Future of Physical Presence Standard in State Tax Landscape Debated
By Alison Bennett
Publication date: 02/05/2010
Utah State Tax Commissioner R. Bruce Johnson Feb. 4 urged Congress to abandon the physical presence standard for sales taxes and not to consider it for income or business activity taxes in the new economy, as lawmakers look at legislation (H.R. 1083) to require physical presence for certain such activity taxes.
At the same time, Joseph Crosby, chief operating officer and senior director of policy for the Council on State Taxation, said the wide variety of existing state tax laws and regulations are a heavy burden on interstate commerce and need clarification.
Testifying before the House Judiciary Subcommittee on Commercial and Administrative Law, Johnson called the 21st century economy “electronic and borderless.” He said most multistate businesses can and do operate anywhere and any time without the encumbrance of physical presence, and stressed that technological developments have completely reshaped the manner in which business is conducted.
‘Economic Presence’ Standard Urged
In written testimony on behalf of the Federation of Tax Administrators, Johnson said businesses that utilize modern technology to penetrate and exploit a state's market, while they may have less of a physical presence in the state than the locally established business, may have more of an impact on a state's economy.
“Reasonable nexus standards must take that into account,” Johnson said. “That is why the current nexus standard for sales tax collection, requiring a physical presence to justify taxation, is not appropriate in the new millennium for either sales taxes or income taxes. Economic presence, taking into account appropriate apportionment formulae, is the fair way to establish basis for collection and payment of tax.”
The standard set in H.R. 1083 would prohibit states from collecting net income tax and imposing various state-specific business activity taxes unless a business has a minimum in-state physical presence of 15 days per year. The standard also excludes businesses that “conduct limited or transient business activity” and considers their in-state employees, agents, and tangible property as requirements for physical presence, according to text of the legislation.
It was reintroduced by Reps. Rick Boucher (D-Va.) and Bob Goodlatte (R-Va.) in February 2009.
Johnson Addresses Court Rulings
He said the physical presence standard adopted by the Supreme Court 43 years ago “should be abandoned for sales taxes and not even considered for income or business activity taxes.” While the standard was reaffirmed by the court in 1992, Johnson said, “even then the Court recognized that it was an anachronism, and that the standard may have been rejected if brought for the first time.”
Johnson said, “[T]he physical presence test is a relic of a bygone era. To assert that it should be the standard for income or business taxes ignores the massive changes to the way that businesses operate.”
Urging a level playing field, he said that, “while it is true that principles of due process may bear on state tax nexus, the precept that is central to and perhaps most controlling in this area is the Commerce Clause of the U.S. Constitution.”
Although part of the states' sovereign authority to regulate and to raise revenue now resides in the national government, “that government cannot fairly exercise this authority without recognizing how significantly it may impact states and their ability to effectively govern,” Johnson said.
States Seeking Balance
He said what states seek “can be stated simply: a balanced federal policy that may prohibit discriminatory or unfair taxes on interstate commerce, but clearly allows states to require interstate businesses to pay their fair share. We believe this is what the drafters of the Commerce Clause envisioned and we have no doubt that it is achievable without coercive federal mandates.”
COST's Crosby argued that state taxation needs closer federal regulation, arguing that “state tax nexus laws and regulations vary widely and are constantly changing. Over the past few years, such changes have been directed almost exclusively toward extending the reach of state tax jurisdiction.”
These efforts, he said, have implicated many different areas of taxation, including personal income taxes, business activity taxes (e.g., corporate net income taxes), sales and use taxes, and telecommunications transaction taxes. “Due to the serious fiscal shortfalls facing states, the pace of these changes is accelerating,” Crosby said, contending that the “hodgepodge” of laws and regulations “burdens interstate commerce in many ways.”
Multistate Companies Assert Burden
Crosby said states currently have widely varying and inconsistent standards regarding the requirement for employees to file personal income tax returns when traveling to a nonresident state for temporary work periods and for employers to withhold income tax on employees who travel outside of their state of residence for temporary work periods. “Congressional adoption of a national, uniform threshold for the taxation of nonresident workers is urgently needed,” he said.
