State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP Oregon Tax Court Upholds Substantial Nexus for Banks Lacking In-State Physical Presence On December 23, 2016, the Oregon Tax Court held that two out-of-state financial institution corporations had substantial nexus in Oregon and were subject to either the corporate income tax or excise tax. 1 The financial institutions did not have a physical presence in Oregon, but purposefully solicited Oregon customers, extended credit, loaned money, pursued collections and utilized the court system in Oregon. The Court determined that subjecting the financial institutions to taxation in Oregon did not violate the Commerce Clause. Background Capital One Auto Finance (Taxpayer) was a member of an affiliated group of subsidiaries wholly owned by the parent, Capital One Financial Corporation (COFC). COFC and its subsidiaries were all incorporated, headquartered, and domiciled outside of Oregon. However, the Taxpayer was authorized to conduct, and conducted, business in Oregon and other states. During the 2006-2008 tax years at issue, the Taxpayer filed consolidated Oregon excise tax returns. The returns included the Taxpayer and other subsidiaries of COFC, Capital One Bank (COB), Capital One FB (FSB), and Capital Services, Inc. In those returns, the Taxpayer excluded the gross receipts of COB and FSB (collectively, the Banks ) from the Oregon sales factor numerator. COB offered credit cards, customer loans and deposits. FSB accepted deposits and engaged in small business and consumer lending. Both COB and FSB offered services to customers throughout the country, including Oregon. The Banks did not obtain authorization to conduct business in the state and had no tangible personal property, offices, employees, or receivables in Oregon. The Banks purposefully solicited Oregon customers through direct mail sent from outside the state. 2 The Banks sent monthly statements to Oregon customers, initiated lawsuits and collection actions in Oregon courts and earned various types of banking fees, including financing charges, overdraft fees and interchange fees from Oregon customers. Release date January 25, 2017 States Oregon Issue/Topic Corporate Income Tax Contact details Michael Boykin Los Angeles T 213.596.8420 E michael.boykin@us.gt.com Nisha Mathew Seattle T 206.398.2445 E nisha.mathew@us.gt.com Jamie C. Yesnowitz Washington, DC T 202.521.1504 E jamie.yesnowitz@us.gt.com Chuck Jones Chicago T 312.602.8517 E chuck.jones@us.gt.com Lori Stolly Cincinnati T 513.345.4540 E lori.stolly@us.gt.com Priya D. Nair Washington, DC T 202.521.1546 E priya.nair@us.gt.com www.grantthornton.com/salt In 2011, the Oregon Department of Revenue audited the Taxpayer s corporate excise returns for the tax years in question and determined that the Banks were subject to the 1 Capital One Auto Fin. Inc., v. Dept. of Revenue, OR. T.C., TC 5197 (Dec. 23, 2016). 2 For example, during 2007 and 2008, the Banks sent approximately 24,600,000 solicitations into the state..
Grant Thornton LLP - 2 corporate excise tax by reason of their lending and depository activities with Oregon customers. The Taxpayer appealed the notices of assessment to the Oregon Tax Court. Specifically, the Taxpayer argued that the Banks were not subject to taxation in Oregon because they lacked physical presence in the state. The Department countered that the lending and depositing activities of the Banks subjected them to the corporate excise tax, regardless of the lack of physical presence in the state. Further, the Department argued that even if the Banks were not subject to the excise tax, they would be subject to Oregon s corporate income tax. Oregon Corporate Excise/Income Tax Regime Oregon s corporate excise tax is measured by net income and imposed on financial institutions doing business in the state. 3 Doing business is defined as any transaction or transactions in the course of its activities conducted within the state by a national banking association, or any other corporation. 4 Similarly, Oregon s corporate income tax in also measured by net income, and imposed on corporations that have Oregon taxable income derived from sources within this State. 5 The term source is not defined by statute, but the Court utilized the dictionary definition of the term, which is a point of origin or a point of emanation. 6 Despite being contained in separate chapters, the corporate excise tax and the corporate income tax were intended to operate as one cohesive tax regime, and the income tax only reaches income not already subject to the corporate excise tax. The Taxpayer argued that the Banks were not subject to either Oregon s corporate excise tax or the corporate income tax because the Banks did not have a physical presence in Oregon. Physical Presence The Court rejected the Taxpayer s argument asserting a physical presence requirement for imposition of the Oregon s corporate excise tax or corporate income tax. With respect to the corporate excise tax, the Court stated that it doubts that there is a physical presence requirement as there is no such requirement appearing in the definition of the excise tax or the term doing business. The Court noted that even if the corporate excise tax did require a physical presence, the income generated from Oregon customers was subject to the corporate income tax as income derived from sources within the state. The Court cited prior Oregon Supreme Court precedent which had clarified that a physical presence is not required for income tax purposes, and stated that taxation of income earned from sources within the state is 3 OR. REV. STAT. 317.010(5). 4 OR. REV. STAT. 317.010(4). 5 OR. REV. STAT. 318.020(1). 6 Per Webster s Third New International Dictionary, p. 2177 (2002).
