United States: Congress Steps Up To "BATSA" Again In The Nexus Game, Proposing The Expansion Of P.L. 86-272

Congress’ latest foray into the nexus arena, the Business Activity Tax Simplification Act of 2006 ("BATSA"), H.R. 1956, has many hearts racing. States have been chipping away at Quill’s ¹ physical presence standard with a batting speed to rival Albert Pujols. ² If passed, BATSA would codify the physical presence standard and expand the protections of P.L. 86-272. While states complain about lost revenue, arguably, the states are not entitled to such revenues in the first place. States have been crowding the plate with increasing vigor. Their ever-aggressive attempts to assert jurisdiction over out-of-state businesses has led to the need for Congressional intervention – one fast "ball-sa" up and in. Not only would BATSA be good law, it would be good for business. Passage of the proposed legislation, however, is not guaranteed. Let’s hope the threat of passage alone is enough to make the states back up off the plate a little.

Current Dilemma: It’s Hard to Play Baseball-sa Without a Bat-sa³

Before P.L. 86-272 was enacted, businesses selling goods in interstate commerce were often forced to litigate the issue of whether they had nexus with various states for income tax purposes. The safe harbor provisions of P.L. 86-272 decreased litigation and provided businesses with needed certainty. Under P.L. 86-272, a state cannot impose an income tax on a business if the business’ only activity in a state is the solicitation of orders for "sales of tangible personal property, which orders are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State." ⁴ Since P.L. 86-272 is limited to businesses selling goods and to state taxes based on net income, unfortunately, many businesses fall outside its protection.

In Quill, the U.S. Supreme Court held that North Dakota could not require Quill Corporation, an out-of-state vendor, to collect and remit use tax because Quill Corporation had no actual physical presence in, or no substantial nexus with, North Dakota. Although Quill was a sales and use tax case, taxpayers who fall outside the protections of P.L. 86-272 have also relied on Quill’s physical presence test in cases involving net income or other business activity taxes. Such taxpayers have met with mixed results. For example, in Rylander v. Bandag Licensing Co., ⁵ the Austin Court of Appeals ruled that the Quill’s physical presence test likewise applies to the Texas franchise tax. In Geoffrey Inc. v. South Carolina Tax Commission, ⁶ however, the South Carolina Supreme Court distinguished Quill, holding that an actual physical presence was not required for income tax purposes to satisfy the Due Process and Commerce Clause.

In light of the mixed results in the courts and lack of uniformity among the states, businesses, particularly those in the service industry, have been forced to litigate the issue of nexus again, and again. It is not uncommon for multistate businesses in the service industry to be, at any given time, litigating multiple state tax cases in which nexus is a central issue. Businesses with intellectual property holding companies have also suffered from the lack of predictability and uniformity. The courts are currently split over whether the physical presence standard of Quill or the economic nexus standard raised in Geoffrey is appropriate with respect to income taxes.

BATSA: An "Alexander Cartwright"⁷ Moment in the Nexus Game

Since Quill, various forms of business activity tax bills have been introduced in Congress, but none have made it out of committee. Currently before Congress, BATSA proposes to regulate certain state taxation of interstate commerce by expanding the application of P.L. 86-272 and codifying a physical presence standard with respect to income and other business activity taxes.

If passed, BATSA expands the application of P.L. 86-272 beginning on the first day of the year following its passage. ⁸ First, the safe harbor provision related to income-based tax under P.L. 86- 272 would be expanded to encompass not just the solicitation of sales of tangible personal property, but sales or transactions involving "all other forms of property, services and other transactions fulfilled from a point outside the State." ⁹ Second, BATSA extends P.L. 86-272 protections to other business activity taxes, ¹⁰ which are defined as:

1. a tax imposed on or measured by gross receipts, gross income, or gross profits;
2. a business license tax;
3. a business and occupation tax;
4. a franchise tax;
5. a single business tax or a capital stock tax; or
6. any other tax imposed by a state on a business for the right to do business in the state or measured by the amount of, or economic results of, business or related activity conducted in the state. ¹¹

