Many states said they would find nexus as a result of the presence of internet servers, telecommuting employees, and transactions involving non-U.S. entities, Bloomberg BNA's 13th annual Survey of State Tax Departments shows.
As emerging technologies, such as cloud computing, continue to proliferate, a growing portion of the U.S. economy is operating independently of state, local, and international borders. This shift has increased the number and complexity of cross-border transactions. It has also allowed companies to reduce the number of locations in which they own property or have employees. The virtual tax base that has emerged has spurred states to aggressively pursue revenues from business activities with a connection to their borders.
The survey results, which detail the states' positions on a wide range of income and sales tax issues, as well as many other gray areas, are available in this week's issue of the Bloomberg BNA Weekly State Tax Report. Additional expert analysis of the results will be presented in a May 9 webinar with Fred Nicely, tax counsel for the Council On State Taxation (COST), and Thomas Shimkin, director of the Multistate Tax Commission's National Nexus Program.
Nexus From a Web Server
Income tax nexus results from owning a web server in their jurisdiction, according to 36 states and the District of Columbia. Several of these jurisdictions said they would find nexus even if the corporation did not make sales into the state. Twenty-six jurisdictions would find nexus for an out-of-state corporation that leased space on a third-party's internet server located within their borders.
Having data on an in-state leased server would trigger nexus in 24 jurisdictions, regardless of whether the data was stored on the server for more or less than six months. Only 12 states and the District of Columbia said nexus would arise from using the services of a web-hosting provider with a web server in their jurisdiction.
From the perspective of the cloud provider, the states' responses that a company would have an income and/or sales and use tax collection obligation by virtue of owning a server in the state is not surprising, said Kendall Houghton, a partner with Alston & Bird in Washington, D.C. "The key issue is whether ownership of the server (and/or licensing of software) creates taxable nexus. Many states have taken this position in formal rulings on the basis that server is tangible property, the presence of which is more than de minimis, and thus satisfies Quill," she said.
But, from the cloud computing purchaser's perspective, the issues become even more challenging and nuanced, said Matthew Hedstrom, a senior associate with Alston & Bird in New York. "Since most cloud computing services involve software, and hosting of such software on servers, the question becomes whether purchasing cloud-based services results in taxable presence," he explained. "Under Quill, the issue would be whether the purchaser would be deemed to own or lease tangible personal property."
"The states' positions may not withstand challenge by taxpayers when you consider that any nexus inquiry is highly fact-intensive," added Hedstrom.
Thirty-six states, plus the District of Columbia and New York City, said income tax nexus would result for an out-of-state corporation with employees that telecommute from homes within their jurisdiction. As in prior years, most of these states said that their position would remain the same even if the corporation had made no sales in the state or the employees telecommuted for only part of their total work time.
This year, 33 jurisdictions said nexus would arise from a single telecommuter who performed back office administrative business functions, such as payroll, as opposed to direct customer service or other activities directly related to the employer's commercial business activities. Thirty-four jurisdictions said nexus would be triggered by a single telecommuting employee who performs product development functions, such as computer coding.
Treatment of Non-U.S. Entities
For 2013, Bloomberg BNA expanded its coverage to include the state tax treatment of non-U.S. entities. "Even more than their domestic counterparts, foreign companies have a steep learning curve when it comes to state taxes," said David Fruchtman, who is of counsel with Horwood Marcus & Berk in Chicago.
"When a foreign company enters the U.S. market, its U.S. sales volume is small, its state tax liability insignificant and its knowledge of U.S. sub-national taxes essentially nonexistent. At this point, a foreign company's failure to comply with state tax obligations often will go undetected by state tax agencies." "Unfortunately," said Fruchtman, "even after generating meaningful amounts of U.S. sales and state tax liabilities, foreign businesses often remain unaware of their state tax obligations. As a result, these companies may have significant multistate tax exposures before they are genuinely aware of their liability for these taxes."
At the federal level, a non-U.S. company generally is not subject to U.S. tax on business income derived in the U.S., unless the income is attributable to a permanent establishment in the United States. The definition of "permanent establishment" varies by treaty, but it is generally defined as a place of management, an office, a construction site, or an agent of the non-U.S. company with authority to enter into contracts. At the state level, whether a non-U.S. entity is subject to tax depends on the entity having nexus with the particular state.
Most states adhere to an economic nexus rationale for income taxes, which does not require a physical presence. As a result, a non-U.S. company can achieve nexus with a state even if it lacks a permanent establishment. Only 18 jurisdictions said that they rely on "permanent establishment" criteria for purposes of making income tax nexus determinations. Another question is whether a state extends the protection afforded under Pub. L. No. 86-272 to non-U.S. entities. Pub. L. No. 86-272 prohibits the imposition of state income-based taxes against businesses engaged in the sale of tangible personal property whose activities in the taxing state are limited to the solicitation of orders. Twenty-four states said that they extend the protection to foreign commerce under Pub. L. No. 86-272 to non-U.S. entities.
Results to Be Analyzed in Upcoming Webinar
The webinar will be held on Thursday, May 9, from 12:30 to 2:00 p.m., ET. Register online to secure your space now. Or, please call 1-800-372-1033, option 6, then sub-menu option 1, and refer to the date and title of the conference. Lines are open Monday through Friday from 8:30 to 7:00 p.m., excluding most federal holidays.
In other developments…
Swapping State Income Taxes for Bigger Sales Taxes Would Make Tax Systems Even Less Fair , by the Center on Budget and Policy Priorities.
Joseph Henchman, of the Tax Foundation , on the 'Marketplace Fairness Act'.
Guidance on refunds and exemptions for qualifying surgical instruments after the Zimmer opinion , by the Texas State & Local Tax Law Blog.
States Are Not Out of the Woods Despite Strong Revenue Gains in the Fourth Quarter , by the Nelson A. Rockefeller Institute of Government.
By Steven Roll
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