11 May 2016 Ohio Supreme Court considers constitutionality of the bright-line factor presence nexus standard under the Commercial Activity Tax On May 3, 2016, the Ohio Supreme Court (Court) heard oral arguments in three consolidated tax cases challenging the constitutionality of the bright-line factor presence nexus standard under the Ohio Commercial Activity Tax (CAT) — Crutchfield1 Newegg,2 and Mason Companies.3 Under the CAT's nexus provision (Ohio Rev. Code Section 5751.01(H)), a person has "substantial nexus" for CAT purposes if any of the following applies: — The person owns or uses a part or all of its capital in Ohio, Ohio Rev. Code Section 5751.01(I) further provides that a person has bright-line presence in Ohio if, at any time during the calendar year, it meets one of the following tests: (a) $50,000 of its property or payroll is in Ohio; (b) $500,000 of its gross receipts are sourced to Ohio; (c) at least 25% of its total payroll, total property or total gross receipts are attributable to Ohio; or (d) it is domiciled in Ohio. The only bright-line factor met by Newegg, Inc. (Newegg), Crutchfield, Inc. (Crutchfield) and Mason Companies (Mason) was the $500,000 Ohio sales factor threshold for the periods at issue. Crutchfield, Newegg and Mason are unrelated on-line retailers that conduct all of their operations outside of Ohio with no physical presence in Ohio during the tax periods at issue. Each out-of-state retailer, however, sold more than $500,000 of products to Ohio customers. As a result, the putative taxpayers were assessed CAT for periods going back to the CAT's inception on July 1, 2005, and received final determinations on those assessments that were appealed to the Ohio Board of Tax Appeals (BTA). In early 2015, the BTA affirmed the Tax Commissioner's determinations, holding that each of the out-of-state retailers was subject to the CAT based solely on their having exceeded the statutory $500,000 sales threshold.4 The out-of-state retailer challenged the assessment, arguing that the CAT's bright-line nexus provision, which imposes the tax based solely on whether a putative taxpayer meets a statutory $500,000 gross receipts threshold from sales to Ohio customers, irrespective of whether the putative taxpayer has an in-state presence, is facially unconstitutional in violation of the substantial nexus requirement of the Commerce Clause. Specifically, the issues before the Court are: — Does Ohio's CAT violate the US Constitution's Commerce Clause by imposing the tax on businesses that have no physical presence in Ohio? On May 3, 2016, the Court heard arguments in Crutchfield, Newegg and Mason. Martin Eisenstein, with Brann & Isaacson, represented the taxpayers while Daniel Fausey, Assistant Attorney General, represented Joseph W. Testa, Tax Commissioner of the State of Ohio. Over the course of the hour-long argument, all of the justices actively questioned both attorneys. Both Eisenstein and Fausey cited the US Supreme Court's (USSC) ruling in Tyler Pipe5 as the leading case. Eisenstein asserted that Tyler Pipe looks at the activities within the state, noting that merely having customers in the state is not enough to create nexus under the Commerce Clause. Fausey asserted that the companies took the steps to establish and maintain a market in Ohio within the scope of Tyler Pipe. The Court's questioning of Eisenstein focused on whether software of the out-of-state retailers was stored in the state and, if so, whether that was sufficient to create nexus. Eisenstein responded that the companies' performed all of their commercial activities outside of Ohio and over the internet with advertising being conducted on a national basis. Eisenstein further stated that, for Commerce Clause purposes, the activities have to be performed on behalf of the companies in the state to prevent undue burden. Eisenstein noted that, under Tyler Pipe, the USSC made clear that there must be some activity in the state on behalf of the putative taxpayer that are connected to establishing and maintaining a market. The Court also asked whether any of the USSC opinions on nexus addressed e-commerce, noting that the way we do business today is a lot different from years ago. Eisenstein cited Quill, arguing that advertising over the internet is the same as the delivery of catalogs at issue in Quill. One Justice suggested that no matter the outcome of this case, it is going to go up to the USSC and asked which of the Quill justices were still on the USSC today. Again the Court focused on the way business is done today, and whether the new way of doing business presents a different question that it must consider. The Court also asked about the out-of-state retailers' data storage in the state, notably the tracking cookies that create pop-up advertising on computers and smartphone