DOWN BUT NOT OUT: THE REVITALIZATION OF THE DUE PROCESS CLAUSE

Nicole Crighton Principal KPMG LLP New York, NY ncrighton@kpmg.com

Hollis Hyans Partner Morrison & Foerster LLP New York, NY 10104-0050 HHyans@mofo.com IP

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AGENDA

Background Due Process “Inherited” Nexus Nexus by Affiliation Method of Delivery Partnerships Telecommuters Temporary Presence Trailing Nexus

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BACKGROUND

Complete Auto Transit v. Brady, 430 U.S. 274 (1977) – Substantial nexus required. Nat’l Geographic Soc’y v. Bd. Of Equal., 430

U.S. 551 (1977) – More than “slightest presence” necessary. Tyler Pipe Indus. V. Wash. Dept. of Rev., 483

U.S. 232 (1987) – Attributional nexus. Goldberg v. Sweet, 488 U.S. 252 (1989) –

Nexus with “activity.” Quill Corp. v. North Dakota, 504 U.S. 298

(1992) – Physical presence standard.

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EARLY DECISIONS

Due process vs. commerce clause

Nexus with the taxpayer vs. nexus with the income or transaction Corporate Income - unitary business -> apportionment formula

activities -> nexus Underwood Typewriter, Co. v. Chamberlain, 254 U.S. 113 (1920) Bass Ratcliff & Gretton, Ltd. v. State Tax Comm’n, 266 U.S. 271 (1924) Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450

(1959): Nor will the argument that the exactions contravene the Due Process Clause bear scrutiny. The taxes imposed are levied only on that portion of the taxpayer's net income which arises from its activities [property, payroll, and sales] within the taxing State. These activities form a sufficient ‘nexus between such a tax and transactions within a state for which the tax is an exaction.’ (citing Wisconsin v. JC Penney)

Use Tax Miller Brothers Co. v. State of Md., 286 U.S. 276 (1954) “Due process requires some definite link, some minimum connection, between a

state and the person, property, or transaction it seeks to tax.” Sometimes nexus w/transaction nexus w/ person …

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QUILL DISTINCTION

Due process and commerce clause nexus are “closely related” and “not always necessary to distinguish.”

Due Process Clause – fundamental fairness (notice and fair warning) Definite link, minimum connection required Satisfied by purposeful availment

“Dormant” Commerce Clause – national economy (economic isolationism) No “undue burden” on Interstate Commerce No discrimination against out of state competitors

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DUE PROCESS

Unlike the commerce clause's substantial nexus requirement, minimum contacts for due process purposes may be established even where a prospective taxpayer has no physical presence in the taxing state. Quill, 504 U.S. at 308, 112 S.Ct. at 1911, 119 L.Ed.2d at 104.

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STATE TAX CASES AFTER QUILL

Use tax collection cases focus on commerce clause physical presence requirement

Corporate income tax cases focus on whether commerce clause requires physical presence

Nexus established by Related Entities, Intangible property (Geoffrey, Inc. v. South

Carolina Tax Commission, 437 S.E.2d 13 (SC 1993), cert demand S10 U.S. 992 (1993)) Customers, Intangible property (KFC Corp. v. Iowa Dept. of

Rev., 792 N.W.2d 308 (Iowa 2010)) Customers, Receipts (Tax Comm’r v. MBNA America Bank,

640 S.E.2d 226 (W.Va. 2006), cert. denied 551 U.S. 1141 (2009))

Due process generally not an issue

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STATE TAX STATUTES AFTER QUILL

Statutes and laws Factor Presence Nexus In-state Intangible Property (IA, NC, MA

directive 96-2) Seem directed at commerce clause decisions What about due process?

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CORPORATE TAX PLANNING AND DUE PROCESS?

Cases questioning due process Can you plan around due process? Decided Scioto ConAgra Watch Barnesandnoble.com (NM) Harley Davidson (CA) Gore (MD) Washington Mutual (Federal Bankruptcy Ct.) Recent US SC due process decisions Nicastro Goodyear (mentions UBP argument in footnote)

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DUE PROCESS In Re Scioto, 279 P.3d 782 (Okla. 2012) Scioto licensed intellectual property to a third party outside

of the State. The third party sublicensed the intellectual property to sub-

licensees in Oklahoma. No nexus - “Due process is offended.”

Griffith v. ConAgra Brands, Inc., 728 S.E.2d 74 (W. Va 2012) ConAgra licensed intellectual property to related and

unrelated parties. The products bearing the intellectual property were

manufactured outside the State, ConAgra did not direct or dictate how the licensees distributed the products and the licensees did not operate any retail stores in the State. No nexus - a lack of “purposeful direction” under Due

Process Clause.

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SCIOTO INSURANCE

Wendy’s International

Scioto Insurance

OK Franchisees

Oldemark LLC

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CONAGRA BRANDS

Affiliate manufacturers

ConAgra Brands

Unrelated manufacturers

WV Retailers IP

IP

Products bearing IP

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NEXUS BY AFFILIATION New Mexico Tax’n and Rev. Dept. v.

