United States: Supreme Court Of Ohio Hears Oral Argument In Crucial Case For Factor-Presence Nexus

The Supreme Court of Ohio heard oral argument in a case involving the Ohio Commercial Activity Tax (the "CAT")—which provides that taxpayers have nexus with Ohio and are subject to tax if they have at least $500,000 of annual sales to Ohio. The focal point of oral argument concerned whether the Commerce Clause requires physical presence for nexus or whether Ohio's $500,000 requirement is constitutionally permissible. Taxpayers with sales to Ohio should closely follow the outcome of this case.

Today, the Supreme Court of Ohio heard oral argument in three consolidated cases1 concerning a question of first impression: whether Ohio's nexus standard for its Commercial Activity Tax (the "CAT")—a gross receipts tax—violates the Commerce Clause. Specifically, under the CAT statute, tax is imposed on taxpayers with at least $500,000 of annual sales to Ohio, regardless of whether the taxpayer is physically present in the state. The cases involve three out-of-state sellers with no physical presence in Ohio: Crutchfield, Inc., Newegg, Inc., and Mason Companies, Inc. (collectively, the "Taxpayers").

History of the CAT The CAT's factor-presence nexus standard has its origins in a 2002 Multistate Tax Commission ("MTC") project to create a model statute for business activity taxes. The MTC adopted a model statute, Factor Presence Nexus Standard for Business Activity Taxes, which found that "substantial nexus" exists for out-of-state retailers if one of four criteria are met, including $500,000 of sales to Ohio.

In enacting the CAT in 2005, Ohio adopted a variation on the substantial nexus requirement in the MTC's model factor-presence statute. A driving force behind Ohio's change was the advent of the national online marketplace and its effect on state economies. Indeed, in today's argument, the court suggested that a primary purpose of the CAT was to level the playing field for Ohio merchants competing with online retailers. Thus, because of the effect of the online marketplace on its economy, which contributed to a projected one-billion-dollar budget shortfall, Ohio chose to phase out its franchise tax and instead implement the CAT.

With the move away from traditional nexus standards, Ohio opened the door for taxpayers to challenge the validity of the CAT. The most significant challenge–Ohio Grocers Assoc. v. Levin2–involved an as-applied challenge from food retailers who argued that the CAT violated state constitutional prohibitions against certain sales or excise taxes on food.3 In finding that the CAT did not violate those provisions, the Supreme Court of Ohio distinguished the CAT from a sales and use tax, holding that the CAT is a tax on the "privilege of doing business" in Ohio.4 This distinction matters because if deemed a sales tax, the CAT would be subject to the physical-presence standard announced in National Bellas Hess v. Department of Revenue5 and Quill Corp. v. North Dakota.6

In today's argument, the court heard its first challenge to the CAT on the basis of the Commerce Clause, and must determine what nexus standard applies to Ohio's tax on gross receipts. The Taxpayers are appealing a decision by the Board of Tax Appeals (the "BTA"), which ruled that it did not have the authority to address the constitutional questions presented in the cases. Specifically, the BTA noted that although the parties "have set forth their respective positions regarding the constitutional validity of the commissioner's application of the statutory provisions in question . . . we find such arguments may only be addressed on appeal by a court which has the authority to resolve constitutional challenges."7

Arguments Raised by the Taxpayers The Taxpayers argue that Ohio's Tax Commissioner cannot assess them on the basis of their sales volume alone. In support of that argument, Taxpayers assert that the U.S. Supreme Court has always required physical presence for gross receipts taxes to meet the constitutional mandate of having a substantial nexus between the state and the taxpayer announced in Complete Auto Transit v. Brady.8 As a result, Taxpayers argue that the CAT violates the Commerce Clause on its face because nexus through sales in excess of a statutory threshold alone, without a physical presence in Ohio, subverts the protections afforded taxpayers by the Commerce Clause.

In today's oral argument, the court got right to the point and asked the Taxpayers to "start with nexus." The court's first question focused on whether the U.S. Supreme Court has decided a case involving similar issues with taxpayers selling into a state where they are not physically present. Justice Pfeifer also asked the Taxpayers whether the U.S. Supreme Court had addressed "e commerce as it is evolving" in the context of the Commerce Clause. Taxpayers responded by noting that the U.S. Supreme Court had addressed the early stages of e-commerce in 1992 with its decision in Quill. But the court seemed to be looking for more, as Justice Pfeifer called Quill "ancient by today's standards."

The Taxpayers focused on the U.S. Supreme Court's decision in Tyler Pipe v. Washington State Department of Revenue9 and noted that the only way they could be subject to the CAT was through physical presence, either its own or by third parties "establishing or maintaining its market" within Ohio. The taxpayers conceded as much when Justice French asked whether they would be subject to the CAT if the "guts of their operations" were in Ohio, i.e., computer servers in Ohio, warehouses in Ohio, and other activities in Ohio. While acknowledging that they would have nexus with Ohio under those facts, the Taxpayers argued they did not have a physical presence in Ohio.

As a result, the Taxpayers argued that they did not have nexus with Ohio, and that ruling in favor of the state would "blaze a new trail" for nexus. In the Taxpayers' view, the only body with authority to expand nexus is Congress.

Arguments Raised by the State The state's brief raises numerous arguments against the Taxpayers' challenge of the CAT. First, the state asserts that the physical presence requirement for a state to impose transaction taxes—as announced in Bellas Hess and reaffirmed in Quill—does not apply to the CAT. Because the CAT is levied "on each person with taxable gross receipts for the privilege of doing business in [Ohio]" and not intended to be "a tax imposed directly on the purchaser," the tax is not a transaction tax subject to Quill's physical-presence rule.10 At oral argument, when questioned whether the Supreme Court of Ohio would need to deviate from existing U.S. Supreme Court precedent—Quill—the state responded: "you don't need to touch Quill."

