• Tax Overview in the United States
  • Internal Revenue Service
  • US-Canada Tax Treaty
• Business Entities
  • Corporations
  • Sole Proprietorships
  • Partnerships
  • Joint Ventures
• Federal Taxation of Corporations
  • Domestic Corporations
  • Foreign Corporations
• State and Local Income Taxes
  • State Tax “Nexus” : An Overview
  • Allocation and Apportionment Rules
  • State Income Tax Reporting Methodologies
  • State Sales Tax
  • Washington Business & Occupation Tax
  • Ohio Commercial Activity Tax
  • Michigan Single Business Tax
• Opportunities for International Investors
• Personal Tax
  • US Taxation of Canadian Snowbirds
  • Moves and Assignments to the US
  • US Estate Tax for Canadians
    

In order for a state to impose a tax on an out-of-state business, that business must meet or exceed a minimum threshold of activity in the state. This principle is commonly known as “nexus”. None of the 50 states have adopted a statutory definition of nexus and there is no uniform nexus standard, but some states have adopted bright-line standards.

Regardless, the states are limited in their ability to impose tax on out-of-state taxpayers by the United States Constitution and federal laws enacted by Congress. Constitutional limitations on a state’s ability to tax an out-of-state business have evolved through case law under the Commerce and Due Process Clauses of the US Constitution. Likewise, limitations established by federal statute have evolved through case law.

Due Process Clause and Commerce Clause Nexus

The Due Process Clause "requires some definite link, some minimal connection, between a state and the person, property or transaction it seeks to tax" (Miller Bros. Co. v. Maryland, 347 US 340 (1954)). A corporation meets the "minimal connection" requirement if it is doing business within a state. However, if a corporation is not technically doing business within a state, the state may still have the ability to tax the corporation based on other criteria. If a foreign corporation's activities give the corporation "fair warning that its activity may subject it to the jurisdiction of a foreign sovereign”, then it has met the minimal connection requirement, regardless of a corporation's lack of physical presence in the state.

The Commerce Clause is concerned with the effects of state taxation on interstate commerce, and thus imposes a higher hurdle. To justify taxing a foreign corporation under the Commerce Clause, a state must establish more than the minimal connection required under the Due Process Clause. In Complete Auto Transit, Inc. v. Brady, Chairman, Mississippi Tax Commission (430 US 274 (1977)), the US Supreme Court established a four-prong test that is still used to determine a state’s ability to tax an activity under the Commerce Clause. Under this test, for a state to have the ability to tax a foreign corporation on its interstate activities:

• sufficient nexus must exist between the taxpayer and the state
• the tax may not discriminate against interstate commerce
• the tax must be fairly apportioned, and
• the tax must be fairly related to the services provided by the state.

All four criteria must be met for a state to have the ability to tax an activity.

The US Supreme Court further clarified the limitations on state taxation under the Due Process Clause and the Commerce Clause in Quill Corporation v. North Dakota (112 S. Ct. 1904 (1992)). In deciding in favour of the taxpayer, the Court upheld a bright-line "physical presence" test it had previously set forth in National Bellas Hess, Inc. v. Department of Revenue (386 US 753 (1967)), in which the Court held that a state cannot constitutionally impose a duty to collect use tax on sales to residents if the seller lacks physical contact with the state. Citing this reasoning in Quill, the court acknowledged that Due Process no longer prevents a state from taxing out-of-state sellers on the basis of some minimal connection, but that the Commerce Clause requires a substantial (physical) nexus before a state can tax interstate activities.

Public Law 86-272

In general, the Constitutional limits to nexus discussed above apply to all types of state taxes, including sales and use taxes, capital based taxes and income taxes. With respect to income taxes, an additional limitation applies. US Public Law 86-272 (“P.L. 86-272”) further limits a state’s ability to impose an income-based tax on non-resident taxpayers. P.L. 86-272 applies where a non-resident company’s sole activity within a state is the presence of individuals soliciting sales (with no authority to accept or reject orders) of tangible personal property for delivery from a stock of goods out-of-state.

Other activities may be protected under P.L. 86-272 so long as the activities are either ancillary to the solicitation of an order or of a de minimus nature. Any activity performed in a state which exceeds P.L. 86-272 standards is not protected and can establish nexus for income tax purposes. Whether activities other than solicitation are sufficiently de minimis to avoid a loss of the protection afforded by P.L. 86-272 depends on whether those activities together establish a “non-trivial” additional connection to the taxing state. However, taxpayers and the states can be expected to interpret the terms “ancillary” and “trivial” differently.

The Multistate Tax Commission (MTC) has published guidelines describing the activities that it considers to exceed solicitation as defined by P.L. 86-272. Examples of these activities include (but are not limited to):

• Making repairs or providing maintenance or service to the property sold or to be sold
• Collecting current or delinquent accounts, whether directly or by third parties, through assignment or otherwise
• Installing or supervising installations at or after shipment or delivery.
• Securing deposits on sales.
• Conducting training courses, seminars or lectures for personnel other than personnel involved only in solicitation.
• Providing any kind of technical assistance or services.
• Approving or accepting orders.
• Consigning a stock of goods or other tangible personal property to any person, including an independent contractor, for sale.

For states that have adopted the MTC guidelines (and even in those that have not but still use the MTC guidelines in determining nexus policy), the above activities generally would cause a state to impose its income tax on an out-of-state taxpayer.

In addition to the nexus-producing activities mentioned above, many state tax authorities have asserted that an out-of-state corporation can have nexus due to the in-state activities of an agent or affiliate. Under this theory of nexus, commonly referred to as agency or attributional nexus, nexus exists when an in-state person or affiliated entity acts as an agent representing the interests of an out-of-state principal. Such theories are generally asserted by state tax authorities on the basis that the out of state taxpayer has an agency, alter ego, or unitary relationship with another person (i.e., individual, corporation, partnership, etc.), even though it may not have direct nexus with the state.

In Tyler Pipe Industries, Inc. v. Washington State Department of Revenue (483 US 232 (1987)), the US Supreme Court held that the “crucial factor governing nexus is whether the activities performed in the state on behalf of the taxpayer are significantly associated with the taxpayer’s ability to establish and maintain a market in the state for sales”. Therefore, if the in-state activities of the taxpayer’s agent or representative are necessary for maintaining the taxpayer’s market and protecting its interests, a state may assert agency/attributional nexus with the taxpayer.

Bob Morrill can be contacted at 519-660-2117 or via email at rmorrill@kpmg.ca       www.kpmg.ca