United States: State Tax Return - Nexus Update: 2003/2004

1. The Supreme Court reconsidered and reaffirmed the continued vitality of the National Bellas Hess v. Illinois Dep't of Revenue, 386 U.S. 753, 18 L. Ed. 2d 505, 87 S. Ct. 1389 (1967), bright line rule of physical presence.

2. The Commerce Clause prohibits states from imposing sales or use tax obligations upon out-of-state sellers unless there is a "substantial nexus" with the taxing state.

1. Requires at least some physical presence.

2. The Supreme Court left the phrase largely undefined. The Court's failure to specifically define the phrase "substantial nexus" has yielded two opposing interpretations:

1. Virtually any physical connection, no matter how incidental or sporadic, is sufficient to constitute "substantial nexus."

2. Physical presence must be significant, permanent or ongoing before "nexus" becomes "substantial."

3. Case-by-case litigation on this issue is prolific as courts define the judicial boundaries of "substantial nexus."

1. Court ruled that licensing of computer software to customers in the state was not "substantial nexus," and expressly rejected a "slightest presence" standard of constitutional nexus.

1. Maintenance of two offices in the state and solicitation by employees of advertising copy totaling $1,000,000 was sufficient to create nexus.

2. "Slightest presence" is not enough. The Supreme Court noted that the taxpayer's activities "establish a much more substantial presence than the expression 'slightest presence' connotes."

1. Ten independent contractors "conducting continuous local solicitation in [the state] and forwarding the resulting orders..." to the taxpayer created nexus.

2. The Supreme Court later described Scripto as representing "the furthest constitutional reach to date of a State's power to deputize an out-of-state retailer as its collection agent for a use tax." National Bellas Hess v. Illinois Dep't of Revenue, 386 U.S. at 757

1. In-state sales representative/independent contractor supplied requisite nexus.

2. Taxpayer's representative resided in Washington and "acted daily on behalf of Tyler Pipe in calling on its customers and soliciting orders" on a continuous basis.

a. Interlott Technologies, Inc. v. Arizona Dep't of Revenue, 205 Ariz. 452 (Ct. App. 2003).

1. Interlott, a lessor and seller of lotteryticket vending machines to the state lottery, installed 200 hundred machines in Arizona and maintained 2 employees in Arizona who responded to service calls, performed maintenance work on the machines, delivered and installed machines, trained customers in the operation of the machines, and relocated machines. During the audit period, there were no machine sales in Arizona, nor any business that resulted from contacts by Interlott's employees in Arizona. All of Interlott's business transactions with Arizona lottery were regulated by a series of short-term leases.

2. The Arizona Department of Revenue ("ADOR") issued a privilege tax assessment to Interlott, imposing tax on gross revenues from the leases to the state lottery. The Arizona Tax Court granted summary judgment to ADOR, on the grounds that Interlott had substantial nexus with Arizona.

3. The Court of Appeals affirmed the judgment of the Tax Court, holding that Interlott's 200 machines and 2 employees in Arizona constituted sufficient nexus to subject it to the transaction privilege tax. Although Interlott did not have a place of business in Arizona, the activities of its employees in the state, such as, performing preventive maintenance on the machines, training others to use and maintain them, and removing and moving them, constituted sufficient contact with the state to create nexus. In addition, the lease agreement was only the beginning of the company's business activity in the state and did not foreclose a determination of nexus.

a. In re: * * *, Comptroller's Decision, Hearing No. 42,441, 2003 Tex. Tax LEXIS 119, (Tex. Cptr. Pub. Acct., July 17, 2003).

1. Petitioner was a foreign manufacturer of medical equipment that had 8 employees in Texas (including 2 field service representatives whose job description included customer on-site maintenance, repair and installation, promotion and development of service revenue). Additionally, Petitioner sponsored a Symposium held in Texas during the year that the franchise tax deficiency was assessed. Petitioner maintained no place of business and was not registered as a foreign corporation in Texas.

2. The Department assessed franchise tax on Petitioner's earned surplus. Petitioner appealed to the Comptroller asserting that it was not subject to the franchise tax under P.L. 86-272.

