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Vol. 20, No. 9 September 27, 2013
SPECIAL REPORT
State Tax Advisory
Board Roundtable
(Vol. 20, No. 9)
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Table of Contents
INTRODUCTION .......................................................S-5
PARTICIPANTS ........................................................S-7
KEY DECISIONS .....................................................S-11
SALES TAX ISSUES .................................................S-21
INCOME TAX ISSUES ..............................................S-31
MTC COMPACT ......................................................S-35
UNCLAIMED PROPERTY ..........................................S-41
AREAS OF REFORM ................................................S-45
Editorial Staff
Editors: George R. Farrah, CPA, Executive Editor; Karen R. Irby, Esq., Managing Editor; Christine Boeckel,
Esq., Steven Roll, Esq., Assistant Managing Editors; Martelli-Yndee Borieux, Esq., Kathleen Caggiano,
Esq., Michel Daze, Esq., Nancy Emison, Esq., Melissa Fernley, Esq., Nadine Gjurich, Esq., Rebecca
Helmes, Esq., Michael Kerman, Esq., Alexis Kimbrough, Esq., Jessica Lechuga, Esq., Priya D. Nair, Esq.,
Tonya Sloans, Esq., Christopher Young, Esq., State Tax Law Editors; Deborah Swann, Esq., Copy Editor;
Gretchen Obert, Publication Editor.
Editorial Support: Beulah Chin, Production Supervisor; Cassandra White, Administrative Assistant.
For information on purchasing copies of this Special Report, please call (800) 372-1033.
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INTRODUCTION
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Introduction
Recent Developments in State Taxation Discussed at
Bloomberg BNA State Tax Advisory Board Roundtable
L
eading state tax experts convened at the Bloomberg BNA State Tax Advisory Board Roundtable to discuss current issues and trends in state taxation. The event was hosted by George Farrah, Executive Editor of Bloomberg
BNA Tax & Accounting.
Moderating the discussion was Arthur R. Rosen, a partner in the law firm of McDermott Will & Emery LLP, and
an expert in tax planning and litigation related to state and local tax matters.
Topics covered by the group include:
s the state tax implications of the controversial Windsor ruling by the U.S. Supreme Court, as well as other
important federal court decisions affecting state tax;
s state efforts to impose sales tax nexus on remote retailers and the prospects of a federal solution to the
online sales tax debate;
s income tax nexus based on the presence of web servers or telecommuting;
s the future of the Multistate Tax Compact in the wake of Gillette and other cases;
s Delaware’s new Voluntary Disclosure Agreement Program; and
s the outlook for sales tax reform at the state level.
This report is divided into the following discussion sections:
s Key Decisions;
s Sales Tax Issues;
s Income Tax Issues;
s MTC Compact;
s Unclaimed Property; and
s Areas of Reform.
The transcripts that follow show the participants’ candid views on these and other topics. Citations to cases and
articles referred to by the participants during their discussions have been added as additional background to aid further research on each topic. Each section is introduced by a brief summary of the developments discussed.
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Participants
Participants
ur panel of state tax experts represent a cross section of state government and national accounting and law
firms. Most of the participants in the Bloomberg BNA State Tax Advisory Board Roundtable are members of the
Bloomberg BNA State Tax Advisory Board. Moderating the Roundtable was State Tax Advisory Board member
Arthur R. Rosen of McDermott Will & Emery LLP. Special guests at the Roundtable were Karl Frieden with the Council on State Taxation, Joseph Henchman with the Tax Foundation, Kendall Houghton with Alston & Bird, Gregory
Matson with the Multistate Tax Commission, and Diann Smith with McDermott Will & Emery LLP. Also participating in the discussion was Steven Roll, an Assistant Managing Editor with Bloomberg BNA State Tax.
O
Below are the biographies of the participants.
Karl Frieden is the Vice President and General Counsel of the Council On State Taxation (COST). Prior to joining
COST, Mr. Frieden was a state and local tax partner with Ernst & Young and before that a tax partner with Arthur
Andersen. Earlier in his career, he was the Deputy General Counsel of the Massachusetts Department of Revenue.
Mr. Frieden has had extensive experience with most types of state and local taxes, including income tax, sales tax,
property tax, payroll tax, and tax credits and incentives. He also has significant experience with global indirect taxes
including VAT and withholding taxes.
Mr. Frieden has spoken on state and local and global indirect tax issues at business, academic and tax policy forums in the U.S., Europe and Asia. He has testified before state legislatures and the U.S. Congress on state tax policy
issues. He is author of numerous articles on state and local taxation; and wrote the book, ‘‘Cybertaxation: The Taxation of E-Commerce’’ - the first comprehensive book written on the taxation of the digital economy. Mr. Frieden received his J.D. from Northeastern University School of Law, and his B.A. from the University of California, Berkeley.
Jeffrey A. Friedman is a partner with Sutherland, Asbill & Brennan LLP. Mr. Friedman has more than a decade of
experience in the state tax field, including work with Sutherland, KPMG, the U.S. Department of Treasury and the
Council On State Taxation (COST). His practice includes state and local tax planning and controversy, including income, franchise, sales and use, unclaimed property and property tax matters.
Prior to joining Sutherland, Mr. Friedman was a partner in KPMG’s Washington National Tax Practice. Before
joining KPMG, Mr. Friedman served as an Attorney-Advisor in the U.S. Department of the Treasury’s Office of Tax
Policy, where he assisted with the development of the U.S. government’s position on domestic and international electronic commerce tax issues.
Earlier in his career, Mr. Friedman served as Vice President and Counsel of the Committee (now Council) On State
Taxation (COST), where he represented large U.S. corporations on state taxation matters. Mr. Friedman’s work for
COST included the filing of amicus briefs with the U.S. Supreme Court and state legislatures.
Joseph Henchman is the Vice President of Legal & State Projects, as well as Vice President of Operations, for the Tax Foundation.
Mr. Henchman is an attorney and policy analyst who supervises the Tax Foundation’s state policy
and legal programs, analyzing state tax trends, constitutional issues, and tax law developments.
Mr. Henchman holds a bachelor’s degree in political science with a minor in public policy from the
University of California, Berkeley and a law degree from George Washington University, where his
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‘‘Why the Quill Physical Presence Rule Shouldn’t Go the Way of Personal Jurisdiction,’’ has been cited as a ‘‘spirited
defense’’ of keeping tax jurisdiction based on physical presence. In 2007, he earned a certificate in International Legal Studies from Justice Anthony M. Kennedy’s summer program at the University of Pacific-McGeorge School of
Law. He is admitted to practice law in the state of Maryland, the District of Columbia, and before the U.S. Supreme
Court.
His media appearances have included The Economist, the New York Times, the Wall Street Journal, USA Today,
the Los Angeles Times, The Baltimore Sun, the Orange County Register, the Philadelphia Inquirer, the Christian Science Monitor, CNN, ABC News, Bloomberg, C-SPAN, NPR, Fox, Forbes, Fortune, Governing, Barron’s, Kiplinger’s,
Stateline, Reuters, and the Associated Press. He has testified or presented to officials in 31 states.
Kendall Houghton is a partner with Alston & Bird in Washington, D.C. Ms. Houghton’s practice focuses on state and local tax planning, tax controversies, and various legal matters related to unclaimed
property/escheat.
She previously served as general counsel to the Council On State Taxation (COST), where she filed
numerous U.S. Supreme Court briefs in cases impacting state taxation of multistate commerce, and
she led a tax policy initiative addressing taxation of Internet transactions.
Ms. Houghton is a member of the Bloomberg BNA State Tax Advisory Board and is the coauthor
of Bloomberg BNA’s Multistate Tax Portfolio entitled Unclaimed Property. Recently, she was a featured speaker at
the Bloomberg BNA webinar entitled Guarding Against Economic Substance, Sham Transaction Doctrines.
Ms. Houghton is a Georgetown University School of Law instructor (L.L.M. program). Ms. Houghton is a featured
speaker at national state tax conferences and schools hosted by COST, TEI, and IPT.
She earned her undergraduate degree from Harvard College, her law degree from New York University, and her
L.L.M. in Taxation from Emory University.
Gregory Matson is Deputy Executive Director of the Multistate Tax Commission. Before joining the
Commission’s staff in May 2006, he spent five years on the legal staff of Tax Executives Institute and
served as staff liaison to TEI’s State and Local Tax Committee.
Prior to joining TEI’s staff, Mr. Matson was the general counsel for the District of Columbia’s Office of Tax and Revenue. He also worked as a trial counsel for the Internal Revenue Service and served
in the U.S. Army Judge Advocate General’s Corps.
Mr. Matson received his B.A. degree from Weber State University, his J.D. from University of
Utah’s College of Law, and his L.L.M. from Villanova University School of Law’s Graduate Tax Program.
Richard D. Pomp is the Alva P. Loiselle Professor of Law at the University of Connecticut School of
Law. He is a summa cum laude graduate of the University of Michigan and a magna cum laude graduate of Harvard Law School. He has taught at Harvard, New York University, Columbia, University of
Texas, and Boston College. In addition, he has been a Distinguished Professor in Residence at the
Chulalongkorn Law School, Bangkok, Thailand, and a Visiting Scholar at the University of Tokyo Law
School and at Harvard Law School. Professor Pomp has served as an expert witness in various courts
throughout the country and as counsel and a litigation consultant to law firms, corporations, accounting firms, and state tax administrations. He has participated in various capacities in U.S. Supreme Court litigation.
Professor Pomp has also served as a consultant to cities, states, the Multistate Tax Commission, the Navajo Nation,
the U.S. Congress, the U.S. Treasury, the Department of Justice, the Internal Revenue Service, the United Nations,
the International Monetary Fund, the World Bank, and numerous foreign countries, including the People’s Republic
of China, the Republic of China, Indonesia, Gambia, Zambia, Mexico, the Philippines, Pakistan, India, and Vietnam.
He is the former Director of the New York Tax Study Commission. Under his tenure, New York restructured its
personal and corporate income taxes, and created an independent tax court. Professor Pomp’s casebook,’’ State and
Local Taxation,’’ has been used in more than 90 schools, state tax administrations, and major accounting firms for
internal training. Portions of the casebook have been translated into Chinese, Dutch, German, Japanese, Spanish,
and Vietnamese. He is also the author of more than 80 articles, numerous chapters in books, and various books and
monographs. His writings have also appeared in The New York Times, The Wall Street Journal, and the Financial
Times. In addition to the local and regional media, Professor Pomp has been interviewed by NPR, Bloomberg Radio,
The New York Times, The Wall Street Journal, and other media outlets.
Professor Pomp sits on numerous advisory and editorial boards, including the Bloomberg BNA State Tax Advisory
Board. He is Chairman of the Board of the Institute on Taxation and Economic Policy.
In 2007, he received the New York University Institute on State and Local Taxation Award for Outstanding
Achievement in State and Local Taxation. In 2008 and 2009, he served as a coreporter for the revision of the Uniform
Division of Income for Tax Purposes Act (UDITPA). In 2009 and 2010, he was a member of the California Commission on the 21st Century Economy. In 2011, he received the Bloomberg BNA Lifetime Achievement Award.
Steven Roll is an Assistant Managing Editor in State Tax for Bloomberg BNA. Since joining
Bloomberg BNA in 1998, Mr. Roll has been writing news stories and feature articles, editing reference
products, and developing practice tools aimed at helping to enhance the performance of state and local tax practitioners. His news stories and feature articles appear regularly in Bloomberg BNA’s
Weekly State Tax Report, Multistate Tax Report, and Daily Tax Report. He also works with nationally
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recognized experts to develop and edit manuscripts for publication in the Bloomberg BNA State Tax Portfolio Series.
Mr. Roll’s responsibilities include overseeing special projects, such as Bloomberg BNA’s annual Survey of State
Tax Departments, and helping to develop new state tax-related products for Bloomberg BNA, such as State Tax
Nexus Tools, the Corporate Income Tax Navigator, the Individual Income Tax Navigator, and the Estates, Gifts and
Trusts Navigator for the Premier State Tax Library.
He also produces webinars on state tax topics and oversees the Bloomberg BNA’s State Tax Blog, the Bloomberg
BNA State Tax Group on LinkedIn, and Bloomberg BNA’s @BBNATax Twitter feed.
Mr. Roll has been quoted in publications, such as the Wall Street Journal and Accounting Today, on various state
tax topics.
In 2012, Mr. Roll was a cowinner of the ‘‘Gold Award’’ from the American Society of Business Publication Editors
for a special report he coauthored regarding the sales and use tax treatment of cloud computing. In 2011, he received
two Bloomberg BNA Excellence Awards. In 2009, he won the Bloomberg BNA’s Degler Reference Quality Award for
his work in creating the first edition of Bloomberg BNA’s State Tax Essentials desk reference book.
Mr. Roll served as President of the American Society of Business Publication Editors from 2007 through 2009.
Prior to joining Bloomberg BNA, Mr. Roll was a legislative associate at Stateside Associates, where he monitored
state legislation for Fortune 500 companies and trade groups.
Mr. Roll graduated cum laude from the State University of New York at Albany, with a B.A. in English Literature.
He earned his law degree from the University of Baltimore School of Law.
Arthur R. Rosen is a partner in the law firm of McDermott Will & Emery LLP and is based in the firm’s Miami office and has a regular presence in the firm’s New York office. His practice focuses on tax planning and litigation relating to state and local tax matters for corporations, partnerships and individuals. Formerly the Deputy Counsel of
the New York State Department of Taxation and Finance, as well as Counsel to the Governor’s Temporary Sales Tax
Commission and Tax Counsel to the New York State Senate Tax Committee, Mr. Rosen has held executive tax management positions at Xerox Corporation and AT&T. In addition, he has worked in accounting and law firms in New
York City.
Mr. Rosen is a Fellow of the American College of Tax Counsel and is listed in Best Lawyers in America, Best Lawyers in New York, Chambers USA and The Legal 500 United States.
Mr. Rosen is a past chair of the State and Local Tax Committee of the American Bar Association’s Tax Section and
a past chair of the National Association of State Bar Tax Sections. He is a member of the Executive Committee of the
New York State Bar Association’s Tax Section, and has served as cochair of its Committees on New York State Tax
Matters, New York City Tax Matters, and State and Local Tax Matters. He also served as President and Chairman of
the NYU Tax Society and is an active member of the Institute for Professionals in Taxation. Mr. Rosen was a member of the steering committee of the NTA Communications and Electronic Commerce Tax Project. He founded and
chairs the annual week-long ‘‘Introduction to State and Local Taxes’’ program, as well as the ‘‘State and Local Taxation II’’ program, offered at New York University. Mr. Rosen serves as a member of the New York State Commissioner of Taxation and Finance’s advisory council, the New York City Commissioner of Finance’s advisory council,
and the New York City Tax Appeals Tribunal’s advisory council.
Mr. Rosen is the editor of the monthly newsletter, Inside New York Taxes, and coeditor of the semimonthly newsletters, New York Tax Highlights and New York Tax Cases. He has written scores of articles that have appeared in
publications such as the Journal of Taxation, the Journal of State Taxation, the Journal of Bank Taxation, the State
and Local Tax Lawyer, Multistate Tax Analyst, Inc. Magazine, the Assessment Digest, the Journal of New York Taxation, and The Tax Executive. In addition, he has spoken hundreds of times throughout the country on state and local
tax matters.
Diann Smith is counsel in the law firm of McDermott Will & Emery LLP and is based in the firm’s Washington,
D.C., office. Ms. Smith focuses her practice on state and local taxation with an emphasis on tax challenges relating
to compliance, controversy, planning and legislative activity.
Ms. Smith has experience representing clients in nexus, tax base, business and nonbusiness income classification,
apportionment and FIN 48 compliance issues. She has also counseled clients on multistate unclaimed property compliance and voluntary disclosure opportunities. She has represented clients from a broad range of industries, including retail, insurance and communications services.
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Ms. Smith has significant experience representing clients before the Multistate Tax Commission. Prior to joining
McDermott, Ms. Smith was counsel at another international law firm, where she also focused on state and local taxation. She also previously served as general counsel for the Council On State Taxation (COST). While at COST, Diann worked on nearly every major state and local tax issue confronting multistate businesses.
Ms. Smith received her J.D. from the Georgetown University Law Center, where she was an editor of the Georgetown Law Journal. She was an adjunct professor at Georgetown University Law Center for the L.L.M. in Taxation
program from 1998 to 2005. She received her B.A. from Miami University.
Mark F. Sommer is a partner with Frost Brown Todd LLC. Mr. Sommer is an attorney in the firm’s
Louisville office where he practices in the areas of federal, state and local tax, economic development
and incentives.
Prior to joining Frost Brown Todd, Mr. Sommer was a member at a major law firm in Louisville.
Mr. Sommer has written extensively in the area of state and local taxation. His articles have appeared in numerous publications, including authoring the Kentucky Chapter of the ABA’s Property
Tax Deskbook, various Council On State Taxation (COST) publications, and several Institute for Professionals in Taxation (IPT) publications. His articles have also appeared in several tax journals, including The Journal of State Taxation, The Journal of Property Taxation, Bloomberg BNA’s Multistate Tax Report, The Tax Lawyer,
and many others.
He is a frequent speaker and lecturer on state and local tax matters at conferences, forums, and groups, such as
the Hartman SALT Forum, Deloitte & Touche Multi-State Tax Institute, Kentucky Society of CPAs, COST, Tax Executives Institute, Kentucky Bar Association, Louisville Bar Association, IPT, and the American Bar Association.
Mr. Sommer is a member of the Bloomberg BNA State Tax Advisory Board. He recently served as Chair of the
SEATA Industry Council. He also served as a Director and Vice-Chairman of the Kentucky Lottery Corporation and
has been recognized as one of the Best Lawyers in America for over 15 years in tax controversy and litigation.
Mr. Sommer obtained his law degree from the University of Cincinnati College of Law and his B.S.B.A. from
Xavier University.
