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Lawmakers’ strategy to strike a decades-old, state-border restriction on taxing sales may prove fruitful before the U.S. Supreme Court, according to a leading state and local tax practitioner.
Statehouses have been teeming with remote sales tax bills during the 2017 legislative session as state lawmakers address budget shortfalls and seek to level the playing field for local, Main Street merchants—all against the backdrop of the high court’s 1992 decision in Quill Corp. v. North Dakota, which precludes states from imposing sales and use tax collection obligations on vendors without a physical presence in-state. Several states have flocked to identical “economic nexus” standards, aspiring to make the 25-year-old federal restriction on remote sales taxation a thing of the past.
During a May 24 webinar highlighting key findings from Bloomberg BNA’s 2017 Survey of the State Tax Departments, Sylvia F. Dion, founder and managing partner of tax-consulting firm PrietoDion Consulting Partners LLC, said that economic nexus regimes could be Quill‘s demise.
“A lot of discussion is whether the Supreme Court will finally decide that they’re going hear a case that deals with economic nexus for sales tax. Will they actually take some action that’s going to reverse Quill? And I think that, yes, that could very possibly happen.”
Litigation over economic nexus models is pending in Alabama, South Dakota and Tennessee, and some foresee potential challenges arising in Indiana and Wyoming. South Dakota’s case has reached the state’s Supreme Court, where state officials continue to acknowledge that the statute conflicts with Quill. However, they have requested the state court submit an opinion that advocates for the Supreme Court to grant review in a subsequent appeal and overturn Quill.
The 17th annual survey canvassed tax policies governing corporate income and sales and use tax, with a focus on nexus and sourcing considerations. Practitioners discussed during the webinar how the survey showed states don’t uniformly publish guidance—such as with nexus policies for corporate income tax purposes—and continue to reach beyond geographic borders for revenue.
The Bloomberg BNA survey found that a majority of states gauge corporate income tax nexus through economic presence standards, but 13 states reported their nexus policy is based on factor presence, with varying degrees of conformity with the Multistate Tax Commission’s model statute, “Factor Presence Nexus Standard for Business Activity Taxes.”
However, the survey illustrated that several jurisdictions haven’t codified their corporate income tax policies based on factor presence.
Practitioners stressed that taxpayers require legal guidance and clarity on a state’s policy position and specific factor-presence thresholds. Fred Nicely, senior tax counsel for the Council On State Taxation, said that several states likely consider the statutory basis for their respective policies to be provisions under which they “assert nexus to the full extent allowed under the U.S. Constitution.”
Ohio was the first state to impose a factor presence nexus standard, tracking the Multistate Tax Commission’s model. Its statutory commercial activity tax recently came under attack in litigation that ultimately settled before reaching the U.S. Supreme Court on appeal—and many practitioners foresee more states mimicking Ohio’s business privilege tax.
Several out-of-state companies— Crutchfield Corp., Newegg Inc. and Mason Companies Inc.—challenged the constitutionality of the statutory tax. However, the state prevailed before the Ohio Supreme Court in November. A divided 5-2 court ruled, in part, that the $500,000 receipt threshold complies with the federal commerce clause.
Nicely explained that the Ohio litigation raised a challenge over the “facial constitutionality” of the state’s factor presence law. However, while the Ohio Supreme Court sustained the law, “that does not prevent a taxpayer from coming back and saying that, as this is applied to our fact situation, we think this is unconstitutional. We do not have enough contacts with the state for them to be able to impose their tax.” One situation could be where a retailer has “isolated sales"—with one or two major sales annually in the state, but without ongoing relationships with in-state customers.
The survey also demonstrated that several states don’t post a ‘de minimis’ standard for activities creating corporate income tax nexus. Nicely said the lack of de minimis provisions raises concerns—he noted that the Washington Legislature “last year saw that it was a problem with the tax agency being really aggressive” in finding nexus established through trade show attendance.
S.H.B. 2938, which Washington Gov. Jay Inslee (D) signed into law March 2016, prohibits the state Department of Revenue from making a substantial nexus determination “based solely on the attendance or participation of one or more representatives of a person at a single trade convention per year in Washington state.”
“States need to put out and publish their de minimis provisions,” Nicely said.
Nicely also saw red flags with some states attributing nexus through a taxpayer’s registration with the Secretary of State. Registering with the Secretary of State to do in-state business relates more to minimum contacts for due process considerations, but he noted that state taxation is subject to nexus restraints under both the due process clause and commerce clause.
Reflecting a widely recognized trend, the survey showed that states continue to migrate toward market-based sourcing for apportionment of receipts from sales of services and intangibles. The number of states using market-based sourcing for services increased to 15, with the addition of Connecticut. And Connecticut and Vermont added to the group of 19 states that source intangibles through a market-based method.
Several states have introduced bills during the 2017 legislative session to enact market-based sourcing—including Arkansas, Montana, New Mexico, North Carolina, and Oregon. Montana adopted a market-based sourcing measure in early May.
“No two snowflakes are alike,” said Bruce Ely, partner with Bradley Arant Boult Cummings LLP, referring to the state-specific nuances for defining a respective market. Nicely agreed, adding that businesses maintain records differently and problems can arise when their record-keeping systems don’t align with a state’s standard.
Likewise, as market-based sourcing becomes more prevalent, more states are moving away from the equally weighted, three-factor apportionment formula (property, payroll, and sales). Whether assigning more weight to sales, or adopting a single-sales factor formula, states are increasingly focusing on the market for apportionment purposes.
Joe Henchman, the Tax Foundation’s vice president of legal and state projects, said that “we may have uniform apportionment again, just a different way.”
Ely said during the webinar that he found “surprising” the responses from states indicating they would tax the gain recognized by the disposition of a nonresident’s interest in a passthrough entity.
“Apparently a number of state DORs haven’t yet digested the Ohio Supreme Court’s landmark—but unsurprising—2016 ruling in Corrigan v. Testa,” Ely previously told Bloomberg BNA for the survey.
In the May 2016 ruling, the Ohio Supreme Court ruled a statute unconstitutional as applied to a taxpayer, where it imposed income tax on a capital gain realized by the remote investor’s sale of ownership interest in a passthrough entity. The statute, Ohio Rev. Code Ann. Section 5747.212, mandated that for nonresidents holding 20 percent or more interest in a passthrough entity, the capital gain from a sale of that interest must be apportioned to Ohio based upon the apportionment factors of the entity.
The Ohio high court ruled that the statute was a due process violation, holding that the state couldn’t tax the proceeds of a nonresident’s sale of intangible personal property on the basis that the entity conducted some of its business in the state.
While the Corrigan ruling was highly fact-specific, Ely said that the Supreme Court’s decision in Comptroller of Treasury of Md. v. Wynne “certainly plays a part in this now.” The landmark 2015 decision found unconstitutional Maryland’s practice of allowing a credit against the state income tax but not against the local tax to residents who paid income tax to another state. At the heart of the analysis was the “internal consistency test” to determine that the tax scheme discriminated against interstate commerce.
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