Technical and policy aspects of crossing the presence nexus threshold: how much of what activities may and should cause taxability?

Introduction

Tax executives and practitioners who are deeply involved in multistate tax issues are very often confronted with seemingly straightforward questions regarding their companies and clients' taxability in a state or local jurisdiction. These questions include:

* If our corporation merely sends employees into a state to negotiate a single transaction, will that cause our corporation to be subject to tax (or to withholding or tax collection requirements) in that state?

* Will our mere retention of, and visits to, an investment banker in a state make our corporation subject to tax there?

* Can we send our buyers into a state to purchase raw material or inventory without subjecting our corporation to tax?

* Will our corporation be subject to tax if we send employees to perform due diligence work at the location of a prospective corporate acquisition?

* What will be the tax effects of our sending employees to a state to attend a meeting of the Board of Directors of a corporation in which we have a substantial investment?

* Does our sending employees to attend a seminar in a state make us subject to tax there?

* Can we perform two installations of our sold equipment in a state and yet not be subject to tax there?

* Can our executives make annual courtesy visits to our major customers in a state without thereby causing taxability there?

* Can our lobbyists visit government officials in a state and still not be subject to tax there?

* Can an employee take a paid vacation trip to a state without the employer being subject to tax in that state?

When one addresses fundamental state tax issues such as those raised by these questions, it is important to keep sovereign governments. Accordingly, they can do anything they wish unless prohibited by a specific limitation found in, or through, the U.S. Constitution. U.S. Const. amend. X. As the Supreme Court stated in Wisconsin v. J.C. Penney Co., 311 U.S. 435 (1940), "the limits on the otherwise autonomous powers of the states are those in the Constitution...." Among the most significant of these limitations in the context of state and local taxation is the prerequisite that there be certain connections between the taxing jurisdiction and both the putative taxpayer and the activities the state is seeking to tax. Consequently, connection ("nexus") issues are often the determinative factors in analyzing the most basic of all tax questions: who and what may be constitutionally taxed.

The technical, legal aspects of nexus issues are often in direct conflict with the best interests of a state and its citizens. In other words, a technical/policy dialectic often arises. This is because state constitutions and state statutes generally provide extremely broad taxing authority for the states. Moreover, federal constitutional constraints, which have been interpreted and applied through years of litigation, have not imposed truly potent constraints. Consequently, states have quite powerful taxing authority. State politicians and policy makers have a tendency to use this authority to raise increasing amounts of revenue to enable them to provide services and goods to their constituents. On the other hand, many political observers have noted that the prime objective of state politicians and policy makers is the creation of jobs (and the consequent enhancement to the wealth of the state's citizens). Discouraging visitors from coming into the state to patronize local businesses or offer them assistance undermines this objective.

In other words, asserting tax jurisdiction whenever constitutionally permissible is often an unwise governmental policy. Thus, state politicians and policy makers must contend with competing forces: (a) their deep desire to increase tax revenues, which is supported by their vast legal taxing authority, and (b) their desire, need, and responsibility to assist in the growth and profitability of their local economies.

To determine to what extent states should exercise their taxing authority, it is first necessary to establish the legal limitations on such authority. This examination requires a review of certain constitutional principles, specifically the "twin nexus" requirements, so that one of those twins, transactional nexus, can be disregarded and the other twin, presence nexus, can be isolated and analyzed in terms of quantity (or magnitude) and quality (or nature). The analysis of the quantitative aspect reveals a general rule that is eminently reasonable. The qualitative analysis, however, yields a possibly severe technical rule and a countervailing policy perspective. This article urges that serious thought be devoted to identifying those situations where there may be no legal prohibition against imposing tax but -- as a responsible policy matter -- tax should not be imposed.

Technical Framework --

Twin Nexus Requirements

A review of the significant authorities in the area of state tax jurisdiction reveals that two independent connections are required for a state tax imposition to meet constitutional nexus standards. The first of these is "transactional nexus," which mandates a connection between the state and the property, transaction, or business activity being taxed. The second is "presence nexus," which mandates a connection between the state and the taxpayer (or tax collector, in the situation of a use tax). The three cases discussed below are good illustrations of these nexus concepts.

In Connecticut General Life Insurance Co. v. Johnson, 303 U.S. 77 (1938), the taxpayer was a corporation commercially domiciled in Connecticut and licensed to do business in California. The corporation was selling insurance directly to insureds located in California and was paying tax to California on such business receipts. The corporation was also engaged in the reinsurance business, which it conducted solely in Connecticut. The underlying primary insurance that the corporation was reinsuring in some cases covered risks located in California. California was seeking to impose tax on this business activity of the corporation.

The ultimate conclusion of the Supreme Court was that although the corporation was clearly subject to the taxing jurisdiction of California and although the corporation's primary insurance business had sufficient connection with that state, the connection between the state and the corporation's reinsurance business was too tenuous to permit California taxation of that business activity.

A more recent case that represents the similar situation in terms of the twin nexus considerations is Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992). There, the taxpayer, a corporation (Bendix) commercially domiciled in Michigan, had active business operations and related property in New Jersey. It filed New Jersey corporation business tax returns covering such business activities. In addition, the corporation passively invested (by buying 20.5 percent of the common stock) in an unrelated, third party (ASARCO) with which it had no unitary relationship. This investment activity took place solely at the corporation's Michigan headquarters. As a result of this investment, the corporation earned dividends and a substantial capital gain. New Jersey sought to tax a portion of this ASARCO-related income. (The New Jersey statute did not recognize the UDITPA business/nonbusiness distinction.)