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Key Decisions
After Landmark Case, State Issues Remain for Same-Sex Couples;
Cases Denied Cert. Leave Corporate Tax Questions Unanswered
ne of the most notable opinions from the U.S. Supreme Court this year was its decision in Windsor, which
struck down section three of the Defense of Marriage Act (DOMA). The holding allows same-sex couples to be
recognized as married for federal tax purposes.
One of the main holdings of the decision is that the federal government will defer to the states on the question of
marriage. However, the Court left unanswered how the federal government would recognize same-sex marriage for
tax purposes when the same-sex couple’s state of residence does not allow them to be married.
Guidance released by the IRS after the Bloomberg BNA State Tax Advisory Board Roundtable suggests that the
federal government’s deference to the states will be limited. Same-sex couples will be recognized by the federal government as married, if the state in which they were married recognizes the union. As a result, a same-sex couple residing in a state that does not recognize same-sex marriage could file a joint federal return if they were married in a
state that recognizes same-sex marriages or civil unions.
Complications still exist for same-sex couples who, in many cases, must file separately for state tax purposes even
after filing jointly at the federal level. At present, guidance from the states on how to compute taxable income under
this scenario is lacking.
Roundtable participants cautioned that any deference of the High Court toward the states does not suggest that
Congress is reluctant to exert its authority in state tax matters.
The general consensus among the participants was that Windsor would likely have little impact on state tax jurisprudence.
Perhaps the most important developments in state tax jurisprudence were all of the cases the High Court chose
not to hear. Denying certiorari in Kimberly-Clark and two Scholastic Book cases, the Court failed to provide further
guidance on the unitary business principle and the sales tax nexus implications of representative relationships.
The Court’s Due Process decisions in Goodyear and McIntyre Machinery in 2011 still reverberate at the state level.
The holdings suggest that, in the high court’s view, placing something in the stream of commerce is no longer sufficient to meet the due process connection standard. Cites to those cases appeared in the pro-taxpayer rulings in Scioto in Oklahoma and ConAgra Brands in West Virginia.
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Rosen: Welcome, everybody. I think we’ll start at the
top and work our way down, so to speak — the top being the United States Supreme Court. The most recent
case that I think we should discuss is United States v.
Windsor, the Defense of Marriage Act case. The case itself, of course, is kind of bizarre. We have the plaintiff
and the defendant, or appellant and appellee, agreeing
with each other and only the amicus taking the opposite
position. The court wasn’t bothered by that.
It seems to me there are three things we want to discuss: one, the specific implications of the judgment for
the various states around the country; two, more generally, the reasoning that was employed by the Court and
how that might affect state taxation, especially in the interstate context; and third, the torturous reasoning that
the Supreme Court walked through to get to the end result.
It might be cleaner if we were to talk about each of
those one at a time. So, let’s start with how the decision
is going to affect the taxation of couples/individuals in
the various states.
Pomp: I think the hardest case will be if you’re in a
state that doesn’t recognize civil unions or marriage,
and then you have a couple wanting to file a joint return.
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Justice Scalia’s criticism of the majority is correct.
The reasoning the majority employed would seem to
strike down state statutes limiting marriage to just a
man and a woman.
Rosen: Any other comments on that? I think what the
Court said, in summary, was that marriage is under the
rule of the states. It’s traditionally a state province. And
so the federal government will have to defer to the
states; the federal government can’t hurt or interfere
with what the states want to do from a policy perspective in the area of marriage.
So, in your last comment, Rick, if the state has not
recognized same-sex people living together or same-sex
marriage — if people don’t get married, then how would
this opinion affect them at all?
Pomp: I think they would have a constitutional right
to be married. They would have to try to exercise that
right, be refused, and litigate the issue. In the meantime, they would file a joint return, which presumably
would be rejected. If they don’t attempt to exercise their
right, they would have no claim to file jointly. If they
end up winning the right to marry, there is the issue of
how far back in time they can file an amended return.
Henchman: That will be at least a couple years away
though and, in the meantime, you know, we have 12 or
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13 states that recognize same-sex marriage or a few
more that recognize civil unions, where (inaudible) the
balance stumbles. At the federal level, I’m guessing the
IRS is going to have to come up with two different sets
of forms for those two groupings of states. Already,
same-sex couples have had to essentially do their taxes
twice - once federal as separate returns and, in states
where they are able to marry, filing joint or married filing separately.
So, now the burden is on couples in the states that
don’t recognize it rather than on the states that do.
Rosen: Moving on to the broader question, if we take
away from the opinion that Congress cannot impede
what states want to do in a traditional state realm, how
might that affect general state and local taxation?
Henchman: It won’t.
[LAUGHING]
Rosen: Well, I’m glad. I was thinking that some
people who think for the government might say that,
well, state taxation is a state realm. And, therefore, federal legislation that seems to constrain or restrain state
taxation would be antithetical to the reasoning in Windsor. But it seems to me — my response to that would be
— the Commerce Clause overrides that idea of what is
traditionally in the state realm. And the opinion also
talks about what is in the state realm going back 200
years. And, of course, the Commerce Clause has been
with us since 1789.
But it seems to me — my response to that would
be — the Commerce Clause overrides that idea
of what is traditionally in the state realm. And the
opinion also talks about what is in the state
realm going back 200 years. And, of course, the
Commerce Clause has been with us since 1789.
ARTHUR R. ROSEN, PARTNER WITH MCDERMOTT WILL &
EMERY LLP
Friedman: Yeah, that’s the answer that I agree with,
there’s no question that Congress has a role to play in
state taxation. I think any opposing view would be
laughed at by the Court at this point. There’s just too
much jurisprudence, there’s too many acts by Congress.
There’s too much activity that’s been well settled to upset that.
Rosen: You said the Court would laugh. I have
learned that members of Congress actually do laugh
when states say, ‘‘You can’t do this or you take away
our sovereignty.’’ I never saw any Member on the Hill
really take that seriously, so I agree with you.
Friedman: Well, you can find a member of Congress
that will laugh about almost anything.
I think that standard is not the one that I would be so
worried about. It would really be whether a majority of
both houses agree as to whether they can regulate in
this area.
Pomp: We all know lawyers who will advance positions for a client that we would find silly.
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KEY DECISIONS
Friedman: I don’t know where it falls on your agenda,
but there has been a lot of talk for years and years now
regarding the appropriate level of state tax incentives. I
know it’s something that various organizations have
been following and criticizing in some respects. And the
Court has been asked to look at it at least once recently
and more than that over a long period of time. And
whether the Congress is going to move into the more
specific intricacies of state taxation, and restricting or
authorizing those specific parts, I think, is a much more
interesting topic than the wholesale expansion or contraction of state taxation that we see in some of the current bills.
Rosen: Okay, let’s move on to where cert. has been
denied, no surprise there of course, I think. When a
state tax case gets denied, we all yawn. Cert. denied in
state taxation, we all yawn. But we know they’re so rare
that if we have anything, then it’s really unique, like Polar Tankers v. City of Valdez or Armour v. Indianapolis.
Jeff, do you want to talk about Kimberly Clark’s cert.
denial?
Friedman: Not a great day. It’s a very interesting case,
I think. And the way in which it played out was unpredictable, where the Alabama Supreme Court ultimately
decided that the income at issue is allocable under the
state’s statute and taxed the entire gain from the sale of
timberland because the land was located in Alabama.
At the same time, I think that there’s little question
that the land at issue that produced the allocated gain
was a unitary asset that was part of the taxpayer’s unitary business. I was truly hoping that the U.S. Supreme
Court was going to take what I perceived to be a conflict between the state statutory result, as applied by the
Alabama Supreme Court, and what I perceived to be the
unconstitutional treatment of allocating the sale of a
unitary asset, as an interesting tension. It gave the
Court another opportunity to address the unitary business principle and how it fits in with some of the state
statutes that we are dealing with. You know, the state
statute at issue in the Alabama case — at the Alabama
Supreme Court — was an old one. It was really one of
the more narrow versions of business income that only
had the transactional test and not the functional test.
So, perhaps, the fact that we don’t see that narrow
statute prevalent today across the country might have
mitigated against the Court taking the case because it’s
not something that the Court felt, perhaps, was going to
reoccur under the more modern business income statutes. But, at the same time, I thought the conflict was
interesting.
Rosen: Yes, you would have thought that maybe the
conflict would get their interest up a little bit. But, I
guess that MeadWestvaco added a little bit to Allied
Signal, but not very much. And maybe there’s not much
more they really want to do in that area. They’ve already ruled twice in the past 20 years.
Friedman: I hear you, but, at the same time, I think
we’re desperately in need of further guidance and clarification as to how to apply Allied Signal. I’m sure that
you would agree that there are a lot of disputes between
taxpayers and states as to how to apply the operational
versus the investment function test, and in what setting,
and actually the types of things you look to in reaching
your determination.
Rosen: Yes, I agree totally.
Pomp: A more compelling case is Glatfelter out of
Pennsylvania.
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Pennsylvania had a modern statute defining business
income. The gain was business income, part of which
was apportioned to Pennsylvania. Delaware was claiming 100 percent of the gain. The record was very clean
and the facts straightforward. I don’t know if Glatfelter
is applying for cert., but I think Art is right — the Court
thinks that they have already dealt with this issue. We
know they haven’t, but in their own minds they think
they have and they’re not going to revisit it.
Friedman: You both may be right, but I hope you’re
both wrong.
Rosen: If I can speak for you, Rick.
Pomp: You usually do speak for me.
I am forced to buy Scholastic books because of my
daughter. And, at my last parent-teacher’s
meeting, I looked around the room to see if I could
find all the stuff her teacher got ‘‘for the
classroom’’ as her compensation. I did not see
anything. So where did it go?
RICHARD POMP, ALVA P. LOISELLE PROFESSOR OF LAW AT
THE UNIVERSITY OF CONNECTICUT SCHOOL OF LAW
Rosen: The Court also denied cert. in the two recent
Scholastic Book cases. Diann, do you want to address
these?
Smith: Sure. I have a fondness for these type of cases,
because it feels like that’s how I started my career in
state and local tax, working on the Troll Book Club
cases. And what I find interesting about these cases and
probably why the U.S. Supreme Court is not interested
in them, is the concept of how far does this concept of
a representative relationship really go? From whose
point of view do you look at? And it seems like, in the
Scholastic Book cases, the state viewed what it looked
like from the outside: it looked like these teachers were
representing Scholastic. And that’s where creating a
market in the state becomes an important concept to
define. The teachers were undoubtedly helping to create a market, but it was only a by-product of the teachers’ primary goal of educating their students.
When I worked on the Troll Book cases, I interviewed a lot of teachers and there was not a single
teacher that thought they were in any way representing
or promoting or helping — whatever the book company
was — to sell books. They thought they were representatives of the students.
Pomp: Yes, but they were glad to take home the microwaves, the mini refrigerators, the fax machines and
everything else they received from Scholastic Books as
compensation for taking orders even if they are not supposed to.
Smith: This tells you how long I’ve been doing state
and local tax, because VCRs were the big issue back in
the day.
And I actually never found a teacher that did take
them home. They used them for the classroom.
Pomp: I am forced to buy Scholastic books because of
my daughter. And, at my last parent-teacher’s meeting,
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I looked around the room to see if I could find all the
stuff her teacher got ‘‘for the classroom’’ as her compensation. I did not see anything. So where did it go?
Smith: And that’s an issue as well. What type of compensation is necessary to be considered enough of a
representative to be working in some sense for the putative taxpayer?
Rosen: Assuming that the quantity of compensation
is at issue, suppose it was a zillion dollars — does it
matter who pays it? Is that determinative? Does that go
to who is the agent, or the representative person? I
haven’t thought that through. Anybody have thoughts
on that?
Smith: Yes, I think that’s definitely an open question.
When you look at some of the multilevel marketingtype situations, the compensation doesn’t really get
paid by the ultimate company. It gets paid by the consumer purchasing the item from the multilevel intermediary marketer. And so, I think, the compensation concept could be an issue as to whether or not they’re representing themselves or representing an out-of-state
marketer.
Frieden: This issue of attributional nexus will appear
again in our discussion of the click-through nexus
cases. The click-through cases are to some extent the
modern day ‘‘digital’’ version of the Scholastic cases.
The question in these cases is whether the in-state presence of ‘‘affiliates’’ in market states that link online buyers with out-of-state e-retailers can create nexus
(through attribution) for these retailers. Ultimately, the
courts must determine if the actions of these ‘‘affiliates’’
is more akin to the door-to-door sales representatives in
Scripto, or to advertisers. However, there are some important differences between the teachers and the web
‘‘affiliates’’ — specifically, that the number of web ‘‘affiliates’’ can be much larger, but their ties with the retailer more tenuous than in the case of the teachers.
Henchman: Does it matter that the teacher took it
home versus [kept it] in the classroom? I mean, if you
had found five VCRs stacked in the cabinet, does that
change the result?
Smith: To me, it looks more like that’s further evidence that the teacher is representing the students, not
the book company in this case. And, so, whatever
they’re doing is on behalf of the students, not on behalf
of themselves or on behalf of the out-of-state company.
Pomp: Why does Scholastic Books bother to spend
the money to litigate? Why don’t they just collect the
bloody tax going forward instead of spending all this
time and money litigating (and losing)? What’s the answer?
[CHATTER]
Pomp: I’m a teacher!
Friedman: But you don’t have a microwave.
Pomp: Where do you think I got it?
Smith: Try collecting tax from students. It’s hard
enough when you have those little envelopes that they
have to collect the money in, right, and to calculate the
tax on top of that.
Pomp: I write the check.
Rosen: It has to be simplified in a number of the
states. All the required details and filing returns in every locality where there’s a school is quite an administrative burden.
Pomp: Is it any different than a mail-order catalogue
that says residents of X state, add on X percent and so
forth? So what if errors get made and the company has
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to write a check? Can that possibly exceed what they
now spend on litigation? Couldn’t they reach an understanding with a state on how to go about this?
Friedman: And by the way, they don’t like collecting
tax either.
Frieden: Has a Scholastic fact pattern come up yet
where the teachers were selling digital books? Of
course, there is a tax base difference because virtually
all states tax books sold in tangible form whereas not all
states tax digital books. But, for those states that do tax
digital books, a similar nexus issue could arise.
Smith: Yes.
Frieden: Has anyone seen a case on that?
Smith: Not that I’ve seen.
Friedman: That would make tax administration even
harder and more problematic.
Henchman: I’m sure if it were easier to collect tax,
they would be happy to. It’s not.
Pomp: Well it is easy for Amazon to collect and they
were not so happy doing so until recently.
Rosen: Let’s change a little bit our orientation here
and talk about an area that a lot of us thought was comatose, but, apparently, is now back alive — and that’s
the due process issue in the context of state taxation.
After Quill bifurcated the analysis and made a distinction between the minimal connection required for due
process and substantial nexus required for Commerce
Clause, a lot of people, and some state courts of course,
thought that due process was a low hurdle to get over.
Some people thought that the Due Process requirement
was subsumed by the Commerce Clause requirement.
However, we have two U.S. Supreme Court cases in
2011, Goodyear and McIntyre Machinery, where there
seems to be a renewed vitality to the Due Process
Clause. And, although in Asahi Metal, we had just a plurality decision where Justice O’Connor said that merely
placing something in the stream of commerce probably
isn’t enough. But, it’s all we had — we didn’t have a majority decision really saying that.
But now I think we have that. We have state cases
that are starting to look at due process. We see taxpayers winning some cases that, I think that three years
ago, we all thought would have been sure losers in state
courts — Scioto and ConAgra Brands. And it seems that
merely placing something in the stream of commerce
clearly doesn’t meet the due process connection standard that would justify a state imposing tax on a seller.
And, a quote from the Tennessee v. NV Sumatra Tobacco Trading Co. case, is great — it says, ‘‘The company’s awareness — largely after the fact — that cigarettes
were being sold in Tennessee fails to evidence purposeful availment of the Tennessee market.’’ This purposeful availment seems to require a real conscious effort to
target a certain market rather than just general business effort where items happen to end up in the market
state. What are people’s thoughts about those developments?
Pomp: The court in Tennessee v. NV Sumatra Tobacco Trading, which is the case you just referred to,
claims that Justice Kennedy’s plurality opinion is not
the controlling opinion in J. McIntyre Machinery. That
role goes to the concurring opinion of Justice Breyer,
joined by Justice Alito, under the rule of Marks v.
United States.
In Marks, the United States Supreme Court held that
when a fragmented Court decides a case and no single
rationale explains the result and enjoys the assent of
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five Justices, the holding of the Court may be viewed as
that position taken by those Members who concurred in
the judgments on the narrowest grounds. That would
make Breyer’s opinion controlling.
Rosen: I think it’s important to remember in Goodyear, there were thousands of tires that ended up in the
forum state and that was in -Smith: Art, Red Earth has created a little bit of a question mark for the Marketplace Fairness Act, which
we’re going to talk about in a little bit. But there have
been issues raised whether the Marketplace Fairness
Act creates due process problems.
Some of the opponents to the Marketplace Fairness
Act have said Congress is going to pass this Act and it’s
going to violate small businesses’ due process rights because it’s going to require them to collect, which when
you look at Red Earth is sort of what they said but in a
much more narrow context in the Cigarette Acts.
Rosen: See, the cigarette cases — I saw that issue
arise because there is no quantity limitation in the federal statute, whereas there is the small business exception in the MFA.
Smith: Exactly, that’s certainly one of the ways those
that support the MFA have tried to distinguish the cigarette cases.
Rosen: Was anybody not shocked by the taxpayer
victories in those two cases, in Scioto and ConAgra
Brands?
Smith: What I was shocked about with Scioto was
what a well-written opinion it was. I thought it very
clearly laid out the issues and the conclusions.
Friedman: I was also shocked that two states, Oklahoma and West Virginia, which previously had seemingly endorsed economic presence nexus through prior
Supreme Court cases in those two states, took such a
thoughtful view of the Due Process Clause in these two
cases. That was shocking to me and exhilarating.
Rosen: Exhilarating is a perfect word, yes.
Sommer: It is surprising with how quickly they did it.