3. Finding that P.L. 86-272 protects only activities that are ancillary to the solicitation of sales, the Comptroller determined that Petitioner exceeded the protection of P.L. 86-272 by making repairs in Texas, investigating creditworthiness, installing its products and conducting training or seminars for customers.

i. Amendments to the Business Corporation Franchise Tax Regulations Relating to Foreign Corpoxrations and Trade Shows, TSB-M-04(1)(C), 2004 N.Y. Tax LEXIS 30 (N.Y. Dept. Tax & Fin., Feb. 17, 2004).

1. On Jan. 22, 2004 amendments were adopted to sections 1-3.3 and 1-3.4 of the Business Corporation Franchise Tax Regulations to set forth a bright line nexus test for foreign corporations participating in trade shows. The amendments apply to taxable years beginning on or after January 1, 2002.

2. § 1-3.3(a)(7) provides that a foreign corporation's participation in a trade show or shows in New York State for 14 days or less during its taxable year for federal income tax purposes will be deemed insufficient to subject it to franchise tax. This is regardless of whether the corporation has employees or other staff present at the trade shows, provided that (1) the corporation's trade show activity is limited to displaying goods or promoting services; (2) no sales are made at the trade show; (3) and any orders received are sent outside New York State for acceptance or rejection and are filled from outside the state.

3. Under § 1-3.4(b)(9)(iv)(i) participation in a trade show or shows in New York State for 14 days or less by a corporation otherwise exempt from franchise tax pursuant to the provisions of Public Law 86-272, is an activity that is entirely ancillary to the solicitation of orders.

i . Texas Comptroller of Public Accounts, Letter Ruling 200311234L (Nov. 21, 2003), available at http:// aixtcp.cpa.state.tx.us/pubs12/200311234l.txt.

1. A corporation guaranteed a loan of a subsidiary that did business in Texas. The corporation had no other contacts with Texas. Question presented to the Texas Comptroller was whether the corporation, in hiring legal counsel to defend itself in litigation relating to the obligation under the guarantee, would be creating a nexus with Texas.

2. Texas Comptroller stated that under the agency's policy a corporation hiring legal counsel to defend itself in litigation in Texas does not create nexus for Texas franchise tax purposes.

1. Independent Contractors, Sales Representatives And Manufacturing Representatives

1. In re Dart Industries Inc., Case No. 04-03 (Feb. 26, 2004), New Mexico Department of Taxation and Revenue

2. Dart Industries Inc., ("Dart"), a Delaware corporation, manufactured and marketed plastic food containers and other home products under the "Tupperware" brand name. Dart had one franchised Tupperware distributorship located in New Mexico. The distributorship sold the Tupperware products to dealers in New Mexico who in turn sold to the consumer. Dart employees were in New Mexico for ten days assisting the distributorship in setting up its business.

3. iii. After an audit conducted by the Multistate Tax Commission on behalf of the Department of Taxation and Revenue ("Department"), the Department concluded that Dart's activities established nexus with New Mexico and exceeded the scope of activities protected by Public Law 86-272. The Department assessed Dart for corporate income and franchise tax.

4. Dart filed a written protest asserting that the assessment was barred by Public Law 86-272. The Department denied Dart's protest finding that Dart's extensive in-state activities exceeded the protection of Public Law 86-272. These activities included: (1) Dart licensed its trademark and franchise system to the New Mexico distributorship; (2) Dart established services for the distributorship; (3) distributorship maintained office in New Mexico; (4) distributorship promoted and protected Dart's trademarks and related goodwill; and (5) distributorship handled customer complaints and warranty claims.

i. Cal. Code Regs. tit. 18 § 1684(a). 

1. Effective Aug. 1, 2001, a retailer is not "engaged in business" in California based solely on its use of a representative or independent contractor in California to perform warranty or repair services for tangible personal property sold by the retailer, provided that the representative or independent contractor and the retailer are not owned by the same person.

i. Baker & Taylor, Inc. v. Kawafuchi, Hawaii Director of Taxation, 82 P.3d 804, 103 Hawai'i 359 (Haw. Jan, 14, 2004).

