State Tax Return I. SUBSTANTIAL NEXUS LITIGATION IN THE STATE COURTS

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1 March 2006 Volume 13 Number 3 State Tax Return NEXUS: UPDATE ON RECENT DEVELOPMENTS Maryann B. Gall Chen Meng Lam Columbus Columbus Law Clerk (614) (614) We keep track of nexus developments each year legislation, administrative interpretations, the passage of rules and regulations, and court cases. This issue of our newsletter outlines important nexus developments from August, 2005, through December, It is organized by the kind of activity that tends to give out-of-state entities nexus planning and litigation difficulties, such as employee visits, trade show attendance, and affiliate nexus. We hope you find it helpful in your planning and compliance work. I. SUBSTANTIAL NEXUS LITIGATION IN THE STATE COURTS A. Employee Visits We now have the concept of horse nexus in the reported literature on what creates nexus. In what is an unbelievable decision for your Senior Editor, the Washington Board of Tax Appeals determined that an out-of-state manufacturer and seller of cattle, horse, and ranch equipment had nexus in Washington because the Texas manufacturer conducted demonstration horse shows. The Board of Tax Appeals found that the manufacturer s horse handlers had created nexus because they displayed its horses in parking lots of Washington retailers! This is a new low for nexus jurisprudence! On the other hand, the Florida Department of Revenue issued a technical assistance advisement that concluded that an annual visit to one Florida customer, during which no sales orders were taken, did not create nexus for a specialty distributor of cable products. In Tennessee, a revenue ruling issued in December, 2005, determined that an out-of-state on-line operator of a website had nexus in Tennessee because it had an employee in Tennessee. 1. FLORIDA a. Technical Assistance Advisement, No. 05A-045 (Florida Dep t. of Revenue, Nov. 2, 2005). i. Taxpayer was an out-of-state specialty distributor of electrical wire and cable ( cable products ). Taxpayer

2 purchased cable products from different sources located around the country and resold the same products to customers. Taxpayer completed some sales to customers domiciled in Florida, but these products were initially purchased from the vendor s other locations and shipped to Florida using third party freight lines. In addition, Taxpayer would purchase cable products from one vendor, with such products shipped from the vendor s Florida warehouse. Taxpayer did not own or lease any property, hold inventory or materials in Florida, or have any employee or agent in Florida. About once a year, an employee of the taxpayer would travel to Florida to visit a customer during which no sales orders were taken. The Department ruled that the once a year visit to one customer during which no sales orders were taken was considered inconsequential, and thus would not create nexus with Florida for sales and use tax purposes. In addition, when an out-of-state vendor shipped to a Florida customer from out-of-state, no nexus would be created, even if the out-of-state vendor had nexus with Florida. The out-ofstate shipping thus would not create nexus. Similarly, when an out-of-state vendor shipped from its warehouse facility in Florida to the customers in Florida, nexus would also not be created by this act alone. 2. TENNESSEE a. Revenue Ruling No , CCH (Tenn. Dep t. of Revenue Dec. 19, 2005). i. Out-of-state Taxpayer operated an online website which allowed customer users to access a database the taxpayer created to search for information that were of interest to the users. Taxpayer charged customers for using the information on its website. In addition, Taxpayer sold software and other hard goods through its website. To increase its user base, Taxpayer purchased a wholly-owned subsidiary which maintained internet message boards for information related to the taxpayer s business sector. Taxpayer posted links to its website on its subsidiary s message board. Taxpayer had one employee in Tennessee who assisted in maintaining the subsidiary s message board and website. The employee accessed the subsidiary s servers which were located outside of Tennessee. The employee had no interaction with the taxpayer s customers. Other than this employee, the taxpayer and its subsidiary did not have other physical presence in Tennessee. -2-

3 i The Department held that the taxpayer had sufficient nexus with Tennessee for sales and use tax purposes. The Department reasoned that because the taxpayer had an employee in Tennessee, the taxpayer had a physical presence in Tennessee and thus had nexus with Tennessee. According to the Department, it was immaterial whether the employee contributed to sales made by the taxpayer. The Department further stated that the physical presence was not slight because the employee benefited from public roads, police protection, a judicial system, and other protections and services afforded by Tennessee. The Department further found that the taxpayer had purposefully directed its activities to Tennessee residents, and determined that the taxpayer s sales activities in Tennessee thus met the Due Process Clause. In finding so, the Department noted the fact that the taxpayer had about 100,000 customers in Tennessee and had made high volume of sales in Tennessee. 3. WASHINGTON a. Priefert Mfg. Co. v. Washington Dep t. of Revenue, No , 2005 Wash. Tax LEXIS 525 (Wash. Bd. of Tax App. Nov. 16, 2005). i. Taxpayer was a Texas corporation engaged in the manufacturing and sale of cattle, horse, and ranch equipment. About nine Washington retailers carried the taxpayer s products. Taxpayer conducted demonstration horse shows in Washington over the past few years, in which the horse handlers were the taxpayer s employees who wore shirts with the taxpayer s logo. Also, the horses used in the shows traveled in the taxpayer s trucks that prominently displayed the taxpayer s logo. The taxpayer also had a sales representative assigned to Washington. The sales representative lived outside Washington but regularly visited the taxpayer s retailers in Washington. Taxpayer had no offices in Washington. i The Department determined that the taxpayer was liable for Washington business and occupation (B&O) tax because it had a nonresident employee soliciting sales in Washington. Taxpayer appealed, arguing that there was insufficient nexus with Washington. The Board held that the taxpayer had sufficient nexus with Washington for B&O tax purposes. The Board found that the -3-