One came on the heels of the other. I mean, it wasn’t
like you had ten years pass, or you had half the court of
appeals or the supreme court turnover. It was almost by
reply mail, only a few years.
It is surprising with how quickly [state appellate
courts followed Goodyear and McIntyre
Machinery]. One came on the heels of the other. I
mean, it wasn’t like you had ten years pass, or
you had half the court of appeals or the supreme
court turnover. It was almost by reply mail, only
a few years.
MARK F. SOMMER, PARTNER WITH FROST BROWN TODD
LLC
Frieden: We have started to see more economic nexus
cases decided for the taxpayer. For awhile, starting with
Geoffrey, and followed by Lanco, MBNA, and similar
cases, the states were winning these cases in the courts.
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But lately, there have been several notable victories for
the taxpayers (e.g., Scioto and ConAgra).
It does bring up the question when, if ever, is the
U.S. Supreme Court going to address this issue? And I
think it also highlights the continuing importance of income tax nexus cases. With all the attention paid to
sales tax nexus since Quill, including the recent debate
over the Marketplace Fairness Act, we must not lose the
perspective that Congressional resolution of that issue
will not necessarily settle the question of the validity of
various economic and intangible property nexus statutes. These statutes focused initially on financial institutions and intangible property holding companies, but
they have since expanded to a much broader range of
industries. And, yet, despite the conflicting decisions
coming from the state courts, the U.S. Supreme Court
continues to be reluctant to take up this issue. So, unless the boundary lines get defined by Congress with
legislation, such as the Business Activity Tax Simplification Act (BATSA), we will continue to operate in an
environment with greater uncertainty over whether
‘‘factor’’ presence or other types of economic presence
create nexus for income tax purposes.
Rosen: Remember that the Supreme Court of South
Carolina, the original Geoffrey case, said that due process was met because the licensor, Geoffrey, did not
prohibit the licensee from opening its first South Carolina store after the license agreement was executed.
The court effectively said that by not prohibiting
something, you’re purposefully directing. Do you think
the South Carolina Supreme Court can say that today,
after McIntyre and Goodyear?
Friedman: No, I don’t think that they would, but they
would probably say something else.
Rosen: To get the same result.
Pomp: I worked on Scioto and the Oklahoma Tax Department made a mistake — and you don’t learn it in
the opinion, but I think it probably influenced the opinion. At the audit level, the department applied a special
apportionment formula, which would have apportioned
more income to Oklahoma than if there was no license
from the captive insurance company in the first place.
In other words, the taxpayer was worse off using the
captive than if they did nothing at all. And while the
trial court had no choice but to rule for the State because of an earlier Oklahoma Geoffrey case, and the appellate court was bound by that earlier decision as well,
I think it had an influence on the Supreme Court.
Now, you don’t see anything about it because it
wasn’t prominent in the oral argument. The oral argument is very well done by Paul Frankel and it basically
diverted attention to how much tax was paid by the restaurants in Oklahoma. How much employment was created? How much income was paid by the franchisees
and their employees?
Rosen: I’m not so sure I agree that it’s irrelevant.
We’ll talk about that when we get to the BATSA discussion. But the economic activity that is really occurring
in the state is generating tax revenue for that state.
Matson: I think, of the two cases, Scioto is the one
that is most odious to the states because, if you look at
the facts in that case, they are almost identical to the
KFC case in Iowa. Yet the results are exactly opposite.
And, so, in comparing the two cases it looks as if you
can structure yourself out of due process nexus and
states would think that’s a problem. They do think
that’s a problem. And I think that’s a problem.
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I think, of the two cases, Scioto is the one that is
most odious to the states because, if you look at
the facts in that case, they are almost identical to
the KFC case in Iowa. Yet the results are exactly
opposite. And, so, in comparing the two cases
it looks as if you can structure yourself out of due
process nexus and states would think that’s a
problem. They do think that’s a problem. And
I think that’s a problem.
GREGORY MATSON, DEPUTY EXECUTIVE DIRECTOR OF THE
MULTISTATE TAX COMMISSION
Sommer: What was the purpose for the creation of
Scioto? Do we know?
Pomp: Yes, we do know. It is in the record. It was argued very well at the trial level. It’s hard to get insurance for foodborne illnesses . . .
Sommer: Right, mad cow disease coverage.
Pomp: Among other things, which the industry does
not like to mention.
[LAUGHING]
Pomp: So, we will just leave it at that.
Sommer: There you go.
Pomp: And, so, they self-insured.
Sommer: Right, because no one would cover the Wendy’s franchisees.
Pomp: Correct.
Sommer: You think that impacted the court to say,
hey — versus the structuring or a strategy concept —
this is real life.
Pomp: That concern provided a legitimate reason for
creating an insurance company. You then had to capitalize the company and they had the best capital of all.
They had intellectual property, which was worth more
than the actuarially predicted amount of claims. The
company was more than adequately capitalized and the
insurance commissioner signed off on the use of the intellectual property as part of the company’s capital. So
there was a valid business purpose and adequate capitalization.
Sommer: But, I think the good news was they never
paid the claim on mad cow?
Smith: Oh, on that? No.
Sommer: Or food, Rick’s foodborne illnesses.
Pomp: Well, that’s because they are a well-run franchise. They are obsessed with safety and hygiene, they
are meticulous in their health concerns, they have
many, many rules in place to assure there are no problems, unlike perhaps others.
Houghton: Greg, you just suggested that the states
find it odious because of the planning aspect. And Diann and Rick are talking about the non-tax business
purpose for that entity. So, are we now going to see a
whole wave of cases brought by your member states
trying to apply a common law doctrine, like sham and
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business for economic substance, in a constitutional
nexus context and how could that work?
Matson: Who our member states are is kind of a moving target these days.
[LAUGHING]
Rosen: We’ll talk about that in a minute.
Matson: I didn’t mean to imply that there was any
question with respect to the legitimacy of the business
structure in the case, but I do think that the concern is,
having seen that structure work, that you will now get
that structure primarily for tax planning purposes. And
I do think it’s going to result in more cases.
Frieden: So, when you mentioned less odious cases —
were you referring to ConAgra?
Matson: No.
Frieden: So, what was your less odious and which
was your most odious case?
Matson: I’m sorry. Yes, of the two, ConAgra is less
odious.
Frieden: ConAgra does represent a fact pattern that is
different than the Geoffrey scenario. In the latter case, a
company was licensing the use of its trade name to instate affiliates, whereas with ConAgra the company is
licensing its patent for manufacturing to another company that makes the products and then introduces the
goods into the stream of commerce. This is one step removed from some of these other cases and it’s a legitimate distinction, I think.
You’re saying that you see it that way as well?
Matson: I personally see it that way.
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Rosen: We’ve had a hard time convincing states
around the country of the difference between licensing
a patent for manufacturing, for example, and licensing
marketing tangibles. And I agree with Karl — there is a
world of difference. A license gives quite a right to do
something, the act of manufacturing, which occurs at a
specific location. And that is the only possible place that
there would be a connection, I think.
Pomp: Why did the ConAgra opinion cite Asahi but
not McIntyre?
Rosen: Asahi is just a plurality decision.
Matson: Both sides in ConAgra cited Asahi in support of their case.
[SIMULTANEOUS AGREEMENT]
Matson: That’s just the nature of plurality opinions.
Pomp: You would have thought ConAgra would have
cited McIntyre.
Matson: Well, they cited Asahi as well.
Pomp: But what happened to McIntyre?
Matson: That I don’t know.
Friedman: Okay, unless it was sitting at the court for
a while and maybe . . . is it possible the briefing was
done prior to McIntyre coming down?
Pomp: You know, I looked at the dates. It looked like
McIntyre had been out for a while.
Friedman: Yeah, I would have [filed a motion].
Smith: I was going to say the same thing.
Sommer: Yes, you would’ve filed a motion to supplement your brief.
Friedman: Yeah.
Rosen: Good point.
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ADDITIONAL BACKGROUND ON DEVELOPMENTS
Allied-Signal Inc. v. New Jersey Dir., Div. of Taxation, 504 U.S. 768 (1992): Allied Signal was the successor in
interest to Bendix Corporation. During the taxable year involved in the case, Bendix sold a 20.6 percent interest in the stock of ASARCO. New Jersey claimed that the gain from the sale was apportionable income,
while Bendix argued that the gain was allocable income. The New Jersey Supreme Court held the gain apportionable, focusing on two factors: the well known and documented diversification policy of Bendix and
the post-sale use of the proceeds by Bendix. However, the U.S. Supreme Court reversed in a 5-4 decision.
Armour v. Indianapolis, 132 S. Ct. 2073 (2012): The U.S. Supreme Court affirmed the Indiana Supreme
Court’s ruling and held that Indianapolis’s forgiveness of the sewer assessments of property owners who
chose to pay through an installment plan, without offering refunds to those who made a lump-sum payment,
did not violate the Equal Protection Clause. The city of Indianapolis replaced its method of financing sewer
improvements with a new system. To ease the transition, the city forgave all outstanding assessments under
the prior system. However, the city did not give refunds to those property owners who had previously paid
their assessments under the old system. The Indiana Supreme Court ruled that the city did not violate the
Equal Protection Clause because forgiving only the outstanding assessment balances was rationally related
to a legitimate governmental interest.
Asahi Metal Indus. Co. v. Superior Ct. of California, 480 U.S. 102 (1987): Defendant’s product was incorporated into goods the customer manufactured and then sold worldwide. A purchaser of the customer’s goods
brought suit against the customer in California, asserting that the goods were defective and caused an accident in which the purchaser had been injured. The plurality opinion of the Superior Court concluded that the
substantial connection must be established by an act of the defendant, which must have been purposefully
directed toward the forum state by the defendant. A third party’s acts cannot be used to establish the required act of the defendant. Moreover, merely placing goods in the stream of commerce does not equate with
the necessary purposeful direction.
Business Activity Tax Simplification Act of 2013 (H.R. 1439), introduced in August 2013: The legislation, known
as the ‘‘BATSA bill,’’ would, among other things, establish a bright-line standard for when a state can impose
a net income tax or other business activity tax on interstate activities. It would define physical presence in a
state to exclude a presence of less than 15 days within a jurisdiction’s borders or transient business activities.
Commerce Clause (Art. I, §8, cl. 3): The Commerce Clause of the U.S. Constitution provides an express grant
of power to Congress to ‘‘regulate Commerce . . . among the several States.’’
Geoffrey Inc. v. Oklahoma Tax Comn., 132 P.3d 632 (Okla. Civ. App. 2005): The Oklahoma Court of Civil Appeals ruled that the imposition of Oklahoma corporate income tax on royalties received by an out-of-state
corporation from sales by its in-state licensee does not violate due process, even though the corporation lacks
physical presence in the state, because licensing for use in the state creates nexus.
Geoffrey Inc. v. South Carolina Tax Comn., 437 S.E.2d 13 (S.C. 1993): The South Carolina Supreme Court
held that the taxation of Geoffrey’s royalty income is not prohibited by the Due Process Clause or the Commerce Clause of the U. S. Constitution. The state has substantial nexus with, and may impose income tax
upon, an out-of-state corporation with no physical presence in state but whose trademarks are used in the
state by a licensee.
Glatfelter Pulpwood Co. v. Pennsylvania, 61 A.3d 993 (Pa. 2013): The Pennsylvania Supreme Court held that
the company’s gains from the sale of Delaware timberland is business income subject to tax in Pennsylvania.
Goodyear Dunlop Tires Operations S.A. v. Brown, 131 S. Ct. 2846 (2011): North Carolina residents whose sons
died in a bus accident outside Paris, France, filed a suit for wrongful-death damages in a North Carolina state
court. Alleging that the accident was caused by tire failure, they named as defendants Goodyear USA, an
Ohio corporation, and three Goodyear USA subsidiaries, organized and operating, respectively, in Luxembourg, Turkey and France. The defendants filed a motion to dismiss on jurisdiction grounds. However, the
North Carolina Court of Appeals held that the state’s courts had general jurisdiction over the defendants because their tires reached the state through ‘‘the stream of commerce.’’ However, the U.S. Supreme Court reversed after finding that the defendants lacked ‘‘the kind of continuous and systematic general business contacts’’ necessary to allow North Carolina to entertain a suit against them unrelated to anything that connects
them to the state.
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ADDITIONAL BACKGROUND ON DEVELOPMENTS — Contd.
Griffith v. ConAgra Brands Inc., 728 S.E.2d 74 (W. Va. 2012): The taxpayer was not subject to West Virginia
corporation net income and business franchise tax on royalties earned from the nationwide licensing of
trademarks and trade names because the company did not have substantial nexus with the state.
J. McIntyre Machinery LTD v. Nicastro, 131 S. Ct. 2780 (2011): The case arose after the plaintiff injured his
hand while using a metal-shearing machine manufactured by J. McIntyre Machinery LTD, which was located
in England. The plaintiff filed suit in New Jersey, which is the state where the injury occurred, and J. McIntyre Machinery moved to dismiss the suit on jurisdictional grounds. The company argued that no more than
four of its machines were located in New Jersey. However, the New Jersey Supreme Court ruled that the
company was subject to the state’s jurisdiction even though at no time had the company advertised in, sent
goods to, or in any relevant sense targeted the state. The U.S. Supreme Court reversed after finding that imposing New Jersey jurisdiction on J. McIntyre Machinery violated Due Process because the plaintiff never
established that the company directed any purposefully driven activity at the state.
KFC Corp. v. Iowa Dept. of Rev, 792 N.W.2d 308 (Iowa 2010): The Iowa Supreme Court that physical presence is not required for the state to impose income tax on an out-of-state fast food franchisor.
Kimberly-Clark v. Alabama Dept. of Rev., No. 2061117 (Ala. Civ. App. 2011): The Alabama Court of Civil Appeals, on remand from the Alabama Supreme Court, affirmed a lower court finding that a company’s gain
from the sale of a paper mill and adjacent timberlands to an unrelated buyer is nonbusiness income.
Lanco Inc. v. New Jersey Div. of Taxn., 908 A.2d 176 (N.J. 2006): The New Jersey Supreme Court held that
the state could constitutionally subject a foreign corporation to its corporation business tax where the corporation lacked physical presence in New Jersey, but derived income through a licensing agreement with a
company conducting retail operations in the state.
Marketplace Fairness Act of 2013 (S. 743), introduced in April 2013: The legislation would automatically allow
SSUTA members to impose collection requirements on all sellers, except small sellers, for remote sales
sourced to member states. Nonparticipating states that conform to specific requirements, such as a single
entity responsible for tax administration, a single audit of remote sellers, and a single sales tax return for remote sellers, would also be permitted to require remote sellers to collect tax.
Marks v. United States, 430 U.S. 188 (1977): The U.S. Supreme Court held that when a fragmented Court
decides a case and no single rationale explains the result and enjoys the assent of five Justices, the holding
of the Court may be viewed as that position taken by those Members who concurred in the judgments on the
narrowest grounds.
MeadWestvaco Corp. v. Illinois Dept. of Revenue, 553 U.S. 16 (2008): The U.S. Supreme Court concluded that
the lower court erred in considering whether Lexis served an ‘‘operational purpose’’ in Mead’s business after determining that Lexis and Mead were not unitary.
Pledger v. Troll Book Clubs Inc., 871 S.W. 2d 389 (Ark. 1994): The Arkansas Supreme Court held that, since
an agency relationship was not proven, Troll Book Club’s sales of books in Arkansas were not subject to use
tax.
Polar Tankers Inc. v. City of Valdez, No. 08-310 (U.S. 2009): The U.S. Supreme Court held that the imposition of a personal property tax by the city on oil tankers violates the Tonnage Clause.
Quill Corp. v. North Dakota, 504 U.S. 298 (1992): The first U.S. Supreme Court case to impose both a Due
Process Clause and a Commerce Clause presence nexus requirement. The taxpayer, Quill, conducted about
$1 million of business a year in North Dakota, but had no physical presence there. The court found that Quill
had due process nexus with North Dakota, but not nexus under the Commerce Clause. The court held that
the due process requirement relating to the connection between the taxpayer and the state mandates only a
minimal connection between the two. This minimal connection standard in the context of state taxes is ‘‘comparable’’ to the standard for in personam jurisdiction. But for purposes of the Commerce Clause, the Court
noted that a higher ‘‘substantial nexus’’ standard was appropriate because the dormant Commerce Clause
requirements are meant to ensure that there is no interference with interstate commerce and that multiple
taxation is avoided. The Court established a bright-line standard of physical presence for purposes of establishing whether nexus exists. Many subsequently decided state appellate cases have taken the position that
the ‘‘physical presence’’ requirement was meant to apply only to sales and use taxes.
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Red Earth LLC v. United States, 657 F.3d 138 (2d Cir. 2010): The court upheld a federal district court decision which granted an injunction, on due process grounds, in favor of a remote seller of cigarettes that challenged the federal scheme for taxing the sales.
Scholastic Book Clubs Inc. v. Connecticut Comr. of Rev. Svcs., No. 11-1532 (Conn. 2012): The Connecticut Supreme Court ruled Scholastic Book Clubs Inc. had sufficient nexus in that state to be liable for sales and use
taxes because the teachers are the company’s representatives.
Scholastic Book Clubs Inc. v. Farr, No. 12-374 (Tenn. Ct. App. 2012): The Tennessee appeals court ruled that
the state may impose sales and use taxes on mail-order and online sales made by Scholastic Book Clubs Inc.,
finding an agency relationship exists between the out-of-state bookseller and the teachers who participate in
its programs.
Scioto Ins. Co. v. Oklahoma Tax Comn., 279 P.3d 782 (Okla. 2012): The Oklahoma Supreme Court held that
payments received by an out-of-state subsidiary from its parent, Wendy’s International Inc., under a licensing agreement for the use of trademarks and other intellectual property by Wendy’s restaurants in Oklahoma
did not create sufficient nexus under the Due Process Clause to impose corporate income tax on the subsidiary.
