Current corporate income tax developments.

• Author: Ruez, D. Bryan
• Position: State taxes

In late 1995 and throughout 1996, an overwhelming number of state (1) statutes were modified, added and deleted, (2) court cases were decided, (3) regulations were proposed, issued and modified and (4) notices, bulletins and rulings were issued or withdrawn. It is impractical even to attempt to identify most of the activity that occurred in the multi-state corporate income and franchise tax area during that period. Accordingly, this article focuses on significant activities in two areas that affect the majority of taxpayers -- nexus and apportionment formulas -- and highlights legislation, court decisions, regulations and rulings that affect many corporate taxpayers.

Nexus

The state in which an entity is incorporated has jurisdiction to tax the corporation, regardless of the amount of business activity conducted there. Whether a state can tax the income of a corporation incorporated outside its borders depends on the relationship between the corporation and the state in which it is conducting business. When a corporation's income is derived partly from property owned or business conducted in more than one state, the corporation will be subject to tax in a state if sufficient nexus is established with that state. ("Nexus" is the degree of business activity that must be present before a taxing jurisdiction can tax an out-of-state corporation.) As indicated below, identifying whether a taxpayer has established nexus remains an area of controversy.

Licensing Intangibles

No state tax case in recent years has cultivated more controversy than Geoffrey, Inc. v. South Carolina Tax Comm'n,[1] in which the South Carolina Supreme Court held that a Delaware passive investment company whose sole connection with South Carolina was the licensing of a trademark used there by a related corporation, was subject to South Carolina income tax. The court held that the physical presence requirements set forth in National Bellas Hess, Inc. v. Dep't of Rev. of Ill.[2] and Quill Corp. v. North Dakota[3] did not apply because Geoffrey was not a sales tax case. According to the court, licensing of intangibles for use in South Carolina and deriving income from their use met the Commerce Clause's substantial nexus test.

While state officials were delighted when the U.S. Supreme Court denied certiorari in Geoffrey, only a few states took immediate action; however, the number of states implementing Geoffrey-type regulations or rules (e.g., Arkansas,[4]( Florida[5], Massachusetts[6], New Jersey,[7] North Carolina[8] and Wisconsin[9]) has dramatically increased. In addition, a couple of states have proposed the adoption of regulations providing that the in-state licensing of trademarks or trade names creates nexus. Over the past year, in auditing corporations, several states actively asserted the Geoffrey nexus approach; these actions are highlighted below.

* Alabama

While some states have attempted to broaden their nexus standards based on Geoffrey, others have abandoned their efforts to pursue that approach. Alabama issued "emergency regulations"[10] effective for tax years beginning after 1994 (and effective only until Feb. 13, 1996) attempting to impose a Geoffrey-type nexus standard for both corporate income and franchise tax purposes. These regulations were withdrawn for further examination; it is unlikely that the state win reintroduce them, based on the decision in Cerro Copper Products, Inc. v. State of Alabama,(11) which held that there is no nexus without physical presence in the state.

* Arkansas

The Arkansas Department of Finance and Administration (DFA) issued Revenue Policy Statement 1995-2,[12] which provides that royalties received from the management of intangible property constitutes business income under Arkansas law and is thus subject to the state's income tax. In developing its policy position, the DFA interpreted the Supreme Court's refusal to hear Geoffrey as an affirmation that the holding is to be applied by all states.

* Iowa

Rule 701-54.2(422) imposes a corporate income tax based on the use of intangibles in the state. An intangible has an Iowa situs if it becomes an integral part of a business activity occurring in the state. Income from intangible property in the state constitutes income from Iowa sources and subjects the holder to state income tax.

* Massachusetts

Massachusetts Department of Revenue (DOR) Directive 96-2[13] imposes excise (income tax on corporations licensing intangibles in the state. Directive 96-2 codified the DOR's informal policy of asserting nexus when a corporation uses intangible property to generate gross receipts in Massachusetts. Effective for tax years beginning after 1995, the Directive states that a corporations activity must be "purposeful" and not de minimis for nexus to be asserted, and provides that companies licensing canned computer software are not subject to the corporate tax, the DOR's position is that such licenses are actually sales of tangible personal properly.

* Mississippi

In 1996, in an attempt to expand the definition of "doing business" in the state, the legislature introduced HB 756, under which foreign corporations having or deriving income in Mississippi would be subject to state income tax. However, the state legislature faded to timely act on the bill, it died in committee.

* New Jersey

The New Jersey Division of Taxation (DOT) adopted regulations aimed at taxing corporations with no physical presence in the state. NJ. Reg. 18:7-1.9 provides that out-of-state corporations receiving fees from New Jersey companies for licensing trademarks for use there are subject to New Jersey's corporate business tax. Taxpayers have already begun testing the validity of the new regulation. Re/Max International Inc. filed suit in New Jersey Tax Court protesting the DOT's final determination that it owes New Jersey tax; the company has no physical presence in the state and is not licensed to do business there, but licenses its trademark to unrelated corporations doing business in New Jersey.

* North Carolina

The North Carolina DOR proposed regulations attempting to impose income tax on out-of-state financial institutions having income from intangibles in the state, these regulations were rejected by the North Carolina Rules Review Commission (NCRRC).[14]

* Tennessee

Over the past year and a half, the Tennessee DOR has taken the Geoffrey approach in audits and assessed tax, interest and penalties against numerous taxpayers who license trademarks and trade names in the state. In response, several taxpayers have filed law suits that are expected to be heard in late 1997.

Limited Partners and LLC Members

* Alabama

In Rev. Rul. 96-005,[15] the Alabama DOR ruled that a corporate member not doing business in the state) of a limited liability company (LLC) doing business in the state is not subject to the corporation franchise tax, mere ownership of an investment in Alabama does not constitute doing business in the state. The ruling did not address the income taxation of an LLC corporate member operating in Alabama.

* Tennessee

In 1996, the state issued additional rulings holding that an out-of-state corporate partner, whose only connection with the state is the ownership of a limited partner interest in a partnership doing business there, is not subject to Tennessee corporate franchise md excise taxes.[16]

In-State Deliveries in Company-Owned Vehicles

* Massachusetts and Virginia

Courts in Massachusetts[17] and Virginia[18] have ruled in favor of the taxpayer that the protection afforded by P.L. 86-272 extends to companies whose activities in the taxing state are limited to the solicitation of sales of tangible personal property, but deliver their products to customers in the taxing state using their own company trucks. It is not presently clear whether these states will appeal.

Use of In-State Printers

Over the past several years, a number of states have enacted laws exempting some out-of-state customers of in-state printers from certain taxes. In 1996, Connecticut enacted such an exemption; New York and West Virginia issued rulings clarifying that out-of-state customers of in-state printing services are not to be subject to state tax if their in-state activities are limited.

* Connecticut

G.S. Section 12-407 (15), enacted by Act 104 and effective for tax years starting after 1995, excludes from the definition of "doing business" the following activities of an out-of-state company that contracts with an in-state commercial printer for printing and distribution of material: (1) the ownership or leasing of tangible or intangible property located on the in-state commercial printers premises; (2) the sale of any kind of property produced or processed at and shipped or distributed from the in-state printers premises: (3) the quality control, distribution or printing-related activities of the out-of-state company's employees or agents at the in-state printers premises and (4) the activities performed by the in-state printer for or on behalf of the out-of-state company.

* New York

The New York State Department of Taxation and Finance recently ruled[19] that out-of-state customers of printing and mailing list services and promotional materials business are not subject to sales, use or corporate franchise taxes if their contacts with the state are limited. The ruling addresses out-of-state businesses that purchase (1) promotional materials or (2) printing or mailing services related to such materials. If the seller delivers the materials to the buyer's out-of-state customers or to a New York mailer who delivers them outside the state, the following activities in New York will not create...