devices, and asked whether the software on the customers' computer was enough to create a presence under these rulings. Eisenstein responded that it was not sufficient to create a presence as the software was an intangible used to help communicate with instate customers and did not establish or maintain a market as required by Tyler Pipe. The Court asked if other jurisdictions have enacted a CAT and wondered how hard it would be if a taxpayer had to pay a CAT in every state. Eisenstein said it would be hard because of all the local jurisdictions and could create double taxation. The Court questioned both attorneys on whether they thought Congress could enact a law to remedy this nexus issue, and asked if such a bill was pending in Congress. Fausey began his argument on behalf of the state by addressing the comment that these businesses are not doing business in Ohio, noting that they had millions of dollars of sales to customers located in the state. In response to the Court's question on the out-of-state retailers' presence in Ohio, Fausey asserted that putting aside that in his view physical presence was not required and that the out-of-state retailers have "plenty" of physical presence in Ohio, they had a presence in the state via data harvesting — monitoring the activity of people in Ohio. The Court asked about the location of the computer used to monitor such activity and wanted to know why this activity differs from how catalog sales were performed. Fausey distinguished the two, explaining that a catalog is paper that comes in the mail while the computer software is stored locally on the customers' computer. The Court then asked whether this happens in the cloud. Fausey responded that it doesn't matter where the computer is because it is an Ohio customer. The Court pointed out that, if the out-of-state retailers had a physical presence, "we wouldn't be here," and asked Fausey if the state is relying on the software, cookies, etc. or if the legislature was relying on the threshold. Fausey responded that it was a layered approach, and noted that the taxpayer used third parties. The Court also asked Fausey whether the state would collect tax on all sales if the companies were present in Ohio. Fausey responded that tax would be imposed only on receipts sitused to Ohio. The Court also asked Fausey why this isn't an issue that Congress should resolve. Fausey asserted that the bright-line nexus standard is not an overreach. The CAT was revamped to fix issues with the franchise tax. Regarding whether the CAT would be a burden when local jurisdictions were considered, Fausey said it was not. Justice O'Connor posed an interesting hypothetical for the state's attorney about whether the CAT was appropriately designed as a tax for the privilege of doing business. He questioned whether a taxpayer with all of its property and all of its employees located in Ohio but all of its sales outside the state (starting with $100 million and then stating $1 billion) would be subject to the tax. Fausey responded that it would pay nothing, with the Justice asking how rational it was for the legislature to design a tax for the privilege of doing business that imposed nothing on a business performing substantial and significant activities in the state. The Court also asked Fausey whether sales and use tax was being collected on the sales into Ohio, and if any states are collecting sales and use tax on internet sales. Fausey explained that some states are moving forward on this, and noted Justice Kennedy's concurring opinion in Direct Marketing Association that Quill should be revisited. In response to the Court's question on whether it should follow Quill's physical presence requirement under stare decisis, Fausey citied the Court's ruling in Couchot6 that Quill doesn't apply outside the context of sales and use tax. Additional information on the cases, including briefs, case activity and oral argument playback information is available on the Ohio Supreme Court's website. — Click here for the Ohio Supreme Court's Crutchfield case information webpage. Questioning in the case was fairly even, the Justices seemed well prepared and left no clear indication of which way they would rule or when the Court may issue its opinion as it is not bound by a specific period in which to release its opinion. What is clear, however, is that regardless of the outcome of this case, the ruling likely will be appealed to the USSC by either party. Moreover, the question of whether the CAT's bright line presence nexus standard is constitutional will not be finally resolved for a few more years. In the meantime, taxpayers should consider their procedural options, such as filing protective refund claims to preserve rights if the CAT nexus standard is ultimately ruled unconstitutional.
Document ID: 2016-0847 | |||||
