Wayfair has, for now, answered the question (at least, in part) of whether economic activity creates substantial nexus under the Commerce Clause for purposes of sales and use taxes. However, questions remain regarding whether and to what extent business activity tax nexus standards could be impacted. While states had boldly asserted economic nexus in the business activity tax context pre-Wayfair, the response since has been somewhat muted, until recently. Three states, Pennsylvania, Texas, and Wisconsin, have recently sought to fill in the blanks with regard to business activity tax nexus, with varied and inconsistent results that may raise more questions and concerns than answers.
In overturning the Commonwealth Court, the Pennsylvania Supreme Court recently held that royalty fees for certain intellectual property were not subject to Pennsylvania sales tax. See Downs Racing LP v. Commonwealth of Pennsylvania, Dkt. No. 70 MAP 2017 and 71 MAP 2017 (Pa. Oct. 25, 2018). The royalties at issue were payments between third parties for IP used in the operation of gaming machines (“Gaming IP”). The Commonwealth argued the Gaming IP was canned software, and thus taxable in Pennsylvania. The Commonwealth also argued, in the alternative, that sales tax was due on the full price paid for the gaming machines along with any ancillary items, such as the Gaming IP. In siding with the taxpayer, the court found the Gaming IP was not subject to sales tax because it did not constitute, nor was it ancillary to, tangible personal property.
Baker McKenzie attended the U.S. Supreme Court’s oral arguments yesterday in South Dakota v. Wayfair, Docket No. 17-494. At issue in the case is whether the Court should abrogate the physical presence nexus standard that it first articulated in National Bellas Hess v. Dep’t of Revenue, 386 U.S. 753 (1967), and later affirmed in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Court’s decision could have a profound impact on sales and use tax nexus in the United States by altering the limitations currently imposed on a state’s ability to require out-of-state retailers to collect such tax.
Under the Tax Cuts and Jobs Act of 2017 (“Federal Tax Reform”), Internal Revenue Code (“IRC”) section 168(k) provides 100% immediate expensing for qualified property placed into service after September 27, 2017 and before January 1, 2023. Pennsylvania, like many states, currently decouples from IRC section 168(k). In most states, decoupling from the immediate expensing provisions in IRC section 168(k) will merely result in a timing difference as most states allow some alternate form of state-level depreciation. However, the Pennsylvania Department of Revenue (“Department”), in a departure from its prior interpretation of Pennsylvania law, recently announced its view that taxpayers are not entitled to a state-level depreciation deduction for property that is fully expensed under IRC section 168(k). A bill has recently been proposed to legislatively reverse the Department’s interpretation and allow a state-level depreciation deduction for property that is fully expensed under IRC section 168(k).