4 B. Trade Shows And Seminars taxpayer s employees (i.e., the horse handlers) had operated in a marketing capacity in Washington, and therefore the taxpayer had physical presence in the state. Moreover, the Board found that the taxpayer s display of its horses in the parking lot of a Washington retailer was designed to market its name and products in Washington. The Board also affirmed the Department s determination that the taxpayer s business visits to Washington retailers through its sales representative were significant in establishing and maintaining a market in Washington. In the following Indiana Department of Revenue Letter of Findings, a final determination of the Indiana Department, a Michigan retailer of sports trading cards, collectibles, and other memorabilia was found to have nexus in Indiana because of its trade show activities in Indiana. They include rental of tables and chairs, inventory in the state, and collecting fees from participating dealers. 1. INDIANA a. Letter of Findings No , CCH (Ind. Dep t. of Revenue, Dec. 1, 2005). i. Taxpayer was a Michigan retailer of sports trading cards, collectibles, and other memorabilia, with its retail store located in Michigan. Taxpayer organized trade shows at shopping malls in Indiana. Apart from selling cards and memorabilia at the shows, Taxpayer also solicited participation at the shows from other dealers and arranged for the use of display spaces within the malls. Taxpayer also advertised the shows in local newspapers and rented tables and chairs needed for the shows from rental companies. Taxpayer then collected rental fees from the dealers attending the shows for the use of the tables and chairs. The Department held that the taxpayer s activities in Indiana were sufficient to qualify as doing business in Indiana for corporate income tax nexus purposes. In holding so, the Department noted the fact that the taxpayer had brought merchandise into Indiana and sold it, rented the tables and chairs, and collected fees from other dealers who also sold their merchandise at these shows. Accordingly, these nexuscreating activities subject the taxpayer to tax on income earned on the sales of merchandise and fees charged to dealers to participate in the trade shows in Indiana. -4-

5 C. In-State Personnel Opinions and rulings from Idaho, Massachusetts, New York, and Texas illustrate an important point if an independent contractor, sales representative, or manufacturing representative is conducting activities within a state for an out-of-state company, the nature, duration, and economic substance of the in-state activities will be closely scrutinized. After this sort of scrutiny, the state taxing agency will make a determination of sales/use or income tax nexus. As always, these determinations are done on a case-by-case basis, so you have to know what the facts are in your particular situation. 1. IDAHO a. Idaho State Tax Commission Decision No , CCH (June 2, 2005). i. Taxpayer was an out-of-state corporation that manufactured, marketed and distributed household products. Taxpayer also sold non-exclusive franchise rights to a number of individuals (independent business owners, also known as IBOs ) in Idaho. These IBOs then conducted numerous solicitation and marketing business activities on the taxpayer s behalf. Taxpayer claimed that it had no employee, business office, manufacturing facility or warehouse within Idaho. i The auditor determined that the taxpayer was subject to Idaho corporate income tax on the basis that the IBOs were taxpayer s representatives and that the in-state activity of the IBOs exceeded the protection of Public Law Taxpayer argued that the IBOs in Idaho were merely its customers, rather than its representatives, and that its activities within Idaho were protected under Public Law Taxpayer further argued that it lacked physical presence in Idaho and thus sufficient nexus with the state because it did not have any employee or other business facility in Idaho. The Commission upheld the tax assessment against the Taxpayer. First, the Commissioner found that that the IBOs were sales representatives of the taxpayer and not merely customers because the IBOs were bound by a contractual relationship with the taxpayer that set out the IBOs responsibilities and the IBOs acted on behalf of the taxpayer in promoting the taxpayer s products. Second, the Commissioner concluded that the IBOs were engaged in business activity that exceeded protection of Public Law because the IBOs solicited sales of intangible franchise -5-

6 rights when they recruited new IBOs on behalf of the taxpayer. According to the Commission, such activity conducted by the IBOs went beyond the mere solicitation of orders for the tangible household products of the taxpayer. iv. In addition, the Commission held that the taxpayer had sufficient corporate income tax nexus with Idaho, finding that the taxpayer had a physical presence within Idaho through the IBOs who conducted in-state solicitation and sales activities on behalf of the taxpayer. The Commissioner also stated that since the taxpayer had a physical presence in Idaho, it need not address the taxpayer s question of whether a corporation with no physical presence in Idaho nonetheless has substantial nexus for income tax purposes. 2. MASSACHUSETTS a. Letter Ruling 05-08, 2005 Mass. Tax LEXIS 72 (Mass. Dept. of Rev., Nov. 21, 2005). i. Taxpayer was a portfolio company organized, outside of the United States, for the purpose of trading commodities, commodity-linked contracts, and securities. A Massachusetts commodity advisor acting as an independent contractor conducted the trading on behalf of the taxpayer pursuant to an investment advisory agreement. The advisor s activities are limited to the following: (1) communicating with the taxpayer s shareholders and the general public; (2) soliciting sales of the taxpayer s stock; (3) auditing its books of account; (4) disbursing payments of dividends, legal and accounting fees, and officer s and director s salaries; (5) making redemption of its own stock; and (6) executing contracts related to the purchase, sale or management of commodities and securities. The Department held the advisor s activities in Massachusetts will not cause the foreign taxpayer to have nexus with Massachusetts. The Department reasoned that since the advisor was an independent contractor on behalf of the taxpayer and its trading activities were limited, the advisor satisfied the independent contractor exception under Massachusetts law which allows the advisor to execute contracts related to the purchase, sale or management of securities without causing the offshore taxpayer to have nexus with Massachusetts for corporate excise purposes. The Department also stated that the independent contractor exception applies equally in a case, -6-

