Rollins Leasing Corp. v. Director, Div. of Taxation

Decision Date20 October 1994
PartiesROLLINS LEASING CORPORATION, Plaintiff-Appellant, v. DIRECTOR, DIVISION OF TAXATION, Defendant-Respondent.
CourtNew Jersey Superior Court — Appellate Division

Jonathan M. Gross argued the cause for appellant (Hannoch Weisman, attorneys; Mr. Gross of counsel and on the brief; Nina L. Dunn, also on the brief).

Gail L. Menyuk, Deputy Attorney General, argued the cause for respondent (Deborah T. Poritz, Attorney General, attorney; Joseph L. Yannotti, Assistant Attorney General, of counsel; Ms. Menyuk, on the brief).

Before Judges PETRELLA, BROCHIN and CUFF.

The opinion of the court was delivered by

PETRELLA, P.J.A.D.

This appeal concerns whether Rollins Leasing Corporation (Rollins), the taxpayer, properly deducted interest expenses on certain notes payable to a trustee for debenture holders on its Corporation Business Tax (CBT) returns for the years between October 1, 1984 and September 30, 1989. Rollins appeals from the December 13, 1993 order and final judgment entered in favor of the Director Division of Taxation (Director), by the Tax Court, which upheld the Director's disallowance of certain interest deductions.

The matter was tried in the Tax Court largely on stipulated facts, and the decision is reported at 13 N.J.Tax 359. Rollins, a Delaware corporation, is a wholly-owned subsidiary of Rollins Truck Leasing Corporation (RTL), 1 a publicly-held company listed on the New York Stock Exchange. Rollins is engaged in leasing, renting, and maintaining trucks, tractors, and trailers.

To provide Rollins with cash for its operations, RTL issued a series of debentures in the public market between April 18, 1983 and March 15, 1989. 2 At the same time, RTL transferred the funds raised to Rollins in exchange for a promissory note payable to RTL, and in accordance with various loan agreements and a collateral trust indenture, dated as of March 21, 1983 (with various subsequent supplements).

All documents acknowledged that they were subject to the March 21, 1983 trust indenture (and subsequently also to seven supplements thereto) between RTL and Continental Illinois National Bank and Trust Company of Chicago (Continental), Trustee for RTL's debenture holders. The latter corporation is a publicly-held banking institution and is unrelated to Rollins, RTL, or any affiliates.

In all, eight promissory notes were issued according to the loan agreements, under which Rollins and RTL agreed to the assignment and negotiation of the notes and loan agreements, as security, to Continental. RTL first assigned its "right, title and interest" in the notes to Continental in an April 18, 1983 "Assignment of Loan Agreement," which Continental also signed and accepted. Rollins consented to the assignment. The assignment agreement referred to the terms of the collateral trust indenture (and any supplements thereto). Consequently, Rollins paid the principal and interest on the promissory notes directly to Continental. Significantly, the loan agreement provided Continental, as holder of the notes, with the following remedies in the event Rollins defaulted:

SECTION 10. Remedies. The holder of the Note, being a party to, or an assignee of, this Agreement, shall be entitled and empowered to institute any suits, actions or proceedings at law, in equity or otherwise, whether for the specific performance of any covenant or agreement contained herein or in the Note or in aid of the exercise of any power granted herein or in the Note, or may proceed to enforce the payment of the Note after demand, or to enforce any other legal or equitable right as holder of the Note, or may proceed to take any action authorized or permitted under the terms of the Indenture with respect to the Note or under any applicable law.

The loan agreement further provided in Section 11:

... Every remedy given hereunder to the holder of the Note shall not be exclusive of any other remedy or remedies, and every such remedy shall be cumulative and in addition to every other remedy given hereunder or now or hereafter given by statute, law, equity or otherwise.

Section 12 of the loan agreement stated:

Successors and Assigns. All the covenants, warranties and agreements contained in this Agreement by or on behalf of the Corporation, the Borrower or the holder of the Note shall bind and inure to the benefit of their respective successors and assigns, whether so expressed or not.

