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States enamored with deceptively attractive "Geoffrey nexus" position.

Although some state tax officials expressed glee over the Supreme Court's decision denying certiorari in Geoffrey, Inc. v. South Carolina Tax Comm'n, 437 S.E.2d 13 (S. Car. Sup. Ct., 1993), state actions in the immediate aftermath of Geoffrey did not mirror the officials' excitement. While a few states quickly embraced the rationale underlying Geoffrey, most states took a "wait and see" approach to formally adopting economic presence nexus positions. (The absence of an intellectually honest nexus analysis in the Geoffrey decision may have impeded states from moving quickly to adopt their own nexus positions based on the decision.) However, the failures of other means to challenge similar corporate structures may have convinced many states that Geoffrey is their best weapon.

Precursors to Geoffrey

Economic presence nexus is not a new concept. Beginning in the late 1980s, a number of states began applying the economic presence theory of nexus to financial services businesses. Indiana, Minnesota, Tennessee and West Virginia all enacted statutes subjecting out-of-state financial services businesses to income tax based simply on an economic presence, including making loans, having credit card customers or depositors, or soliciting or rendering financial services to customers in the state. Reports now indicate that these states are targeting multistate credit card companies and lenders for audit.

More recently, Kentucky (networth franchise tax imposed on banks), Pennsylvania (bank shares tax) and Massachusetts have passed laws applying the economic presence theory of nexus to financial services businesses. Further, New Mexico regulations provide that franchisors are subject to gross receipts tax, despite the absence of a physical presence in the state. In fact, the South Carolina Supreme Court relied on two New Mexico gross receipts tax decisions involving franchisors to support its decision in Geoffrey. Hawaii has also asserted nexus on the basis of licensing intangible rights for use in Hawaii. Now that the dust has settled on Geoffrey, states are now moving to impose "Geoffrey nexus" on taxpayers outside of financial services. One common theme among these states is that, other than Iowa, they have not adopted Geoffrey by statute; rather, they apply it pursuant to (1) formal administrative rule or policy statement or (2) informal audit position. Although these rules or audit positions remain subject to challenge constitutionally, they may also be subject to procedural challenges, since these actions may exceed a state department of revenue's rule-making authority.

Administrative Geoffrey Developments

Arkansas, Florida, North Carolina and Wisconsin have formally promulgated Geoffrey rules or statements of policy. These rules limit their Geoffrey nexus positions to licensing of intellectual property (such as trademarks, tradenames, patents and copyrights) and sales or licensing of other intangible property (such as computer software, franchises, and other intangible rights). They do not extend their Geoffrey positions to encompass all types of activities that constitute economic exploitation of a market when the economic presence theory of nexus is taken to its logical (or illogical) extreme.

Nexus rules based on Geoffrey have also been proposed in New Jersey. Other states are also asserting Geoffrey nexus positions on audit, including Maine, Maryland, Massachusetts, Missour), New Hampshire and Tennessee, which have announced (or have recently taken) Geoffrey audit positions with respect to passive investment companies.

The Outlook

Despite the troubling point that an increasing number of states are willing to place reliance on an (constitutionally suspect at best) opinion from a sister state's supreme court, it may be necessary to "educate" the states on the precedential value of the Geoffrey decision outside of its specious constitutional parameters. It has legal, precedential value only in South Carolina. That the U.S Supreme Court denied certiorari is not critical, although states may read something into the Court's refusal to exercise its discretionary jurisdiction. For instance, according to Arkansas policy statement, "The United States Supreme Court denied Geoffrey's request for the Court to review the case, which means that the South Carolina decision now applies in all states with tax laws similar to the South Carolina tax law." (Emphasis added.) This is not true. When the Supreme Court denies certiorari, this does not signify the Court's agreement with or judgment on the merits of the lower court's decision (as opposed to the Court's dismissal for want of a substantial Federal question).

Recent events also indicate that taxpayers should take comfort in knowing that Geoffrey is being questioned by impartial arbiters. For example, the Geoffrey decision was recently rejected by Alabama's chief administrative law judge for purposes of Alabama's foreign franchise tax in Cerro Copper Products, Inc. v. Alabama Dep't of Revenue, No. F9 1 111 (12/11/95).


Although the Geoffrey decision is constitutionally suspect at best, states appear unable to resist the temptation held out by the South Carolina court's decision. Unless (and until) the U.S Supreme Court (or a series of state courts) rejects Geoffrey, taxpayers are left with many practical dilemmas presented for their current corporate structures. Taxpayers must carefully consider their tax return filing obligations, as well as available measures to enhance or re-engineer their corporate structures in light of the increasing momentum the Geoffrey decision is receiving in a number of states.


Committee Projects and Activities

Committee Objective

In 1995, the objective for the State and Local Taxation Committee was revised and approved as the following: To promote administrative uniformity and fairness in state tax laws. To identify leading judicial, legislative and administrative state tax issues and formulate the AICPA position for approval by the Tax Executive Committee, and advocate as appropriate.

Committee Comments to the MTC

The committee has prepared and submitted comments to the Multistate Tax Commission (MTC) on the Nexus Guideline for Application of a Taxing State's Sales and Use Tax to a Remote Seller (MTC staff draft) and on the proposed amendment to MTC Regulation IV.18.(c). Special Rules: Sales Factor. In addition, the committee is developing comments on the proposed amendment to MTC Regulation IV.1.(a) Business and Nonbusiness Income Defined.