The Supreme court held that the corporation was subject to the taxing jurisdiction of New Jersey. It continued, however, that even though New Jersey could constitutionally tax business activities that occurred in that state (or that were operationally or unitarily related to such activities), the state could not impose tax on income from the investment in ASARCO because that investment was not operationally related to the corporation's (Bendix's) activities in the state. The Court explained: "[Iln the case of tax on an activity, there must be a connection to the activity itself, rather than a connection only to the actor the State seeks to tax."

Quill Corp. v. North Dakota, 504 U.S. 298 (1992), which represents the reverse situation (in the context of the twin nexus approach) to the two previously discussed cases, established the current framework and general standards applicable in all presence nexus analyses. In the case, the putative taxpayer (more accurately, "tax collector") was a corporation engaged in the mail order office supply/stationery business that made substantial sales into North Dakota. Quill's only connection with that state was the mailing of promotional materials to recipients in the state, shipping orders into the state, and owning a few floppy disks that were at customer locations in the state. North Dakota sought to require Quill to collect the state's use tax on its sales of goods into the state.

Although the transactions at issue -- the use of goods in the state by the customers and the shipping of the goods by the seller -- established the requisite transactional nexus between the activity and the state, the Supreme Court held that there was insufficient presence nexus between the putative taxpayer and the state. The Court, however, first held that the Constitution's Due Process Clause, for all state tax purposes, requires only that a putative taxpayer have "minimum contacts" with the taxing state. This flows from the intent of the Due Process Clause, which is to ensure fairness and notice. The connection with the state that is necessary to satisfy this minimum contacts standard is comparable to that needed to support a state court's jurisdiction over a defendant in a civil matter (the distinction between "comparable" and "identical" warrants an independent discussion beyond the scope of this article). As articulated in cases such as Burger King Corp. v. Rudzewicz, 471 U.S. 462 (1985), that standard is met if the entity "purposefully avails itself of the benefits of an economic market in the forum state." Accordingly, under the facts in this case, there was no Due Process bar that prevented North Dakota's imposing use tax collection responsibility on Quill. Stated simply, the Due Process Clause does not require physical presence in the state.

The Court turned next to the Constitution's Commerce Clause. It held that the clause requires that a putative taxpayer (or tax collector and remitter, in the case of use taxes) have "substantial nexus' with the taxing state. This flows from the intent of the Commerce Clause, which is to ensure that there be a free flow of commerce throughout the United States, so that there is a single, integrated national economy. In the context of sales and use taxes, at least with respect to mail order situations, the Court held that this substantial nexus standard is not met if the putative taxpayer lacks physical presence in the state. (Quill's few floppy disks in the state were too insignificant to establish such physical presence.)

In the context of other state taxes, the Court explicitly declined to rule what would or would not constitute substantial nexus. On one hand, the Court made it clear that it felt constrained, owing to stare decisis principles (because of its prior decision in National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967)), to impose the physical presence requirement in Quill's factual situation. The Court intimated that it might have ruled otherwise (presumably more pro-state) had it been writing on a "clean slate." On the other hand, the rationale supporting the physical presence requirement -- establishing a bright-line test that would permit commerce to flow easily throughout the nation in order to ensure a single, integrated economy -- is as compelling, if not more so, in the context of taxes imposed directly on interstate businesses as it is in the context of merely requiring interstate businesses to collect taxes from their customers. The Supreme Court has hinted that a greater degree of nexus may be required in the direct tax situation than in the tax collection context. See Felt & Tarrant Manufacturing Co. v. Gallagher, 306 U.S. 62 (1939) and National Geographic Society v. California Board of Equalization, 430 U.S. 551 (1977). It has also, however, frequently used precedents from one context to support its conclusions in the other.

The balance of this article assumes that the transaction or activity that the state is considering taxing is sufficiently connected to the taxing state to allow the state constitutionally to impose tax and, hence, focuses on the presence nexus requirement. This requirement (as set forth in Quill) has two dimensions: the Due Process Clause test and the Commerce Clause test. Under these tests, it is essential to answer the following fundamental questions: What quantity or magnitude of activities or contacts may and should establish taxability under the presence nexus concept? What type of activities or contacts may and should be relevant for taxability determinations, under the presence nexus concept for purposes of the Due Process Clause and the Commerce Clause?

The Necessary Quantity of Presence Nexus:

The Nexus-causing Activity or Contacts Must

Be Regular and Systematic

A. Constitutional Quantitative Requirements

The Due Process Clause requirement that there be purposeful availment of an economic market in the taxing state means that a corporation's occasional, unplanned, and aberrational contacts with a state should not result in taxation under that Clause. The Commerce Clause requirement that there be substantial nexus and its purpose of establishing and maintaining a free flow of commerce among the states seems, even more so, to mean that a corporation's sporadic contacts with a state should not result in taxation.

Much of the case law regarding state taxing jurisdiction predates the Supreme Court's Quill bifurcation (or dissection) of the presence nexus issue into Due Process and Commerce Clause components. Nevertheless, they are useful in demonstrating that in virtually every case where the Court had found adequate nexus, the taxpayer's presence has been systematic and continuous. Sporadic contacts are not to be taken into consideration.

One of the most fundamental decisions that has a profound effect on state taxation is International Shoe Co. v. Washington, 326 U.S. 310 (1945). The case involved a putative taxpayer that was a corporation commercially domiciled in Missouri that had 12 salesmen based in Washington. These individuals conducted the corporation's business, utilizing samples and occasionally renting display rooms. Washington sought both to impose its employment-related tax on the corporation and to use its courts to implement collection of the tax. The Supreme Court held that because the corporation's presence, through its employees, was "continuous and systematic" rather than "casual," the corporation was subject to the tax and to the jurisdiction of the Washington courts.

