International Flavors & Fragrances, Inc. v. Director, Division of Taxation

507 A.2d 700, 102 N.J. 210, 1986 N.J. LEXIS 882

• Court: Supreme Court of New Jersey
• Decided: April 10, 1986
• Status: Published

Opinions

The opinion of the Court was delivered by

GARIBALDI, J.

This appeal requires us to interpret provisions of the New Jersey Corporation Business Tax Act, N.J.S.A. 54:10A-1 to -40. Under the Act, the tax is measured by a corporation’s net worth and net income. This case concerns the calculation of net income. Specifically, at issue is N.J.S.A. 54:10A-4(k)(l) (section 4(k)(l)), which provides that .100% of the dividends that a corporate taxpayer receives from a subsidiary owned by the taxpayer “to the extent of 80% or more ownership of investment” shall be excluded from the taxpayer’s net income. The critical question is whether section 4(k)(l) requires direct record ownership of 80% of a subsidiary’s stock or whether it is permissible for the corporate taxpayer and its wholly-owned subsidiary to aggregate the stock that they own in the dividend-paying subsidiary in order to satisfy the 80% ownership test.

I

The facts are stipulated. International Flavors and Fragrances, Inc. (IFF), a New York corporation authorized to do business in New Jersey, is subject to the New Jersey Corporation Business Tax Act. During 1975 and 1976, the tax years in issue, IFF owned 100% of the capital stock of International Flavors & Fragrances IFF (Nederland) B.V. (IFF-Holland), 30% of the capital stock of International Flavors & Fragrances IFF (France) S.A.R.L. (IFF-France), and 63% of the capital stock of I.F.F. Essencia & Frangrancias Ltda. (IFF-Brazil). IFF’s wholly-owned subsidiary IFF-Holland owned all of the remaining stock of IFF-Brazil and IFF-France.

During the tax years 1975 and 1976, IFF received dividends from IFF-France and IFF-Brazil that it included in its taxable income for federal income-tax purposes. ¹ On its New Jersey corporation business-tax return, IFF excluded from its entire net income-tax base 100% of the dividends that it received from IFF-France and IFF-Brazil pursuant to section 4(k)(1).²

The Director of the New Jersey Division of Taxation, Department of the Treasury (the Director), took the position that “80% or more ownership of investment” required that IFF be the direct record owner of the stock of IFF-Brazil and IFF-France. Consistent with this interpretation, the Director issued a final determination that IFF had underreported its net income-tax base by failing to include 50% of the dividends that it had received from IFF-France and IFF-Brazil during the tax years in issue.³ • The Director, therefore, assessed additional taxes and interest for those years. IFF filed a complaint with the Tax Court, contending that it met the “80% or more ownership of investment” test by aggregating IFF and IFF-Holland’s direct ownership of stock in IFF-France and IFF-Brazil. Thus, IFF argues that it was entitled to the 100% dividend exclusion from net income even though it was not the record owner of 80% of the stock of IFF-Brazil and IFF-France, because the remainder of the stock of those corporations was owned by IFF-Holland, its wholly-owned subsidiary.

The Tax Court held that IFF-France and IFF-Brazil were 80%-owned subsidiaries of IFF under section 4(k)(1) and therefore IFF was entitled to the 100% dividend exclusion. 5 N.J.Tax 617 (1983). In a published per curiam opinion, the Appellate Division affirmed, 7 N.J.Tax 652, essentially for the reasons stated in the Tax Court’s opinion, with a brief additional discussion of Fedders Fin. Corp. v. Director, Div. of Taxation, 96 N.J. 376 (1984), and Mobay Chem. Corp. v. Director, Div. of Taxation, 96 N.J. 407 (1984).

II

The New Jersey Corporation Business Tax Act, N.J.S.A. 54:10A-1 to -40, enacted in 1945, requires a corporation to pay a franchise tax “for the privilege of having or exercising its corporate franchise in 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 on the basis of entire net income. N.J.S.A. 54:10A-5.