On July 23, 1991, the Director issued a notice of tax assessment to Rollins and assessed CBT deficiencies totaling $251,936, plus interest and penalties, for the taxable periods between October 1, 1984 through September 30, 1989. These deficiencies resulted, in part, because the Director disallowed certain amounts Rollins had excluded as interest expense on its CBT returns. 13 N.J.Tax at 362. Rollins protested the assessment, and the parties subsequently conferred. The Director then issued "a revised final determination in the amount of $239,063, plus penalties and interest." Ibid.

The Tax Court upheld the final determination of the Director (with minor modifications to the amount owed by Rollins), reasoning that RTL was the primary obligor under the debenture agreements. Id. at 369. Although the Tax Court appropriately ruled out indirect payments of the debt from Rollins to RTL, id. at 369-370, it then found that the payments were direct payments owing from Rollins to RTL, stating:

The use of a trustee and the negotiation of the notes are integral parts of the transaction in which the parent has borrowed directly for the purpose of lending to its subsidiary. The payments by taxpayer to the trustee constitute a repayment by the subsidiary of the parent's primary obligation to repay the debentures. Therefore, the loan repayments must be treated as loan repayments by the subsidiary to its parent.

[Id. at 370.]

I.

Rollins basically asserts that although it had borrowed the funds from RTL, Rollins owed its indebtedness directly to Continental. Once Continental became a holder of the promissory notes it could, among other things, enforce payment of the notes in its own name. RTL, as the endorser, could not sue and recover from Rollins unless RTL paid the obligation and re-acquired possession of the notes. Rollins reasons that it was primarily obligated to Continental, as holder of the notes, for repayment of the loan, while RTL was secondarily liable or a guarantor. Thus, Rollins concludes, the debentures were not a debt instrument of Rollins, but rather, the notes constituted Rollins' obligation to an unaffiliated lender.

The Director, on the other hand, contends that Rollins owed its debt directly to RTL, not to Continental or the debenture holders, and that RTL cannot "change the fact" that Rollins was directly indebted to RTL because RTL required Rollins to pay its debentures. According to the Director, Continental did not take the endorsed promissory notes from RTL in exchange for its obligation under the debentures, but, instead, "as security or collateral" for RTL's obligations. The Director also asserts that RTL pledged the notes to Continental to ensure that it would use Rollins' loan payments to retire its debt obligation to the debenture holders. Under that approach, Rollins was, in effect, a guarantor of RTL's obligations under the debentures. The Director also argues that the endorsements of the notes were restrictive, rather than unconditional, and, thus, RTL only transferred to Continental a security interest in the notes, not an outright ownership of Rollins' indebtedness.

The Director further argues that Continental could only have transferred, negotiated, discharged, or enforced payment of the notes upon event of default and, until that happened, the notes constituted collateral and were held as security for RTL's debt obligation. Under this view, the Director contends that there was only a pledge of Rollins' debt by RTL as security for its own debt and, thus, this did not convert Rollins' debt from a direct indebtedness to RTL into a direct indebtedness to Continental, nor relieve Rollins of its indebtedness to RTL. Finally, the Director maintains, without basis in the record, that Rollins made its payment to Continental at the direction of RTL and not as a consequence of any direct indebtedness of Rollins to Continental. This argument implies that any secondary obligation Rollins had to Continental came into existence only as a consequence of Rollins' direct obligation to RTL and the promises Rollins made to RTL in consideration for the loan.

II.

The New Jersey Corporate Business Tax Act (Act), N.J.S.A. 54:10A-1 to -40, is an annual franchise tax on a domestic or foreign corporation "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 computed by adding prescribed percentages of a net worth 3 and net income tax base. N.J.S.A. 54:10A-4(d), 4(k), and 5.

The Act imposes a tax on the entire net income of a corporation, computed without exclusion, deduction, or credit of "90% of interest on indebtedness owing directly or indirectly to holders of 10% or more of the aggregate outstanding shares of the taxpayer's capital stock of all classes...." N.J.S.A. 54:10A-4(k)(2)(E) (emphasis added). The phrase " '[i]ndebtedness owing directly or indirectly' [includes], without limitation[,] ... all indebtedness owing to any stockholder or shareholder and to members of his immediate family where a stockholder and members of his immediate family together or in the aggregate own 10% or more of the aggregate outstanding shares of the taxpayer's capital stock of all classes." N.J.S.A. 54:10A-4(e). See also N.J.A.C. 18:7-4.5(b). Thus, a corporation can only reduce its "net income" by ten percent of the interest on...

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