Current corporate income tax developments.

• Author: Boucher, Karen J.
• Position: State taxation

EXECUTIVE SUMMARY

* Oklahoma became the thirty-seventh state to join the MTC National Nexus Program.

* Courts in seven states addressed the definition of apportionable business income.

* The Florida intangibles tax on accounts receivable is being phased out.

An avalanche of state and local tax statutes, cases, regulations and rulings were issued in late 1997 and throughout 1998. This article focuses largely on corporate state income tax developments in the nexus and apportionment areas, but also highlights other significant corporate legislation, court decisions, regulations and rulings.

During 1998, an overwhelming number of state statutes were added, deleted or modified; court cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn. Because it is impractical to summarize all of these activities, this article focuses on some of the more interesting items in the following four corporate income tax areas: nexus; tax base; and apportionment(1); it also includes some other significant income and non-income tax developments.

Nexus

Application of P.L. 86-272

P.L. 86-272 prohibits a state from taxing a business whose only connection with the state is the solicitation of orders for sales of tangible personal property sent out of the state for approval or rejection, and, if approved, filled and shipped by the business from a point outside the state. Several rulings addressed whether a taxpayer's in-state activities fall within the protection of P.L. 86-272.

Kansas

The Department of Revenue (DOR) ruled that a Texas corporation that licensed the use of software to residents and occasionally held a one- or two-day seminar was liable for corporation income tax.(2) The taxpayer develops and distributes educational curricula (including computer software) for private, public and home schooling; this activity is centralized at its headquarters in Texas. Any income from Kansas would stem from telephone or mail orders to the headquarters for materials shipped from Texas; however, on occasion, the company may hold a one-to two-day educator's convention in Kansas, during which it may sell some incidental items on site.

The DOR noted that only the solicitation to sell tangible personal property is afforded immunity under P.L. 86-272; the leasing, renting, licensing or other disposition of tangible personal property, or transactions involving intangibles (e.g., franchises, patents, copyrights, trademarks, service marks, etc.) or any other type of property are not protected activities. Thus, the license to use software and the holding of seminars in Kansas subjected the taxpayer to corporate income tax.

Massachusetts

In Amgen, Inc. v. Comm'r of Rev.,(3) the Supreme Judicial Court affirmed a decision of the Appellate Tax Board that the taxpayer was liable for Massachusetts corporate income tax because its activities in the state exceeded mere order solicitation. The taxpayer was a Delaware corporation with its primary place of business in California. It developed two new pharmaceutical products; its activities in Massachusetts were primarily the sales of these products. The taxpayer also monitored the research and clinical studies performed in that state, provided multi-day educational seminars, maintained ownership and control of the supplies used in such studies and retained employees to review specific patient charts and answer patient-specific questions. Additionally, the taxpayer was involved in patent infringement litigation in the state.

The taxpayer asserted that these activities were protected, as they were ancillary to order solicitation and, therefore, should not subject the company to Massachusetts taxation. However, the Appellate Tax Board ruled, and the Supreme Judicial Court affirmed, that the activities were not ancillary to the solicitation of orders; rather, they had an independent business purpose. The company was therefore subject to the state's corporate income tax.

* New York

A foreign corporation stores its inventory of food products in unaffiliated public warehouses throughout the U.S., including three warehouses located in New York (the New York Warehouses). The company ships the food products from its processing facilities outside New York to the warehouses by common carrier; unrelated third-party brokers take orders for the sale of food products in New York. The company's corporate offices in another stare approve the orders taken by the independent contractors and arrange for the shipping from the warehouses directly to customers by common carrier. In addition, the company has two sales managers, based in offices located outside New York, who travel to New York once or twice a year for one-week periods to meet customers and inspect the New York Warehouses.

The New York State Department of Taxation and Finance (Department) ruled(4) that the storage of the company's product at public warehouses would not subject it to corporate income tax, if the New York Warehouses are providing fulfillment services for the company and the storage of the company's product in New York is in conjunction with the use of such services. As to the sales managers' activities in New York of inspecting the warehouses, these activities are conducted in connection with the use of the fulfillment services of the New York Warehouses; thus, they would not cause the company to be deemed to be doing business, employing capital, owning or leasing property or maintaining an office in New York.

In addition, even if the sales managers' activities in New York when meeting with customers constitute the solicitation of orders under P.L. 86-272 and Business Corporation Franchise Tax Regulations Section 1-3.4(b)(9), these activities in New York would not cause the company to be taxable. However, it was concluded that insufficient facts were presented to determine whether the sales managers activities in New York are sufficient to subject the company to corporate tax.

* New York

A manufacturing company's primary New York customer operates its manufacturing process using a "just in time" inventory delivery concept. To protect the customer's continued supply, a small quantity (approximately one day's usage) of the company's shipments to this customer are stored in transit at a warehouse operated by a common carrier of freight in New York. The company pays storage and handling charges separate from delivery charges for this service.

In addition, the company uses an account team approach in marketing to this customer. The team includes members from marketing, engineering, finance, manufacturing and quality assurance. Marketing members visit the customer's location on a regular basis, usually at least once a month. To assure the customer's satisfaction, all team members stay in regular contact with the assigned customer, usually by telephone, mail or e-mail, with a face-to-face meeting only once or twice per year.

The Department ruled(5) that the company's account team approach in marketing, as described in the ruling request, made it impossible to determine whether a particular incidental activity is related to the sale that precedes it or the sale that follows it. However, if the account team's activities in New York do not serve any independent business function apart from their connection to the solicitation of orders, they would not subject the company to the corporate income tax. As to the storage of product at an instate warehouse, that activity falls within the fulfillment services nexus exception under New York Tax Law Section 209.2(f) and thus, does not subject the company to the corporate income tax.

* North Carolina

A North Carolina DOR Directive(6) clarifies that P.L. 86-272 does not apply to the franchise tax, because that Federal law prohibits a state from imposing an income tax on income derived in the state by a corporation if its only activity in the state is the solicitation of sales of tangible property. As stated in G.S. 105-114(a), the franchise tax is a privilege tax or an excise tax, not a tax on income. Thus, a corporation protected from the payment of income tax under P.L. 86-272 is not protected from the payment of franchise tax.

* North Carolina

Included in the stare Budget Bill(7) is a directive that the General Assembly's "Revenue Laws Commission shall study the issue of when a corporation is doing business in North Carolina for the purposes of G.S. 105-130.3" (i.e., the corporate income tax).

* Virginia

An out-of-state corporation, employing salespeople in Virginia who solicit sales of its tangible products, established a "car stock program" under which salespeople can acquire inventory on a voluntary basis for resale to the corporation's customers. The salespeople acquire the stock from the corporation or an outside party, hold title and bear all risks of loss. Because of the nature of the car stock program, participation requires that inventory be maintained in the state.

The Department of Taxation determined(8) that the salespeople are not acting as independent contractors when participating in the car stock program and that the following activities conducted under this program were not ancillary to solicitation: acceptance, approval and fulfillment of the car stock program order; maintenance of inventory in Virginia; and collection of some payments for orders. These nonancillary activities, on the whole, were more than de minimis and subjected the corporation to Virginia corporate income tax.

Other Nexus-Creating Activities

* Florida

The authors understands that the Florida DOR withdrew an income tax assessment(9) against Aaron Investment Co., a Delaware corporation that owns certain trademarks used by Aaron Rents. The taxpayer argued that (1) it lacks nexus and (2) even if it were found to be subject to tax, its interest and royalty income is excluded from the sales factor; therefore, it would have no income apportioned to...