Because Quill does not apply, the state argued it only needs to demonstrate that the Taxpayers' activities directed toward Ohio create an "economic nexus" between the Taxpayers and the state. When pressed by the court to identify its strongest U.S. Supreme Court case in its favor, the state offered Tyler Pipe v. Washington State Department of Revenue.11 In this case, also involving a gross receipts tax, the U.S. Supreme Court considered whether the taxpayer's in-state representatives were significantly associated with the taxpayer's ability to "establish and maintain a market" in Washington. The state urged the Supreme Court of Ohio to ask this same question: do the Taxpayers' activities establish or maintain a market for sales in Ohio? Importantly, the Taxpayers argue that this question misses the point of Tyler Pipe, which determined whether the activities performed in-state by third parties helped establish or maintain a market. By removing the in-state aspect of Tyler Pipe, the Taxpayers assert that the state is misapplying Tyler Pipe.

Nevertheless, the state—applying Tyler Pipe without the requirement of an in-state representative or other in-state physical presence—alleges that "[f]oremost among [Taxpayers'] business activities in Ohio is the harvesting of consumer data from online users."12 By using tracking devices such as "cookies" on Ohio customers' computers, Taxpayers can "grow and maintain its Ohio market." The cookies harvest data in the form of names, addresses, phone numbers, and email addresses of Ohio customers in order to improve online marketing capabilities.

In addition to the use of cookies, the state alleges that Crutchfield "aggressively marketed online and offline to grow and develop" its market in Ohio. Importantly, if the CAT is appropriately deemed a transaction tax such that Quill applied, its marketing activities in Ohio engaged from outside Ohio would not suffice to give Taxpayers a physical presence in Ohio. However, because the state alleges that the CAT is not subject to Quill, it asserts that these marketing activities do not preclude the state from asserting nexus over Ohio. These marketing activities include "display ads" that appear on customers' web browsers; "paid search" ads to target visitors' search trends; and the use of shopping comparison sites to represent its products when searches contain certain keywords by the users.13

Finally, the state argues that the $500,000 sales threshold "is a proxy for the high level of activity required to generate those amounts of receipts in the state and correlates to the benefits and protections offered by Ohio."14 This "bright-line" reflects the "modern trend among states recognizing that nexus may exist over a party that conducts significant business in the forum state, without regard to whether that entity is physically present."15 If physical presence is not required, then the $500,000 threshold exists to determine when a retailer's activities are substantial enough such that Ohio can assert its taxing authority over an out-of-state retailer.

What's Next? Taxpayers with substantial sales to Ohio customers should pay close attention to these cases. If the decision by the BTA is upheld, taxpayers making at least $500,000 in Ohio sales are subject to the CAT, which is imposed at a rate of 0.26% of Ohio taxable gross receipts. Taxpayers should prepare to comply with the CAT in the event the Supreme Court of Ohio finds the tax constitutional.

Regardless of the outcome, the decision may be appealed to the U.S. Supreme Court. Although the Court denies cert in the overwhelming majority of cases appealed, these cases could be candidates for review. The cases raise issues on the Court's radar in the wake of Direct Marketing Association v. Brohl;16 namely, whether the physical-presence standard announced in Bellas Hess and reaffirmed in Quill is still a legitimate test to determine whether a taxpayer has a substantial nexus with a state.

While the Taxpayers are seeking resolution through the courts, relief is also being sought by federal legislation. The Business Activity Tax Simplification Agreement ("BATSA") has been introduced in Congress numerous times over the past decade, and most recently in the House of Representative on June 1, 2015.17 This legislation would prohibit states like Ohio from imposing business activity taxes on taxpayers without a physical presence in the taxing state. BATSA was addressed at today's argument: the Taxpayers argued that Congress, and Congress alone, has the ability to regulate interstate commerce. BATSA—or any other legislation passed by Congress—would resolve this issue for the nation as a whole. The state's response was that, as a separate sovereign, "the state is free to impose any tax it desires."

For more information on these cases and their impact on your business, contact the authors of this alert or the Reed Smith state tax attorney with whom you regularly work.

Footnotes

1 Crutchfield Corp. v. Testa, Case No. 2015-368 (Ohio Mar. 6, 2015); Newegg, Inc. v. Testa, Case No. 2015-483 (Ohio Mar. 25, 2015); Mason Cos., Inc. v. Testa, Case No. 2015-794 (Ohio May 19, 2015). The cases were consolidated by the Ohio Supreme Court for purposes of oral argument.

2 See Ohio Grocers Assoc. v. Levin, 916 NE.2d 446 (Ohio 2009).

3 Ohio Const. art. XII, § 13.

4 See Ohio Grocers Assoc., 916 NE.2d at 455.

5 386 U.S. 753 (1967).

6 504 U.S. 298 (1992).

7See, e.g., Newegg, Inc. v. Testa, BTA decision, Case No. 2012-234 (February 26, 2015).

8 430 U.S. 274 (1977).

9 483 U.S. 232 (1987).

10 See Appellee Tax Commissioner's Merit Brief, Crutchfield, Corp. v. Testa, No. 2015-368 (Ohio October. 20, 2015).

11 483 U.S. 232 (1987).

12 See Appellee's Brief, Crutchfield, Corp. v. Testa, No. 2015-368 (Ohio October. 20, 2015).

13 Id.

14 Id.

15 Id.

16 575 U.S. __ (2015).

17 H.R. 2584 (June 1, 2015)

This article is presented for informational purposes only and is not intended to constitute legal advice.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
McDermott Will & Emery
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
McDermott Will & Emery
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions