Proposed Amendments: N.J.A.C. 18:7-5.2(a)2.i.(1) and 18:7-5.2(a)2.ii.(1).

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1 TREASURY-TAXATION DIVISION OF TAXATION Corporation Business Tax Entire net income; how computed Proposed Amendments: N.J.A.C. 18:7-5.2(a)2.i.(1) and 18:7-5.2(a)2.ii.(1). Authorized by: Robert K. Thompson, Director, Division of Taxation Authority: N.J.S.A. 54:50-1 and N.J.S.A. 54:10A-27 Calendar Reference: See Summary below for explanation of exception to calendar requirement. Proposal Number: Submit comments by January 6, 2006 to: Nicholas Catalano Chief, Regulatory Services Branch Division of Taxation 50 Barrack Street P.O. Box 269 Trenton, NJ The agency proposal follows:

2 Summary The proposal amends Subchapter 7 of N.J.A.C. 18 by adding a new paragraph to subsections 18:7-5.2(a)2.i. and 18:7-5.2(a)2.ii. The proposed rule which applies to both subsections, is promulgated following the opinion rendered by the New Jersey Tax Court in UNB Investment Co., Inc., v. Director, Division of Taxation, 21 N.J. Tax 354 (Tax 2004). The taxpayer appealed the Division s disallowance of an exclusion from entire net income for dividends received by the plaintiff from its wholly owned subsidiary which was a real estate investment trust (REIT). The Director had argued that his position was based on the interpretation of the statutory language and purpose contained in N.J.S.A. 54:10A-4(k)(5) and 54:10A-4(l), both of which pertain to REITs. The Director concluded that the two statutes together supported the disallowance of the dividends received deduction by a corporate parent of a REIT subsidiary, reflecting treatment consistent with federal income tax laws. The court viewed the Director s construction of the Corporation Business Tax Act as reasonable and supported by statutory authority. The court, however, invalidated the assessment that had been made against the taxpayer because the Division had not promulgated a rule informing the public of the exception to the rule regarding the dividends received deduction.

3 While reviewing the legislative history, the court reasoned that the legislative intent was to follow federal treatment of REITs as provided in I.R.C. 857(c)(2), which prohibits the exclusion of REIT dividends from corporate income. As expressed in the summary portion of Assembly Bill No. 499 (subsequently enacted as P.L. 1972, c. 89), the dividend exclusion was intended not only to prevent double taxation of corporate income, but also to encourage corporations to locate to New Jersey. The court agreed with the Director that his construction harmonized N.J.S.A. 54:10A-4(k)(5) and 54:10A- 4(1), and was consistent with the statutory scheme read as a whole, in addition to being consistent with the legislative intent to maintain New Jersey s competitive position in attracting REITs. The court, however, was constrained to conclude that a rule setting forth the Director s interpretation of law and general Division policy was required, pursuant to the principles set forth in Metromedia, Inc. v. Director, Div. of Taxation, 97 N.J. 313 (1984). Because the Division has provided a 60-day comment period on this notice of proposal, this notice is excepted from the rulemaking calendar requirements pursuant to N.J.A.C. 1:30-3.3(a)5. Social Impact The proposed amendments are expected to have a beneficial social impact by notifying taxpayers and their advisors, that dividends received by a corporation from a subsidiary REIT cannot be deducted from entire net income for New Jersey corporation

4 business tax purposes. They attempt to rectify and clarify a possible ambiguity that results when applying a policy limiting the deduction for dividends received in a manner consistent with federal law, and regulation N.J.A.C. 18:7-5.2(a)2 as it presently exists, relating to the dividend exclusion. Proposing this interpretation of the exclusion rule which conforms to federal treatment, keeps taxpayers properly informed and allows them to accurately calculate entire net income for the purposes of filing corporate business tax returns and paying appropriate tax. Taxpayers also will be able to avoid additional tax assessments and penalties due to the underpayment of tax liabilities. Economic Impact The proposed amendments are expected to improve the administration and enforcement of the Corporation Business Tax Act and the Uniform Tax Procedure Law N.J.S.A. 54:48-1, et seq. Additionally, the proposal may help to reduce costs of tax administration by preventing the processing of unnecessary amended returns, collection efforts that may be required due to the underpayment of tax, and further appeals or assessment protests. Increased tax payments due to this exception to the dividend received deduction rule may generate an indeterminate increase in funds collected by the Division.

