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Nexus has been a vexing issue for the business community and state revenue departments for years. This spring, two petitions for certiorari were filed before the United States Supreme Court asking for a decision on whether the imposition of franchise and corporate income taxes by a state violates the Commerce Clause when a company has no physical presence in that state.1 In June, the Supreme Court declined to hear the cases.

This article examines the case of Tax Commissioner of the State of West Virginia v. MBNA America Bank, N.A.2 In Lanco, Inc. v. Director, Division of Taxation,3 the New Jersey Supreme Court upheld the determination of Appellate Division of New Jersey Superior Courts that “the Director constitutionally may apply the Corporation Business Tax notwithstanding a taxpayer’s lack of a physical presence in New Jersey.”4 In the MBNA case, the West Virginia Supreme Court of Appeals (West Virginia Supreme Court) similarly held that although MBNA did not have a physical presence in West Virginia the state could impose its business franchise and corporation net income taxes on MBNA’s activity within the state.5 

This was far from a unanimous decision, however; with a very spirited dissent by Justice Benjamin, who stated his fear of courts engaging “in some form of legislative activism for which the only support is political, not legal.”6

Background

MBNA, a company that primarily engaged in issuing and servicing VISA and MasterCard credit cards, appealed the imposition of West Virginia’s business and franchise tax and corporation net income tax for the tax years of 1998 and 1999 based on facts that MBNA’s principal place of business and commercial domicile was in Wilmington, Delaware during the years in question and that it had no real or tangible property and no employees located in West Virginia. The Chief Administrative Law Judge (ALJ) with the Office of Tax Appeals ruled in favor of MBNA reasoning that: 

[U]nder the Commerce Clause, a state may not subject an activity to a tax unless that activity has a ‘substantial nexus’ with the taxing state, and a mere economic exploitation of the market is not sufficient. Because it was agreed that MBNA does not have a physical presence in West Virginia, the ALJ concluded that the State’s business franchise and corporation net income taxes could not be imposed on MBNA’s activity within the State.7

The Tax Commissioner appealed the ALJ’s decision to the Circuit Court of Kanawha County, and the court found that physical presence is not necessary to show a substantial nexus for purposes of state taxation of foreign corporations. The court went on to find that MBNA’s significant business in West Virginia was sufficient to meet the substantial nexus standard and therefore the imposition of the State’s business franchise and corporate net income taxes on MBNA did not violate the Commerce Clause.

MBNA appealed the circuit court’s order to the West Virginia Supreme Court. In determining whether the Commerce Clause was violated by imposing the state’s business franchise and income taxes on MBNA, the West Virginia Supreme Court examined the nexus standards established in the U.S. Supreme Court decision Quill Corp. v. North Dakota8 and 15 U.S.C. § 381(a), more commonly known as P.L. 86-272. 

In the Quill decision, the Court held that “a vendor whose only connection with customers in a taxing state is by common carrier or the United States mail is free from state-imposed duties to collect sales and use taxes, because such a vendor lacks the substantial nexus with the taxing state required by the commerce clause.” While 15 U.S.C. § 381(a)/P.L. 86-272 provides that:

No State, or political subdivision thereof, shall have power to impose, for any taxable year ending after September 14, 1959, a net income tax on the income derived within such State by any person from interstate commerce if the only business activities within such State by or on behalf of such person during such taxable year are either, or both, of the following: 

(1) the solicitation of orders by such person, or his representative, in such State for sales of tangible personal property, which orders are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State; and (2) the solicitation of orders by such person, or his representative, in such State in the name of or for the benefit of a prospective customer of such person, if orders by such customer to such person to enable such customer to fill orders resulting from such solicitation are orders described in paragraph (1).

The West Virginia Supreme Court also took note of congressional bills such as H.R. 1956, 109th Congress (April 28, 2005), “which would amend 15 U.S.C. § 381 to apply to, in addition to tangible property, all other forms of property, services, and other transactions fulfilled from a point outside the State.”9 

The court concluded, however, that “Quill’s physical-presence requirement for showing a substantial Commerce Clause nexus applies only to use and sales taxes and not to business franchise and corporation net income taxes.”10 It rejected MBNA’s arguments that a physical presence was required to establish nexus for the imposition of the state’s business franchise and net income tax. 

