N.J. Admin. Code § 18:7-5.18

Current through Register Vol. 56, No. 11, June 3, 2024

Section 18:7-5.18 - Related party transactions

(a) Interest paid, accrued, or incurred to a related member shall not be deducted in calculating entire net income, except that a deduction may be permitted:

1. To the extent that the taxpayer establishes that:

i. A principal purpose of the transaction giving rise to the payment of the interest was not to avoid tax otherwise due;

ii. The interest is paid pursuant to arm's length contracts at an arm's length rate of interest; and

iii. The related member was subject to a tax on its net income or receipts in this State or another state or possession of the United States or in a foreign nation, a measure of the tax includes the interest received from the related member, and the rate of tax applied to the interest received by the related member is equal to or greater than a rate three percentage points less than the rate of tax applied to taxable interest by this State;

2. If the taxpayer establishes, to the satisfaction of the Director of the Division of Taxation, that the disallowance of a deduction is unreasonable by clear and convincing evidence, and any one of the following circumstances applies:

i. Unfair duplicate taxation;

ii. A technical failure to qualify the transactions under the statutory exceptions;

iii. An inability or impediment to meet the requirements due to legal or financial constraints;

iv. An unconstitutional result; or

v. The transaction is equivalent to an unrelated loan transaction; or

3. If the taxpayer and the Director agree in writing to the application or use of an alternative method of apportionment; or

4. To the extent that the taxpayer establishes that the interest is directly or indirectly paid, accrued, or incurred to:

i. A related member in a foreign nation that has in force a comprehensive income tax treaty with the United States and, for tax years beginning on or after January 1, 2018, the taxpayer also establishes that:

(1) The related member was subject to tax in the foreign nation on a tax base that included the amount paid, accrued, or incurred; and

(2) The related member's income received from the transaction was taxed at an effective tax rate equal to or greater than a rate of three percentage points less than the rate of tax applied to taxable interest by the State of New Jersey. In claiming this exception, the taxpayer shall disclose on its return for the privilege period:

(A) The name of the related member;

(B) The amount of the interest;

(C) The relevant foreign nation; and

(D) Such other information as the Director may prescribe; or

ii. An independent lender through a related member as conduit, provided that the taxpayer legally guarantees the debt on which the interest is required;

5. For purposes of this subsection:

i. "Foreign nation" means an established sovereign government that is recognized as such by the United States Department of State;

ii. "Comprehensive income tax treaty" means a convention, or agreement, entered into by the United States and approved by Congress, with a foreign government for the allocation of all categories of income subject to taxation and/or the withholding of tax on interest, dividends, and royalties, for the prevention of double taxation of the respective nations' residents, and the sharing of information;

iii. "Foreign corporation" means a business entity incorporated or organized under the laws of a foreign nation;

iv. "Domestic subsidiary" means a business entity incorporated under the laws of any state or commonwealth of the United States;

v. "Related member" means a person that, with respect to the taxpayer during all or any portion of the privilege period, is:

(1) A related entity;

(2) A component member as defined in I.R.C. § 1563.(b);

(3) A person to or from whom there is attribution of stock ownership in accordance with I.R.C. § 1563.(e); or

(4) A person that, notwithstanding its form of organization, bears the same relationship to the taxpayer as a person described in (a)4v(1) through (3) above of this definition;

vi. "Related entity" means:

(1) A stockholder who is an individual, or a member of the stockholder's family enumerated in I.R.C. § 318., if the stockholder and the members of the stockholder's family own, directly, indirectly, beneficially, or constructively, in the aggregate, at least 50 percent of the value of the taxpayer's outstanding stock;

(2) A stockholder, or a stockholder's partnership, limited liability company, estate, trust, or corporation, if the stockholder and the stockholder's partnerships, limited liability companies, estates, trusts, and corporations own, directly, indirectly, beneficially, or constructively, in the aggregate, at least 50 percent of the value of the taxpayer's outstanding stock; or

(3) A corporation, or a party related to the corporation in a manner that would require an attribution of stock from the corporation to the party or from the party to the corporation under the attribution rules of I.R.C. § 318., if the taxpayer owns, directly, indirectly, beneficially, or constructively, at least 50 percent of the value of the corporation's outstanding stock. The attribution rules of I.R.C. § 318., apply for purposes of determining whether the ownership requirements of this definition have been met;

vii. The disclosure requirement for interest paid to a related member is deemed to be satisfied if the taxpayer provides a schedule of:

(1) The name of the related member;

(2) The country of domicile of the related member;

(3) The amount paid to the related member; and

(4) The nature of payment or, alternatively, by providing a copy of Federal Form 5472 or its equivalent as an attachment to Form NJ CBT-100;

viii. "Rate of tax" means allocation factor times the tax rate percentage.

