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

Transcription

1 September 2007 Volume 14 Number 9 State Tax Return NEXUS: UPDATE ON RECENT DEVELOPMENTS Maryann B. Gall Columbus (614) Laura A. Kulwicki Columbus (330) We keep track of nexus developments on a regular basis - legislation, administrative interpretations, the passage of rules and regulations, and court cases. This issue of our newsletter updates important nexus developments during the Third Quarter, It is organized by the kind of activity that tends to give out-of-state entities nexus planning and litigation difficulties, such as in-state presence, affiliate nexus, intangible nexus, and new legislation in Michigan and New Hampshire with broad new nexus standards. We hope you find it helpful in your planning and compliance work. I. SUBSTANTIAL NEXUS LITIGATION IN THE STATE COURTS A. In-State Personnel 1. Independent Contractors, Sales Representatives, and Manufacturing Representatives. It is often a good idea to ask a state tax department for an advisory opinion concerning nexus issues. Here, an out-of-state retailer had complex retail and distribution functions and was concerned about whether any nexus would be created in Missouri if a new distributor would be used. In a sensible decision, the Missouri Department concluded that, on the specified facts, the out-of-state retailer did not have nexus for sales tax collection purposes. a. MISSOURI i. Letter Ruling LR3885 (Mo. Dept. of Rev. dated May 17, 2007, released August 8, 2007). ii. The request for a letter ruling presented the following facts: Retailer operated retail websites that offered products for retail sale to customers via the Internet. Retailer neither owned nor leased any real property in

2 Missouri; Retailer did not employ anyone in Missouri; and Retailer was not registered as a retail seller in Missouri. iii. iv. Retailer s affiliate, Distributor, performed fulfillment and distribution functions for Retailer. Retailer and Distributor owned no part of the other. Like Retailer, Distributor currently had no physical contact with Missouri, but was considering whether to establish a new distributor within Missouri, called Newco. Newco would purchase and hold products from nonaffiliated vendors, until such time as Retailer purchased them for resale. For a per-unit handling fee, Newco would also perform labeling, packaging, shipping, and other fulfillment services for Retailer. Title would pass from Newco, momentarily to Retailer, and then immediately to the end-user when the goods are delivered to a common carrier at Newco s Missouri facility. According to agreements between Newco and Retailer, Newco is an independent contractor performing its services on a non-exclusive basis, and is without authority to contractually bind Retailer. v. The Department ruled that on these facts Retailer would not be required to collect Missouri sales tax. Even if engaging in business under Missouri s tax statutes was interpreted to cover Retailer s connection with Missouri through Newco, such an interpretation would not be consistent with the requirement that nexus be substantial. vi. Likewise, Retailer would not be subject to Missouri sales tax. A company can be taxed only if it has property, payroll, or sales in Missouri. The Department observed that Retailer would momentarily own property in Missouri (i.e., during the period between purchasing the goods for resale and delivering them to the common carrier at the same location). Such a reading, however, would not be consistent with the Commerce Clause cases requiring a substantial nexus and not merely a de minimus contact.

3 B. Affiliate Nexus This situation comes up on a regular basis does an out-of-state parent corporation guaranteeing certain obligations of a subsidiary or affiliate in a state create nexus? The Virginia Tax Commissioner decided that, on the specific facts in this advisory, that the parent did not get nexus with Virginia when it signed on leases as a guarantor by corporate affiliates. 1. VIRGINIA a. Ruling of Commissioner, P.D , 2007 WL , Dep t of Tax (Jul. 19, 2007). i. A foreign parent corporation owned a group of corporations that in turn owned retail entities located in Virginia with a distribution center in Virginia. The parent and one of corporations in the parent s group (the guarantor corporation) provided lease guarantees for properties leased by members of the parent s group. The members of the parent s group in turn made lease guarantee payments back to the parent. The parent sought a ruling as to whether it had nexus with Virginia for income tax purposes. ii. The commissioner ruled that the parent corporation did not have nexus with Virginia. The Virginia Administrative Code G exempts de minimis connections with Virginia. The commissioner found that several factors justified the conclusion that neither the parent nor the guarantor corporation had a nexus with Virginia. [N]either the Parent nor [guarantor corporations have] employees or property located in Virginia, and [a]ll the Parent s and [guarantor s] business activities occur outside of Virginia. Characterizing the parent s and guarantor s other activities as de minimis, the commissioner concluded that neither the Parent nor [the guarantor corporation] has a nexus with Virginia for income tax purposes. C. Michigan Single Business Tax As you know, Michigan rescinded the always difficult SBT and passed a new "Michigan Business Tax." Section 201(1) imposes "business income tax" on every