Scripto Inc. v. Carson, 362 U.S. 207 (1960): The U.S. Supreme Court held that 10 independent contractors
‘‘conducting continuous local solicitation in [the state] and forwarded the resulting orders . . . ’’ to the taxpayer created nexus. In National Bellas Hess, the Court said Scripto was ‘‘the furthest constitutional reach
to date of a State’s power to deputize an out-of-state retailer as its collection agent for a use tax.’’
Tennessee v. NV Sumatra Tobacco Trading Co., No. M2010-01955-SC-R11-CV (Tenn. March 28, 2013): The
Tennessee Supreme Court held that Tennessee courts lack personal jurisdiction over an Indonesian cigarette
manufacturer, who had withdrawn its cigarettes from the United States market, under the Due Process
Clause of the Fourteenth Amendment.
Troll Book Clubs Inc. v. Ohio Tax Comn., No. 92-X-597 (Ohio Bd. Tax App. 1994): The Ohio Board of Tax Appeals, relying on the fact that an agency relationship did not exist because Troll did not exercise control over
the teachers to sufficiently establish such a relationship, held that Troll could not be required to collect Ohio
use tax.
United States v. Windsor, No. 12-307 (U.S. June 26, 2013): The U.S. Supreme Court held that the federal
Defense of Marriage Act is unconstitutional under the Fifth Amendment.
West Virginia Tax Comr. v. MBNA America Bank, 640 S.E.2d 226 (W. Va. 2006): The West Virginia Supreme
Court of Appeals held that a credit card issuer that annually generated millions of dollars in gross receipts
attributable to citizens of West Virginia is subject to the state’s corporate income and franchise taxes despite
lacking a physical presence in the state. The court found that the U.S. Supreme Court’s bright-line physical
presence test only applies to sales and use tax nexus determinations.
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Sales Tax Issues
Fate of Marketplace Fairness Act Remains Uncertain
As Sales Tax Laws Lag Behind Modern Business Practices
he U.S. Senate’s passage of the Marketplace Fairness Act was an important milestone toward the passage of legislation granting states the authority to collect sales or use taxes from remote retailers. But the legislation’s prospects remain uncertain from a substantive and political standpoint. Regardless of the legislation’s fate, state
sales tax laws continue to dramatically lag behind widely adopted technological and business innovations such as
cloud computing. Significant challenges would remain in achieving significant uniformity in state sales and use tax
laws, even if the legislation were enacted.
Substantively, the legislation is grounded upon the authority of Congress under the U.S. Commerce Clause to enact legislation on matters affecting interstate commerce. It is unclear, however, if the Marketplace Fairness Act would
withstand scrutiny under the Due Process Clause, some participants suggested. If such a challenge was successfully
made, its impact could be limited. Instead of striking down the entire act, a court would likely rule for a taxpayer
making the challenge on an ‘‘as applied’’ basis.
Many of the sales tax compliance challenges that exist today would still remain even if the Marketplace Fairness
Act were enacted. The legislation does not require the states to adopt uniform administrative rules. Questions surrounding the nexus policies of states that decline to simplify their sales tax laws in conformance with the legislation
would continue to linger.
Politically, the legislation seems headed for a steeper climb in the U.S. House, where House Judiciary Committee
Chair, Bob Goodlatte, and other members appear to be in no rush to enact the version of the measure approved by
the Senate. Another question is whether an attempt will be made to tack onto the legislation tax proposals that have
been traditionally unpopular with the states. This could include the Mobile Workforce Act, Business Activity Tax Simplification Act, the Digital Goods & Services Tax Fairness Act, and even the Internet Tax Freedom Act, which expires
in 2014.
T
Rosen: Okay, let’s move on to legislative activity in
this area of tax jurisdiction. We have the Marketplace
Fairness Act that has been mentioned a couple of times
already. And, just to summarize, of course, the bill says
there are two categories of states in the country: those
that are members of the Governing Board of the
Streamlined Agreement and other states. Any state
that’s a member of the Streamlined Governing Board,
as long as the Streamlined Agreement continues to
have certain minimum simplification requirements, can
require those sellers with sales over a certain threshold
to collect and remit that state’s tax.
The other states can also require remote sellers over
a certain threshold to collect and remit that state’s tax
but only if they meet certain simplification criteria.
I think there are two things we should talk about.
First, the substance of the bill and, then, what we think
might happen from a political perspective. Any comments on the substance?
Pomp: Picking up on Diann’s earlier point, Congress
cannot legislate due process. It can expand your due
process rights; that’s what the last clause in the 14th
Amendment says, but it can’t take away due process
rights that you have. I have a due process right not to
have to collect a use tax under certain conditions and I
don’t think there’s anything Congress can do about that
in the Marketplace Fairness Act.
Even if that Act passes, I think we are going to be
right back asking the due process question — If I have
a website that you access, and I don’t do anything affirmative in your state within the meaning of McIntyre,
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can I be made to collect the use tax on sales in your
state, when you access my website?
Matson: I think that remains a live question.
Smith: I have a question here because I’m looking at
the Red Earth case and looking at the Marketplace Fairness Act. One of the questions that comes up for me is
to respond to people who are opposing it on due process grounds. If the Marketplace Fairness Act were to
pass, what is the remedy if someone claims that it violates their due process?
In the Red Earth case, it seems to me the remedy is
the whole act is unconstitutional rather than not enforceable against that particular individual. How do you
see that playing out in what is the current language in
the Marketplace Fairness Act?
Pomp: The state would issue an assessment and the
taxpayer would resist the assessment arguing the lack
of due process. It would be an ‘‘as applied’’ argument.
Rosen: Diann, are you asking whether the whole Act
would go down or whether it would be restricted in
some way?
Pomp: I think it would be struck down as applied to
me.
Smith: That’s what I thought, but then the Red Earth
case seems to call it into question.
Sommer: Yes, I share that same viewpoint — which is
a big picture point — what is remedy? Where are you
going to go with this? And, more to the point, there is
the practical ramification of the same premise and going right back to local court to interpret the fundamental federal concepts. And that you’re going to have
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rogue opinions, perhaps. And you may, in fact have
some jurisdiction that allows class actions to proceed.
Frieden: I want to make a few comments on some of
the other issues and complexities that will remain —
even if the Marketplace Fairness Act (MFA) is passed
and states are allowed to impose sales and use tax collection responsibilities on ‘‘remote’’ sellers. Clearly, the
U.S. Senate vote in favor of the legislation was a huge
step — although uncertainty remains on the House side.
We’ve been dealing with this post-Quill, post Bellas
Hess landscape for a long time — and passage of the
MFA would significantly change the jurisdictional rules
within which the states and multistate businesses operate. However, we need to be aware that the law change
would not wash away all of the jurisdictional issues and
differences in state and local sales and use tax rules that
have imposed compliance burdens on multistate tax
businesses. First, the MFA does not require states to
have uniform administrative rules — and it is likely that
there will be more simplification among the 22 states
that belong to the Streamlined Sales and Use Tax
Agreement than in many of the other states. As long as
a state meets the minimum threshold requirements of
the MFA, it can still choose to have a sales and use tax
base, tax rates and administrative rules that are different than many other states. Second, the MFA will not
render the click-through and other sales and use tax
nexus cases irrelevant. Some states may choose not to
meet the requirements of the MFA and therefore
‘‘physical presence’’ will remain the nexus standard in
those states. Moreover, the MFA allows states to have a
different tax base for remote sellers than for other vendors.
For instance, New York currently has different sales
and use tax treatment for ‘‘clothing’’ at the state and local levels. If New York wanted to include clothing in the
tax base that applies to remote vendors, under the MFA
rules it would have to change its tax structure, since the
MFA requires that the state and local tax base must be
the same for any particular category of goods or services. New York could opt out and not include clothing
in the tax base that applies to remote vendors. The result would be that the physical presence nexus standard
would still apply to remote vendors of clothing in New
York.
Finally, other complexities will arise in the interpretation of the MFA itself. For example, what ‘‘free’’ computer software do the states have to provide under the
MFA? How will the states provide exempt sale information? What will be the certification procedures relating
to ‘‘certified service providers?’’ As with all new major
legislation, many of these issues will be resolved by
state regulations and/or future litigation.
While some of these issues could be resolved by further changes to the language in the MFA, there may be
practical political limits to how much can be changed
without impacting the prospects for passage of the
MFA. The bottom line is that the passage of the MFA
would create a tidal wave of change in the sales and use
tax landscape — but still leave us with many of the old
issues in a somewhat scaled down form.
Rosen: We’re going to spend a minute examining
Rick’s premise that Congress can’t deprive due process
rights. When I was young and naive like Rick is, I used
to believe that courts decided cases in a rigorous, logical, rational manner without thinking about the result
on policy. Do you believe that the U.S. Supreme Court
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would not be influenced at all by Congress enacting
something like the Marketplace Fairness Act in a somewhat hazy area — that there would be some de facto
deference to Congress in the due process area?
However, we need to be aware that the [enactment
of the Marketplace Fairness Act] would not wash
away all of the jurisdictional issues and differences
in state and local sales and use tax rules that
have imposed compliance burdens on multistate
tax businesses.
KARL FRIEDEN, VICE PRESIDENT AND GENERAL COUNSEL
OF THE COUNCIL ON STATE TAXATION (COST)
Pomp: I don’t think on the due process issue.
Friedman: I would like to disagree. While it’s easy to
say you cannot restrict due process rights for a person,
at the same time, Congress has called for legislation in
this area.
Rosen: The Court has called.
Friedman: I’m sorry, the Court has called for congressional action here and more importantly, in my view at
least, I think this discussion and I know I’m sure some
will disagree — this discussion regarding due process
clause issues associated with the Marketplace Fairness
Act, I believe, is a red herring. No federal law could be
viewed as perfect and clearly this one isn’t perfect. Karl
noted some of the imperfections just now in terms of
some of the ambiguities that will remain postMarketplace Fairness Act and I’m sure there are others
that we haven’t talked about yet.
And there’s other federal legislation where Congress
has acted. I would point to the Mobile Telecom Sourcing Act, which has a primary place of use concept. You
can find numerous due process clause issues associated
with sourcing telephone calls to a person’s residence
that have nothing to do with that person’s residence.
You know, it seems to me to be in fact a more recurring
and significant issue associated with the Mobile Telecom Sourcing Act, which has been with us now since
’98, ’90-something. And you know, it’s at bottom a good
Act that I think both consumers and telecom providers
appreciate. But, I think we all agree that there are some
imperfections there.
The same thing holds true with the Marketplace Fairness Act. I’m sure that there are imperfections and
there will be occasional instances where there will be
due process clause problems.
But getting back to Diann’s question regarding what
would happen if that were to occur? I don’t see the Marketplace Fairness Act being upended as a result of a fact
pattern that results in a due process clause violation.
And, I think those instances will be few and far between.
Rosen: When I developed the principle incorporated
in the Mobile Telecommunications Sourcing Act, I was
following the effort of Jefferson Lines, which had just
been decided. That’s what I grabbed onto because it’s
very simple to administer for the industry. And, so, it
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was more of a Commerce Clause solution than due process. Going back to what Rick was just saying, the due
process analysis would have to be undertaken on a
taxpayer-by-taxpayer basis. We thought that it would
be a rare situation where an individual’s primary place
of usage would not relate to the actual usage of the
phone at all.
Friedman: Is that true today?
Rosen: I beg your pardon?
Friedman: Do you feel that way now?
Rosen: That there would be no nexus at all? It would
probably be very rare. Not saying it would never happen, but necessarily relatively rare.
Pomp: Even you go home from time to time.
[LAUGHING]
Pomp: Mark’s comments underscore a point — the
industry wanted that legislation. No one in the industry
really has an incentive to try to strike it down with a due
process argument and you know people will do exactly
that attacking the Marketplace Fairness Act.
Rosen: Alright, whoever has the best crystal ball,
what do you think is going to happen with this legislation? We’ve heard that the chairman of the House Judiciary Committee, Bob Goodlatte, has said that he’s not
going to rush it. He’s going to provide a set of principles
that he thinks any sales tax legislation should abide by
and those principles should be released shortly after the
recess. And House leadership said they are in no rush
to enact what the Senate did. Of course, we also hear
talk about the other state tax bills: Mobile Workforce,
BATSA, Digital Goods, and even the Internet Tax Freedom Act, which expires next year. So, what do people
think is really going to happen here?
Friedman: And there’s more, right? There’s the Digital Goods Taxation.
Rosen: Right.
Friedman: Oh, I’m sorry. And the cell phone one?
Rosen: Wireless Act.
Friedman: Yeah, there’s a lot on the table. You want
me to reply? Marketplace Fairness will be enacted in
Rick’s lifetime.
[LAUGHING]
Rosen: Anytime this year?
Sommer: He just put a marker on your back.
[LAUGHING]
Sommer: Yes, you have a bull’s eye on your back,
counselor.
Pomp: I will apply the rule against perpetuities.
[LAUGHING]
Pomp: I’m really safe.
Rosen: So, any thoughts about what’s going to happen or will anybody risk guessing? What do you hear
from people on the Hill and/or what business lobbyists
are saying?
Henchman: I’m going to NCSL [National Conference
of State Legislatures] in two weeks. I’m sure some of
you are, too, and, every year at NCSL, I go to this cheerleading rah-rah session about how this is the year that
— it used to be called the Main Street Fairness Act —
the Marketplace Fairness Act is going to pass. And, you
know, it’s all very convincing there, and there’s always
lots of reasons about why this is the year it’s going to
happen. I find it hard to believe because the only way it
passes the Republican House is if it’s attached to
BATSA or Mobile Workforce. And, if that happens, the
states will walk and they will actively oppose it. Correct
me if I’m wrong.
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There’s a little trivia fact to counter that — which
somebody told me — which is every Republican
senator over the age of 50 voted for [the
Marketplace Fairness Act], but every Republican
senator under that age voted against it.
JOSEPH HENCHMAN, VICE PRESIDENT OF LEGAL & STATE
PROJECTS FOR THE TAX FOUNDATION
Sommer: I share those views and I think the price is
too high . . . independently you can do anything. But,
there’s too much on the table now. I mean, there’s too
many forces, counterbalanced and countervailing, that
no one will reach across the aisle to accommodate.
Henchman: December was ridiculous. At the Tax
Foundation, we’re kind of in the middle on this issue, so
we get people on both sides talking to us about it. And
there was a flurry of activity in the lame duck session
where everybody said it’s going to happen in the lame
duck and my response to that was, ‘‘we’ll be lucky if we
don’t have the whole tax system expiring in the lame
duck.’’
I’d be surprised if they fix that in the month of December and, actually, they did. They did it early on
January 1.
Sommer: Out in America’s heartland where we live
and practice, why would we be so naive to think that tax
legislation is special? Okay, I mean nothing else can get
done up here for lack of a better term, right? So, why
would we think that?
Rosen: Lady Godiva thought it was special enough.
She got the tax repealed by her husband when she
made her famous ride.
But, it was something that Joe said about state opposition; if they were combined — if Marketplace Fairness
were combined with some of the other bills — do you
mean to imply that opposition by the executive branch
of most states would kill the bill?
Henchman: I think Congress likes it when everybody
comes to them in agreement or at least everybody in
front of them. And it makes it harder to pass this kind
of stuff when everybody is opposed.
Rosen: Harder, but not impossible.
Henchman: Yeah, I mean, I think Mobile Workforce
has a pretty good shot because, although some of the
states are still opposed, or one of the states is still opposed, there’s more of a consensus on that.
Pomp: What I had heard is that BATSA is essentially
a poison pill intended to kill the Act.
Rosen: Not because the executive branch of the majority of states would be against it. The NCSL [National
Conference of State Legislatures] has a resolution supporting it.
Pomp: The NCSL might not speak for all the states. .
.
Rosen: And a number of states have passed resolutions, at least in one House. And, so, I think the executive branch — so you got to keep that in mind when you
say the states are opposed to it — it’s only one branch
of the government.
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Frieden: I think the passage of the Marketplace Fairness Act this year in the House is still an uphill battle,
but we shouldn’t understate the changing dynamic. A
year ago, we didn’t have the Senate voting for the MFA
by a two-thirds to one-thirds margin. That’s a very significant step — after 11 years of introduction of similar
legislation — that it finally passes one of the two legislative bodies. So, I mean, it is moving forward, but
whether its passage is this year or in a couple years, it’s
difficult to predict.
Rosen: But, we all know there’s no cooperation in the
House and the Senate.
Henchman: There’s a little trivia fact to counter that
— which somebody told me — which is every Republican senator over the age of 50 voted for it, but every Republican senator under that age voted against it.
Rosen: Wow.
Henchman: I don’t know if time is on your side on
that.
Rosen: Okay, turning to what’s happening on the
state level at this area. We have states taking different
approaches to attributing one company’s nexus or one
person’s nexus in that state to somebody outside the
state. Attributional nexus covers all types of areas
where this type of nexus largely takes place. Jeff, want
to talk about this?
Friedman: Gore — are you talking about Gore?
Rosen: Well, you’re supposed to talk about the clickthrough statutes first.
Friedman: Oh, I’m sorry. Well, there’s a lot of legislative activity — it seems like every year now — regarding nexus expansion as it relates to sales and use taxes
specifically. The legislation really comes in two major
categories, and then you can cut it down from there into
subcategories. The two major categories, as Karl just
mentioned, one is click-through nexus and we’re awaiting a cert. petition by Amazon to the U.S. Supreme
Court, as to the validity of New York’s version of clickthrough nexus. And I say ‘‘version’’ because there are
different versions of click-through bills that have been
enacted by the states. But New York’s version is the oldest and also the one that’s the subject of a cert. petition
to the U.S. Supreme Court.
The other category of nexus legislation is the more
standard and traditional one I’ll call affiliate nexus, and
we’re seeing some interesting things there as well.
Where, if you’re an out-of-state seller related to another
entity that is already within the state’s taxing jurisdiction, that connection will draw the otherwise out-ofstate seller into the state’s taxing regime. And interestingly, I mentioned Gore before, but we’re seeing unitary
occur within the context of sales tax nexus jurisdiction.
