State & Local Tax Alert
Breaking state and local tax developments from Grant Thornton LLP
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Ohio Supreme Court Holds CAT’s Bright-Line Presence Nexus
Standard Satisfies Commerce Clause
Release date
November 22, 2016
On November 17, 2016, the Ohio Supreme Court held that the bright-line presence nexus
standard that applies to the Commercial Activity Tax (CAT) satisfies the substantial nexus
requirement under the Commerce Clause of the U.S. Constitution.1 The business
challenging the imposition of the CAT, an out-of-state retailer that did not have a physical
presence in the state, had nexus with Ohio because its annual gross receipts in Ohio
exceeded the $500,000 statutory threshold.
States
Background
Chad Davies
Cleveland
T 216.858.3664
E [email protected]
At issue was the applicability of the CAT to Crutchfield Corporation, a corporation based
in Virginia that is a direct marketer of consumer electronics. During the relevant tax
periods, Crutchfield’s server, warehouse and distribution center were all located in
Virginia, and Crutchfield had no employees or facilities in Ohio. However, Crutchfield’s
annual gross receipts to customers in Ohio exceeded $500,000. Crutchfield acknowledged
selling and shipping consumer electronics to customers in Ohio, but argued that it had no
activities or contacts in Ohio that were sufficient for Ohio to constitutionally impose the
CAT. As a result, Crutchfield did not file Ohio CAT returns. Subsequent to Ohio’s
assessment of the CAT, Crutchfield filed petitions for reassessment. Crutchfield appealed
from three final determinations of the Ohio Tax Commissioner that affirmed multiple
CAT assessments relating to periods from July 1, 2005 through June 30, 2012. Following
the final determinations, Crutchfield filed an appeal with the Ohio Board of Tax Appeals
(BTA).
Before the BTA, Crutchfield argued that its gross receipts could not be taxed by Ohio
because it lacked the in-state presence necessary to establish substantial nexus under the
Commerce Clause.2 The BTA’s decision focused solely on whether Crutchfield had nexus
with Ohio for purposes of the CAT. Under a plain reading of the CAT statutes, an entity
has substantial nexus with Ohio if it has a bright-line presence, which is defined in part as
having taxable gross receipts of at least $500,000 in the state. Following the precedent
1
Crutchfield Corp. v. Testa, Ohio Supreme Court, No. 2015-0386, Nov. 17, 2016. The majority
opinion was joined by five of the seven justices.
2 Crutchfield, Inc. v. Testa, Ohio Board of Tax Appeals, Nos. 2012-926, 2012-3068, 2013-2021, Feb.
26, 2015. For a discussion of this decision, see GT SALT Alert: Ohio Board of Tax Appeals Holds
Out-of-State Retailers with Significant Gross Receipts Have Substantial Nexus for CAT.
.
Ohio
Issue/Topic
Commercial Activity Tax
Contact details
Geoffrey Frazier
Cincinnati
T 513.345.4620
E [email protected]
Jamie C. Yesnowitz
Washington, DC
T 202.521.1504
E [email protected]
Chuck Jones
Chicago
T 312.602.8517
E [email protected]
Lori Stolly
Cincinnati
T 513.345.4540
E [email protected]
Priya D. Nair
Washington, DC
T 202.521.1546
E [email protected]
www.GrantThornton.com/SALT
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established in L.L. Bean,3 Crutchfield had substantial nexus with Ohio because its gross
receipts exceeded the statutory threshold for the relevant periods. Because the BTA did
not have jurisdiction to consider constitutional issues, it could not decide the
constitutionality of the CAT bright-line presence nexus statute.
CAT Nexus Standards
Under Ohio law, the CAT is imposed on persons with taxable gross receipts for the
privilege of “doing business” in Ohio that have substantial nexus with the state.4 “Doing
business” in Ohio means engaging in any activity, whether legal or illegal, that is conducted
for, or results in gain, profit, or income at any time during the calendar year.5
To meet the substantial nexus standard, a person must: (1) own or use a part or all of the
person’s capital in Ohio; (2) hold a certificate of compliance authorizing the person to do
business in the state; (3) have a bright-line presence in Ohio; or (4) otherwise have nexus
with Ohio to an extent the person can be required to remit the CAT under the U.S.
Constitution.6 A person has a bright-line presence in Ohio for a reporting period if such
person: (1) has property in the state with an aggregate value of at least $50,000; (2) has
payroll in the state of at least $50,000; (3) has gross receipts in the state of at least
$500,000; (4) has at least 25 percent of its total property, payroll or gross receipts in the
state; or (5) is domiciled in the state.7
Arguments on Appeal
On appeal, Crutchfield argued that imposition of the CAT violated the dormant
Commerce Clause because it lacked “substantial nexus” with Ohio. Crutchfield contended
that its nexus with Ohio was not substantial because it did not have a physical presence in
the state. In response, the Ohio Tax Commissioner argued that the Commerce Clause
does not impose a physical presence requirement for the CAT and that the $500,000 salesreceipts threshold satisfied the substantial nexus requirement. Also, the Tax Commissioner
argued that even if the Commerce Clause does impose a physical presence requirement,
Crutchfield’s computerized connections with Ohio consumers involved the presence of
tangible personal property that constituted physical presence in the state.
