United States

Washington: Appeals Court Addresses Transactional Nexus

May 04, 2015
From KPMG TaxWatch

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The Washington State Court of Appeals recently addressed certain B&O tax issues. The taxpayer, an Arizona-based distributor of electronics and computer products, had an office in Washington State during the tax years at issue. Following a B&O tax audit, the Department determined that the taxpayer miscalculated its B&O tax base by excluding receipts from “national sales” and “third-party drop-shipped sales.” “National sales” were sales delivered into Washington that resulted from orders placed outside Washington State with assistance from an out-of-state office. “Drop-shipped sales” involved out of state orders where the taxpayer’s customer directed the taxpayer to ship the products directly to its own customer in Washington, i.e, the taxpayer was drop shipping to a Washington customer on behalf of another seller. In both instances, the taxpayers Washington State office was not involved in the transactions. After a trial court ruled in favor of the Department with respect to the national sales and ruled for the taxpayer in regard to the drop-shipped sales, both parties appealed.

Under Washington law, B&O tax is imposed on every person engaging in the business of making wholesale sales in Washington on the gross proceeds of sales of such business at a rate of 0.484 percent. A B&O tax rule provides that Washington does not assert B&O tax on sales of goods which originate outside the state unless the goods are received by the purchaser in Washington. Relying on this rule, the taxpayer argued that B&O tax did not apply to drop-shipped sales because its customer—the wholesale buyer—did not take physical possession of the goods in Washington. Rather, the taxpayer’s customer’s customer received the goods in Washington. The court, observing that the only purchaser who took delivery or possession of the drop-shipped products did so from the taxpayer in the state of Washington, rejected the taxpayer’s reliance on the rule. Rules, which are merely interpretive, do not constrain the courts, and in the court’s view, the statute clearly subjected such sales to B&O tax. The court also gave no weight to the Department’s reliance on documents (obtained during discovery) indicating that the Department had planned to change its rule to avoid taxpayers asserting the exact same position that the taxpayer was asserting.  

The court next addressed the taxpayer’s constitutional arguments. Notably, the taxpayer argued that the dormant commerce clause allowed it to “disassociate” its Washington-bound national and drop-shipped sales because its in-state personnel played no significant role in those transactions. In other words, it argued that a state may impose tax on interstate sales only if there is a substantial nexus between the seller’s activities and the state and those activities are significantly associated with the sales at issue. The court rejected the taxpayer’s “transactional” nexus argument, noting that its reliance on the U.S. Supreme Court language in Allied Signal requiring “a connection to the activity itself, rather than a connection only to the actor” does not require the activities establishing the necessary connection to the state be directly associated with the transactions seeking to be taxed. Further, the taxpayer relied on two cases from 1951 that, while not specifically overruled, had been watered down, so to speak, by subsequent dormant commerce clause precedents. In the court’s view, these more recent precedents, including Scripto and Tyler Pipe, demonstrated that the taxpayer’s Washington activities created sufficient nexus for all of its Washington-bound sales. Please contact Steven A. King at 206-913-4881 with questions on Avnet, Inc. v. Washington State Dep’t of Revenue.

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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.