6. Examples:

Example 1: Royal Palm, Ltd., a foreign parent corporation, owns directly or indirectly 100 percent of the outstanding shares of a U.S. domestic subsidiary, Red Oak, Inc. and 100 percent of the outstanding shares of Little Palm, Ltd., a foreign subsidiary, a corporation. Royal Palm, Ltd. and Little Palm, Ltd. are domiciled in jurisdictions subject to a comprehensive income tax treaty with the United States of America. Red Oak, Inc. is in need of short-term and/or long-term funding. Little Palm, Ltd. is established by Royal Palm, Ltd. to represent the worldwide affiliated group and issue commercial paper, or enter into financing arrangements with lending institutions, or borrow funds from unrelated parties on behalf of the affiliated group. The proceeds of these transactions are then used to fund the operating or capital investment activities of one or more of the members of the worldwide affiliated group. Interest expense attributable to amounts lent by Little Palm, Ltd., the foreign subsidiary, to Red Oak, Inc., the U.S. domestic subsidiary, and any costs associated with the origination of the lending which are assessed to Red Oak, Inc. as expense recovery of the lending originations, would not be added back to Red Oak's Federal taxable income provided that the loans are at arm's length rates and properly documented.

Example 2: Same facts as Example 1, but Royal Palm, Ltd., the foreign parent, will borrow the funds and lend directly to the operating companies including Red Oak, Inc., the domestic subsidiary. Interest expense attributable to amounts borrowed by Red Oak, Inc., the domestic subsidiary, from Royal Palm, Ltd., the foreign parent, and any costs associated with the lending which are assessed to Red Oak, Inc. as an expense recovery of the lending originations would not be added back to Federal taxable income provided that the loans are at arm's length rates and properly documented.

Example 3: Same facts as Example 1, but Little Palm, Ltd., the foreign subsidiary, or Royal Palm, Ltd., the foreign parent, establishes a second domestic subsidiary, White Pine, Inc., to facilitate the borrowing and on-lending activities. White Pine, Inc. will be authorized to borrow from Little Palm, Ltd., the foreign subsidiary, or from third party sources such as commercial paper markets or bond markets either inside the United States or outside the United States. White Pine, Inc. will lend the proceeds of the borrowings to Red Oak, Inc. Red Oak, Inc. will pay interest to White Pine, Inc. on the borrowings. All interest expense attributable to amounts borrowed by Red Oak, Inc. from White Pine, Inc. except any traced to domestic sources or countries that do not have a comprehensive treaty with the United States, and any costs associated with the origination of the lending which are assessed to Red Oak, Inc. as expense recovery of the lending originations would not be added back to Federal taxable income provided that the loans are at arm's length rates and properly documented.

Example 4: Same facts as Example 1, but Little Palm, Ltd., the foreign subsidiary, forms White Pine, Inc. White Pine, Inc. borrows funds from Little Palm, Ltd. and holds the funds. The funds are made available for loan to Red Oak, Inc. and Blue Spruce, Inc., another affiliated domestic subsidiary on an as needed basis. White Pine, Inc. manages the lending transactions for two or more affiliated entities within the United States. White Pine, Inc. will loan funds to Red Oak, Inc. and Blue Spruce, Inc. White Pine, Inc. will charge an origination fee to cover the costs charged by Little Palm, Ltd., the foreign subsidiary to White Pine, Inc., a domestic subsidiary. Red Oak, Inc. and Blue Spruce, Inc. will make periodic interest payments and/or principal payments, depending on the terms of the notes. The interest and loan origination expenses paid by Red Oak, Inc. and Blue Spruce, Inc. to White Pine, Inc. will not be added back to Federal taxable income provided that the loans are at arm's length rates and properly documented.

Example 5: Mr. Jones, a New Jersey resident, owns 100 percent of the shares of Zippy Corp., a corporation properly capitalized and organized and doing business in New Jersey. Zippy Corp. has not made a New Jersey S-election. Mr. Jones loans Zippy Corp. money at an arm's length rate under an arm's length contract. Zippy Corp. may take an interest deduction, provided that one of the exceptions applies: for example, if Mr. Jones pays New Jersey gross income tax at a rate within three percent of nine percent, then Zippy Corp. may take the deduction. If Zippy Corp. does not get a deduction, Mr. Jones may not exclude the interest income from his gross income tax taxable income.