Entire net income is defined as total net income from all sources, and is deemed prima facie equal to the taxable income that the taxpayer is required to report to the United States Treasury Department, with exceptions that are not pertinent here. N.J.S.A. 54:10A-4(d), -4(b), -5. The Act provides for certain adjustments to federal taxable income. One such adjustment is at issue in this case, namely, N.J.S.A. 54:10A-4(k)(1), which states:

Entire net income shall exclude 100% of dividends which were included in computing such taxable income for federal income tax purposes, paid to the taxpayer by one or more subsidiaries owned by the taxpayer to the extent of the 809? or more ownership of investment described in subsection (d) of this section. With respect to other dividends, entire net income shall not include 50% of the total included in computing such taxable income for federal income tax purposes * * *. (Emphasis added.)

“Ownership of investment” is described in N.J.S.A. 54:10A-4(d) (section 4(d)), which provides for a reduction in the net worth of a corporation. In pertinent part, it reads:

The foregoing aggregate of values shall be reduced by 50% of the amount disclosed by the books of the corporation' for investment in the capital stock of one or more subsidiaries, which investment is defined as ownership (1) of at least 80% of the total combined voting power of all classes of stock of the subsidiary entitled to vote and (2) of at least 80% of the total number of shares of all other classes of stock except nonvoting stock which is limited and preferred as to dividends. In the case of investment in an entity organized under the laws of a foreign country, the foregoing requisite degree of ownership shall effect a like reduction of such investment from net worth of the taxpayer, if the foreign entity is considered a corporation for any purpose under the United States federal income tax laws, such as (but not by way of sole examples) for the purpose of supplying deemed-paid foreign tax credits or for the purpose of status as a controlled foreign corporation. (Emphasis added.)

The critical question is whether the New Jersey Legislature intended to exclude from a corporation’s net income base 100% of the dividends that it receives from an indirectly-owned subsidiary. We look first at the statutory language. It is a well-established principle of statutory construction that a court should follow the clear import of statutory language. Fedders Fin.Corp. v. Director, Div. of Taxation, 96 N.J. at 385. Neither N.J.S.A. 54:10A-4(k)(1) nor N.J.S.A. 54:10A-(4)(d) contains an express requirement of record ownership. Section 4(k)(l) refers to “ownership of investment” and section 4(d)(1) speaks in terms of “total combined voting power.” Therefore, to aid in interpreting the statute, we look beyond its words to examine, first, the Legislature’s purpose in adopting the 80%-of-owner-ship-of-investment requirement, and second, the ordinary and well-understood meaning of ownership in the corporate world. Such an examination discloses that the Legislature intended that the 80%-ownership test be satisfied by aggregating a corporate taxpayer’s stock with that of its wholly-owned subsidiary in a dividend-paying subsidiary.

First, the terms used by the Legislature in N.J.S.A. 54:10A-4(k)(1), and in the pertinent part of N.J.S.A. 54:10A-4(d), all reflect the same objective. That objective, revealed in the first sentence of section 4(k)(1), is to provide relief from the potential double taxation that inheres in the taxation of corporate dividends received from a corporate subsidiary.

