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Current corporate income tax developments.


* In some states, the taxpayer's delivery of goods in its own vehicles does not constitute nexus (e.g., Massachusetts and New York); in others (e.g., Indiana and Texas, it does.

* Some states have held that, while certain services were beyond "mere solicitation," the were de minimis and, thus, did not trigger nexus.

* New York, Iowa and Tennessee have promulgated new nexus exemptions.

As has been the trend in recent years, states continue to try to increase revenues by expanding the activities that constitute nexus for corporate tax purposes. Part I of this two-part article focuses on significant nexus activities that will affect the majority of taxpayers and highlights the novel approaches demonstrated by some of the more aggressive states.

As with prior years, over the past 15 months an overwhelming number of state statutes were modified, added and deleted; court cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued or withdrawn. Because it is impractical to summarize all of these activities, Part I of this article focuses on significant nexus activities that will affect the majority of taxpayers and highlights the novel approaches demonstrated by some of the more aggressive states. Part II, in the September issue, will address tax base and apportionment issues.


PL. 86-272 prohibits a state from taxing a business when its only connection with the state is the solicitation of orders for sales of tangible personal property that are sent out of the state for approval or rejection, and, if approved, filled and shipped by the business from a point outside the state. A number of state cases and rulings have addressed whether the taxpayer's in-state activities fall with the protection of P.L. 86-272.

Activities Exceed Solicitation

* Massachusetts

In Kennametal Inc. v. Comm'r of Rev.,(1) the Massachusetts Supreme Court narrowly interpreted the U.S. Supreme Court's decision in Wisconsin Dep't of Rev. (DOR) v. William Wrigley, Jr., Co.,(2) to impose Massachusetts' corporate excise tax. Under P.L. 86-272, taxpayers can solicit tangible personal property sales in a state without becoming subject to its income tax. Wrigley provided the first guidance as to what constituted "solicitation" under P.L. 86-272, defining it as any activities "entirely ancillary to requests for purchases" that do not serve any independent business purposes.

The Massachusetts Supreme Court ruled that the taxpayer's frequent in-plant presentations, inventory analysis for tool standardization programs and testing of samples exceeded solicitation. According to the court, these activities not only invited orders, but also ingratiated customers to the company and assisted them in making buying decisions.

* Massachusetts

In Amgen, Inc. v. Comm'r of Rev.,(3) the taxpayer was held liable for Massachusetts corporate income tax, because its activities in the state exceeded mere order solicitation. The taxpayer was a Delaware corporation with its primary place of business in California. It developed two new pharmaceutical products; its activities in Massachusetts were primarily the selling of these products. The taxpayer also monitored the research and clinical studies performed in Massachusetts, provided multi-day educational seminars and maintained ownership and control of the supplies used in such studies and retained employees to review specific patient charts and answer patient-specific questions. Additionally, the taxpayer was involved in patent infringement litigation in Massachusetts.

The taxpayer asserted that all of these activities were protected because they were ancillary to order solicitation, and therefore should not subject it to tax in Massachusetts. However, the Massachusetts Appellate Tax Board ruled that the activities were not ancillary to order solicitation; rather, they had an independent business purpose that subjected the company to Massachusetts corporate income tax for the years in question.

In-State Delivery/Backhauling in Company-Owned Vehicles

* Indiana

An S corporation that printed and delivered newspapers for numerous customers, including customers in Indiana, was doing business there; thus, its shareholders were required to report their share of the company's income or loss derived from Indiana sources.(4) Generally, a taxpayer is doing business in Indiana for apportionment purposes if it operates a business enterprise or activity in the state, including merchandise distribution to customers directly from company-owned vehicles when title passes at the time of distribution. In the instant case, the taxpayer owned a Kentucky printing plant at which a majority of its production was for local customers. However, some of the customers served by the Kentucky plant were from the surrounding states, including Indiana. Because the taxpayer delivered newspapers to its Indiana customers' business place using its own trucks and sent salespeople into Indiana for business, its activities there exceeded mere order solicitation.