7 as here, of traded commodities and commodity-linked contracts. 3. NEW YORK a. Advisory Opinion, Petition No. C050304A, 2005 N.Y. LEXIS 268 (N.Y. Dep t. of Tax & Fin., Oct. 24, 2005). i. Taxpayer, incorporated and located in New Jersey, was a corporation that performed monitoring services of its personal emergency response and alarm systems. Most of the taxpayer s customers were in New Jersey, but some sales had been made to customers in New York. Taxpayer did not have an office, employees, representatives or inventory in New York. Taxpayer contracted with a third party to buy and install monitoring equipment in New York homes, and paid the third party for such installation and equipment. Taxpayer then invoiced the New York customers for the sale of the equipment, installation, and monitoring services. Taxpayer only performed the monitoring services from its New Jersey facility over telephone lines and radio signals. The Department held that the taxpayer was not doing business in New York for corporate franchise tax purposes. The Department reasoned that the activities of the third parties hired by the taxpayer as independent contractors in New York to install and service the monitoring equipment were not considered activities conducted by the taxpayer. The Department also noted that the taxpayer was not employing capital in New York, did not own or leased property in New York, and did not maintain an office in New York. The Department further stated that the results would, however, be different if there was an agency relationship between the taxpayer and the third parties. b. Advisory Opinion, Petition No. C040526A, 2005 N.Y. LEXIS 295 (N.Y. Dep t. Tax & Fin., Dec. 12, 2005). i. Taxpayer was an out-of-state manufacturer and seller of concrete amenities. Taxpayer did not have any employees or property located in New York. All of the taxpayer s product sales in New York originated from out-of-state salesmen or independent contractors. All purchase orders from customers in New York were forwarded to the taxpayer s headquarters outside of New York. All orders were constructed, fabricated and shipped from outside of New York using common carriers. -7-

8 i Taxpayer did not install its products and offered minimal assistance on repairs of its products sold in New York. Generally, if a product was damaged, Taxpayer would send a new item to the customer instead of repairing the damaged item. If repairs were needed, the work was primarily performed by the taxpayer s customer on the job site, with support provided by the taxpayer by telephone from outside of New York. Only on a rare occasion (perhaps once every two or three years) had the taxpayer sent its employee to New York to repair an item. The Department held that although the on-site repair activities performed (once every two or three years) exceeded the solicitation of orders within the protection of Public Law , such activities were de minimis in New York and would not subject the taxpayer to franchise tax. In addition, the Department held that that the taxpayer s other contacts with New York, being a defendant in a product liability case and being a party to an agreement with a university for the development of new products) also did not constitute doing business in New York. The Department reasoned that being a defendant in a product liability case was not an activity for which the taxpayer was organized in its pursuit of profit, and that under the agreement with the university, the taxpayer was not an agent but merely a licensee allowed to sell the products developed. According to the Department, such activities did not constitute doing business in New York. 4. TEXAS a. In Re: ***, Texas Comptroller Decision Hearing No. 44,052, CCH (Tex. Cmptr. Pub. Acct., Oct. 5, 2005). i. Taxpayer was a manufacturer of store fixtures located in Utah. Taxpayer had initially delivered fixtures to Texas customers in company trucks, but after the taxpayer sold its trucks, it began delivering fixtures to Texas using common carriers. During the relevant period, Taxpayer used its related company to install fixtures in Texas and hired an individual to come into Texas to solicit orders. After the change in delivery method, Taxpayer collected use tax only on transactions where its employees or third-party contractors had performed installation in Texas. Upon audit, the auditor determined that the taxpayer was required to collect use tax on all sales made to Texas customers, not just on transactions for which the taxpayer -8-

9 had invoiced customers for installation. Taxpayer believed that it was required to collect use tax on only those transactions for which nexus was established, that is, transactions which it had performed installation in Texas. Specifically, Taxpayer argued that for fixtures delivered into Texas using common carriers with no accompanying installation in Texas, there was insufficient nexus between the transaction and the state to subject such sales to use tax. i The Department upheld the additional use tax assessment against the taxpayer, reasoning that the activities of performing installation in Texas and hiring an individual to solicit orders within the state are nexus-creating activities for the taxpayer. Once nexus was created, Taxpayer was therefore subject to Texas use tax on all taxable sales made to Texas customers, not just those sales that involved installation. The Department acknowledged that delivery by common carrier itself did not create nexus, and that if the taxpayer had not engaged in installation activities, there would be insufficient nexus to impose use tax on all taxable sales that the taxpayer made to Texas customers. D. Affiliate Nexus In a very sensible decision in Alabama, the Administrative Law Judge ruled that an Illinois taxpayer was not subject to Alabama corporate income tax because it had rail cars leased to its customers that traversed Alabama and stopped at various Alabama locations. The Alabama Department appealed the case and this matter should be closely watched by all taxpayers. Also, the Illinois Department of Revenue issued an affiliate nexus determination for a Connecticut retailer that sold hockey jerseys through the Internet. Because the facts of manufacturing and shipment are different, you are urged to carefully review this determination if you are doing business in Illinois. The Maryland Comptroller, in its newsletter, adopted the California version of agency nexus found in the bn.com and borders.com litigation. Finally, in its letter ruling, the Massachusetts Department of Revenue reached the opposite result and distinguished the Borders Online, LLC v. State Board of Equalization decision in California from the facts presented to it by an out-of-state retailer. -9-