The 1968 amendments to the Corporation Business Tax Act, L. 1968, c. 250, which provide for the 100% exclusion of subsidiary dividends and for the section 4(d) definition of subsidiary, were designed to implement the recommendations of the State Tax Policy Commission (the Commission). It is clear that a major concern of then-Governor Richard J. Hughes and the Commission was to remove impediments to New Jersey’s economic growth. Among those impediments was the treatment “afforded corporations which do business in New Jersey but also have substantial investment in subsidiaries, especially foreign subsidiaries incorporated in foreign countries and in other states.” Commission on State Tax Policy, The 12th Report at XY (1968). By letter to Senator Toolan, Governor Hughes requested the Commission to study a number of proposals, including a proposal to eliminate the “taxation of dividends received by a parent company from a subsidiary company ...” Letter from Governor Richard J. Hughes to Senator John E. Toolan (May 25th, 1967), reprinted in Commission on State Tax Policy, The 12th Report at 115. Moreover, the Governor requested the Commission “to review the New Jersey corporate tax structure, with particular reference to its effect on the location of corporate headquarters and their capital investment employment in the state.” Commission on State Tax Policy, The 12th Report at 31. The Commission’s Report found that two of the three significant areas of inequity in the corporate-tax law, as it stood prior to the amendments, were its treatment of subsidiary capital and subsidiary dividends. Id. at 44. It considered those two areas of inequity to be negative factors when corporations considered where to locate their headquarters. The Commission Report stated:

Dividends received from such subsidiaries are also an important tax factor. Under the present tax law such subsidiary capital is included in the tax base for the net worth tax, and 50% of the dividends received by the parent corporation from the subsidiary are included in the tax base for the income tax. The result is that major corporations will find a serious tax disadvantage in locating their corporate headquarters in New Jersey, especially if they do a national or worldwide business in which subsidiaries are often a required form of business organization. These same corporations can be a source of important economic development, jobs and tax base for the state. '[/A (emphasis added.)]

In the Press Release accompanying the amendment, Governor Hughes proclaimed the revisions as essential to the continuation of the equitable relationship between government and commerce. New Jersey Press Release Accompanying S. 837 (1968). He stated:

These adjustments derive from recommendations of the State Tax Policy Commission, which was established to insure that New Jersey is not left behind by other states whose tax policies have taken into account the multi-state nature of so much of today’s big business. The division of income and net worth among several taxing jurisdictions, each with a legitimate interest in a business concern, presents one of the most complex and far-reaching questions which government must resolve. We in New Jersey, by this change in our law, make crystal clear our determination to derive from industry and commerce no more than a full fair share of financial support. (Emphasis added.)

The Commission’s Report and Governor Hughes’ statement make it clear that the major reason for the 1968 amendments adopting section 4(k)(l) was to encourage corporations to locate in New Jersey by removing the added tax on dividend income received from a subsidiary. Both the Commission and the Governor thought that New Jersey’s corporate tax policy was shortsighted, particularly with respect to the taxation of investments in, and dividends from, subsidiaries of large multi-national corporations. To make New Jersey competitive with those other states, the Commission recommended the adoption of section 4(k)(l). In so doing, the Commission and the Governor believed strongly that such corporations would be an important boost to the economic growth of the state, leading to more jobs and eventually to more taxes for the state. The solution that the Legislature chose — to offer tax incentives to businesses in order to encourage them to locate in this state — is not usual. Legislatures do so because they think that the benefit the entire state will derive from the infusion of new economic blood into its economy more than compensates for any temporary loss of tax revenue that it may incur.

Given the Legislature’s clear objective to encourage economic growth by removing the tax on the dividends that a corporation receives from its subsidiary, we do not believe that it intended to differentiate between first-tier and second-tier subsidiaries. Whether a corporation directly owns 80% of a subsidiary’s stock (first tier) or whether it indirectly owns 80% of the subsidiary’s stock through a wholly-owned subsidiary (second tier) is of no matter. A corporation deciding where to locate is hardly less deterred by a tax on its second-tier subsidiary than by one on its first. IFF and its subsidiaries, notwithstanding their complex structure, retained the essential unity that the Legislature intended to favor by its enactment of N.J.S.A. 54:10A-4(k)(l).