4 taxpayer with "business activity" within Michigan, unless prohibited by P.L The tax rate is 4.95%. Section 200(1) contains an extremely broad nexus standard, no surprise to those of you who have had to deal with the SBT. According to the new statute, more than one day in Michigan or actively soliciting sales in Michigan creates tax nexus. 1. Michigan Business Tax Enacted, see Enrolled Mich. Senate Bill No. 94 (effective Jan. 1, 2008). D. Intangible Nexus a. In anticipation of the repeal of the Michigan Single Business Tax, Michigan recently passed a new Michigan Business Tax that taxes (1) business income and (2) modified gross receipts. The act specifically provides nexus standards for both forms of the tax, which is effective January 1, b. The business income tax is imposed on every taxpayer with business activity in Michigan unless protected by P.L Business activity means activity conducted with the object of gain, benefit, or advantage to the taxpayer. c. The modified gross receipts tax is imposed on any taxpayer either (1) with physical presence in Michigan for more than one day, or (2) who actively solicits sales in Michigan and has $350,000 or more of gross receipts attributable to state sources. Although this is almost certain to be appealed, the Massachusetts Appellate Tax Board has determined that a credit card bank does not need to have physical presence nexus with the Commonwealth in order to be liable for the financial institutions excise tax. Additionally, the ATB ruled against Geoffrey with respect to income tax nexus. Unbelievable but true, these cases are still being decided after the original 1993 South Carolina Supreme Court decision. 1. MASSACHUSETTS a. Capital One Bank v. Commissioner of Revenue, Docket Nos. C & C262598, CCH (Mass. Appellate Tax Bd. June 22, 2007) i. The Commissioner of Revenue assessed Capital One Bank and Capital Bank F.S.B. ( the Banks ) for

5 $1,758, under the financial institution excise, Mass. G.L. ch. 63, 1, which is based on net income. Although the Banks had no physical presence in Massachusetts, over 400,000 residents held credit cards issued by the Banks, generating over $60 million in income. The Commissioner denied the Banks requests for abatement, finding that the Banks had substantial nexus with Massachusetts. The Banks appealed to the Appellate Tax Board ( the Board ), conceding that the tax statute applied, but challenging the constitutionality of that statute. ii. iii. iv. The Board affirmed the constitutionality of the tax. The only issue of any weight was whether the Banks had substantial nexus with the state. The Banks again argued that without physical presence, the tax could not withstand Commerce Clause scrutiny. The Board rejected the Banks position that Quill s physical-presence test applied to the income-based tax. The Quill Court, the Board asserted, made clear in two separate instances that it has not extended the bright-line physical presence test to taxes other than sales and use tax. Looking to numerous state cases, the Board held that substantial nexus could be shown in non-sales-and-use-tax cases through, for example, a significant economic presence. Looking beyond the Banks physical absence, the Board found substantial nexus. [T]he Banks deliberate and targeted exploitation of the Massachusetts economic market and its use of the commonwealth s governmental infrastructure and resources constitute substantial nexus, and thus the tax was constitutional. b. Geoffrey, Inc. v. Commissioner of Revenue, Docket No. C (Mass. Appellate Tax Bd. July 24, 2007) i. Geoffrey, Inc. is the holder of various trademarks associated with Toys "R" Us, including the Geoffrey giraffe character. Geoffrey was a Delaware corporation and did not own or lease any real property in Massachusetts, nor did it employ anyone there. It did, however, license its trademark assets to Toys "R" Us, Kids "R" Us, and Babies "R" Us retail stores for