Grant Thornton LLP - 3 based not on property rights or the physical presence of the Taxpayer, but upon the substantial economic benefit conferred on a Taxpayer in the conduct of its business. 7 Although the Banks did not have a physical presence in Oregon, the Banks had engaged in marketing and solicitation in Oregon, earned millions of dollars in fees from Oregon customers, and used Oregon s debt enforcement mechanisms to collect on delinquent accounts. 8 Based on the economic activities of the Banks in Oregon, the Court found that whether the Banks were doing business for excise tax purposes or earning income derived from sources within this state for income tax purposes, the Banks directed their activities to access and extract economic benefits from Oregon persons. Therefore, the income of the Banks was subject to Oregon taxation under either the corporate excise tax or the corporate income tax. Commerce Clause Nexus After determining that the income of the Banks was properly subject to taxation in Oregon, the Court next considered whether the economic nexus of the Banks was sufficient for purposes of the Commerce Clause of the federal constitution. The Taxpayer argued that economic activity alone is insufficient to satisfy the substantial nexus requirement of the Commerce Clause, and therefore the Banks did not have substantial nexus with Oregon. In support of its argument, the Taxpayer relied upon the physical presence requirement established by Quill Corporation v. North Dakota. 9 In rejecting the Taxpayer s argument, the Court noted that Quill rested on two bases. First, the imposition of sales and use tax on taxpayers without physical presence in the state creates an undue burden. Second, there are settled expectations with respect to a physical presence standard for sales or use taxes. The Court concluded that under both of these bases, Quill did not require or even suggest a physical presence standard for net income taxes. Undue Burden Notably, the Quill court found that the virtual welter of complicated obligations in the state sales and use tax regimes created an undue burden on interstate commerce. 10 Specifically, in its assessment of state sales and use tax collection obligations, the Quill court noted that there were over 6,000 sales or use tax jurisdictions and that in each of these jurisdictions a taxpayer could be required to collect and remit tax in substantially different ways. Furthermore, a taxpayer must also ensure that the appropriate amount of sales or use tax is collected from the customer before making sales into the jurisdiction, or risk making errors in the collection and remittance process. 7 See Welch Holding Co. v. Galloway, 89 P.2d 559 (Or. 1939); see also John I. Haas, Inc. v. Tax Com., 361 P.2d 820 (Or. 1961); Ann Sacks Tile & Stone, Inc. v. Dept. of Rev., Oregon Tax Court, No. TC 4879, 20 Or. Tax 377, November 29, 2011. 8 For the 2006-2008 tax years at issue, the Banks had approximately 500,000 Oregon customers, participated in several thousand Oregon lawsuits annually, and earned annual fees of approximately $150 million from Oregon customers. 9 Quill Corporation v. North Dakota, 504 U.S. 298 (1992). 10 Id.
