Corporate Close Up: Five Things to Know About Factor Presence Nexus

Today, eight states, Alabama, California, Colorado, Connecticut, Michigan, New York, Ohio, and Tennessee, apply a factor presence standard to determine when an out-of-state corporation has sufficient nexus to justify the imposition of a business income tax. 

With factor presence nexus growing in popularity, here are five things to know:

1. Factor presence nexus is a subset, or modified version of, economic presence nexus.

“Factor presence helps define a de minimis standard for economic presence,” Brian Kirkell, principal at RSM US LLP, told Bloomberg BNA in April when asked about results of the 2016 Survey of State Tax Departments. Kirkell said he found it strange that people are looking at factor presence as a separate standard.

2. The MTC model statute uses both economic and physical presence to determine nexus.

The Multistate Tax Commission’s model statute, Factor Presence Nexus Standard for Business Activity Taxes, quantifies the level of activity that constitutes economic nexus. Nexus is triggered if any of the following thresholds are exceeded during the tax period: $50,000 of property; $50,000 of payroll; $500,000 of sales; or where in-state property, payroll or sales exceeds 25 percent of total property, total payroll or total sales.

As a result, a state that adopts this type of approach may assert nexus based on a bright-line amount of economic activity alone or a reasonable amount of physical presence alone.

3. Most of the states that adhere to a factor-presence nexus standard use a market-based approach for sourcing sales receipts for purposes of computing the numerator of their apportionment formula’s sales factor. 

Alabama, Tennessee, California, Connecticut, Michigan, New York and Ohio all use market-based sourcing for receipts from services, intangibles or both. 

4. Some practitioners think factor-based nexus is unconstitutional because there is no substantial nexus analysis.

There may be some due process concerns in the application of the standard, particularly in the area of digital goods, Kirkell noted. This very issue is playing out in Ohio. Earlier this month, oral arguments were heard by the Ohio Supreme Court in three cases asking whether electronic retail contacts with Ohio by out-of-state corporations satisfy a physical-presence nexus standard, as applied to Ohio’s commercial activity tax (CAT).

Basically, the taxpayers, Crutchfield Inc., Newegg Inc., and Mason Cos. Inc., meet the CAT’s bright-line presence standard because each had annual Ohio gross receipts exceeding $500,000; however, they were not physically present in the Buckeye State. For this reason, the taxpayers argue that they cannot be taxed because they lack substantial nexus, which they also argue is required by Tyler Pipe Industries Inc. v. Department of Revenue, 483 U.S. 232 (1987) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992). 

5. Factor presence nexus probably is not going away any time soon.

The tendency of market-based sourcing states to adopt factor-based nexus suggests that the factor presence nexus standard will not fade into the background in the near future. Sometimes it is hard to nail down physical presence in a virtual world, but a factor-based approach that expands on the economic presence standard appears to offer a solution.

Continue the discussion on LinkedIn: Is a factor presence nexus standard more fair than a vague economic presence standard?

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