Barnesandnoble.com, LLC, 303 P.3d 824 (N.M. 2013) Internet retailer (“Retailer”) was affiliated with a corporation that

operated retail bookstores in New Mexico (“Bookstore”). Lower court found nexus based on “functional equivalent” See Kmart Corp. v. Tax’n and Rev. Dept., 131 P.3d 22 (N.M. 2005)

New Mexico Supreme Court did not apply functional equivalent test, but found that substantial nexus existed. Facts included: Bookstore’s promotion of Retailer through sales of gift cards

redeemable on Retailer’s website and bearing Retailer’s name; Bookstore’s policy of sharing customer email addresses with Retailer; Bookstore’s implicit endorsement of Retailer through the companies’

shared loyalty program and Bookstore’s return policy; and Bookstore’s in-state use of logos and trademarks, which Retailer also

used.

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BARNESANDNOBLE.COM

Barnesandnoble.com Barnes and Noble Booksellers

NM Customers

Trademark HC

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US SUPREME COURT CASES

J. McIntyre Machinery, Ltd. v. Nicastro Issue (2011) Issue: personal jurisdiction over a foreign manufacturer that had

worked with a distributor to market its products in the US but not specifically in New Jersey. Holding: NJ did not have DP nexus because manufacturer had not

engaged in any activities in NJ that revealed an intent to invoke or benefit from the protection of New Jersey’s laws. Dissent: manufacturer marketed to entire US and did nothing to

exclude the NJ market.

Goodyear. v. Brown (2011) FN: Neither below nor in their brief in opposition to the petition

for certiorari did respondents urge disregard of petitioners’ discrete status as subsidiaries and treatment of all Goodyear entities as a “unitary business,” so that jurisdiction over the parent would draw in the subsidiaries as well. Respondents have therefore forfeited this contention.

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DUE PROCESS

Daimler AG v. Bauman, 134 S.Ct. 746 (2014) The appellate court held that DaimlerChrysler AG was

subject to personal jurisdiction in California based on the contacts of its subsidiary because the subsidiary’s actions in the State were “a critical aspect” of DaimlerChrysler AG’s business operations and DaimlerChrysler AG had “purposefully and extensively interjected itself into the California market” through the subsidiary.

Oral argument was heard in the United States Supreme Court October 15, 2013. Supreme Court revered the appellate court’s decision on January 14, 2014.

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DUE PROCESS

Gordon (D.C. Cir. 2013) Whether Prevent All Cigarette Trafficking Act (“PACT Act”) could

require “delivery sellers” to collect all state taxes that in-state retailers must collect. The court affirmed the lower’s court’s injunction against the

enforcement of taxing provisions under the PACT Act under due process grounds. The court analyzed the underlying rationale of the Due Process

Clause and explained that a “simple but controlling question to test the lawfulness of an exercise of taxation power is whether the state has given anything for which it can ask return.”

NV Sumatra (Tenn. 2013) Manufacturer sold cigarettes to a wholesaler that, in turn, sold to

another third party who arranged for the cigarettes to be sold in Tennessee. No nexus – due process would be violated if a manufacturer could

be liable for tax as a result of “placing its … cigarettes in the international stream of commerce.”

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“INHERITED” NEXUS

Gore Enterprise Holdings, Inc. v. Comptroller of the Treasury, 87 A.3d 1263 (Md. 2013) Court concluded that two out-of-state subsidiaries

had “inherited” nexus because they participated in their parent corporation’s unitary business and the parent corporation had nexus. The parent’s apportionment factors in the State were

used to apportion the receipts of the subsidiaries. On appeal, Court clarified the “unitary nexus” theory.

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NEXUS BY AFFILIATION In re Washington Mutual, Inc., (Bankr. D. Del. 2012) A federal bankruptcy court held that a parent company was not liable

for the tax obligations owed by its subsidiaries because imposition of tax would violate the Due Process and Commerce Clauses. The court rejected the State’s asserted nexus theories that the parent

was subject to tax because it had filed a consolidated return in its own name in the State and because it owned entities that did business in the State.

Harley-Davidson, Inc. & Sabs. V. Franchise Tax Bd., No. 37-2011-00200846-CU-MC-CTL (San Diego Super. Ct. May, 2013) Two out-of-state special purpose entities were created to bundle and

securitize the loans offered by the common parent into notes to sell to investors. The court concluded that the two special purpose entities had nexus

with the State because the entities did not have “a business existence separate and apart from” the financing subsidiaries that conducted business in the State. A notice of appeal has been filed.

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NEXUS BY AFFILIATION Performance Marketing Ass’n v. Hamer, 998 N.E. 2d

54 (Ill. 2013) The court found that Illinois’ affiliate nexus statute provisions that

imposed use tax collection obligations on out-of-state internet retailers with a “person” in the State to refer potential customers were “void and unenforceable” because they were “expressly preempted” by the federal Internet Tax Freedom Act. The court explained that the Internet Tax Freedom Act prohibits a

state from imposing “discriminatory taxes on electronic commerce” and that the provisions in question did not impose use tax collection obligations for “offline” referrals.

