Proponents' Case for a Federally-Imposed Business Activity Tax Nexus Threshold Has Little Merit
End Notes
[1] Two leading experts on state taxation concur:
This line of reasoning is indefensible, whether the benefits corporations receive are defined broadly, to mean the ability to earn income, or defined more narrowly to mean specific benefits of public spending, one of which is the intangible but important ability to enforce contracts, without which commerce would be impossible. A profitable corporation clearly enjoys both types of benefits. It is true that in-state corporations may receive greater benefits than their out-of-state counterparts, for example, because they have physical assets that need fire and police protection. But that is a question of the magnitude of the benefits and the tax that is appropriate to finance them — something that is properly addressed by the choice of apportionment formula and the tax rate, not the type of yes/no question that is relevant for issues of nexus. The answer must clearly be a resounding yes to the question of whether the state has given anything for which it can ask in return.
Charles E. McLure Jr. and Walter Hellerstein, “Congressional Intervention in State Taxation: A Normative Analysis of Three Proposals,” State Tax Notes, March 1, 2004, p. 721. The article was sponsored by the National Governors Association. McLure is a Senior Fellow with the Hoover Institution at Stanford University and was Deputy Assistant Secretary of the Treasury for Tax Analysis during the Reagan Administration. Walter Hellerstein is Francis Shackelford Professor of Taxation at the University of Georgia Law School and author of the most well-known legal treatise on state taxation.
[2] It is true that the Whitney and International Harvester cases focused on whether New York and Wisconsin, respectively, had the right to tax the income of the out-of-state recipients rather than assert taxing jurisdiction over the recipients themselves. It is also true that both cases were decided before Quill articulated a novel legal principle that the Due Process and Commerce Clauses of the Constitution imposed their own — and different — nexus requirements for state taxation of out-of-state corporations. Nonetheless, given the Court’s explicit statements in Quill that its earlier cases had not established a physical presence nexus threshold for taxes other than the sales tax, it arguably is more likely than not that states have the authority under current constitutional law, at least in certain circumstances, to impose business activity taxes on income earned by non-physically-present companies.
That conclusion was supported by the late Jerome Hellerstein, widely recognized as one of the preeminent experts of the last 50 years on constitutional law bearing on state taxing authority. In an article written after the Quill decision, he stated: “The U.S. Supreme Court has made it clear that the presence of the recipient of income from intangible property in a state is not essential to the state’s income tax on income of a nonresident.”
In short, the Supreme Court determined long ago that, at least in certain circumstances, it is entirely fair for a state to tax the income earned within its borders by a non-physically-present person or business.
[3] Courts in Illinois, Indiana, Iowa, Louisiana, Maryland, Massachusetts, New Jersey, New Mexico, North Carolina, Oklahoma, South Carolina, and West Virginia have held that physical presence is not required for BAT nexus. Courts in Tennessee and Texas have held that it is. A Missouri case cited by BATSA proponents as supporting their position was decided on state law grounds having nothing to do with nexus under the Constitution. An Alabama case they also cite was effectively reversed by a subsequent decision. Recent decisions in Indiana, New Jersey, Oklahoma, and West Virginia held that physical presence was required for nexus under the specific facts of the cases but did not overrule previous cases in each state finding that physical presence is not inherently required.
[4] State court decisions in Iowa, Massachusetts, New Jersey, North Carolina, and West Virginia that upheld the states’ positions that a business need not be physically present in a state to have BAT nexus there were all appealed to the U.S. Supreme Court. The Supreme Court denied review in all five cases.
[5] See a letter dated November 11, 1995 from Fred E. Ferguson of Arthur Andersen representing the Financial Institutions State Tax (FIST) Coalition to the Chairman of the Multistate Tax Commission (MTC) in support of the proposed financial institutions apportionment regulation. The letter states: “The FIST Coalition believes that the Apportionment Rules should serve as the model for uniform state apportionment of income of financial institutions. We encourage the MTC to adopt the rules, recommend that its member states favorably consider the rules for adoption, and urge the MTC to seek uniform adoption among non-member states as well.” The rules FIST endorsed included provisions assigning receipts from interest to the states in which a bank’s borrowers are located. Members of the FIST Coalition named in the letter included Citicorp, which now supports BATSA. See also a letter dated April 16, 1990 from Ruurd Leegstra of Price Waterhouse to the MTC’s General Counsel accompanying a “Proposal of the Broadcasters” dated April 13, 1990 and drafted by the ABC and NBC networks. The proposal included a provision apportioning advertising receipts of radio and television broadcasters based on the location of listeners/viewers. Both letters are on file in the headquarters office of the MTC.
[6] OECD, Addressing Base Erosion and Profit Shifting, February 2013.
[7] OECD, Action Plan on Base Erosion and Profit Shifting, July 2013.