* Massachusetts

The Massachusetts Supreme Judicial Court affirmed a Superior Court decision that PL. 86-272 protection extends to companies that limit their activities within the taxing state to solicitation of tangible personal property sales, but deliver their products to customers using their own company trucks.(5) The U.S. Supreme Court denied certiorari on May 26, 1998.

* New York

A recent ruling held that, unless de minimis, a corporation's backhauling activities create nexus for state corporate franchise tax purposes.(6) An Indiana manufacturing company delivers its products to New York customers via its own commercial vehicles; it also uses them to pick up products that do not meet customer specifications and return them to Indiana. The company also transports back to Indiana the New York customers' trim and scrap, for which they receive a credit against future purchases. The company earns approximately 4% of its New York total revenues from backhauling activities when it picks up goods (other than delivered products) from its customers or from other entities and delivers them to an Indiana location.

The Department of Taxation and Finance (Department) held that while product delivery to New York customers via company-owned commercial vehicles would not subject the company to franchise tax, the post-delivery backhauling activities subject it to such tax, unless those activities are de minimis. The Department further held that the company's backhauling activities unrelated to product delivery, which produce 4% of the company's total revenues earned in New York, were not de minimis and subjected the company to New York corporate franchise tax.

* Tennessee

The Tennessee DOR ruled(7) that a corporation's backhauling and collection activities create nexus for Tennessee franchise and excise tax purposes. In addition to delivering its products, the company uses its commercial vehicles to pick up defective products that do not meet customer specifications and to transport back to its plant the Tennessee customers' trim and scrap. The company does not charge customers for hauling back the defective products and trim and scrap. The DOR ruled that the company's backhauling activities exceed solicitation; thus, it is subject to franchise and excise taxes.

In addition, if a customer does not pay its account as expected, a salesperson visits the customer and requests that payment be made. The DOR ruled that the company's collection activities exceed solicitation and therefore create nexus for both franchise and excise taxes.

* Texas

An out-of-state steel parts and refuse container manufacturer was held to be subject to the Texas franchise tax, because it delivered its products to customers in Texas using its own trucks.(8) An administrative law judge held, and the tax division affirmed, that the seller's delivery of goods is only protected if the goods are delivered through the U.S. Postal Service or a common carrier. Because the seller delivers goods using its own trucks, P.L. 86-272 protection does not apply; thus, the seller is subject to earned surplus tax.

Trivial/De Minimis In-State Activities

* New York

Periodically, Company will conduct one-day seminars for both existing and prospective customers to train retailers on proper methods of fitting prosthetic devices, increase product awareness and create goodwill. Attendance at these seminars is generally limited to 30 or fewer participants, who each pay a $55-$60 fee. Company estimates that three seminars will be conducted annually in New York. The Department ruled(9) that these training seminars exceed activities ancillary to order solicitation, because Company is giving technical advice on product use after the products are delivered to customers. However, Company's conduct of the seminars constitutes de minimis activities; accordingly, Company is not subject to corporate franchise tax.

* New York

The Department ruled(10) that a foreign corporation participating in two five-day trade shows in New York was not subject to corporate franchise tax, because the activity constituted only a trivial connection with the state. The corporation did not take orders or sell its goods at the trade shows and did not otherwise do business in the state. The corporation's limited activity of displaying goods at the trade shows, although deemed to exceed order solicitation, was still exempt under P.L. 86-272 as de minimis.

* South Carolina

The South Carolina DOR set forth(11) examples of in-state activities that do not create nexus with the state. Among the more interesting examples are:

[] Owning a subsidiary that is incorporated in and transacts business in South Carolina.

[] Negotiating and obtaining loans from a South Carolina bank (including visiting the state for one or two days twice a year to discuss business with a bank).

[] Passive investors owning interests in securitized credit card debt or mortgage loans that include debtors and property located in the state.

[] Having a Website that is accessible in (but not located in) South Carolina.

[] Delivering products to South Carolina customers using the seller's own delivery vehicles.

[] Employees purchasing raw materials and inventory while in the state.

