Current corporate income tax developments.

• Author: Boucher, Karen J.
• Position: Part 1

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

During 2001, 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cases were decided; regulations were proposed, issued and modified; and bulletins and rulings were issued, released and withdrawn.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 article focuses on some of the more interesting items in the corporate income tax areas of nexus, tax base and entity-classification conformity. Part II, in the April 2002 issue, will discuss apportionment, filing methods and unitary groups. Both parts also address other significant income tax and nonincome tax developments.

Nexus

Application of P.L. 86-272

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

* MTC

At its annual meeting, the Multistate Tax Commission (MTC) adopted a resolution amending the MTC Statement of Information Concerning Practices of the MTC and Signatory States Under Public Law 86-272 by deleting section IV.A.20, which had identified as an unprotected activity the shipment or delivery of goods into the state by private or contract carrier.

* California

A court of appeals affirmed (1) a superior court decision that a parent with no contacts in California could be subject to tax based on a wholly owned subsidiary's offices there. Readers Digest Association (RDA) sold magazines into the state; the subsidiary sold or solicited sales of advertising pages in the U.S.

The parties had agreed that the subsidiary was engaged in selling (or soliciting orders for the sale of) tangible personal property (i.e., advertising pages). The court held that the subsidiary was not an independent contractor, because it did not hold itself out to the public as an agent for other magazines; thus, RDA was doing business in California through the subsidiary, subjecting RDA to taxation.

* Iowa

The Department of Revenue and Finance (DRF) amended Iowa Admin. Code, Chapter 52, subrule 52.1(2), to clarify that P.L. 86-272 protection does not extend to brokers, manufacturers' representatives or other persons or entities selling products for another person or entity.

* Iowa

The DRF addressed (2) whether a Nebraska taxpayer whose activities would otherwise be protected by P.L. 86-272 would establish income tax nexus under three scenarios. Under the first case, it ruled that nexus would not be established if a taxpayer paid a management fee to its Iowa subsidiary to compile and consolidate financial statements.

In the second situation, the taxpayer occasionally used legal services provided by the in-state subsidiary and paid fair value. According to the DRF, generally, this would not constitute nexus; however, if the Iowa corporation is authorized to represent the Nebraska taxpayer in non-de minimis activities not protected by P.L. 86-272 as part of the legal services contracted, nexus might exist. In the third case, the DRF ruled that arranging for a contract carrier to pick up and deliver raw material the taxpayer purchased from Iowa suppliers did not create nexus.

* Nebraska

In Rev. Rul. 24-01-01, (3) the Nebraska Department of Revenue (DOR) ruled that deliveries into the state by a company using its own vehicles are protected under P.L. 86-272. Such deliveries, by themselves, do not create nexus for income tax purposes; accordingly, having no other contact with Nebraska other than mere solicitation, the company has no income tax filing obligation with the state.

Trademark/Tradename Companies

* Louisiana

In Kevin Assodates, Inc., (4) which involved the use of a Delaware holding company to reduce Louisiana franchise tax, a court held for the taxpayer. Noting that the plan involved the transfer of assets to Delaware and citing SYL, Inc., (5) the court found that the purpose was to reduce Louisiana tax, a valid purpose. The DOR has appealed.

* New Mexico

The court of appeals ruled (6) that the imposition of gross receipts and income taxes against a Michigan trademark holding corporation did not violate the U.S. Constitution. The case involved a Kmart subsidiary, Kmart Properties Inc. (KPI), to which Kmart had transferred certain trademarks and tradenames (such as the Kmart logo). The subsidiary (which has no business locations in New Mexico) charges Kmart a royalty for their use. Kmart operated almost a dozen stores in the state at the time of the assessments. The transactions allowed Kmart to reduce or eliminate its taxable income in New Mexico, as it deducted the royalty payments.

The court found that the use of the marks within the state's economic market to generate income for KPI established nexus between that income and the state's legitimate interests sufficient to justify imposition of state income tax. The court further found that "the combination of Kmart Corporation's activities in New Mexico, together with the tangible presence of KPI's marks, constitutes the functional equivalent of physical presence" for taxing purposes. Kmart is expected to appeal.

* North Carolina

Effective Jan. 1, 2001, under HB 1157, Laws 2001, royalty payments received for the use of trademarks in the state are income derived from doing business there. In addition, certain deductions for royalty payments resulting from the use of a trademark or similar intangible property made to related members must be added back to net income, or the trademark entity must elect to file and pay the tax.

Other Nexus-creating Activities

* MTC

In September 2001, the MTC issued a response to the Internet Tax Fairness Coalition's document, Business Activity Taxes: Myth vs. Fact. The MTC's position is that businesses have nexus in states in which they have a significant customer base, whether or not they have a physical presence.

* Georgia

Effective for tax years beginning after 2001, the DOR amended Regulation 560-7-7-.03 to provide that a corporation will be deemed to own property or do business in the state whenever it is a partner (limited or general) in a partnership that owns property or does business there. It also provided that a corporation that is a limited partner in a business partnership must include its pro-rata share of partnership property, payroll and gross receipts in its own apportionment formula. The validity of the regulation is questionable, as it runs contrary to case law.

* Iowa

The DRF ruled (7) that the mere holding of a Certificate of Authority does not create income tax nexus.

* Massachusetts

The DOR ruled (8) that the filing of a Massachusetts business trust document with the secretary of state, in and of itself, does not subject that entity to taxation by the state.

* Massachusetts

The supreme judicial court ruled (9) that Adams International Trucks, Inc., which rents and leases trucks through a wholly owned division (Ideal Leasing), has nexus with Massachusetts. From 1992-1996, a portion of Adams's fleet of leased vehicles logged almost 15,000 miles on Massachusetts roads, sometimes making pickups or deliveries. Ideal Leasing also provided lessees with fuel-tax-licensing services. From 1992-1995, Adams purchased 164 fuel tax decals for its vehicles from the DOR.

In addition, Ideal Leasing remits fuel tax to each state and makes quarterly reports of fuel purchases and vehicle mileage. To provide licensing, registration and fuel tax services, Ideal Leasing requires lessees to submit reports detailing the number of miles traveled by each vehicle in each state.

The court concluded that the presence of Adams's vehicles in Massachusetts through its lease agreements established nexus. Adams's contacts were not the result of "the unilateral activity of another party or a third person"; instead, Adams paved the way for lessees to operate the vehicles throughout Massachusetts by providing the requisite registration and licensing services. Moreover, the court found that if Adams itself operated its vehicles within Massachusetts, the income it earned from this activity clearly could be the subject of a corporate excise tax. The fact that a lessee (rather than Adams) drove the trucks within Massachusetts did not dictate a different result.

* Massachusetts

The DOR ruled (10) that a company's provision of accounting, custodial, investment management, shareholder and other administrative services, and the receipt, generation and maintenance of relevant electronic and paper records and reports for investment companies (Funds) organized outside the U.S. does not cause the Funds to be subject to Massachusetts taxation.

*...