Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
Report of the Task Force on Business Activity Taxes and Nexus
of the ABA Section of Taxation State and Local Taxes Committee
This Report was prepared by members of the Task Force on Business Activity Taxes and Nexus of the American Bar Association Section of Taxation State and Local Taxes Committee. The Report attempts to educate readers on business activity taxes and the current business activity tax nexus debate, by objectively presenting the issues and positions of various constituencies affected by the debate. The Report provides an in-depth background and history leading to the present federal and state rules governing business activity taxes, as well as what changes the various interested factions (business, individual taxpayers, and taxing authorities) would like to see made to the present rules. The Report also details federal legislation that has been introduced to address these issues. Both representatives of business and representatives of state government were given the opportunity to comment on the issues addressed in the Report and, although there was no consensus on many issues, information on their respective viewpoints was included in the Report to the extent possible.
The explosive growth of technology in the last century has had the equivalent effect on business that Gutenberg’s printing press had on the spread of civilization. Location has become less relevant as a factor in business planning and operations. Large corporations now routinely do business across both state and national borders. In fact, it is no longer unusual for small businesses to have multistate operations and an interstate and international customer base via the internet. While the number of business taxpayers with operations that fit neatly within one state decreases on a daily basis, the number of subnational taxing jurisdictions seeking to impose tax on these operations has increased. The District of Columbia and most of the states1 now impose some type of tax on business income or proceeds or even the increase in value or wealth that a business may enjoy as a result of its operations (the business activity tax).
A topic of fundamental concern to all businesses that operate throughout the United States, as well as to those who must impose and collect the taxes that “we pay for civilized society,” is: What limits are there on the ability of state or local government to impose a franchise tax, corporate income tax, business license tax, gross profits tax, capital stock tax, or any other type of tax on the revenues and accretions to wealth that a nonresident business receives directly or indirectly from sources in the state or locality?
A Task Force of the State and Local Tax Committee of the Section of Taxation of the American Bar Association has studied this question and prepared the Report that follows. The authors determined that the following escalating problems may pose a threat to the smooth functioning of interstate commerce:
1. Many taxpayers historically have viewed the principal limit on a state’s ability to tax the income or profits of a nonresident to be a prerequisite that the nonresident have some “physical presence” in the taxing jurisdiction—a standard facing increasing, successful challenges by state-taxing authorities. States contend this standard improperly allows businesses to “exploit” their markets without paying tax.
2. An increasing number of states are asserting the equivalent of nationwide taxing jurisdiction over nonresidents on the basis of “economic nexus,” on the premise that a state may exact a levy from a nonresident whether or not physically present in the state in exchange for providing a market for the nonresident’s goods or services. Taxpayers contend an economic nexus standard results in tax imposition on businesses that do not receive meaningful government benefits—such as police protection, schools, and infrastructure—from the taxing jurisdiction, and who are likely to be already paying for such benefits in the jurisdictions in which they are located (in contrast to a physical presence requirement for nexus which implies a less tenuous connection to actual benefits in the taxing jurisdiction).
3. The states, however, have widely varying approaches to jurisdiction over nonresidents—and sometimes do not clearly articulate standards of when economic nexus is triggered—as well as varying systems of taxation, arguably creating an increased risk of multiple taxation of the same income and difficulty in planning for any business operating in interstate commerce.
Although neither the states’ rights advocates nor those who advocate on behalf of the business community agree on a solution, no constituency is happy with the system as it presently exists. Taxpayers complain that the applicable rules are not clear and do not permit sound business planning or, more to the point, that the rules are clear but that they are interpreted too aggressively or applied improperly to give undue advantage by the states. States continue to struggle financially and complain of taxpayers allegedly “gaming” the system to avoid paying tax in any jurisdiction. Further, the states claim they are losing revenue as a result, particularly in light of the increase in internet sales activity. All of the issues arise in the context of interstate commerce, an area within the concern and jurisdiction of the federal government. However, the judiciary has been much more active than the legislature, creating piecemeal, case-specific law, not wholly satisfactory to any constituency.
Legislation has been introduced, and seriously considered, to address these issues in the form of the Business Activity Tax Simplification Act of 2008 (House BATSA) and the Business Activity Tax Simplification Act of 2007 (Senate BATSA) (collectively, BATSA). The text of the two bills is identical. This legislation has raised both the hopes of the business community and the ire of state government and is modeled on prior legislation that did not make it through Congress.
The enactment of federal legislation regarding the taxation of interstate commerce is not unprecedented. For example, in 1959 Congress enacted Public Law 86-272 to address when state or local net income taxes may be imposed on interstate sellers of tangible personal property.5 This legislation has provided certainty to such businesses over the years, but has been eroded as a source of protection for taxpayers through the shift to a service-based economy and arguably aggressive state action. State taxing authorities, for their part, contend that this legislation impermissibly intrudes on a state’s authority to impose tax.
In light of this ongoing national debate and the potential for federal legislation, this Report attempts to present objectively the issues and the positions of the various constituencies affected. This Report is not intended to advocate support for or opposition to the positions of the various affected constituencies. The scope of this Report is necessarily limited. For example, this Report addresses nexus for sales and use tax purposes only as far as the discussion relates to nexus in the context of business activity taxes. This Report does not address local business activity taxes, although the issues are comparable. Nor does it discuss the complex tax issues raised by international business operations, although that is an issue that warrants comprehensive analysis. This Report provides in-depth background and history leading to the present federal and state rules governing business activity taxes, as well as what changes the various interested factions—business, individual taxpayers, and taxing authorities—would like to see made to the present rules.