[] Leasing tangible personal property located at an in-state printer if, once the printing work is completed, the printer ships the materials out of state for addressing and mailing.

[] Employees attending an annual training seminar, convention, trade show, retreat or board of directors' meeting in the state for no more than 14 consecutive days per year.

(The result is the same even if the employees stay in contact with their office and conduct business via telephones or fax machines, or fly into the state in a company plane.)

* Tennessee

In Advance Magazine Publishers, Inc. v. Huddleston,(12) the Chancery Court held that the taxpayer had not established sufficient nexus in Tennessee as a result of maintaining rolls of paper inventory at an unrelated printing facility in the state and making annual quality assurance visits. For Tennessee to levy its franchise and excise taxes on a corporation, the corporation must be "doing business in Tennessee." "Doing business" is not defined by Tennessee law; thus, the court reviewed previous cases in establishing its definition. The court relied primarily on a Tennessee case that denied the taxpayer's right to apportion its income outside of the state, notwithstanding inventory and quality assurance checks in North Carolina.(13) The state has appealed.

New Nexus Exemptions

* Iowa

Effective for tax years beginning after 1996, employee training or education, or foreign corporations' use of facilities in Iowa for this purpose, is an exempt activity that does not constitute doing business in the state; thus, it does not render a foreign corporation subject to Iowa corporate income tax.(14)

* New York

Legislation enacted during 1997 allows taxpayers to maintain inventory in New York without establishing nexus in the state.(15) Under the new law, taxpayers can store inventory with non-affiliated "fulfillment services" companies for later use by the latter. Fulfillment services companies are third parties that accept and ship orders, respond to customer requests and prepare and collect invoices on behalf of their clients. Previously, the ownership of inventory or performance of these activities in New York would have triggered income and sales/use tax filing responsibilities.

* Tennessee

The Governor recently signed S.B. 2240, which modifies the definition of "doing business" to carve out a number of activities that will not subject a corporation to Tennessee tax. Under this legislation, the following in-state activities will not subject a corporation to Tennessee excise (income) or franchise tax:

[] Ownership of a limited interest in a partnership operating in Tennessee.

[] Ownership of a membership interest in a board-managed limited liability company (LLC) located in of doing business in Tennessee.

[] Presence of employees and/or product samples and/or other promotional materials at one or more trade shows, exhibits, conventions or similar events in the state for a total of not more than 20 days per calendar year; provided, however, that the activities of the entity's employees while in Tennessee are limited to maintaining or facilitating the trade show or convention; the purchasing of goods on behalf of their employer; the solicitation of sales; and the gathering of samples, promotional material or other information offered at the event.

[] Activities by publishers of magazines and books, who contract with Tennessee printers for the printing of their magazines or books, when such activities in Tennessee are limited solely to activities having to do with the printing, storage, labeling and/or delivery to the U.S. mail or common carrier of such magazines or books; or the maintenance of raw materials with respect to such activities; or the maintenance of employees solely in connection with the production and quality control of such printing, storage, labeling and/or delivery; provided that the publisher and printer are not affiliated with one another.

[] Physical presence in Tennessee of an out-of-state entity's equipment, tooling, inventory and employees on a temporary basis, when (1) the activity in which such items and employees are engaged is not the pursuit, creation or maintenance, by the out-of-state entity or any entity that is affiliated with it, of a market in this state; (2) the equipment and tooling are not used, worked on or held in this state by an entity that is affiliated with the out-of-state entity; (3) the out-of-state entity's employees have no control over the use or work done in this state by the in-state entity; and (4) the extent and value of such items, the number of such employees, and the number of days the employees work in this state, in light of all the facts and circumstances, are qualitatively and quantitatively de minimis.

[] The temporary presence in Tennessee of employees solely for the purpose of purchasing goods from vendors in Tennessee for use in the employer's business out-of-state; provided that the total number of days the employer has one or more employees present in this state does not exceed 30 per calendar year; and further provided that the employer does not furnish, directly or indirectly, any office in Tennessee for their use.

