The Washington Court of Appeals has held that a business had substantial nexus for purposes of the state's Business & Occupation (B&O) Tax for the sale of goods delivered to Washington addresses even though the activities of its office in the state were not directly connected to the sales.1 The business met the nexus requirements because its Washington office was significant in establishing and maintaining a market for its goods in the state. As a result, the business was not able to avoid taxation by dissociating its activities in the state from its sale of goods destined to Washington addresses.
Background
Avnet, a corporation based outside Washington, was a large distributor of electronic items that shipped all of its products from distribution centers outside Washington. An Avnet office in Washington had more than 40 employees that served customers in the state and conducted other activities related to market and product development.2 The Washington Department of Revenue (Department) determined that Avnet had miscalculated its B&O Tax for 2003 through 2005 by improperly excluding two categories of sales described as "national sales" and "third party drop-shipped sales." The national sales category involved transactions where an Avnet customer placed an order from outside Washington with an Avnet sales office outside the state, but directed Avnet to ship products to the customer in Washington. The drop-shipped sales category also involved an Avnet customer located outside Washington placing an order with an Avnet sales office outside the state, but Avnet's customer directed Avnet to ship products to a third party located in Washington.3
After an unsuccessful administrative appeal at the Department, Avnet paid the disputed amount under protest and filed an action in a local trial court. The trial court granted Avnet's motion for summary judgment regarding the drop-shipped sales and granted the Department's motion for summary judgment regarding the national sales. Both parties filed appeals.
Drop-Shipped Sales Subject to Tax
The Court of Appeals reversed the trial court and held that the drop-shipped sales were subject to the B&O Tax. As explained by the Court, Washington imposes B&O Tax on every person that has "substantial nexus" with the state "for the act or privilege of engaging in business activities."4 For wholesale sales, the tax is imposed on "every person engaging within this state in the business of making sales at wholesale" and is based on the "gross proceeds of sales."5 "Sale" is defined as "any transfer of the ownership of, title to, or possession of property for a valuable consideration."6 Washington courts have broadly interpreted this statute to tax interstate commerce almost as far as the dormant Commerce Clause permits.7 For the drop-shipped sales, Avnet did not deliver the products to its own buyer outside Washington, but delivered the products to its buyer's customer in the state. Because the only transfer of property to any buyer occurred within Washington, this statutory language brought the drop-shipped sales within the reach of the B&O Tax. According to the Court, an administrative rule further supported the conclusion that the drop-shipped sales were subject to the B&O Tax. Under the rule, a sale occurs in Washington "when the goods are delivered to the buyer in this state, irrespective of whether title to the goods passes to the buyer at a point within or without this state."8 The Court reiterated that the only delivery to any buyer that occurred was within Washington. Under the both the statutory definition of "sale" and the rule's criteria for determining when a sale takes place in Washington, the drop-shipped sales took place in Washington.
Avnet unsuccessfully argued that the wholesale B&O Tax did not apply to the dropshipped sales because Avnet's customer, the wholesale buyer, did not take physical possession of the goods in Washington. In support of its argument, Avnet cited an administrative rule providing that B&O Tax is not imposed on "sales of goods which originate outside this state unless the goods are received by the purchaser in this state and the seller has nexus."9 Based on a specific example provided in the rule,10 Avnet argued that its buyers did not receive the goods within the meaning of the rule. The Court distinguished the example and explained that the crucial factor was that the only buyer who took delivery from Avnet was located in Washington. The Court also characterized Avnet's approach as an impermissible elevation of form over substance,11 where corporate convenience in negotiating or contracting outside Washington did not hide the fact that the location of the sale was where the buyer took delivery and possession of Avnet's products. Finally, the Court discounted this argument because the rule cited by Avnet was an "interpretive rule" that explains the Department's views and does not constrain the courts. Accordingly, the Court explained that the "language of the rule can provide Avnet no more haven than the B&O statute does."
Shipments to Washington Customers Subject to Tax
The Court of Appeals affirmed the trial court and held that Avnet's national sales were subject to the B&O Tax. Avnet unsuccessfully argued that its national sales were exempt under a rule that allegedly excluded sales not significantly associated with Avnet's activities in Washington. The same administrative rule that Avnet used to support its drop-shipped sales argument provides that "a seller [who] carries on significant activity in this state and conducts no other business in the state except the business of making sales . . . has the distinct burden of establishing that the instate activities are not significantly associated in any way with the sales into this state."12 Because its Washington office did not engage in the activities listed in the rule that would establish that the B&O Tax applied to its sales, Avnet argued that the office's activities in Washington were not significantly associated with the sales. In rejecting this argument, the Court reiterated that an interpretive rule cannot provide more protection than afforded by the B&O Tax statute.
