Update on attributional nexus.
In the November-December 1989 issue of The Tax Executive, a colleague and I published an article that (1) analyzed the historical foundations regarding constitutional limitations on state tax jurisdiction and (2) discussed recent attempts by state taxing authorities to assert jurisdiction over a corporation based on the presence within the state of that corporation's agent, alter ego, or unitary affiliate. (Rosen & Bernstein, State Taxation of Corporations: The Evolving Danger of Attributional Nexus, 41 Tax Executive 533 (1989).) During the past year, several cases regarding attributional nexus have been decided by various courts. This article summarizes those cases.
Agency Found in Missouri
In Amway Corporation v. Director of Revenue, 794 S.W.2d 666 (Mo.1990), the Missouri Supreme Court sustained the assessment of the State's corporate income tax on Amway, even though the company had no employees or property in Missouri. Amway, a Michigan-based company, sold products to distributors located in Missouri, which resold them either to consumers or to other distributors. In addition, the distributors solicited for sales of distributorships. Distributorships are direct agreement between the new distributor and Amway, and the initial and annual fees are paid by the new distributorships directly to Amway. A distributor who solicits new distributorships obtains indirect benefits through increased market, volume discounts, and the opportunity to become a "direct distributor."
Amway asserted that it was not subject to the state's income tax because (1) it had no presence in Missouri, and (2) even assuming it were present in the state, its activities were protected by Public Law No. 86-272. Reviewing the relationships between Amway and its distributors, the Missouri Supreme Court disagreed. If found that the company's Missouri distributors were acting as agents for Amway and, therefore, that Amway was present in the state. The court also concluded that the sales of distributorships were sales of intagibles independent from the sales of products and, hence, were unprotected by Public Law No. 86-272. Thus, Amway's income from sales of goods and distributorships was subject to apportionment for imposition of the state's income tax.
The court reviewed the twin nexus requirements: (1) connection between the taxpayer and the taxing state, and (2) connection between the income sought to be taxed and the state. (These requirements were discussed at length in the 1989 article.) The court reasoned that although the Missouri-based distributors were not employees of Amway and although the distributorship contracts were between the new distributorship and Amway, "[o]ne may be a representative or agent for the limited purpose of soliciting sales without being an employee and without having the legal authority to enter into contracts on behalf of another." Id. at 671. The court found that the soliciting distributors "were clearly authorised to act on behalf of Amway in soliciting the sale of distributorships. In doing so, they were Amway's representatives." Id.
In bolstering its conclusion that presence nexus exited because of the agency relationship, the court seems to have unnecessarily equated "presence" with "economic exploitation." Futhermore, the court effectively blurred the two separate nexus requirements when it stated:
Whether the corporation's activities are done through employees or non-employees who have authority to solicit business on a corporation's behalf, it has availed itself of the substantial benefits of engaging in a commercial activity in a state for which the corporation may be subject to a state income tax "unembarrassed by the Constitution."
Id. at 672 (citation omitted).
Agency Found Lacking in Mississippi
In Mississippi State Tax Commission v. Bates, 567 So. 2d 190 (Miss. 1990), the Mississippi Supreme Court rejected the State Tax Commission's imposition of sales tax assessments on a carpet store that was located in Alabama. The Commission has asserted that Mississippi sales tax was due on all sales from the Alabama store to Mississippi residents where the invoice included charges for delivery on installation. The court accepted the Chancery Court's findings that the sales were "closed" in Alabama and that the Mississippi installations were performed by independent contractors who were not agents of the carpet store.
Customers of the carpet store had three choices regarding installation: (i) specifying a particular installer, (ii) installing the carpet themselves, or (iii) accepting the store's
recommendation of one of two local installers. The two installers who were recommended by the store were independent firms, unrelated to the store. They utilized their own trucks and equipment and had their own independent places of business; the store owned no installation equipment itself. The store did not supervise or maintain control over the details of the final results of the installer's work. If the customers paid the installation fee to the store, the store would keep the fee for the installers to pick up; the store "did not profit, financially or otherwise, from referring an installer to a customer or by holding the installation fee or the carpet of a customer for an installer." Id. at 191 n.l.
The Mississippi Supreme Court focused on the Commerce Clause's four-prong Complete Auto Transit test, and found that there was insufficient nexus between the store and Mississippi to sanction taxation. Inasmuch as the installers were found not to be agents of the store, the store was held not be conducting business in the state. Consequently, the tax assessments were annulled.