Statutory Challenges to CAT Assessments
The Court rejected Crutchfield’s arguments that it did not have nexus with the state under
the CAT statutes. Crutchfield unsuccessfully argued that the Court should strictly construe
the term “doing business” by holding that Crutchfield’s lack of physical presence indicated
that it was not “doing business” in the state. According to the Court, interpreting this
phrase to exclude situations where there is no physical presence would be inconsistent
with the statute’s language. The Court explained that “the reference to a ‘physical
3
L.L. Bean, Inc. v. Levin, Ohio Board of Tax Appeals, No. 2010-2853, March 6, 2014 (settled on
appeal, Nov. 20, 2014). For a discussion of this case, see GT SALT Alert: Ohio Board of Tax
Appeals Holds Out-of-State Retailer with Significant Gross Receipts Has Substantial Nexus for
CAT.
4 OHIO REV. CODE ANN. § 5751.02(A).
5 Id.
6 OHIO REV. CODE ANN. § 5751.01(H).
7 OHIO REV. CODE ANN. § 5751.01(I). Note that “bright-line nexus” is also referred to as “factor
presence nexus.”
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presence’ requirement is unambiguously absent, and the insistence that this tax is imposed
on persons based on the $500,000 sales-receipts threshold is unambiguously incorporated
by reference.”8 Also, the Court rejected Crutchfield’s argument that statutory language
providing that “gross receipts” excludes any receipts for which taxation would be
unconstitutional9 should be interpreted to prevent imposition of the CAT based on the
$500,000 sales-receipts threshold. The Court explained that this proposed interpretation
was irreconcilable with statutory language providing that the “[p]ersons on which the
commercial activity tax is levied include, but are not limited to, persons with substantial nexus
with this state.”10 Also, the statute that excludes certain receipts “does not create an exception to
the statute’s substantial nexus definition.”11
Taxable “Local Incidence” Not Required
The Court rejected Crutchfield’s argument that “substantial nexus” requires a taxable
“local incidence.” In its analysis, the Court considered the case law before and after
Complete Auto Transit, Inc. v. Brady.12 As explained by the Court, Complete Auto “altered how
the dormant Commerce Clause interacts with a state’s taxing powers.” Prior to Complete
Auto, the Ohio Supreme Court characterized the U.S. Supreme Court case law as
“embodying ‘[a]t the opposite ends of the conceptual spectrum . . . two competing . . .
propositions that (1) a state may not levy a tax for the privilege of engaging in interstate
commerce . . . and (2) interstate commerce must pay its way in relation to the immediate
benefits and protections afforded it by the state.’”13 In Complete Auto, the U.S. Supreme
Court replaced this framework with a four-prong test, under which a state tax is valid if it:
(1) is applied to an activity with a substantial nexus with the taxing state; (2) is fairly
apportioned; (3) does not discriminate against interstate commerce; and (4) is fairly related
to the services provided by the state.
Crutchfield relied on cases decided before Complete Auto in which a taxable “local incident”
was required before a state tax could be imposed because the privilege of engaging in
interstate commerce was regarded as being immune from state taxation. The Court
determined that Crutchfield incorrectly equated the taxable “local incident” required in
earlier cases with “substantial nexus” under Complete Auto. As explained by the Court,
“Complete Auto abolished the prohibition against levying a tax on the privilege of engaging
in interstate commerce, and the Supreme Court’s articulation of the substantial-nexus test
was not intended to resurrect it.”
Physical Presence Standard Does Not Apply to CAT
According to the Court, the physical presence standard adopted in Quill v. North Dakota,14
a case involving the sales and use tax, does not apply to business privilege taxes such as the
CAT. Although physical presence in a state may constitute substantial nexus, the Court
determined that Quill’s physical presence requirement does not apply to a business
privilege tax if there is an “adequate quantitative standard” to guarantee that the taxpayer
8
Emphasis in original.
OHIO REV. CODE ANN. § 5751.01(F)(2)(ll).
10 OHIO REV. CODE ANN. § 5751.02(A) (emphasis added by Court).
11 Emphasis in original.
12 430 U.S. 274 (1977).
13 United Air Lines, Inc. v. Porterfield, 276 N.E.2d 629 (Ohio 1971).
14 504 U.S. 298 (1992).
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has substantial nexus with the state. In this case, the $500,000 sales threshold provides the
requisite quantitative standard. The Court explained that this holding is supported by Quill
and the related U.S. Supreme Court precedent.
According to the Court, the case law subsequent to Complete Auto, including Quill, implied
that the physical presence requirement does not apply to business privilege taxes. Rather,
business privilege taxes should be distinguished from sales and use taxes when applying
the four-prong test under the Commerce Clause. Under Oklahoma Tax Commission v.