10 1. ALABAMA a. Union Tank Car Co. v. Alabama, No , 2005 Ala. Tax LEXIS 3 (Ala. Dep t. of Revenue, Jan. 11, 2005). i. Taxpayer was a Delaware corporation, headquartered in Illinois, that manufactured and leased railroad cars to customers throughout the United States. During the tax years at issue, Taxpayer manufactured the railcars in Illinois and Texas, and executed all its leasing agreements in Illinois. Upon the execution of a lease, the lessee arranged for a railroad to pick up the railcar from the taxpayer s manufacturing facility and hauled the railcar to a location designated by the lessee. The leases were for a fixed monthly amount, paid to the taxpayer in Illinois. Taxpayer had no control over where the leased railcars were used. None of the taxpayer s regional sales offices and repair and service centers was located in Alabama. Taxpayer conducted no business, had no employees, and owned no property in Alabama. Taxpayer, however, had one Alabamabased lease customer and also some other lessees which used its railcars in interstate commerce in Alabama. i Upon audit, the Department determined that the taxpayer was liable for Alabama corporate income tax on the basis that the taxpayer conducted its leasing business in Alabama and derived income (the alternative prong under Alabama s income tax nexus statute) from the lessees use of its railcars located in Alabama. On appeal, the Chief Administrative Law Judge ( ALJ ) disagreed with the Department and held that the taxpayer was not subject to Alabama corporate income tax because it was not doing business in Alabama or deriving income from sources in Alabama. The ALJ reasoned that because the lease contracts were executed in Illinois, the railcars were picked up and returned by the lessees in Illinois, and the lease payments were made to the taxpayer in Illinois, the taxpayer was considered to be doing business and earning income in Illinois. Moreover, the amount of the lease payments was fixed, and did not depend on how frequently or where the lessee used the railcars. The fact that the lessees used the railcars in Alabama, over which the taxpayer had no control, was therefore irrelevant. Accordingly, the ALJ held that the taxpayer lacked sufficient nexus with Alabama. -10-

11 iv. Importantly, the ALJ made clear that it was deciding the case purely on statutory, not constitutional, grounds. The ALJ explained that since it had determined that the taxpayer was not subject to Alabama income tax under the Alabama statute, it need not address the next issue of whether Alabama was constitutionally prohibited from taxing the taxpayer by the Due Process and/or Commerce Clauses. v. The ALJ set forth the standard in determining when a lessor would be subject to Alabama income tax: (1) if a leasing business located in Alabama leases property in Alabama, all of the lease proceeds would be subject to Alabama income tax, regardless of where the leased property was used; but (2) if an out-of-state leasing business whose only contact with Alabama is the use of leased property by lessees in Alabama, the business would not be liable for Alabama income tax. vi. The Department has appealed the case to Montgomery County Circuit Court. However, the ruling has not been issued by that court yet. 2. ILLINOIS a. Private Letter Ruling No. IT GIL, 2005 Ill. PLR LEXIS 173 (Ill. Dep t. of Revenue, Sept. 9, 2005). i. Taxpayer, incorporated in Connecticut, sold hockey jerseys at retail through Internet. Taxpayer purchased its hockey jerseys from a vendor located outside Illinois. An unrelated Illinois subcontractor ( BBB ) performed embellishment services (stitching of letters and/or numbers) on the jerseys prior to shipping them to the end customer. The stitching materials were provided by BBB. Taxpayer did not have any other property or employees located in Illinois. All shipments were made via common carrier. Taxpayer provided five scenarios regarding its business operations utilizing BBB. In scenario 1, Taxpayer ordered jerseys from its vendor which were drop shipped directly to BBB in Illinois. BBB then stored the jerseys until the taxpayer received an order for a jersey at which time BBB performed its alterations and drop shipped the jersey to the end customer on behalf of the taxpayer. Scenario 3 had similar facts as scenario 1 except that, instead of BBB drop shipping the jersey to the end customer, the jersey was shipped to the taxpayer in Connecticut who then shipped the jersey to the end customer. The Department held that in both scenario 1 and -11-