1. Baker, a Delaware corporation with its principal place of business in North Carolina, sold books and other educational materials to several customers in Hawaii, including the Hawaii State Library ("Library"). Baker had no office in Hawaii, no employees based in Hawaii, and no real property in Hawaii. Baker sent employee representatives to call on customers in Hawaii. Sales were made pursuant to contract obtained through bidding with Hawaii. Baker's corporate representatives visited Hawaii on an ongoing basis to support customers through its software and training.

2. The Tax Appeal Court held that Baker's operations in Hawaii were sufficient to require Baker to pay the general excise tax on its sales to the Library. On further appeal, the Supreme Court of Hawaii affirmed on the grounds that Baker engaged in active solicitation of the sales in Hawaii.

3. The Supreme Court applied the standard from Tyler Pipe Industries, Inc. v. Washington Dep't of Revenue, 483 U.S. 232 (1987) and Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), asking whether the activities performed by the representatives were "significantly associated " with Baker's ability to "establish and maintain a market" in Hawaii. Relying on Arizona Dep't of Revenue v. Care Computer Sys. Inc., 4 P.3d 469 (Ariz. Ct. App. 2000), the Supreme Court found that the "volume" and "function" of Baker's representatives in Hawaii exceeded that of the representatives in Care Computer, and that Baker had a physical presence that was significantly associated with its establishment and maintenance of the Hawaii market. Moreover, Baker's sales representatives established long and valuable relationships with the Library, and such activity significantly enabled Baker to maintain the Library's business in Hawaii.

i. Indiana Department of Revenue Letter of Findings, 02-0499, 02-0500 (April 1, 2004) 

1. Taxpayer was an out-of-state manufacturer with four resident sales persons in Indiana. Taxpayer holds a 79% interest in a related, out-of-state company ("Related Company"). Taxpayer's four salespersons solicit sales in Indiana on behalf of both Taxpayer and Related Company. Related Company pays for the services of Taxpayer's salespersons through a costsharing arrangement.

2. The Department of Revenue ("Department") assessed Taxpayer corporate income tax finding that Taxpayer's activities exceeded the protection of Public Law 86-272.

3. Taxpayer filed a written protest asserting that the assessment was barred by Public Law 86-272. The Department claimed that Taxpayer was subject to tax on the service income it received from Related Company. The Department cancelled the assessment finding that Taxpayer's activities consisted solely of solicitation of sales and were protected by Public Law 86-272. The Department stated, however, that if Taxpayer performed services on behalf of a third-party in Indiana that service income would be subject to tax.

1. Kentucky legislators introduced H.B. 299 on Jan. 15, 2004 that would extend the Kentucky sales tax to retailers that use a representative to establish or maintain a marketplace in Kentucky.

2. The bill expands the definition of "retailer engaged in business" to include any retailer located outside Kentucky that uses a representative, either full-time or part-time, in Kentucky if the representative performs any activities that help maintain or establish a marketplace for the retailer, including receiving or exchanging returned merchandise sold by the retailer.

3. The bill is currently pending in the House Committee, and if enacted, the sales tax changes would take effect after July 31, 2004.

i. Home Impressions, Inc. v. Director, Division of Taxation, Docket No. 000099-2003, 2004 N.J. Tax LEXIS 14 (N.J. Tax Ct. June 7, 2004).

1. Home Impressions ("Corporation") was incorporated in North Carolina and manufactured and sold mailboxes and mailbox posts. Its principal place of business was in North Carolina and it did not own or rent property, or maintain an office in New Jersey. The Corporation solicited orders in New Jersey through independent contractors. The orders taken were sent to North Carolina for approval and shipped from the Corporation's distribution center in Virginia. The Director of the Division of Taxation assessed corporation business tax finding substantial nexus based on the activities of the independent contractors on behalf of Corporation. The Director, after protest by Corporation, affirmed the assessment and Corporation appealed to the Tax Court.

2. The Tax Court found that the Corporation's activities in New Jersey amounted to "continuous and widespread solicitation of business" in New Jersey thus satisfying the minimum contacts required under the Due Process Clause.

