In July 2023, then-Gov. Phil Murphy of New Jersey signed legislation (P.L. 2023, c.96) making significant changes to the corporation business tax (CBT), including retroactive provisions affecting business taxpayers and revisions to the state’s partnership sourcing rules.
Effective for tax years beginning on or after January 1, 2023, nonresident taxpayers must source partnership receipts using a single-sales-factor apportionment method under New Jersey’s CBT Act, aligning partnership sourcing with the corporate sourcing regime. Previously, a partnership’s business allocation percentage was determined under a three-factor formula, with sales sourced using a cost-of-performance approach. Under the new law, partnership receipts are sourced using New Jersey’s corporate market-based sourcing rules, making sales factor sourcing far more important for investment management partnerships.
Since the 2023 enactment of the new rules, many nonresident taxpayers have found themselves running afoul of the sourcing changes. Further, the retroactive application to January 1, 2023, has caused additional complexity for both resident and nonresident taxpayers.
Rules for Sourcing Service Receipts
Under the corporate market-based sourcing rules, receipts from services are sourced to New Jersey based on where the benefit of the service is received rather than where the services are performed. That represents a meaningful shift in sourcing methodology by focusing on the location of the customer or end recipient of the service.
For investment management companies, that approach increases the importance of identifying where customers, investors, or beneficiaries are located, which can materially affect apportionment when fund investors are spread across multiple jurisdictions. As a result, investment managers with geographically dispersed investor bases could see a significant change in how their service receipts are sourced for New Jersey tax purposes.
Asset Management Services
N.J. Admin. Code §18:7-8.10A(8) defines asset management services to mean the “rendering of investment advice, making determinations as to when sales and purchases are to be made, or the selling or purchasing of assets and related activities. As used in this sub-subparagraph, ‘related activities’ means administration services, distribution services, management services, and other related services.”
Under N.J. Admin. Code §18:7-8.10A(8), receipts from asset management services are sourced to New Jersey using a look-through approach based on the domicile of the ultimate investor or beneficiary. Specifically, receipts are sourced to New Jersey if: (i) the services are provided directly or indirectly to individuals domiciled in New Jersey; (ii) the services are provided to a pension plan, retirement account, or institutional investor to the extent the beneficiaries of that plan, account, or similar asset pool are domiciled in New Jersey; or (iii) the services are provided to a regulated investment company to the extent its shareholders are domiciled in New Jersey.
As a result, sourcing depends on the location of the ultimate investors or beneficiaries rather than that of the fund, management entity, or contractual counterparty. Given the historical ambiguity in this area and the statutory alignment now in place between the partnership and corporate sourcing regimes, investment management partnerships should consider the application of the new rules.
Reasonable Approximation
If the domicile of the beneficiaries cannot be determined, New Jersey allows receipts to be sourced using a reasonable approximation method. Under that approach, the location where the benefit of the services is received is determined in a manner consistent with the recipient’s activities to the extent that information is available to the taxpayer.
Under N.J. Admin. Code §18:7-8.10A(a)(8)(ii)(1), the taxpayer bears the burden of demonstrating that its method is reasonable. Depending on the relevant facts and circumstances, acceptable proxies for allocating receipts to New Jersey could include the most recent available population census data for the jurisdictions where the business customer operates; the gross domestic product of those jurisdictions; per capita gross domestic product; the domicile of the sponsor of the plan, account, or asset pool; the sponsor’s payroll apportionment factor; or the sponsor’s ratio of New Jersey employees to total employees. The taxpayer generally must apply the same reasonable proxy from year to year unless it can establish that a different proxy is more accurate in a subsequent year.
Practical Implications
As a result of the statutory changes, investment management partnerships must source management fee receipts under the CBT asset management sourcing rules, including the beneficiary-based look-through approach. Accordingly, investment managers with no physical presence in New Jersey might still have New Jersey sales factor exposure, nexus, and filing obligations to the extent their investors or beneficiaries are domiciled in the state.
BDO Insight
- Beginning in 2023, partnerships are required to apply CBT sourcing and apportionment rules in New Jersey.
- Although signed into law in July 2023, the regulations apply retroactively to tax years beginning on or after January 1, 2023. Retroactive tax law has been found to be unconstitutional in some instances as a violation of due process rights. New Jersey’s law has yet to be challenged on constitutional grounds.
- For asset management services, New Jersey’s regulations expressly require a look-through approach based on investor or beneficiary domicile.
- Investment managers structured as partnerships might have New Jersey filing obligations even in the absence of physical presence in the state.
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