12 3, Taxpayer would have sufficient nexus with Illinois for corporate income tax purposes. The Department reasoned that BBB in effect acted as an independent contractor that stored the jerseys for the taxpayer. Because the jerseys were stored in Illinois and continued to belong to the taxpayer, Taxpayer was not protected by Public Law i iv. In scenario 2, the jerseys were stored by the taxpayer in Connecticut. Upon receiving an order, Taxpayer then shipped the jersey to BBB in Illinois which then drop shipped to the end customer on behalf of the taxpayer. In scenario 5, Taxpayer purchased jersey directly from BBB which then shipped to customers on behalf of the taxpayer. In scenario 2 and 5, the Department found insufficient nexus with Illinois because BBB in effect acted as an independent contractor for the taxpayer in shipping completed goods to the taxpayer s customers. According to the Department, the using of an independent contractor for shipment and delivery purposes was within the protection of Public Law In Scenario 4, same as scenario 2 except that, instead of BBB drop shipping the jersey to the end customer, the jersey was shipped back to the taxpayer in Connecticut who then shipped to the end customer. The Department determined that, assuming that the taxpayer s customers were not from Illinois, there was insufficient nexus between the taxpayer and Illinois to subject the taxpayer to Illinois income taxes. 3. MARYLAND a. Newsletter, Maryland Comptroller of the Treasury, Fall i. An out-of-state vendor will have nexus for sales and use tax purposes if it has offices, distribution, storage or other facilities for the sale of tangible personal property or a taxable service in Maryland. The same applies if the out-of vendor has an agent, salesperson, repairman, or other representative in Maryland or that enters Maryland on a regular basis. An out-of-state Internet or catalog business that allows brick and mortar retailers located in Maryland to place orders, take returns or provide other services on its behalf has nexus with Maryland for sales and use tax purposes. It will then be required to collect the Maryland sales and use tax on all taxable sales and services delivered to Maryland -12-

13 customers, even though these businesses are separate legal entities. 4. MASSACHUSETTS a. Letter Ruling No (Mass. Dep t. of Revenue, Nov. 8, 2005). i. An out-of-state business ( Taxpayer ), together with its outof-state subsidiaries ( affiliates ), sold tangible personal property into Massachusetts via mail-order of the Internet. Taxpayer did not own or lease property in the state, have instate employees, participate in in-state trade shows, and were not registered to do business in the state. At present, Taxpayer and its affiliates did not have sales or use tax nexus with Massachusetts. i Taxpayer planned to establish a retail store in Massachusetts ( Retail store ) which would sell similar merchandise, using similar trade names, as its out-of-state affiliates. The inventories of the Retail store would, however, not be identical to the inventories of the affiliates. The Retail store would conduct no in-store advertising for any of the affiliates. Although the Retail store planned to purchase catalogs from the affiliates for reference guides and merchandise education, these catalogs would be kept under the counter and would not be readily available to customers in Massachusetts. The Retail store s customers would not be able to order items from the affiliates at the store. In addition, under the Retail store s return policy, customers could return all items carried by the Retail store. This policy applied not only to items purchased from the out-of-state affiliates but to those items purchased from unaffiliated competitors. The Retail store and the affiliates would participate in a joint credit card program allowing customers to accrue points that could be redeemed for items purchased at the Retail store, online, or through mail orders. The Department held that the establishment of the in-state Retail store would not create sales and use tax nexus for the out-of-state taxpayer, concluding that there must be some additional connection between related corporations beyond a related company name and similar inventory of merchandise to constitutionally require an out-of-state affiliate with no physical presence in Massachusetts to collect sales or use tax. According to the Department, the Retail store was engaging in business for itself, and its activities, at most, would only have an incidental impact on the out-of-state affiliates market in the state. The Department also made -13-

14 clear that common ownership is not determinative, and that the connection with the state does not have to rise to the level of the in-state store acting as agent for the out-of-state affiliates under common law principles. iv. The Department found that the Retail store s return policy, which applied to merchandise wherever originally purchased by the Retail Store, was distinguishable from the return policy at issue in Borders Online, LLC v. State Board of Equalization, 2005 Cal. App. LEXIS 875 (Cal. Ct. App. May 31, 2005). Unlike Borders Online, the policy here did not meaningfully benefit the out-of-state affiliates, as the Retail store only allowed returns of merchandise that were carried by and sold in that store. Second, the Department found that the use of catalogs and common gift certificates only incidentally benefited the affiliates. Third, the Department found that the market for the affiliates had already been established, and that based on past experiences in other states, the Retail store opening was expected to cause a reduction in the out-of-state affiliates sales into Massachusetts. The Department found this to be a compelling point, as it shows that the store is not growing or maintaining a market for its affiliates. 5. PENNSYLVANIA a. Legal Letter Ruling No. CRP (Penn. Dep t. of Revenue, Aug ). i. Taxpayer had no employees, direct business activities or other physical presence in Pennsylvania. Three affiliates, designated as Company X, Company Y, and Company Z, located in Pennsylvania performed various activities for the taxpayer in Pennsylvania. The Department reviewed the operations of each of these affiliates and concluded that only Company Z s activities would create nexus for the out-ofstate taxpayer. Company X would provide management and corporate shared services to the taxpayer for an arm s-length fee. A second affiliate, Company Y, would provide the taxpayer with pharmaceutical development services in Pennsylvania for arm s-length, cost-plus fees. The Department concluded that the activities of these two affiliates would not create corporate tax nexus for the taxpayer because they would not be acting as agents or representatives of the taxpayer. -14-