The defendant in McGee v. International Life Insurance Co., 355 U.S. 220 (1957), was a Texas-domiciled insurance company that had only one policyholder in California. That policyholder had successfully brought suit under that policy in the California courts and was seeking to have the resulting judgment enforced in the Texas courts. The corporation had no office or employees in California and had solicited no business there (it had merely assumed the policy from another insurance company). The Supreme Court concluded that the corporation was not protected by the Due Process Clause, because it had a "substantial connection" with California, where the insurance policy had been delivered, where the insured resided, and from where premiums had been sent. This case may be seen as an extreme case of the Supreme Court's giving a broad application of the "fair play" and "reasonableness" that the Due Process Clause is intended to provide.

The in-state contacts of the putative taxpayer in General Trading Co. v. State Tax Commission of Iowa, 322 U.S. 335 (1944), consisted of employing traveling salesmen there and sending orders into the state. The Supreme Court found that this regular presence of the salesmen was sufficient to allow Iowa to require the corporation to collect and remit the state's use tax.

In Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450 (1959), the putative taxpayer, a corporation based in Iowa, maintained personnel in Minnesota and leased sales offices there (and generated 48 percent of its sales there). The Supreme Court, primarily concerned with the then-valid distinction between a tax on the privilege of engaging in interstate commerce and a tax on income derived from engaging in such a business, found this presence was sufficient to warrant imposition of Minnesota tax on the corporation. The Court specifically noted the "regular and systematic course of solicitation" that occurred in Minnesota.

In Scripto, Inc. v. Carson, 362 U.S. 207 (1960), the putative taxpayer conducted "continuous local solicitation" of customers in Florida, utilizing independent contractors. The Supreme Court found no meaningful distinction between the corporation's use of independent contractors and situations where employees were used. Accordingly, this regular and consistent solicitation through contractors was found sufficient to warrant imposition of use tax collection responsibilities on the corporation. Similarly, in Tyler Pipe Industries v. Washington State Department of Revenue, 483 U.S. 232 (1987), the Court found that the use of independent contractors rather than employees was not constitutionally significant.

Two years before Tyler Pipe, the Supreme Court decided Burger King Corp. v. Rudzewicz, 471 U.S. 462 (1985). Despite the decision's notoriety, it seems that few people appreciate the full significance of the Court's conclusion in light of the relevant facts in the case. The plaintiff, a Florida-based franchiser, had entered into a 20-year franchise agreement with the defendant to operate a local outlet in Michigan. The plaintiff brought suit relating to the agreement and payments thereunder in the Florida courts. The Court acknowledged that a party in one state contracting with a counter party in second state will not automatically result in the second state's having Due Process Clause jurisdiction over the first party. Nevertheless, in this case the Court held that the parties "envisioned continuing and wide-reaching contacts with [the plaintiff] in Florida." Accordingly, it was eminently reasonable to subject the defendant to the civil jurisdiction of the Florida courts.

In Standard Pressed Steel Co. v. Washington State Department of Revenue, 419 U.S. 560 (1975), the putative taxpayer was a corporation commercially domiciled in Pennsylvania. The corporation maintained one full-time employee in Washington and also sent a group of engineers into Washington for periods of about three days approximately every six weeks. The Supreme Court found this presence sufficient to warrant imposition of Washington's Business and Occupation Tax. A similar result was obtained in a case involving a corporation having independent contractors acting as its sales representatives in Washington. Tyler Pipe Industries v. Washington State Department of Revenue, 483 U.S. 232 (1987).

Inasmuch as state tax jurisprudence is largely based on common law in personam principles, cases such as World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286 (1980), become very important. The case was brought by a plaintiff who had purchased a car from a Volkswagen dealer in New York, and then took it to Oklahoma where he had an accident and where he commenced the resulting suit. The plaintiff contended that Volkswagen should be subject to the civil jurisdiction of the Oklahoma courts because the company should have foreseen that its cars might be in an accident there. The Supreme Court determined that a party will be subject to the jurisdiction of a state where it "purposefully avails itself of the privilege of conducting activities within the forum state." Mere foreseeability that a product will find its way into the forum state was found to be insufficient. Accordingly, the jurisdictional requirement under the Due Process Clause was not met.

A case that may have a great amount of significance in the general nexus context, and special significance in the contexts of sublicensing of intangibles and electronic commerce, is Asahi Metal Industries v. Superior Court of California, 480 U.S. 102 (1987). There, a customer of the defendant incorporated the defendant's product into goods the customer manufactured and sold throughout the world, including California. A purchaser of the customer's goods brought suit against the customer, asserting that the goods were defective and caused an accident in which the purchaser had been injured. The customer filed a cross-claim against the defendant. The plurality opinion of the Supreme Court concluded that the substantial connection must be established by an act of the defendant itself and that the act 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.

Bensusan Restaurant Corp. v. King, Civ. 3992, 1996 U.S. Dist. LEXIS 13035 (S.D.N.Y. Sept. 9, 1996), is potentially an extremely crucial case. The plaintiff, a New York corporation, brought a trademark infringement suit against the owner of a Missouri jazz club for using the name "Blue Note" in the Missouri club's Internet website advertisement. The defendant asserted that the federal court in New York had no jurisdiction, based on Due Process Clause and state statutory arguments. The federal district court, citing the Court's decisions in Burger King, World-wide Volkswagen, and Asahi Metal held that placing information on a computer outside the forum state that was merely accessible by residents of the forum state did not rise to the level of purposeful direction of economic activity into the state. Accordingly, there was insufficient presence nexus to support the court's jurisdiction.