3. The Tax Court found no reason to deviate from Quill Corp. v. North Dakota's, 504 U.S. 298 (1992) substantial nexus analysis in the context of franchise tax, and determined that the physical presence of the Corporation's independent contractors within New Jersey constituted substantial nexus for purposes of the Commerce Clause.

i. Advisory Opinion, Petition No. S030625B, 2004 N.Y. Tax LEXIS 56 (N.Y. Dept. Tax & Fin., Feb. 24, 2004). 

1. Boat America and BoatU.S. are separate legal entities. Boat America acts as an agent for BoatU.S. by providing administrative services assistance to BoatU.S. members. BoatU.S. also made sales through its catalog and website and retained independent contractors to provide towing services to BoatU.S. members in New York.

2. West Marine, Inc. operated 4 retail stores in New York and sold BoatU.S. memberships. Based on this, the Department found that West Marine was an independent contractor/agent of BoatU.S and that Boat U.S. had sufficient nexus with New York to require it to collect sales and use tax on any sales of taxable property which it made by catalog or other means in New York.

3. The Department found that as long as Boat America acted as a disclosed agent of BoatU.S. in dealing with the towing providers and had no agents or employees in New York performing services, it did not have nexus.

ii. Advisory Opinion, Petition No. S030523A, 2003 N.Y. Tax LEXIS 309 (N.Y. Dept. of Tax & Fin., Nov. 19, 2003).

1. Monarch Towel Co., Inc. ("Petitioner") manufactured and distributed bathrobes and towels. Petitioner was located in New Jersey and had no offices in New York. Petitioner did have an independent salesman that showed some of the clothing lines for children to retail stores in New York.

2. The Department of Taxation and Finance found that the presence of independent contractors or agents of an out-of-state corporation in New York is sufficient nexus to require the corporation to collect tax on its sales shipped and delivered into the state.

i. Philadelphia Eagles Football Club, Inc. v. City of Philadelphia, 823 A.2d 108 (Pa. 2003).

1. The NFL, of which the Philadelphia Eagles Football Club ("Taxpayer") is a member, received payments, referred to as "media receipts," from the networks for the exclusive right to broadcast the live telecasts of NFL football games. The media receipts were divided evenly among the NFL teams and in the tax years in question, Taxpayer played onehalf of its games in Philadelphia and the other half in venues around the country. Taxpayer argued that the City of Philadelphia ("City") had incorrectly assessed the amount of Business Privilege Tax ("BPT") owed by Taxpayer by using 100% of the media receipts in the BPT calculation. Taxpayer argued that because only half the football games were played and broadcast in Philadelphia, only 50% of the media receipts should have been subject to the BPT calculations.

2. The Philadelphia Tax Review Board determined that the Taxpayers media receipts constituted fees for services rendered and therefore, that only onehalf of the media receipts should be included in the gross receipts for purposes of assessing the BPT. The Court of Common Pleas reversed the Board's determination and concluded that the media receipts were copyright royalties (not fees for services rendered) and that 100% of those copyright royalties were subject to the BPT (Section 322 of BPT allocates all copyright royalties to the City of the taxpayer's commercial domicile is also Pennsylvania). The Court of Common Pleas also found that the Taxpayer had sufficient nexus with Philadelphia to permit, under the Commerce Clause, the imposition of the BPT.

3. The Supreme Court of Pennsylvania agreed with the Court of Common Pleas that media receipts were copyright royalties.

4. On appeal the Taxpayer argued that the City's levy on 100% of the media receipts violated the external consistency requirement of the Commerce Clause. The Supreme Court agreed finding that taxation of 100% of the media receipts, when half were from games telecast outside Philadelphia, was arbitrary and had no rational relationship to the Taxpayer's business activity in Philadelphia. The finding of substantial nexus by the Court of Common Pleas was not contested on appeal, and thus, was not addressed by the Supreme Court.

i. In re: * * *, Texas Comptroller's Decision, Hearing No. 39,829, Tex. Tax Rep. (CCH) 402-678 (Tex. Cmptr. Pub. Acct. Feb. 24, 2004).