6 use in Massachusetts. From these licenses, Geoffrey received substantial royalty income. ii. iii. iv. The Tax Commissioner of Massachusetts discovered the foregoing during an audit of one of Geoffrey s affiliates and assessed Geoffrey for $1,692,598 in unpaid income-based tax. Geoffrey appealed. Its primary argument was that it lacked substantial nexus with Massachusetts under Quill. The Appellate Tax Board decided in favor of the Tax Commissioner. Relying heavily on its recent opinion in Capital One Bank. The Board reiterated that the physical presence requirement in Quill is not applicable to an income-based excise. In Quill s place, the Board applied an economic presence test and held that Geoffrey satisfied it. Under the agreements in question, Geoffrey permitted the use of its trademarks solely in Massachusetts and derived over $33 million in royalties from the Massachusetts consumer marketplace during the years at issue. On these facts, Geoffrey had purposefully derived substantial economic gain from the Massachusetts market and hence established substantial nexus. E. Doing Business In The State This is an update on the January, 2006, decision of the Kentucky Board of Tax Appeals. On appeal, the court reversed the BTA decision concerning an out-of-state corporation that received a distributive share of partnership income from partnership entities doing business in Kentucky. The out-of-state corporation neither owned nor leased property in Kentucky. It had no employees in Kentucky. The Department contended that Kentucky could impose income tax on the taxpayer despite the lack of physical presence. The BTA held in favor of the taxpayer on statutory grounds but did not address the constitutional nexus arguments made by the parties.

7 1. KENTUCKY a. Asworth Corp. v. Revenue Cabinet, Kentucky Board of Tax Appeals, Order No. K-19449, January 27, 2006, rev d, Franklin Cty. Cir. Ct., No. 06-CI-288, June 14, F. Doing Business In The State i. On appeal, the Franklin Circuit Court of Kentucky reversed the Board s decision and held that Asworth had nexus in Kentucky solely due to its investment in the pass-through entity as limited partner. The court explained that Asworth had acquired nexus with the state through the partnership that did business within the state, as Kentucky recognizes the flow-through nature of partnerships and, accordingly, imposes state income tax upon the partners rather than upon the partnership itself. According to the court, the Board erred when it failed to acknowledge the governing Kentucky statute that imposes income tax on corporations that carry on business as partners in a partnership doing business in the state, even if the corporation does not have any property or payroll in the state. Along with other states, New Hampshire has now adopted the "economic exploitation of the marketplace" standard for its business profits tax. Effective July 1, 2007, trying to business in any fashion in New Hampshire subjects an out-of-state corporation to potential tax liability. 1. NEW HAMPSHIRE a. H.B. 2, Ch. 263, effective July 1, i. Effective July 1, 2007, New Hampshire amended the definition of business activity for its business profits tax to include a substantial economic presence. The new definition reads: Business activity means a substantial economic presence evidenced by a purposeful direction of business toward the state examined in light of the frequency, quantity, and systematic nature of a business organization s economic contacts with the state. Business activity includes, but is not limited to, a group of actions performed by a business organization for the purpose

8 of earning income or profit from such actions and includes every operation which forms a part of, or a step in, the process of earning income or profit from such group of actions. The actions ordinarily include, but are not limited to, the employment of business assets, the receipt of money, property, or other items of value and the incurring or payment of expenses. Notwithstanding any other provision of this paragraph, a holder of an ownership interest in a qualified investment company as defined in RSA 77-A:1, XXI, shall not be deemed to be carrying on any business activity within this state due solely to its holding an ownership interest in such qualified investment company. R.S.A. 77-A:1, XII (amended by H.B. 2, Ch effective Jul. 1, 2007). This article is reprinted from the State Tax Return, a Jones Day monthly newsletter reporting on recent developments in state and local tax. Requests for a subscription to the State Tax Return or permission to reproduce this publication, in whole or in part, or comments and suggestions should be sent to Gail Whelan (214/ ) in Jones Day s Dallas Office, 2727 N. Harwood, Dallas, Texas or StateTaxReturn@jonesday.com. Jones Day All Rights Reserved. No portion of the article may be reproduced or used without express permission. Because of its generality, the information contained herein should not be construed as legal advice on any specific facts and circumstances. The contents are intended for general information purposes only.