Pushing the Nexus Envelope

* Iowa

The Iowa DOR is notifying corporations earning royalty income from licensing trademarks and trade names within the state that they may be subject to corporate income tax. These letters request either a legal brief detailing disagreements to the state's assertion or the necessary documentation to calculate the tax.

The DOR has taken the position that the ownership of intangibles located within Iowa creates nexus for corporate taxpayers. In response to Geoffrey, Inc. v. South Carolina Tax Comm'n,(16) the General Assembly of Iowa amended the Iowa Code's definition of "income sources from within this state" to include intangibles. Iowa Code Section 422.33 defines "income sources within this state" as "income from real, tangible, or intangible property located or having a situs in this state." Further, Iowa Reg. 701-52.1 (422) states:

the term "intangible property located or having a situs within Iowa" means generally that the intangible property belongs to a corporation with its commercial domicile in Iowa or, regardless of where the corporation which owns the intangible property has its commercial domicile, the intangible property has become an integral part of some business activity occurring regularly in Iowa.

The amendment is effective for tax periods beginning after 1994.

* Michigan

The Michigan Department of Treasury (DOT) was forced to abandon its long-standing "resident employee" standard that, for an out-of-state company to be subject to the single business tax (SBT), it must have a resident employee in the state. This position was contrary to the standard used by many other jurisdictions that impose non-income taxes based on activity by nonresidents and nonemployees. However, in MagneTek Controls, Inc. v. Dep't of Treasury,(17) the Michigan Court of Appeals adopted the physical presence test used by the New York Court of Appeals.(18) As a result, the DOT was required to restate its nexus standard.

Under Rev. Adm. Bull. 1998-1,(19) an out-of-state business is subject to the SBT if it regularly and systematically conducts in-state business activity through its employees, agents, representatives, independent contractors, brokers or others acting on its behalf, whether or not these individuals or organizations reside in Michigan. For this purpose, regular and systematic business activity exists when at least 10 days of business activity occur in Michigan on an annual (i.e., a 12-month tax year) basis. However, regular and systematic business activity may exist (depending on the facts and circumstances) when fewer than 10 days of business activity occur in Michigan annually. When examining the facts and circumstances of in-state business activity, conducting any of the following activities in Michigan for two or more days on an annual basis will be rebuttably presumed to constitute regular and systematic business activity:

[] Soliciting sales.

[] Making repairs or providing maintenance or service to property sold or to be sold.

[] Collecting current or delinquent accounts related to sales of tangible personal property through assignment or otherwise.

[] Installing or supervising installation at or after shipment or delivery.

[] Conducting training for employees, agents, representatives, independent contractors, brokers or others acting on the company's behalf, or for customers or potential customers.

[] Providing customers any kind of technical assistance or service (including, but not limited to, engineering assistance, design service, quality control, product inspections or similar services).

[] Investigating, handling or otherwise assisting in resolving customer complaints.

[] Providing consulting services.

[] Soliciting, negotiating or entering into franchising, licensing or similar agreements

The bulletin is effective for all open tax periods ending after 1988. While it provides relief for Michigan companies seeking to avoid sales factor throwback, companies located outside of Michigan may find that they have an SBT obligation for current and/or prior years.

* North Carolina

During 1996, the North Carolina DOR proposed amendments to its regulations to expand the definition of "doing business" to enable the state to tax out-of-state financial institutions that do not have a physical presence in the state. However, the North Carolina Rules Review Commission rejected the DOR's proposed rule on the grounds of ambiguity. Nevertheless, the DOR has not given up; this past winter, it again proposed amending the doing business rules to expand its taxing jurisdiction. However, the DOR was forced to withdraw its proposed rule, because it was determined that a fiscal note was required. The DOR is expected to propose expanding the doing business rules again next year after it has had an opportunity to put together the required fiscal note.


