Commerce Clause


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.

Statutory definitions often carry ambiguous terms and subtle distinctions. However small these distinctions may seem, their interpretation can mean millions in state tax.  In Massachusetts, for example, multistate corporations generally apportion their business income using a three-factor formula based on a property factor, a payroll factor, and a double-weighted sales factor.  However, certain out-of-state corporations, like “manufacturing corporations” or “mutual fund service corporations,” may be required to apportion their business income using Massachusetts’s single-sales factor apportionment formula.  In the event a single-sales factor apportionment formula applies, an out-of-state company’s Massachusetts corporate excise tax liability may increase, as none of that company’s out-of-state property and payroll expenses are accounted for in apportioning income.          

In a decision that may foretell the future of business privilege tax nexus, the Washington Supreme Court in November upheld the imposition of the state’s business & occupation (B&O) tax on an out-of-state distributor with respect to sales that were not generated by the distributor’s in-state office. In Avnet Inc. v. Dep’t of Rev., Dkt. No. 92080-0 (Wash. 2016), the Court effectively killed any notion that transactional nexus is required to impose the B&O tax—a tax on the privilege of doing business in Washington.  This case, coupled with the Ohio Supreme Court’s decision in Crutchfield v. Testa, which was decided one week before Avnet and involved Ohio’s similar Commercial Activity Tax (CAT), continue the trend of aggressively pursuing nexus in the business privilege tax context.

The recent Harley-Davidson opinion from the Superior Court of California, County of San Diego is an alarming example of why it is important to apply the appropriate constitutional standard in state tax cases.  In a Commerce Clause challenge, where the taxpayer argued a California statute discriminated against interstate commerce, both the California Appellate Court and the trial court applied Equal Protection standards in their Commerce Clause analyses.  In doing so, the courts upheld an otherwise discriminatory tax scheme on the grounds that it furthered the state’s legitimate interests in generating revenue and ensuring income is fairly apportioned among the several states.  Such a holding effectively guts the protections offered under the dormant Commerce Clause and highlights the analytical differences between discrimination under the Commerce Clause and discrimination under the Equal Protection Clause.