Transactional Nexus
Avnet argued that the dormant Commerce Clause exempted the disputed sales from the B&O Tax.13 This argument was based on the substantial nexus requirement and focused on "transactional nexus." According to Avnet, the dormant Commerce Clause allowed it to "dissociate" its sales delivered to Washington addresses by showing that its Washington personnel played no significant role in the transactions. Avnet argued that "states may impose a tax on interstate sales only if there is a substantial nexus between the seller's activities and the state and those activities are significantly associated with the sales at issue." The Court held that the case that Avnet cited for this proposition, Allied-Signal, Inc. v. Director, Division of Taxation,14 did not support this argument. Allied-Signal requires that the taxing state must have a sufficient connection both to the taxpayer and the activity taxed, but it does not impose a requirement that the taxpayer's activities creating the necessary connection to the taxing state have some direct connection to the specific sales taxed.
In support of its argument, Avnet cited two cases from 1951, Norton Co. v. Department of Revenue15 and B.F. Goodrich Co. v. State.16 The Department conceded that these cases were similar to the instant case and have not been expressly overruled. The Department has taken the positon that more recent cases demonstrate that Avnet's activities in Washington created sufficient nexus for taxing all of the sales bound for the state.17 After noting that Norton's foundations have been eroded by subsequent cases, the Court agreed with the Department that more recent cases have expanded the range of activities relevant to the substantial nexus analysis. For example, in Tyler Pipe Industries,18 the U.S. Supreme Court held that there was sufficient nexus to impose tax on the sales into Washington even though the business did not have an office, own property or have employees residing in the state. Pursuant to Tyler Pipe Industries, the crucial factor is whether the activities in the state are "significantly associated with the taxpayer's ability to establish and maintain a market in this state for the sales."19 The Washington Court of Appeals explained that these cases "show a progressive broadening of the types of activities that may establish substantial nexus for purposes of state taxation of interstate commerce." These cases illustrate that "a state need not demonstrate a direct connection between a taxpayer's nexus-creating activities and particular sales into the state in order to tax those sales."
Maintaining Market in Washington
As discussed above, U.S. Supreme Court decisions do not require a direct connection between Avnet's activities in Washington and the specific sales, but Avnet's activities in the state must be significant in establishing and maintaining a market for its goods in the state. The Court concluded that Avnet's Washington office met this requirement because its employees engaged in a variety of market research and product development activities aimed at building and maintaining the company's market in Washington, as well as other locations.
Commentary
This case essentially precludes businesses from making a "dissociation" argument that they do not have substantial nexus with Washington for B&O Tax purposes because their activities in the state are not directly related to their sale of items that are delivered to customers in the state. Under the U.S. Supreme Court decisions, the state must show that a company's in-state activities are significant in establishing and maintaining a market in the state. However, this standard provides much less protection than was offered under the "dissociation" theory. This decision turned on the Washington administrative rule cited by Avnet which does allow companies to establish that their activities in the state are not significantly associated with the sales into Washington, though it should be noted that reliance on an example in the rule that was not parallel to the instant facts made it more difficult for the Court of Appeals to accept Avnet's argument. Further, the Court of Appeals' discounting of Avnet's attempt to rely on an interpretive administrative rule to support its argument is relevant. Apparently, if the "interpretive" classification for a particular Department rule is apt, such rule appears to be entitled to less deference than other Department rules and provides little support for the party relying on such rule. As this case may be interpreted as an expansion of the activities that satisfy the substantial nexus requirement for purposes of the B&O Tax, such interpretation (if an appeal is unsuccessful) is likely to result in more out-of-state companies being subject to the tax.
Footnotes
1 Avnet, Inc. v. Department of Revenue, Washington Court of Appeals, No. 45108-5-II, April 28, 2015.
2 There was no indication that this office participated in soliciting or filling orders, investigating customer credit, or providing technical support to the end users in the specific sales at issue. 3 Generally, this third party was the Avnet customer's own customer.
4 WASH. REV. CODE § 82.04.220; Lamtec Corp. v. Department of Revenue, 246 P.3d 788 (Wash. 2011).
5 WASH. REV. CODE § 82.04.270.
6 WASH. REV. CODE § 82.04.040(1).
7 Coast Pacific Trading, Inc. v. Department of Revenue, 719 P.2d 541 (Wash. 1986).
8 WASH. ADMIN. CODE § 458-20-103.
9 WASH. ADMIN. CODE § 458-20-193(7).
10 WASH. ADMIN. CODE § 458-20-193(11)(h).
11 See Chicago Bridge & Iron Company v. Department of Revenue, 659 P.2d 463 (Wash. App. 1983).
12 WASH. ADMIN. CODE § 458-20-193(7)(c).
13 To satisfy the dormant Commerce Clause, a state tax imposed on an out-of-state corporation must: (i) be applied to an activity with a substantial nexus with the taxing state; (ii) be fairly apportioned; (iii) be nondiscriminatory with respect to interstate commerce; and (iv) be fairly related to the services provided by the state. Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
14 504 U.S. 768 (1992).
15 340 U.S. 534 (1951).
16 231 P.2d 325 (Wash. 1951).
17 Tyler Pipe Industries, Inc. v. Washington Department of Revenue, 483 U.S. 232 (1987); Standard Pressed Steel Co. v. Washington Department of Revenue, 419 U.S. 560 (1975); General Motors Corp. v. Washington, 377 U.S. 436 (1964).
18 483 U.S. 232.
19 Id.
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