1. Taxpayer was in the business of collection services. Taxpayer obtained a certificate of authority to do business in Texas and named a Texas company as its registered agent. The certificate of authority was surrendered after Dec. 2000 and a certificate of termination was issued in March, 2001. Taxpayer contracted with Texas companies to provide collection services, loss recovery services and loss prevention services and had six contract salespersons in Texas soliciting business on its behalf.

2. The Comptroller found that the holding of a certificate of authority and/or sales tax permit is insufficient to establish substantial nexus; however, Taxpayer's six contract salespersons established substantial nexus.

ii. Alpine Industries, Inc. v. Strayhorn, No. 03-03-00643-CV, 2004 Tex. App. LEXIS 6242 (Tx. Ct. App. July 15, 2004). 

1. Alpine was a Tennessee based company that sold its equipment throughout the U.S. (including Texas) through a network of independent salespersons. Alpine asserted that its network of independent salesperson did not establish substantial nexus in Texas.

2. The Court disagreed, finding that "Alpine's extensive network of salespersons-even though they are independent contractors-establish[ed]" sufficient nexus and satisfied the physical presence test of Quill v. North Dakota, 504 U.S. 298 (1992). 

a. Annox, Inc. v. Kentucky Revenue Cabinet, 2003 Ky. Tax LEXIS 246 (Ky. BTA Nov. 18, 2003).

1. Annox is a telecom services reseller with Kentucky customers. It had agreements with local telecom companies to use their physical networks and employees for customer service and connections. Annox relied heavily on Bell South, a local telecom company, in installation of phone service and assignment of new customers' telephone numbers to Annox's customers. Annox had no equipment or employees in Kentucky, and solicited customers by direct mail and through an Internet website maintained outside Kentucky. Annox was assessed public service corporation property tax for 2001 and appealed, asserting it did not have nexus with Kentucky.

2. The Board ruled that the physical presence nexus rule set forth in Quill Corp. v. North Dakota, 112 S.Ct. 1904 (1992), applies only to sales and use taxes, and applied the test in Tyler Pipe Industries Inc. v. Washington Dept. of Revenue, 483 U.S. 232 (1987) to find nexus for Annox. Even when there is no physical presence, the Board indicated that attributional nexus can be established if "the activities performed in this state on behalf of the taxpayer are significantly associated with the taxpayer's ability to establish and maintain a market in this state for sales."

3. The Board found that Annox had nexus with Kentucky because its contacts with the state were significantly associated with its ability to establish and maintain a market in Kentucky. Annox had the absolute right to use the physical networks of the local telecom companies. Also, since Annox operated in Kentucky only with the permission of the state Public Service Commission, the state licensing requirement established nexus with Kentucky. The Board also found nexus through Congressional action, since Congress had consented to state nexus over telecom resellers. Moreover, the Board also relied on the fact that Bell South employees acted on behalf of Annox in Kentucky, and that without the actions of Bell South on its behalf, Annox could not have offered its services in Kentucky.

4. Per the Board, no appeal of this decision was taken.

a. In the Matter of the Petition of CWM Chemical Services, Inc., DTA No. 818757, 2003 N.Y. Tax LEXIS 307 (N.Y. Tax App. Trib., Dec. 11, 2003). 

1. CWM Chemicals Services, LLC ("CWM") was a Delaware limited liability company, registered to do business in New York, that owned and operated a hazardous waste treatment, storage and disposal facility in New York. CWM provided services to its customers including picking up the waste at the customer's property and transporting it to CWM's New York facility for disposal. Some customers were outside New York and CWM did not charge tax on services sold to out-of-state customers.

2. The Tax Appeals Tribunal found that the services were integrated maintenance services and that the component parts of the services could not be separated for tax purposes. As a result, the issue was whether the entire price of the services was subject to tax in New York.

3. The Tax Appeals Tribunal focused on the time and place of the sale of the service and its connection to New York. Since there was no connection with New York State at the time of the sale, New York lacked nexus to tax the transaction. This case is interesting because it finds inadequate transactional nexus, even when the taxing state clearly had a strong connection with the service at issue.