On appeal from the Superior Court, Appellate Division.
The opinion of the court was delivered by: Justice LaVECCHIA
(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized).
Whirlpool Properties, Inc. v. Director, Division of Taxation
LaVECCHIA, J., writing for a unanimous Court.
At issue is whether N.J.S.A. 54:10A-6(B) (the "Throw-Out Rule" or "Rule"), is facially constitutional under the Due Process Clause, U.S. Const. amend. XIV, § 1, and the Commerce Clause, U.S. Const. art. I, § 8, cl. 3.
New Jersey uses a three-factor formula to calculate a multi-state corporation's New Jersey Corporate Business Tax (CBT) by apportioning income between New Jersey and the rest of the world. For taxpayers with regular places of business outside of New Jersey, the portion of entire net worth and entire net income that is subject to New Jersey taxis determined by multiplying each by an allocation factor that is the sum of the property fraction, the payroll fraction, and two times the sales fraction, divided by four. N.J.S.A. 54:10A-6. The sales fraction is at issue here. Without the Throw-Out Rule, the sales fraction is calculated by dividing the taxpayer's receipts (sales of tangible personal property, services, and all other business receipts) in New Jersey by total receipts. N.J.S.A. 54:10A-6(B). The Throw-Out Rule, adopted in 2002 and since repealed, increased a corporation's New Jersey tax liability by "throwing out" sales receipts that are not taxed by other jurisdictions from the denominator of the sales fraction. That always increases the sales fraction, causing the apportionment formula and resulting CBT to increase.
Whirlpool Properties, Inc. (Whirlpool) is incorporated and has its principal place of business in Michigan and conducts all activities outside of New Jersey. Whirlpool earns income by licensing brand names that it owns and manages. Whirlpool did not file New Jersey tax returns or pay CBT from 1996 to 2003. The Director calculated allocable income using information gleaned from related entities and issued Whirlpool a CBT deficiency assessment of nearly $25 million for those years. Before the Throw-Out Rule became effective, the portion of income allocated to New Jersey for 1996 through 2001 ranged between 0.9546 and 1.3337 percent. Using the Rule, Whirlpool's 2002 income was allocated to New Jersey 29.2572 percent and 41.8647 percent, respectively.
Whirlpool appealed the assessment to the Tax Court and challenged the constitutionality of the Throw-Out Rule. On motions for partial summary judgment on the Rule's facial constitutionality, the Tax Court determined that the proper standard of review is set forth in United States v. Salerno, 481 U.S. 739 (1987), which upholds a statute if it can operate constitutionally in some instances. Then, turning to the Rule's viability under Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), the court focused on fair apportionment. In the end, the Tax Court concluded that the Rule satisfies Salerno by operating constitutionally when income excluded from the sales fraction denominator is generated in part by New Jersey activities, when the Rule has no material effect on the sales fraction, and when the property and payroll fractions substantially temper its impact. The Appellate Division affirmed. Whirlpool Props., Inc. v. Dir., Div. of Taxation, 25 N.J. Tax 519 (App. Div. 2010). Addressing the due process claim, the panel noted that apportionment formulas need only avoid attributing income to the taxing state "out of all appropriate proportion" to business conducted in the state. Explaining that Whirlpool did not contest that it "had a nexus with New Jersey" independent from its "unitary business," or that "sales to non-taxing states were part of that business," the panel determined that New Jersey had a "constitutionally sufficient nexus to those sales." The panel also found that the Throw-Out Rule does not discriminate against interstate commerce because it does not cause double taxation and avoids the "forbidden impact on interstate commerce" of "pressuring" out-of-state corporations to increase New Jersey activity. The Court granted Whirlpool's motion for leave to appeal. 204 N.J. 35 (2010).
HELD: For corporate taxpayers having a substantial nexus to New Jersey, the Throw-Out Rule may apply constitutionally only to untaxed receipts from states that lack jurisdiction to tax the corporation due to insufficient connection with the corporation or due to congressional action such as 15 U.S.C.A. §§ 381-84 (commonly referred to as "P.L. 86-272"), but not to receipts that are untaxed because a state chooses not to impose an income tax.