Which, I think, is very troubling and wrong, frankly. I
believe it’s West Virginia that has embedded a unitary
test within their affiliate nexus statute.
On the click-through side, we’ve seen litigation outside of New York. I think everybody is well aware of
what’s gone on in Illinois and other places. And I suspect that we’re going to see more litigation as states
continue to enact click-through bills. And we can cross
reference our discussion earlier regarding due process
clause nexus — I think these jurisdictional laws present
some very interesting issues. A few issues of these bills
are worth noting.
The compensation issue, Art, that you raised earlier;
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lier regarding who is a ‘‘representative’’ and under what
circumstances the representative is acting on behalf of
an out-of-state seller. There’s no end in sight in the litigation challenging these laws.
Smith: Jeff, I have a question for you. This has always
sort of bothered me. For the states that have adopted
the click-through nexus, we know what their position is
on click-through, but, for the states that have not adopted click-through nexus, do you think that it’s required to have some type of legislation to impose the
collection liability?
It seems to me that there’s always emphasis on the
states that have adopted it, but, for the non-adopting
states, I still think there’s a big risk.
It seems to me that there’s always emphasis on
the states that have adopted [click-through
nexus], but, for the non-adopting states, I still
think there’s a big risk.
DIANN SMITH, COUNSEL WITH MCDERMOTT WILL &
EMERY LLP
Friedman: Agreed, agreed. And we’ve seen, even before the creation of click-through nexus statutes, disconnects between tax jurisdiction and the determination of who is a ‘‘retailer’’ or ‘‘vendor’’ under a state’s
law. There are a lot of integration issues.
Sommer: The practical element is that what is the
number one tax type where, effectively, an agency can
pierce the corporate veil? Sales and use tax collection —
fundamentally number one, at least in dollars and
cases, I would suggest in virtually every state. And, so
now, you have a small, you literally have a run-out-ofyour basement affiliate operating through some of the
providers on the internet and now we’ve got clickthrough nexus. Something doesn’t happen and the business fails. An LLC, family capitalized. We can draw this
fact pattern. And next thing you know, mom and dad
are being pursued individually under responsible officer
tax liability.
To Rick’s point about due process, I think this is a
case where I think a judge will sit up and take notice on
that. You know, one involving individuals and not mega
businesses.
I think that’s an understatement and that’s where I’m
going. I think implementation and integration could
very well be number one on the issue list for this.
Friedman: And we’re early on. I think Maryland might
have been the first to do this in a weird way. But, I think
some other states more recently have tied their implementation of either affiliate nexus or their implementation to the Marketplace Fairness Act to the passage of
the federal legislation. Is that some kind of acknowledgement that until there’s some federal statute that
maybe this kind of nexus expansion is inappropriate or
illegal even?
Rosen: Interesting. I know a couple states — it’s
clearly a political way of making sure that Congress
acts — say that the Member’s constituents are going to
have higher taxes from other taxes in our state unless
you, Member, do this. And then, to address Diann’s
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question, I know at least the tax officials in New York
and Connecticut believe that their statutes were not
necessary except, if anything, to create a statutory presumption. And New York is auditing prior to the effective date of the statute. They say that Tyler Pipe and
Scripto allow them to do that.
Which leads to what I think is a pretty simple legal
question here — does the activity inside the state equate
to, using Tyler Pipe language, activities that are significantly associated with the out-of-state company’s ability to establish and maintain the in-state market?
I had a tax official from a major state tell me on Friday that, well, that’s just an example of a situation, it’s
not the limit. But, then I cited Quill, where the U.S. Supreme Court said that Scripto was the furthest they’ve
ever gone, indicating that that is a limit. So, I think the
real question is whether click-through activity is merely
advertising or is something closer to in-your-face meeting, as the facts were in Scripto and Tyler Pipe.
Smith: Art, I think that’s why the history of clickthrough is important. New York was sort of the beginning of it. And as I understand it in New York, it started
out by the Department of Taxation and Finance issuing
a TSB-M because of a local hockey team had an affiliate
relationship and the hockey moms and dads were actually telling people, ‘‘go to our website, purchase
through this website.’’ To me, now you have someone in
the state trying to get people to buy your products.
Friedman: A local market.
Smith: A local market, exactly, versus what the clickthrough has evolved into is some guy, who’s really into
Star Trek, sitting in his basement, doing a Star Trek
blog and having people from all over the world come to
his blog. The way he pays for his computer time is to be
an affiliate.
Pomp: But, that it is not the way New York interprets
its statute.
Smith: Right.
Pomp: The statute lends itself to that interpretation,
it’s poorly drafted, but the tax department has narrowed it to require solicitation in the state, which makes
it really Scripto, except for the presumption. I would
have thought the impossibility of rebutting that presumption would have been the heart of Amazon’s case,
but it wasn’t.
Rosen: It was at the Supreme Court — the trial court
is the Supreme Court in New York — it was focusing on
the presumption and, as it went up the ladder, was
when it got more into the tax issue.
Pomp: The trial court did not focus on the impossibility of rebutting the presumption. If I send an e-mail out
to all my associates, and I ask everyone to tell me that
they’ve done no solicitation in NY, what are the odds of
getting 100 percent responses back? Zero! When I have
asked NY tax officials this question, they have said,
‘‘Well, we’ll interpret the presumption quite reasonably.
We understand you’ll never get 100 percent back.’’ That
should be at least in a regulation.
Sommer: To my points earlier about individual liability and the fact patterns behind it.
[SIMULTANEOUS AGREEMENT]
Frieden: I think that’s a really important point, Rick.
As I mentioned before, the ‘‘click-through’’ nexus cases
are sort of a modern day ‘‘digital’’ version of Scripto.
However, there are important differences. For one, the
digital websites’ interaction with customers is not direct
or face-to-face as was the case with the independent
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contractors in Scripto. And, second, as you mention,
there is the issue of the validity of the ‘‘presumption’’ element in the statutes that was not present in Scripto. Finally, these cases are not completely going away, even
if the Quill physical presence standard is altered by passage of the Marketplace Fairness Act. There are likely
to be some states that don’t adopt the MFA, or don’t
adopt it for all categories of remote vendors, and, thus,
the issue of what constitutes ‘‘physical presence’’ for
sales and use tax nexus purposes will continue to be an
issue for the foreseeable future.
Matson: If only there were an organization where
states could get together and work on uniformity in this
area.
[LAUGHING & CHATTER]
Friedman: By states, how many states do you mean?
[LAUGHING & CHATTER]
Rosen: Karl, you know, it seems that everything
we’ve talked about so far, particularly everything we
talked about on nexus, is really important when we talk
about the modern world of cloud computing. You want
to talk about that?
Frieden: Yes. I would like to throw out a few thoughts
on cloud computing. One, there has been a steady
stream of articles on cloud computing and the different
variations within business models. For instance, cloud
computing encompasses software as a service, the platform as a service, or the infrastructure as a service.
Within cloud computing, there is a continuum of models with variations in how much control the customer
has over the remote server environment. A lot of what
we’ve just talked about relating to affiliate nexus or
click-through nexus applies, as well, to the analysis of
cloud computing and server locations in market states.
We can gain some insight to how the states might approach this topic by looking at the Bloomberg BNA
2013 Survey of State Tax Departments on income tax
nexus relating to web servers. While this survey did not
address sales tax nexus [for cloud computing], many of
the positions taken by the states for income tax purposes are relevant to what could happen around cloud
computing and sales tax.
The first finding was that 36 states (and D.C.) indicated that owning a web server in their jurisdiction
would create income tax nexus for the company owning
the property. This is not a surprising result given the
presence of physical property in the state.
The second finding of the Bloomberg BNA survey
was that 26 jurisdictions would find income tax nexus
for an out-of-state business that leased space on a third
party’s internet server in their state. This harkens back
to the fact patterns in the early days of the computer
age that dealt with ‘‘time sharing’’ on computers owned
by third parties. The third finding was that 24 states
would find income tax nexus for an out-of-state business that stored data on an in-state server, regardless of
whether the data was stored for more or less than six
months. Finally, 12 states went even further and said
nexus would arise for an out-of-state business using the
services of a web-hosting provider with a web server in
their jurisdiction.
Again, I repeat, this survey is based on state perspectives on income tax nexus [for cloud computing], not
sales tax nexus. Nevertheless, the survey results offer
some insights into how states might handle sales tax
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ing. And the position that leasing space or storing data
on a remote server creates a taxable presence would
certainly have far reaching implications — if states
choose to enforce it. It could be even more controversial
and more expansive than click-through nexus. In our
digital era, businesses (and individuals) are increasingly relying on cloud computing and remote servers to
handle transactions, store data, and utilize computer
software. In many of these instances, the businesses
can not readily identify the locations of the remote servers. So, with those opening remarks on nexus as it relates to cloud computing, I throw it open for discussion.
What do you all see as the emerging issues in this
space?
Rosen: It seems to me that there are two different categories of these fact situations. I think a lot of states are
taking the economic development view of servers in
their state or. . .
Friedman: Is it farms that we’re looking for?
Rosen: Server farms — that they want to encourage
those businesses to expand in the state, employ people
in the state. Therefore, they’re not going to tax those
businesses’ customers. So, we call it market patronization in contrast to market exploitation, and many states
will not impose tax if your presence is to patronize the
local market. There have been 20 or 30 rulings in cases
that take that position, so I think that’s important to
keep in mind when you look at the analysis here. You
also have to keep in mind the economic development issues.
Pomp: How do you find out where the party you’re
dealing with has their servers and where your data is? I
assume I don’t send them an e-mail asking, so how do I
discover this?
Frieden: Well, it’s a great question and it points up the
difficulty of basing nexus determinations on the location of a remote server that holds a customer’s data or
software. Frequently, a company may not know the locations of the servers of its vendors. Or the servers may
actually be in multiple locations and data may be held
or backed up in more than one location. So even if you
get over the hurdle of whether there is a taxable presence based on a taxpayer’s utilization of a server in a
market state, or based on the actions of the owner of
the server on behalf of the taxpayer, you are still left
with the difficulty of tracking the location of the server(s). This type of problem emerges in many dimensions in the digital world. For instance, for either income tax or sales and use tax purposes, it is not easy to
source the sales of digital goods and services that are
purchased by a business and used on a multistate or
multinational basis. Cloud computing has further complicated this scenario, as has the rise of the number of
states utilizing market sourcing rules for income tax
purposes instead of the traditional cost of performance
rules.
Rosen: And there’s a big difference, I think, between
small buyers and large buyers. For our clients, for example, we know where the service providers have their
servers; we then put limiting language in the contracts,
saying something like, ‘‘You’ll only use service located
in this state or that state.’’
Friedman: We do the same.
Rosen: And, so, the smaller companies obviously
don’t have that. If you just go on the internet and buy a
service, you can’t do that.
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Houghton: Yeah and, to your point, and, Jeff, yours: if
you’re saying, don’t put our data on servers in Illinois,
California and Texas — is that the Geoffrey play you
were referring to earlier from a due process standpoint?
If you’re trying to prevent presence or intangible connections to this? But do you have to now, under McIntyre? Do you just have to not intend for your data to be
in California, Illinois or Texas?
Rosen: I think you know the answer to that. We need
to be mindful of the difference between planning and
controversy. You don’t want to invite the fight, but, if
you’re already in the fight, then you raise those issues.
Friedman: Yeah, and what Kendall suggested, which
is what’s going on and it’s terrible. You know, if you
think about the business decisions that are being tax
motivated because of what I perceive to be goofy tax positions, we’re now telling the business people that you
should contractually require a third party to maintain
your data or to perform some type of electronic service
or information service on your data in a state that’s a
‘‘good’’ state and not a ‘‘bad’’ state, what kind of tax
policy is that?
You know, if you think about the business
decisions that are being tax motivated because of
what I perceive to be goofy tax positions, we’re
now telling the business people that you should
contractually require a third party to maintain your
data or to perform some type of electronic service
or information service on your data in a state
that’s a ‘‘good’’ state and not a ‘‘bad’’ state, what
kind of tax policy is that?
JEFFREY A. FRIEDMAN, PARTNER WITH SUTHERLAND,
ASBILL & BRENNAN LLP
Sommer: To the concept of proper planning and good
business, the licensing agreements we reviewed five
and ten years ago are not even close to what we’re seeing today. And the last persons to ever review licensing
agreements ten years ago were the tax geeks, and now
they’re starting, the techies shoot it down the hall and
say, ‘‘Are we shooting ourselves in the foot for tax purposes by even contemplating this transaction, let alone
executing it?’’
Friedman: And, then, the crazy looks that you get
when you say only use servers in state X versus state Y.
Smith: And, particularly, it’s when the technology
gets so far beyond the taxing. So, when you get into the
virtual servers and can you write it in the contracts that
you won’t be using servers in a certain state, when with
virtual servers it’s wherever the . . .
Friedman: Cloud is?
Smith: Exactly.
Sommer: I mean doesn’t everyone have nexus with
Maryland? Isn’t Fort Meade in Maryland?
[LAUGHING]
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Frieden: For this reason, there are certainly some
states that have already carved out safe harbors for the
utilization of servers in their jurisdiction. These jurisdictions don’t want to discourage high technology businesses from locating in their state if the businesses rely
on servers or cloud computing in their business model.
This issue is potentially larger than the click-through
nexus issue because it impacts all kinds of businesses,
not just e-retailers. The question of how much data a
company can store or how much software hosted on a
remote server a company can utilize — without creating
a taxable physical presence — is certainly a daunting
one.
Another troubling aspect of this issue is that there
are still perplexing decisions being made by states on
the characterization of software or digital transactions.
For instance, there is the Thomson Reuters case in
Michigan — now on appeal — where the Michigan
Court of Claims affirmed the Michigan Department of
Treasury’s finding that taxpayer’s ‘‘Checkpoint’’ electronic information service should be categorized as prewritten computer software and thus taxed as tangible
personal property. I would have thought that this issue
was settled long ago — that a digital information service
does not turn into tangible personal property simply because it contains a little bit of software in it. While this
case is not directly analogous to the issue of whether
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utilizing space on a computer server can constitute a
taxable lease of tangible property, it does highlight the
confusion that frequently accompanies the analysis of
digital transactions.
Pomp: And can any of this be audited five years after
the fact? If the auditor asks the company where did it
store your data in order to confirm what you might have
told the department, I doubt the company could determine that even if they wanted to cooperate.
Rosen: I think in the example where there’s a contract limiting the activity, that would be convincing
enough. I think there are court cases, like Bloomingdale’s By Mail, a Pennsylvania case, where there are
company rules, some employee broke the rules, but that
won’t be held against the company. But small companies, you’re absolutely right, how are they going to
prove it?
Friedman: And, Rick, aren’t we getting to a place
where states take the position that you have nexus here
unless you prove that you don’t?
Sommer: Again, to my comment earlier about the
software licensing contracts, you can draft and revise
forever, but, at the end of the day, will you be able to
overcome that shift, that paradigm, which I think is reality today, that the states are saying, ‘‘prove it?’’
Friedman: I’m relieved you said ‘‘shift.’’
[LAUGHING]
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ADDITIONAL BACKGROUND ON DEVELOPMENTS
Business Activity Tax Simplification Act of 2013 (H.R. 1439), introduced in August 2013: The legislation, known
as the ‘‘BATSA bill,’’ would, among other things, establish a bright-line standard for when a state can impose
a net income tax or other business activity tax on interstate activities. It would define physical presence in a
state to exclude a presence of less than 15 days within a jurisdiction’s borders or transient business activities.
Commerce Clause (Art. I, §8, cl. 3): The Commerce Clause of the U.S. Constitution provides an express grant
of power to Congress to ‘‘regulate Commerce . . . among the several States.’’
Digital Goods and Services Tax Fairness Act of 2013 (S. 1364), introduced July 2013: The legislation prohibits multiple or discriminatory taxes on the sale or use of digital goods and services and provides that taxes on the
sale of those items may only be imposed by a state or local jurisdiction encompassing the customer’s tax address.
Due Process Clause (Amendment XIV, §1): The Due Process Clause of the U.S. Constitution provides that a
state may not ‘‘deprive any person of life, liberty, or property, without due process of law.’’
Geoffrey Inc. v. South Carolina Tax Comn., 437 S.E.2d 13 (S.C. 1993): The South Carolina Supreme Court
held that the taxation of Geoffrey’s royalty income is not prohibited by the Due Process Clause or the Commerce Clause of the U.S. Constitution. The state has substantial nexus with, and may impose income tax
upon, an out-of-state corporation with no physical presence in state but whose trademarks are used in the
state by a licensee.
Goodyear Dunlop Tires Operations S.A. v. Brown, 131 S. Ct. 2846 (2011): North Carolina residents whose sons
died in a bus accident outside Paris, France, filed a suit for wrongful death damages in a North Carolina state
court. Alleging that the accident was caused by tire failure, they named as defendants Goodyear USA, an
Ohio corporation, and three Goodyear USA subsidiaries, organized and operating, respectively, in Luxembourg, Turkey and France. The defendants filed a motion to dismiss on jurisdictional grounds. However, the
North Carolina Court of Appeals held that the state’s courts had general jurisdiction over the defendants because their tires reached the state through ‘‘the stream of commerce.’’ However, the U.S. Supreme Court reversed after finding that the defendants lacked ‘‘the kind of continuous and systematic general business contacts’’ necessary to allow North Carolina to entertain a suit against them unrelated to anything that connects
them to the state.
Internet Tax Freedom Act Amendments Act of 2007 (H.R. 3678), enacted Oct. 31, 2007: The legislation extends the
moratorium on state and local taxation of Internet access and electronic commerce to Nov. 1, 2014.
