Nexus through the presence of intangibles.

• Author: Dennen, Sylvia

Most corporate taxpayers are familiar with the Supreme Court's decision in Quill Corp. v. North Dakota, 112 Sup. Ct. 1904 (1992), in which the Court held that a mail-order seller could not be required to collect a state's sales or use tax unless the seller had a physical presence in the state. The issue of whether the "physical presence" standard is applicable only to sales and use taxes has not been definitively answered. In part as a result, states that have been forced to forgo use tax revenue are attempting to impose income tax filing responsibility on companies deriving income through the presence of intangibles.

On July 6, 1993, in Geoffrey, Inc. v. South Carolina Tax Commission, No. 23886 slip op. 11993), the South Carolina Supreme Court held that a corporation had taxable nexus in the state because it derived royalty income from the licensing of its trademarks and trade names to Toys R Us in South Carolina. The court found sales made by Toys R Us through its retail outlets in the state created an account receivable and Geoffrey's licensing agreement with the company resulted the creation of a franchise. According to the court, the Quill "physical presence" test applied only to sales and use taxes; therefore, the presence in the state of the intangible account receivable and a franchise was sufficient nexus for the imposition of income tax on Geoffrey. Geoffrey was appealed to the Supreme Court, which declined to review it.

Assuming for argument's sake that the Supreme Court in Quill did intend to establish the "physical presence" test only for sales and use taxes, it does not necessarily follow that a mere economic presence or the presence of intangibles in a state will confer nexus under the Commerce Clause of the U.S. Constitution. The Supreme Court distinguished nexus requirements under the Due Process and Commerce Clauses in Quill; any purposeful exploitation of a market is sufficient under Due Process, but the Commerce Clause requires a "substantial presence." It is possible that a substantial presence may be found through activities not requiring a physical presence, but the Court did not define "substantial presence." Could, for example, the creation of an...