Expanding the scope of delivery under Public Law no. 86-272.

• Author: Peric, Gary

In today's atmosphere of stagnant or declining tax revenues and slowly recovering economies, many state taxing authorities have become aggressive in pursuing net income taxes from corporations that are not legally or commercially domiciled in the state (hereinafter referred to as "multistate businesses"). By focusing on nexus standards that are not based on physical presence, many states have increased the risk that a multistate business's activity in a state creates an income tax filing obligation. In addition, the adoption of 100-percent sales-factor apportionment and severely punitive penalty regimes in some states has increased the potential costs of nonfiling.

Since 1959, certain multistate businesses have been able to rely on the protection afforded by the Interstate Income Tax Act of 1959 (commonly referred to as Public Law No. 86-272) to avoid filing net income tax returns. (1) Specifically, Public Law No. 86-272 prohibits a state from imposing a tax based on net income on a multistate business whose only state activities are (1) solicitation of orders for sales of tangible personal property, and (2) shipment or delivery of that property, if (3) the orders are sent outside of the state for approval and fulfillment.

In 1992, taxpayers and the states were given guidance on the meaning of the term "solicitation" for purposes of Public Law No. 86-272 when the Supreme Court of the United States decided Wisconsin Department of Revenue v. William Wrigley, Jr., Co. (2) The Court has not, however, provided equivalent guidance on the scope of "delivery," another key element of Public Law No. 86-272. Consequently, a number of states have sought to narrow the term "delivery" to include only the shipment of goods from a location outside the state via a third-party common carrier.

These efforts, however, are subject to challenge. Indeed, the scope of statutorily protected "delivery" is arguably significantly greater than the shipment or delivery of goods from outside the state via common carrier. Specifically, if delivery for purposes of Public Law No. 86-272 were construed under the same legal analysis that the Supreme Court in Wrigley applied to "solicitation," the scope of protected delivery would include not only delivery, but also activities ancillary to delivery. In other words, the dividing line between those protected and unprotected activities would, as is the case in respect of "solicitation," be between those activities that serve "no independent business function" other than delivery and those activities that the multistate business "would have reason to engage in anyway," but allocates to its instate delivery function.

Given the more than 50 years of authority and practice favoring a narrow interpretation of "delivery" under Public Law No. 86-272, this interpretation might be viewed as potentially impractical or spurious. There are a number of situations, however, where the protections provided by Public Law No. 86-272 should be construed as significantly broader than generally recognized, including situations where (1) the multistate business's presence in the state is directly related to delivery, such as the presence of company-owned delivery vehicles; and (2) the multistate business's presence in the state is entirely ancillary to the delivery of the company's goods in the state, such as the presence of reusable containers, and to delivery that includes certain scenarios with the presence of inventory in a state as well as some backhauling.

Statutory Background

Public Law No. 86-272 originally was enacted as a stopgap measure. (3) It followed closely on the heels of a controversial 1959 decision of the Supreme Court of the United States in Northwestern Cement v. Minnesota. (4) In that case, the Court ruled that net income from the exclusively interstate operations of a multistate business may be subjected to state taxation, as long as the levy is not discriminatory and is properly apportioned to local activities within the taxing state that create nexus. In the wake of that decision, businesses and Congress expressed concerns about the uncertainty it created for multistate businesses regarding the level of local activity required to impose net income tax.(5) The federal statute was passed in response, providing in part:

No State ... shall have power to impose ... a net income tax on the income derived within such State by any person from interstate commerce if the only business activities within such State by or on behalf of such person during such taxable year are either, or both, of the following:

(1) the solicitation of orders by such person, or his representative, in such State for sales of tangible personal property, which orders are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State.... (Emphasis added.)

The law also mandated a congressional study of state taxation of interstate commerce, which led in 1964 to a report commonly known as the Willis Commission Report. (6) The multivolume report highlighted some of the ambiguities in Public Law No. 86-272:

The primary area of ambiguity in the statute revolves around the terms "solicitation" and "delivery"--the question of what kinds of activity may be considered an integral part of the process of solicitation and sale..... [A]lthough the statute makes it clear that delivery of goods into a State does not deprive the selling company of statutory immunity, there can be doubt about the meaning of delivery.

The drafters of the Willis Commission Report expressed uncertainty over whether installation work (which could include jobs requiring five minutes or five weeks), a retention of a security interest in the goods sold, or warranty repairs that take place on a customer's premises could be considered within the scope of protected delivery.

Supreme Court's Consideration of "Delivery"

The Wrigley case in 1992 was not the first time the Supreme Court weighed in on Public Law No. 86-272. Two decades before, it considered the scope of the statute's protection in Heublein, Inc. v. South Carolina Tax Commission. (7) The taxpayer in that case arranged its business in South Carolina to solicit sales and to conform to the regulatory requirements of South Carolina's Alcoholic Beverage Control Act. To comply with this regulatory regime, Heublein shipped inventory into the state consigned to its employee representative. Once the inventory was received, the employee representative was required to obtain permission from the South Carolina Alcoholic Beverage Control Commission before transferring it to the local wholesaler.

Based on these activities, the state imposed income taxes on Heublein, and the company sued to recover its payments. In ruling for the state, the Supreme Court said the question was whether South Carolina's regulatory regime for liquor control "serves legitimate state purposes other than assuring that the state may tax the firm's income." Holding that the regulatory regime was...