Overstock.com, Inc. v. New York Dept. of Tax’n &

Finance, 987 N.E. 2d 621 (N.Y. 2013), cert. denied, 134 S.Ct. 682 (2013) The court upheld the constitutionality of New York’s affiliate nexus

statute which creates a rebuttable presumption that a vendor is doing business in the State when it solicits business through an in-state representative and compensates that representative with a commission.

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METHOD OF DELIVERY The Country Shop (Oh. Bd. of Tax Appeals 1993) An out-of-state retailer’s use of a contract carrier to make

deliveries in the State did not require the retailer to collect and remit use tax. Use of a contract carrier is not dispositive in and of itself

to create nexus - the determination must be made that the contract carrier operated as the retailer’s agent.

Furnitureland South, Inc. v. Comptroller of the

Treasury, 771 A.2d 1061 (Md. 2001) An out-of-state retailer was found to have nexus when it

was determined that its deliveries in the State were made by an affiliated contract carrier that provided repair service. The decision was vacated and remanded by the Maryland

Court of Appeals on procedural grounds with no decision on the merits.

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PARTNERSHIPS BIS LP, Inc. v. Director, Div. Of Tax’n, 2014 W.L.

1394176 (N.J. Super. Ct. App. Div. 2014) An out-of-state investment company held a 99% limited partnership

interest in a limited partnership that did business in New Jersey. The court found that the investment company did not have nexus with

New Jersey because it was not “integrally related” with the New Jersey partnership.

Village Super Market of PA v. Director, Div. Of Tax’n,

27 N.J. Tax 394 (N.J. Tax Ct. 2013) An out-of-state limited partner in a New Jersey limited partnership

was found to have nexus with New Jersey because its business was integrally related to the State by virtue of its limited partnership interest in the New Jersey limited partnership. The court distinguished the matter from BIS LP, explaining that in

this matter both partnerships were in the same line of business, were parties to the same cash management agreement, had common management and shared a principal place of business in New Jersey.

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TELECOMMUTERS Warwick McKinley (Cal. State Bd. of Eq. Jan. 11, 2012) The SBE held that an out-of-state corporation had a substantial

nexus with California for corporate franchise tax purposes because it had an employee who worked remotely from the employee’s California home. The SBE reasoned that the corporation was afforded

substantial and enduring benefits and protections that enabled it to generate business in the State and that the corporation had a regular, systemic and substantial connection with, and physical presence within, California.

Telebright Corp. v. Director, Div. of Tax’n, 38 A.3d 604

(N.J. Ct. App. 2012) A company’s employee moved to New Jersey and developed

and wrote software code from her computer in New Jersey. The court found that the employee’s creation of computer code

was no different than the manufacturing of parts to a product that will be assembled elsewhere and held that the employee’s presence in the State was enough to satisfy constitutional nexus requirements.

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TEMPORARY PRESENCE Midland Central Appraisal Dist. v. BP America Prod. Corp.,

282 S.W.3d 215 (Texas Ct. App. 2009) The appraisal district sought to impose an ad valorem tax

on crude oil located in a county that was a part of an interstate, common carrier pipeline system. The court concluded that the oil was not taxable because

it was in the stream of interstate commerce and that any delay in the county was necessary for the operation of the pipeline system. The court found that there was no substantial nexus with

the activity. See also Peoples Gas, Light, & Coke Co. v. Harrison Cent.

Appraisal Dist.

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TRAILING NEXUS Oklahoma Tax Comm’n Letter Ruling 13-066 (Oct.

23, 2013) Stated that an entity has to file an Oklahoma Business

Activity Tax return if the only 2012 activity in the State was the payment of $25 in Oklahoma Business Activity Tax for the 2011 tax year.

Wash. Dep’t of Rev. Special Notice (Sept. 10, 2010) RCW 82.04.220(2) (Business and Occupation Taxes) – “A

person who has a substantial nexus with this state in any tax year … will be deemed to have a substantial nexus with this state for the following tax year.” “The trailing nexus period for retail sales tax (RST) is still

four years, plus the current year, under WAC 458-20-193 (Rule 193).”

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OTHER ISSUES

Allied Domecq Spirits & Wines USA, Inc. v. Comm’r of Revenue, (Mass. App. Tax Bd. May 22, 2013) A corporation transferred employees and business

functions to an affiliate. Appellate Tax Board found that transfer did not have a

valid business purpose or economic effect beyond the avoidance of tax. Affiliate did not have sufficient nexus with Massachusetts

to be a taxpayer.

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QUESTIONS

Hollis Hyans Morrison & Foerster LLP 250 West 55th Street New York, NY 10019-9601 (212) 468-8050 HHyans@mofo.com

Nicole Crighton Principal KPMG LLP 345 Park Avenue New York, NY 10154 (212) 954-8696 NCrighton@kpmg.com