In Wisconsin Department of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992), the Supreme Court was confronted with determining what activities a corporation could conduct in a state and not lose the protections of Public Law No. 86-272. That federal statute prevents states and their subdivisions from imposing an income tax or a tax measured by income on a business whose only business activities in the state are the solicitation of sales of tangible personal property, when the orders for such sales are accepted outside the state, and the goods are delivered or shipped into the state from outside the state. Among the Court's conclusions was a holding that the activity of restocking retailers' racks with gums, although perhaps insignificant in terms of revenue that it directly generated for the corporation, was significant and nontrivial for purposes of the federal statute because the activity was conducted on a regular, systematic basis. Although this case concerned a federal statute instead of Constitutional presence nexus, the Court's analysis demonstrates its continuing focus on the concept of "regular and systematic" rather than absolute quantities.

B. Policy Considerations

Regarding the Quantitative Standard

Although state tax administrators may try to argue differently, it seems clear that the Constitution requires that a putative taxpayer's contacts with the state, whether they be "purposeful direction of economic activities into a state" for purposes of the Due Process Clause or "substantial nexus" for purposes of the Commerce Clause, be regular and systematic. Visits that are not in the ordinary course of a corporation's standard business activities -- whether they be accidental or dictated by an extraordinary or aberrational event -- should not result in taxation. The Supreme Court decisions discussed above clearly reflect this concept: occasional, irregular incursions into a state have not been found to establish a taxable presence. Further, those connections between the state and the putative taxpayer must have been established consciously by the putative taxpayer itself. This is a relatively reasonable standard that businesses can readily accept, so there is no need for state tax administrators to exercise any discretion in this area; the Constitution adequately protects interstate businesses and no additional standards are needed to help in-state businesses. Of course, establishing that which constitutes "regular and systematic" will be somewhat controversial, but that is a necessary consequence of common law jurisprudence, where legal standards can narrow disagreements only asymptotically.

C. Recent State Cases Examining the

Presence Nexus Quantitative Issue

Florida Department of Revenue v. Share International Inc., 676 So.2d 1362 (Fla. 1996), cert denied, ___ U.S. ___ (Jan. 6, 1997), has generated a great amount of interest. There, the putative taxpayer was a nondomiciliary corporation that manufactured and distributed chiropractic supplies and sold its products through direct mail. For three days every year, the corporation's president and vice president were speakers and coordinators at a national seminar in Florida. During the seminar, the corporation's products were displayed and sold, and sales taxes were collected and remitted on these sales. The Department of Revenue asserted that the taxpayer should be collecting sales tax on all sales, including mail-order sales, to Florida. The Florida Supreme Court determined that the corporation did not have substantial nexus with Florida and, thus, could not be compelled to collect and remit use tax on mail-order sales to Florida residents. In the context of our discussion here, this case demonstrates the obvious principle that even though a corporation's presence in a state may be systematic and regular (annual), the absolute magnitude of that presence must be more than slight or de minimis.

Orvis Co. v. Tax Appeals Tribunal of New York, 86 N.Y.2d 165 (1995), cert. denied, 116 S. Ct. 518 (1995), has become "something of a benchmark" that is being used regularly by state tax administrators in various jurisdictions throughout the country. The putative taxpayer, Orvis, sold both retail and wholesale sporting equipment. Orvis's retail sales were through mail-order catalog purchases shipped from Vermont by common carrier or U.S. mail. Orvis also sold its merchandise at wholesale to New York retail establishments. Orvis employees visited New York retailers during the audit period somewhere between 12 and 76 times.

New York's highest court did "not read Quill to make a substantial physical presence of an out-of-state vendor in New York a prerequisite to imposing the duty upon the vendor to collect the use tax from its New York clientele." Rather, it held, Quill simply cannot be read as equating a substantial physical presence of the vendor in the taxing State with the substantial nexus prong of the Complete Auto test." The Court of Appeals held that "[w]hile a physical presence of the vendor is required, it need not be substantial. Rather, it must be demonstrably more than `slightest presence.'" Using this standard, the court concluded that the activities of Orvis and VIP (the putative taxpayer in a companion case with somewhat similar facts) were sufficient to subject the companies to use tax collection liability. The court found that Orvis's visits to New York suggested "systematic visitation" and that such visitation "demonstrably exceeded the 'slightest presence' test." Furthermore, the court found that VIP's visits to New York "significantly contributed to VIP's ability to establish and maintain a market for [its productsl." The dissent noted that the facts in the U.S. Supreme Court decisions relied upon by the majority demonstrated that while the putative taxpayer's presence in the taxing state was minimal in quantity, it was continuous and systematic. In terms of the "regular and systematic" principle, a very convincing argument may be made that even though the dissent is clearly correct in the law, the facts in this case -- systematic and regular visits into the state -- could nevertheless support a finding of taxable presence.

