NEXUS. Navigating Through the Rising Oceans of Nexus- Economic Nexus and P.L , Protected and Unprotected Activity

Transcription

1 NEXUS Navigating Through the Rising Oceans of Nexus- Economic Nexus and P.L , Protected and Unprotected Activity Ben Elliott, Deloitte Tax LLP Scott Ewing, Deloitte Tax LLP May 14,

2 Agenda Overview Corporate Income Tax Nexus - PL Economic Nexus/Factor Presence - Income/Franchise Tax Nexus Cases Practical Considerations 2

3 Overview What is Nexus? The connection or link that must be established with a taxing jurisdiction before the taxing jurisdiction can subject an entity to the responsibility of paying or collecting the jurisdiction s tax State Nexus Statutes A very low nexus threshold is the general rule Typical state statutes will assert nexus to the limits of the U.S. Constitution 3

4 Constitutional Restrictions U.S. Constitution prohibits a state from taxing a person unless both the Due Process Clause and Commerce Clause requirements are met Due Process Clause: Requires minimal connection between taxpayers interstate activities and the taxing state Commerce Clause: Requires that taxpayers activities have a substantial nexus with the taxing state 4

5 Overview of Basic Nexus Federal Restrictions Jurisdiction to T a x Political Reality Generally define the outer limits of a state's authority to assert nexus A state s right, conferred by statute, to impose a tax on a particular entity States prefer taxing out-of-state, as opposed to in-state, business interests ( tax exporting ) 5

6 Traditional Sales & Use Tax Nexus U.S. Supreme Court Precedent: Physical presence still the standard Quill Corp. v. North Dakota, 504 U.S. 298 (1992) National Bellas Hess, Inc. v. IL Dep t of Rev., 386 U.S. 753 (1967) Includes in-state activities of agents, independent contractors and/or employees of affiliated entities Scripto, Inc. v. Carson 362 U.S. 207 (1960) Tyler Pipe Industries, Inc. v. Wash. Dep t of Rev., 483 U.S. 232 (1987) Sellers subject to use tax collection, if it has physical presence in the taxing state, even if the seller's activities in the state have no relation to the transaction being taxed Nat l Geographic Society v. CA Board of Equal., 430 U.S. 551 (1977) 6

7 Landmark Case Law - Nexus National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967) U.S. Supreme Court held that, under the Commerce and Due Process Clauses, a vendor was required to have physical presence in a state in order for that state to require the vendor to collect use taxes on mailorder purchases 7

8 Landmark Case Law Nexus Quill Corp. v. North Dakota, 504 U.S. 298 (1992) Quill was a mail-order vendor of office supplies Quill did not maintain an office or have any employees in the state and delivered all of its merchandise via US mail or common carrier North Dakota asserted Quill created nexus in the state through systematic solicitation via catalogs and advertising flyers and therefore was required to collect use tax on sales to North Dakota residents The U.S. Supreme Court held that although Quill s economic presence in North Dakota satisfied the Due Process Clause minimum connection test, the Commerce Clause substantial nexus test was not satisfied because Quill did not have a physical presence in North Dakota 8

9 Sales & Use Tax - Agency Nexus Scripto v. Carson, 262 U.S. 207 (1960) The U.S. Supreme Court sanctioned the agency theory of nexus, finding that an out-of-state seller who used independent contractors to solicit business could be required to collect the state s sales tax Tyler Pipe Indus., Inc. v. Washington State Dep t of Revenue, 483 U.S. 232 (1987) The U.S. Supreme Court ruled that representatives performing activities on behalf of a seller while physically present in a state may create sales tax nexus for a seller if such activities are significantly associated with the seller s ability to establish and maintain a marketplace in the state for its sales 9

10 U.S. Supreme Court Update (March 3, 2015) In Direct Marketing Assoc n v. Brohl, 575 U.S. (2015), Justice Kennedy made statements in his concurrence indicating Quill is ripe for reconsideration and could possibly be overturned: Given changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court s holding in Quill. A case questionable even when decided, Quill now harms States to a degree far greater than could have been anticipated earlier. The instant case does not raise this issue in a manner appropriate for the Court to address it. It does provide, however, the means to note the importance of reconsidering doubtful authority. The legal system should find an appropriate case for this court to reexamine Quill and Bellas Hess.

11 Corporate Income Tax - Nexus 11

12 Public Law Public Law Federal law enacted in 1959 Protects out-of-state corporations from nexus for net income tax purposes, but only if all the requirements are met History Northwestern States Portland Cement (1959) In Northwestern States Portland Cement (1959), Supreme Court ruled that mere solicitation was sufficient to create constitutional nexus Congress Reaction Business community convinced Congress that such a low threshold for nexus would impede interstate commerce 12

13 Public Law A non-resident corporation is protected by P.L from the imposition of a net income tax if its only in-state activity is: Solicitation of orders for the sale of tangible personal property Approved outside the state, and Shipped or delivered from a point outside state MTC Statement of Practices under P.L includes a listing of: 13 protected activities 20 unprotected activities 13

14 Public Law Examples of Protected Activities Solicitation of orders Providing at no charge samples and promotional materials Providing a vehicle to sales personnel for their use in conducting protected activities Examples of Unprotected Activities Installation and start-up Customer training Engineering, design and technical assistance Warranty, maintenance and repair Credit and collection 14

15 Public Law P.L does NOT protect a non-resident corporation from a state net income tax if its in-state activity is: Protection is only against the imposition of a net income tax, not any of the following: Leasing of tangible personal property Sales of services Sale or lease of realty Sale or license of intangibles Sales and use tax nexus Modified Gross Receipts tax component of Michigan MBT Washington B&O tax nexus Franchise taxes on capital or net worth (e.g., PA) Texas Margins Tax NJ s alternative minimum assessment (intro. 2002) P.L only applies to income tax and to the solicitation of sales of tangible personal property Sale of services is not protected, nor is solicitation of the sale of services 15

16 Nexus Has Anything Changed? Nature of the U.S. economy has significantly changed since P.L enacted Is limitation to sales of tangible personal property still relevant? Application service providers Software as a Service business models On-line service providers Royalties Customization of canned software What activity exceeds mere solicitation of orders? Third party warranty support Intercompany activity 16

17 Factor-based Nexus Pushing Constitutional Limitations States are expanding their view of constitutional limitations Multistate Tax Commission Model Factor Nexus Statute Substantial nexus is established if any of the following thresholds are exceeded during the tax period: a dollar amount of $50,000 of property; or a dollar amount of $50,000 of payroll; or a dollar amount of $500,000 of sales; or twenty-five percent of total property, total payroll or total sales. Does this level of activity constitute a minimum connection between the state and the taxpayer s interstate activities? Factor-based nexus states currently include: 17 California Colorado Connecticut New York Ohio Washington

18 Nexus: Doing Business Redefined California has expanded its doing business statute to adopt bright line statutory nexus rules effective for tax years beginning on or after January 1, Among other things, a taxpayer is now deemed to be doing business in California if any of its apportionment factors in California exceed either the fixed dollar amount or percent of total thresholds (for 2014) below: Measure Fixed dollar Percent of total Sales $529,562 25% Property $52,956 25% Payroll $52,956 25% For the threshold, must use the state s market based sourcing rules for sales of other than TPP, regardless of the method actually used to apportion such sales (e.g., cost of performance when the single sales factor election was foregone in 2011 or 2012). The sales, property and payroll include the taxpayer s pro rata distributive share of pass through entities. Observation: This rule can trap the unwary pass through owner/partner. 18

19 Economic Nexus Constitutional Limitations Is physical presence still a constitutional requirement to assert income tax nexus? Economic Nexus - States have the right to assert nexus over taxpayers which have an economic presence in the state, even those which lack a physical presence in the state. Theoretically, significant gross receipts attributable to an in-state customer may give a company economic nexus within the state. Geoffrey Nexus Geoffrey nexus applies when licensed intellectual property is used in a state. (Geoffrey, Inc. v. South Carolina Tax Commission 437 S.E. 2d 13, cert. den. 114 S.Ct. 550 (1993)). Selected states with Economic Nexus statutes or rulings in place include the following: Maine New Hampshire Oregon Michigan ( active solicitation ) New Jersey Wisconsin 19

