KINKO'S NETWORK, INC v. DIRECTOR, DIVISION OF TAXATION

NOT FOR PUBLICATION WITHOUT THE

APPROVAL OF THE APPELLATE DIVISION

SUPERIOR COURT OF NEW JERSEY

APPELLATE DIVISION

DOCKET NO. A-0

KINKO'S NETWORK, INC.,

Plaintiff-Respondent,

v.

DIRECTOR, DIVISION OF

TAXATION,

Defendant-Appellant.

_______________________________

Before Judges Lihotz, St. John and Rothstadt.

On appeal from the Tax Court of New Jersey, Docket No. 020998-2010.

Michael J. Duffy, Deputy Attorney General argued the cause for appellant (John J. Hoffman, Acting Attorney General, attorney; Melissa H. Raksa, Assistant Attorney General, of counsel; Mr. Duffy, on the brief).

David J. Gutowski argued the cause for respondent (Reed Smith LLP, attorneys; Mr. Gutowski, on the brief).

PER CURIAM

Defendant Director, Division of Taxation (Division) appeals from a December 3, 2013 final judgment entered by the Tax Court granting plaintiff Kinko's Network, Inc. (Kinko's) summary judgment. The Tax Court concluded Kinko's timely filed a refund request, pursuant to N.J.S.A. 54:49-14(b), for taxes paid from a 2006 deficiency assessment and rejected the Division's argument the refund was grounded upon an issue outside the scope of its audit. We conclude the unique facts and circumstances presented in this case support a finding that the subject of the refund request was raised and considered during the audit, and was preserved for purposes of Kinko's claim for post-audit relief. Accordingly, we affirm.

These undisputed facts are taken from the summary judgment record. Kinko's is a Delaware corporation, headquartered in California. Kinko's Ventures, Inc. (Ventures) is a trademark holding company and an affiliate of Kinko's. Ventures licenses certain trademarks and trade names to Kinko's in exchange for royalty payments. Ventures is not a New Jersey corporation and does not conduct business or own assets in the state.

In 2002, Kinko's used Ventures' intangible property to sell products in New Jersey and paid Ventures $70,656,890 for licensing associated with those sales. When reporting its 2002 New Jersey Corporate Business Tax (CBT) income, Kinko's deducted the royalties as a business expense. However, because those payments were made to a corporate affiliate, which did not pay CBT in New Jersey, Kinko's was required to "add-back" the same sum to its overall net income. See N.J.S.A. 54:10A-4.4(b). In essence, Kinko's 2002 CBT liability included Ventures' royalty income.

In 2006, the Division, assisted by the Multistate Tax Commission (MTC),1 simultaneously audited Kinko's and Ventures for a period that included the 2002 tax year. In conformance with this court's decision in Lanco, Inc. v. Dir., Div. of Taxation, 379 N.J. Super. 562 (App. Div. 2005), certif. granted, 186 N.J. 245 (2006), the Division concluded Ventures was obligated to file a 2002 CBT return and pay tax on the royalty income it received from Kinko's retail sales in New Jersey. Therefore, even though Ventures had no physical presence or tangible assets in New Jersey, CBT liability resulted from the revenue stream it derived from Kinko's use of its intangible property used in New Jersey sales. The Division issued Ventures a proposed CBT deficiency assessment on June 12, 2006. Ventures did not immediately satisfy that assessment pending review of Lanco by the Supreme Court.

That same day, the Division also issued to Kinko's a proposed 2002 CBT deficiency assessment, revising the sales fraction used to determine the percentage of its sales attributed to New Jersey business (the allocation factor).2 The audit reallocated certain sales income originally excluded by Kinko's in its initial CBT return, increasing the applicable allocation to include sales "fairly attributable to economic activity within the . . . state." Whirlpool Props., supra, 208 N.J. at 165 (citation and internal quotation marks omitted). The Division applied the modified allocation factor to Kinko's 2002 net income, which included the $70,656,890 paid as royalties to Ventures, to compute its 2002 CBT liability. Schedules attached to the deficiency assessment contained handwritten entries, which the Division concedes were made by its auditor.