Agency or Alter Ego Not Discussed in Tennessee
In Pearle Health Services, Inc. v. Taylor, 799 S.W.2 660 (Tenn. 1990), the Tennessee Supreme Court sustained the imposition of Tennessee use tax collection responsibility on Pearle for sales made by one Pearle subsidiary, Pearle Labs, to franchisees of another PEarle subsidiary, Pearle Vision Centers (PVC). The court found that "Pearle through Pearle Labs, sold optical-related products to the franchisees." The court also noted that Pearle periodically sent representatives into the state. Citing Scripto Inc. v. Carson, 362 U.S. 207 (1960), and Standard Pressed Steel Co. v. State of Washington Department of Revenue, 419 U.S. 560 (1975), the court found that such representatives and the business they enhanced supported a finding of adequate nexus.
The Pearle decision is very confusing. On the one hand, the references to Pearle employees' conducting business in the state supports a finding that the decision is based on traditional, render than attributional, nexus principles. On the other hand, the opinion discusses the relationship between Pearle and the franchisees in the state, stating that the visits by Pearle representatives and the need for the franchisees to obtain permission from PVC before purchasing products from any suppliers other than Pearle "tie[ ] the franchisees to the parent company as their primary supplier."
In any event, the decision disregards the interposition of Pearle Labs, which was the entity selling the products. The court's decision may be based --
* on Pearle's own employees being in the state,
* on Pearle Labs' employees being in the state,
* on attribution of the presence of Pearle Labs' employees to Pearle,
* attribution of the presence of Pearle Vision Centers' employees to Pearle or Pearle Labs, or
* on attribution of the franchisees' presence to Pearle or Pearle Vision Centers.
The precise rationale for the decision is unclear because the court seemingly ignored the different corporate entities without any analysis of their legal relationships. Although some state tax administrators might argue the Pearle supports automatic attribution of nexus to all members of an affiliated group, such a reading greatly overstates (or significantly misreads) the decision.
Unitary Attribution Upheld in Maryland
In Comptroller of the Treasury v. Armco Export Sales Corp., 82 Md. App. 429 (1990), Maryland's imposition of its corporate income tax on corporations not present themselves in the state was sustained by the state's Court of Special Appeals. At issue was the taxability of Domestic International Sales Corporations (DISCs) that had no property, employees, or other presence in Maryland. (Each DISC's corporate parent, however, was clearly subject to tax in Maryland).
In sustaining the assessments, the court repeatedly noted that each DISC was merely a "phantom book entry corporation" and that "no activity is performed by the DISC to earn the income." Id. at 430-31. Although this language seemed to presage an alter ego relationship between each DISC and its parent, the court stated, "the nexus is established by the parent of the phantom corporation [engaging] in the export business in the state." Id. at 432. The court explained that no independent nexus between the DISC and the state was required "due to the very nature of a DISC, which has no tangible property or employees and can only conduct its activity and do business through branches of its unitary affiliated parent." Id. at 435. Addressing the issue directly, the court sadi:
The three key elements for constitutional nexus were affirmatively established in each of these three DISC cases. They are:
1. The parent is engaged in business in Maryland.
2. The parent is unitary with the DISC.
3. The apportionment formula is fair.
Id. at 436.
In defense of its approach, the court observed that since it may not be constitutionally pemissible for a DISC's domiciliary state to tax all its income, if Maryland did not tax an apportioned part, the DISC would pay no taxes. This line of reasoning -- supporting a finding of nexus to ensure that some jurisdiction gets tax revenues -- is obviously suspect.
No Agency Found In Pennsylvania
Bloomingdale's By Mail, Ltd. v. Department of Revenue, 567 A.2d 773 (Pa. 1989), analyzed whether Pennsylvania could require an out-of-state mai-order vendor to collect the state's use tax relating to shipments made into the state. The Department of Revenue asserted that since the mail-order corporation -- Bloomingdale's By Mail (By Mail) -- had a corporate affiliate in the state operating retail stores (Bloomingdale's), and since those stores (1) accepted returns of goods purchased from By Mail by two Department of Revenue employees (even though By Mail's catalogs stated that returns were to be sent directly to By Mail), (2) offered many of the same items as By Mail, and (3) utilized many of the same sales motifs, By Mail should be subject to the state's taxing jurisdiction.