J. McIntyre Mach. LTD v. Nicastro, 131 S. Ct. 2780 (2011): The case arose after the plaintiff injured his hand
while using a metal-shearing machine manufactured by J. McIntyre Machinery, which was located in England. The plaintiff filed suit in New Jersey, which is the state where the injury occurred, and J. McIntyre Machinery moved to dismiss the suit on jurisdictional grounds. The company argued that no more than four of
its machines were located in New Jersey. However, the New Jersey Supreme Court ruled that the company
was subject to the state’s jurisdiction even though at no time had the company advertised in, sent goods to,
or in any relevant sense targeted the state. The U.S. Supreme Court reversed after finding that imposing New
Jersey jurisdiction on J. McIntyre Machinery violated due process because the plaintiff never established that
the company directed any purposefully driven activity at the state.
Marketplace Fairness Act of 2013 (S. 743), introduced in April 2013: The legislation would automatically allow
SSUTA members to impose collection requirements on all sellers, except small sellers, for remote sales
sourced to member states. Nonparticipating states that conform to specific requirements, such as a single
entity responsible for tax administration, a single audit of remote sellers, and a single sales tax return for remote sellers, would also be permitted to require remote sellers to collect tax.
Maryland Comp. of the Treas. v. Gore Enter. Holdings Inc., (Md. Ct. Spec. App. 2013), cert. granted, (Md. May
17, 2013): The Maryland Court of Special Appeals held that two out-of-state subsidiaries holding their parent company’s patents and financial assets are unitary with the parent and have sufficient nexus for their income to be subject to tax by Maryland.
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ADDITIONAL BACKGROUND ON DEVELOPMENTS — Contd.
Mobile Telecommunications Sourcing Act (H.R. 4391), enacted July 28, 2000: The legislation establishes the rules
for determining the state and local government treatment of charges related to mobile telecommunications
services. The legislation states that all charges for mobile telecommunications services that are deemed to be
provided by the customer’s home service provider are to be subjected to tax, charge, or fee by the taxing jurisdictions whose territorial limits encompass the customer’s place of primary use, regardless of where the
mobile telecommunication services originate, terminate, or pass through. No other taxing jurisdiction may
impose taxes, charges, or fees on charges for such mobile telecommunications services, including how to determine a customer’s place of primary use.
Mobile Workforce State Income Tax Simplification Act of 2013 (H.R. 1129), introduced March 2013: The legislation
provides that the wages of employees performing job duties in more than one state are only subject to income tax in the state of the employee’s residence, and the state within which the employee is present and
performing job duties for more than 30 days during the calendar year.
National Bellas Hess, Inc. v. Illinois Dept. of Rev., 386 U.S. 753 (1967): The first U.S. Supreme Court case to
address whether taxable nexus existed where there was adequate transactional nexus, but inadequate presence nexus. National Bellas Hess’s only connection with Illinois consisted of mail order catalog sales, with
merchandise shipped into Illinois (merchandise was also shipped to destinations throughout the United
States) by mail and common carrier. The U.S. Supreme Court held that Illinois could not constitutionally
subject the Missouri seller to an Illinois use tax collection duty on such sales.
Okla. Tax Comn. v. Jefferson Lines, 514 U.S. 175 (U.S. 1995): The U.S. Supreme Court held that Oklahoma’s
sales tax on the full price of a ticket for bus travel from Oklahoma to another state does not violate the Commerce Clause.
Overstock.com Inc. v. New York Dept. of Taxn. and Fin., 987 N.E.2d 621 (N.Y. 2013): The New York Court of
Appeals held that the internet tax statute, which subjects online retailers soliciting business through in-state
affiliates to sales tax, is valid under the Commerce Clause and the Due Process Clause.
Quill Corp. v. North Dakota, 504 U.S. 298 (1992): The first U.S. Supreme Court case to find both a Due Process Clause and a Commerce Clause presence nexus requirement. The taxpayer, Quill, conducted about $1
million of business a year in North Dakota, but had no physical presence there. The Court found that Quill
had Due Process nexus with North Dakota, but not nexus under the Commerce Clause. The Court held that
the Due Process requirement relating to the connection between the taxpayer and the state mandates only a
minimal connection between the two. This minimal connection standard in the context of state taxes is ‘‘comparable’’ to the standard for in personam jurisdiction. But for purposes of the nexus under the Commerce
Clause, the court noted that a higher ‘‘substantial nexus’’ standard was appropriate because the dormant
Commerce Clause requirements are meant to ensure that there is no interference with interstate commerce
and that multiple taxation is avoided. The Court established bright-line standard of physical presence for
purposes of establishing whether nexus exists. Many subsequent state appellate decisions have taken the position that the ‘‘physical presence’’ requirement was meant to apply only to sales and use taxes.
Red Earth LLC v. U.S., 657 F.3d 138 (2d Cir. 2010): The court upheld a federal district court decision which
granted an injunction, on due process grounds, in favor of a remote seller of cigarettes that challenged the
federal scheme for taxing the sales.
Scioto Ins. Co. v. Okla. Tax Comn., 279 P.3d 782 (Okla. 2012): The Oklahoma Supreme Court held that payments received by an out-of-state subsidiary from its parent, Wendy’s International Inc., under a licensing
agreement for the use of trademarks and other intellectual property by Wendy’s restaurants in Oklahoma
did not create sufficient nexus under the Due Process Clause to impose corporate income tax on the subsidiary.
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ADDITIONAL BACKGROUND ON DEVELOPMENTS — Contd.
Scripto Inc. v. Carson, 362 U.S. 207 (1960): The U.S. Supreme Court held that 10 independent contractors
‘‘conducting continuous local solicitation in [the state] and forwarded the resulting orders . . . ’’ to the taxpayer created nexus. In National Bellas Hess, the Court said Scripto was ‘‘the furthest constitutional reach
to date of a State’s power to deputize an out-of-state retailer as its collection agent for a use tax.’’
Streamlined Sales and Use Tax Agreement, ratified in 2002: This multistate agreement is meant to simplify and
modernize sales and use tax administration in the member states in order to substantially reduce the burden
of tax compliance.
Thomson Reuters Inc. v. Mich. Dept. of Treas., No. 11-91-MT (Mich. Ct. Cl. 2012), appeal docketed, No.
313825 (Mich. Ct. App. Dec. 14, 2012): The Michigan Court of Claims ruled that subscriptions to the company’s research service are taxable uses of prewritten computer software.
Tyler Pipe Indus. Inc. v. Wash. Dept. of Rev., 483 U.S. 232 (1987): The U.S. Supreme Court noted, with approval, the Washington Supreme Court’s statement that ‘‘the crucial factor governing nexus is whether the
activities performed in the state on behalf of a taxpayer are significantly associated with the taxpayer’s ability to establish and maintain a market in this state for sales.’’ However, the high court found that Washington’s manufacturing tax discriminated against interstate commerce in violation of the Commerce Clause.
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Income Tax Issues
Confusion Reigns Supreme as States Apply Income Tax
Nexus Analysis with Surprising Results in a Variety of Contexts
ncome tax nexus can arise in a variety of contexts, where the shifting of employees and business functions to an
affiliate constituted a sham transaction, to telecommuting in New Jersey, to subsidiaries in a unitary business inheriting their parent’s nexus. But there is one aspect of nexus that remains constant as it is applied across these
different settings: Confusion among taxpayers and state tax agencies.
For example, most jurisdictions’ nexus policies with respect to telecommuting seem counterintuitive given the
public policy benefits, such as reduced traffic congestion and pollution, that come from allowing employees to work
from home. But most states agree that the presence of a single telecommuter within their borders is a sufficient contact to warrant the imposition of their income tax on an out-of-state corporation. This is so even if the telecommuting employee was performing back office operations, such as payroll, most states said in the recent Bloomberg BNA
Survey of State Tax Departments.
In one recent case, a state chose not to find nexus despite a company’s assertion that several employees were
working within its borders. The Massachusetts Appellate Tax Board found that nexus was not created after a parent
corporation subleased office space from one of its in-state affiliates and then transferred employees to work there.
The employee transfers were a sham because they were specifically designed to have no economic effect or business
purpose beyond the creation of tax benefits, the board concluded.
The issue of income tax nexus becomes even more blurry when applied in the unitary business context. The instate presence of a parent corporation created nexus for two out-of-state subsidiaries, the Maryland Court of Special
Appeals recently held. The opinion seems to suggest that taxable nexus can be triggered by merely being part of the
same unitary group with a taxable entity.
I
Rosen: There’s been a lot of talk over the past decade
and a half about telecommuters and the social benefits
of telecommuting regarding traffic and the pollution
compared to people commuting physically. But, yet, we
have states taking a position that having an employee in
the state full time leads to taxation of the company.
Steve, you want to talk about that?
Roll: We’ve asked for years in the Bloomberg BNA
Survey of State Tax Departments: Will having a single
employee telecommute from your state create nexus for
an out-of-state corporation? And the vast majority of
states have said yes. And that’s been a trend for the 13
years we’ve been doing the survey.
So, last year, we broke it down a little more. We
asked what if it’s a single employee who is performing
only back office administrative functions such as payroll. And got just about the same number, 33 states—as
opposed to 36—said, yes, that would create nexus.
Also, we asked, what if they were just doing product
development functions, like computer coding, and 34
said, yes, it would create nexus. And that’s consistent
with New Jersey’s Telebright case. So, it’s interesting a
lot of people express shock at (inaudible). But that’s
been in our survey for years.
Pomp: And then you get this case out of Massachusetts, Allied Domecq Spirits and Wines, where the taxpayer purposely transferred an employee to create
nexus and that wasn’t respected.
Roll: They call that a reverse nexus case.
Rosen: How about the one in Alabama? About two
years ago, a company that thought it had nexus there
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efit but the court said, no, that’s not a substantial
enough presence. Let’s move on here. Jeff, do you want
to talk about Gore?
Friedman: Sure, I’ll do it quickly. What an awful decision! It’s a disaster.
Smith: Jeff, you and I both taught with the Georgetown L.L.M. program and I always told my students to
remember one thing: ‘‘that unitary does not equal
nexus.’’ And, on every exam, there was always someone who said because they’re unitary they have nexus
and now I know where they went to work.
[LAUGHING]
Friedman: Hopefully, your students weren’t my students.
Houghton: But, it’s exacerbated by throwing into the
mix the economic substance/business purpose analysis.
So, first you’re unitary. Now, you’re going to say you
have no substance or purpose. Which, you would think,
would mean you disregard it. But, no, now were going
to pull it in under a nexus theory. It’s just internally inconsistent.
Friedman: You’re right, Kendall. And then they reattribute the apportionment formula to boot, like this is
the cherry on top. It’s awful.
Rosen: These things get a life of their own sometimes, just very, very scary for those of us who know
what the right answer is.
Friedman: It is scary for those of us who know the
right answer and it’s also scary for those of us, who I’m
sure are all of us, that have read Maryland’s Court of
Appeals decisions in the past, which are less than clear.
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I mean, to be polite about it, they were less than clear in
some of their analysis.
Rosen: You live in Maryland, don’t you, Jeff?
Friedman: I do live in Maryland.
Rosen: Is it your responsibility, then, that this court is
doing this now?
Friedman: Kendall, don’t you also live in Maryland?
Houghton: Yes, I do.
Pomp: I have a question for you, Jeff, why didn’t the
court go down the economic nexus path?
Friedman: The more mainstream-type decision making, let’s call it?
Pomp: Than this atrocity.
Friedman: We don’t believe Maryland’s Court of Appeal adopted an economic nexus standard. The Court of
Special Appeals came out with this bad unitary nexus
decision that we’ve been talking about, really did fundamentally confuse the unitary business principle and tax
jurisdiction, which I think everybody in the room will
agree was wrong. They should not have done it.
Now, why didn’t the Court of Appeals look to a more
standard Geoffrey-type standard?
INCOME TAX ISSUES
Friedman: I wish I knew, Rick, and it probably had
something to do with the way in which the case was
presented by the Comptroller’s Office to the court. My
sense is that they must be somewhat concerned—
speaking for myself here and not for the taxpayer—they
must be somewhat concerned that the Court of Appeals’
decisions are not on all fours with Geoffrey and, therefore, they didn’t want to apply a simple Geoffrey-type
approach in this case, but I don’t know.
Houghton: It just struck me that you know it’s easier
for the comptroller to put a theory in front of the court
that at least looks kind of like something they’ve seen
or generated before, than trying to setup a new area of
taxability.
Smith: So, what is a taxpayer not involved in a tax
planning situation—it doesn’t have what we think of as
nexus with Maryland but does have an affiliate in Maryland that it has a unitary relationship with, what is that
nonresident taxpayer supposed to do as far as now filing on its own?
Sommer: Restructure, right?
[LAUGHING & CHATTER]
We don’t believe Maryland’s Court of Appeal
adopted an economic nexus standard. The Court of
Special Appeals [in Gore] came out with this bad
unitary nexus decision that we’ve been talking
about, really did fundamentally confuse the unitary
business principle and tax jurisdiction, which I
think everybody in the room will agree was wrong.
They should not have done it.
Friedman: We asked the Comptroller’s Office, but I’m
sure some of you have engaged in discussions with the
Maryland Comptroller’s Office, too. And I think that
they’re wondering the same thing that we’re wondering
in how far to take this very confusing jurisdictional
principle. There are a ton of cases queued up in the
Maryland system from audits and appeals through the
Maryland Tax Court, waiting to see what is going to
happen with this court decision at the Court of Appeals.
I suspect we won’t have a decision until sometime in
the first half of 2014. It’s going to be some time but, until that happens, there is, to your point Diann, a lot of
confusion on the applicable standards regarding how to
file, or whether to file, in Maryland. It’s awful.
JEFFREY A. FRIEDMAN, PARTNER WITH SUTHERLAND,
ASBILL & BRENNAN LLP
Pomp: Yes, why didn’t the state go down that path?
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ADDITIONAL BACKGROUND ON DEVELOPMENTS
Allied Domecq Spirits and Wines USA Inc. v. Massachusetts Comr. of Rev., No. C282807 (Mass. App. Tax Bd.
2013): The Massachusetts Appellate Tax Board ruled that a tax plan in which an out-of-state parent corporation sought to establish nexus in Massachusetts for the purpose of allowing its in-state subsidiary to offset
income with the parent’s losses was disregarded as a sham transaction because it was motivated exclusively
by the desire for tax avoidance.
Geoffrey Inc. v. South Carolina Tax Comn., 437 S.E.2d 13 (S.C. 1993), cert. denied, 510 U.S. 992 (1993): The
South Carolina Supreme Court held that the licensing of an intangible for use in the state and the derivation
of income therefrom constituted a ‘‘substantial nexus’’ with the state for purposes of the imposition of an income tax.
Goodyear Dunlop Tires Operations S.A. v. Brown, 131 S. Ct. 2846 (2011): North Carolina residents whose sons
died in a bus accident outside Paris, France, filed a suit for wrongful death damages in a North Carolina state
court. Alleging that the accident was caused by tire failure, they named as defendants Goodyear USA, an
Ohio corporation, and three Goodyear USA subsidiaries, organized and operating, respectively, in Luxembourg, Turkey and France. The defendants filed a motion to dismiss on jurisdictional grounds. However, the
North Carolina Court of Appeals held that the state’s courts had general jurisdiction over the defendants because their tires reached the state through ‘‘the stream of commerce.’’ However, the U.S. Supreme Court reversed after finding that the defendants lacked ‘‘the kind of continuous and systematic general business contacts’’ necessary to allow North Carolina to entertain a suit against them unrelated to anything that connects
them to the state.
J. McIntyre Mach. LTD v. Nicastro, 131 S. Ct. 2780 (2011): The case arose after the plaintiff injured his hand
while using a metal-shearing machine manufactured by J. McIntyre Machinery, which was located in England. The plaintiff filed suit in New Jersey, which is the state where the injury occurred, and J. McIntyre Machinery moved to dismiss the suit on jurisdictional grounds. The company argued that no more than four of
its machines were located in New Jersey. However, the New Jersey Supreme Court ruled that the company
was subject to the state’s jurisdiction even though at no time had the company advertised in, sent goods to,
or in any relevant sense targeted the state. The U.S. Supreme Court reversed after finding that imposing New
Jersey jurisdiction on J. McIntyre Machinery violated due process because the plaintiff never established that
the company directed any purposefully driven activity at the state.
Maryland Comp. of the Treas. v. Gore Enter. Holdings Inc., (Md. Ct. Spec. App. 2013), cert. granted, (Md. May
17, 2013): The Maryland Court of Special Appeals held that two out-of-state subsidiaries holding their parent company’s patents and financial assets are unitary with the parent and have sufficient nexus for their income to be subject to tax by Maryland.
Quill Corp. v. North Dakota, 504 U.S. 298 (1992): The first U.S. Supreme Court case to find both a Due Process Clause and a Commerce Clause presence nexus requirement. The taxpayer, Quill, conducted about $1
million of business a year in North Dakota, but had no physical presence there. The court found that Quill
had Due Process nexus with North Dakota, but not nexus under the Commerce Clause. The court held that
the Due Process requirement relating to the connection between the taxpayer and the state mandates only a
minimal connection between the two. This minimal connection standard in the context of state taxes is ‘‘comparable’’ to the standard for in personam jurisdiction. But for purposes of the Commerce Clause, the court
noted that a higher ‘‘substantial nexus’’ standard was appropriate because the dormant Commerce Clause
requirements are meant to ensure that there is no interference with interstate commerce and that multiple
taxation is avoided. The court established a bright-line standard of physical presence for purposes of establishing whether nexus exists. Many subsequently decided state appellate cases have taken the position that
the ‘‘physical presence’’ requirement was meant to apply only to sales and use taxes.
Telebright Corp. Inc. v. New Jersey Div. of Taxn., 25 NJ. Tax 333 (N.J. Tax Ct. 2010), aff’d, 38 A.3d 604 (N.J.
Super. Ct. App. Div. 2012): A taxpayer based in Maryland allowed an employee to telecommute from home
in New Jersey on a full-time basis. The employee developed and wrote software code, sending it electronically to the taxpayer’s computer in Maryland. The New Jersey Tax Court found the employee’s daily presence in New Jersey satisfied the substantial nexus requirement of the Commerce Clause because the corporation enjoyed the benefits of the state’s labor market. On appeal, the New Jersey Superior Court affirmed.