The Director urges that we ignore the Legislature’s intent and interpret the statutory provisions on the basis of the Division of Taxation’s administrative practice. Since the enactment in 1968 of the statutory provisions in question, the Division of Taxation has consistently interpreted the term “subsidiary,” as defined by N.J.S.A. 54:10A-4(d), and as used in N.J.S.A. 54:10A-4(k)(1), -4(d), and 54:10A-9, to require the taxpayer corporation to have actual ownership of 80% of the total voting and nonvoting stock of another corporation, except nonvoting stock that is limited and preferred as to dividends.⁴

Recently, in two tax cases, we specifically addressed the deference to be given an administrative agency’s construction of a statute. In Airwork Servs. Div. v. Director, Div. of Taxation, 97 N.J. 290, 296 (1984), we acknowledged that the practical administrative construction of a statute over a period of years should be given great weight by the courts. Nevertheless, as we stated in Airwork,

[t]he court will consider this factor only when it is not [sic] satisfied that the Legislature’s intent cannot otherwise be determined by a critical examination of the purposes, policies, and language of the enactment. When such circumstances point strongly to the imputation of a particular legislative intent, they may not be outweighed or overcome simply by a countervailing administrative practice. [Airwork, 97 N.J. at 298.]

In its deference to agencies’ interpretations of statutes, the dissent disregards this clear admonition.

Likewise in Fedders Fin.Corp. v. Director, Div. of Taxation, 96 N.J. 376, 392 (1985), we stated:

It is well established that the Director’s regulatory authority cannot go beyond the Legislature’s intent as expressed in the statute. As Justice Clifford observed in Service Armament Co. v. Hyland, 70 N.J. 550, 563 (1976), “an administrative interpretation which attempts to add to a statute something which is not there can furnish no sustenance to the enactment.” (Emphasis added.)

Deference to an agency in its administration of a statute, however, does not overcome the abundantly clear purpose of the legislation. Because the legislative purpose in this case is so apparent, the Director’s reliance on the Division of Taxation’s administrative practice is misplaced.⁵

III

The Court’s interpretation of the statute accords not only with the Legislature’s purpose but also with the ordinary and well-understood meaning of ownership in the corporate world. In examining statutory language, we are mindful that in the absence of an explicit indication of a special meaning, words will be given their ordinary and well-understood meaning. Service Armament Co. v. Hyland, 70 N.J. 550, 556 (1976).

Clearly, IFF possessed one-hundred percent of “the ownership of investment” in IFF-Holland, and through its ownership of IFF-Holland it possessed 100% of the ownership of investment in IFF-France and IFF-Brazil. Thus, for all practical intents and purposes IFF owned 100% of the investment in IFF-France and IFF-Brazil, as well as in IFF-Holland. Equally important, IFF owned 100% of the “total combined voting power” of IFF-Brazil and IFF-France because IFF owned 100% of IFF-Holland, and therefore it was able to control the voting power of IFF-Holland. Thus, IFF effectively owned not merely 80% but 100% of the ownership of investment. Such a holding conforms with the economic realities of the corporate world and with the statute.⁶ One final point. We do not accept the Director and the dissent’s contention that we rejected precisely this sort of look at economic reality in Fedders Fin. Corp. v. Director, Div. of Taxation, 96 N.J. 376 (1984), and Mobay Chem. Corp. v. Director, Div. of Taxation, 96 N.J. 407 (1984), and instead focused on the literal language of the pertinent statutes. To the contrary, in those cases the majority and dissent chose between their alternate views as to which economic factors most influenced legislative intent.

In Fedders, we addressed an entirely different issue. The concept of “ownership of investment” that is central to this case was never addressed. The taxpayer Fedders Financial Corporation, a wholly-owned subsidiary of its corporate parent, created a subsidiary Fedders Capital, N.V., from which it borrowed sums raised by that subsidiary in the Eurodollar market. The narrow legal issue was whether the debt owed by Fedders Financial to its subsidiary, Fedders Capital, constituted an indebtedness that was owed “indirectly” by Fedders Financial to its own parent, Fedders Corporation, within the meaning of “indebtedness owing directly or indirectly” under N.J.S.A. 54:10A-4(e). This Court held that in order to come within the phrase “indebtedness owing directly or indirectly,” the taxpayer must be indebted to its stockholder, and that loans between affiliated corporations of a common parent are not presumed conclusively to be loans to the parent. This Court found the Director’s per se approach to the question — conclusively presuming loans among parties under common control to be tantamount to loans to the common parent — to be inconsistent with the language and intent of the statute. Such a per se approach would be in total disregard of economic reality. Our holding here and our holdings in Fedders and Mobay emphasize the need to look at the statute and legislative intent. In each of those cases we considered economic reality only to aid in interpreting the statute, not to substitute judicial will for legislative enactment.

