States’ Response to Nexus Legislation
In the last several years, more states have attempted to expand the definition of nexus for income and sales tax purposes. Gary Bingel, EisnerAmper SALT partner-in-charge, takes a look at some state law provisions that have been enacted in response to this trend as well as ongoing attempts by Congress to codify the nexus standard at the federal level.
State Legislation, Then and Now
In October 2002, the Multistate Tax Commission issued a model rule that set forth a bright-line nexus test for business activities based on thresholds of property, payroll or sales in a state. Although the presence of property or payroll is a traditional nexus trigger in states, businesses and states alike focused on the sales factor – a purely economic measure of business activity.
In 2005, Ohio adopted a factor presence test to determine which businesses are subject to the state’s commercial activity tax (“CAT”). Under this test, even businesses with no physical presence in the state are subject to the CAT if they have sales in Ohio of $500,000 or more. Because the CAT is not an income tax, protections afforded to certain business activities under P.L. 86-272 do not apply.
Several states have followed Ohio’s lead and enacted similar nexus-expanding provisions to impose a sales tax collection obligation. The U.S. Supreme Court’s ruling in Quill v. North Dakota, 504 U.S. 298 (1992), which requires some sort of physical presence in a state to establish nexus, would seem to preclude these economic nexus laws, at least in the sales tax area. States have nevertheless begun to enact them in a direct attempt to overturn the Quill decision.
A couple of challenges have emerged. An Alabama Department of Revenue regulation that imposes a sales tax collection requirement on remote retailers with Alabama sales exceeding the regulatory threshold, has been challenged in the Alabama Tax Tribunal. In South Dakota, three online retailers have challenged the state’s economic nexus law in state circuit court (South Dakota v. Wayfair, Inc., et al., S.D. Cir. Ct., No. 32 Civ. 16-000092) South Dakota has appealed the circuit court ruling. In both cases, the states actively seek rulings that will eventually overturn the Quill decision.
Federal Legislative Efforts: Codifying Quill
While state legislatures and regulatory authorities are pushing the boundaries of what constitutes nexus for both income tax and sales tax purposes, Congress has introduced similar bills in each of the last two years that would go the other way, codifying the physical presence requirements of Quill and restricting the states’ ability to impose taxes or collection obligations on businesses.
2016 Bill: In July 2016, H.R. 5893, the “No Regulation Without Representation Act of 2016,” was introduced in the House. Sponsored by Representative F. James Sensenbrenner, Jr. (R-WI), the bill attempted to add clarity to the nexus rules by permitting a state to impose an obligation on a person for the collection of a sales, use, or similar tax or to report sales; assess such a tax on a person; or treat a person as doing business in state, only if the person has a physical presence in the state for the calendar quarter for which the obligation or assessment is imposed.
Physical presence will only be present if the person owns or leases real or tangible personal property in the state; has one or more employees, agents or independent contractors in the state specifically soliciting orders from in-state customers or providing design, installation or repair services; or maintains an in-state office where it regularly employs three or more employees for any purpose. The bill also defines certain activities that would be considered de minimis, including contractual agreements with in-state individuals who receive commissions for referring customers to the person, physical presence in the state for less than 15 days per year, product delivery via common carrier, or Internet advertising services not exclusively directed toward in-state customers.
2017 Bill: In June 2017, H.R. 2887, the “No Regulation Without Representation Act of 2017” was also introduced by Representative Sensenbrenner. The 2017 bill is significantly broader than its predecessor: It requires a person to have physical presence before a state can either tax or regulate the person’s business activities. Regulate is defined broadly to include a variety of potential state standards and requirements. The 2017 bill also expands the physical presence rule beyond sales and use taxes to all taxes imposed by the state, including business activity taxes and net income taxes.
While the definition of “physical presence” is similar to the 2016 bill, it differs in several respects: It includes maintaining a commercial or legal domicile in the state, requires that agents or independent contractors used to establish a market in the state be exclusive to the person, and modifies the prior bill’s requirement that three or more employees be regularly employed in the state to eliminate the requirement that the person also maintain an in-state office.
In addition to the de minimis activities described in the 2016 bill, the 2017 version includes the following activities that do not establish physical presence: ownership by a person outside the state of an interest in an in-state LLC or similar entity with physical presence in the state; furnishing of information to customers or affiliates inside the state, if the information is used or disseminated from a point outside the state; and business activities directly related to a person’s potential or actual purchase of goods or services in the state, provided that final decision to purchase is made out-of-state.
What Can We Expect?
Both federal bills would have significant impact on the expanded economic nexus provisions recently enacted by states. For example, the de minimis rule would invalidate click-through nexus rules by specifically exempting them from the definition of physical presence. In addition, because the definition of “person” treats each member of an affiliated group as a separate person, states could no longer look to attribute the activities of related entities to one another in order to establish nexus, thereby dealing a blow to affiliate nexus provisions.
Finally, since the definition of “seller” excludes entities such as marketplace providers, referrers, third-party carriers providing delivery services and certain financial intermediaries, provisions imposing obligations on these entities would be preempted. Note: The 2017 bill does carve out an exception for sales made by a marketplace provider of its own products.
With its provisions prohibiting all regulation and expanding its reach to all taxes, the 2017 bill would, if enacted, have even more far-reaching impact on businesses and on states. If enacted, the bill would likely preempt any pending court challenges to the recently enacted nexus expansion laws and would provide some level of certainty in the marketplace. However, it is difficult to predict whether the legislation will pass, and in its absence the ongoing tug-of-war between the states and businesses will likely continue in the courts. Due to the complexities involved, you should closely monitor these developments. If you have questions our SALT experts are available to discuss.
Business Tax Quarterly - Summer 2017