The court reasoned that the employee’s activities in the state constituted ‘‘doing business’’ as defined by New
Jersey’s statute and regulations. Due process arguments were rejected, with the court finding that the imposition of tax was justified because the employee was working on a full-time basis in the state for the taxpayer. The court reasoned that if the employee violated the restrictive covenants in her employment contract,
then relief could be sought in New Jersey courts. As a result, the taxpayer had sufficient minimum contacts
with New Jersey to permit taxation.
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MTC Compact
Amidst Rising Doubts Over MTC Compact’s Future,
Agency’s Spokesman Offers a Less Dire Prognosis
everal states have recently renounced membership in the Multistate Tax Compact or have departed from its significant provisions. This occurred in response to litigation in several Compact member states dealing with the
ability of a taxpayer to make an election to use the Compact’s model provisions instead of state-specific corporation income tax provisions.
This shift away from the Compact could have a significant impact on multistate corporations and could even
threaten the Compact’s viability.
But the expected demise of the MTC Compact has been greatly exaggerated, argued Gregory S. Matson, the organization’s deputy executive director. Critics contend that the Compact is a binding contract that few jurisdictions
stick to.
This would be a damaging assertion for a regulatory or boundary compact, which are generally binding in nature,
said Matson. But the same cannot be said for advisory compacts, he explained.
Because the MTC Compact provisions dealing with apportionment are advisory in nature, the states’ variances on
these issues should not threaten the Compact’s validity, he said.
Meanwhile, practitioners are asking whether some states’ retroactive withdrawal from the Compact’s provisions
is setting the stage for the jurisdictions to successfully bar taxpayers’ refund claims.
S
Rosen: Let’s move on to the Multistate Tax Commission, the Compact, legislation in several states, as well
as the related litigation. What’s going on there?
Matson: Thanks, Art. Here I am a year later. I’m still
glad to be here. I got into some trouble for my remarks
at this forum last year because I said some things with
respect to my view of what the Compact was originally
intended to be versus what it is now. And that got
picked up in an article where I was referred to as ‘‘the
smoking gun.’’
And, in an effort to make sure that I’m not a smoking
gun this year, and for Billy Hamilton’s benefit, I just
want to say that as sympathetic as I may be in my remarks regarding the taxpayer’s argument in Gillette, I
am not agreeing with the taxpayer’s argument in Gillette. I stand by my opinion—and let me emphasize that
I am speaking for myself here—that the framers of the
Compact intended a more formal and structured role
for the Commission vis-a-vis the states than the one the
Commission has had since the advent of the U.S. Steel
litigation in the mid-1970s. But this is not to say that I
agree with the taxpayer’s position in Gillette that the
Compact operates as a binding contract among the
states that are party to it.
I do think that the issue of the nature of the Multistate Tax Compact is a fair one. And that’s really what
is at the core in the Gillette case. There are also some
other issues specific to California, of course.
But, where do things stand at the moment? The California Supreme Court has taken up the case. Gillette’s
answer brief just come out a couple of weeks ago and
the Franchise Tax Board’s reply brief is due sometime
mid-September. Amicus briefs will be due early October.
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I had the good fortune of actually meeting Michael
Herbert, tax partner with PricewaterhouseCoopers
LLP, during our meetings in San Diego last week, and
had an ongoing dialogue with him for a couple of days.
I found him to be very engaging, and not at all the evil
architect of our destruction that I thought he might be.
And I told him so. I am sympathetic to Michael’s thinking; he started this mess because of his professional interest in the whole area of interstate compacts. And all
of the speculations, implications, and permutations that
are now being discussed with respect to the Multistate
Tax Commission grow out of his conviction that the
Multistate Tax Compact is very much an interstate compact in the fullest sense of the word. So, it was good to
meet him and have that dialogue. I don’t agree with him
on many points, but I am sympathetic to his line of argument and the consistency of it.
But having read Gillette’s answer brief, I think it goes
too far in several respects and I’ll give two examples of
that. First, the notion that vindicating the 47-year existence of the Multistate Tax Commission and the way it
has operated will somehow overthrow 200 years of interstate cooperation through interstate compacts, I
think, is overblown. I am trying to get up to speed in the
area of interstate compacts and am working my way
through ‘‘The Evolving Use and the Changing Role of
Interstate Compacts: A Practitioner’s Guide’’ by Broun,
Buenger, et al., American Bar Association 2006. This
work is referenced in the Gillette briefs. And one point
I am taking away from the book is that not all compacts
are the same. And I don’t just mean congressionally approved versus not congressionally approved. There are
boundary compacts, regulatory compacts, and advisory
compacts. We say that the Multistate Tax Compact is an
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advisory compact and that this makes a world of difference. It undercuts the strength of much of the legal argument that comes out of interstate compact law dealing with both boundary and regulatory compacts. And
it lays bare the notion that the sky will start falling if a
court determines that the Multistate Tax Compact isn’t
a binding contract among the states. That’s the first
thing.
The second thing is, in reading the answer brief,
there’s a strong implication that the Multistate Tax
Compact was the states’ answer to the recommendation
of the Willis Commission that state and local taxation
being administered centrally by the federal government, and the way the states prevented federal takeover
of state tax systems.
Frankly, I find the notion that less than a dozen
states adopting the Multistate Tax Compact would prevent Congress from preempting state taxation to be
laughable. Because at first you’re talking about, I think,
ten states adopting the Compact. And, never, has Compact membership in the Commission ever approached
half the states of the United States.
So, I just don’t think that, in and of itself, even if influential, the Compact was enough to have prevented
Congress from acting on the Willis Commission recommendations. This idea comes up in the sense that somehow there’s been a bait and switch by the states. That
Article III and Article IV of the Compact are the crux of
the Compact, the sine qua non of its purposes with respect to uniformity. And, I just don’t see it. Frankly, for
me and other Commission staff, the crux of the Compact is Article VI, as that has the organizational provisions and, most important, the funding mechanism.
We say that the Multistate Tax Compact is an
advisory compact and that this makes a world of
difference. It undercuts the strength of much
of the legal argument that comes out of interstate
compact law dealing with both boundary and
regulatory compacts. And it lays bare the notion
that the sky will start falling if a court determines
that the Multistate Tax Compact isn’t a binding
contract among the states.
GREGORY MATSON, DEPUTY EXECUTIVE DIRECTOR OF THE
MULTISTATE TAX COMMISSION
But, so, the notion that states have somehow sold
Congress a pig in a poke with respect to the Compact
by short-circuiting the Article III election or deviating
from the classic three-factor apportionment in Article
IV (which contains the Uniform Division of Income for
Tax Purposes Act) is not credible to me.
There are cases other than Gillette pending. Michigan is the state with cases furthest along after Gillette.
The Michigan Supreme Court has granted review in
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peals level. But there are also the Anheuser-Busch and
Lorillard Tobacco cases. Lorillard Tobacco was a state
win; Anheuser-Busch was a taxpayer win. Same court,
different judges. Both have asked the Supreme Court to
bypass the Court of Appeals.
And then you have the case in Oregon, Health Net,
and you have Graphic Packaging in Texas, and many
other cases that are not as far along.
So, with that, I’m going to pause. I know you’re on
the wrong side of this issue, Rick. I think you had a
question and then I can address legislation and other issues.
Pomp: I mean it’s sometimes hard to turn the clock
back to what the politics of that day were compared to
today. But why do you think Congress stopped its efforts?
Matson: I’m going to go back to what Mark said earlier with respect to how easy it is to get things done here
in Washington, D.C. I think there were a lot of other
factors at play. The Willis Commission Report recommended centralized tax administration of state and local taxation by the feds. Whether there was a Multistate
Tax Compact back then or not, I just don’t think centralized federal administration was politically viable.
Pomp: They also recommended federal legislation
with a two-factor formula.
Rosen: I agree with what you’re implying, Rick, that
I think, once you had the Compact executed and a few
states joining in, everybody assumed it was going to
keep rolling along and, therefore, Congress stepped out
of the game. Later, it was too great an effort to get it reinitiated.
Sommer: Sounds like Streamlined, right?
[LAUGHING]
Rosen: No comment.
Matson: If that was the case, then there were at least
six attempts to have Congress approve the Multistate
Tax Compact through legislation. And the MTC
[Multistate Tax Commission] would be a very different
organization today if Congress had done that. If it had
such an effect on Congress’s thinking with respect to
state taxation, why didn’t Congress approve it? Why
didn’t they do that?
Pomp: How would it be different?
Matson: Well, express Congressional approval would
have happened before the U.S. Steel case and I think
the U.S. Steel case is a watershed moment in both the
Commission’s conceptualization of itself and, interesting enough, the taxpayer’s perception of the Commission. Michael Herbert pointed that out to me. I have always thought of U.S. Steel as being a very watershed
moment for the Commission in its relationship with the
states. But he raised a similar point with respect to taxpayers which I had not thought about before: he thinks
it was a watershed moment — because following the
U.S. Supreme Court’s decision, taxpayers acquiesced.
Because they thought, well, that was that and they gave
up thinking much about the effect of the Compact. Now,
we are seeing a return to that era in these cases.
I’m going to quickly absolve myself of the responsibility for discussion of the uniformity project on Article
IV (UDITPA) amendments because the hearing officer
for those five amendments is sitting right here. But in
terms of states withdrawing from the Compact, California repealed the Compact last year; Utah repeals and
reenacts without Articles III and IV effective July 1st;
Oregon does the same thing, but the effective date is go-
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ing to be sometime in October for that; Minnesota,
whose Compact didn’t have Article III and Article IV,
they simply repealed effective July 1st; and D.C. also repealed and reenacted without Articles III and IV but
that is awaiting the Mayor’s signature and then a 30-day
waiting period.
Henchman: Did South Dakota do something?
Matson: Yes, but let me talk about South Dakota in a
second, Joe. All of this repealing and reenacting is basically a method of mitigating potential liability in these
Article III election cases.
Now, South Dakota. South Dakota repealed the
Compact, effective in March. It didn’t have anything to
do with the Article III litigation, though — South Dakota
doesn’t have a corporate income tax, and in following
the legislative hearings with respect to their repeal, the
Article III cases were not mentioned. South Dakota continues to be as involved with us as they were, the Compact was really almost vestigial in their tax laws. So
their withdrawal had to do with other machinations,
and not Gillette.
Pomp: I’ll just say one word — the Hearing Commissioner’s Report will be out before the financial institution regulations.
[LAUGHING]
Pomp: That is my commitment, you heard it first.
Henchman: That’ll be right before Marketplace Fairness.
Sommer: One follow-up question: on the state acts —
the legislative acts — some withdrawing and some are
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reenacting and carving it out, does anyone see that as
an effort to kind of bootstrap into the Johnson Controls
theory? Diann, I know you followed that case closely in
Kentucky, where basically the court is denying over
$100 million dollars of refunds on a retroactive basis
saying, ‘‘You know what, we needed a legislative act because we saw a train wreck, from a fiscal perspective,
coming.’’ They passed the act and it’s over. Do we see
that, does anyone see. . . to your point about. . . not putting you on the spot, but you mentioned South Dakota
kind of like, why did they do that? And that raised a
question to me — is some of this positioning at the local
level, along those lines?
Rosen: And it’s the only distinction that, here in the
Compact, you have some contract law provisions, reliance on a contract, which in Johnson Controls, I don’t
think was really there. That’s the big distinction.
Sommer: It had reliance on the statute to file your refund claim.
Matson: And I should just point out, if Michael Herbert is right, the repeal and reenactment stuff won’t do
any good.
Smith: I agree that, if Gillette is correct, yes.
Matson: Right. And the fact that Minnesota didn’t
have Article III and Article IV in their Compact for so
many years won’t do them any good, either. Also, according to a footnote in Gillette’s answer brief, California’s repeal may well be challenged. But anyway, I
should have no trouble making it to retirement, I think.
[LAUGHING]
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ADDITIONAL BACKGROUND ON DEVELOPMENTS
Anheuser-Busch Inc. v. Michigan Dept. of Treas., No. 11-85-MT (Mich. Ct. Cl. 2013): The Michigan Court of
Claims held that multistate taxpayers are entitled to apportion their Michigan income under the Multistate
Tax Compact irrespective of statutes mandating otherwise because the MTC is binding upon the state legislature and, therefore, it can only be repealed in whole by statute, not in part by subsequent conflicting laws.
Gillette Co. v. California Franch. Tax Bd., 147 Cal. Rptr. 3d 603 (Cal. Ct. App. 2012), appeal docketed, No.
S206587 (Cal. Jan. 16, 2013): The California Court of Appeal ruled that the Multistate Tax Compact is a valid
compact binding California to its apportionment election provision because California did not repeal and
withdraw from the Compact in 1993. The Multistate Tax Compact obligates member states to allow taxpayers to apportion multistate income using the three-factor formula in the Compact, or the state’s own alternative apportionment formula. California enacted the Multistate Tax Compact in 1973, and the Compact’s formula supersedes the formula enacted in California in 1993 requiring taxpayers to apportion income based on
a double-weighted sales factor.
Graphic Packaging Corp. v. Combs, No. D-1-GN-12-003038 (Dist. Ct. Travis Cnty. Tex. filed Sept. 27, 2012):
The company asserts it may elect to apportion its income using the Multistate Tax Compact’s three-factor
apportionment formula instead of Texas’ single-sales factor apportionment formula.
Health Net Inc. v. Oregon Dept. of Rev., No. 120649D (Or. T.C. filed July 2, 2012): The company asserts it
may elect to apportion its income using the Multistate Tax Compact’s three-factor apportionment formula
instead of Oregon’s single-sales factor apportionment formula.
IBM Corp. v. Michigan Dept. of Treas., No. 306618 (Mich. Ct. App. 2012), appeal docketed, 832 N.W.2d 388
(Mich. July 3, 2013): The Michigan Court of Appeals held that the Michigan Business Tax Act repealed the
Compact’s election provision by implication and affirmed the lower court’s ruling that IBM was required to
compute its tax liability pursuant to the Michigan Business Tax Act.
Lorillard Tobacco Co. v. Roth, 786 N.E.2d 7 (N.Y. 2003): The New York Court of Appeals ruled certain types
of promotions used by cigarette manufacturers that are not universally available to retailers violate the Cigarette Marketing Standards Act.
Miller v. Johnson Controls Inc., 296 S.W.3d 392 (Ky. 2009): The Kentucky Supreme Court ruled that the
amendment of corporate tax statutes to bar the filing of combined tax returns under the unitary business
concept and the issuance of refunds for years prior to 1995 does not violate the Due Process Clause.
Multistate Tax Compact, Art. III, §1: Provides, in pertinent part, that ‘‘[a]ny taxpayer subject to an income tax
whose income is subject to apportionment and allocation for tax purposes pursuant to the laws of a party
State or pursuant to the laws of subdivisions in two or more party States may elect to apportion and allocate
his income in the manner provided by the laws of such States or by the laws of such States and subdivisions
without reference to this compact, or may elect to apportion and allocate in accordance with Article IV.’’
Multistate Tax Compact, Art. IV, §9: Provides that ‘‘[a]ll business income shall be apportioned to this State by
multiplying the income by a fraction the numerator of which is the property factor plus the payroll factor
plus the sales factor and the denominator of which is three.’’
U.S. Steel v. Multistate Tax Comn., 434 U.S. 452 (1978): The U.S. Supreme Court held that the Multistate
Tax Compact, which established the Multistate Tax Commission, does not violate the Commerce Clause or
the Fourteenth Amendment and is not invalid under the Commerce Clause because it lacked Congressional
approval.
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Unclaimed Property
Draconian Unclaimed Property Laws Lurk Below
Delaware’s Business Friendly Surface, Practitioners Say
elaware has long enjoyed its reputation as a business-friendly state in which most businesses choose to incorporate. Among the key attractions are a well-established business court, friendly tax laws, and a Secretary of
State’s office that stays open until midnight.
But lurking beneath this attractive exterior is one trait that receives far less attention: a growing appetite for unclaimed property. Under rules established by the U.S. Supreme Court, holders of unclaimed property who lack the
owner’s address must turn over the property to the state of incorporation. In many cases, this is Delaware.
In response to growing criticism over its enforcement of its unclaimed property laws, Delaware enacted legislation
last year granting the Secretary of State (as opposed to the State Escheator) a limited three-year window to enter into
voluntary disclosure agreements with holders of unclaimed property. Unlike the look-back period for the prior VDA
Program, which requires holders to report property dating back to 1991, those who agree to participate in the new
program could be eligible to receive a shorter look-back period.
The 2012 legislation provided that holders who enter the new VDA Program with the Secretary of State by June
30, 2013 and complete the VDA by June 30, 2014, will be eligible for a shortened look-back period to 1996. Holders
who enter the new VDA Program after June 30, 2013, but before June 30, 2014, but still complete their VDA by June
30, 2015, will be eligible for a shortened look-back period to 1993. Holders may not apply for the new VDA Program
after June 30, 2014.
While the shortened look-back period provides reason for cheer to holders of unclaimed property, the state’s practice of hiring third parties to perform audits continues to draw criticism.
D
Rosen: I guess one of the hottest issues in the world
of abandoned property is Delaware’s VDA [Voluntary
Disclosure Agreement] Program. Kendall, do you want
to talk about that?
Houghton: Sure, well, we can talk about the VDA Program, which is kind of a user-friendly feature of unclaimed property right now, albeit the only one in the
arena. Delaware’s Secretary of State was getting an earful from corporate America and from certain organizations, including COST, regarding the facts that the audit program has been outsourced to aggressive contract
firms that, at least historically and arguably still, have a
financial stake in the outcome of the audits; that the
VDA Program that was ostensibly available to corporate holders was being operated by the state escheater
and that he was outsourcing VDAs for review by the
same contract audit firm; and, basically, the general attitude that if you were incorporated in, or otherwise domiciled in, Delaware that you were basically going to be
paying millions of dollars to Delaware. It was just a
matter of coming up with the right inflated number.
