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A528 Class Notes

Class #1
Essential and inherent attribute of sovereignty that belongs as a matter of right to every state and government Not derived by consent of owners of property to be taxed by US constitutional grant of authority, or federal statute Constitution presupposes the states authority to lay taxes and that such taxation may impose some burdens on federal govt.

What is nexus? minimum amount of contact an entity must have with a state for the state to have jurisdiction to impose its tax Tax nexus is an extension of civil jurisdiction o When a state can impose its power over persons or property Types sales tax vs. income tax Although each taxing state has the right to enact and enforce its own tax laws, their power is limited by: o US constitution Separate clauses and/or amendments Due process/equal protection 14th amendment Commerce clause Article I, section 8 o Federal statutory limitations o State nexus statutes State statutory definition of doing business

Limits & amendments Due process/Equal Protection (14th amendment): o No state shall make or enforce any law which shall deny to any person within its jurisdiction the equal protection o No state shall make or enforce any law which shall deprive any person of life, liberty, or property without due process of law Embodies concepts of fairness, requiring notice & opportunity to be heard o Supreme court has interpreted due process to require: Definite link/minimum connection between the state and the taxpayer or activity it seeks to tax

Rational relationship between the measure of the tax and the intrastate values of the enterprise

Is nexus always bad? Not always, can be a benefit o Enforcement, sales/use tax, income franchise tax Must have nexus in 2 or more states to apportion income o Can result in less than 100% of income being taxed Nexus required to use carryover losses to offset income

Commerce clause 4 prong test Complete Auto Transit: Established a four pronged test to determine whether the commerce clause would permit a state to impose tax on interstate transaction o Substantial nexus: significant connection between the state and the taxpayer or taxpayers activity o Fairly apportioned: state can assess tax on only its fair share of an interstate transaction o Non-discrimination: tax doesnt discriminate against interstate by favoring intrastate commerce o Fairly related to state services: tax has reasonable relationship to benefits provided by the taxing state Quill Corp Case: o Substantial nexus = physical presence o Still most important decision regarding constitutional nexus JC Penney National Bank Case: o Analysis: under due process JC has nexus because it exercises privilege of doing business in TN by purposefully directing its activities there Quill explains commerce clause requires more than doing business (physical tax) and there is no basis for having a different standard for income/franchise than sales/use i.e. NO SUBSTANTIAL NEXUS Orvis & VIP o Under quill, a taxpayer must have substantial physical presence to have substantial nexus o While a physical presence of vendor is required, it need not be substantial Substantial nexus requires physical presence that is demonstrably more than the slightest presence

Implies the existence of a level of physical presence that is so small that it does not trigger substantial nexus De Minimis Rule: o What level of physical presence is necessary to create nexus? Income or sales tax? Basis for rule: o Complete auto: commerce clauses requires substantial nexus o Quill: TP had title to 4 floppy disks in ND rejected slightest presence

Class #2
Commerce clause 4 prong test o Substantial nexus Not just minimum contacts between TP and state Quill case set precedent of physical presence o Fairly apportioned o Non-discrimination o Fairly related to state services Key idea is there undue burden on interstate commerce? Due Process: opportunity to be seen and heard Quill case drew a distinction between vendors that have physical presence and vendors that transact business through mail and common carriers

Non-Physical Presence Nexus concepts Economic nexus o TP engaging in any activity for the purpose of financial gain may be subject to tax, because they are exploiting the marketplace o Direct activities to exploit marketplace Representational/attributional nexus o Agency nexus: 3rd parties that perform services on behalf of TP may establish nexus for out of state TP o Affiliate nexus: the in state presence of an affiliated member may establish nexus for its out of state affiliate

Scripto vs. Carson Georgia sub sold writing instruments w/ advertising Didnt own/rent property or have resident EEs in Florida Marketed products using 10 independent contractors

Sales reps that werent EE was without constitutional significance Independent agents continuous local solicitation created nexus Arrangement w/ sales reps is meaningless if activities performed in state on behalf of TP are significantly associated with TPs ability to establish & maintain a market for its sales in this state An out-of-state seller will have nexus by attribution of a third party's in-state activities when: o The third party is acting "on behalf of" the out-of-state seller, and o The third party's activities are "significantly associated with the taxpayer's ability to establish and maintain a market in this state for the sales." A company who doesnt have a physical presence in a state may still be found to have a substantial nexus if its connection with an in-state third party meets the requirements.