Kinko's challenged the inclusion of its royalty payments when calculating its net income, maintaining since Ventures was required to file a CBT return claiming the New Jersey royalty receipts, it was entitled to deduct that sum, reducing its overall net income subject to CBT. Kinko's posited the amount qualified for an exception to the "add-back" rule.

The Division conferenced the issue and rejected Kinko's requested deduction as "premature" because Ventures had not yet paid the assessed 2002 CBT. Kinko's was issued a Notice of Assessment on August 8, 2006, declaring a tax deficiency of $107,637.18, based upon the modified allocation factor.

On October 12, 2006, the Supreme Court issued an opinion upholding Lanco and its imposition of CBT liability on a foreign company deriving income from a licensee's retail sales generated in New Jersey. See Lanco, Inc. v. Dir., Div. of Taxation, 188 N.J. 380, 382-83 (2006), cert. denied, 551 U.S. 1131, 127 S. Ct. 2974, 168 L. Ed. 2d 702 (2007). Ventures paid $162,437 in CBT for the 2002 royalty income received from Kinko's New Jersey sales on October 20, 2006. Kinko's satisfied its assessed tax liability on December 19, 2006.

On January 30, 2008, Kinko's challenged the deficiency assessment by filing a post-audit refund claim, pursuant to N.J.S.A. 54:49-14(b). Kinko's reasserted the auditor erroneously denied its requested application of the exception to the "add-back" rule and to deduct royalty expenses remitted to Ventures. Kinko's maintained the reduction would reduce its net income, to which the revised allocation factor was applied, thereby decreasing its overall CBT liability computed for New Jersey. The refund claim did not challenge the increase to Kinko's allocation factor.

Concluding the deficiency assessment solely concerned adjusting Kinko's 2002 allocation factor, the Division denied Kinko's refund request as untimely, finding it raised an issue that was not addressed by the audit. The Division noted the royalty receipts were not added back into Kinko's income by the auditor, but rather included by Kinko's as reported in its original CBT return. Kinko's request for reconsideration was denied.

On August 5, 2008, Kinko's filed a written protest and request for a hearing, reasserting the arguments previously made in its refund claim. The Division rejected the request, and on September 20, 2010 issued a final determination denying Kinko's refund claim.

On December 17, 2010, Kinko's initiated an action in the Tax Court challenging the final determination. The complaint sought a refund of the assessed taxes, maintaining the Division's denial of its refund claim for the deduction of royalty expenses was unreasonable. It also contested the Division's use of the "throw-out" rule, alleging its application violated the Commerce Clause of the United States Constitution.

Following discovery, cross-motions for summary judgment were filed. The Tax Court judge issued an oral decision denying the Division's motion and granting Kinko's summary judgment on its claim for a refund. Making specific factual findings based upon documents contained in the record, the judge concluded the Division "erred in denying [Kinko's] refund request as untimely" because "[t]he issue of the exception to the add-back was raised by the deficiency assessment," as shown by the handwritten notations made by the auditor. An order memorializing the Tax Court's decision was entered on October 18, 2013. The order was self-executing, stating it would become a final judgment on December 3, 2013, if Kinko's dismissed the second count of its complaint seeking attorney's fees. Following entry of final judgment, the Tax Court judge submitted an amplified opinion on January 31, 2014. This appeal ensued.

Judgments of the Tax Court are binding on appeal "when supported by adequate, substantial[,] and credible evidence." City of Atl. City v. Boardwalk Regency Corp., 19 N.J. Tax 164, 192 (App. Div. 2000) (citation and internal quotation marks omitted); Global Terminal & Container Serv. v. City of Jersey City, 15 N.J. Tax 698, 70203 (App. Div. 1996). See also Rova Farms Resort, Inc. v. Investors Ins. Co. of Am., 65 N.J. 474, 483-84 (1974) (setting forth the standard for appellate review of non-jury trials). "This [presumption] is especially so with respect to the findings of the Tax Court because of [its] special expertise . . . ." Boardwalk Regency Corp., supra, 19 N.J. Tax at 192. See also Waksal v. Dir., Div. of Taxation, 215 N.J. 224, 231 (2013). "Moreover, '[s]ince the judges assigned to the New Jersey Tax Court have special expertise, [this court] will not disturb their finding[s] unless they are plainly arbitrary or there is a lack of substantial evidence to support them.'" Pine St. Mgmt. Corp. v. City of E. Orange, 15 N.J. Tax 681, 686 (App. Div. 1995) (first and second alterations in original) (quoting G & S Co. v. Borough of Eatontown, 6 N.J. Tax 218, 220 (App. Div. 1982)), certif. denied, 144 N.J. 172 (1996).

