United States: Washington ALJ Upholds B&O Assessment On German Company's Royalty Income

On May 31, 2016, the Washington Department of Revenue (DOR) Appeals Division released a Determination (No. 15-0251, 35 WTD 230) denying a German pharmaceutical company's business and occupation tax (B&O) protest. The administrative law judge (ALJ) ruled that while the nondiscrimination provisions contained in Article 24 of the US-Germany Income tax Treaty (Treaty) "may apply," the B&O does not discriminate against non-US businesses because it is imposed on any business deriving royalty income from Washington sources and applies equally to foreign and US companies. The ALJ also found that the company could avoid double taxation of the royalty income by excluding income taxed by Washington from its German tax base. While the company also challenged the constitutionality of the 2010 B&O economic nexus law, the ALJ declined to entertain it—citing a lack of authority to rule on the constitutionality of Washington statutes.


The company in this case is a German pharmaceutical company with no physical presence in Washington. Due to an inconsistency within the decision itself, it is unclear whether the company had a US presence outside Washington or none at all. Throughout the relevant years, the company received royalties based on where its pharmaceutical products were sold. After an audit was conducted of related entities, the company was assessed Washington B&O (plus interest and penalties) on royalties it received from sales of its products in Washington from June 2, 2010, through December 31, 2013.

The company disputed the assessment on the basis that it: (1) lacks constitutionally required nexus with Washington and (2) is protected by the Treaty.


Citing to the economic nexus standard enacted by Washington in 2010, the ALJ outlined the various thresholds (i.e., more than $250,000 in Washington receipts for 2010-2012 and more than $267,000 for 2013) and noted that the company "far exceeded" the thresholds during those years. The decision notes that while the taxpayer argued that the economic nexus law is unconstitutional under the commerce and due process clauses, the DOR does not have the authority to declare a law unconstitutional (only the courts do). Accordingly, the DOR denied the taxpayer's petition on the first issue.

Regarding the Treaty protections, the ALJ's first ruled that the B&O does not discriminate against foreign businesses. In doing so, the decision acknowledged that the nondiscrimination article "may apply to Washington's tax on royalties." The Model US Income Tax Treaty (Model Treaty) on which the US-Germany Treaty is based is generally limited to federal income taxes (despite language in the nondiscrimination article specifically including state and local taxes in the nondiscrimination analysis). Because of the broad limitation in scope, states have argued that the Model Treaty's nondiscrimination provisions do not apply to state and local taxes. Despite the apparent hesitation, the ALJ noting that the nondiscrimination provisions "may apply" to state and local taxes is significant.

The ALJ also ruled that the double taxation relief in the Treaty did not prevent Washington from imposing tax on the company. Specifically, the decision notes that the "[t]axpayer should be able to exclude [the] income taxed by Washington from its German tax base, [] avoiding double taxation." This conclusion assumes that the income is subject to the federal income tax, which isn't apparent from the decision (or general application of the B&O). The ALJ points out that the Treaty is generally limited to federal income tax and does not cover state and local taxes, making the double taxation relief cited inapplicable to the B&O on the royalties.

Practice Note

This is not the first time a company has attempted to challenge Washington's B&O economic nexus threshold. See Det. No. 14-0342, 34 WTD 250 (2015) (ruling that an out-of-state web hosting company with more than $250,000 in total service taxable receipts in the state had substantial nexus with Washington and rejecting claims that the B&O violated the commerce clause or due process clause, as applied). While Washington appellate court decisions have not required a physical presence as alleged by the company, each of the prior decisions was based on the pre-2010 qualitative nexus standard and the economic nexus threshold enacted in 2010 has not been thoroughly vetted by the courts in Washington. Should the company appeal this Determination, it will be able to raise the issue of the statute's constitutionality before a branch authorized to rule on the issue and give the courts the opportunity to establish precedent on the issue.

Perhaps more significant is Washington's application of the Treaty's nondiscrimination provisions (Article 24) to state and local taxes—despite general limitation elsewhere in the Treaty to federal income taxes. While the B&O was not found to be discriminatory in this case, this should open the door to the treaty argument for future taxpayers in other contexts (and other states) when foreign taxpayers are being treated differently. Because the nondiscrimination provisions are found in the Model Treaty that Treasury uses to negotiate treaties, foreign taxpayers should carefully review the provisions in the US Income Tax Treaty applicable to their country, as it likely contains similar relief. Outside the nondiscrimination provisions, foreign taxpayers (such as the company here) have historically not had success arguing that state taxes violate the "speaking with one voice" prong of the dormant Foreign Commerce Clause analysis described in Japan Lines due to their inconsistency with federal income tax policy and treaties or international agreements when state taxes are not specifically mentioned. See, e.g., Wardair Canada, Inc. v. Florida Dep't of Revenue, 477 US 1, 12, 106 S. Ct. 2369, 2375 (1986) (stating that "[b]y negative implication arising out of more than 70 agreements..., the United States has at least acquiesced in state taxation of fuel used by foreign carriers in international travel").

Further, we understand that an eastern state that has adopted economic nexus (pursuant to a court decision on a general statutory "from sources within this state" provision), previously took the same positon as Washington here; however, after ambassadors from a few countries complained, the state ended its effort to impose its corporate income tax on alien licensors.

Washington ALJ Upholds B&O Assessment On German Company's Royalty Income

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