From Concrete to the Cloud: 5 Events that Shaped US Nexus Law
- March 18, 2016 | Mark Berens
Fair warning for tax law purists and jurists: The information below attempts to capture 60-plus years of complex legal theories, casework, and litigation regarding nexus. Books have been written on these cases; legal careers have been built upon any one of them. Together or separate, they’re very complicated, always dissected, and bitterly argued by highly trained legal and business professionals such as yourselves.
But most of us don’t live in your world. We’re laypeople, and we’re pretty much content to just appear informed and intelligent at bars and parties by borrowing your hard-won knowledge. With that goal in mind, below is grossly simplified background on these five cases --with key takeaways -- to help our kind out when cocktail-party chatter inevitably turns to the history of United States nexus law.
Thank you for your patience.
#1. Northwestern States Portland Cement Co. v. Minnesota
In the 1950s, Iowa-based Portland Cement Company leased office space in Minnesota for its sales reps to solicit orders. With each sale, the orders were sent to and filled back at the Iowa office. However, these transactions led to a tax bill from the host state of Minnesota. This didn’t sit well with Portland Cement, which refused to pay the tax.
By February 1959, the beef had reached the Supreme Court, which upheld the tax by stating that as long as the taxation didn’t discriminate against interstate commerce and was properly apportioned to activities that create nexus within the state, it’s fair.
When word got out, the US business community loudly voiced concern over the rule’s complexity and its presumed negative impact on interstate commerce. Their gripes were legitimate: Suddenly, a business that manufactured a product and filled orders in one location had to figure out how its income could be divided “fairly” among multiple jurisdictions. To keep the peace, Congress enacted a new law. Perhaps too quickly...
Key takeaway: Portland Cement v. Minnesota is generally considered to be the starting point of the great, ongoing nexus debate.
#2. Public Law 86-272
Just seven months after the Supreme Court ruling, Congress enacted the Interstate Income Act of 1959 (commonly referenced as Public Law 86-272). Its aim was simple: to prevent businesses from being taxed by states with which they had minimal contact.
While the hastily passed PL 86-272 wasn’t without its shortcomings (it only provided income tax protection for sellers of tangible personal property whose contacts with the state are limited to solicitation, didn’t protect a taxpayer soliciting or performing services in the state, and didn’t apply to non-income-based taxes), its biggest flaw was that it had no limitation. Because its authors didn’t add a termination date, a law that was originally proposed as a temporary stop-gap solution regarding states’ taxation of business net income is still very much in effect nearly 60 years later.
Key takeaway: While noble in its aim, PL 86-272 was passed too quickly, not fully thought-out, and raises as many questions today (because it’s still valid) as it provides answers.
#3. National Bellas Hess v. Department of Revenue of Illinois
The Bellas Hess case introduced the “bright line” physical presence rule.
Bellas Hess was a Kansas-based catalog retailer making sales in multiple states. One state, Illinois, attempted to collect sales tax. Bellas Hess refused, and (again) the case went to the Supreme Court.
In its 1967 ruling, the Supreme Court said that only businesses with nexus in a state have to collect that state’s sales tax. In short, if you can check off one of these physical presence boxes -- for example, a warehouse, office, retail location, employees, vehicle, etc. -- you have clearly defined, “bright line” nexus.
Key takeaway: By drawing a line in the sand to define nexus, Bellas Hess attempted to bring a single standard to deciding nexus.
#4. Complete Auto Transit v. Brady
Complete Auto introduced a new, multilevel test for determining whether a business tax is lawful.
Michigan-based Complete Auto delivered vehicles to Mississippi dealerships. For “the privilege of engaging or continuing in business or doing business” in Mississippi, the state levied a tax on Complete Auto, which disagreed with the levy.
This case also went to the Supreme Court, which ruled in favor of Mississippi. During its deliberations, the Court established a “four-prong” test to determine the constitutionality of a tax:
- Substantial nexus: There must be a clear connection between a state and a potential taxpayer, enough to impose a tax.
- Nondiscrimination: Interstate and intrastate taxes should not favor one over the other.
- Fair apportionment: There should be taxation of only the apportionment of activity that transpires within the taxing jurisdiction.
- Fair relationship to services provided by the state: The company must enjoy services (such as police protection) while in a state.
Key takeaway: The Complete Auto case brought a more modern and balanced approach in relation to the checkbox, bright-line approach favored by the rule in Bellas Hess.
#5 Quill Corp. v. North Dakota (and Geoffrey Inc. v. South Carolina Tax Commission)
The Quill case brought the added (and current) complexity of computers to the mix.
The Quill Corporation sold office equipment and stationery in the United States, including in North Dakota, through catalogs, flyers, magazine ads, and phone calls. Quill had no physical presence (no sales people or stores) in North Dakota, but did have a computer there, running a software program that some of its North Dakota customers used to check inventory and place orders.
North Dakota said the software created nexus and imposed a tax on Quill; Quill fought the decision. Again, the Supreme Court weighed in and, in 1992, sided with Quill by affirming that software alone doesn’t create nexus (a ruling that Amazon cited for years to justify not charging sales tax for its online sales).
However, the Court left the door open for different theories of nexus, implying that a physical presence wasn’t always required. A year later, that theory was tested...
In 1993’s Geoffrey Inc. v. South Carolina Tax Commission, the South Carolina Supreme Court held that a taxpayer who licensed intangibles for use in the state and derived income for their use could be found to have “substantial nexus” in the state, clearly allowing for nexus without physical presence. Other jurisdictions soon followed.
Key takeaway: Quill left the door open by saying physical presence may not be required to collect sales tax. Geoffrey walked through that door, leading states to wonder out loud, “If physical presence is out the window, what do we do now?” The answer: Let’s rethink everything and call it “economic nexus theory.”
Bonus: “Economic Nexus Theory” (and the Marketplace Fairness Act)
After Quill and Geoffrey, economic nexus theory gained traction. In this theory, greater importance is placed on generated revenues versus physical presence. In short, a business doesn’t need in-state presence but simply income -- at least enough to demonstrate that the entity has “availed itself of the economic markets” in the jurisdiction.
Coupled with economic nexus theory is the Marketplace Fairness Act (MFA). This law would make it easier for a state to collect sales and use taxes from sales made by out-of-state or “remote” (no in-state physical presence) sellers. It’s part of the Streamlined Sales Tax Agreement that a number of states have signed onto. But, so far, MFA is not law.
From Concrete to the Cloud
There you have it, a brief summary of five legal cases (and one theory) of incredible complexity behind what seems to be a simple decision: when and if a business has enough of a presence in a state for it to collect and remit that state’s taxes.
All kidding aside, this is serious business that’s affecting the core of not only our economy but international economies, and will continue to do so until it’s sorted out. In the space of 50 or more years, focus has shifted from Portland Cement to Amazon, from concrete to the Cloud, and back and forth. For the people trying to sort it all out, it’s hard for anyone -- legal scholar or barfly -- to decide which one is easier to pin down.