No Physical Presence Needed for Tax: Ohio High Court

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

By Christopher Brown

Nov. 17 — A taxpayer’s physical presence in Ohio isn’t necessary for the imposition of the state’s Commercial Activity Tax, a divided Ohio Supreme Court ruled in three closely watched cases decided upon the same grounds ( Crutchfield Corp. v. Testa , Ohio, No. 2016-Ohio-7760, 11/17/16 , Newegg Inc. v. Testa , Ohio, No. 2016-Ohio-7762, 11/17/16 and Mason Cos., Inc. v. Testa , Ohio, No. 2016-Ohio-7768, 11/17/16 ).

The taxpayers, two sellers of electronics and a seller of footwear that have no facilities or employees in Ohio, argued that a physical presence was necessary for the imposition of the tax, citing the U.S. Supreme Court’s foundational Quill rule under the federal dormant commerce clause.

But Chief Justice Maureen O’Connor, writing for the 5-judge majority, held that the commerce clause doesn’t impose a physical-presence requirement and that the $500,000 sales-receipt threshold set forth in the CAT statute satisfied the commerce clause requirement of substantial nexus.

“This is a big case, a really big case that will provoke a lot of thinking by taxpayers and practitioners going forward. I wouldn’t be surprised if other states don’t start using this in their arsenal to argue in favor of applying their gross receipts tax to out-of-state sellers,” Stephen K. Hall, a partner with Zaino Hall Farrin LLC in Columbus, Ohio, told Bloomberg BNA Nov. 17.

Business-Privilege Taxes

Focusing on the distinction between the use tax and the CAT, O’Connor said that the court’s reading of case law indicates that “that the physical-presence requirement recognized and preserved by the United States Supreme Court for purposes of use-tax collection does not extend to business-privilege taxes such as the CAT.”

In dissent, Judge Sharon Kennedy rejected the significance of the distinction between the use tax and business-privilege taxes for the purpose of analyzing nexus requirements, and said that the court remained bound by the U.S. Supreme Court’s divisive rule from Quill Corp. v. North Dakota, 504 U.S. 298, (1992). That rule is being challenged in several cases stemming from a flurry of recently implemented state rules.

“While I am sympathetic to all Ohio-based businesses that must pay a business-privilege tax such as the CAT, this court nevertheless should follow the law as it exists today,” Kennedy said.

Other Taxes Could Be Implicated

In a statement, Ohio Tax Commissioner Joe Testa said, “We are pleased with the decisions of the Ohio Supreme Court in upholding the constitutionality of the bright-line test in Ohio’s Commercial Activity Tax. The Court’s decision recognizes Ohio’s legitimate interest in applying its singular general business tax evenhandedly on both in-state and out-of-state businesses. It is reasonable that out-of-state businesses, who enjoy over $500,000 annually in gross receipts from Ohioans, should pay the CAT just as their Ohio peers do.”

Martin Eisenstein, managing partner of Brann & Isaacson in Lewiston, Maine, who represented the taxpayers in all three cases, told Bloomberg BNA Nov. 17 that he was disappointed with the ruling, which he said the taxpayers will review carefully before deciding whether to appeal to the U.S. Supreme Court.

“The court ruled that the physical presence requirement for nexus from the U.S. Supreme Court’s Quill ruling does not apply to a gross receipts tax,” Eisenstein said. “That’s a conclusion that we, along with the two dissenting justices, disagree with. But I should note that the Quill standard still does apply to sales and use taxes.”

Taxpayers who didn’t think they owed the tax should consider voluntary disclosures, Hall said, adding that other taxes also could be implicated by the court’s reasoning.

“This case seems to imply that income tax nexus could be similar to CAT nexus,” he said. “Maybe just having clients or buyers in the state will be enough, and maybe companies that thought they did not owe income tax in a state will find that the state tax administrator is taking the position that the tax is owed.”

Quill Review Unlikely

Jeff Stockdale, senior policy advisor for the Council of State Governments, told Bloomberg BNA Nov. 17 that the council was pleased that the court had rejected expanding the Quill physical presence rule to include Ohio’s CAT.

“Because of Quill, states are not allowed to tax sales made by interstate retailers. They lose out on billions of dollars in tax revenue each year, exacerbating the budget deficits many already face,” he said. CSG joined the amicus brief with other national organizations representing state and local governments that agree that Quill has “had clear and deleterious effects on state treasuries and local economies and should not be further expanded.”

Mark Nebergall, president of the Software Finance and Tax Executives Council, expressed skepticism that the U.S. Supreme Court would accept a petition to review the case.

“A betting man would say ‘No,’” he told Bloomberg BNA Nov. 17. “The Supreme Court doesn’t take very many cases to start with, and hasn’t take a case on physical presence since Quill. And there’s a footnote in Quill that says that this is a matter that is up to Congress. If Congress hasn’t seen fit to make any changes, members of the court could easily say, ‘Why should we get involved?’”

Looking to Past Cases

In the 24-page ruling, the Ohio supreme court first rejected the taxpayers’ statutory challenges to the CAT assessments, before moving to their commerce clause challenges.

The “main flaw” in the taxpayers’ argument was its reliance upon a theory of interstate-commerce immunity from state taxation that was abandoned by the U.S. Supreme Court in 1977 in Complete Auto Transit Inc., v Brady, 430 U.S. 274, 97 S.Ct. 1076, 51 L.Ed.2d 326 (1977), the court said.

Complete Auto abolished the prohibition against levying a tax on the privilege of engaging in interstate commerce, and the Supreme Court’s articulation of the substantial-nexus test was not intended to resurrect it,” the court said.

Distinguishing Tax Types

In the U.S. Supreme Court’s Quill decision, the court said that the physical-presence rule was worth preserving for sales and use taxes because the settled expectations of mail-order sellers arising from previous Supreme Court decisions may have facilitated interstate business, the Ohio court said. But Quill’s holding that physical presence is a necessary condition for imposing the tax obligation doesn’t apply to a business privilege tax such as the CAT, as long as the privilege tax is imposed with an adequate “quantitative standard that ensures that the taxpayer’s nexus with substantial,” it said.

The basis of the court’s holding could be found in Quill, where the Supreme Court said that it hadn’t articulated the same physical-presence requirement for other taxes that it had established for sales and use taxes, the Ohio court said. In addition, case law since Complete Auto established that business privilege taxes should be distinguished from transaction taxes for the purposes of applying the four-prong commerce clause test established in Complete Auto, it said.

As for state court rulings cited by the taxpayers in support of their argument that physical presence in the state is necessary for the imposition of a gross receipts tax, those cases stand rather for the proposition that physical presence is a sufficient condition for the imposition of the tax, the court said.

“Given our reading of the United States Supreme Court cases, there is no reason for us to view those decisions as authority for the proposition that physical presence would have been a necessary condition as well,” it said.

To contact the reporter on this story: Christopher Brown in St. Louis at

To contact the editor responsible for this story: Ryan C. Tuck at

Copyright © 2016 Tax Management Inc. All Rights Reserved.

Request Weekly State Tax Report