High Court Denies Review to Massachusetts Cases Involving Substantial Nexus Challenges

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

By J.P. Finet

The U.S. Supreme Court declined to review two Massachusetts Supreme Court rulings that upheld the constitutionality of the state's income-based excise taxes on out-of-state entities under a substantial nexus test. [Capital One Bank (USA) NA v. Massachusetts Comr. of Rev., U.S., No. 08-1169, cert. denied 6/22/09; Geoffrey Inc. v. Massachusetts Comr. of Rev., U.S., No. 08-1207, cert. denied 6/22/09]

In both Massachusetts rulings, the court found that income-based excise taxes could be imposed on entities that lacked a physical presence in the state because the companies still had a substantial nexus with the state.

The Massachusetts court found in Capital One that the imposition of its financial institutions excise tax on banks that lacked a physical presence in the state met the substantial nexus requirement of the U.S. Constitution's Commerce Clause because the banks issued credit cards used by state residents.

In Geoffrey, it said the state's imposition of a corporate excise tax satisfied the substantial nexus test because the firm's trademark licensing exclusively to Toys “R” Us-Mass Inc. and Baby Superstore generated continued business and substantial annual royalty income from stores in the state.

The Massachusetts court found in both cases that the U.S. Supreme Court's ruling in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), was limited to sales and use taxes. In Quill, the court found the Commerce Clause precluded a state from imposing sales tax obligations on an out-of-state corporation without a physical presence in the state.

Attorneys Seek Bright-Line Test

Attorneys following the issue had hoped the court would take up one (or both) of the Massachusetts appeals to clarify whether Quill applied to income-based taxes.

“They were hoping that the Supreme Court would clarify whether the physical presence test was just a sales and use tax concept, or whether it was a requirement for imposing a tax on any out-of-state entity,” Robert Willens told BNA June 22. Willens is president of the tax and consulting firm Robert Willens LLC in New York and is an adjunct professor of finance at Columbia University Graduate School of Business.

Todd A. Lard, general counsel for the Council On State Taxation (COST), told BNA June 22 that his organization filed an amicus brief asking the court to take the cases and provide a simple, bright-line rule for the courts to follow.
“I think our interest is that we really feel that there should be a clear line based on physical presence to trigger nexus,” he said. “A taxpayer should have a physical presence before a state can impose a business activity tax.”

Daniel B. De Jong, an attorney with Tax Executives Institute (TEI) who helped write the amicus briefs the group filed in support of supreme court review of the cases, agreed that the lack of a supreme court decision has led to uncertainty.

“What taxpayers are left with is uncertainty as to whether the physical presence test in Quill applies outside the sales tax,” De Jong told BNA June 22. “A decision by the supreme court would provide, I would think, more certainty than we have right now.”

De Jong noted that TEI's brief said a clear standard for all taxes is critical.
“Permitting differing standards based on tax type would embolden States to continue considering alternative revenue raising methods to avoid the constitutional limits articulated in Quill,” the brief said.

Willens said he expected most states, if not all, to adopt the reasoning of the Massachusetts court. He added that many states are currently looking to cover budget shortfalls.

Congress May Need to Address Issue

Lard said the fact the court has side-stepped the issue may mean that it is time for Congress to step in and provide a legislatively imposed test.

Indeed, the National Association of Manufacturers (NAM) issued a news release June 22 urging Congress to enact H.R. 1083, the Business Activity Tax Simplification Act. NAM said the legislation would establish a bright-line test of physical presence to determine whether a state can impose business activity taxes, including state income taxes, on an out-of-state business engaged in interstate commerce.

“Prompt enactment of H.R. 1083 will help stem an expected flood of ‘creative' state taxation of out-of-state companies,” NAM said. “The legislation will establish a bright-line physical presence test of when a state can tax an out-of-state company, preventing arbitrary taxation without jeopardizing the ability of states to legitimately tax businesses with in-state operations. Companies of all sizes will benefit from the certainty of a uniform rule on state taxation.”

The full text of the Massachusetts opinions is available on the Internet at http://massreports.com/slipops.