15 i Taxpayer would sell products to Company Z pursuant to a Product Sales Agreement ( Agreement ), and ship the products directly from its out-of-state warehouse to Company Z s customers. The Agreement recognized that Company Z would be soliciting orders for the sale of products owned by the taxpayer. Although the Agreement did not specify on whose behalf the solicitation activities would be conducted, the Department concluded that Company Z solicited on the taxpayer s behalf because the taxpayer paid Company Z an amount which was dependent upon such solicitation activities. The Department accordingly concluded that the taxpayer was subject to franchise tax in Pennsylvania because Company Z s solicitation activities on the taxpayer s behalf would either create or maintain a Pennsylvania market for the taxpayer. In addition, if Company Z were to execute contracts in Pennsylvania on the taxpayer behalf, the taxpayer may lose the protection under Public Law and be subject to Pennsylvania corporate net income tax. 6. WEST VIRGINIA a. Technical Assistance Advisory (W.Va. Tax Dep t., Aug. 24, 2005). i. Parent, an out-of-state retailer, had several subsidiaries, three of which are a customer service subsidiary ( Contact subsidiary ), an e-commerce service provider ( E-commerce subsidiary ), and a retailer subsidiary ( Retailer subsidiary ). The Parent and the Retailer subsidiary had no property or employees in West Virginia, but the Contact subsidiary had a customer service facility in West Virginia. The Contact subsidiary provided presale and post-sale support to only out-of-state Internet and telephone customers purchasing from the Retailer subsidiary, and all customer contacts originating from inside West Virginia would be blocked, that is, s and phone contacts from West Virginia residents to Contact subsidiary would be re-routed to a separately incorporated customer service entity located outside West Virginia. In addition, the Contact subsidiary would take orders from out-of-state customers on behalf of the out-ofstate Retailer subsidiary. The Department held that the provision of customer support services and/or the order taking from out-of-state customers by the Contact subsidiary would not result in the Contact subsidiary s nexus with West Virginia being imputed to Retailer subsidiary. The Retailer subsidiary was not liable for -15-

16 West Virginia sales or use tax on sales of their products to customers in West Virginia as a result of the services provided by the Contact subsidiary. In holding so, the Department looked to the following facts: (1) that the Contact subsidiary had entered into arms length transactions with the Retailer subsidiary in providing such customer services support; (2) that the Contact subsidiary would not actively solicit orders; (3) that the Contact subsidiary would not deliver ordered goods to the purchasers; and (4) that the Contact subsidiary would not provide customer support to West Virginia customers. i The Department further stated that if, however, the Retailer subsidiary were to maintain a physical presence in West Virginia and make sales to West Virginia residents, the Retailer subsidiary would be liable for such taxes, regardless of where the customer support took place. E. In-State Advertising/Solicitation The New Jersey Tax Court found that a Pennsylvania manufacturer and seller of candy and confections exceeded the federal immunity found in P.L for income tax for a variety of reasons picking up damaged or returned goods from its New Jersey customers and collecting payments on current and delinquent accounts. This New Jersey decision is a good explanation of what is acceptable and what crosses the line over mere solicitation, as instructed by the U.S. Supreme Court in the Wrigley case. 1. NEW JERSEY a. Asher, Inc. v. Director, Division of Taxation, No , 2006 N.J. Tax LEXIS 1 (N.J. Tax Ct. Jan. 5, 2006). i. Taxpayer was a Pennsylvania-based manufacturer and seller of candy and confections. During the relevant period, Taxpayer did not lease or own any real property in New Jersey. Taxpayer was registered to do business in New Jersey and regularly solicited business in New Jersey. Taxpayer employed two salespersons who, equipped with catalogs and samples, solicited and visited customers in New Jersey. In addition, Taxpayer employed about eight drivers to deliver ordered products to its New Jersey customers on a daily basis. While delivering the products, the drivers also picked up damaged or returned goods from New Jersey customers. The delivery drivers also collected payments on current and delinquent accounts from New -16-

17 Jersey customers. Both the picking up of goods and the collection of accounts by drivers were performed as a matter of company policy. i iv. The Department assessed New Jersey corporation business tax (CBT) against the taxpayer. The Department determined that the taxpayer s activities of picking up and replacement of damaged or returned goods and the collection of current and/or delinquent accounts in Tennessee exceeded solicitation and thus were not protected under Public Law According to the Department, such activities served an independent business function activity that did not facilitate the actual solicitation of orders. Taxpayer appealed, arguing that the delivery of products using its own drivers to New Jersey customers did not result in loss of immunity under P.L Taxpayer further argued and that the pickup of products and collection of payments from New Jersey customers were ancillary to the solicitation of sales, and were also de minimis activities. The New Jersey Tax Court upheld the CBT assessment against the taxpayer. Although the court recognized that the mere delivery by the taxpayer s drivers did not jeopardize P.L tax immunity, the court held that the picking up of goods and the collection of accounts by delivery drivers in New Jersey were not protected under P.L The court further held that such activities were not ancillary to the solicitation of sales. Importantly, the court reasoned that these activities may help facilitate sales by providing better service to customers but the activities do not help facilitate the requesting of sales. The court also distinguished this case from Wisconsin Dep t. of Revenue v. Wrigley, 505 U.S. 214 (1992) on the basis that the delivery drivers picking up damaged goods were not salesmen and were not regularly engaged in solicitation. Moreover, the collection of accounts by the drivers was not supervised by the taxpayer s sales department. The court further held that the activities were not so limited in scope or frequency as to constitute de minimis activity. In finding so, the court looked to the company policy regarding the pick up of products and the collection of accounts, as well as the regularity of such activities. These findings, according to the court, showed that it was not a case in which a delivery driver picked up goods or payment on a few occasions as a courtesy to the customer. Such activities -17-

18 F. MICHIGAN Single Business Tax were thus sufficiently systematic to constitute a non-trivial connection to New Jersey. The Michigan courts are still trying to figure out the retroactive application, if any, of the new nexus standard announced by the Michigan Department in its RAB This issue is still in play in Michigan and you should keep a close eye on it if you have Michigan single business tax issues. a. J.W. Hobbs Corp. v. Michigan Dep t. of Treas., No MT, 2004 WL (Mich. Ct. Cl. 2004), rev d, 706 N.W.2d 460 (Mich. Ct. App. 2005). i. A panel of the Michigan Court of Appeals reversed the decision of court of claims, holding that the Department was not bound by prior guidance RAB in determining SBT nexus for Hobbs tax years. The court of appeals relied on its decision in Syntex Laboratories v. Dep t. of Treasury, 590 N.W.2d 612 (Mich. App. 1989) to conclude that the new nexus standard under Gillette and RAB could be applied retroactively to While the court allowed for a retroactive application of SBT, the court made clear that it did not require retroactive application. The court of appeals then remanded the case to the court of claims to determine whether Hobbs independent contractor who solicited sales in Michigan and its handful of yearly visits to the state by other employees constituted sufficient nexus to impose SBT under the new nexus standard in RAB The court of appeals also indicated that the court of claims, on remand, should apply the principles it enunciated in Magnetek Controls, Inc. v. Dep t. of Treasury, 562 N.W.2d 219 (Mich. Ct. App. 1997) (applying Quill s bright-line test and concluding that the presence of any sales force at all provides more than a slightest presence to support a finding of nexus) and Rayovac Corp. v. Dep t. of Treasury, 691 N.W.2d 57 (Mich. Ct. App. 2004) (applying Magnetek to find that the presence of three salespersons and one manger in Michigan, who solicited but did not accept or approve orders, constituted substantial nexus). b. Int l Home Foods, Inc. v. Michigan Dep t. of Treasury, No , 2005 Mich. App. LEXIS 2432 (Mich. Ct. App., Oct. 4, 2005) -18-

19 i. Taxpayers were businesses based outside of Michigan which maintained a sales force that called upon Michigan businesses. The sales force, who worked out of their individual homes, encouraged businesses to place orders for the taxpayers products at the taxpayers out-of-state offices. Those orders were then processed and shipped to Michigan customers from outside the state. i A panel of the Michigan Court of Appeals here reached an opposite conclusion from J.W. Hobbs Corp. v. Michigan Dep t. of Treas., 706 N.W.2d 460 (Mich. Ct. App. 2005) with respect to the retroactive effect of Gillette. Relying on In Re D Amico Estate, 460 N.W.2d 198 (1990), the panel concluded that the Department was bound by its earlier interpretive ruling RAB and accordingly cannot apply a different position to the detriment of a taxpayer for activity before March 1, 1993, the date of the release of this Court s opinion in Gillette. The panel also noted, in a footnote, that the panel s decision in J.W. Hobbs merely follow[ed] Syntex and did not address the application of D Amico to the Department s prior guidance. Importantly, the panel dismissed the Department s reliance on Topps Co. v. Dep t. of Treasury, No (Mich. Ct. App. 1999) which held that D Amico did not apply to the Gillette line of cases. The panel concluded that it was not bound by unpublished decisions and chose not to follow Topps because it was incorrectly decided. Accordingly, in determining whether the taxpayers in-state activities constituted substantial nexus for tax years before the release of Gillette in 1993, the Department was bound by its prior guidance in which the protections of P.L would apply to the SBT. The panel then remanded the case to the claims court to determine whether the taxpayers were subject to the SBT during the relevant years. G. Intangible Nexus A trilogy of important cases has been issued by the courts in New Jersey, New Mexico, and Oklahoma. The Lanco favorable decision by the New Jersey Tax Court was strikingly overruled and is now on appeal to the Supreme Court of New Jersey. In New Mexico, the final determination of the New Mexico Supreme Court in Kmart Properties was finally issued, with an important clarifying interpretation of the gross receipts tax in New Mexico and when it can be imposed on an out-of-state seller. The Oklahoma Civil Appellate Court on December 23, 2005, adopted the same -19-

