United States

Washington State: German Company Subject to Tax on Royalty Income

Jun 20, 2016
From KPMG TaxWatch

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Recently, the Appeals Division of the Washington State Department of Revenue addressed the application of the state’s Business & Occupation (B&O) Tax economic nexus rules to a foreign company receiving royalties from in-state sources. The taxpayer at issue, a German company, had no physical presence in the United States. It received royalties, however, based on where its pharmaceuticals were sold. Under Washington State law, an out-of-state taxpayer with over $250,000 of receipts from in-state sources is deemed to have substantial nexus with Washington State for B&O tax purposes. This threshold amount is adjusted periodically for inflation; however, the taxpayer exceeded the statutory threshold for all the tax years at issue. The taxpayer argued that the economic nexus rules violated the Due Process and Commerce Clauses of the U.S. Constitution, and that it was protected from taxation under a tax treaty entered into between the U.S. and Germany.

The Appeals Division first held that, as an administrative body, it did not have the authority to declare the statutes it administered to be unconstitutional. Next, it held that the U.S./German treaty did not bar Washington State from imposing B&O tax on the taxpayer’s royalty receipts. The taxpayer argued that a nondiscrimination provision in the treaty barred Washington State from imposing the tax. However, the Appeals Division concluded that the tax on royalties was not discriminatory against non-U.S. businesses vis-à-vis U.S. businesses, as the tax applied equally to both, and was imposed on any business deriving royalty income from Washington sources. The taxpayer also tried to argue that it would be subject to double taxation on its royalty income. However, the taxpayer had a permanent establishment in the U.S. outside Washington State; thus, the royalties (per the treaty) should be excluded from its German tax base. The Appeals Division also noted that the treaty does not cover Washington's B&O Tax on royalties (or any state or local tax, for that matter), and thus, implicitly, the treaty permits taxation of royalties by Washington under Washington's tax system. Please contact Michelle Baisler at 206-913-4117 with questions on Determination 15-0251.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

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.