United States

Ohio: State Supreme Court Upholds Constitutionality of Factor-Presence Nexus Test

Nov 21, 2016
From KPMG TaxWatch

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The Ohio Supreme Court has ruled that the factor-presence nexus standard that applies for purposes of the Commercial Activity Tax (CAT) is constitutional. Under Ohio law, an entity is subject to the CAT if it has substantial nexus with Ohio. Ohio law provides a number of activities that can cause an entity to have substantial nexus with the state, including when an entity has a “bright-line presence.” An entity has a “bright-line presence” in Ohio if it has at least $50,000 of property or payroll in the state, at least $500,000 of taxable gross receipts in the state, or at least 25 percent of the entity’s total property, payroll, or gross receipts is in Ohio.

The taxpayer at issue, a mail order and Internet retailer of electronics, had over $500,000 of sales to Ohio customers, yet did not pay CAT. After being assessed by the Commissioner, the taxpayer argued that because it lacked a physical presence in Ohio, the Commerce Clause of the U.S. Constitution precluded it from being subject to CAT. The Board of Tax Appeals held that based on the plain language of the law―which is presumed to be constitutional―the taxpayer was deemed to have substantial nexus with Ohio. The Board was not able to opine on the constitutionality of the factor-presence nexus statute. The taxpayer subsequently appealed to Ohio’s highest court.

In a lengthy opinion, the Ohio Supreme Court rejected the taxpayer’s challenges to the imposition of CAT. Most significantly, the court held that the physical-presence rule articulated in Quill did not apply to business privilege taxes, such as the CAT, whether measured by income or gross receipts “as long as the privilege tax is imposed with an adequate quantitative standard that ensures that the taxpayer’s nexus with the state is substantial.” In the court’s view, the Quill decision itself indicated that the physical presence standard applied only to use tax collection. Furthermore, cases decided after Complete Auto established that business privilege taxes (such as the CAT) could be distinguished from transaction taxes- such as sales and use taxes. The court drew specific attention to the Supreme Court’s decision in Jefferson Lines where it referred to a gross receipts tax as “simply a variety of a tax on income.” Next, the court, noting that most state courts have declined to apply Quill outside of the sales tax context, rejected the taxpayer’s reliance on a line of cases purporting to impose a physical presence standard for gross receipts tax purposes. Finally, the court held that the $500,000 of sales in Ohio threshold provided the “substantiality” necessary to comply with the substantial nexus requirement articulated in Complete Auto and to take the activities in Ohio beyond the “purposeful availment” and “definite link” required for due process purposes. Interestingly, one Justice dissented on the basis that Quill was applicable and the court should have remanded the case back to the Board of Tax Appeals to determine if the taxpayer had a physical presence in Ohio. Please contact Brandon Erwine at 614-249-1877 with questions on Crutchfield Corp. v. Testa.


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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.