An exegesis of the Multistate Tax Commission nexus guideline: the physical presence requirement.

• Author: Gall, Maryann B.

Introduction

1. Background

   In order for a state to impose a sales or use tax collection obligation on a taxpayer, the Commerce Clause of the United States Constitution requires that the taxpayer must have a "substantial nexus" with the state.(1)(*) Unfortunately the Supreme Court has not provided a precise definition of this key term. For example, in Quill Corp. v. North Dakota,(2) the leading Supreme Court case addressing "substantial nexus," the Court held a taxpayer whose only contact with a taxing state was the delivery of goods through common carrier and the licensing of software to customers residing in the taxing state did not have "substantial nexus." In reaching its decision, the Court explained that the bright-line physical presence requirement announced in National Bellas Hess, Inc. v. Department of Revenue of Illinois(3) -- which prohibits a state from imposing use tax collection obligations on out-of-state sellers that have no physical presence in the state -- is consistent with the "substantial nexus" requirement. Quill also hinted that a taxpayer may lack "substantial nexus" with a taxing state, even though it maintains the "minimum contacts" necessary to satisfy the Constitution's Due Process Clause.(4)

   Thus, while Quill provides good general guideposts and teaches that "substantial nexus" requires physical presence, the precise nature of the physical presence is unknown. Consequently, it should be no surprise that this uncertainty has produced significant litigation and a variety of interpretations by the state courts around the country

   In an effort to establish a uniform standard for determining when an out-of-state taxpayer has "substantial nexus" with a state for sales and use tax purposes, the Multistate Tax Commission (MTC)(5) promulgated a guideline entitled "Nexus Guideline for Application of a Taxing State's Sales and Use Tax to a Remote Seller."(6) Although the MTC's Guideline is denominated a "discussion draft" and has not been formally approved by the MTC or any of its member states, it illustrates some of the current thinking on the subject of "substantial nexus" and evidences where the MTC and the states are moving on this critical issue.

2. Overview

   The Guideline is divided into two basic sections: (1) the Guideline statement, which is itself divided into Commerce Clause and Due Process Clause components, and (2) an Examples Section, which illustrates what does and does not constitute "substantial nexus" under the Guideline. The focus of this article is on the Commerce Clause component of the Guideline -- most specifically, the Guideline's definition of "physical presence."

   The Commerce Clause component of the Guideline states that "substantial nexus" exists where "an out-of-state business or its representative is, or is deemed to be, physically present in the taxing State."(7) The Guideline lists nine activities that create or are deemed to create "physical presence" within the taxing state.(8) Owing to subject matter overlap, these nine activities fall into six classifications:

   (1) the existence of real or tangible personal property

   located within the taxing state;

   (2) the existence of intangible property located within

   the taxing state;

   (3) the retention of representatives or employees

   within the taxing state;

   (4) the performance or rendering of services within

   the taxing state;

   (5) the maintenance of telecommunication linkages

   within the taxing state; and

   (6) the existence of other "activities" within the taxing

   state.

   This article analyzes each of these activities in light of the controlling case law to determine whether such "physical presence" in fact creates "substantial nexus," as it has been defined by the courts. The article is intended to identify the relative strengths and weaknesses of the Guideline, as well as to provide a better understanding of current "substantial nexus" law.

   General Observations

   The objective of the Guideline -- to apprise businesses of the restrictions against sales and use taxation that exist as a result of the "substantial nexus" requirement of the Commerce Clause -- is certainly commendable. The Guideline. however, falls short of its goal for three reasons.

   First the Guideline's definition of "physical presence" is more expansive than a majority of courts have found. Secondly,. the Guideline asserts broader taxing jurisdiction than sanctioned by Quill by failing to recognize the brightline physical presence requirement. Lastly, the Guideline destroys the distinction between the Due Process requirement of "minimum contacts" and the Commerce Clause requirement of "substantial nexus." Thus, the Guideline is inconsistent with Quill, representing an unjustified attempt by states to expand their taxing jurisdiction and to increase tax revenues. Adoption of the Guideline in its current version promises to create more confusion than it would eliminate and, for this reason, should cause the member states of the MTC to reject it.

   Nevertheless, there are some aspects of the Guideline's "physical presence" definition that are consistent with the current sales and use tax jurisprudence. Consequently, some provisions of the Guideline have the potential to eliminate some of the uncertainty in this area. The MTC should focus on these because they would be useful for the business community.

   Analysis of the Guideline's Physical Presence Provisions

1. Real or Tangible Personal Property in the Taxing State

   The first Guideline provision states that ownership of real or tangible personal property in the taxing state is sufficient to create "physical presence" and, therefore, "substantial nexus." In general, courts have held that ownership of real or tangible personal property consistently located or maintained within the taxing state is sufficient to create "substantial nexus." For instance, in National Geographic Society v. California Board of Equalization,(9) the Supreme Court held that the taxpayer's maintenance of two offices in California to solicit advertising for its D.C.-based magazine created "substantial nexus" with California and. thus, justified the State's imposition of a use tax on the taxpayer's unconnected mail-order activities in California.

   1. Physical Presence Unrelated to the Activity Being Subject to Tax

      In the wake of National Geographic, courts have found that "substantial nexus" is satisfied, even if the ownership of the property is unrelated to the business or sale at issue. For example, in Steelcase, Inc. v. Director, Division of Taxation,(10) the taxpayer maintained a warehouse in New Jersey, but used it for purposes unconnected with the transactions at issue. Nevertheless, the court still found "substantial nexus" because the taxpayer had a physical connection with New Jersey. Similarly, in Time, Inc. v. Massachusetts Commissioner of Revenue,(11) a tax tribunal held that mail-order sales by Time's Time-Life Books Division were properly taxable because Time operated an unrelated news bureau in Massachusetts and also employed individuals in Massachusetts to solicit advertising for some of its publications.

      Since the first Guideline provision does not specify that the property ownership must be connected with the activity in question, it is consistent with Steelcase and Time.

   2. Temporary In-State Presence

      Courts have generally found that the temporary presence of the taxpayer's property in the taxing state, even if transitory in nature, creates "substantial nexus" when the taxpayer exercises rights or powers incident to ownership but only when the taxpayer itself has a permanent presence in the state.(12)

      For example, in Central Transportation, Inc. v. Tracy,(13) a shipper's processing of its own business equipment and supplies in Ohio generally consumed a few minutes, and in all cases less than a few hours. Nevertheless, the court found "substantial nexus" and imposed a sales and use tax on the goods because such an exercise of rights over property was significant enough to create "substantial nexus" with Ohio. Similarly, in Vinmar, Inc. v. Harris County Appraisal District,(14) Vinmar, a Texas corporation, purchased plastic resin for export to foreign customers. After it purchased the resin, it held the product in its warehouse until import clearances could be obtained. Vinmar's exercise of control of resin, albeit temporary, was sufficient to create "substantial nexus."

      This line of cases, however, does not support a nexus finding when there is no permanent presence in the state of the owner of the property. Thus, the Guideline overreaches in this area.

   3. Presence Limited in Character or De Minimis in Nature

      Courts have refused to find "substantial nexus" when the presence of property in the taxing state is limited in purpose, or when the ownership interest in merely "technical" or de minimis in nature.(15) In Cally Curtis Co. v. Groppo,(16) for instance, the court held an out-of-state company that sold and leased industrial films and videotapes for personnel training did not have "substantial nexus" with the taxing state (Connecticut), even though it technically owned property in the state during the three-day period in which customers could "preview" the film prior to purchase. The court found that such de...