News and Insights

New Jersey Tax Court Upholds Throwout Rule for Sales Apportionment Factor

Tax Development Jul 01, 2008

On May 29, 2008, New Jersey Tax Court Judge Harold Kuskin issued an opinion in the case of Pfizer et al. v. Director, (Tax Ct., 2008), denying the plaintiffs’ motion for summary judgment on the issue of whether New Jersey’s “Throwout Rule” is facially unconstitutional. The Court also granted New Jersey’s motion for partial summary judgment on the issue.

The Throwout Rule requires Corporation Business Tax return filers, when calculating their sales apportionment factor, to exclude from the denominator any sales sourced to a state where the taxpayer is not subject to any corporate income tax, irrespective of whether the taxpayer is protected under Public Law 86-272 or where the other state has no corporate income tax.

Three additional plaintiffs—General Engines, Federated Brands, and Whirlpool Properties—joined Pfizer in the motion solely for purposes of challenging the facial constitutionality. Arguments were heard before Judge Kuskin on March 28, 2008.

The plaintiffs argued that the Throwout Rule is facially unconstitutional because it results in New Jersey’s being able to tax income under circumstances where the taxpayer’s New Jersey activities were not involved in the generation of the income, providing examples of instances where a sale could have originated outside of New Jersey and delivered to a state where the taxpayer was not taxed. The plaintiffs also argued that the Throwout Rule violated the Supremacy Clause of the U.S. Constitution because application of the rule resulted in the taxation of income not taxable under Public Law 86-272.

The Director countered that, in a broad sense, the value received by the plaintiffs by the State of New Jersey was sufficient to satisfy the Due Process and Commerce Clauses relating to fair apportionment and fair relationship to services provided by the state. Relying on prior U.S. Supreme Court case law, the Director contended that states are free to pursue their own fiscal policies as they see fit so long as they fairly relate to benefits and protections provided, and reducing the denominator in the sales apportionment factor does not increase a corporation’s tax burden to the extent it is rationally related to the values connected with New Jersey. The Director also argued that the Throwout Rule was not subject to a Supremacy Clause challenge because the rule, itself, was not an imposition of tax but merely a part of the calculation of the corporation’s taxable income in New Jersey.

The Tax Court held that the standard for determining whether a taxing provision was facially discriminatory requires a showing that the taxing statute, in no instance, had ever operated constitutionally. The Tax Court then determined that the Throwout Rule is not unconstitutional because it could, in certain circumstances, operate in a constitutional manner, such as in instances where sales excluded from the sales fraction had no material effect on the sales fraction because sales in the non-taxing state(s) were insignificant in relation to the corporation’s total sales or when the property and payroll factors tempered the impact of the sales factor.

The Court also held that Supremacy Clause challenges to the Throwout Rule would fail for two reasons. First, Public Law 86-272 does immunize from taxation all income resulting from sales into another state. Second, the Throwout Rule, itself, is not actually a tax, affecting only the denominator used in the calculation of the New Jersey receipts factor.

Because the case dealt with a motion for summary judgment on the single issue of facial unconstitutionality, the Tax Court specifically noted that it was not ruling on other issues raised by Pfizer that the Throwout Rule is unconstitutional as applied to it or to the contentions of the other plaintiffs.