PwC alternatives alert, May 25, 2010

New Jersey tax court holds limited partner lacked nexus

The New Jersey Tax Court held that a company was entitled to a refund of corporation business tax (CBT) because it held a passive interest in a limited partnership, was not unitary with the partnership, and was not otherwise doing business in the state. While the decision is currently under appeal, clients with a similar fact pattern should consider filing protective claims for refund to protect their interest pending the final resolution of this matter.

In 2009, the New Jersey Tax Court held that a company was entitled to a refund of corporation business tax (CBT) because it simply held a passive interest in a limited partnership, was not unitary with the partnership, and was not otherwise doing business in the state. [BIS LP, Inc. v. Division of Taxation, N.J. Tax Ct., Docket No. 007847-2007 (7/30/09)]

Background and Discussion. BIS LP, Inc. (BIS) held a 99% interest in BISYS Information Solutions, LP (Solutions), a limited partnership that held all of the BISYS Group Inc. (ultimate parent company of BIS) banking information solutions division operating in New Jersey.

BIS filed its 2003 Corporation Business Tax (CBT) return and elected to be treated as an investment company pursuant to N.J.S.A. 54:10A-4(f). On audit, the New Jersey Division of Taxation (Division) denied the investment company tax treatment and held that BIS is unitary with Solutions as to be subject to the CBT. The Division issued a Notice of Assessment which BIS appealed to the New Jersey Tax Court. In its appeal, BIS was seeking both an abatement of the assessment and a complete refund of the amount of CBT it paid on its 2003 return on the basis that it had no constitutional presence in New Jersey.

New Jersey nexus: Pursuant to N.J.A.C. 18:7-7.6(c), a foreign corporate limited partner is considered to be doing business in the state and must file a CBT return if it meets tests set out in the Division's regulations. In its review, the court generally focused on whether the business of Solutions was integrally related to the business of BIS.

The court held that although BIS receives 100 percent of its income from its limited partnership interest, it was not a general partner, did not have control of the business, did not have a place of business in the state, and did not have employees, agents, representatives, or property in the state. As a result, the court held that its business activities in New Jersey were not sufficient to give the state jurisdiction to impose tax under the criteria of N.J.A.C. 18:7-1.9 and 1.6.

Further, the court held that Solutions and BIS are not integrally related leading the court to conclude that BIS was a passive investor in Solutions and had no control or potential for control in the business of Solutions. Moreover, Solutions and BIS were also in different lines of business. On that basis, BIS's claim for refund was allowed in its entirety.

The Tax Court also held that BIS qualified as a New Jersey investment company. The benefit of being a New Jersey investment company is that only 40% of the income of the company is taxed by the state. There was a change in the Division's regulations in 2006 that disqualifies a limited partnership interest from being an investment company asset. The investment company argument is only viable for tax years prior to 2006. Also, investment company status is irrelevant if, as was the holding in the BIS case, the out-of-state corporate limited partner does not have nexus for corporation business tax purposes.

Current status

Presently, the decision has been appealed to the New Jersey Appellate Court.

Impact on the alternative investments industry

Because of the uncertainty surrounding the nexus implications of limited partners with respect to the CBT, it is recommended that companies with a similar fact pattern consider filing protective claims for refund with the Division to protect their right to recover refunds once the decision is finalized with no further appeals.

The application of this decision will have a significant impact on the asset management industry as companies (blockers, funds and other pass-through entities) generally hold a limited partner interest in entities that may have activities in New Jersey. For example, a corporate blocker entity of a sovereign wealth fund that merely has a limited partnership interest in an underlying fund with New Jersey source income may not arguably have sufficient nexus as to require it to file and be subject to CBT. Moreover, fund-of-funds, hedge funds or real estate funds that generally hold a limited partnership interest in entities operating in New Jersey, may also not have the requisite nexus as to be required to file a return with the state. Depending on the client's facts and circumstances, an entity with a limited partnership interest that is not unitary with the fund, may not have nexus to trigger a filing obligation for the fund or its investors. Importantly, New Jersey has different tests than other states for determining whether a corporate partner is unitary with a partnership. Corporate partners that are unitary with a partnership in other states may not be unitary for New Jersey corporate business tax purposes.