February 16, 2022
California Franchise Tax Board TAM discusses application of P.L. 86-272 to activities conducted over the internet
In Technical Advice Memorandum 2022-01 (FTB TAM 2022-01) (issued February 14, 2022), the California Franchise Tax Board (FTB) advised on applying P.L. 86-2721 to "fact patterns that are common in the current economy due to technological advancements … " (i.e., activities conducted over the internet and telecommuting). P.L. 86-272 is a federal law that prohibits states from imposing state income tax on out-of-state sellers whose in-state activities do not exceed soliciting orders of tangible personal property.
The FTB's positions on protected and nonprotected internet activities largely follow those expressed in the recently revised Statement of Information concerning practices of the MTC and supporting states under P.L. 86-272 (Statement) issued by the Multistate Tax Commission (MTC), without specifically adopting or referencing the Statement.
In 2018, the US Supreme Court held in South Dakota v. Wayfair 2 that a physical presence was not required under the dormant Commerce Clause in order for a state to require an out-of-state seller to collect sales taxes. Following this ruling, the MTC began revising the Statement, which it first issued in the 1980s and updated periodically "to address changes that have occurred during the past two decades in the economy and the way that business is conducted." Although the Wayfair Court was not interpreting P.L. 86-272, the MTC said in the Statement that states supporting the revisions "consider the Court's analysis as to virtual contacts to be relevant to the question of whether a seller is engaged in business activities in states where its customers are located for purposes of [P.L. 86-272 ]." In the FTB TAM 2022-01, the FTB said California also considers the Court's analysis in Wayfair relevant.
On August 4, 2021, the MTC approved the revised Statement, adding a section on activities conducted over the internet and updating its already existing list of unprotected activities to include telecommuting. For a detailed discussion of the Statement, see Tax Alert 2021-1608.
FTB TAM 2022-01 addresses how out-of-state sellers should apply P.L. 86-272 to common fact patterns seen in the current business environment as a result of technological advancements. The business in the TAM's fact patterns (1) makes sales to California customers, (2) is commercially domiciled in another state, and (3) only has California activities mentioned in the fact patterns.
Under FTB TAM 2022-01, the FTB views protected business activities for purposes of P.L. 86-272 to include:
Under FTB TAM 2022-01, the FTB views unprotected business activities to include:
FTB TAM 2022-01 includes the FTB's reasoning as to how it determined whether each fact pattern is a protected or an unprotected activity.
The FTB concluded the TAM by stating "an Internet seller is shielded from taxation in the customer's state if the only business activity it engages in within that state is the solicitation of orders for sales of tangible personal property, which orders are sent outside that state for approval or rejection, and if approved, are shipped from a point outside of that state."
Out-of-state businesses conducting activities that were not previously listed as unprotected activities in the FTB's Publication 1050, should consider evaluating their California activities and determine whether those activities continue to fall within that protection. In particular, businesses should consider whether their company website and business activities transacted over the internet constitute activities that are now unprotected activities under FTB TAM 2022-01.
The applicability of FTB TAM 2022-01 to prior years remains unclear, as it does not include an effective date, or address the provisions and applicability of the current FTB Publication 10504 guidance. Thus, it is currently unclear whether the FTB will apply FTB TAM 2022-01 prospectively or retroactively. If a business has not previously filed tax returns in California, the applicable statute of limitations has not begun to run; taxpayers may wish to consider California's voluntary disclosure program to limit past liabilities and penalties in light of this new guidance. Also, California's definition of throwback sales may have interesting implications for California businesses making sales out of state in light of the P.L. 86-272 limitations in FTB TAM 2022-01.
1 Currently codified at 15 U.S.C Section 381.
2 South Dakota v. Wayfair, Inc., 585 U.S. ___; 138 S. Ct. 2080 (2018).
3 P.L. 86-272 protection would still apply if the telecommuting employee's activities in California were limited to the solicitation of orders for sales of tangible personal property or are entirely ancillary to the solicitation.
4 FTB Pub. 1050, Application and Interpretation of Public Law 86-272.