State taxation of financial institutions: a multidimensional landscape; businesses that could be considered "financial institutions" must be aware that many states have adopted broad economic nexus provisions.

• Author: Awdeh, Lutof

An area that is sometimes overlooked by financial institutions is the array of various economic nexus regimes that are imposed by an increasing number of states. Economic nexus provisions, which often target financial institutions, vary considerably from state to state, and they can trigger income or franchise tax filing responsibilities of which taxpayers are often unaware. A number of states also impose taxing regimes that were established specifically for the purpose of taxing financial institutions.

Two landmark cases, both decided in 2007, that have been instrumental in setting the stage for the expansion of state economic nexus regimes, particularly in the context of financial institutions, are Commissioner v. MBNA America Bank, N.A., and Capital One Bank and Capital One F.S.B. v. Commissioner. (1) MBNA was decided by the Supreme Court of Appeals of West Virginia and involved a Delaware-domiciled bank that provided credit card services to customers. MBNA argued that it was entitled to corporate income and franchise tax refunds because it did not have nexus with West Virginia. However, the court determined that since MBNA continuously and systematically engaged in activities such as direct mail, telephone solicitation, and promotion in West Virginia that produced significant receipts attributable to customers within the state, the bank had nexus with West Virginia under the state's economic nexus provisions.

In Capital One Bank, decided by the Massachusetts Appellate Tax Board and affirmed by the Massachusetts Supreme Judicial Court, it was determined that the two credit card banks at issue had nexus with Massachusetts for purposes of the state's Financial Institution Excise Tax (FIET) since the banks conducted activities with 100 or more Massachusetts residents and had receipts exceeding $500,000 attributable to state sources, thus satisfying the state's economic nexus provisions. (2) In both MBNA and Capital One, a physical presence was not required to trigger nexus for income or franchise tax purposes, provided that the banks were targeting customers within the state and were deriving significant receipts from those customers.

Financial Institutions: Broadly Defined

Taxpayers that may be affected by the various state economic nexus provisions or that may be subject to special taxing regimes aimed at businesses involved in making loans or extending credit are often unaware of how potentially broad the scope is of what can be considered a financial institution. A state's definition of financial institution often includes entities that engage in activities or perform functions that would not generally be associated with traditional banks.

For example, for purposes of the Massachusetts FIET, financial institutions subject to the tax and its nexus provisions include not only banks and savings and loan associations, but also any other corporation in substantial competition with financial institutions that derives more than 50% of its gross income from loan origination, lending activities, or credit card activities. (3) Connecticut's definition of a financial service company is similar to the definition of a financial institution in Massachusetts and provides that a financial service company is any company, other than an insurance company or a real estate broker, that derives 50% or more of its gross income from activities that include loans; investment banking services; management, distribution, or administrative services to or on behalf of an investment entity; actuarial services; and leasing or acting as an agent, broker, or adviser in connection with leasing real and personal property that is the functional equivalent of an extension of credit. (4) New Jersey defines a financial business corporation as a corporation that is in substantial competition with the business of national banks, and that also employs moneyed capital with the object of making a profit by its use as money. (5)

As the above definitions demonstrate, the scope of businesses...