5 Federal Standards Statement A federal standards statement is not required because the rulemaking authority is pursuant to provisions of the State Uniform Tax Procedure Law, N.J.S.A. 54:50-1, and the Corporation Business Tax Act, N.J.S.A. 54:10A-27, and is not subject to any Federal requirements or standards. The proposal is intended to amend existing rule N.J.A.C. 18:7-5.2, which is a matter of statutory interpretation and communication of Division policy. Jobs Impact The proposed amendments are not expected to result in the creation or loss of jobs in the State. The proposed amendments address an issue related to statutory interpretation by the Division of Taxation and the communication of general policy considerations. The proposed amendments should not affect the ability of businesses to maintain and create jobs in New Jersey. Agriculture Industry Impact The proposed amendments will have no impact on the agriculture industry, other than the general impact felt by all industry groups and the general public.

6 Regulatory Flexibility Analysis The proposed amendments are intended to restrict the application of the dividends received deduction, N.J.A.C. 18:7-5.2, by excluding from deductibility those dividends distributed by a REIT subsidiary, as discussed in the summary above. The State Uniform Tax Procedure Law, N.J.S.A. 54:48-1 et seq., contains tax procedures affecting most taxpayers, including small businesses as the term is defined in the Regulatory Flexibility Act, N.J.S.A. 52:14B-16 et seq. The proposed change to the rule should not impose any additional reporting or recordkeeping requirements or any additional annual compliance costs on small businesses. Small businesses and other taxpayers may wish to consult with accountants or legal professionals in order to review the new rule to determine the relevance of the rule to their own tax situations. The costs to small businesses for professional services that aid in the proper application of the new rule should be minimal, since it conforms to the tax treatment under federal tax law. Smart Growth Statement The proposed amendments will have no impact on the achievement of smart growth and implementation of the State Development and Redevelopment Plan. Full text of the proposal follows (additions indicated by underline thus; deletions indicated in brackets [thus]).

7 18:7-5.2 Entire net income; how computed (a)1. (No change). 2. Deduct from Federal taxable income: i. 100 percent of all dividends or amounts deemed dividends for Federal purposes included in Federal taxable income which were received from subsidiaries meeting the definition of a subsidiary under N.J.A.C. 18:7-4.11(a)1 of this chapter and 100 percent of all dividends from those subsidiaries which were added to Federal taxable income in accordance with (a)1 above; (1) Dividends received from an entity qualified as a real estate investment trust (REIT) as defined under IRC Section 856, and N.J.S.A. 54:10A-4(l), are ineligible for inclusion in the dividends received deduction for corporations as provided in the subparagraph above. Any dividend received directly or indirectly from a REIT, for the taxable year in which the dividend is paid, is not treated as a dividend and is not included as part of the dividends received deduction otherwise available to the taxpayer in determing net income derived from business carried on in New Jersey. For purposes of this subsection, directly or indirectly means whether or not the dividend passes through a subsidiary or affiliate of the taxpayer, the amount of the REIT distribution may not be included in the dividends received deduction, at any level. For those taxpayers that are subject to New Jersey corporation business tax, REIT distributions in conformity with federal law are subject to taxation.

8 ii. Fifty percent of all dividends or amounts deemed dividends for Federal purposes included in Federal taxable income or added to Federal taxable income in accordance with (a) above if received from 50 to less than 80 percent owned subsidiaries defined under N.J.A.C. 18:7-4.11(a)2. Dividends received from a regulated investment company which are treated as interest for purposes of the Internal Revenue Code and/or which are not considered qualifying dividends for Internal Revenue purposes are not eligible for deduction or exclusion from entire net income under this subsection. (1) Dividends received from an entity qualified as a real estate investment trust (REIT) as defined under IRC Section 856, and N.J.S.A. 54:10A-4(l), are ineligible for inclusion in the dividends received deduction for corporations as provided in the subparagraph above. Any dividend received directly or indirectly from a REIT, for the taxable year in which the dividend is paid, is not treated as a dividend and is not included as part of the dividends received deduction otherwise available to the taxpayer in determining net income derived from business carried on in New Jersey. For purposes of this subsection, directly or indirectly means whether or not the dividend passes through a subsidiary or affiliate of the taxpayer, the amount of the REIT distribution may not be included in the dividends received deduction, at any level. For those taxpayers that are subject to New Jersey corporation business tax, REIT distributions in conformity with federal law are subject to taxation.