Blog Tax News Navigating Nexus. Multistate Business Operations Face a Wide Variety of State Taxes.

Navigating Nexus. Multistate Business Operations Face a Wide Variety of State Taxes.

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Navigating Nexus. Multistate Business Operations Face a Wide Variety of State Taxes.
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Nexus can be a hidden danger for a company with a multistate presence. Certain activities might cause nexus for sales and use tax, income tax, franchise tax or other business taxes. One key to successfully navigating these widely varying provisions is for tax professionals to review the statutes and rulings of each state in which a business client might be considered as doing business. The connection might not be obvious, particularly for sales and use tax. And some states levy types of taxes that might not be familiar to business owners and managers, such as those on gross receipts or business activity.

 

Another, less well-known key is familiarity with states’ provisions for voluntary disclosure and amnesty. Businesses might need a CPA experienced in negotiating with the state or states in question to use these tax controversy resolution tools, especially if they didn’t think they had nexus for an earlier period but belatedly determine that they did.

NEXUS AND TYPES OF TAX

Sales tax. Federal law requires a state to have “substantial nexus” to a seller to require that seller to collect sales and use tax. The definition of “substantial nexus” has always been a subject of contentious debate between states and businesses. Generally, however, it means having a physical presence in the state , whether by salesperson, contractor, location or a number of different events (see Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and National Bellas Hess v. Department of Revenue, 386 U.S. 753 (1967)). Owning or leasing tangible personal property or real property in the state is usually considered to establish sales-and-use-tax nexus. Depending on the state, some other common activities that can result in nexus are listed in the sidebar, “Nexus Study Overview and Checklist,” below.

Income, franchise and other business taxes. Having nexus for sales tax purposes does not necessarily mean a taxpayer will have nexus for income tax purposes, as a higher level of business activity may be required. Historically, state income tax nexus has been created when an out-of-state company derives income from sources within the state, owns or leases property in the state, or employs personnel who engage in activities that go beyond those “protected” under federal interstate commerce laws. Under 15 USC § 381 (commonly referred to by its 1959 enacting legislation, PL 86-272) states imposing a tax based on or measured by net income may not impose that tax on out-of-state taxpayers whose only connection with the state is the solicitation of orders for sales of tangible personal property when such orders are approved and shipped from outside the state. Since PL 86-272 applies only where the in-state activities are the solicitation of orders for sales of tangible personal property, it has no applicability where the solicitation is for the sale of intangible property, real estate or services.

Although PL 86-272 offers protection from income tax, it does not offer protection from a state’s franchise tax, which is imposed for the privilege of doing business in the state and generally based on an apportioned capital, net worth or another non-income base. Currently, about half the states impose a franchise tax, either in conjunction with, or in lieu of, an income tax. In general, a taxpayer with sales tax nexus will be subject to the state’s franchise tax.

Additionally, in recent years several states replaced their income tax with non-income-based taxes. These include the Michigan business tax (MBT), the Texas margin tax (TMT), and the Ohio commercial activities tax (CAT). Like the Washington state business and occupation (B&O) tax and the Delaware gross receipts tax, the MBT, TMT and CAT are not based on or measured by income, but are imposed on gross receipts generated from the sale of products or services, the value of a business’s transactions or some other modified base.

Gross receipts taxes are imposed on the seller and are similar to a privilege tax. It should be noted that taxes based on gross receipts are not sales taxes, even if the same sales receipt impacts both the seller’s gross receipts tax liability and the purchaser’s sales or use tax liability. The MBT, TMT and CAT also require “affiliated” taxpayers engaged in unitary business operations to report their income on a combined basis, thus further expanding their reach. Because gross-receipts and other business taxes are not based on or measured by net income, they are not subject to the protection of PL 86-272. Thus, a taxpayer with even minimal activity within a state could likely find itself subject to one of these taxes.

Not only are states enacting non-income-based taxes, adopting mandatory combined reporting and aggressively broadening the concept of nexus, they also are seeking to capture a larger proportion of the taxable income of multistate businesses by replacing the traditional, equally weighted payroll, property and sales apportionment with formulas based predominantly or solely on the percentage of sales to customers in the state.

COMPARING NEXUS STANDARDS

Physical presence is the most obvious and traditional nexus standard, especially, as noted earlier, for sales and use tax. A number of states, however, are reaching beyond the traditional view of nexus toward an “economic nexus” standard in which physical presence is not required as long as there is an “economic” connection to the state. For example, in the income tax arena, the exploitation of a trademark, where a fee is paid to use the trademark, has been held to be enough to create nexus for the owner of the trademark. See, for example, Geoffrey Inc. v. Commissioner of Revenue, 899 N.E.2d 87 (Mass. 2009), and Lanco Inc. v. Director, Div. of Taxation, 188 N.J. 380 (2006). Substantial economic nexus has also been successfully asserted with respect to banking and financial services and products directed into a state. See, for example, Capital One Bank v. Commissioner of Revenue, 899 N.E.2d 76 (Mass. 2009), and West Virginia Tax Commissioner v. MBNA America Bank, N.A., 220 W.Va. 163 (2006).

Activities that can create a link between a company and state through the use of subsidiaries or agents will result in agency or affiliate nexus. Such activity might be an entity accepting returns for its online affiliate, as in Borders Online LLC v. State Board of Equalization, 29 Cal. Rptr.3d 176 (Cal. Ct. App. 2005), or even, in some cases, teachers handing out book order forms (see, for example, Scholastic Book Clubs v. State Board of Equalization, 255 Cal. Rptr. 77 (Cal. Ct. App. 1989)). Unless there is a clear separation of the relationship between the out-of-state seller and the in-state activities, a case can be made for nexus. Almost like the game “six degrees of separation,” the seller needs to be aware of any activities of related entities.

Currently, the hottest controversy in affiliate nexus is the New York “Amazon law” fallout (see JofA coverage: “Amazon Loses Round in N.Y. Nexus Fight,” April 2009, page 72; and “Online Retailers Battle N.Y. Nexus,” Oct. 2008, page 96). To date, New York has successfully created a connection through Amazon.com’s New York “affiliates,” state residents to whom the company paid commissions when purchasers “clicked through” their websites to its site. Amazon is appealing the 2009 New York state trial court decision siding with the state. Some states followed suit by introducing similar legislation. Colorado, North Carolina and Rhode Island enacted some version of the “Amazon” nexus presumption law. After Colorado introduced its new law, Amazon pulled its affiliates program there, even though the Colorado law does not specifically identify referral programs for online retailers as creating nexus. Most recently, Connecticut and Minnesota have introduced similar legislation, and additional states will probably introduce or reintroduce this type of legislation over the next year. It is important for the taxpayer to understand its relationships with other vendors, contractors or even partner programs.

Many states would like to require remote sellers to collect their tax even absent physical presence. This would be easier if sales tax laws were made simpler and more uniform, which is the purpose of the Streamlined Sales and Use Tax Agreement (SSUTA).

To date, 23 states have passed conforming legislation, and there are 20 full member states, which agree to comply with uniform sourcing rules and to simplify exemptions. The SSUTA generally makes it easier for small businesses to determine what rate of tax to charge and provides a centralized registration system that uses a single application to register a filer in all participating states. The SSUTA could also make it easier for the federal government to play a role in unifying the state systems. On July 1, 2010, HB 5660, the “Main Street Fairness Act” was introduced in Congress and referred to the House Judiciary Committee. It proposes to overturn the physical presence requirement for sales-and-use-tax collection, allowing SSUTA member states to require out-of-state sellers to collect their tax.


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