20 rationale in an Oklahoma intangible nexus case concerning Geoffrey. Finally, Virginia issued rulings in August, 2005, on various intangible nexus scenarios. 1. NEW JERSEY a. Lanco, Inc. v. Director, Division of Taxation, 21 N.J. Tax 200 (N.J. Tax Ct. 2003), rev d, No. A T1, 879 A.2d 1234 (N.J. Sup. Ct. App. Div. 2005) i. On appeal, the Superior Court of New Jersey, Appellate Division reversed the decision of the Tax Court. The Superior Court held that Quill s physical presence test only applies to sales and use taxes, and was inapplicable to the New Jersey CBT in this case. The Superior Court found that Lanco s licensing of its intangible property to Lane Bryant for use within New Jersey was sufficient to create nexus for New Jersey CBT purposes. Accordingly, New Jersey could tax Lanco s income from licensing fees despite the lack of physical contact with the state. i In limiting Quill s physical presence test to only sales and use tax purposes, the Superior Court aligned its position with that of Geoffrey, Inc. v. South Carolina Tax Comm n, 437 S.E.2d 13, cert. denied, 510 U.S. 992 (1993), A & F Trademark, Inc. v. Tolson, 605 S.E.2d 187 (N.C. Ct. App. 2004), cert. denied (2005), and Sec y, Dep t. of Revenue v. Gap (Apparel), Inc., 886 So.2d 459 (La. Ct. App. 2004). The Superior Court held that that the New Jersey Business Corporation Tax may be constitutionally applied to income derived from licensing fees attributable to New Jersey. In doing so, the Superior Court did not set forth specific facts that it was relying on to find substantial nexus, but merely recited to the factors asserted by the State: (1) the long-term contractual licensing relationship of Lanco with Lane Bryant located in New Jersey; (2) the protection afforded by the New Jersey judiciary to the Lanco s rights under the licensing agreement and its right to protect its trademark and service marks; (3) the maintenance of New Jersey s highway system and production of an educated workforce; and (4) the New Jersey s police, fire and judicial protection of the physical property upon which Lanco s trademarks are used. 2. NEW MEXICO a. Kmart Properties, Inc. v. New Mexico Dep t. of Taxation and Revenue, No. 21,140 (N.M. Ct. App. 2001), aff d in part, rev d in -20-

21 part sub nom. Kmart Corp. v. New Mexico Dep t. of Taxation and Revenue, No. 27,269, CCH (N.M. Dec. 29, 2005). i. A writ of certiorari was granted on January 9, 2002 by the New Mexico Supreme Court. The action was stayed during Kmart s bankruptcy proceedings. Subsequently, the stay was lifted and Kmart was substituted for KPI after the two companies were merged and Kmart assumed KPI s state taxation rights and obligations. i The New Mexico Supreme Court reversed the court of appeal s holding on the gross receipts tax issue. The Supreme Court first stated that the statute had been amended to make it clear that the transaction should be treated as a nontaxable out-of-state sale of the license to use intangible property, rather than a taxable in-state lease of intangible property used by the licensee. According to the Supreme Court, since KPI s licensing of the trademarks to Kmart must be analyzed as a sale of property and the license agreement between Kmart and KPI was consummated in New Mexico, New Mexico gross receipts tax did not apply to royalties resulting from that license agreement. Importantly, the Supreme Court rejected the Department s argument that the location of the trademark, rather than where the licensing agreement was made, was determinative and that the intangible property in this case had attained a business situs in New Mexico. The fact that the trademarks were used in New Mexico was irrelevant, according to the Supreme Court. The Supreme Court, however, affirmed the court of appeal s holding that the use of the trademarks within New Mexico s economic market established a sufficient nexus to impose New Mexico corporate income tax on KPI. The Supreme Court based its opinion on statutory analysis, and so did not review the challenges raised under the Commerce and Due Process Clauses of the U.S. Constitution. The Supreme Court thus did not review the lower court s opinion which held that physical-presence standard in Quill did not apply to state income tax and that the use of KPI s trademarks within New Mexico s economic market established a sufficient nexus between that income and the state under Complete Auto Transit. 3. OKLAHOMA a. Geoffrey, Inc. v. Oklahoma Tax Comm n, No. 99,938, CCH (Okla. Civ. App. Dec. 23, 2005). -21-

22 i. Geoffrey was formed in Delaware as part of a reorganization of its parent corporation which operated retail toy and children s stores in Oklahoma and other states. The parent corporation assigned intangible properties to Geoffrey in exchange for Geoffrey s stock. Geoffrey then licensed the intangible properties back to the parent corporation in exchange for royalty fees which were based on the sales generated within Oklahoma by the parent corporation. During the relevant period, Geoffrey did not have full-time employees in Oklahoma, nor did it own or lease any property in the state. The parent corporation deducted the royalty payment on its Oklahoma tax return. Geoffrey did not file an Oklahoma tax return to report the royalty payment it received. Geoffrey argued that it was not subject to Oklahoma corporate income tax because it lacked physical presence in the state and hence sufficient nexus with the state. i The Commissioner determined that there was substantial nexus between Geoffrey and the state. The Commissioner reasoned that the licensing of Geoffrey's intangible properties for use within Oklahoma's economic market for the purpose of generating substantial income for Geoffrey, established sufficient nexus with the state and justified the imposition of the Oklahoma corporate income tax. According to the Commissioner, physical presence, as Geoffrey had argued, was not required in finding substantial nexus. Geoffrey appealed the case to the ALJ but review was denied. On further appeal, the Oklahoma Court of Civil Appeals affirmed the Commissioner s determination. The court held that physical presence was not necessary in Oklahoma to satisfy the substantial nexus requirement of the Commerce Clause in this case because Quill s physical presence did not apply to taxes other than sales and use taxes. The court aligned itself with the benefits analysis adopted by Geoffrey, Inc. v. South Carolina Tax Comm n, 437 S.E.2d 13 (S.C. 1993) and concluded that (1) the real source of Geoffrey's income was not a paper agreement, but the Oklahoma customers of parent corporation; (2) by providing an orderly society in which the parent corporation conducted business, Oklahoma had allowed Geoffrey to earn income pursuant to its licensing agreement, (3) Geoffrey had received benefits from Oklahoma as shown by the fact that it earned income in this State, and (4) the tax was rationally related to such benefits because only that portion of Geoffrey's income -22-