On appeal, the Division challenges the judge's findings as unsupported by the record, reasserting the arguments it previously presented. The Division maintains Kinko's royalty expense deduction was not an issue raised by the deficiency assessment and, thus, its refund claim was properly rejected because it fell outside the scope of recovery provided by N.J.S.A. 54:49-14(b). The Division also contests the judge's interpretation of the statute, arguing he impermissibly expanded the scope contrary to its express language. The Division suggests Kinko's had the opportunity to seek relief under N.J.S.A. 54:49-14(a) to challenge the tax assessed, but failed to timely do so.

The Division's arguments are grounded on the interpretation of N.J.S.A. 54:49-14, governing procedures for filing a refund claim for "original or additional tax assessed against" the taxpayer. The issues as framed, present legal questions, which are "not entitled to . . . deference and [are] subject to our de novo review." Waksal, supra, 215 N.J. at 231 (citation and internal quotation marks omitted).

When reviewing a statute, "[w]e begin . . . with the statute's plain language, which is the best indicator of the Legislature's intent." Id. at 232. "If the statute is clear and unambiguous on its face and admits of only one interpretation, [court's should] delve no deeper than the act's literal terms to divine the Legislature's intent." Koch v. Dir., Div. of Taxation, 157 N.J. 1, 7 (1999) (alteration in original) (citation and internal quotation marks omitted). If a conflict in interpretation exists, however

[the] legislative provision should not be read in isolation or in a way which sacrifices what appears to be the scheme of the statute as a whole. Rather a statute is to be interpreted in an integrated way without undue emphasis on any particular word or phrase and, if possible, in a manner which harmonizes all of its parts so as to do justice to its overall meaning.

[Ibid. (quoting Zimmerman v. Mun. Clerk of Twp. of Berkeley, 201 N.J. Super. 363, 368 (App. Div. 1985)).]

The statute at issue provides remedies to a taxpayer who challenges the Division's determinations made in a deficiency assessment. Specifically, a taxpayer may file for a refund if

a. Any taxpayer, at any time within four years after the payment of any original or additional tax assessed against him, unless a shorter limit is fixed by the law imposing the tax, may file with the director a claim under oath for refund, in such form as the director may prescribe, stating the grounds therefor, but no claim for refund shall be required or permitted to be filed with respect to a tax paid, after protest has been filed with the director or after proceedings on appeal have been commenced as provided in this subtitle, until such protest or appeal has been finally determined. . . .

b. No taxpayer shall be precluded from claiming a refund of additional tax assessed solely on the ground that the taxpayer neither protested or appealed from any part of the assessment. A taxpayer may, pursuant to this subsection, file a claim for the refund of the assessment of additional tax if (1) the taxpayer neither protested nor appealed from the assessment, (2) the taxpayer paid the assessment in full within one year after the expiration of the period allowed for filing a protest of the assessment, (3) the taxpayer files the claim for the refund within 450 days of the expiration of the period allowed for filing such a protest, and (4) the amount of the refund claimed pursuant to this subsection does not exceed the amount of the assessment paid. . . . A refund claim shall be filed under oath, in a form as the director may prescribe, and shall state the grounds therefor, which grounds shall be limited to those issues raised by the deficiency assessment itself and shall not include any additional issues with respect to the original assessment of tax . . . .

[N.J.S.A. 54:49-14 (emphasis added).]

We agree the statute is unambiguous, limiting refund claims "of the assessment of additional tax" to "issues raised by the deficiency assessment itself." Ibid. However, we cannot abide defendant's limited application of the statute on the specific and unique facts presented in this matter. The Division's determination, limiting the scope for relief from the deficiency assessment to include only challenges to the revised allocation factor, ignores its review of the royalty expense issue during the audit.

