Court Declines to Hear Challenge to Cities Taxing Beyond Their Borders

February 19, 2008

The U.S. Supreme Court today declined to hear a case involving the taxation of a Michigan business in Washington State. The case, Ford Motor Co. v. City of Seattle, involved $1.7 million in taxes charged by the cities of Seattle and Tacoma on the Ford Motor Co., for its sales to dealers located in Washington State. Although only most of Ford’s wholesale activity occurred outside Seattle and Tacoma, the two cities assessed taxes on 100 percent of the sales.

The Washington Supreme Court had narrowly ruled for the cities. That decision allowed municipalities to reach into the coffers of out-of-state businesses, by permitting them to collect local sales tax on Ford’s Michigan sales to dealers. The state supreme court ignored the long-established rule that business activity cannot be taxed unless there it reaches a minimum level of nexus.

Four justices on the lower court disagreed with the ruling, in a dissent authored by Justice Richard Sanders. He wrote that because transfer of title occurs at delivery in Michigan, the sales at wholesale are not within the city limits and is thus beyond the cities’ power. He also noted that allowing a city to impose a tax on 100% of an out-of-state company’s business subjects the company to double taxation on that income.

This is a violation of the Commerce Clause of the U.S. Constitution, which prohibits burdens on interstate commerce. Justice Sanders correctly concluded: “A local tax is valid only when the tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State.”

Unfortunately, the U.S. Supreme Court decided not to clarify the level of activity that a foreign corporation must meet before being subject to taxation. Their silence may allow municipalities to overtax and overburden businesses thousands of miles away.

We extensively discussed the importance of the physical presence rule in this paper, this letter, and this brief.

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