The definition of "other business activity taxes" specifically excludes "a sales tax, a use tax, or a similar tax, imposed as the result of the sale or acquisition of goods or services, whether or not denominated a tax imposed on the privilege of doing business." ¹²

Enlisting an Umpire by Codifying the Physical Presence Standard¹³

BATSA codifies the physical presence standard for net income tax and other business activity taxes. BATSA provides that

A person is deemed to have physical presence in a state only if, for 21 days or more in the aggregate during a taxable year, such person’s business activities in the state include any of the following activities: ¹⁵

• An individual or employee physically in the state, but excluding from determining whether the 21-day limit has been exceeded: ¹⁶

• Activities in connection with a possible or an actual purchase of goods or services, for consumption by the person’s business.
• Gathering news for print, broadcast, or other distribution through the news media.
• Meeting government officials for purposes other than selling goods or services to such government.
• Merely attending educational or training conferences.
• Nonprofit participation in charitable activities.

• Using the services of an agent (excluding an employee) to establish or maintain the market in the state, if such agent does not perform business services in the state for any other person during such taxable year. ¹⁷

• The leasing or owning of tangible personal property or of real property in the state, but excluding from determining whether such 21-day limit has been exceeded: ¹⁸

• Tangible personal property located in the state for purposes of being assembled, manufactured, processed, or tested by another person for the benefit of the owner or lessee, or used to furnish a service to the owner or lessee by another person.
• Marketing or promotional materials distributed in the state.
• Any property to the extent used ancillary to an activity excluded from the computation of the 21- day period.

A person is deemed to have physical presence in a state only if, at least one day during a taxable year, such person’s business activities in the state include any of the following activities: ¹⁹

• The sale within a state of tangible personal property, if delivery of the property originates and is completed within the state.

• The performance of services that physically affect real property within a state.

The physical presence standard does not apply to exempt businesses or individuals domiciled in the state in which the tax is imposed. ²⁰ Further, BATSA’s physical presence standard should not be construed to modify or affect any state business activity tax liability of an owner or beneficiary of a partnership, S Corporation, LLC, trust, or similar entity that has a physical presence in the state. ²¹

For the states, the true cost of BATSA is unknown and hotly contested. The National Governors Association’s ("NGA") "ballpark" estimate of the cost to all states is $2.2 to $3.1 billion in the first year and $4.7 to $8 billion annually thereafter. ²² The Congressional Budget Office ("CBO") estimates the cost at $1 billion in the first year and $3 billion annually by 2011. ²³ Ernst & Young’s estimate, prepared for the Council On State Taxation, is $434 million in the first year. ²⁴ Ernst & Young maintains that the NGA and CBO estimates are too high for various reasons, including (i) the states in the NGA report disagreed on the bill’s interpretation, erroneously included some transaction taxes, and relied on prior versions of the bill; (ii) the states in the NGA did not use consistent methods or assumptions; (iii) both the NGA and CBO estimates failed to net the increases in state revenues; and (iv) both the NGA and CBO studies make unsupported assumptions regarding the extent of taxpayer restructuring in years following the bill’s passage. ²⁵ If the Ernst & Young estimate is the most accurate, BATSA results in a loss of revenue of 0.8 percent of all business activity taxes covered by the bill. ²⁶

The predictability and rationale of BATSA make for good law. The physical presence rule correctly and fairly matches taxes paid with benefits received. ²⁷ BATSA is consistent with U.S. tax treaty language; thus, it creates more equity between foreign-based corporations doing business in the U.S. and U.S.-based businesses. ²⁸ Codification of the physical presence standard should end the economic nexus debate raised by Geoffrey and foster competition between the states to create favorable tax environments to attract businesses. The physical presence standard promotes interstate commerce and reduces often burdensome compliance costs by limiting state filings for di minimis activities. The certainty afforded by the expansion of the P.L. 86-272 safe harbor will reduce administrative and litigation expenses for both businesses and states. BATSA is good for business, and for enterprising states.

Unfortunately, more people are betting on baseball than this bill. Although stranger things have happened, it seems unlikely that Congress will hit this one out of the park. Write your respective Congressmen and Senators if you support the bill. Otherwise, sit back and enjoy the game.■

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