Beware Ohio's CAT.

• Author: Tapia, Jennifer K.
• Position: Commercial activity tax

Public companies have been involved in interstate commerce for many years. The Internet has made such commerce more accessible to privately held smaller businesses, allowing them to expand their markets and increase sales. However, this increase in interstate commerce has had a negative effect on states that have an income tax system. Most of these tax systems are out-of-date and unable to bring in sufficient dollars to support ever-growing state budgets. This has caused some states to explore new tax systems, such as subjecting flowthrough entities to corporate franchise taxes or establishing a gross receipts tax.

A good example of this is Ohio. For the last several years, it has had a hard time collecting enough tax revenue to support its budget, causing budget and funding cuts. Ohio's previous tax system placed most of the tax burden on manufacturers. The tax system was composed of a franchise/income tax levied on C corporations and a personal property tax levied on every business that held personal property used in a trade or business within the state. This tax system was adequate in the past, when most Ohio businesses were capital-intensive companies. However, the state has seen a shift from a manufacturing-based economy to one more focused on the service sector. This greatly reduced the tax dollars being collected, as service businesses are usually organized as flowthrough entities and are not capital-intensive.

In an effort to increase revenue, Ohio proposed an overhaul of its tax system that resulted in a gross receipts tax, entitled the commercial activity tax (CAT). The tax was enacted July 1, 2005 as part of the state's biannual budget; see L. 2005, H66. The tax is a low-rate, broad-based tax levied on all Ohio taxable gross receipts. Its intent is to shift some of the tax burden from capital-intensive businesses to service-based ones, and also to out-of-state businesses that sell into Ohio. Additionally, the tax provides an incentive to Ohio businesses to sell their products and services outside the state; these gross receipts are not subject to the CAT.

Bright-Line Nexus

A component of the CAT is the bright-line nexus rule, OH Rev. Code (ORC) [section] 5751.01(H)(3). Under P.L. 86-272, a state cannot tax a business for mere solicitation of sales in that state; a physical connection with that state is needed to establish nexus. However, P.L. 86-272 only governs income tax on interstate transactions. In the CAT, Ohio chose to...