Example 6: Mr. Smith, a New Jersey resident, owns 100 percent of the shares of Pin Corp., a corporation organized and doing business in New Jersey. Pin Corp. has not made a New Jersey S-election. Mr. Smith lends Pin Corp. $ 5,000 at an arm's length rate under an arm's length contract. When Pin Corp. files its Form CBT-100, the Stockholder's Equity reflected on its Balance Sheet, Schedule B, is $ 200.00. Mr. Smith paid gross income tax on the payments received from Pin Corp. However, Pin Corp. may not claim an interest deduction for interest paid to Mr. Smith. The "loan" is actually a contribution to capital, since the corporation is undercapitalized.

(b) Interest expenses and costs, as well as, intangible expenses and costs directly or indirectly paid, accrued, or incurred in connection with a transaction with one or more related members shall not be deducted in calculating entire net income, except that a deduction may be permitted:

1. If the interest expenses and costs, as well as, intangible expenses and costs are directly or indirectly paid, accrued, or incurred to a related member in a foreign nation that has in force a comprehensive income tax treaty with the United States and, for tax years beginning on or after January 1, 2018, the taxpayer establishes that:

i. The related member was subject to tax in the foreign nation on a tax base that included the amount paid, accrued, or incurred;

ii. The related member's income received from the transaction was taxed at an effective tax rate equal to or greater than a rate of three percentage points less than the rate of tax applied to taxable interest by the State of New Jersey; and

iii. In claiming this exception, the taxpayer shall disclose on its return:

(1) The name of the related member;

(2) The amount of the interest expenses and costs and intangible expenses and costs deducted;

(3) . The relevant foreign nation; and

(4) Such other information as the Director may prescribe;

2. If the interest expenses and costs, as well as, the intangible expenses and costs that the taxpayer establishes meet both of the following:

i. The related member during the same income year directly or indirectly paid, received, accrued or incurred the portion to or from a person that is not a related member; and

ii. The transaction giving rise to the interest expenses and costs or the intangible expenses and costs between the taxpayer and the related member did not have as a principal purpose the avoidance of any portion of tax;

3. If the taxpayer establishes, to the satisfaction of the Director, that the adjustments are unreasonable by clear and convincing evidence, and any one of the following circumstances applies:

i. Unfair duplicate taxation;

ii. A technical failure to qualify the transactions under the statutory exceptions;

iii. An inability or impediment to meet the requirements due to legal or financial constraints;

iv. An unconstitutional result; or

v. The transaction is equivalent to an unrelated loan transaction; or

4. If the taxpayer and the Director agree in writing to the application or use of an alternative method of apportionment.

(c) For purposes of (b) above:

1. "Foreign nation" means an established sovereign government that is recognized as such by the United States Department of State;

2. "Comprehensive income tax treaty" means a convention, or agreement, entered into by the United States and approved by Congress, with a foreign government for the allocation of all categories of income subject to taxation and/or the withholding of tax on interest, dividends and royalties, for the prevention of double taxation of the respective nations' residents, and the sharing of information;

3. "Foreign corporation" means a business entity incorporated or organized under the laws of a foreign nation;

4. "Domestic subsidiary" means a business entity incorporated under the laws of any state within the United States;

5. "Intangible property" to which intangible expenses and costs relate, means and includes, but is not limited to, patents, patent applications, trade names, trademarks, service marks, copyrights, mask works, trade secrets, film, information technology, and similar types of intangible assets;

6. "Intangible expenses and costs" means and includes:

i. Expenses, losses and costs for, related to, or in connection directly or indirectly with the direct or indirect acquisition, use, maintenance or management, ownership, sale, exchange, or any other disposition of intangible property to the extent such amounts are allowed as deductions or costs in determining taxable income before operating loss deduction and special deductions for the taxable year under I.R.C. §§ 1. et seq.;

ii. Losses related to, or incurred in connection directly or indirectly with, factoring transactions or discounting transactions;

iii. Royalty, patent, technical, and copyright fees;

iv. Licensing fees; and

v. Other similar expenses and costs;

7. "Interest expenses and costs" means amounts directly or indirectly allowed as deductions under I.R.C. § 163., for purposes of determining taxable income under the code to the extent such expenses and costs are directly or indirectly for, related to, or in connection with the direct or indirect acquisition, maintenance, management, ownership, sale, exchange, or disposition of intangible property;

8. "Related member" means a person that, with respect to the taxpayer during all or any portion of the privilege period, is:

i. A related entity;

ii. A component member as defined in I.R.C. § 1563.(b);

iii. A person to or from whom there is attribution of stock ownership in accordance with I.R.C. § 1563.(e); or

iv. A person that, notwithstanding its form of organization, bears the same relationship to the taxpayer as a person described in (b)5viii(1) through (3) above of this definition;

9. "Related entity" means:

i. A stockholder who is an individual, or a member of the stockholder's family enumerated in I.R.C. § 318., if the stockholder and the members of the stockholder's family own, directly, indirectly, beneficially or constructively, in the aggregate, at least 50 percent of the value of the taxpayer's outstanding stock;

ii. A stockholder or a stockholder's partnership, limited liability company, estate, trust, or corporation, if the stockholder and the stockholder's partnerships, limited liability companies, estates, trusts, and corporations own, directly, indirectly, beneficially, or constructively, in the aggregate, at least 50 percent of the value of the taxpayer's outstanding stock; or

iii. A corporation, or a party related to the corporation in a manner that would require an attribution of stock from the corporation to the party or from the party to the corporation under the attribution rules of I.R.C. § 318., if the taxpayer owns, directly, indirectly, beneficially, or constructively, at least 50 percent of the value of the corporation's outstanding stock. The attribution rules of I.R.C. § 318., apply for purposes of determining whether the ownership requirements of this definition have been met;

10. The disclosure requirement for interest paid to a related member shall be deemed to be satisfied if the taxpayer provides a schedule of:

i. The name of the related member;

ii. The country of domicile of the related member;

iii. The amount paid to the related member; and

iv. The nature of payment or, alternatively, by providing a copy of Federal Form 5472 or its equivalent as an attachment to Form CBT-100;

(d) Examples applicable to (b) above are as follows:

Example 1: Large Co. A.G., a foreign corporation, domiciled in a jurisdiction that has entered into a comprehensive tax treaty with the United States of America, owns directly or indirectly 100 percent of the outstanding shares of three U.S. domestic subsidiaries (Red Corp., White Corp., and Blue Corp.) and 100 percent of the outstanding shares of Funding, N.V., a foreign subsidiary. Red Corp. and White Corp. utilize certain technology developed by Large Co. A.G. in their daily operations of manufacturing products for resale. Blue Corp. was formed to hold, and does hold, the U.S. rights to certain technologies developed by Large Co. A.G. Red Corp. and White Corp. pay a royalty to Blue Corp. for the ability to use the technology developed by Large Co. A.G. in its daily operations. Blue Corp. pays an annual royalty to Large Co. A.G. based on the amount of royalties it receives from Red Corp. and White Corp. Amounts paid to Blue Corp. by Red Corp. and White Corp. would not be subject to disallowance. Also the amounts paid by Blue Corp. to Large Co. A.G. would not be subject to disallowance.

Example 2: Same facts as Example 1, except that, Large Co. A.G. has entered into an agreement to securitize certain financial assets. Red Corp. sells its receivables to White Corp., a bankruptcy remote, special purpose company, at a discount. White Corp. pledges the receivables to a lending institution that issues commercial paper backed by those receivables. Large Co. A.G. and Red Corp. have guaranteed that 100 percent of any receivable pledged is collectible. The discount on the sale of the receivables by Red Corp. to White Corp. is not subject to disallowance.

Example 3: A limited partner receives guaranteed payments for its investment in a limited partnership. The payment is similar to a payment on preferred stock. The related member rules apply if the guaranteed payment is above market/arm's length values.

(e) Subsections (a), (b), (c), and (d) above do not apply to transactions between related members included in a combined group reported on the New Jersey combined return. Subsections (a), (b), (c), and (d) above only apply to transactions between members of a combined group reported on the New Jersey combined return and related members not included in the combined group reported on the New Jersey combined return.

Example: Companies A and B are members of a combined group (Combined Group E) that files a mandatory New Jersey combined return. Related member Companies C and D are not part of the combined group filing the New Jersey combined return. Subsections (a), (b), (c), and (d) above apply to transactions between Combined Group E and Companies C and D, but do not apply to Companies A and B because those companies are in Combined Group E.

(f) A taxpayer may claim an unreasonable exception, if that taxpayer includes Global Intangible Low Taxed Income (GILTI) in its entire net income from a related party and the expenses from the same related party would otherwise be required to be added back. See N.J.A.C. 18:7-5.19.

N.J. Admin. Code § 18:7-5.18

Amended by 49 N.J.R. 1694(a), effective 6/19/2017

Amended by 53 N.J.R. 544(a), effective 4/5/2021