During 1997, the Multistate Tax Commission (MTC) established a public participation working group to review its draft sales/use tax nexus guidelines, which clarify the states' understanding of the constitutional limits on sales/use tax nexus under both the Due Process and Commerce Clauses. The January 1998 states' version of these guidelines push the nexus envelope and in many examples finds that nexus is present in situations in which several state courts have held to the contrary. While the document is being drafted to address sales/use tax nexus, MTC Nexus Bulletin 95-1(20) clearly states that "there is no question that when a company has sufficient contact with the State to support the constitutional imposition of a use tax collection and reporting obligation, with respect to the State into which the company is selling, nexus exists for the application of an income, franchise, or comparable tax as well."

Other Nexus Activities

* Massachusetts

In Aloha Freightways, Inc. v. App. Tax Bd.,(21) the Massachusetts Appellate Tax Board held that an Illinois-based shipping company had sufficient nexus with Massachusetts, because its in-state delivery and pick-up services were regular, ongoing and substantial during the tax year at issue. The taxpayer had generated more than $55,000 in business from its Massachusetts activities for the 1986 tax year.

* Oregon

In CRIV Investments, Inc. v. DOR,(22) the Oregon Tax Court held that a foreign corporation that was a limited partner in partnerships engaged in real estate activity in Oregon was subject to corporate income tax. The court held that although the taxpayer's Oregon activities may not rise to the level of "doing business" within Oregon, the taxpayer is sufficiently connected to Oregon, because it is a limited partner in partnerships doing business within Oregon and realizing income from this activity. Accordingly, Oregon can tax the entity on its distributive share of the partnerships' income.

(1) Kennamental Inc. v. Comm'r of Rev., Mass. Sup. Jud'l Ct., No. SJC-07448 (10/29/97), aff'g Mass. App. Tax Bd., Nos. 170029, 183527 and 18603 (11/1/96), cert. denied.

(2) Wisconsin DOR v. William Wrigley, Jr., C., 505 US 214 (1992).

(3) Amgen, Inc. v. Comm'r of Rev., Mass, App. Tax Bd., Nos. 218135, 236076 and 236077 (6/4/97).

(4) Ind. Rev. Rul. IT 96-03 (1/7/97).

(5) National Private Truck Council, Inc. v. Comm'n of Rev., 688 NE2d 936 (1997), aff'g Mass. Sup'r Ct., Suffolk, No. 93-5647-H (1/3/97), cert. denied.

(6) TSB-97(8)C (3/27/97).

(7) Tenn. DOR, Rev. Rul. No. 97-15 (6/2/97).

(8) Tex. Comp. of Pub. Accts., Comptroller's Dec., No. 36,012 (12/4/97).

(9) TSB-A-97(7)C (3/26/97).

(10) TSB-A-97(6)C (3/24/97).

(11) S. Car. DOR, Rev. Rul. 98-3 (1/21/98).

(12) Advance Magazine Publishers, Inc. v. Huddleston, Tenn. Chancery Ct., 20th Jud'l District, Davidson Cty., No. 94-2140-III (8/20/97).

(13) Signal Thread Co. v. King, 435 SW2d 468 (1968).

(14) H.F. 354, Laws 1997.

(15) Chs. 389 and 681, Laws 1997.

(16) Geoffrey, Inc. v. South Carolina Tax Comm'n, 437 SE2d 13 (1993), cert. denied.

(17) MagneTek Controls, Inc. v. Dep't of Treasury, Mich. Ct. App., No. 181612 (2/7/97).

(18) See Orvis Co. v. Tax App. Tribunal of New York, 654 NE2d 954 (1995).

(19) Mich. Rev. Adm. Bull. 1998-1 (2/24/98).

(20) MTC Nat'l Nexus Program Bull. 95-1 (issued December 1995).

(21) Aloha Freightways, Inc. v. App. Tax Board, Mass. App. Tax Bd., No. 169514 (3/12/97).

(22) CRIV Investments, Inc. v. DOR, Ore. Tax Ct., No. 4046 (4/23/97).
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Title Annotation:state law; part 1
Author:Boucher, Karen J.
Publication:The Tax Adviser
Date:Aug 1, 1998
Previous Article:Significant recent developments in estate planning.
Next Article:The clergy's unique tax issues.

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