State and Local Tax:State Tax Nexus –

No Physical Presence Required

Sarfraz Bacchus Brian McCuller Manager Managing Director

National State and Local Tax Practice

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Objectives

• Describe the general rules of state income/franchise and sales/use tax nexus

• Contrast sales/use tax nexus rules from those for income/franchise taxes

• Describe recent trends in both income/franchise and sales/use tax nexus

• Discuss remedial options available to taxpayers

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Agenda

• Constitutional Underpinnings• Public Law 86-272• Economic Nexus • Factor Presence Nexus• Attributional Nexus • Click-Through Nexus

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State Tax Nexus

Nexus – definite link or minimum contacts• Jurisdiction must have sufficient “nexus” with:

– person, – property, or – transaction

• A business operating in more than one state must address whether it has nexus with each jurisdiction

• Level of activity giving rise to “sufficient” nexus varies

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State Tax Nexus

Constitutional Hurdles to State Taxation• Due Process

– Fourteenth Amendment– Minimum connection – “Fair warning” – embodies traditional notions of fair play and

substantial justice.

• Commerce Clause– Congress regulates interstate commerce– Requires “substantial nexus” to tax – Protect states from trade wars– Imposition of tax could impede interstate commerce

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State Tax Nexus

Commerce Clause Violations• Double taxation• Discrimination against out-of-state business• Taxation of activities unconnected to the taxing state• Taxation of taxpayers with insufficient contact to the

taxing state

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Public Law 86-272

Federal Defense of Interstate Commerce• Federal response to concerns about state nexus• Prevent undue burden on interstate commerce• Protect solicitation activities from creating nexus• Applies only to income taxes• Applies only to sales of tangible personal property• Goods must be shipped from out of state• Not applicable to sales/use, franchise, gross receipts• Immunity extends to independent contractors

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Public Law 86-272

Wisc. DOR v. Wm. Wrigley, Jr. Co., 505 U.S. 214 (1992).• Defined the term “solicitation of orders”

– explicit verbal requests for orders and – any speech or conduct that implicitly invites an order

• P.L. 86-272 protects solicitation activities, not the sales process

• De minimis or trivial unprotected activities is allowed pursuant to P.L. 86-272

• In light of Wrigley decision, the Multistate Tax Commission issued guidance on protected and unprotected activities

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Public Law 86-272

• Approving sales orders• Making repairs• Distributing free samples• Training a sales force• Maintaining a home office• Collecting on delinquent

accounts• Making credit decisions

• Training a customer to sell the product

• Taking a check as a deposit• Recruiting sales personnel• Using a telephone answering

service• Training marketing staff• Resolving customer

complaints

What are protected activities?

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Public Law 86-272

Attempts to Update Public Law 86-272• Business Activity Tax Simplification Act legislation• Apply P.L. 86-272-type concepts to all business taxes• Create uniformity among types of taxes imposed on

interstate commerce by states• Significant pushback from states

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State Tax Nexus

Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977)• Four-prong test for state income tax nexus

– Substantial nexus– Fair apportionment– Cannot discriminate against interstate commerce– Fairly related to services received

• Established two standards for valid imposition of tax• Failed to adequately define “substantial nexus”

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State Tax Nexus

Quill Corporation v. North Dakota, 504 U.S. 298 (1992)• Distinguished the Due Process and Commerce Clause

standards• Targeting a state’s marketplace gives “fair warning” of

Due Process• Cited National Bellas Hess v. DOR that physical

presence is needed to satisfy the Commerce Clause “substantial nexus” requirement for sales and use taxes.

