State Nexus Debate Enters New Phase

July 12, 2007

The Supreme Court’s refusal to hear the case of FIA Card Services v. Tax Commissioner of the State of West Virginia—a case we urged the Court to take—means that the debate over nexus enters a new phase. With a new bill introduced by Senators Schumer and Crapo (S. 1726), Congress will now decide whether physical presence will be the nexus standard for the 21st century or whether the current system of doubt and confusion will continue.

Not that there is a lot of doubt among state officials. They believe that the Supreme Court’s decision to not hear FIA Card Services settled the issue in favor of their preferred nexus standard: economic presence. Consider the following, all of which occurred after the Supreme Court refused to hear the case:

  • The Massachusetts Appellate Tax Board recently ruled that the state could force a credit card company to pay its Financial Institutions Tax despite the fact that the credit card company had no employee or operations in the state, and cited the West Virginia Supreme Court of Appeals opinion in FIA Card Services.
  • The New Hampshire budget included language that expands the state’s nexus standard to “substantial economic presence,” using the FIA Card Services opinion as a framework.
  • In response to the introduction of S. 1726, Joe Huddleston, Executive Director of the Multistate Tax Commission, boldly suggested* that “there never was a (state) physical presence rule” and that such a rule “doesn’t speak to the 21st century.”

Huddleston is right to frame this debate in terms of “21st century” tax systems but wrong in his conclusion that physical presence is no match for the new economy (and certainly wrong in his view that there was never a state physical presence standard).

From the MTC’s point of view, states have the right to tax any economic activity that occurs within their borders, but an unstated and growing concern for the states is that physical presence limits the ability of states to export their tax burden to out-of-state companies. Anyone who followed the business tax reform debates in Ohio and Michigan knows that tax exportation played a fundamental role in the shaping of the new business tax systems in those states. Indeed, it is likely that one of the current trends in state tax policy, the resurgence of gross receipts taxes, is due in part to the ease with which such taxes can be exported to out-of-state companies.

As Congress debates S. 1726 it will have to decide whether the Commerce Clause protects interstate commerce or state rights, rights which state lawmakers are currently exercising in an effort to export the tax burden to out-of-state companies. We suggest that the Commerce Clause was intended to protect and enhance interstate commerce and that the state tax exporting trend is a sound justification for Congressional action in the nexus area.

Furthermore, we believe that physical presence is the best choice if Congress wants to choose the nexus rule that maximizes interstate trade and the economic growth and opportunity that flows from that trade. The modern economy allows businesses to have “economic presence” everywhere since customers are only a mouse-click away. Such a rule would subject companies to a potentially devastating burden of complying with the differential business tax systems of 50 states (and their localities).

A physical presence rule, on the other hand, protects interstate commerce from this compliance burden since most companies typically have physical presence in far fewer states than sales, while still leaving the states free to tax businesses who employ labor and capital in their jurisdiction. This truly represents the “21st century” approach to nexus under the Commerce Clause.

*Huddleston’s comments were made in an article called “Debate Over Physical Presence Rule Will Move to Congress After Supreme Court Declines to Hear Economic Nexus Case” (link unavailable).


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