Grant Thornton LLP - 4 In contrast with these sales and use tax burdens, the Court in this instance noted that the burdens associated with excise or income tax regimes are much less onerous than sales or use tax and do not rise to the level of an undue burden. Unlike the sales and use tax obligations, the corporate income and excise taxes do not require collection from third parties and are paid based upon income earned in the state as determined at the end of a tax period and not at the beginning. Therefore, the Court concluded that imposition of the corporate excise and income taxes on economic activity does not constitute an undue burden on interstate commerce. Settled Expectations The settled expectations basis for the Quill Court s physical presence nexus standard was comprised of two separate components: the necessity and benefits of a bright-line rule and settled expectations established by prior case law. In the first instance, for sales or use tax purposes, a corporation must know at the time of its first sale what its obligations are and whether it has substantial nexus with the state such that it would need to collect and remit tax. However, for excise or income taxes, a corporation may periodically evaluate whether its activities have or will create substantial nexus such that it will need to pay tax based on its income in the state at the end of the tax period. Moreover, no collection of tax from third parties is required. Accordingly, the Court found that the benefit of, and need for, a bright-line physical presence rule is diminished. With respect to the second component, in Quill, the court found that the physical presence rule established by prior case law, namely Bellas Hess, had engendered substantial reliance and has become part of the basic framework of a sizeable industry. 11 In contrast, there is no Supreme Court precedent with respect to income or excise taxes that requires a physical presence. Furthermore, the Court noted that the issue of physical presence and income or excise taxes has been litigated across the country with varying degrees of success on both sides. Therefore, the Court found that there were no settled expectations with respect to the physical presence requirement and income or excise taxes upon which the Taxpayer could have reasonably relied upon. Substantial Nexus and Economic Presence After determining that the Commerce Clause does not require a physical presence for taxes measured by net income, the Court next considered whether the economic presence of the Banks in Oregon was sufficient to establish substantial nexus. To satisfy the nexus requirement, there must be more than a slightest presence, outside of any connection with customers via common carriers. 12 However, if there are sufficient economic contacts with the state, an out-of-state business may be made to pay its way. 13 The Court held that the economic activities of the Banks created a substantial nexus in Oregon. The Banks had sent millions of solicitations, repeatedly extended credit, pursued collection, and earned millions of dollars in revenue in Oregon. Based on these facts, the Court stated that this is not a case of a Taxpayer having only a slightest presence in 11 Id. 12 Id. 13 Complete Auto Transit, Inc., v. Brady, 430 U.S. 274 (1997).
Grant Thornton LLP - 5 Oregon. There was extensive contact in the state of Oregon by the Banks. Therefore, the Taxpayer s significant economic activities alone were sufficient to establish substantial nexus with Oregon. Commentary This decision mirrors the recent Crutchfield decision, in which the Ohio Supreme Court determined that an out-of-state retailer had nexus for purposes of Ohio s Commercial Activities Tax, based on its economic presence in the state. 14 Unlike this decision, however, Crutchfield did not consider the application of the Quill physical presence standard to an income tax, but rather a tax for the privilege of doing business. Notwithstanding this significant difference, the recent decisions in Ohio and Oregon may embolden other states, particularly those facing budget deficits, to aggressively interpret economic nexus. Notably, financial institutions and banks have frequently been targets of economic nexus arguments by states. For example, West Virginia and Tennessee courts have considered whether state income tax could be imposed against banks without physical presence. 15 As a result of the Oregon Tax Court s decision, other financial institutions that have Oregon markets but lack physical presence nexus should consider whether they nevertheless may be subject to taxation in Oregon. Finally, the Court opinion highlights the fact that in 2015, U.S. Supreme Court Justice Kennedy suggested that the Court should reexamine its holding in Quill. It will be interesting to see if the U.S. Supreme Court takes on this issue in the near future or whether state courts will continue to interpret the relevant Constitutional standards. The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP. This document supports the marketing of professional services by Grant Thornton LLP. It is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject of this document should contact Grant Thornton or their tax advisor to discuss the potential application of this subject matter to their particular facts and circumstances. Nothing herein shall be construed as 14 Crutchfield Corp. v. Testa, Ohio Supreme Court, No. 2015-0386, Nov. 17, 2016. The majority opinion was joined by five of the seven justices. See GT SALT Alert: Ohio Supreme Court Holds CAT s Bright-Line Presence Nexus Standard Satisfies Commerce Clause. 15 Tax Commissioner of West Virginia v. MBNA American Bank, 640 S.E.2d 226 (W. Va. 2006); J.C. Penney National Bank v. Johnson, 19 S.W.3d 31 (Tenn. Ct. App. 1999).
Grant Thornton LLP - 6 imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed.