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Interstate tax nexus guidelines from the U.S. Supreme Court.

Over the past several years, state and local governments have become much more aggressive in their attempts to raise revenue both in the sales and use tax arena, and through corporate income taxes. The zealousness of state legislators and tax departments is amply evidenced by the number of court cases challenging their attempts.

The U.S. Supreme Court has finally spoken on the issues in two cases that will have far-reaching and long-term effects on our state and local tax scheme. Quill Corp. v. North Dakota, 5/26/92, addressed sales and use taxes, and Wisconsin Department of Revenue v. William Wrigley Jr., Co., 6/19/92, addressed corporate net income.

Quill involved an out-of-state mail order company's obligation to collect sales or use tax for goods sold in North Dakota, Wrigley involved the limits of PL 86-272, in conferring immunity from Wisconsin state net income taxes based on mere solicitation of goods by out-of-state sellers.

In Quill, the Court held that the Commerce Clause prohibited a state from imposing an obligation on an out-of-state mail order company (without any physical presence in the state) to collect sales or use tax on goods sold to in-state residents. Advertising and direct mail solicitation were not "dofng business" for sales or use tax purposes. A physical presence within the state was needed to provide the nexus required for the state to impose an obligation to collect ,ales and use tax on the company; economic presence was not enough. Thus, the case of National Bellas Hess, Inc., 386 US 753 119671, was affirmed.

By basing its decision solely on Commerce Clause grounds, the Court opened the door land in fact invited) Congress to legislate a solution to this problem. National Bellas Hess, which had barred the states from imposing these collection obligations on out-of-state companies on both Commerce Clause and Due Process grounds, had cast a doubt over whether such legislation would be constitutionally permitted. It now is certain that legislation, such as the ill-fated Equity and Interstate Competition Act of 1989, would have been valid if enacted.

Wrigley, on the other hand, dealt with the question of the definition of solicitation. PL 86-9.72 confers immunity from state net income-based taxes on interstate businesses whose only in-state activities consist of solicitation of orders for sales of tangible personal property, accepted or rejected outside the taxing state. The problem was determining which activities were protected under the "mere solicitation" standard.

In Wrigley, the Court announced that protected solicitation, for net income tax purposes, included those activities entirely ancillary to requests for purchases that served no independent business function apart from their connection to the solicitation of orders. Unprotected solicitation includes those activities that an out-of-state company may assign to its in-state solicitors, but would conduct in the taxing state anyway. Thus, protected solicitation includes the use of company owned vehicles, salesmen's samples, providing display racks, solicitation visits to a customer of a customer, and the training of a sales force, whether in hotels or in the home of in-state employees.

However, under PL 86-272, the following are not protected: free replacement of stale or damaged goods by salesmen, charging a customer for goods provided by the salesmen, storing goods used for customer or salesmen replacement purposes or other nonsolicitation purposes, and providing instate technical assistance.

Nevertheless, the Court inferred that a de minimis exception may be found in PL 86-272. The minimum threshold, for net income tax nexus purposes, is whether the aggregate nonimmune activities establish a "nontrivial additional connection with the taxing state." In Wrigley, the combination of agency stock checks and the small inventory of gum held in Wisconsin for replacement constituted a "nontrivial additional connection" with the state, and therefore Wrigley was not protected by PL 86272.

Left less clear by the Wrigley Court were two specialized situations: home offices and credit activities by sales personnel in the taxing state. In-state home offices are protected by PL 86-272, unless the home office can be formally attributed to the out-of-state company or to "agents of that company in their agency capacity." Credit dispute resolution activities by a sales manager in a specific dispute are protected if the purpose of the activity is customer goodwill {i.e., ingratiating the salesmen with the customer). But the sales manager cannot be involved in checking a potential customer's creditworthiness.

In summary, the nexus for state sales tax purposes requires a physical presence in the taxing state, while the nexus for state net income tax purposes requires more than mere solicitation. A narrow de rainfinis exception applies to protect companies that step beyond the mere solicitation threshold. Note that the Court did not extend the protection from taxation to franchise or other taxes due to mere solicitation. Also, the Court did not decide whether a tax measured by net income could constitute a nonexempt franchise or privilege tax. From Barry Gerber, J.D., CPA, Pittsburgh, Penn.
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Author:Gerber, Barry
Publication:The Tax Adviser
Date:Oct 1, 1992
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