In Hearing No. 32, 349, Comptroller of Public Accounts of Texas, 1995 Tex. Tax LEXIS 38 (Jan. 30, 1995), a Florida-based computer systems vendor sold hardware, licensed software, and provided telephone support to customers in Texas. The vendor also sent its own employees into Texas to train its customers' employees. The Comptroller was seeking use tax on the amounts paid by customers for each of these items; the corporation asserted that it was not a retailer under Texas law and that its nexus with Texas was unsubstantial. The Comptroller ruled that because (1) the putative taxpayer was licensing software in Texas and (2) software is tangible personal property under Texas law, the corporation was a retailer subject to use tax collection responsibility. Acknowledging that the Supreme Court in Quill had determined that licensing some software in a state did not amount to having substantial nexus with that state, the Comptroller nevertheless concluded that the additional presence created by employees of the corporation being in the state to train customer personnel qualified as physical presence under Quill and so the use tax imposition was upheld. Moreover, amounts received for telephone service provided to Texas customers from outside of Texas were held to be taxable because it was the equivalent to maintaining property in Texas. Inasmuch as the training sessions in Texas appear to have been a regular and ordinary part of the corporation's business, the conclusion of taxability is not surprising.

A case with similar facts to those in the Texas Comptroller's decision discussed above is Care Computer Systems, Inc. v. Arizona Department of Revenue, Arizona Board of Tax Appeals, 1995 Ariz. Tax LEXIS 24 (1995). After citing Quill's conclusion regarding the mere licensing of software not establishing substantial nexus, the Board of Tax Appeals noted that Arizona precedent reveals that the maintenance of a full time salesperson in Arizona was insufficient to create a taxable presence. Phoenix v. West Publishing Co., 148 Ariz. 31 (1985), cert. denied, 477 U.S. 909 (1986). The Board added that occasional on-site supervisory support at an Arizona construction site was similarly insufficient to create nexus. State Tax Commission v. Murray Co. of Texas, 87 Ariz. 268 (1960), judgment vacated and remanded, 364 U.S. 289 (1960), second opinion, 89 Ariz. 61 (1960), cert. denied, 366 U.S. 950 (1961). The Board concluded:

[T]o have a substantial nexus, then, a business

must have more than just a large number of sales

and occasional visits of personnel. In this case the

Department contends the nexus is sufficient based

on one salesperson visit per year, perhaps 21 days

of customer training per year by non-resident

personnel, and approximately 180 transactions for

roughly $385,000 of Arizona income conducted

through the mails and delivered by common

carriers. Although Appellant held title to two personal

computers in Arizona for seven months during the

audit period that were the subject of a

lease-purchase transaction, this does not indicate

Appellant had significant property within the state

sufficient or intended to establish a business

presence here.

The court's reliance on the fact that the company's presence in the state consisted merely of "occasional visits" is consistent with the principle of "regular and systematic."

A case that well illustrates the significant impact that a temporary presence can have is Cole Bros. Circus, Inc. v. Huddleston, Commissioner of Revenue of Tennessee, App. No. 01-A-01-9301-CH-00004, Cir. 1993 Tenn. App. LEXIS 386 (Sept. 6, 1993). Cole Bros., a Florida corporation, provided circus performances in various eastern states. During the 3-1/2 year audit period, the corporation was physically present in Tennessee for four days during the first year, seven days the next year, thirteen the next year, and five days the last year. Its presence in Tennessee during those days consisted of substantial equipment (Cole Bros. was the largest tented circus in the United States), which was hauled on 27 trucks, and its 209 full-time human employees. Having already collected sales tax on circus admissions (by sending revenue department employees to the box office during the circus' visits to the state), Tennessee was seeking use tax on the equipment (allowing credit for tax paid to other states). The court upheld the assessment, noting that the corporation certainly received benefits from the State (roads, stores, police and fire protection) and took advantage of Tennessee real property that it rented and Tennessee radio stations and newspapers through which it advertised. The court explained that the relevant statute provided no de minimis exception and that there was not authority for the Department of Revenue or the Court to apportion the use tax based on the portion of time the subject property was in Tennessee. The court's conclusion in this case is far from surprising in light of the regularity (annual) and absolute magnitude (substantial) of the circus' presence in Tennessee.

A recent decision that gave full consideration to the Supreme Court's analysis plus several post-Quill state decisions is Philip Crosby Assoc. v. Alabama Department of Revenue, (Ala. Dept. Rev. A.L.J. Div. Doc. No. U.96-143 (Dec. 4, 1996)). There, a Florida-based management consulting firm was assessed Alabama use tax on books, videos, and other items it had sold to Alabama customers outside of Alabama for use within Alabama. Although the corporation generally held its seminars outside of Alabama, during a one-year period its employees made not only 26 visits into Alabama for direct sales and other revenue-related activities, but also another 69 visits to the state for consulting, on-site training, and other business-related activities. The Administrative Law Judge reviewed the quantity and quality of contacts found them sufficient to create taxable nexus in the large body of precedent and specifically rejected the notion that substantial nexus in a state requires a permanent presence. He accordingly found the corporation liable for the use tax. Here again, the regularity and amount of in-state contacts makes the court's decision not surprising.

John Swenson Granite, Inc. v. State Tax Assessor, 685 A.2d 425 (Me. 1996), involved a New Hampshire-based corporation that sold $4 million of granite to customers in Maine during the audit period (less than five years). Although registered with Maine as a retailer, the corporation had not collected or remitted use tax on its Maine sales. The court summarily concluded that the corporation "was directing its activities towards this State, and taxing them was constitutionally fair." In doing so, it relied on the following facts: 180 deliveries into the state each year using its own trucks (which accounted for about 89 percent of its Maine deliveries); its vice president visited customers in Maine two to five times a year; and its employees who resided in Maine gave technical advice to Maine customers four or five times over the audit period. Under the principle of regular and systematic presence, a different result would have been a surprise.

