OHIO NEXUS Anyone..?

On August 10, 2010, the Ohio Department of Taxation made a final determination in a petition for reassessment filed by L.L. Bean, Inc. ("L.L. Bean" or "Company") regarding eight assessments of commercial activity tax. The Tax Commissioner Richard A. Levin found that the Company's $500,000 in annual taxable gross receipts in the state created substantial nexus. Commissioner Levin rejected the argument that the Commerce Clause and physical presence standard established in Quill Corp. v. North Dakota (1992), 504 U.S. 298, prevented the state of Ohio from imposing the commercial activity tax.

Pursuant to R.C. 5751.01, the state of Ohio levies a commercial activity tax "on each person with taxable gross receipts for the privilege of doing business in this state." Furthermore, the commercial activity tax is levied on corporations with substantial nexus with the state of Ohio. A corporation with substantial nexus must meet one of the following four conditions set forth in R.C. 5751.01(H):

1. Owns or uses a part of or all of its capital
2. Holds a certificate of compliance with the law of this state authorizing the company to do business in the state
3. Has bright-line presence
4. Otherwise has nexus with the state to an extent that the company can be required to remit the tax imposed under this chapter under the Constitution of the United States

Pursuant to R.C. 5751.01(I), a company has bright-line presence if any of the following conditions are met:

1. Has at any time during the calendar year property in the state with an aggregate value of at least $50,000
2. Has during the calendar year payroll in the state of at least $50,000
3. Has during the calendar year taxable gross receipts of at least $500,000
4. Has at any time during the calendar year within the state at least 25% of its total property, total payroll, or total gross receipts
5. Is domiciled in the state as an individual or for corporate, commercial, or other business purposes

Commissioner Levin wrote that L.L. Bean had a bright-line presence, and therefore, substantial nexus with the state and was subject to the commercial activity tax because its taxable gross receipts exceeded $500,000 in the state of Ohio in each of the calendar years at issue.

In opposition to the tax assessment, L.L. Bean argued that the Commerce Clause of the United States Constitution prevents the State of Ohio from levying the commercial activity tax pursuant to R.C. 5751.01(H) because the physical presence standards required by National Bellas Hess v. Ill. Rev. Dep't (1967), 386 U.S. 753 and Quill. In Quill, the Supreme Court of the United States held that North Dakota's requirement that an out-of-state mail order company with no physical presence in the state remit use tax violated the "substantial nexus" requirement of the Commerce Clause.

In response to L.L. Bean's argument, the Tax Commissioner contended that the Supreme Court and most state courts have declined to extend the reasoning and standards in Quill to taxes other than sales and use tax. For example, in Couchot v. State Lottery Commission (1996), 74 Ohio St.3d 417, the Court found that the physical presence requirement did not apply to the taxation of lottery winnings in the state of Ohio. Similarly, the Ohio Department of Taxation declined to extend the standards in Quill to the commercial activity tax. Commissioner Levin also rejected the contention that the commercial activity tax is the functional equivalent of a sales or use tax. Commissioner Levin concluded that if the physical presence requirement in Quill applies only to sales or use tax, then the conditions for substantial nexus in the state of Ohio for the purpose of levying commercial activity tax would not violate the Commerce Clause.

The Tax Commissioner contended that, although L.L. Bean did not have a physical presence in the state, L.L. Bean's "continuous, systematic, and significant solicitation and exploitation of the economic marketplace in Ohio" was sufficient to satisfy the substantial nexus requirement of the Commerce Clause and the minimal connection needed to satisfy the Due Process Clause of the Untied States Constitution.

The imposition of the commercial activity tax in the state of Ohio by the Ohio Department of Taxation marks a growing trend by the states to levy taxes, other than sales and use taxes, against companies "doing business" within their borders without a physical presence as required by Quill. Michigan, Minnesota, Oklahoma, Washington and Texas are a few of the additional states that levy some form of a business activity tax against companies with an economic presence, rather than a physical presence, in the state. If these business activity taxes are not viewed as sales or use taxes, which seems increasingly likely, then the constitutionality of the taxes would not be subject to the rationale in Quill, and whether a company is subject to tax would no longer depend on a physical presence in the state.

Corporations can now conduct significant business in a state without any physical presence. As the recent final determination of the Ohio Department of Taxation indicates, companies conducting business in a state without any physical presence may still be subject to taxes in the state.

Schiff Hardin LLP represents taxpayers in connection with civil controversies and criminal tax investigations and litigation arising with federal and state authorities. Not only are the number of such controversies on the rise, but the line between civil and criminal tax matters is becoming more difficult to identify, both for taxpayers and for their advisors.

For more information, feel free to contact one of the attorneys identified in this issue of Tax Talk.

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