20 Income/Franchise Tax Nexus Cases 2013 Indiana Tax Court decision. No. 49T TA-24 (Ind. T.C. Sept. 16, 2013) The Indiana Tax Court held that Indiana does not apply an economicpresence nexus approach to its corporate income tax Gore Enter. Holdings, Inc. v. Comptroller of the Treasury, 437 Md. 492 (2014) The court held that the Maryland Tax Court did not err in holding that the Maryland Comptroller had the authority to tax two subsidiaries because they were subsidiaries with no economic substance as separate business entities apart from their parent, therefore, those subsidiaries were taxable entities 20

21 Income/Franchise Tax Nexus Cases Swart Enterprises v. FTB (Fifth District Court of Appeal no. F070922, Fresno County Superior Court no. 13CECGO2171.) Iowa taxpayer with.02% ownership interest in a CA LLC sought refund of taxes, penalties, and interest assessed against it as a result of its passive investment in the LLC. FTB contended that taxpayer's passive interest in a California LLC is sufficient to trigger the doing business standard in California and minimum tax. On Nov. 14, 2014, California issued an order granting Taxpayer s Motion for Summary Judgment, holding that Taxpayer was not doing business in California and not subject to the $800 minimum tax and a Notice of Entry of Judgment was filed on Nov. 25, On January 16, 2015, the FTB filed a Notice of Appeal. [Taxpayer] v. FTB (Fourth District Court of Appeal no. DO64241, San Diego County Superior Court no ) Superior Court for San Diego County held that 2 special purpose entities the parent company created to securitize loans from financing subsidiaries had nexus with California because they were part of one corporate enterprise and did not have a business existence separate and apart from their parent company. Court also ruled that the SPEs were "financial corporations" under California law. Taxpayer filed for appeal in California Court of Appeal, Fourth Appellate District. The case is fully briefed. 21

22 Practical Considerations - Nexus 22

23 Nexus Re-Fresh When was the last time nexus was analyzed? Do the Company s state nexus positions still make sense given its operations and the evolving laws of the states in which it operates? Is there a difference in where the Company files for sales/use tax and income tax purposes? Does the Company file sales/use tax and income tax returns in all of the states in which its employees visit? Has the Company modified its distribution channels? Has the Company restructured/expanded its sales force? Have there been any mergers/acquisitions/dispositions? Did the Company migrate its intellectual property? Does significant customers/revenue relate to states where the Company does not file? Permanent establishment versus state tax nexus 23

24 Nexus Other Considerations Always a difficult situation to address Nothing prevents passage and enforcement of factor-based and economic presence nexus thresholds (even if ultimately found unconstitutional) If taxpayer elects not to file, risks penalties, etc. Voluntary Disclosure Agreements may mitigate penalty and look back period If taxpayer elects to file, possibility of no refund, even if tax held to be unconstitutional Consider coalition to contest tax and or/work through non profit tax organizations (e.g., CalTax) May mitigate litigation costs 24 Pick strongest facts to litigate

25 Is Nexus Always Bad? Nexus can be beneficial in certain circumstances Taxable presence in other states can result in less than 100% of income being taxed. If throwback or throwout rule exists, taxpayer must have nexus in the destination states to avoid throwback/throwout In certain states, only nexus affiliates may join in filing a consolidated return. Nexus required to use carryover losses to offset income. 25

26 California Sales Factor Throwback Overview Generally, sales originating from California of tangible personal property to another state or foreign jurisdiction in which the taxpayer is not taxable must be thrown back to California. Focus on whether taxpayer is taxable in destination state. California approach either(i) taxpayer actually files in other state, or (ii) other state has right to tax. Some states focus on whether taxpayer actually files. Observation: California s economic nexus rules can minimize throwback in a number of situations. 26

27 Effect of Bright-Line Nexus Standard on Throwback Does a State s Bright-line Nexus Position Largely Obviate Throwback? California Chief Counsel Ruling : Taxpayer not required to throw back sales to California because it met the $500K threshold in a foreign jurisdiction and thus was taxable in the foreign jurisdiction. No P.L protection exists for foreign based taxpayer. Retroactive Application of Factor Presence Nexus FTB Technical Advice Memorandum ( TAM ) State s position that factor presence does not apply to tax years prior to January 1, TAM asserts that physical presence is a requirement prior to January 1, Observation: What other situations involve throwback besides sales of tangible personal property? 27

28 Contacts Scott Ewing Sacramento, California (916) , Ben Elliott Sacramento, California (916) , 28

29 About this presentation This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation. 29

30 About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Please see for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting. Member of Deloitte Touche Tohmatsu Limited 30