The Nature of Activities That Are

Significant for Presence Nexus

A. The Nature of Business Activities

That Are Relevant

Analyzing the various precedents, some observers have concluded that the Due Process Clause requirement of "purposeful direction of economic activity into a state" refers only to market exploitation activities, which they interpret to mean incursion (physical or otherwise) into the state to promote or solicit sales in that state. While not free from doubt, there is substantial support for the conclusion that the Commerce Clause requirement of substantial nexus also refers only to connections with the state relating to sales promotions and solicitations.

Unfortunately for many businesses, there is some, albeit not overwhelming, support for not limiting the relevant activities for the requisite Due Process test to those associated with marketing. First, many of the significant cases have involved fact situations where the putative taxpayer's (or defendant's) presence in the state was for nonmarketing activities, such as the extreme example (for Due Process Clause purposes) in Burger King where "purposeful direction" was found where the defendant merely commenced an anticipated intricate, long-term relationship with a counter party located in the forum state (though Burger King, an in personam case, may not be directly applicable in a state tax context). Also significant is the ultimate principle that all business activities are theoretically undertaken as economic activities to generate income, whether directly or indirectly, whether immediately or in the long-term. This, coupled with the principle that all businesses, even those engaged in interstate commerce, must pay their fair share of taxes in consideration of receiving the benefits of government and an organized society, can lead to the conclusion that, in the context of technical Due Process jurisdictional jurisprudence, virtually all business activities are relevant for determining whether there is sufficient nexus between a corporation and a state to permit the state to tax on the corporation.

In contrast, one can find very convincing authority to support the argument that the Commerce Clause requirement for substantial nexus refers only to direct market-related activities. In Tyler Pipe, the Supreme Court quoted the Washington Supreme Court's statement that "the crucial factor governing nexus is whether the activities performed in this state on behalf of the taxpayer are significantly associated with the taxpayer's ability to establish and maintain a market in this state for the sales." Even in Miller Bros. Co. v. Maryland, 347 U.S. 340 (1954), rehearing denied, 347 U.S. 964 (1954), cert. denied, 166 S. Ct. 518 (1955) -- which is ostensibly a Due Process decision, but which was decided decades before the bifurcation of the presence nexus requirement into its Due Process and Commerce Clause components -- focused on the fact that "Miller had no solicitors in Maryland; there was no 'exploitation of the consumer market'; no regular, systematic displaying of its products by catalogs, samples or the like." The Court seemed influenced by the fact that "...Miller did not go to Maryland for sales."

In addition to this authority, there is logical appeal in the proposition that the substantial nexus required by the Commerce Clause must consist of connections that are of a different nature from those required for Due Process purposes. This argument holds that "substantial" cannot mean merely more in quantity of the same kind of connections that establish minimum connections because the quantity of Quill's connections with North Dakota was quite large. More specifically, "substantial" arguably means activities that are more directly and integrally connected with generating income -- that is to say, marketing activities.

B. Recent State Cases Examining the

Presence Nexus Qualitative Issue

In a technical assistance advisement, Florida Tech. Adv. Mem., 96(c) (1-001) (1996), the Florida Department of Revenue concluded that the residence of eight of a corporation's 15 officers in Florida creates nexus for corporate income tax purposes. The officers' residence implied that management decisions were being made in Florida, since there was no evidence of corporate activities elsewhere.

Although Associated Electric & Gas Insurance Services v. Clark, 676 A.2d 1357 (R.I. 1996), has not received much publicity -- perhaps because it implicates only Due Process considerations -- it is a case that warrants much concern because of its broad interpretation of "purposeful availment." In the case, the putative corporate taxpayer collected premiums from four natural gas companies located in Rhode Island. The corporation had no physical presence in the state and received all insurance contracts directly from the insureds by mail. The corporation was assessed Rhode Island's gross insurance premiums tax. The corporation argued that subjecting it to the tax violated the Due Process Clause. The Rhode Island Supreme Court upheld imposition of the tax. Citing Quill, the court determined that the taxpayer had "purposefully availed" itself of the benefits of an economic market in Rhode Island and, thus, was subject to tax in Rhode Island. Commerce Clause considerations were not relevant because the corporation was engaged in the insurance business.

In Matter of NADA Services Corp., DTA No. 810592, 1996 N.Y. Tax LEXIS 45 (Feb. 1, 1996), 20 visits into the state over a 39-month period was held not to create sales and use tax nexus for an out-of-state publisher. After considering the publisher's contacts in light of Supreme Court precedents and Orvis Co. v. Tax Appeals Tribunal of New York, 86 N.Y.2d (1995), cert. denied, 116 S. Ct. 518 (1995), the administrative law judge concluded that the publisher was not sufficiently involved in the conduct of economic activities in New York to exceed the threshold of physical presence beyond the "slightest presence" established by Orvis. This conclusion was based on a factual determination that the visits to New York were inconsequential in effect and/or unrelated to the sale at issue. These trips included trips to visit with independent contractors under contract to solicit display advertising in the publisher's publications; trips to obtain data for an article; one trip to appear in an honorary judging role; and 15 trips to attend educational seminars. Sporadic drop-ins by independent contractors who were selling (nontaxable) advertising did not exceed the "slightest physical presence" test, even though the contractors were required to visit New York for the purpose of client contact and solicitation. The judge's rationale was that such activity was limited and that the economic activity performed (advertising) was not subject to sales tax. The judge also noted that the publisher did not maintain an advertising sales office so it could not be said that it enjoyed fire and police protection; there was no evidence of continuous local solicitation of the product sought to be taxed; and there were no product-oriented systematic visits. While economic activity was performed on the publisher's behalf in New York, the nature of the activity and the totality of the publisher's contacts with the state were too little and far removed from the publisher and from the transactions upon which the use tax collection obligation was based to constitute something "demonstrably more" than the slightest physical presence in the state.

