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U.S. Supreme Court clarifies state taxation of out-of-state corporations.

Through its ruling in Wisconsin Department of Revenue v. William Wrigley, Jr. Co., 112 Sup. Ct. 2447 (1992), the U.S. Supreme Court provided clarification of the Federal law that protects out-of-state corporations from state income tax when their in-state activities are limited to the solicitation of sales.

PL 86-272 prohibits a state from taxing the income of a corporation whose only in-state business activities consist of solicitation of orders for tangible goods, provided the orders are sent out-of-state for approval and the goods are delivered from out-of-state. Historically, the parameters of PL 86-272 were not clear, particularly the definition of the term "solicitation." The subject of extensive litigation since the law's passage in 1959, solicitation has been interpreted broadly by some state courts , while others have viewed it very narrowly.

The Supreme Court's, Wrigley decision provides some clarity. First, the Court held that the term "solicitation of orders" includes all activities that are "entirely ancillary" to requests for orders. Ancillary activities are those with no independent business function apart from their connection with soliciting orders. Second, the Court held that there is a de minimis exception for activities that are not entirely ancillary. The test of whether in-state activity, other than solicitation of orders, is sufficiently de minimis to avoid a corporation losing its tax immunity in a particular state depends on whether that activity establishes a "nontrivial additional connection with the taxing state."

The Supreme Court held that Wrigley's activities in Wisconsin went beyond "solicitation," thereby subjecting the company's income to Wisconsin corporate franchise tax. In holding that Wrigley's business activities in Wisconsin exceeded PL 86-272, the Court detemiined that some of its activities were protected while others were not.

As a result of the Wrigley decision, many activities that were historically questionable in various states are now protected, including (1) providing company autmobiles and computers; (2) handling some customer complaints; (3) training Of sales representatives; (4) carrying samples; (5) arranging displays and Providing promotional advice; and (6) intervention in credit disputes. However, in Wrigley, activities deemed not ancillary to solicitation included the replacement of stale gum, the supply of gum to new customers and the storage of gum. The hst of protected and unprotected activities delineated in Wrigley is not, of course, all-inclusive. Accordingly, it is likely that states will continue to review activities on a case-by-case basis to determine those activities that are entirely ancillary to solicitation. Litigation is also likely to continue to determine whether activities that go beyond solicitation are de minimis, thereby avoiding tax nexus with a state.

In light of the Wrigley decision, states may also become more aggressive in pursuing other theories to establish a tax nexus, such as "attributional nexus" (i.e., nexus created by an agent or unitary business or under an "alter ego" principle). In other words, foreign corporations may not be able to avoid a state's corporate income tax by simply limiting their in-state activities to those protected under PL 86-272 and enumerated in Wrigley.

An emerging area under attributional nexus is the "unitary business" theory. Historically used in tax apportionment cases, this theory has recently been applied to the issue of tax jurisdiction. The unitary approach provides that related entities may be subject to tax on the basis of economic integration with the entity operating within the taxing state. Under this approach, an out-of-state entity may be subject to tax in a state with which it has no direct or indirect connection except for its role in an overall unitary business.

The "alter ego" principle generally applies when the affairs of one corporation are dominated and controlled by an affiliate such that the dominated corporation may be considered the affiliate's alter ego. Accordingly, if one company has income tax nexus with a state, it may create nexus for its affiliates based on its degree of control over the affiliates.

Nexus can also be created through contractual arrangements (a variation on the agency theory). State courts have held that out-of-state companies may not avoid tax nexus through contractual arrangements with in-state companies to conduct activities on their behalf. The existence of nexus through such a relationship is generally based on the physical presence of a corporation's representative in a state, regardless of the legal characterization of that relationship.

The Multistate Tax Commission has proposed revisions to its guidelines for PL 86-272. These guidelines (which may undergo further revisions prior to being finalized) adopt the Supreme Court's opinion in Wrigley and attempt to list permitted and nonpermitted activities. By providing some overall certainty in this area, the revised guidelines should benefit both states and corporate taxpayers alike.

Similarly, New York State has proposed amendments to its regulations related to the types of activities that will subject a foreign corporation to the N.Y. Corporate Franchise Tax in light of Wrigley. The New York amendments specifically provide language from the case, including the directive that "ancillary activities, other than maintaining an office, that serve no independent business function apart from their connection to the solicitation of orders" will be protected.

Although the Supreme Court's decision in Wrigley has not answered all the questions regarding the circumstances under which an out-of-state corporation will have its income subject to a state's taxing authority, it has provided useful guidehnes as to the type of in-state activities that will create nexus. This clarification should allow corporations to structure business operations in a manner designed to minimize state tax exposure. However, the states will likely respond by pursuing other nexus theories in order to tax out-ofstate corporations.
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Author:Perraglia, James
Publication:The Tax Adviser
Date:Apr 1, 1993
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