[8] For the changes in OECD permanent establishment rules under consideration, see: OECD, Revised Discussion Draft, BEPS Action 7: Preventing the Artificial Avoidance of PE Status, May 15, 2015.
[9] Tyler Pipe v. Washington, 1987. In Tyler Pipe, the Court held that hiring an independent representative in a state to solicit sales and conduct other activities that helped an out-of-state corporation create and maintain a market for its products was no different from having an employee in a state engaged in the same activities and did indeed establish BAT nexus for the out-of-state corporation. There was no suggestion in the case that the holding would have been any different if the in-state representative had solicited sales on behalf of more than one out-of-state company; indeed, the evidence strongly suggests that the representative did. The Tyler Pipe decision of the Washington State Supreme Court, which the U.S. Supreme Court reviewed, states that the Washington representative of Tyler Pipe was Ashe and Jones, Inc. of Seattle. Ashe and Jones was characterized by Tyler Pipe as an independent contractor, suggesting that it solicited Washington sales on behalf of multiple out-of-state businesses. Ashe and Jones appears to have been at that time a typical “manufacturers’ representative” firm with multiple clients. The company certainly has multiple clients today, including Tyler Pipe. See: http://www.sdajnw.com/manufacturers/.
[10] Bradley W. Joondeph, “Are State Courts Biased Against Taxpayers that Seek the Protection of Federal Law?” State Tax Notes, October 27, 2003. Cases interpreting the application of P.L. 86-272 since this article was published include Alcoa Building Products v. Mass. Commissioner of Revenue (2003), Asher v. N.J. Division of Taxation (2005), Inova Diagnostics, Inc. v. Texas Comptroller of Public Accounts (2005), and Skagen Designs, Ltd. v. Minn. Commissioner of Revenue (2012).
[11] See, for example, footnotes 16 and 17 of the April 13, 2011 letter to the House Judiciary Committee Subcommittee on Commercial and Administrative Law in support of BATSA from the Coalition on Rational and Fair Taxation. Those footnotes identify 13 cases litigated since the Quill decision. There have been about ten additional cases not listed there in Louisiana, Oklahoma, Iowa, and Washington.
[12] See: Wisconsin Dept. of Revenue. v. William Wrigley, Jr., Co., 1992. In 1972 the Supreme Court had heard a case on a very narrow issue involving the interaction between P. L. 86-272 and state regulation of the sale of alcohol.
[13] See the source cited in Note 1, p. 735.
[14] Bayer Corporation, General Electric, Johnson & Johnson, and Dick’s Sporting Goods were members of the “CompetePA” coalition lobbying for the so-called “single sales factor apportionment” incentive in Pennsylvania. See: http://206.193.231.121/CompetePA/Members.asp. Johnson & Johnson and Walt Disney were members of the “Coalition for a Competitive California” lobbying for single sales factor legislation there. See “Report of Lobbying Coalition” for the first quarter of 2008, available at cal-access.ss.ca.gov/Misc/pdf.aspx?filingid=1326354&amendid=0. The latter two companies also funded the “No on 24” campaign in the fall of 2010 opposing a ballot measure that would have repealed California’s single sales factor law. All five companies are listed as current members of the Coalition for Interstate Tax Fairness and Job Growth at www.interstatetaxfairness.com/who-we-are/.
[15] For a description of how this “intangible holding company” tax shelter operates, see p. 5 of CBPP’s analysis of BATSA.
[16] Different versions of BATSA were first introduced in the second session of the 106th Congress in April 2000 as S. 2401 and H.R. 4267. Compare “Left unchecked, this expansion of the states’ power to impose business activity taxes will have a chilling effect on the entire economy as tax burdens, compliance costs, litigation, and uncertainty escalate” (Testimony of Arthur R. Rosen before the Subcommittee on Commercial and Administrative Law of the Judiciary Committee in the U.S. House of Representatives, June 9, 2000) to “Left unchecked, this attempted expansion of the states’ taxing power will have a chilling effect on the entire economy as tax burdens, compliance costs, litigation, and uncertainty escalate.” (Statement of Arthur R. Rosen before the Subcommittee on Regulatory Reform, Commercial and Antitrust Law of the Committee on the Judiciary, United States House of Representatives, June 2, 2015.)
[17] See the testimony of Carey J. Horne on pp. 9-13 of the September 27, 2005 hearing on H.R. 1956 before the Subcommittee on Commercial and Administrative Law of the House Judiciary Committee. H.R. 1956 was the version of BATSA introduced in the 109th Congress.
[18] Statement of Elizabeth Harchenko before the Senate Committee on Commerce, Science, and Transportation, March 14, 2001.
[19] Data on annual foreign direct investment flows into the United States are available at https://www.bea.gov/international/di1fdibal.htm. The first high-profile attempt by a state to enforce an “economic presence” nexus standard against a Delaware trademark holding company was the South Carolina v. Geoffrey case decided by the South Carolina Supreme Court in 1993.