Crosby also said that changes in the economy over the last few decades have dramatically reduced the barriers to engage in interstate commerce for companies of all sizes, but said this is why certainty should be provided by the federal government.
“The uncertainty created by conflicting interpretations of the Constitutional nexus standard for business activity tax jurisdiction results in unnecessary administrative and litigation expense for both taxpayers and states,” he said.
The third and final witness at the hearing, Walter Hellerstein, Francis Shackelford distinguished professor in taxation law at Georgetown University, Washington, D.C., said in its consideration of the various proposals for limiting, expanding, or otherwise modifying the existing nexus rules embodied in judicial doctrine, the subcommittee should keep in mind that there is no global or “one-size-fits-all-solution” to the problems involved.
No Uniform Solution Seen
“Each of the problems and each of the proposed solutions arises in a different context and a solution for one problem may well be inappropriate for another problem,” he said.
“If the Subcommittee is going to recommend nexus legislation consistent with the legislation's stated goals of ‘fairness’ and ‘simplification,’ it will need to address each problem in the particular context in which it arises with a sensitivity both to the broad tax policy concerns at issue as well as the extremely significant issue of state tax administration, which may vary from context to context,” Hellerstein said.
He said in his view, “Any effort to draft nexus rules that fails to take account of these differences is unlikely to succeed and may do more harm than good. Physical presence sometimes is and sometimes is not the standard for nexus under existing judicial doctrine defining nexus. These judicially crafted rules regarding nexus do not bind Congress.”
He said lawmakers should “start with a clean slate in considering whether, and if so, under what circumstances the physical presence rule for nexus makes sense in a world in which physical presence is becoming less important every day.”
The complete text of this article can be found in the BNA Daily Tax Report, February 5, 2010. For comprehensive coverage of taxation, pension, budget, and accounting issues, sign up for a free trial or subscribe to the BNA Daily Tax Report today. Learn more »
© 2010, The Bureau of National Affairs, Inc.
Future of Physical Presence Standard in State Tax Landscape Debated
By Alison Bennett
Publication date: 02/05/2010
Utah State Tax Commissioner R. Bruce Johnson Feb. 4 urged Congress to abandon the physical presence standard for sales taxes and not to consider it for income or business activity taxes in the new economy, as lawmakers look at legislation (H.R. 1083) to require physical presence for certain such activity taxes.
At the same time, Joseph Crosby, chief operating officer and senior director of policy for the Council on State Taxation, said the wide variety of existing state tax laws and regulations are a heavy burden on interstate commerce and need clarification.
Testifying before the House Judiciary Subcommittee on Commercial and Administrative Law, Johnson called the 21st century economy “electronic and borderless.” He said most multistate businesses can and do operate anywhere and any time without the encumbrance of physical presence, and stressed that technological developments have completely reshaped the manner in which business is conducted.
‘Economic Presence’ Standard Urged
In written testimony on behalf of the Federation of Tax Administrators, Johnson said businesses that utilize modern technology to penetrate and exploit a state's market, while they may have less of a physical presence in the state than the locally established business, may have more of an impact on a state's economy.
“Reasonable nexus standards must take that into account,” Johnson said. “That is why the current nexus standard for sales tax collection, requiring a physical presence to justify taxation, is not appropriate in the new millennium for either sales taxes or income taxes. Economic presence, taking into account appropriate apportionment formulae, is the fair way to establish basis for collection and payment of tax.”
The standard set in H.R. 1083 would prohibit states from collecting net income tax and imposing various state-specific business activity taxes unless a business has a minimum in-state physical presence of 15 days per year. The standard also excludes businesses that “conduct limited or transient business activity” and considers their in-state employees, agents, and tangible property as requirements for physical presence, according to text of the legislation.
It was reintroduced by Reps. Rick Boucher (D-Va.) and Bob Goodlatte (R-Va.) in February 2009.