Although Kinko's adjusted tax liability, as set forth in the deficiency notice, directly resulted from a recalculation of the allocation factor by applying the "throw-out" rule, the auditor also considered and rejected Kinko's claimed deduction in income by excluding royalty payments remitted to Ventures. Both the conference and audit worksheets show the Division examined the requested royalty deduction issue and rejected it when calculating Kinko's total income subject to the allocation factor for purposes of computing its tax liability.

The Tax Court judge found

[T]he schedules attached to the June 12, 2006 proposed assessment of CBT [evince] the fact that [Kinko's], which was audited at the same time as Ventures and represented by the same counsel, raised with the auditor the prospect that if Ventures was compelled to file CBT returns and pay CBT on the revenue realized from [Kinko]'s royalty payments for 2002 New Jersey sales, then [Kinko's] would be entitled to an exception to the [a]dd-[b]ack [r]ule for 2002. Schedule 0931.3 shows for tax year 2002 on the line identified as intangible expenses add-back a "Per Return" figure of 0, a "Per Audit" figure of $70,656,890 and a "Difference" of $70,656,890. It is undisputed that [Kinko's] actual 2002 CBT return showed an add-back of royalty expenses of $70,656,890. The only plausible explanation for the "Per Return" figure of 0 on schedule 0931.3 is that it is a reflection of [Kinko's] argument . . . it [wa]s entitled to an exception to the [a]dd-[b]ack [r]ule because the Division, while auditing [Kinko's], was simultaneously notifying Ventures that it was subject to CBT for 2002 and had to pay tax on the royalty payments it received from [Kinko's] for 2002 sales. The "Per Audit" figure of $70,656,890 reflects the fact that the auditor rejected [Kinko's] position, because the Division was not prepared to conclude that [Kinko's] was entitled to the exception to the [a]dd-[b]ack [r]ule until Ventures actually filed its CBT return and paid the tax.

The Division's attempt to attribute these figures to a scrivener's error is unconvincing for several reasons. First, the [Division] did not produce a certification from the scrivener certifying that the figures on schedule 0931.3 were errors. Second, the magnitude of the alleged error a $70.6 million deduction for a taxpayer that had only $75 million of income makes the scrivener's error theory incredible. Third, the alleged error which first appeared on a schedule attached to the June 12, 2006 proposed assessment was not corrected in the August 8, 2006 Notice, which referenced the "enclosed information" that included schedule 0931.3. Nor are the handwritten notations on schedule 0931.3 evidence that the "error" was corrected by the auditor. The meaning of the notes is unclear, but it appears that the author entered the allocation figure [was] reported by [Kinko's] on its return and the allocation figure ultimately adopted by the auditor. . . .

Additionally, schedule 1131 and schedule 1216 both reflect the fact that the exception to the [a]dd-[b]ack [r]ule was raised by the August 8, 2006 assessment. Schedule 1131 shows the add-back of $70,656,890 as a "State Adjustment to Income." Schedule 1216, concerning "Intangible Expenses Cost Add Backs," shows an "As Reported" figure of $70,656,890, an "Audit Adjustment Reverse Amount Reported" of ($70,656,890)[,] and then an "Intangibles Expenses and Costs Add[-]back Per Audit" figure of $70,656,890. The only credible explanation for these figures is that the schedule reflects [Kinko's] position that it should be granted an exception to the [a]dd-[b]ack [r]ule and the auditor's rejection of that position.

The court understands that [Kinko's] originally reported add-back of $70,656,890 was not changed by the auditor. The mere fact that the figure was not changed, however, does not mean that the exception to the [a]dd-[b]ack [r]ule was not considered during the audit. If, as [Kinko's] claims, it requested an exception to the [a]dd-[b]ack [r]ule and its request was rejected by the auditor, then the add-back reported on [Kinko's] CBT return would not be changed by the auditor. The add-back on the return did not change because the issue of an exception was raised by the taxpayer and rejected. It is the very fact that the auditor refused to change the add-back figure that [Kinko's] challenges in its refund claim.