The court rejected this argument, finding that the two merchandise returns accepted by the stores to be "aberrational" and that the common merchandise and sales motifs were insufficient to establish an agency relationship. The court find that "Bloomingdale's stores in Pennsylvania do not solicit orders on By Mail's behalf nor act as its agents in any fashion and By Mail does not solicit orders for Bloomingdale's." Id. at 778. Adding that "By Mail does not have agents acting on its behalf in Pennsylvania," the court stated that a "true agency relationship results only if there is an agreement for the creation of a fiduciary relationship with control by the principal." Id. No such relationship was found to exist in this case, so Bloomingdale's By Mail could not be required to collect Pennsylvania's use tax.
No Agency Found in Connecticut
The facts is SFA Folio Collections v. Bannon, Docket No. 338611 (Super. Ct.-Hartford Jud. Dist. Apr. 4, 1990), were similar to those in Bloomingdale's By Mail. SFA Folio's affiliate, Saks Fifth Avenue, operated retail stores in Connecticut while SFA Folio was an out of state mail-order vendor. The two corporations shared information, the same logotype, and the same merchandise lines. Nevertheless, the court concluded that SFA Folio could not be required to collect the state's use tax because the two operations -- the mail-order and the stores -- were operated by two distinct corporate entities.
The court relied on the fact that "the day-to-day operation of [the store] and Folio are conducted by separate management groups and neither group makes decisions for the other corporation." In the absence of any agency relationship, SFA Folio was not subject to the state's taxing jurisdiction.
No Alter Ego Found in New York
In Nittetsu Leasing (U.S.A.) Inc., TSB-A-90(5)C, a New York Advisory Opinion, the Department of Taxation and Finance ruled that a holding company would not be subject to the state's corporation franchise tax as a result of its activities relating to its subsidiary, Nittetsu Leasing (N.Y.) Inc. Although the parent's books would be kept in New York by the subsidiary's employees who would also perform other administrative tasks for the parent, the parent would compensate the subsidiary for such services on an arm's-length basis. All of the subsidiary's operations would be conducted by the subsidiary's own officers and employees. Further, and apparently very importantly, the parent would not make loans to the subsidiary nor gurantee any loans obtained by the subsidiary.
The Department noted that a holding company is not normally considered taxable in New York if its activies are confined to owning stock in a corporation that does business in New York, receiving and distributing income derived therefrom, and performing internal management. On the other hand, if the holding company substantially assisted its New York subsidiary, through loans or loan guaranties or through coordination or supervision of the subsidiary's business activities, then the holding company would be operating a business in New York through itw own agents and would thus be taxable. Inasmuch as the facts in the Advisory Opinion petition did not include such activities, Nittetsu Leasing (USA) Inc. would not be subject to tax in New York.
With a few worrisome exceptions, the most recent decisions regarding attributional nexus have incorporated traditional rigorous legal analyses in determining whether the presence in a taxing jurisdiction of one corporate entity could be attributed to another entitiy that was not so present. The Tennessee Pearle decision, however, causes concern because it apparently attributes presence nexus among affiliates without any analysis or reasoning. It is difficult, if not impossible, to know what the true sidnificance of the decision is. The Maryland Armco Export decision is potentially more dangerous because it attempts to establish a new hard-and-fast principle, nexus attribution through unitary relationships, without any reference to legal precedent or jurisprudential reasoning. Out of whole cloth, the court has developed a three-step rule to support a funding of taxable nexus.
The decisions in most states are gratifying to those who refuse to be cynical in these times of state fiscal hardships: courts are indeed still applying the law. The cynical among us, however, may gloat as they review the Tennessee and Maryland decisions.
ARTHUR R. ROSEN is with Morrison & Foerster in New York City. Mr. Rosen was formerly the Deputy Counsel of the New York State Department of Taxation and Finance and has held executive tax management positions at Xerox and AT&T. He is a past chairman of the Committee on State and Local Taxes of the American Bar Association's Tax Section, a member of the Executive Committee of the New York State Bar Association and the National Association of State Bar Tax Sections, and Editor of the monthly newsletter, Inside New York Taxes.
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|Author:||Rosen, Arthur R.|
|Date:||Jan 1, 1991|
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