Wayfair and the corporate income tax

Hello, I’m Shirley Sicilian, National Director for State and Local Tax Controversy, and a managing director in the State and Local Tax practice of our Washington National Tax office. I’m also and a member of the Tax Dispute Resolution network. And it’s in that capacity that I’m here with you today to talk a bit about the U.S. Supreme Court’s Wayfair decision. Wayfair was a sales tax case, of course. But its nexus analysis may have implications for other taxes too, including corporate income. And when we apply it that context, we see a few notable distinctions. They involve retroactivity, nexus with the taxpayer, nexus with the income subject to tax, and – indirectly – PL 86-272.

Let’s start with Retroactivity

• Unlike a legislative enactment of a new law, which would generally be presumed to apply prospectively only; a judicial interpretation of an existing law is generally presumed to apply whenever that law applies … retroactively as well as prospectively.
• A whole body of case law exists around those few situations where a decision may not be retroactive, and no doubt smart lawyers will be researching that carefully at some point. In the meantime, the U.S. Supreme Court’s decision itself implied that Wayfair applies retroactively.
• But that doesn’t mean states have to enforce it retroactively.
  • In fact, the Supreme Court suggested that doing so might violate a different constitutional concern – regarding undue burden.
  • So, perhaps in response to the court, or maybe to avoid attracting a congressional override, states have been very careful not to enforce Wayfair retroactively for sales and use tax purposes.
• But – other than in one state, Texas – no such guarantees have been announced for income taxpayers.
  • This may be because a majority rule has emerged from about 11 or so state court cases that the Quill physical presence requirement never did apply in the context of an income tax.
  • To be fair though, that majority rule was not free from doubt in states where it hadn’t been litigated.
  • California is a great example. In the Harley Davidson case – a 2015 case involving the California franchise tax – the California court of Appeal quoted extensively from Quill before it observed, in a footnote, that it need not decide in “this” case whether the Quill physical presence rule applied to the franchise tax. And this is despite the legislature having previously enacted a factor presence economic nexus statute.
• This doesn’t necessarily mean a state will or can immediately apply the new constitutional nexus interpretation retroactively, or even prospectively.
  • Other provisions of the federal constitution limit imposition of a tax. For example, the due process clause may require a state to issues some form of guidance if, and before, it decides to exercise an expanded constitutional jurisdiction.
  • There may be state law limits as well, in statutes or regulations that limit or put some qualifications on state exercise of jurisdiction.
• Until the retroactivity question is explicitly resolved, it may remain an area of some uncertainty for income taxpayers, more-so than sales taxpayers.

The second observation deals with nexus over the taxpayer –

• This is what the Wayfair case was all about. Wayfair tells us that having sales in a state may indicate the seller is “carrying on a business” there, which could mean it has some form of connection – economic or virtual, if not physical – that is sufficient to establish “substantial nexus” and require payment of a tax.
• How do we know when a sale is “in” a state?
  • For sales of TPP – whether we’re talking about sales tax or income tax – the rules are similar. It’s “destination” for sales tax and “where delivered” for income tax. And it’s not usually that hard to figure out.
  • But for sales of services or IP, that’s a different story, especially when the customer itself is a multistate business.
    • For sales tax, with some notable exceptions, the tax doesn’t usually apply to sales of services or intangibles.
    • But for income tax, it does. The rules are different across states – whether it’s COP or MBS. And they are difficult to interpret.
  • So if the proposition is that sales in a state creates some tax obligation there, the question becomes “which state?” It’s not always clear and the answer is different in different states.

The third observation is about nexus with the thing that is subject to tax. 

• In Wayfair, the sellers had conceded that the state had nexus to tax the sale. The court noted this in its decision, and said that “it has long been settled” that a sale has nexus in the state where it’s consummated, so that it can be treated as a local transaction and subject to tax.
• But for income tax, the thing subject to tax is not a sale. It’s income. And the question of whether a state has jurisdiction to tax income is not such a simple one. It’s also not a new one though. We answer this question with the unitary business principle and formulary apportionment. A state can only tax income if it’s arising from taxpayer activity conducted within the state. A state can tax an apportioned share of income arising from taxpayer activity conducted outside the state, but only if that out-of-state activity has some concrete connection (i.e. is unitary with) a taxpayer activity conducted inside the state. The policy rationale for a sales factor is that a sale likely indicates some market activity by the taxpayer, so a state can attribute some income to that activity.
• But in some cases for some taxpayers, sales sourced to a state may not reflect any activity there. And if they don’t, then there isn’t any activity in the state that could give rise to income – meaning – the sale, by itself, may not be sufficient to establish nexus with the income.
• For example, is the place where a customer has customers, or where a customer enjoys a benefit, or where a customer uses a product, necessarily the place where the seller is carrying on its own business?
• In some cases, it may not be. In those cases, that form of sales factor sourcing – based on customer activity – may not be a good indication of where taxpayer activity is taking place that’s giving rise to the income. And in those cases, we may see increased controversy in the future.

Last but not least, PL86-272

• A result of Wayfair is that more taxpayers may have constitutional nexus with more states. In the context of income tax, that could mean more taxpayers will want to consider whether they qualify for PL 86-272 protection. And that could mean PL 86-272 may soon be carrying a heavier load.
• But the federal statute is 60 years old. Arguing over its interpretation feels like fitting a 2019 peg into a 1959 hole. The Multistate Tax Commission has initiated a work group to consider amending its “Statement of Information” regarding PL 86-272, which many states have signed on to, and which hasn’t been amended since 1995.
• There are interpretational opportunities that may not have been necessary to consider before – for both taxpayers and states. And in those cases, we may see increased controversy in the future.

Feel free to contact me at 202-533-3466.