Geoffrey Inc. v South Carolina Geoffrey has no property or payroll in SC Geoffrey is a sub in DE of Toys R Us o Owned parents trade names/trademarks Geoffrey licenses intangibles to Toys R Us for 1% of aggregate sales of All Toys R Us Stores Can SC impose a tax on Geoffreys SC income even though Geoffrey had no physical presence in SC? Quill physical presence test doesnt apply to income taxes! By licensing intangibles for use in SC and deriving income from their use in SC, Geoffrey has substantial Nexus

MBNA v Indiana DOR Economic presence is sufficient to establish nexus Commerce clause doesnt require physical presence

Economic Nexus Is quill sole nexus standard or is Geoffrey a viable standard for income taxes o Answer still unknown Drawbacks of economic nexus o Lacks Quills bright line rule o Easily abused because standards can be enforced selectively Although economic nexus cases usually involve affiliated companies the basis of decisions could be asserted against unrelated companies

Nexus Case Study Facts that create nexus o Sub 3 has sales force in various locations regardless if they are contractors or not o Zoom has sales people in major US cities o Zoom has clothing on consignment in various states Potential Nexus Problems o Presence of sales personnel creates nexus for #3 and Zoom o Catalogs left at 3rd party stores Look to frequency If periodic placing catalogs may be difficult for state to argue nexus If regular placings then state could argue that catalogs are solicitations Recommend strategies to reduce tax exposure o Segregate sales team and their activities to reduces parents nexus o Limit the activities to those that would not create an agency relationship o Stop practice of leaving catalogs in stores i.e. mail to stores from outside of the state may not be feasible from business prospective

Class #3
collection of sales/use tax is an expansion of mail order issues growth of internet has heightened tax gap- competitiveness with brick and mortar

Amazon.com LLC v. New York o Facts: Amazon is headquartered in California. Have a program where the pay People a commission for referring others to their website. o Issue: Does this statute (receipts >$10,000 in commissions) violate the commerce clause? o Rule: commerce clause o Analysis: Essentially amazon has setup agents across the country. o Conclusion: Court ruled in favor of the state.

Goldberg vs. Sweet Does Illinois tax on interstate call violate commerce clause because the tax is imposed on more than that portion of activities performed in Illinois Illinois assessed 5% tax on telecommunications companies Call has to originate or terminate in Illinois (interstate), and be charged to an Illinois resident Is tax fairly apportioned? Is tax internally consistent? o If applied by every jurisdiction it would result in no more than ALL the unitary businesss income being taxed o If call has to be charged in state where tax is assigned, you could never tax the same call in another state ok Is tax externally consistent? o You look at whether activities the company does within the state to produce income are being taxed in that state or activities outside that state are being taxed o Economic justification for The value taxed to discover whether the tax reached beyond that part of value that is fairly attributable to economic activity within the taxing state Illinois said tax was fairly apportioned

Davis vs. Dept of Revenue of Kentucky Does Kentuckys taxation of out of state bonds, but not in state bonds, violate the non-discrimination prong of the US commerce clause? Said wasnt unconstitutional, even though facially unconstitutional because discriminated against other states Said externally consistent by leveling playing field and that these rules have been here forever and would disrupt market if changed

American River vs. Dept of Revenue Tax not fairly related to services Waters are property of US not Illinois No services were provided to tugboats in Illinois

Class #4
Substantial nexus: o Physical presencequill o More than slightest presenceorvis

o Physical presence may not be requiredQuill & Geoffrey o Nexus attributed via relationshipScripto & Amazon Fairly apportioned Goldberg v. Sweet o Internal consistency o External consistency

PL 86-272 Supreme court ruled that mere solicitation was sufficient to create constitutional nexus Business community lobbied and convinced congress that such a low nexus threshold would impede interstate commerce Protects out of state companies with substantial nexus from imposition of net income tax IF ALL requirements are met ONLY APPLIES TO NET INCOME TAX Nonresident company is protected from imposition of income tax if its only instate activity is: o Reps engaged in solicitation of orders o For the sale o Of tangible personal property o Approved outside of the state and o Shipped or delivered from a point outside the state Nonresident company whose only instate activity is to use independent agents to solicit, make sales, or maintain offices Protected activities: o Solicitation of orders o Providing at no charge samples and promotional materials o Providing a vehicle to sales personnel for their use in conducting protected activities Unprotected activities: o Installation and start up o Customer training o Engineering, design, and technical assistance o Warranty, maintenance, and repair o Credit and collection

Wrigley Case Did sales reps exceed solicitation of orders for purposes of PL 86-272? Supreme court decision of solicitation of orders: o Making requests for purchases o Entirely ancillary activities that serve no independent business function apart from their connection to the solicitation of orders

Court also recognized de minimis level of non-protected activities would NOT forfeit

Deliveries PL 86-272 Are deliveries made using company owned trucks protected? Orders must be filed by shipment or delivery from a point outside the state Courts have generally ruled that deliveries are protected

State Income Tax Base & Tax Liability Federal Taxable Income (Form 1120 Line 28/30) +/- state modifications (int. on fed. Treasury/ = State Tax Base - Total Net Allocable income/loss (nonbusiness income) = State apportionable income (business income) x state apportionable % + income allocated to state x state tax rate - state tax credits = Net Income Tax Liability for the state

Class #5
Division of tax base: Specific allocation o To the state of its source o attribute the whole to one state Apportionment o Division by formula o Assume elements of business reflect an amount a state may tax Separate accounting 3 approaches to dividing income: Unitary approach Business/non-business method (Indiana) o Transactional test- focus on scope of TP regular trade or business o Functional relationship test- relationship between income, the income producing property, and TPs regular trade or business Whether asset giving rise to the income was integral part of the TPs business or whether it was a short-term investment Type of income o Focus on character of income

