On February 7, 2019, the Ohio Court of Appeals for the 10th Appellate District (appeals court) affirmed the Ohio Board of Tax Appeals' (BTA) ruling in Greenscapes Home and Garden Products, Inc. v. Testa,¹ that an out-of-state corporation with no physical presence in Ohio is subject the Ohio Commercial Activity Tax (CAT) because application of the state's sourcing provisions satisfied one of the CAT's bright-line presence factors (i.e., the $500,000 Ohio receipts factor). The appeals court also found that the application of the CAT to the corporation's sales does not violate Due Process when the corporation, by purposefully distributing its products through national retailers, knew that its products would be shipped to Ohio.

Greenscapes is a Georgia-based corporation and had no locations or other physical presence in Ohio. It sold lawn and garden products to big box retailers that have distribution centers and retail outlets in Ohio. When one of its big box customers placed an order, Greenscapes was provided with a delivery address. Greenscapes prepared a bill of lading, but was not responsible for shipping. The customer would arrange for a carrier to pick up the product at Greenscapes' sole facility located in Georgia. Upon loading on the carrier's truck, the goods became the customer's property and Greenscapes had no ability to track the final destination of the products.

The Ohio Department of Taxation (Department) made nexus inquiries of Greenscapes, which, in response, initially registered for the CAT and began filing returns and paying CAT taxes for the years 2011 through 2012. The Department then issued an audit commencement letter to Greenscapes. After some preliminary correspondence, Greenscapes declined to participate in the audit and stopped filing returns. The Department issued an assessment for the audit period that went back to 2007. Greenscapes appealed the assessments and filed refund claims for the returns it did file. The Department affirmed the assessments and denied the refund claims from which Greenscapes appealed to the BTA. The BTA, however, affirmed the Department's actions.

The assessment was based on an application of Ohio Rev. Code Section 5751.033(E), which sources receipts from sales of tangible personal property to Ohio to the place where it is ultimately received after all transportation is completed. In applying the sourcing statute, the Department also relied on two Ohio Supreme Court decisions: Dupps Co. v. Lindley² and House of Seagram, Inc. v. Porterfield,³ applying a similar sourcing statute relating to the former Corporation Franchise Tax. Those cases involved taxpayers that were filing Ohio franchise tax returns and the controversy revolved around whether certain dock sales with an Ohio destination should be included in the Ohio sales factor numerator. The Ohio Supreme Court held that customer-provided transportation was considered transportation for purposes of applying the sourcing rule. In Greenscapes' case, the Department concluded that once receipts were sourced to Ohio, one of the CAT's bright-line presence factors (i.e., the $500,000 Ohio receipts factor), was satisfied, triggering nexus for CAT purposes.

Greenscapes appealed. It argued that the assessment violated both the Commerce Clause and the Due Process Clause of the United States Constitution. In rejecting Greenscapes' Commerce Clause objections, the appeals court relied on the Ohio Supreme Court's decision in Crutchfield Corp. v. Testa,⁴ and the United States Supreme Court's decision in South Dakota v. Wayfair,⁵ and noted that physical presence is not required to have nexus for CAT purposes.⁶ The appeals court then noted that the Ohio Supreme Court found in Dupps and House of Seagram that there was "ample nexus to support the tax in question." However, those cases held that the sourcing statutes were constitutionally applied for purposes of the measurement of the tax liability, not nexus. In both cases, the appeals court noted, the taxpayers had nexus and were already filing returns. Nonetheless, the appeals court held that Greenscapes had nexus for CAT purposes based on the application of the sourcing statute as informed by those Corporation Franchise Tax decisions with the resultant triggering of bright-line presence nexus under the CAT statute.⁷

The appeals court also rejected Greenscapes' Due Process objections. Greenscapes relied on Asahi Metal Industry Co. v. Superior Ct. of California,⁸ arguing that the passive knowledge that goods may end up in Ohio is not sufficient to satisfy the "purposefully directing" standard under the Due Process clause jurisprudence. The appeals court rejected this argument and cited other, lower federal court decisions addressing due process jurisdiction in product liability cases in which it was concluded that a company that sold products to a national retailer for resale to customers in the forum state had purposefully availed itself of the forum state. Because Greenscapes had purposefully taken advantage of the distribution ability of national retailers, The appeals court concluded, it knew that its products would be shipped to Ohio, and this knowledge was sufficient to satisfy Due Process.