Perhaps as a Matter of Policy, States

Sometimes Do Not Assert Taxability

Readers of state tax decisions are accustomed to seeing taxing agencies exercising their authority to (and often past) constitutional limits, and regularly seeing their conduct condoned by the courts. There have been a surprising number of instances, however, where the contrary seems to have occurred. It is worthwhile to sample some of these and consider the underlying motive for the conclusions reached.

In Signal Thread Co. v. King, 222 Tenn. 241 (1968), the putative taxpayer owned thread that was in North Carolina for processing by an independent contractor. The Tennessee Department of Revenue had asserted additional franchise tax against the corporation, claiming that the corporation was not doing business outside of Tennessee. The Tennessee Supreme Court held that "the processed thread in the hands of the independent contractor manufacturer was there as an independent act of business on the Thread Company's part in the state of North Carolina." Accordingly, the corporation was not doing business in North Carolina so the Tennessee tax was sustained.

The putative taxpayer in Matthew Bender & Co. v. Comptroller of the Treasury, St. Tax Rep. (CCH) [Paragraph] 201-347 (Md. Ct. Spec. App. 1989), was a publishing corporation, domiciled outside of Maryland, that utilized an independent printer in Maryland on an ongoing basis. To facilitate the printing, the corporation maintained a supply of its own paper at the printer. Further, at various times during the year, a number of the corporation's employees visited the printing facility. The Comptroller had asserted Maryland income tax against the corporation. Relying on the Tennessee decision in Signal Thread, the court concluded that the corporation was not subject to tax because the manufacturers were independent contractors. The lower court had also noted that the visits of the corporation's employee, like the storage of the paper, were to facilitate the work of the printer.

Reflecting this apparent sensitivity to the geographic flexibility of the printing industry's customer base, several states have adopted specific legislation. These statutes generally provide that an out-of-state customer will not be subject to tax in the state if its in-state activities are limited to patronizing an in-state printer, maintaining printing-related tangible personal property at the printer's location, and even visiting the printer's location. Some of these statutes relate only to sales and use taxes, some relate only to franchise taxes, some to both. Among the states that have taken this position are Connecticut (1996 Conn. Acts 104), Florida (Fla. Stat. [Sections] 212.0596 (1996)), Indiana (Ind. Code [Subsections] 6-2.5-8-11 and 6-3-2-2.3 (1996)), Illinois (Ill. Rev. Stat. ch. 35 [Double Paragraph] 105/2 and 5/205(f) (1996)), Kentucky (Ky. Rev. Stat. [Subsections] 139.340(2) and 141.040(1)(i) (Michie/Bobbs-Merrill 1996)), Ohio (Ohio Rev. Code [Subsections] 5741.17(A)(4) and 5733.09(D)(2) (Anderson 1996)), Pennsylvania (1995 Pa. Laws 21, ch. 9), Tennessee (Tenn. Code [Sections] 67-6-203(b) (1996)), Texas (Tex. Admin. Code tit. 34, [Sections] 3.546 (1996)), Utah (Utah Code [Sections] 59-7-102 (1996)), and Wisconsin (Wis. Stat. [Sections] 71.23(3)(a)-(b) (1996)). Similar activity has taken place in New York (N.Y. Tax Law [Sections] 1115(h) (McKinney 1996) and Counsel of N.Y.S. Tax Department Addresses Nexus Issue, 96 STN 203-47 LEXIS (Oct. 18, 1996)).

In American Association of Advertising Agencies, Inc., N.Y.S. Tax Commission Advisory Op., TSB-H-80(32)C (Nov. 14, 1980), advertising agents located in New York, in conjunction with performing services for clients that had no New York tax presence, purchased various materials as agents for those clients. These materials, such as photoengraving plates and drawings, became the property of the client upon their purchase by the agency. The taxpayer organization was seeking a ruling regarding the nontaxability of its member's clients under New York's corporation franchise tax. The Department of Taxation ruled that the ownership of property in the described situation was "minimal" and accordingly would not subject the clients to New York tax.

In Aluminum Co. of Canada, N.Y.S. Tax Commission Advisory Op., TSB-A-83(9)C (May 9, 1984), the potential taxpayer was a foreign corporation engaged in the manufacture of primary aluminum, a process that yields the byproduct dross which itself contains some aluminum. The corporation was considering shipping the dross to a New York processor, which would reclaim the aluminum from the dross and ship it back to the corporation (and discard the remaining waste). The corporation was seeking a ruling that this practice would not by itself cause it to be subject to the New York corporation franchise tax. The Department of Taxation ruled that the "ownership of property in New York in the manner described herein is... minimal" and no tax would be imposed.

In Cargill Financial Services Corp., N.Y.S. Dept. of Tax. and Fin., TSB-A-90(20)C (Sept. 26, 1990), a Delaware corporation commercially domiciled in Minnesota was engaged in the business of trading financial instruments and commodities; some of the corporation's trades were executed by independent brokers on various exchanges in New York. The corporation sought a private ruling that it would not be subject to the New York corporation franchise tax if (1) it employed independent brokers to trade in commodity futures contracts in precious metals on a New York exchange, and (2) in certain situations, it took title to the metals for short periods of time (the metals would be located in warehouses or vaults in New York). The Department of Taxation and Finance ruled that the use of independent brokers does not constitute the doing of business of the principal. Further, it held that the occasional ownership of the precious metals in New York would be "minimal," and ownership would not subject the owner to New York taxation.