May Dept Store v. IDOR Issue: is the gain on the sale of a division apportionable business income? Rule: business income means income arising from transactions and activities in regular course of TP regular course of business/ and includes income from tangible and intangible property if transaction constitutes integral part of TPs regular trade or operations Allied Signal Case Facts: headquartered in Michigan, successor of Bendix. Bendix realized a $211m capital gain on its sale of minority stock interest (20.6%) in ASCARCO, a NJ subsidiary Issue: if gain is business income, NJ can tax part but if the gain is allocable income, it must be allocated to the commercial domicile Analysis: NJ supreme court held the gain was apportionable b/c Bendix had a corporate strategy of acquisition and divestiture as an integral operational activity. The supreme court reaffirmed the importance of the unitary business but said it is not the sole determinant of apportionability. It announced an operational function standard of apportionability. i.e. when the payor and the payee are unrelated, the income is allocated unless it serves an operational rather than an investment function If income is for investment purpose, rather than operational, than it can be allocated Unitary business principle apportion income

Class #6
Unitary business principle: o Recognizes 1) states boroad authority to use formulas to assess a corps intrastate value 2) a states authority to tax is limited to the value fairly attributable to activities in taxing state o Income from unitary business may be apportioned; non-unitary business cant be apportionable Intangible income cant be apportioned if paid by non-unitary business UDITPA Business/non-business approach o Transactional test: focus scope on TPs regular trade or business o Functional relationship test: analyzes relationship between income, the income producing property, and the TPs regular trade or business Asks question whether the asset giving rise to income was integral part of TPs business or whether it was a short term investment Type of income approach: focus on character of income at issue o Ex: Delaware- rent, royalty, and capital gain income is always allocable regardless of relationship of the property that produced it Allied signal o NJ court held that gain was apportionalbe b/c bendix had a corporate strategy of acquisitions

Three factor apportionment Most states use 3 formula factor that equally weighs property, payroll, and sales 20 states use double weighted sales formula that gives sales factor weight of 50% Purpose of giving more weight to sales: o To tax larger % of non-residents income b/c sales are their major activity in the state o Ro provide tax relief for resident companies with more in state property and payroll activities o To avoid voter wrath for higher taxes Property factor o Exclusions and treatment of intangibles Payroll factor o Exclusion of amounts paid to independent contractors Sales factor o Destination rule for sourcing TPP, throwback rule/throwout rule for sourcing TPP, gross receipts v. net receipts, sourcing other than TPP, special industry rules Sales factor (TPP= tangible personal property) Numerator: in state sales/Denominator: sales everywhere Sales: defined as receipts from sales of inventory, services, rent and royalties from licensing intangibles Destination test: assigns receipts from transfers of TPP to numerator of state where property is delivered or shipped to a purchaser Throwback rule: exception to destination rule- receipts from transfers from tPP assigned to numerator of taxing state even if it is not the destination state if TP not subject to income tax or franchise tax measured by income in destination state Income producing activity test: all or nothing test- assigns receipts from transfers of other than TPP to numerator of the state where the greater part of the income producing activity is performed (alternatively, some state assign income to the location of recipient or benefit) Throw-out rule: b/c intangible income is not readily attributed to specific income producing activity, excluded from both numerator and denominator McDonnell Douglas v. FTB Facts: In that case, the seller manufactured aircraft in California and transferred physical possession of the aircraft to its customer's employees in this state. The customer's employees then flew the aircraft to another state or country for use in out-of-state operations. Despite the fact that the purchasers' employees or agents were in the state of California at the time that possession of the aircraft was transferred to them, the court held that the purchasers were not "in this state," if the goods were "destined for use" in another state. In so doing, the court emphasized the drafter's objective of the sales factor: to reflect contributions of the consumer state in the production of the taxpayer's income. Rule: CA state if delivered to CA even if ultimately destined out of state Analysis: for the proposition that "sales of tangible personal property should be apportioned to the state or country of destination, provided the taxpayer is subject

to tax in such state or country. If [not] . . . the sales are apportioned to the state or country from which shipped." In McDonnell Douglas, the court held that if goods are received by a purchaser in California and transported by the purchaser to its place of business in another state, to reflect the purposes of UDITPA and the contributions of the consumer state, the sale should properly be treated as a sale in the destination state. Under the same analysis, if physical possession of goods is transferred by a seller to a purchaser in another state and the goods are taken by the purchaser into California to its place of business in this state, the sale is a California sale unless the seller is not taxable in this state. Because, in such case, the property would not have been delivered in California, to be a California sale, the property must therefore have been "shipped" to meet the conditions of Section 25135(a). Thus, to be consistent with the court's holding, transportation by the purchaser, inclusive of transporting mobile property under its own power, must be considered "shipment" to the purchaser within this state.

Included in Sales Factor All gross receipts from the sale of inventory or services, interest, dividends, rents, sale of assets, and other business income (Sherwin-Williams Case) Property Factor All states use average value for property rather than an existing value when determining the amount to use in the property factor No state includes intangibles property in the factor Property value: valued at average original or historical cost plus the cost of additions and improvements