• Limited holding to solely sales and use taxes

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State Tax Nexus

Economic Nexus• States have successfully argued Quill only applies to

sales and use tax• No physical presence required for other taxes• Two approaches (not mutually exclusive)

– Stretching of attributional nexus principle– Directing one’s economic activity at a state’s marketplace (Due

Process) might be enough “contact”

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State Tax Nexus

Judicial Application of Economic Nexus• Related party intangible holding company

– SC: Geoffrey– MD: W.L. Gore; Chicago Classics; SYL– MA: Geoffrey– NJ: Lanco– NM: Kmart Properties– NC: A&F Trademark

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State Tax Nexus

Judicial Application of Economic Nexus• Unrelated intangible holding company

– IA: KFC Corp.

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State Tax Nexus

Judicial Application of Economic Nexus• Directing economic activity

– MA: Capital One Bank– TN: J.C. Penney– WV: MBNA America Bank

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State Tax Nexus

Legislative/Administrative Application of Economic Nexus• FL: TAA No. 07C1-007• CT: Conn. Gen. Stat. § 12-216a• MN: Minn. Stat. § 290.15(1)(b)• NE: Ruling 24-08-1• NJ: TAM (1-10-11)• OR: Rule 150-317.010• VA: Ruling No. 08-63

Factor Presence Nexus

• Typical factor presence standard (ex. MI)– $500,000 of receipts in a state;– $50,000 of property in a state; – $50,000 of payroll in a state; or– At any time during the calendar year within the state at least 25

percent of the taxpayer’s total property, total payroll, or total gross receipts.

• Adopted in:– OH: Commercial Activity Tax– MI: Michigan Business Tax and Corporate Income Tax– CA, CO, & CT: Corporate income/franchise taxes – OK: Business Activity Tax

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State Tax Nexus

Attributional/Agency Nexus• Out-of-state entity’s relationship with an in-state entity• Scripto, Inc. v. Carson and Tyler Pipe Ind., Inc. v.

Washington DOR– Independent contractor can create nexus– Agent, even working for several principals, creates nexus

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Amazon Laws and Sales Tax Nexus

Click-Through Nexus• Not a tax on Internet sales • Relates to affiliate nexus• Origin from New York’s “Amazon Law”• Marketplace Equity Act

– Recent federal legislation introduced to authorize states to require remote sellers to collect taxes without having to conform to the Streamlined Sales and Use Tax Agreement.

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Amazon Laws and Sales Tax Nexus

Click-Through Nexus• Two types:

– Impose Collection Requirement: • Enacted: NY, RI, NC , IL, AK, CA (temporarily suspended), CT• Proposed: AZ, HI, MN, MS, NM, TX, VT, LA , MI, PA

– Impose Notification Requirement:• Enacted: OK, SD, VT• Proposed: AL

• Growing trend:– Newly enacted in 2011: IL, AK, SD, VT, CT, CA (temporarily

suspended)

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State Tax Nexus

Click-Through Nexus• Successful Challenges:

– Discriminates and unduly burdens interstate commerce• Direct Marketing Association v. Huber (Civil Case No. 10-CV-

01546-REB-CBS) – Violates First Amendment free speech

• Amazon v. Lay (No. C10-664 MJP)

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Preventative Measures

• Nexus Study• Voluntary Disclosure Agreements (“VDA”)• Tax Amnesty Programs

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When the State Calls

• Usually the initial contact is in the form of a nexus questionnaire

• No longer eligible for VDAs or amnesty programs?• Consequences of “losing” or not completing a nexus

questionnaire

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Summary/Key Takeaways

Sales Tax• Substantial nexus• Physical presence• Attributional nexus• Click-through nexus• Quill

Non-SalesTax• Substantial nexus• No physical presence• Attributional nexus• Economic nexus• Factor presence nexus• Quill not applicable• PL 86-272 protection

(income tax only)

National SALT Contacts

Craig Williams

Managing Director

(770) 858-4464

Brian McCuller

Managing Director

(901) 842-2850

Todd Harke

Senior Manager

(770) 858-4465

Sarfraz Bacchus

Manager

(770) 858-4454

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CBIZ MHM Business Tax Planning Guide

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Thank You

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