken to avoid taxes, the court overruled his action.

In 2002, the General Assembly nullified the Supreme Court's Carpenter decision by expressly barring companies from using methods like Carpenter's to reduce or avoid state corporation taxes. But the state has not gone so far as to presumptively disallow interest or similar payments among corporate affiliates (PA 02-1, MSS).

EXTENDING THE CORPORATION TAX'S REACH

The New Jersey act extends that state's corporation tax to any corporation that derives income from New Jersey sources. The tax formerly applied only to corporations doing business, employing or owning capital property, or maintaining an office in New Jersey.

Connecticut's corporation tax law is similar to New Jersey's former statute. It covers any corporation that engages in one or more of the following activities in the state:

_ Owning or leasing (as lessee) real property

_ Maintaining an office or compensating an employee for using his home as an office

_ Selling tangible personal property

_ Performing or soliciting orders for services

_ Selling or soliciting orders for real property

_ Maintaining inventory in a public warehouse

_ Having an employee, wherever based, perform certain activities in the state, such as managerial, research, or customer service activities

_ Delivering merchandise inventory on consignment to its distributors and dealers

_ Owning or leasing (as lessee) personal property unrelated to soliciting orders

_ Participating in approval of distributors and dealers where customers or users can have its products repaired or serviced

_ Acting as an electric supplier or entity or maintaining or establishing a market to sell electricity to customers in the state

_ Acting as a general partner of a partnership (excluding certain investment partnerships) that does business in the state (CGS §§ 12-214, 216; Regs. Of Ct. State Agencies, 12-214-1)

NONOPERATIONAL INCOME ALLOCATION

The New Jersey act requires companies to apportion 100% of "nonoperational income," such as headquarters-managed investment income unrelated to the company's normal business operations, to the state where the company's headquarters are located, rather than apportioning it among all states where the company operates. For companies headquartered in New Jersey, this provision increases the taxable income apportioned to the state.

Connecticut currently requires corporations to apportion all their business and nonbusiness income according to the applicable apportionment formula, regardless of where the company is headquartered (CGS § 12-218).

FOREIGN TAX DEDUCTION

The New Jersey act eliminates a deduction for taxes paid to foreign nations.

Connecticut's foreign tax deduction excludes only foreign taxes that the company could not deduct on its federal return because it took a federal foreign tax credit (Skaarup Shipping Corp. v. Commissioner of Revenue Services, 199 Conn. 346 (1986)).

"WITHHOLDING" FOR PASS-THROUGH ENTITY OWNERS

To help enforce requirements that nonresident pass-through entity owners report income from New Jersey entities on their personal income tax returns, the New Jersey act requires such entities, other than those listed on a national exchange, to pay the state a percentage of the income to be allocated to each nonresident owner before distributing it. The withholding payment is 9% of income for corporate owners and 6. 37% for individual owners.

Connecticut requires owners of pass-through entities to report their business income on their personal income tax returns but has no similar withholding provision (CGS § 12-701).

INCREASED MINIMUM TAX

The New Jersey act increased the state's minimum corporation tax from $ 210 to $ 500 per year for most corporations and to $ 2,000 per year for corporations that are members of affiliated or controlled groups with total payrolls of $ 5 million or more.

Connecticut's minimum tax is $ 250 per year for all corporations, including each corporation included in a combined return (CGS § 12-219).

LOWER TAX RATE FOR SMALL BUSINESSES

The New Jersey act reduced the state's corporation tax rate from 7. 5% to 6. 5% for businesses with net taxable incomes under $ 50,000.

Connecticut's net income tax rate is 7. 5% for all corporations (CGS § 12-214(a)).

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