The battle over states’ right to tax out-of-state businesses has taken an interesting turn. In three opinions released yesterday, the Ohio Supreme Court ruled that physical presence is not a necessary condition for imposing Ohio’s commercial activity tax (CAT).
The commercial activity tax is not the same as sales and use tax. Instead of taxing each transaction, it is an annual tax imposed on the privilege of doing business in Ohio, and it cannot be passed on to the consumer. Since being implemented in July 2005, in-state businesses with Ohio taxable gross receipts of $150,000 or more per calendar year must register for the CAT. The commercial activity also applies to businesses located outside of Ohio “if the taxpayer has enough business contacts with the state.”
The taxpayers (Crutchfield Corp., Newegg, Inc., and Mason Cos.) involved in the three cases heard by the Ohio Supreme Court challenged the state’s right to impose CAT on revenue earned from sales of products ordered from and shipped to locations in Ohio. None of the businesses have a physical presence in Ohio in the form of real estate or employees. All contended that they lacked a “substantial nexus” with Ohio, and that the state cannot burden a company with taxes unless substantial nexus exists.
Substantial nexus is possible without physical presence
The court disagreed, determining that “CAT’s $500,000 sales-receipts threshold is adequate quantitative standard that ensures that taxpayer’s nexus with Ohio is substantial.” In fact, it maintains that Ohio law “invites the constitutional challenge.”
Under R.C. 5751.02(A), “doing business” is defined as follows:
“Engaging in any activity … that is conducted for, or results in, gain, profit, or income, at any time during a calendar year. … A taxpayer is subject to the annual privilege tax for doing business during any portion of such calendar year.”
Under R.C. 5751.01(I)(3), a bright-line presence in this state exists when a person “has during the calendar year taxable gross receipts of at least five hundred thousand dollars.”
As the Crutchfield opinion notes, “The statute speaks of taxing ‘the privilege of doing business in this state’ without stating an ‘in-state activities requirement,’ much less any reference to the additional requirement of physical presence within the state.” Indeed, “the reference to a ‘physical presence’ requirement is unambiguously absent, and the insistence that the tax is imposed on persons based on the $500,000 sales-receipts threshold is unambiguously incorporated by reference.”
The three businesses had argued that the physical presence precedent upheld by the 1992 United States Supreme Court decision Quill Corp. v. North Dakota prohibits Ohio from imposing CAT on them. The Ohio Supreme Court decisions hold that a tax based solely on gross receipts should apply to everyone who generates gross receipts in the state, not only on those with a physical presence in the state.
State v. federal solutions
In Quill, SCOTUS noted that Congress “has the ultimate power” and “may be better qualified” to resolve the underlying issue, that of the taxation of interstate commerce. To date, Congress has not answered that call. With the recent upheaval on Capitol Hill, it’s hard to predict if or when federal lawmakers will take on internet sales tax and consider one of four existing bills: the Marketplace Fairness Act of 2015, the Remote Transactions Parity Act, or the Online Sales Simplification Act — each of which enables states to tax certain remote sales — or the No Regulation Without Representation Act, which would definitively prohibit that.
So long as Congress fails to provide a solution, states will continue to challenge the existing physical presence precedent upheld in Quill, and taxpayers will continue to challenge state policies that increase their tax burden. As the recent Ohio Supreme Court decisions indicate, the courts are likely play an important role in this issue in the face of Congressional inaction. Indeed, several states are lining up to argue their right to tax remote sales before the Supreme Court of the United States.
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The three Ohio Supreme Court opinions are: Crutchfield Corp. v. Testa, Slip Opinion No. 2016-Ohio-7760; Newegg, Inc. v. Testa, Slip Opinion No. 2016-Ohio-7762; and Mason Cos., Inc. v. Testa, Slip Opinion No. 2016-Ohio-7768.