The CPA Journal

N.J. Supreme Court Affirms Drop Shipment Apportionment

By Irwin Mittelman, JD, CPA

The New Jersey Supreme Court affirmed two lower courts by holding that a New Jersey manufacturer must include the income from sales to its wholly owned distributor in its apportionment factor, regardless of where the product is shipped. The decision will likely have consequences for companies with affiliated companies that sell their product (Stryker Corp. v. Dir., NJ Sup. Ct., Dkt. No. A-27-00, 6-14-2001).

The facts of this case were fully explored at the tax court level [Stryker Corp. v. Dir., (1999) 18 NJ Tax 270]. Stryker Corporation, a manufacturer of orthopedic hips and knees, shares a building with its wholly owned subsidiary, Osteonics, which sells Stryker products. When Osteonics takes an order for Stryker, it is entered by computer and relayed to Stryker’s computer system. Stryker fills the order and ships it directly to Osteonic’s customers. When Stryker prepared its corporate tax returns for the years 1988–1992, it included in the numerator of the receipts factor only those sales that were physically shipped to locations in New Jersey. The director of taxation included in the apportionment factor all the sales to Osteonics, regardless of where they were shipped, under the reasoning that the sales to Osteonics were earned in New Jersey even though not physically shipped there.

The tax court ruled that the out-of-state shipments should not be included in the receipts factor under NJSA 54:10-6(B)(1)(2), which includes them when the “receipt or appropriation of the orders are shipped to points within the state.” It reasoned that this part of the statute only applies when there is a physical shipment of goods in New Jersey. It also ruled, however, that the receipts should be included under NJSA 54:10-6(B)(6) as “all other business receipts” earned within the state.

Decision and Impact

The supreme court held that the lower court decisions should be upheld not only on state grounds but also on constitutional grounds, and even under the rules of statutory construction. On state grounds, it held that the destination sales rules of NJSA 54:10A-6(B)(1)(2) were not the exclusive method for the apportionment of receipts from the sales of tangible personal property and that the director was not precluded from utilizing NJSA 54:10-6(B)(6) to reflect the taxpayer’s activity within the state. The internal consistency clause of the commerce clause of the U.S. Constitution was not violated through application of the statute. It addressed the issue of statutory construction, most pertinently ejusdem generis, the rule of construction which states that “when general words follow the specific words in a statute the general words are construed to embrace only the objects similar in nature to the objects enumerated by the preceding specific words.” The court did not refute the logic of this argument; it noted, however, that this canon of construction is limited to situations where there is an expression of doubtful meaning, and it has no application where the legislative design is expressed unambiguously.

Legislative action. One of the most persuasive arguments presented by Stryker’s counsel was a review of the legislative history of the receipts apportionment factor. Counsel noted that, twenty years after its enactment, the legislature had deleted a section of the statute that seemingly identified drop shipment situations when a receipt should be apportioned to the state. The relevant section reads: “for the purposes of this subsection (3), an order shall be deemed received or accepted within the State if it has been received or accepted by an employee, agency or independent contractor chiefly situated at, connected with … or sent out from a permanent or continuous place of business of the taxpayer within the state” [NJSA 54:10A-6(B)(3)]. The court examined this statutory change and, based on a 1967 bill memorandum, concluded that it was merely a corrective amendment to fulfill the legislature’s intent that receipts from the sale of tangible personal property would be calculated entirely on a destination basis.

Analysis. Because this is a decision of first instance, New Jersey taxpayers should examine their business structure organization within this state. It is unclear whether the principles espoused in Stryker will be applied broadly or remain limited to the fact pattern.

State and Local Editor:

Stewart Buxbaum, CPA
S. Buxbaum & Company P.C.

Interstate Editor:

Nicholas Nesi, CPA
BDO Seidman LLP

Contributing Editors:

Henry Goldwasser, CPA
M.R. Weiser & Co. LLP

Steven M. Kaplan, CPA
Kahn, Hoffman, Nonenmacher & Hochman, LLP

Warren Weinstock, CPA
Marks Paneth & Shron, LLP

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