A contrary result was reached in International Coffee Corp., N.Y.S. Dept. of Tax. and Fin., TSB-A-95(19)C (Nov. 13, 1995), where the potential taxpayer was a corporation engaged in commodity trading. The corporation's primary business was the purchase and sale of the physical commodity (green coffee beans), but it also traded in commodity futures which were generally closed out with offsetting transactions. Occasionally, however, the corporation took title to the commodity underlying the fulfilled futures transactions and sometimes those commodities were located in New York. The Department of Taxation and Finance ruled that the corporation would be subject to tax because of the ownership of property in New York. It distinguished Cargill because here (1) the corporation was engaged in the business of buying and selling coffee beans (instead of being primarily engaged in the trading of financial instruments) and (2) the corporation sometimes sold the actual commodities underlying the fulfilled futures contract directly to customers (instead of through the exchange). A contrary result was also reached in Anonymous, N.Y.S. Dept. of Tax. & Fin., TSB-A-91(18)C (Sept. 23, 1991) where the Department of Taxation and Finance ruled that in contrast to the Cargill situation (where the corporation was merely trading securities through an independent broker), a corporation was doing business and therefore subject to tax in a situation involving a "market maker"/ "specialist" corporation that had numerous obligations and was conducting a market maker operation jointly with an individual "principal member" of the American Stock Exchange on that exchange in New York.

Another interesting case is the New York State Tax Commission's Declaratory Rul. TSB-H-80(2)C (Rev. (April 4, 1980), wherein a Delaware corporation maintained no office in New York and had as its sole asset a portfolio of securities. The Commission first noted that the mere ownership of property and the collection and distribution of income derived therefrom does not constitute doing business and that the incidental replacement of securities and the reinvestment of securities and the reinvestment of funds similarly does not constitute doing business. However, a corporation that does systematically and regularly buy and sell securities is conducting a business. Under the facts presented, where the portfolio was to be managed by a professional management corporation with the goal of maintaining principal and protecting it from "the vicissitudes of inflation," an active business would be conducted because the state of the economy would require more than casual and incidental investments and reinvestments of the portfolio. Accordingly, the corporation would be subject to tax.

In Electron Fusion Devices, N.Y.S. Dept. of Tax. and Fin., TSB-A-96(62) S (Oct. 1, 1996), a Rhode Island manufacturer of precision liquid-dispensing equipment did not solicit business in New York but did intend to participate in a trade show in New York for two or three days each year. It regularly shipped goods into New York by U.S. mail or common carrier. The corporation requested a ruling that it was not required to collect and remit New York sales and use taxes on its sales into New York. The Department of Taxation and Finance ruled that, under the Orvis Co. rationale, no tax responsibilities would be imposed here because the corporation's activities were not "demonstrably more than a 'slightest' presence."

In Alabama Rev. Rul. 96-004 (Sept. 19, 1996), a U.K. corporation with no other presence in Alabama was considering purchasing raw materials, storing them at a subsidiary's plant in Alabama, having an intermediate product manufactured from the raw materials by the subsidiary in Alabama, and then having the intermediate product shipped to it in the United Kingdom. At all times, the corporation would retain title to the property. The U.K. corporation sought a ruling that it would not be subject to the Alabama corporate income tax or to the Alabama foreign corporation franchise tax. Noting that Alabama case law provides that a corporation will be considered doing business in the state only when it conducts in the state transactions that are the "real or chief business of the corporation" and not merely "incidental," the Department of Revenue concluded that the ownership of the material and intermediate product -- from which the corporation "will derive no income" -- will not subject the corporation to tax.

Finally, Iowa Admin. Code 701-52.1 (422), Subrule 52.1(2) (1996) sets forth the following Iowa activities as not creating nexus: holding board of directors or shareholders meetings, holiday parties, or employee appreciation dinners; maintaining bank account; borrowing money; using Iowa courts; owning and controlling a subsidiary that is either incorporated in or transacting business in Iowa; recruiting personnel when the hiring takes place outside of Iowa.

States Should Expand and Publicize 

Nontaxability Policies

It seems quite clear that states are becoming increasingly sensitive to the business development and economic ramifications of their tax administration policies. When a state reacts rationally and enacts clear legislation setting forth the qualitative and quantitative thresholds for taxation, multistate businesses are more comfortable doing business with in-state businesses and therefore increasingly do so. As a result, local businesses benefit and the goal of having a free flow of commerce across state lines is advanced.

States that promulgate regulations to the same or similar effect may approximate the achievements attained by states that enact statutes but are unable to provide as much comfort to out-of-state businesses, owing to the relative fragility of regulations.

States that require formal ruling requests or litigation that conclude with taxpayer-favorable results are perhaps short-sighted and intellectually dishonest. For each business that requests a ruling, there must be several that do not exert the effort and that, knowing that the ruling will not technically apply to them, take their business elsewhere. What is most disturbing are those situations where the taxing agency apparently believes it necessary to support its pro-economy conclusion by using strained, even contorted, reasoning.

To assist local businesses by encouraging out-of-state customers to patronize them and to assist in building a healthier American economy, states should adopt clear, meaningful presence nexus thresholds. To enhance the ease of doing business even further, and to offer states comfort that they are not "going out on a limb," organizations such as the Federation of Tax Administrators and the Multistate Tax Commission may wish to consider adopting a model or proposed uniform statute. They may even wish to explore the idea of two different nexus thresholds: a lower one that would cause taxability relating only to the specific incursion and a higher one that would result in the taxpayer's being fully subject to the state's tax laws. This would be similar to the approaches taken by in personam "long-arm" jurisdictional states.