State tax matters for foreign corporations.

• Author: Todorova, Maria

The Experts: Maria Todorova and Eric J. Coffill

Even though state taxation has moved away from the worldwide unitary method, with Alaska being the only state currently requiring use of the worldwide unitary method and only then regarding oil and gas corporations, there are still many situations where non-U.S. companies should be attuned to state (and even local) tax issues.

Question: What is a state's ability to tax a non-U.S. company?

Answer: Each state has its own law as to when a company, U.S. or foreign, is subject to tax, so the law of each state in which a company is doing business must be consulted, and the results will vary among states. However, as a broad proposition, the Commerce Clause of the United States Constitution, as it applies to both U.S. and foreign companies, requires "substantial nexus" in order for a state to impose a filing obligation and a tax. Having a physical presence in a state, e.g., property or employees, will almost always give rise to nexus to tax. More recently, the trend among states is to tax based upon so-called economic nexus, i.e., nexus in the absence of a physical presence in a state. For example, an economic nexus standard now being followed in a growing number of states, including California, is a standard of $500,000 of sales attributable to the state. Other states have different thresholds, such as New York, with a standard of $1 million of sales in the state.

The consequences of not filing returns where a company is subject to tax in a state can be significant. Many states have open statutes of limitation, or extended statutes of limitation, for a state to assess a deficiency in the case of non-filers. Some consequences are more subtle, including where states haves moved from a physical presence standard to an economic nexus standard. In California, for example, a water's-edge election is only valid (the default method being worldwide unitary) if every member of the combined reporting group that is subject to tax makes the election. FTB (the California Franchise Tax Board) recently had to issue guidance to address situations where non-U.S. members of that group that had economic nexus only in California had not participated in the election, which technically would have invalidated the election for all members of the group (FTB Notice 2016-02, September 9, 2016).

Question: What about treaty protection and permanent establishment rules?

Answer: Income tax treaties generally limit a country's...