In conclusion, we hold that the Legislature in enacting the 80%-or-more-ownership-of-investment test in section 4(k)(l) intended that a corporate taxpayer could aggregate its ownership of stock in a dividend-paying subsidiary with the stock owned in such subsidiary by its wholly-owned subsidiary. This holding conforms with the strongly-expressed legislative intent and with the language of the statute.

Accordingly, we affirm the judgment of the Appellate Division.

1 Under the Internal Revenue Code, IFF-France and IFF-Brazil were deemed controlled foreign corporations of IFF. See 26 U.S.C. § 6038 (1982). For federal tax purposes, control over a foreign corporation is defined as:

(1) Control. — A person is in control of a corporation if such person owns stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or more than 50 percent of the total value of shares of all classes of stock, of a corporation. If a person is in control (within the meaning of the preceding sentence) of a corporation which in turn owns more than 50 percent of the total combined voting power of all classes of stock entitled to vote of another corporation, or owns more than 50 percent of the total value of the shares of all classes of stock of another corporation, then such person shall be treated as in control of such other corporation. * * *

[26 U.S.C. § 6038 (emphasis added).]

2 It is stipulated that solely because of an oversight, IFF did not exclude 50% of its investment in IFF-France and IFF-Brazil from its net worth base. «Such an exclusion would have been consistent with its interpretation of N.J.S.A. 54:10A-4(d).

3 N.J.S.A. 54:10A-4(k)(1) provides that all dividends, regardless of the source, are subject to an automatic 50% exclusion from net income. Dividends received by a corporate taxpayer from a subsidiary in which it has "80% or more ownership of investment” are subject to a 100% exclusion.

4 The Director has not stated his position on record ownership in any regulation promulgated pursuant to the rulemaking requirements of the New Jersey Administrative Procedure Act, N.J.S.A. 52:14B-1 to -13. He has promulgated only one regulation, N.J.A.C. 18:7-4.11, to interpret N.J.S.A. 54:10A-4(d), and that regulation does no more than reiterate the statute.

5 Equally without merit is the Director’s extension of the general rule that tax exemptions are to be construed against a taxpayer to what he characterizes as “an item of tax preference". — a term not to be found anywhere in the statute and for which the Director does not provide a definition. That general rule is merely a presumption. The ultimate inquiry remains legislative intent. MacMillan v. Director, Div. of Tax., 180 N.J.Super. 175, 178 (App.Div.1981), aff'd, 89 N.J. 216, 218 (1982) (Pashman, J., dissenting).

We likewise find unpersuasive the Director's reliance on the New Jersey Business Corporation Act, N.J.S.A. 14A:1-2(r), which defines subsidiary "to mean a corporation whose outstanding shares are owned directly or indirectly by another corporation,” as proof that the Legislature knew how to incorporate an indirect ownership test when it desired one. We agree with the Tax Court that the Business Corporation Act’s language cannot sensibly be used to give meaning to the language of the Corporation Tax Act. 5 N.J.Tax at 626.

6 We limit this holding to cases where the corporate taxpayer and its wholly-owned subsidiary together own 100% of the direct ownership of the stock of the dividend paying subsidiary. We do not decide whether the ownership of stock by a parent may be aggregated with that of a less-than-wholly-owned subsidiary in order to satisfy the 80%-or-more ownership test in a second subsidiary.