When presented with the case of J.C. Penney Nat’l Bank v. Johnson, in which a Tennessee Court applied the physical presence test to Tennessee’s attempted imposition of income taxes on an out-of-state credit card company, the West Virginia Supreme Court acknowledged J.C. Penney was factually on point and addressed the same issue as the one before it.11 However, the court rejected the reasoning in J.C. Penney and declined to apply it to the MBNA case.12

Instead, the court stated it had “no trouble” concluding that MBNA’s systematic and continuous business activity in this state produced receipts attributable to its West Virginia customers, sufficient enough to create substantial nexus.13 

Prior to this conclusion, the court discussed “the great challenge in applying the Commerce Clause to the ever-evolving practices of the marketplace.” Advances in technology were mentioned liberally; including references to a world that now has iPods.14 The court went on to state: 

This recognition of the staggering evolution in commerce from the Framers’ time up through today suggests to this Court that in applying the Commerce Clause we must eschew rigid and mechanical legal formulas in favor of a fresh application of Commerce Clause principles tempered with healthy doses of fairness and common sense. This is what we have attempted to do herein.15

The court then concluded that “West Virginia’s imposition of its business franchise and corporation net income taxes on MBNA for the tax years 1998 and 1999, did not violate the Commerce Clause.”16

Dissent

In the lone dissenting opinion, Justice Benjamin decried the majority’s opinion in no uncertain terms:

The majority, in its opinion, boldly goes where no court has gone before. In doing so, the majority relies not on bedrock constitutional principles or on established legal precedent, but rather on legal commentaries with thinly veiled state-favoring taxing agendas, a strained and inaccurate reading of the United States Supreme Court’s decision in Quill [citation omitted] and a unilateral restatement of the important policy considerations which led to the inclusion of the Commerce Clause within the United States Constitution because, according to the majority opinion, the framers could not possibly have foreseen the future. The majority opinion gives legal sanction to a state taxing scheme which impermissibly burdens the interstate commerce of the nation.17

Justice Benjamin continued:

There is no precedential support whatsoever for the conclusions reached by the majority decision. None. None at the state level. None at the federal level. Ignoring that our consideration here should be the effect of the tax in question on interstate commerce, rather than the type of tax it is, none of the rhetoric raised by the majority opinion explains why a state’s imposition of a tax on an out-of-state corporation with no presence, tangible or intangible, on income realized from an out-of-state account does not adversely affect the nation’s interstate commerce, an analysis identified by the United States Supreme Court as the cornerstone of constitutional jurisprudence [citation omitted].18

In his dissenting opinion, Justice Benjamin questioned the real purpose behind the case (“One might well argue that the State of West Virginia, under the facts of this case, is attempting to engage in extraterritorial taxation.”19) and concluded that the majority analyzed various taxes in an inconsistent manner (“The majority opinion attempts mightily to distinguish between forms of taxes, such as sales and use taxes on the one hand, and income and franchise taxes on the other hand, in attempting to defend its disregard for the substantial nexus standards required in Quill.”20). 

Perhaps, however, Justice Benjamin’s most searing criticism of the majority’s opinion was his commentary on judicial activism and the court:

I must admit to some disdain for the rather elite nature of “foreseeability of the framers” arguments. Frequently, such invocations serve no purpose other than an attempt to excuse legislating from the bench. Other times, such invocations simply serve as the argument of last resort by courts searching for a legal basis to justify result-based decision-making. Caution should by necessity be the watchword when any court seeks to expand the power of the State on the basis of the “foreseeability of the framers” argument.21

The Supreme Court declining to hear the MBNA and Lanco cases will likely result in renewed efforts by the business community to enact federal legislation similar to the aforementioned H.R. 1956 (Business Activity Tax Simplification Act of 2005). Without such a law, there will be a continued lack of uniformity in the application of tax nexus standards by individual states.

*Dean Heyl is an attorney licensed in Washington, D.C. and South Dakota. 

 

Endnotes

1 MBNA America Bank, N.A. v. Tax Commissioner of the State of West Virginia (March 8, 2007) and Lanco, Inc. v. Director of Taxation, (March 9, 2007). 

2 640 S.E.2d 226 (2006) (cert. denied). 

3 908 A.2d (2006) (cert denied). 

4 Id. 

5 640 S.E.2d 226. 

6 Id. at 239. 

7 Id. at 228. 

8 504 U.S. 298 (1992).

9  H.R. 1956’s official title was the Business Activity Tax Simplification Act of 2005. In addition to including intangible property, H.R. 1956 would have also prohibited state taxation of an out-of-state entity unless such entity had a physical presence in the taxing state. Specifically, Sec. 3 (Jurisdictional Standard for State and Local Net Income Taxes and Other Business Activity Taxes) stated:

(a) In General- No taxing authority of a State shall have power to impose, assess, or collect a net income tax or other business activity tax on any person relating to such person’s activities in interstate commerce unless such person has a physical presence in the State during the taxable period with respect to which the tax is imposed.

10  640 S.E.2d 226 at 232.

11  19 S.W.3d 831 (Tenn. Ct.App. 1999).

12  Id. at 235.

13  Id. at 236.

14  Id.

15  Id.

16  Id.

17  Id. at 237.

18  Id. at 237.

19  Id. at 238.

20  Id. at 239.

21  Id. at 241.

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