Johnson Addresses Court Rulings
He said the physical presence standard adopted by the Supreme Court 43 years ago “should be abandoned for sales taxes and not even considered for income or business activity taxes.” While the standard was reaffirmed by the court in 1992, Johnson said, “even then the Court recognized that it was an anachronism, and that the standard may have been rejected if brought for the first time.”
Johnson said, “[T]he physical presence test is a relic of a bygone era. To assert that it should be the standard for income or business taxes ignores the massive changes to the way that businesses operate.”
Urging a level playing field, he said that, “while it is true that principles of due process may bear on state tax nexus, the precept that is central to and perhaps most controlling in this area is the Commerce Clause of the U.S. Constitution.”
Although part of the states' sovereign authority to regulate and to raise revenue now resides in the national government, “that government cannot fairly exercise this authority without recognizing how significantly it may impact states and their ability to effectively govern,” Johnson said.
States Seeking Balance
He said what states seek “can be stated simply: a balanced federal policy that may prohibit discriminatory or unfair taxes on interstate commerce, but clearly allows states to require interstate businesses to pay their fair share. We believe this is what the drafters of the Commerce Clause envisioned and we have no doubt that it is achievable without coercive federal mandates.”
COST's Crosby argued that state taxation needs closer federal regulation, arguing that “state tax nexus laws and regulations vary widely and are constantly changing. Over the past few years, such changes have been directed almost exclusively toward extending the reach of state tax jurisdiction.”
These efforts, he said, have implicated many different areas of taxation, including personal income taxes, business activity taxes (e.g., corporate net income taxes), sales and use taxes, and telecommunications transaction taxes. “Due to the serious fiscal shortfalls facing states, the pace of these changes is accelerating,” Crosby said, contending that the “hodgepodge” of laws and regulations “burdens interstate commerce in many ways.”
Multistate Companies Assert Burden
Crosby said states currently have widely varying and inconsistent standards regarding the requirement for employees to file personal income tax returns when traveling to a nonresident state for temporary work periods and for employers to withhold income tax on employees who travel outside of their state of residence for temporary work periods. “Congressional adoption of a national, uniform threshold for the taxation of nonresident workers is urgently needed,” he said.
Crosby also said that changes in the economy over the last few decades have dramatically reduced the barriers to engage in interstate commerce for companies of all sizes, but said this is why certainty should be provided by the federal government.
“The uncertainty created by conflicting interpretations of the Constitutional nexus standard for business activity tax jurisdiction results in unnecessary administrative and litigation expense for both taxpayers and states,” he said.
The third and final witness at the hearing, Walter Hellerstein, Francis Shackelford distinguished professor in taxation law at Georgetown University, Washington, D.C., said in its consideration of the various proposals for limiting, expanding, or otherwise modifying the existing nexus rules embodied in judicial doctrine, the subcommittee should keep in mind that there is no global or “one-size-fits-all-solution” to the problems involved.
No Uniform Solution Seen
“Each of the problems and each of the proposed solutions arises in a different context and a solution for one problem may well be inappropriate for another problem,” he said.
“If the Subcommittee is going to recommend nexus legislation consistent with the legislation's stated goals of ‘fairness’ and ‘simplification,’ it will need to address each problem in the particular context in which it arises with a sensitivity both to the broad tax policy concerns at issue as well as the extremely significant issue of state tax administration, which may vary from context to context,” Hellerstein said.
He said in his view, “Any effort to draft nexus rules that fails to take account of these differences is unlikely to succeed and may do more harm than good. Physical presence sometimes is and sometimes is not the standard for nexus under existing judicial doctrine defining nexus. These judicially crafted rules regarding nexus do not bind Congress.”
He said lawmakers should “start with a clean slate in considering whether, and if so, under what circumstances the physical presence rule for nexus makes sense in a world in which physical presence is becoming less important every day.”
The complete text of this article can be found in the BNA Daily Tax Report, February 5, 2010. For comprehensive coverage of taxation, pension, budget, and accounting issues, sign up for a free trial or subscribe to the BNA Daily Tax Report today. Learn more »
© 2010, The Bureau of National Affairs, Inc.
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