The Division's June 12, 2006 correspondence to Kinko's stated the following "Adjustments" were made to Kinko's 2002 CBT return: "(1) The receipts fraction of the allocation factor has been revised. The throw[-]out rule is enforced. SEE THE ENCLOSED INFORMATION." The notice of adjustment referenced N.J.S.A. 54:10A-6(B) (allocation factor), N.J.A.C. 18:7-8.7 (business allocation factor); and N.J.A.C. 18:7-8.8 (scope of allocable receipts). The Division conceded before the Tax Court, "any attachments to the notice would be fair game." It is these very documents which support inclusion of the issue presented in Kinko's refund request.

Certainly, the Notice of Deficiency reflects the final audit adjustment applied the "throw-out" rule and recalculated the allocation factor. Based on the notice alone, the Division is correct to suggest this presents a challenge "with respect to the original assessment of tax," falling outside the focus of the audit and, therefore, requiring refund relief to be sought under N.J.S.A. 54:49-14(a), not N.J.S.A. 54:49-14(b). However, we reject this narrowed view based upon the facts and circumstances presented in this case.

We determine the unusual facts in this matter include as "issues raised" during the joint audits of affiliated companies, a determination of which entity should claim the royalty stream as income for purposes of assessing CBT liability. Deferring to the judge's factual findings, which we conclude are "supported by adequate, substantial[,] and credible evidence," in the record, Toll Bros. v. Twp. of W. Windsor, 173 N.J. 502, 549 (2002) (citation and internal quotation marks omitted)), we reject the Division's view limiting the deficiency assessment solely to the allocation factor.

The audit work papers attached to the proposal of adjustments, and explicitly incorporated into the Notice of Deficiency, specifically addressed the issue arising between the two affiliates regarding the same royalty income. The documents show the auditor considered reducing Kinko's total income by the royalties it paid to Ventures, but ultimately declined when calculating the tax, pending Ventures' payment of its assessed tax liability. Therefore, for purposes of Kinko's refund claim, the uncontroverted reference to and incorporation of the attached audit work papers substantiate the Division examined, considered and rejected the requested reduction of income for the Ventures royalty expense.

We also do not agree this decision upends the well-defined statutory and regulatory provisions governing taxation issues. We agree a taxpayer may not arbitrarily raise issues during an audit to unnecessarily expand its scope and direction. As we noted, the unique circumstances presented in the simultaneous audits of these affiliated companies support a conclusion summary judgment was properly granted on Kinko's refund request pursuant to N.J.S.A. 54:49-14. The Tax Court judge's findings that audit documentation corroborated Kinko's assertion the issue was raised in the August 8, 2006 deficiency assessment and, therefore, preserved for purposes of a refund request, will not be disturbed. The resultant conclusion, as narrowed by our opinion, is upheld.

1 Created by the Multistate Tax Compact, the MTC is an intergovernmental state agency which regulates the tax liability of large multistate taxpayers. See Multistate Tax Commission, http://www.mtc.gov/The-Commission/Multistate-Tax-Compact (last visited on July 8, 2015). New Jersey is a sovereignty member of the MTC. See Multistate Tax Commission, http://www.mtc.gov/The-Commission/Member-States (last visited on July 8, 2015).

2 Generally, a multistate taxpayer's liability is determined by apportioning or "allocating" income between individual jurisdictions considering the source of receipts. See Whirlpool Props., Inc. v. Dir., Div. of Taxation, 208 N.J. 141, 150 (2011). A three-prong formula is applied, "weigh[ing] a multi-state corporate taxpayer's property, payroll[,] and sales." Ibid. "[T]he sales fraction is calculated by dividing the taxpayer's New Jersey receipts by total receipts of the corporate taxpayer. Id. at 151. Under the "throw-out" rule, N.J.S.A. 54:10A-6(B), the sales factor is modified, removing from the calculation sales in a state where the taxpayer is not filing a tax return. Whirlpool Props., supra, 208 N.J. at 151. "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." Ibid. We note, the "throw-out" rule has since been repealed. See L. 2008, c. 120; Whirlpool Props., supra, 208 N.J. at 150.