Court Upholds Commercial Activity Tax

Significant court decisions don’t always wait for publishing deadlines.

I had just finished writing a story on the expansion of nexus by the states (in the December issue of Accounting Today) when the Ohio Supreme Court voted to uphold Ohio’s Commercial Activity Tax against a Constitutional nexus challenge. Its decision in Crutchfield Corporation v. Testa, on November 17, held that the CAT does not require a taxpayer be physically present in the state in order for it to have substantial nexus in the state and be subject to the tax. The court said that the CAT’s $500,000 sales threshold is an “adequate quantitative standard that assures the taxpayer’s nexus with Ohio is substantial.”

Although Gross Receipts Taxes, such as Ohio’s CAT, are on the rise, it’s still unclear what nexus standard the U.S. Supreme Court would apply. Here, Ohio decided not to apply Quill’s physical presence requirement. This is significant because it is the first case to uphold a factor-presence standard for GRTs, according to Reed Smith tax attorneys Paul Melniczak and Jon Maddison. They note that other state GRTs are modeled similarly, so other state courts will likely turn to this decision if and when they review their own statute.

The physical presence test established by Quill applies to sales taxes, but the 1992 decision left unanswered the question as to its application for income tax nexus. Public Law 86-272 limits states’ ability to impose income tax by prohibiting taxing the income of businesses whose only activity in the state is the solicitation of orders, so long as the orders are accepted at and delivered from a point outside the state.

Is there a real difference between an income tax (prohibited by P.L. 86-272) and a business activity tax? Apparently so, as many states have enacted such taxes. In the case of Crutchfield, the court acknowledged that “Crutchfield is based outside Ohio, employs no personnel in Ohio, and maintains no facilities in Ohio. The business that Crutchfield does in Ohio consists solely of shipping goods from outside the state to its consumers in Ohio using the United States Postal Service or common-carrier delivery services.”

The tax commissioner argued that Commerce Clause case law does not impose a physical presence requirement and that as a result, the $500,000 sales-receipts threshold set forth in the Ohio CAT statute satisfied the Commerce Clause requirement of a substantial nexus. The Ohio Supreme Court agreed.

The court felt that the CAT was clearly not a sales tax, because it replaced the income tax, according to Melniczak and Maddison. “Ohio still has a sales tax, and Quill’s physical presence standard would still apply to it,” noted Melniczak. “A sales tax is imposed on people like you and me. When you buy something at CVS, CVS has to collect and remit the tax. It falls on the purchaser, but the vendor has to collect and remit it. A Gross Receipts Tax has nothing to do with the purchaser. It’s measured on the gross receipts of the seller, but the Ohio purchaser does not have any obligation to pay the tax.”

To determine whether the $500,000 was sufficient to find substantial nexus, the court relied on a balancing test from an earlier case, according to Maddison.

“Under that test, we are to weigh the burden on interstate commerce from the tax against the benefit to intrastate commerce,” he said. “What you would expect is that it would be unconstitutional if after the balancing test, the burden outweighs the benefit. The court concluded that the $500,000 threshold does not impose an excessive burden, but it did not tell us why or how it reached that conclusion. It reminds me of the Supreme Court case on obscenity that you know it when you see it. There has to be a line somewhere, but the court didn’t say what the line is or how it would determine it.”

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