Current corporate income tax developments.

• Author: Boucher, Karen J.
• Position: Part 1 - State taxation

This two-part article discusses a plethora of recent state pronouncements issued in the corporate income tax area. Part I addresses nexus and tax base; Part II, in the next issue, examines apportionment, administration and other developments.

During 1999, 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cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn.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, Part I of this two-part article focuses on some of the more interesting items in the corporate income tax areas of nexus and tax base. Part II, in the April 2000 issue, will discuss apportionment, administration and other significant income tax and nonincome 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 and legislation addressed whether a taxpayer's in-state activities fall within the protection of P.L. 86-272.

* Alabama

The Department of Revenue (DOR) issued Tax Policy Letter 99-001,(1) explaining the difference between the state's nexus rules (Reg. 810-27-1-4.19) and the Multistate Tax Commission's "Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272" (MTC Statement). For Alabama tax purposes, owning, leasing, maintaining or using certain property in the state creates nexus only if it is conducted on a regular or systematic basis; however, no definition of "regular or Systematic" is provided in either the MTC Statement or Alabama's policy statement. In addition, the DOR's treatment of intangible personal property is in lieu of the MTC Statement's "unprotected activities," under which nexus is created by entering into franchising or licensing agreements and by selling or otherwise disposing of franchises and licenses.

As to the transfer of property to the franchisee or licensee, the DOR's treatment applies to the selling of "intangible personal property which is neither an isolated nor transient event nor intrinsic to the related" tangible personal property, rather than to the "selling or otherwise transferring of tangible personal property" under the franchise or license, as provided in the MTC Statement.

* Arizona

SB 1235, signed into law as Chapter 191, provides that a taxpayer otherwise protected under P.L. 86-272 will not be subject to income tax as a result of the presence of consignment inventory in the state if: (1) the presence of such inventory is a requirement of the taxpayer's contract with its customer; and (2) the inventory is located on the customer's property. The new law applies retroactively to tax years beginning on and after Dec. 31, 1998.

* California

In Legal Ruling 99-1,(2) the Franchise Tax Board (FTB) addressed the application of P.L. 86-272 to sales from California to Puerto Rico. The FTB found that commerce with Puerto Rico is interstate commerce under P.L. 86-272 and that it should be considered a state for P.L. 86-272 purposes. The FTB concluded that Puerto Rico has no jurisdiction to tax a corporation's Puerto Rico destination sales if the corporation's activities there are limited to solicitation of orders for the sale of tangible personal property. Consequently, the corporation's Puerto Rico destination sales shipped from California will be included in the numerator of the California sales factor under the throwback rule.

Other Nexus-Creating Activities

* Alabama

For tax years beginning after 1999, Act 99-665 provides that every financial institution conducting (1) a credit card business through the issuance of credit cards to Alabama residents or businesses or (2) a business employing moneyed capital coming into competition with the business of national banks, will be subject to tax.

* Louisiana and Oregon

These states joined the MTC National Nexus Program, bringing the total number of states participating in that program to 39. The National Nexus Program is a voluntary disclosure program under which nonfilers or their representatives may contact the National Nexus Program to work out a multistate disclosure agreement.

* Maryland

In three recent cases, the Maryland Tax Court held that an out-of-state affiliate of a Maryland corporation is not subject to state corporate income tax if the affiliate is a nonphantom entity (i.e., if it has some substance). The court ruled that the licensing of trademarks in the state does not constitute substantial nexus as required by the Commerce Clause. Further, the Comptroller failed to follow the proper rulemaking requirements when it amended its policy on taxing foreign trademark subsidiaries. The Comptroller has appealed all three decisions.

SYL, Inc. v. Comptroller of the Treasury(3) involved a Delaware subsidiary holding and managing trademarks, service marks and tradenames. It maintained an office with furniture in Delaware. The corporate and financial records were kept, and mail was received, at the Delaware office. The subsidiary had its own bank account and an employee and the requisites for corporate existence were met. In addition, legal counsel was retained by the subsidiary for purposes of protecting its marks.

Crown Cork & Seal (Delaware), Inc. v. Comptroller of the Treasury(4) involved a Delaware subsidiary that licensed back to its parent trademarks and patents the parent had contributed to it. As in SYL, Inc., the court found that the subsidiary is a viable entity established for valid business purposes, including protecting valuable intellectual property rights from hostile takeover. The subsidiary maintained an office in Delaware, met all corporate formalities, had separate bank accounts and employees performing services under written employment agreements. In addition, the subsidiary received royalty income from third parties (other than its parent or an affiliate) during some of the years in issue.

MCI Int'l Telecommunications Corp. v. Comptroller of the Treasury(5) involved an out-of-state operating company receiving a management fee from a related Maryland company. Again, the court found that the taxpayer was not a phantom corporation. The taxpayer performs income-generating activity (i.e., the transfer of inbound and outbound calls over international territory). Revenues were earned from non-affiliated, as well as affiliated, entities. In addition, the taxpayer has substantial property on its books and has incurred personnel expense through the payment of management fees to its parent.

* North Carolina

DOR Directive CD-99-1(6) provides that a mortgage lender that does not maintain a place of business in the state has nexus for corporate income and franchise tax purposes if it (1) makes more than $5 million in loans secured by North Carolina real property and (2) uses employees, agents or independent contractors to perform services or activities in the state to solicit or finalize such loans. A corporation that invests in a loan by buying it (in whole or in part) from another person does not "make" a loan and does not have nexus.

* North Carolina

In Perkins Restaurants,(7) the Tax Review Board ruled that Perkins was doing business in North Carolina by virtue of its ownership of a limited partnership interest in a partnership doing business in the state.

* Oregon

SB 26, signed into law as Sec. 4, Chapter 30, Laws 1999, provides that out-of-state financial institutions may take, acquire, hold and enforce notes secured by mortgages or trust deeds and make commitments to purchase such notes without being subject to corporate income tax. An out-of-state financial institution also may foreclose the mortgages or trust deeds in the state's courts, acquire the mortgaged property, hold, own and operate the property for up to five years and dispose of the property without being subjected to corporate income tax. These provisions apply to tax years beginning after 1996.

* Tennessee

Under current...