That was the corporate perception and, frankly, in
many instances, the reality.
And, so, Secretary of State Bullock and Governor
Markell heard that messaging and worked on a bill
which passed and has generated a new VDA Program
sponsored by the Secretary of State’s office. The VDA
Program is in fact administered by third parties, the
Drinker Biddle law firm and two accounting firms. But
those administrators and the Secretary of State have
continued to articulate their commitment to making this
a process whereby holders can fairly square up with the
state if they have liabilities.
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So, there are certainly many participants in that program now; however, as corporations were signing up,
the escheater’s office started issuing audit notices. And,
on top of what’s been happening in Delaware, you have
audit firms, such as Verus Financial and the Unclaimed
Property Clearinghouse (UPCH) and other smaller audit firms, selling their services to the states and conducting, I would say, industry- or property-specific audit initiatives. So things are, in fact, not quieter or less
hazardous for corporate holders than they had been in
the past.
Diann, I want to get your opinion on this — I’ve been
listening to our discussion today on state tax issues and
the cases and the appeals to the U.S. Supreme Court. I
think that people like us who do unclaimed property
work are more likely to get in front of the U.S. Supreme
Court, in the remainder of our careers, on an unclaimed
property case than on state tax matters. For instance, it
could be the operation of federal preemption — there’s
plenty of federal laws that control the accounting, or the
commercial transactions, or the terms of certain kinds
of transactions, consumer protection laws at the federal
level, which holders are saying absolutely preempt the
state unclaimed property laws. The states generally
don’t agree, hence that’s a litigatable issue.
Holders are also arguing that unreasonable estimation techniques and other behaviors on the parts of the
auditors are generating due process deprivations of
property — that is, property of the holder — not property held by the holder for owners. There are jurisdictional claims aplenty to foreign owner property held by
U.S. companies — may the states escheat that property?
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rivative rights doctrine, which is one of the primary operational and restrictive principles in the area of law,
serve as a barrier to state unclaimed property claims?
So, we’re very excited by it.
Smith: I agree. I think, particularly for both procedural and substantive due process issues, that that has
historically been something that, regardless of the law,
the U.S. Supreme Court has been interested in. We saw
that the U.S. Supreme Court did not take the American
Express v. Eristoff case. But, there’s some education going on at the U.S. Supreme Court where they start to realize that there are several of these cases, and that they
are the appropriate Court to get involved. So, it would
not surprise me if we see a couple cert. petitions filed,
not accepted, but, then at some point, the U.S. Supreme
Court does get involved in the next five years.
Delaware’s Secretary of State was getting an earful
from corporate America and from certain
organizations, including COST, regarding the facts
that the audit program has been outsourced to
aggressive contract firms that, at least historically
and arguably still, have a financial stake in the
outcome of the audits; that the VDA Program that
was ostensibly available to corporate holders
was being operated by the state escheater and
that he was outsourcing VDAs for review by the
same contract audit firm; and, basically, the
general attitude that if you were incorporated in,
or otherwise domiciled in, Delaware that you
were basically going to be paying millions
of dollars to Delaware.
KENDALL HOUGHTON, PARTNER WITH ALSTON & BIRD
LLP
Frieden: To put state revenues from abandoned property in perspective, the COST study on ‘‘Total State and
Local Business Taxes’’ released this year found that
businesses paid $649 billion in state and local taxes in
fiscal year 2012. Revenues that states receive from
abandoned property programs are not included in that
total. However, in the last ten years, the total state revenues from abandoned property have doubled from $20
billion to $41 billion. So from the perspective of many
multistate businesses, issues surrounding the administration and enforcement of abandoned property laws
are frequently as important as the issues relating to
other state and local tax categories. COST has pub-
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lished a scorecard on unclaimed property laws called
‘‘The Best and Worst of State Unclaimed Property
Laws.’’ The study identified significant differences between states in the fairness of their administration procedures — particularly with regard to statutes of limitations, treatment of interest, independent appeals processes, and exemptions for business-to-business
transactions. Interestingly, many states do not apply
rules utilized to make tax administration more balanced
to their abandoned property laws.
Delaware, obviously, is the state with the largest reliance on abandoned property revenues. The proportion
of Delaware’s gross revenue attributable to unclaimed
property is 14 percent, so this is a really big deal for that
state. And yet last year, Delaware returned only 2 percent of its total abandoned property collections to consumers. So the bottom line is that while abandoned
property collections are not technically a ‘‘tax,’’ they
raise many of the same issues as tax assessments and
collections and businesses should be afforded more of
the procedural safeguards that are commonly found in
the tax arena.
Henchman: It’s an issue that almost nobody knows
about, but when somebody does learn about it, they’re
outraged. And so, to me, I think the key is — everybody’s got to know about it. I don’t know if that’s
enough to get Delaware’s new ‘‘service with a smile’’
into something more manageable because of the huge
financial incentive to them that you mentioned. I don’t
know what will work, but step one is spreading the
word.
Friedman: Kendall, given the parade of horribles that
you ran through, why would any company be domiciled
in Delaware now?
Houghton: That is certainly a question many companies under audit have asked themselves and some have
redomesticated. So, you know, there’s been some reaction to the sense that they giveth with one hand, which
is the Secretary of State’s very well structured and favorable program. . .
Henchman: Open 24 hours a day.
Houghton: Yes, and, you know, a great body of case
law and statutory law if you’ve got corporate governance issues and other corporate law questions, and
they taketh away with the Escheatment Office. So, the
Secretary of State’s messaging around the VDA Program, just to put a bow on it, is that they actually don’t
care what they’re bringing in. And I believe Secretary
Bullock when he says that, because his goal is to polish
up the brand again, ‘‘Look we’ll be doing okay if at the
end of the day we’ve got more companies actually filing
the regular annual reports, so what we may be losing
out on in terms of audit assessment opportunities we’ll
make it up on the other end.’’
As a dollar and cents calculation, I’m not sure that’s
right, but they’re very concerned about not losing
ground to the Nevadas of the world that are trying to
compete with Delaware to become domicile states of
choice.
Pomp: Karl, do you know how much they get from
the annual filing fees and registration fees and similar
payments? I’d be curious to compare that to what Delaware gets from unclaimed property. Why haven’t the
non-Delawares of the country lobbied Congress for federal legislation?
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ADDITIONAL BACKGROUND ON DEVELOPMENTS
American Express Travel Related Serv. v. Sidamon-Eristoff, 669 F.3d 359 (3d Cir. 2012), cert. denied 133 S. Ct.
345 (U.S. 2012): The Third Circuit upheld the district court’s denial of Amex’s motion for a preliminary injunction on the grounds that Chapter 25’s provision reducing the abandonment period for travelers checks
violates the Due Process Clause, the Contract Clause, the Takings Clause and the Commerce Clause of the
U.S. Constitution.
Delaware Voluntary Disclosure Agreement Legislation (H.B. 2), enacted Jan. 30, 2013: The legislation clarifies that
holders having previously entered into a voluntary disclosure agreement prior to June 30, 2012, may enter
into the new program regarding any related party not included in an earlier voluntary self-disclosure or for
property types and/or periods not included in a prior agreement; and gives holders, electing into a voluntary
self-disclosure prior to June 30, 2013, up to one additional year to enter into an agreement and make payment or enter into a payment plan.
Delaware Voluntary Disclosure Agreement Legislation (S.B. 258), enacted July 11, 2012: The legislation provides
that holders not currently reporting abandoned property, or already engaged in claims resolution with the
State Escheator, are eligible to resolve claims before the Secretary of State in a process that limits the reporting of abandoned property to 1996 or 1993.
Bloomberg BNA offers a wealth of products covering state taxes to fit your needs. If you like this report,
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Areas of Reform
Single-Party Control Has Uneven Effect on Tax Reform;
Push to Replace Income Tax with Sales Tax Loses Steam
any believed that the stage was set for significant tax reform following the 2012 election, which saw a single
party wrest control of both chambers of the legislature, as well as the governor’s office, in several states. But
results among the states tended to vary. North Carolina, in which the Republicans control both the Legislature
and Governor’s office for the first time since Reconstruction, saw the enactment of several important tax changes in
2013. But little changed in other states that are also controlled by a single party such as Nebraska.
One reform tactic that has found its way into lawmakers’ playbooks in several states is replacing the income tax
with an expanded sales tax that applies to additional services.
But support for the idea is beginning to fray. For example, Louisiana’s Gov. Bobby Jindal (R), who championed
the approach for much of the year, ended up scrapping his proposal to eliminate the state’s personal and corporate
income tax and expand the sales tax base to include additional services.
One major critic of the idea is the Council On State Taxation (COST). Expanding the sales tax base to include additional types of services can have a disproportionate impact on business purchases, the organization concluded in a
recent report. In addition, taxing business-to-business services raises numerous problems, including arbitrary and
hidden differences in effective sales tax rates that distort consumer choices, distortions in firm structure and operations, violations of horizontal and vertical equity principles, detrimental impacts on the state’s business competitiveness, and extreme difficulties with compliance, the COST report said.
M
Frieden: Do we have time to discuss the number of
proposals over the last year to expand the sales tax base
to services? This was a very important trend this year; it
started big and then kind of fizzled out. Do we have
time to talk about that?
Roll: Well, actually, we were going to talk about the
prospects for tax reform, so I think that’s part of Joe’s
discussion.
Henchman: Federal or state?
[LAUGHING]
Henchman: Since you brought up the sales tax, I
guess sales tax is the subject. You know, Professor
Mikesell out in Indiana does his chart every so often, in
Tax Notes, of the percent of the economy subject to the
sales tax, which at the state level audit, has been on a
steady decline. At one point, 70 percent or 80 percent,
nowadays maybe around 30 percent or 40 percent, because we’ve exempted a lot of goods and because of the
internet, but primarily because services have grown as
a share of the economy and we don’t tax services under
the sales tax.
It’s kind of distressing to us, and I’m sure to many of
you, that if you get a bunch of public finance scholars
into a room and tell them to design a sales tax, chances
are likely it will be a tax on all final retail sales of goods
and services with all business transactions exempt. And
that is not what a sales tax looks like in any state in the
United States.
So, our message, at least, has been is that’s what a
sales tax should look like, and, if you want to try to do
it, we’ll do what we can to help you do it. Unfortunately,
there are other players out there that do not want that
to happen for various reasons, whether that be some in
certain industries or some people at the state level,
there’s a lot of players in this field of course. And so, ofTAX MANAGEMENT MULTISTATE TAX REPORT
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ten, what starts out as perhaps a pure proposal, even
before it’s introduced to the public and to the legislature, turns into something it’s not. So, for example, in
Louisiana this year, what started out as a — what at one
point was going to be a pretty pure sales tax reform, exempting all inputs and expanding just services, coupled
with some other changes elsewhere in their tax code,
turned into, upon introduction, taxing business inputs
— a greater taxation of business inputs. And a similar
thing happened in Nebraska, too.
So, for example, in Louisiana this year, what
started out as a — what at one point was going to
be a pretty pure sales tax reform, exempting all
inputs and expanding just services, coupled with
some other changes elsewhere in their tax code,
turned into, upon introduction, taxing business
inputs — a greater taxation of business inputs.
And a similar thing happened in Nebraska, too.
JOSEPH HENCHMAN, VICE PRESIDENT OF LEGAL & STATE
PROJECTS FOR THE TAX FOUNDATION
And those, of course, contributed to the defeat of
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ness community. Nebraska, in particular, has a tax on
agriculture outputs and a couple of farmers in Nebraska
didn’t like that. And then Louisiana having opposition
from the business community. So, we’re drumming the
message — in my view, this is inevitable — if the sales
tax is going to remain a viable revenue source for
states, some state, at some point, is going to have make
the transition to taxing services and it will be unprecedented.
There’s a couple of states, of course, that do tax services, but that’s because they’ve always taxed services.
The transition is a lot harder, and I don’t really think it’s
a policy problem, although there is some level of how
do you draw that line between business-to-business
transactions and final retail sales. In some cases, I think
it’s primarily a political problem.
Frieden: Just a couple numbers to highlight the problem with the sales and use tax as applied to business-tobusiness services because this is again where the value
added tax (VAT) that essentially allows a ‘‘credit’’ for B
to B services is different than the retail sales and use
tax. For those unfamiliar with the VAT (which is used
in virtually every other nation other than the U.S.), it
typically imposes an ‘‘input’’ value added tax on business purchases, but then it provides a credit for those
taxes when the ‘‘output’’ value added tax is imposed on
final Business-to-Consumer (B to C) sales. The retail
sales tax has no such ‘‘credit’’ mechanism and, therefore, frequently leads to the pyramiding of sales tax
with the tax charged on both the B to B transaction and
the B to C transaction.
Henchman: We’re thinking about putting out a very
basic introductory piece on the difference between sales
tax, VAT, and gross receipts tax. Because you’d be surprised how many people should know better, let alone
the general public, but, people that should know better,
get this confused.
Frieden: The point I was going to make is that, at the
state and local level in the U.S., we have a retail sales
and use tax system and that is unlikely to change in the
foreseeable future. Within this system, any expansion
of the sales and use tax base to tax services is likely to
disproportionately impact business-to-business transactions. During the last year, this issue surfaced as legislation was introduced in a number of states, including
Louisiana, Minnesota, Nebraska and Ohio, to significantly expand the sales tax base to cover more services.
Frequently, this legislation was coupled with proposals
to lower the corporate and personal income tax rates.
However, all of these efforts eventually failed or were
significantly curtailed — generally in the face of business opposition to additional taxes on business inputs.
To put this issue in perspective, a COST study issued in
2013, ‘‘What’s Wrong with Taxing Business Services,’’
determined that the taxation of business purchases of
goods and services (B to B transactions) already accounts for 44 percent of the sales and use tax base in
the U.S.
Currently, the sales and use tax on business inputs is
the largest tax on businesses at the state level accounting for $130 billion in taxes on a tax base of $2.3 trillion.
The COST study also found that the expansion of the
sales tax base to encompass more services typically
ended up being a tax on business, not on household
purchases, with upwards of 70 percent of all the new
taxes falling on purchases of business inputs. So this is
the conundrum that states find themselves in today. As
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they look for new revenue sources, the expansion of the
sales tax base is highly appealing since only about 24
percent of all household goods and services are currently subject to the sales tax. A lot of these exemptions
from the sales and use tax base — for instance for education, housing and health care — are for sound policy
reasons. Other exemptions make less sense and simply
reflect an outdated tax base that was designed when the
economy was primarily based on goods production and
consumption. But if states seek to expand the tax base
to services without providing an exemption for business
purchases this ends up being largely a tax on the state’s
businesses, with a potentially detrimental impact on the
state’s competitiveness. So, the point here is that, it’s really hard — and this is one of the constraints on tax
policy as long as we have a retail sales tax — it’s really
hard to expand the sales tax base into some of the bigger service categories without imposing a tax on B to B
transactions as opposed to B to C transactions, which
was the original intent of the retail sales tax.
The COST study also found that the expansion of
the sales tax base to encompass more services
typically ended up being a tax on business, not on
household purchases, with upwards of 70 percent
of all the new taxes falling on purchases of
business inputs. So this is the conundrum that
states find themselves in today.
KARL FRIEDEN, VICE PRESIDENT AND GENERAL COUNSEL
OF THE COUNCIL ON STATE TAXATION (COST)
My final comment is that efforts to expand the sales
tax base that end up increasing the sales tax on business purchases cut against what many states are trying
to do on the corporate income tax side with single sales
factor apportionment rules and market sourcing of services and intangibles. These corporate income tax reforms are designed to remove disincentives for businesses to locate facilities and payroll in a state by basing the income tax on where the customer is, not where
the company’s property and payroll are located. With
the sales tax on business services, the states are going
in the other direction, which is why there’s a lot of confusion.
Pomp: Two quick points — building on Karl’s point —
our sales tax rates, the true rate, is not just the statutory
rate. The effective rate is a combination of the statutory
rate plus the tax on business inputs and that combination may well start approaching some of the value
added tax rates.
And, second, one of the reasons some of these broad
sales tax reforms, like Florida’s, failed is because when
you tax business-to-business purchases in the interstate
context, the use tax becomes unmanageable. And that
was, in part, Florida’s story — they just didn’t know
how to handle the use tax, for example, on advertising.
You should not be taxing advertising in the first place.
Because Florida relies so heavily on its sales tax, it has
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limited exemptions for business inputs and it followed
that structure when it adopted its short-lived tax on services.
Henchman: Imagine if use tax was uncollectible.
[LAUGHTER]
Pomp: Boy, that would be a real problem.
Roll: There’s one question I wanted to ask you — just
politically, we have so many states now that are under
single party control, so that the legislature is entirely in
control of the Republican Party or vice versa, and the
governor’s office is under the same party control. It was
interesting, I was just at a session that Art arranged last
week. It was eight revenue commissioners and the one
from Oklahoma was saying, ‘‘Well, the legislature’s entirely controlled by Republicans, we have a Republican
governor, but the legislature still doesn’t trust us.’’ So,
it seems like they still have a chilly relationship. Do you
think single party control really matters when it comes
to tax reform?
Henchman: It depends on the state. North Carolina
was able to pass something pretty dramatic this year
and I think the single party control helped do that there.
The fact that there was Republican control of the legis-
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lature and the governor for the first time since Reconstruction, so they had a lot of things they wanted to do
once they finally got in.
In many other states, I don’t think it really matters. I
mean, Nebraska, although nominally nonpartisan is a
state with a Republican legislature and a Republican
governor and they have other factions. In states where
you have one party control, to a certain degree, then
you start getting other ways that people divide themselves up into factions and that gums things up. I mean
D.C. is as Democratic as any jurisdiction in the country
can be, but anybody who follows local politics knows
that it’s not monolithic. There are reformed Democrats
and, shall we say, nonreformed Democrats and that
changes the political dynamic more than just looking at
party labels would suggest.
Roll: Alright, great. Well, Art, do you have anything
else?
Rosen: No, sir. I think everybody had some really
good stuff to contribute and I want to thank everybody.
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