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By Bruce S. Schaeffer, Esq.
New York, NY
As states struggle to close budget gaps, many are seeking to capture sales tax or income tax revenues from franchise companies, distributors and online sellers based outside their borders. These companies, in turn, have challenged such laws vigorously, claiming they do not have the requisite nexus in the taxing state. Some recent developments serve to highlight the tricky issue of physical presence.
Petition for Certiorari Filed Against Washington's Business and Occupancy Tax Levied on Sellers Without "Physical Presence"
A certiorari request to the U.S. Supreme Court has been filed in the case of Lamtec Corp. v. Department of Revenue of the State of Washington.1 The petition claims there are two questions presented: (1) Does the holding in Quill2 that the Commerce Clause prohibits imposing sales and use tax on a corporation without physical presence in the State "apply to other state taxes, such as an excise tax on conducting business within the State?" and (2) Were Lamtec's minimal contacts sufficient to establish nexus?
Lamtec is a privately held New Jersey corporation that manufactures vapor barriers and insulation facings. Their products are sold wholesale to customers throughout the country, primarily by phone orders placed with its New Jersey headquarters. It has no employees, permanent facilities, offices, addresses or phone numbers in the State of Washington. Neither does it have independent contractors, agents, affiliated companies, property or inventory in the State.
From 1997 to 2003 it received approximately $9 million of orders from Washington and "three Lamtec employees visited at most twelve customers in Washington…. During the entire eight years from 1997 to 2004, Lamtec employees were in Washington on some part of approximately 50 to 70 days, or approximately seven or eight days a year."
As I see it, there will be at least four major issues before the Court, if it grants certiorari:
1. Is the Washington Business & Occupancy ("B&O") tax the same as a sales and use tax?
According to the State's highest court, Washington's B&O tax is not a sales tax. The majority opinion held (6-3) that "the B&O tax differs sharply from a sales or use tax," distinguishing the two because "[S]ales and use taxes are stated separately, imposed on a transaction by transaction basis, and usually involve numerous limitations and exemptions" while the B&O tax is imposed annually on gross revenues.
2. Does Quill's Commerce Clause prohibition apply to any taxes other than sales and use taxes?
By this author's count, the Quill majority opinion makes clear no less than eight times that it applies only to sales and use taxes. For example, "While cases subsequent to Bellas Hess and concerning other types of taxes have not adopted a bright-line, physical presence requirement similar to that in Bellas Hess,their reasoning does not compel rejection of the Bellas Hess rule regarding sales and use taxes."3
3. Is there a legitimate split among the circuits as alleged in the cert. petition?
Although the petition for certiorari argues the point, there is not really much of a split among authorities. The only citations offered in the petition in favor of its position are more than 10 years old and may not stand for the proposition cited while a whole host of other more recent cases have held – consistently, year after year, since Geoffrey in 19934 – that economic nexus is sufficient for income taxation and that Quill is limited to sales and use taxes.
4. How much contact is enough to yield tax nexus?
This appears to be a matter of arithmetic and if the Court takes the case, it will presumably require an analysis of the concept of de minimis. However, this issue has been presented to the U.S. Supreme Court over and over again for more almost two decades and it has regularly denied certiorari.
KFC Also Files for Certiorari Against Iowa Corporate Income Tax Levied Without "Physical Presence"
Right after Lamtec, on April 28, 2011, KFC also filed a petition for certiorari (Dkt. 10-1340) asking the U.S. Supreme Court whether Iowa violates the Commerce Clause by imposing its corporate income tax on an out-of-state business that has no physical presence in the state. KFC has no physical presence in Iowa, but receives royalty and license income from franchisees that operate in the state and so challenged Iowa's corporate income tax assessment on the basis that KFC lacks a requisite "physical presence" for nexus with the state. The Iowa Supreme Court, after examining Quill upheld the assessment ruling that physical presence is not required under the Commerce Clause of the U.S. Constitution in order for Iowa to impose an income tax on revenue earned by an out-of-state corporation from the use of its intangibles by franchisees within Iowa.
The essence of the Iowa high court decision was the Court's holding "that a physical presence is not required under the dormant Commerce Clause of the United States Constitution in order for the Iowa legislature to impose an income tax on revenue earned by an out-of-state corporation arising from the use of its intangibles by franchisees located within the State of Iowa… [B]y licensing franchises within Iowa, KFC has received the benefit of an orderly society within the state and, as a result is subject to the payment of income taxes."5
BAT Simplification Act Reintroduced in U.S. House
On the same issue of whether or not "physical presence" is a prerequisite for tax nexus, a bill denominated the Business Activity Tax Simplification Act of 2011 (H.R. 1439) was introduced in the U.S. House of Representatives by Rep. Bob Goodlatte, R-Va., and several cosponsors on April 8, 2011. It was referred to the Judiciary Committee and is similar to legislation that has been introduced in previous Congresses and never been adopted.
The legislation would prohibit a state from imposing any business activity tax on a taxpayer, unless the taxpayer has a physical presence in the state for 15 days or more during the year. Physical presence would require having employees in the state, using an exclusive agent to establish or maintain a market in the state, or leasing or owning tangible personal property or real property in a state. Presence in a state "to conduct limited or transient business activity" would not establish physical presence sufficient to yield tax nexus.
For more information, in the Tax Management Portfolios, see Schaeffer, 559 T.M., Tax Aspects of Franchising, Rosen, 1430 T.M., Jurisdictional Limitations: Attributional Nexus, and Hellerstein, 1400 T.M., Federal Constitutional Limitations on State Taxation.
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