This year marks the twentieth anniversary of the U.S. Supreme Court's decision in Quill Corp. v. North Dakota, and the Supreme Court has given every indication that it will not be taking any nexus cases even though many issues still remain unsettled.
The views are those of Maryann B. Gall, of MB Gall Tax in Columbus, Ohio, speaking at New York University's 31st Institute on State and Local Taxation. Ms. Gall was one of several tax experts discussing income tax nexus issues, including intangible property, telecommuting employees, and the use of independent contractors performing nonsolicitation activities.
In counterpoint to Quill, as a landmark case that has also been in place for decades, Geoffrey Inc. v. South Carolina Tax Commission, 313 S.C. 15 (1993), cert. denied; 114 S. Ct. 550 (1993), considered whether an out-of-state intangible holding company had substantial nexus with South Carolina for income tax purposes if it licensed intellectual property to a related party doing business in the state. The South Carolina Supreme Court held that the out-of-state company's use of intangible property within South Carolina's borders was sufficient to trigger nexus. With many states having adopted its rationale, Geoffrey marks its 20th anniversary next year.
The recent decision in KFC Corporation v. Iowa Dept. of Rev., 792 N.W. 2d 308 (2010), presented the Iowa Supreme Court with the same issue faced by the court in Geoffrey. The court concluded in KFC that physical presence was not required for the state to impose tax on a franchisor's royalty income. The income was subject to tax because franchisor KFC had a sufficient nexus with the state through its licensing agreements with local franchisees.
In 2012, however, two other state supreme courts faced with a similar fact pattern reached the opposite conclusion, the panel said. In Scioto Insurance Co. v. Oklahoma Tax Comn., 279 P.3d 782 (Okla. 2012), the Oklahoma Supreme Court held that receiving royalties from an affiliated restaurant corporation did not establish corporate income tax nexus with Oklahoma, and in Griffith v. ConAgra Brands Inc., 728 S.E.2d 74 (W.Va. 2012), the West Virginia Supreme Court of Appeals found that the receipt of royalties related to the use of trademarks and trade names, some of which were used in West Virginia, did not trigger corporate income tax nexus.
Noting that both Scioto and ConAgra were good for taxpayers, Prof. Richard D. Pomp, of the University of Connecticut, said he believed ConAgra to be the more important case, given that West Virginia had previously adopted the economic nexus rationale in West Virginia Tax Commissioner v. MBNA American Bank N.A., 640 S.E.2d 226 (W. Va. 2006). Another reason why ConAgra is significant, Pomp said, is because “it reads as a Due Process case.”
The U.S. Supreme Court recently addressed Due Process Clause jurisdictional requirements in two tort cases--McIntyre Machinery LTD v. Nicastro, 131 S. Ct. 2780 (2011) and Goodyear Dunlop Tires Operations S.A. v. Brown, 131 S. Ct. 2846 (2011). “Those cases weren't cited in ConAgra, but they were in the back of the opinion,” Pomp said. But ConAgra did cite Asahi Metal Industry Co. v. Superior Court of California, 480 U.S. 102 (1987), which stands for the proposition that merely putting something in the stream of commerce does not constitute activity directed at a forum state, he added.
“Another big nexus issue that many businesses overlook is telecommuting employees who could create nexus problems,” Laura A. Kulwicki, an attorney at Vorys, Sater, Seymour and Pease in Akron, Ohio, said. Businesses may have longtime employees moving out of state for personal reasons, and the business may decide to allow these employees to telecommute without determining whether there would be a nexus problem. Employee nexus issues can depend on whether the worker is an employee or an independent contractor, said Kulwicki.
States are less likely to find income tax nexus if the employee is performing an administrative function, she said. But she pointed out some recent exceptions to this rule. In Telebright Corporation Inc. v. New Jersey Director, Division of Taxation, 25 NJ. Tax 333 (N.J. Tax Ct. Mar. 24, 2010), aff'd 424 N.J. Super. 384 (March 2, 2012).
In that case, a taxpayer based in Maryland allowed an employee to telecommute from home in New Jersey on a full-time basis. The employee developed and wrote software code, sending it electronically to the taxpayer's computer in Maryland.
The New Jersey Tax Court found the employee's daily presence in New Jersey satisfied the substantial-nexus requirement of the Commerce Clause because the corporation enjoyed the benefits of the state's labor market. On appeal, the New Jersey Superior Court affirmed. The court reasoned that the employee's activities in the state constituted “doing business” as defined by New Jersey's statute and regulations. Due Process arguments were rejected, with the court finding that the imposition of tax was justified because the employee was working on a full time basis in the state for the taxpayer. The court reasoned that if the employee violated the restrictive covenants in her employment contract, relief could be sought in New Jersey courts. As a result, the taxpayer had sufficient minimum contacts with New Jersey to permit taxation.
However, a different result involving a remote worker was reached in Virginia. In Ruling of Commissioner P.D. 10-154, (Va. Dept of Tax., July 28, 2010), the taxpayer was a company based outside the United States that produced and distributed online video games. One of the company's executives performed administrative and management tasks from his home in Virginia. The Virginia Department of Revenue was asked to advise whether having an executive live in the state was sufficient to trigger nexus for the Business, Professional and Occupational License tax.
The Commissioner ruled that nexus was not created because the company performed only administrative and management tasks in the state and was not holding itself out as a business that operates from the employee's home. Because sales solicitation did not occur at the employee's home office, nor was it directed or controlled from there, there were no receipts attributable to Virginia, the Commissioner reasoned.
The limitations imposed on state authority by federal Pub. L. No. 86-272 sometimes do not apply to alternative work arrangements, Kulwicki noted. Pub. L. No. 86-272 restricts a state from imposing a tax based on net income if the company's only in-state business activity is the solicitation of orders for sales of tangible personal property. In Appeal of Warwick McKinley Inc., No. 489090, (Cal. State Bd. of Equal, Jan. 11, 2012) (not to be cited as precedent), the protections of Pub. L. No. 86-272 were lost when an employee of a Massachusetts corporation did consulting and recruiting work from her home in California.
The California Franchise Tax Board argued that maintaining a single employee in the state was sufficient to trigger income tax nexus. The corporation countered that it did not have any California clients, its employee's in-home office was not “publicly attributed” to the company, and its employee engaged in protected sales activities as defined in federal Pub. L. No. 86-272. The State Board of Equalization concluded that Pub. L. No. 86-272 protections did not apply because the employee's involved recruiting services and not the solicitation of tangible personal property.
In at least one case, using independent contractors to perform warranty work destroyed a company's protection under Pub. L. No. 86-272, said Kulwicki. In Ann Sacks Tile and Stone Inc. v. Oregon Dept. of Rev., TC 4879 (Or. Tax Ct. 2011), the company had a sales force and contracted with unrelated third parties to perform warranty repair work and other services for its products. There was no dispute that the activities of the sales representatives were protected by Pub. L. No. 86-272. But the case turned on whether the independent contractors and the company's other in-state connections destroyed its immunity under Pub. L. No. 86-272. The court found that company was not protected because the contractors conducted activities pursuant to contracts with the company that went beyond the activities protected under Pub. L. No. 86-272 for independent contractors.
By Steven Roll and Denise Ryan
Copyright 2012, The Bureau of National Affairs, Inc.