1. Under the formula apportionment method used by many states to tax multi-state corporations, all receipts, property, and income of a "unitary business" are included in the tax base and then multiplied by a formula to determine what portion of the tax base the state may tax. The most common is the three-factor formula that averages property, payroll, and sales factors; it has been justified as a practical approximation of the distribution of a corporation's income sources or social costs. Under the Complete Auto test for analyzing constitutionality under the Commerce and Due Process Clauses, a state's formula will be sustained when it (1) is applied to an activity that has a "substantial nexus" with the state, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to services provided by the state. (pp. 19-23)
2. "Substantial nexus" requires a minimum connection between the state and the transaction it seeks to tax. Fair apportionment requires internal and external consistency. A formula is internally consistent if, when hypothetically applied by all jurisdictions, it would result in a tax on no more than all of the corporation's income. It is externally consistent only if it reflects a "reasonable sense of how income is generated," which requires a practical inquiry into the interstate activity taxed in relation to the in-state activity. The discrimination prong reflects the dormant Commerce Clause bar against a state imposing a heavier tax burden on out-of-state businesses than on state residents competing in an interstate market. The fair relation prong examines whether the taxpayer received benefits from the state. Here, the facial constitutionality of the Throw-Out Rule does not turn on the substantial nexus prong because income that is so separate from New Jersey activity that it could not be constitutionally taxed here would not be part of the taxpayer's unitary business or its tax base regardless of the Throw-Out Rule. Also, for a general revenue tax, the fair relation prong requires only that a taxpayer was accorded the benefits of an organized society. (pp. 23-30)
3. Whether the Throw-Out Rule is fairly apportioned depends on what types of receipts are thrown out: (1) receipts not taxed by a state because it lacks sufficient constitutional contact or because of action by Congress setting a lower threshold for what activity is sufficient for a state to tax it, such as P.L. 86-272, which prohibits state income tax on businesses whose only in-state activity is selling or soliciting orders for property shipped into the taxing state; and (2) receipts not taxed because a state chooses not to have an income tax. The Rule is internally consistent because if all states threw out untaxed receipts, no more than 100% of income would be taxed. However, throwing out receipts because a state chooses not to tax is externally inconsistent because that decision is independent of a taxpayer's business activity and has no bearing on how much income is attributable to New Jersey. On the other hand, the Rule arguably is externally consistent when untaxed receipts are thrown out due to a state's lack of jurisdiction to tax. While this increases New Jersey's share, New Jersey may have contributed more to receipts than what is suggested by the sales factor without the Rule; thus, it may be reasonable to allocate a greater percentage to New Jersey. That this interpretation may not always lead to a fair outcome does not render the Rule facially unconstitutional; unfairness may be addressed through an as-applied challenge. Construing the Throw-Out Rule narrowly so that it generally operates constitutionally, the Court interprets the Rule as operating only to throw out receipts from states without taxing jurisdiction. This is consistent with the legislative intent to close a loophole and throw out "nowhere sales" (sales that result in income assigned so it is taxed nowhere) from the sales fraction, causing more income to be assigned where a corporation actually operates. As so construed, the Rule is facially constitutional. (pp. 30-38)
4. Turning to Complete Auto's remaining prong, the Rule is not facially discriminatory because it applies equally to in-state and out-of-state businesses; and in light of the limiting interpretation, it has no discriminatory effect. Finally, the Court's construction, which results in a facially constitutional operation regarding fair apportionment, makes it unnecessary to wade deeply into whether the Salerno standard of review should have been applied here. (pp. 38-43)
5. In sum, in applying the Complete Auto test and based on the Court's limiting interpretation, the Throw-Out Rule is not facially unconstitutional. For corporate taxpayers having a substantial nexus to New Jersey, the Rule may apply constitutionally only to untaxed receipts from states that lack jurisdiction to tax the corporation. (pp. 43-44)
The judgment of the Appellate Division is AFFIRMED AS MODIFIED.
CHIEF JUSTICE RABNER and JUSTICES LONG, ALBIN, RIVERA-SOTO and HOENS join in JUSTICE LaVECCHIA's opinion.
JUSTICE LaVECCHIA delivered the opinion of the Court.
We granted leave to appeal to consider a facial challenge to the constitutionality of N.J.S.A. 54:10A-6(B) (the "Throw-Out Rule" or "Rule"), whose application, while it was in effect, increased a multi-state taxpayer's New Jersey Corporate Business Tax (CBT) liability. See N.J.S.A. 54:10A-1 to -41. Although the Rule has since been repealed, see L. 2008, c. 120, it had substantial impact on multi-state entities such as the taxpayer-appellant in this matter. Whirlpool Properties, Inc. (Whirlpool), a Michigan corporation with its principal place of business in Michigan, raised the present constitutional challenge in its complaint, filed with the Tax Court, appealing a CBT deficiency assessment of $24,883,399.24 imposed by the State Director of the Division of Taxation ("Director") with respect to tax years 1996 through 2003. In tax years 2002 and 2003, the Director's application of the Throw-Out Rule resulted in substantially heightened assessments against Whirlpool. In the present challenge, Whirlpool claims the Rule violates the Due Process Clause, U.S. Const. amend. XIV, § 1, and the Commerce Clause, U.S. Const. art. I, § 8, cl. 3.
The constitutionality of using a formula apportionment method for deriving local taxable income has been long established. See Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159, 165, 103 S. Ct. 2933, 2940, 77 L. Ed. 2d 545, 553 (1983). The formula apportionment method apportions a corporation's income between the taxing jurisdiction and the rest of the world. Ibid. New Jersey's apportionment methodology utilizes a three-factor formula that weighs a multi-state corporate taxpayer's property, payroll and sales, a recognizably common, and constitutionally unremarkable, general approach.*fn1 However, this facial challenge focuses pointedly on the less-common Throw-Out Rule, and its effect on the sales factor in New Jersey's formula.
Without application of the Throw-Out Rule, the sales fraction is calculated by dividing the taxpayer's New Jersey receipts by total receipts of the corporate taxpayer. N.J.S.A. 54:10A-6(B). The Throw-Out Rule modifies the sales fraction, transforming the fraction into one that divides New Jersey receipts only by taxed receipts. L. 2002, c. 40. The effect is consistent: By throwing out receipts from the denominator, the sales fraction always increases, causing the apportionment formula and the taxpayer's resultant CBT liability to New Jersey to increase.
Critical to the analysis of the constitutionality of New Jersey's Throw-Out Rule is the fact that the receipts that may be thrown out fall into two types: (1) receipts that are not taxed because the state lacks the jurisdiction to tax due to insufficient business activity by the taxpayer in that state, and (2) receipts that are not taxed because a state has chosen not to have an income or similar business activity tax, so the degree of business activity by the taxpayer in that state is irrelevant to the imposition or not of such a tax.
A court is duty-bound to give to a statute a construction that will support its constitutionality. We find that the Throw-Out Rule may operate constitutionally, under a fair apportionment analysis, when applied to untaxed receipts from those states that lack jurisdiction to tax the corporate taxpayer due to the insufficient business activity in that state, but not when applied to receipts that are untaxed due to a state's determination not to have an income or similar business activity tax. We therefore construe the Throw-Out Rule so as to limit the receipts that may be thrown out to untaxed receipts from those states that lack jurisdiction to tax due to the insufficient business activity by the taxpayer in that state. Based on the limiting construction that we give to the statute, we conclude that the Throw-Out Rule is facially constitutional when implemented in such fashion for corporate taxpayers whose activities have a substantial nexus to New Jersey. Accordingly, we affirm, as modified, the judgment of the Appellate Division.
I. Fundamental constitutional principles limit a state's ability to tax out-of-state entities. Reduced to its most straightforward formulation, a state simply cannot "'tax value [that is] earned outside its borders.'" Container Corp., supra, 463 U.S. at 164, 103 S. Ct. at 2939, 77 L. Ed. 2d at 552 ("Under both the Due Process and the Commerce Clauses of the Constitution, a State may not, when imposing an income-based tax, 'tax value earned outside its borders.'" (quoting ASARCO Inc. v. Idaho State Tax Comm'n, 458 U.S. 307, 315, 102 S. Ct. 3103, 3108, 73 L. Ed. 2d 787, 794 (1982))). Because many major corporations have operations "in more than one State,  arriving at precise territorial allocations of 'value' is often an elusive goal, both in theory and in practice." Ibid.
One method of deriving local taxable income is through the utilization of a formula apportionment method, which apportions a corporation's income "between the taxing jurisdiction and the rest of the world on the basis of a formula taking into account objective measures of the corporation's activities within and without the jurisdiction." Id. at 165, 103 S. Ct. at 2940, 77 L. Ed. 2d at 553. Subject to some constraints, the United States Supreme Court has ruled it permissible, under Due Process and Commerce Clause considerations, to use a formula apportionment method to derive local taxable income for multi-state corporations. See id. at 182, 103 S. Ct. at 2949, 77 L.
Ed. 2d at 564. New Jersey's corporate business tax scheme follows that general approach. Accordingly, a full explanation of that scheme at the outset will provide necessary context for analysis of the issues this case presents.
A. New Jersey's CBT requires every domestic or foreign corporation to pay an annual franchise tax . . . for the privilege of having or exercising its corporate franchise in this State, or for the privilege of deriving receipts from sources within this State, or for the privilege of engaging in contacts within this State, or for the privilege of doing business, employing or owning capital or property, or maintaining an office, in this State. [N.J.S.A. 54:10A-2.]
The tax is assessed based on a corporation's entire net worth and entire net income. N.J.S.A. 54:10A-5. For taxpayers with regular places of business outside of New Jersey, the portion of entire net worth and entire net income that is subject to New Jersey tax is "determined by multiplying such entire net worth and entire net income, respectively, by an allocation factor which is the property fraction, plus twice the sales fraction plus the payroll fraction and the denominator of which is four[.]"*fn2 N.J.S.A. 54:10A-6. The property fraction is determined by dividing the average value of the taxpayer's property in New Jersey by the average value of the taxpayer's property everywhere. N.J.S.A. 54:10A-6(A). Similarly, the payroll fraction is determined by dividing the taxpayer's New Jersey payroll by total payroll. N.J.S.A. 54:10A-6(C).
Without the Throw-Out Rule, the sales fraction is calculated by dividing the taxpayer's New Jersey receipts by total receipts. N.J.S.A. 54:10A-6(B). Receipts from sales, services, rents, royalties, and other business receipts in New Jersey are "divided by the total amount of the taxpayer's receipts, similarly computed, arising during such period from all sales of its tangible personal property, services, rentals, royalties and all other business receipts, whether within or without the State."*fn3 N.J.S.A. 54:10A-6(B). The Throw-Out Rule modifies the sales fraction by excluding receipts assigned to jurisdictions in which the taxpayer is not subject to income or similar business activity taxes*fn4 from the denominator of the sales fraction. The Business Tax Reform Act of 2002 amended the CBT to include the Throw-Out Rule by adding the following to the final paragraph of N.J.S.A. 54:10A-6(B): provided however, that if receipts would be assigned to a state, a possession or territory of the United States or the District of Columbia or to any foreign country in which the taxpayer is not subject to a tax on or measured by profits or income, or business presence or business activity, then the receipts shall be excluded from the denominator of the sales fraction.
[L. 2002, c. 40, § 8, repealed by L. 2008, c. 120, § 2; but see L. 2002, c. 40, § 6, repealed by L. 2008, c. 120, § 1 (limiting tax liability caused by ...