Implications

The taxpayer has the right to appeal this decision to the Ohio Supreme Court. Since this decision comes from a county court of appeals instead of the BTA, the Ohio Supreme Court's jurisdiction is discretionary. It is not known at this time whether the taxpayer will appeal.

The appeals court often cited Wayfair, which critiqued the efficacy of the Quill⁹ physical presence requirement as applied to remote retailers that maintain a "continuous and pervasive virtual presence" in a state to generate sales to end consumers. By contrast, a wholesaler such as Greenscapes does not sell to end consumers but instead sells to other businesses — in this case, big box retailers. The appeals court did not address this distinction in describing the taxpayer's connection to the in-state marketplace.

In the wake of the U.S. Supreme Court's ruling in Wayfair,¹⁰ states are asserting bright-line "factor presence" economic nexus standards for many different kinds of state taxes other than sales tax, which was the object of that decision. The U.S. Supreme Court, however, has not opined on the constitutional viability of a bright-line standard as a per se determinant of nexus.¹¹ Bright-line sales factor thresholds, in particular, should give pause to any business undertaking an economic nexus analysis. The states' disparate sourcing rules (which were not designed to impose jurisdiction but to divine a fair apportionment of income) now appear to be used by the states to determine a presumption of a nexus, which could result in similarly-situated taxpayers being treated differently.

In this way, the appeals court's decision appears to conflate an Ohio sourcing statute with nexus principles without regard to applicable Due Process nexus standards. Even with the rejection of physical presence as an applicable nexus standard, it is still unclear whether destination sales, without more, are sufficient to create nexus for state tax purposes. The Ashai Metal decision, along with other decisions addressing the Due Process clause, such as J. McIntyre Machinery Ltd.,¹² raise the question of whether placing an item in the stream of commerce, without more, is sufficient to satisfy Due Process for state tax purposes.

Finally, Ohio's statute for sourcing receipts from sales of tangible personal property represent one side of a long-standing debate over the application of the destination sourcing concept. Ohio, like other states, situses such receipts according to where property is "ultimately received." In the facts of Greenscapes, the Department determined that some goods were sitused to the taxpayer's customers' distribution centers, which were located in Ohio. The appeals court noted the taxpayer's knowledge that its big box customers sell to consumers in Ohio, but did not analyze the connection between a retailer's logistical operations and its sales to consumer markets actually in Ohio. As states are trending towards using sourcing statutes to assert nexus, in addition to measuring a taxpayer's liability, this will continue to be an area of controversy.

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ENDNOTES

¹ Greenscapes Home and Garden Products, Inc. v. Testa, No. 17-AP-593 (Ohio Ct. App., 10th App. Dist., Feb. 7, 2019).

² Dupps Co. v. Lindley 62 Ohio St.2d 305 (1980).

³ House of Seagram, Inc. v. Porterfield, 27 Ohio St.2d 97 (1971).

⁴ Crutchfield Corp. v. Testa, 151 Ohio St.3d 278 (2016).

⁵ South Dakota v. Wayfair, 138 Sup. St. 2080 (2018).

⁶ In those cases, both involving remote internet sellers, the courts' decisions turned not only on the fact that there were sales with the destination states that were imposing the tax, but also on the remote sellers' substantial virtual presence in those taxing states based on their internet presence and that they were purposefully directing activity to establish markets in those states, thus establishing nexus under the Commerce Clause. In Crutchfield, the Ohio Supreme Court also concluded that the CAT's $500,000 bright-line receipts threshold did not impose undue burdens on interstate commerce.

⁷ The court did not address whether the application of the tax in this case created undue burdens on interstate commerce.

⁸ Asahi Metal Industry Co. v. Superior Ct. of California, 480 U.S. 102, 112-113 (1987).

⁹ Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

¹⁰ See EY Tax Alert 2019-0305.

¹¹ In fact, the holding in Wayfair actually concluded that a different bright-line test (the physical presence requirement originally set forth in Quill) operated to "treat[] economically identical actors differently, and for arbitrary reasons" and for that reason was struck down under the Commerce Clause.

¹² J. McIntyre Machinery Ltd. v. Nicastro, 131 S. Ct. 2780 (2011).