Nexus guideline comments: Specifically, on Oct. 25, 1994, the MTC issued a Nexus Guideline for Application of a Taxing State's Sales and Use Tax to a Remote Seller. As the committee mentioned in its comments submitted to the MTC on Apr. 12, 1995, the AICPA supports the MTC's efforts to develop uniform standards for determining when an out-of-state taxpayer has nexus with a state for purposes of sales and use tax collection duties. Fair and uniform nexus standards would relieve the administrative and compliance burdens imposed on businesses by the piecemeal, state-by-state development of nexus standards. However, the committee believes that, in several crucial respects, the approach taken in the guidelines is fundamentally deficient; these issues must be resolved if the guidelines are to achieve their stated goals.

[] Various aspects of the guidelines extended states' taxing powers beyond those allowed by the U.S. Constitution.

[] The guidelines fail to recognize that the higher jurisdictional nexus standards of substantial connection (i.e., physical presence) required by the Commerce Clause of the U.S. Constitution control, not the nexus standard of minimum contacts (i.e., purposefully directing activities toward a state) under the Due Process Clause of the U.S. Constitution.

[] The concept of "deemed" physical presence should not be used.

The guidelines should not treat an interest in intangible property as creating physical presence or deemed physical presence.

[] The guidelines should contain a duration standard based on the sales tax reporting period (i.e., monthly or quarterly, rather than 12 months).

The guidelines should have a reasonable, quantitative de minimis rule. After meeting with the Executive Director of the MTC on Dec. 6, 1995, the committee requested the formation of a working group with the MTC on the nexus guidelines.

Sales factor comments: On Apr. 21, 1995, the MTC held a hearing on the proposed amendment to MTC Regulation IV.18.(c). Special Rules: Sales Factor. The committee sent a representative to the hearing, and developed comments that were submitted to the MTC on dune 27, 1995. The comments focus on:

[] The proposed change should be made by statute rather than by regulation.

[] The lack of consistency in applying rules relating to the apportionment of receipts from the sale of intangibles.

[] Ambiguity in the definition of business versus nonbusiness income covered by the regulation.

[] Potential distortion in the sales factor on the sale of an intangible derived from a significant operational function of the taxpayer.

[] Technical compliance issues involving the computation of net gains at the transactional level.

On Dec. 28, 1995, the MTC issued an Interim Report of Hearing Officers on the proposed amendment. The report said that, in light of concerns raised, the MTC Executive Committee should consider the adoption of one of two alternatives to the original proposal and approve an additional hearing session for consideration of the alternative proposals. The first alternative makes several changes in the language to the original proposal and reflects the suggestions of various respondents. The second alternative, a draft proposal submitted by the California Franchise Tax Board staff, departs significantly from the language of the original proposal, but addresses many of the issues and concerns raised during the hearing process. The committee is currently reviewing these alternatives. An MTC hearing on the alternatives was held on May 3,1996.

Business and nonbusiness income defined: In April 1995, the MTC released a proposed amendment to MTC Regulation IV.1. (a) Business and Nonbusiness Income Defined. The proposed amendment is designed to clarify confusion over the limits of business (i.e., apportionable) income. In particular, the amendment attempts to reconcile the transactional and functional tests for distinguishing business income with the constitutional limitations on the scope of apportionable income. The committee is currently developing comments and plans to testify at the MTC hearing on this proposed amendment. The committee has requested a working group be set up with the MTC on this issue as well.

Report on Corporate State Tax Administrative Uniformity

In June 1995, the committee updated the AICPA Report on Corporate State Tax Administrative Uniformity to:

[] Illustrate the significant differences among the states in administrative matters related to corporate income taxation.

[] Describe the problems these differences cause taxpayers and state tax administrators.

[] Make recommendations as to administrative uniformity.

The report outlined the many state rules on filing dates, penalties, reporting of Federal adjustments and statutes Of limitations, and presented recommendations for uniformity. The committee sent copies of the report to all the state CPA societies and various state tax organizations. After receiving feedback from the Committee on State Taxation (COST), Tax Executives Institute (TEI), the MTC, the Utah Tax Commission, the Montana Society of CPAs and the Florida Institute of CPAs, the committee plans to summarize the comments and actively pursue the consideration of these recommendations by the various state legislative bodies, especially those states with the least uniform rules. All Tax Section members received a complimentary copy of the report last summer. (For additional copies, call the AICPA Order Department at 1-800-862-4272 and request product # 061044.)

Attribution of Expenses for Tax-Exempt Income

The committee is developing a practice guide on the various methods used by states to attribute expenses for purposes of disallowance as used to purchase or carry tax-exempt interest.

Checklist on Nexus Issues

The committee is developing a checklist/organizer on the different state tax treatments of nexus.

The Tax Adviser Column

The committee has started a quarterly column on state and local taxes in The Tax Adviser: An annual update was published in the April and May 1996 issues, and the column begun in this issue will appear quarterly.

Liaison Efforts

The committee is continuing and increasing its liaison efforts with various state tax organizations, including the MTC, COST, Federation of Tax Administrators, TEI and the IRS (Simplified Tax and Wage Reporting System and Fed-State Relations Office). The committee will meet on June 5, 1996 in Washington, D.C., and encourages members to attend and share their thoughts with the committee.


Editor's note: Ms. Manos-McHenry chairs the AICPA Tax Division State and Local Taxation Committee, of which Mr. Lippman and Mr. Krevitsky are members. Ms. Sherr is the committee's technical manager.
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Article Details
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Author:Lippman, Michael H.
Publication:The Tax Adviser
Date:Jun 1, 1996
Previous Article:Sales management for tax practices.
Next Article:Allocations using a reasonable method other than those specifically stated in regulations.

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