Jefferson Lines, Inc.,15 for purposes of applying the Complete Auto test, a gross receipts tax on
an interstate seller occupies the same constitutional category as an income tax on the same
seller, but imposing sales tax on the in-state purchaser occupies a different category. Even
though the CAT is imposed on gross receipts rather than income, the Court noted that the
CAT was enacted to replace the corporate franchise tax and is imposed on the privilege of
engaging in income-producing activity. Furthermore, following Quill, most state courts
have held that the physical presence standard does not apply to taxes on, or measured by,
income.
The Court also held that under Tyler Pipe Industries, Inc. v. Washington State Department of
Revenue,16 physical presence is not necessary to impose a business privilege tax. Under the
“most accurate characterization” of Tyler Pipe, consistent with Complete Auto and Quill, a
taxpayer’s physical presence in a state is a sufficient, but not necessary basis for
imposing a business-privilege tax.
Sales Threshold Adequately Ensures Substantial Nexus
The Court expressly held that the $500,000 sales-receipts threshold satisfies the substantial
nexus requirement of Complete Auto. In general, when a state statute fairly addresses a
legitimate public interest, and it only has an incidental effect on interstate commerce, the
statute will be upheld unless the burdens on interstate commerce are “clearly excessive” in
relation to the benefit.17 If the state were taxing all receipts regardless of sales volume, the
CAT could become clearly excessive if taxpayers with a small sales volume were taxed. By
establishing a sales threshold, the legislature prevented the CAT from being clearly
excessive.
After acknowledging that the $500,000 threshold chosen by the legislature may be
arbitrary, the Court explained that Crutchfield did not provide a reason why the threshold
should be a greater amount. The establishment of a threshold amount is necessary to
define the legal obligations to taxpayers. Given the threshold, the Court undertook a
benefit – burden analysis and concluded that the burdens of the CAT on interstate
commerce were not “clearly excessive” in comparison to the benefits of taxing the receipts
of in-state and out-of-state sellers in a similar way. Therefore, the Court held that the
CAT’s bright-line presence standard satisfies the substantial nexus standard under the
dormant Commerce Clause. The Court did not address the Tax Commissioner’s
alternative argument that the physical presence standard had been satisfied by Crutchfield.
15
514 U.S. 175 (1995).
483 U.S. 232 (1987).
17 Pike v. Bruce Church, 397 U.S. 137 (1970).
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Dissent
Two of the justices joined in an extensive dissenting opinion claiming that the Court
should follow current and established U.S. Supreme Court precedent requiring physical
presence nexus under Quill and Tyler Pipe, even though these precedents prospectively
could be overturned or superseded by Congress. Also, the dissent did not see any
meaningful difference between a gross receipts tax such as the CAT and a use tax for
purposes of determining substantial nexus. Therefore, the dissent contended that the case
should be remanded to the BTA for a determination of whether Crutchfield had a physical
presence in Ohio under Quill.
The dissent noted that a retailer could be forced to comply with the CAT if only one Ohio
resident spent more than $500,000 on its products. The dissent hypothesized that this
could happen in the instance where an Ohio manufacturing business ordered one machine
from an out-of-state business. In this case, one transaction in interstate commerce could
cause the out-of-state business to be subject to the CAT, without any other connections to
Ohio. The dissent explained that this is the undue burden on interstate commerce that the
Quill court was attempting to prevent.
Commentary
This case is significant because it is the first opinion issued by a state supreme court that
considers the constitutionality of a bright-line presence standard to determine nexus for
purposes of a corporate-level tax in lieu of physical presence. The bright-line presence test
contained in the CAT statute is similar to the Multistate Tax Commission’s factor presence
nexus standard model statute that was adopted in 2002. In addition to Ohio, states such as
Alabama, California, Colorado, Connecticut, Michigan, Nevada, New York, Tennessee and
Washington have adopted some type of factor presence nexus standard for corporate
income tax or gross receipts tax purposes. Therefore, the constitutionality of this nexus
approach has become increasingly important. Also, this decision is particularly relevant to
online retailers that have physical operations in a small number of jurisdictions and sell to
a national marketplace over the Internet. An argument can be made that the objective
thresholds used to decide whether substantial nexus exists conflict with the judicial
concept of determining substantial nexus on a case-by-case basis. Based on the
significance of this case, Crutchfield is expected to file a petition for certiorari with the U.S.
Supreme Court.
Due to the fact that this case concerns the application of bright-line nexus to a gross
receipts tax rather than a corporate income tax in operation in most states, its impact may
be somewhat limited. This case does not necessarily support the constitutionality of a
bright-line nexus statute for corporate income tax purposes.
The dissent is thorough and raises some interesting points. As explained by the dissent, it
does not seem equitable to impose the CAT on an out-of-state retailer that makes only a
single sale in Ohio of a piece of manufacturing equipment that costs $500,000. In this
situation, the retailer arguably does not have substantial nexus with the state.
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