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Michigan Nexus Guidance: CorporateIncome Tax – Bright‐Line TestAA.23Substantial nexus: A taxpayer has substantial nexus in Michigan and issubject to the corporate income tax if it:1.Has in-state physical presence more than 1 day during the tax year.22.Actively solicits sales in Michigan (meaning either 11. speech,speechconduct or activity that is purposefully directed at or intended toreach persons within Michigan and that explicitly or implicitlyinvites an order for a purchase or sale; or 2. speech, conduct oractivity purposefully directed at or intended to reach personswithin Michigan that neither explicitly nor implicitly invites anorder but is entirely ancillary to requests for purchase or sale order)33.H gross receiptsHasi t off 350 350,000000 or more sourcedd tto MiMichigan,hior4.Has an ownership or beneficial interest in a flow-through entity(either directly or indirectly through one or more other flowthrough entities) that has substantial nexus in Michigan

Business Activity Tax Nexus Bill (BATSA)A. Creates a physical presence requirement before a state couldassert jurisdiction and impose a tax on a businessB. Expands upon PL 8686-272272 by applying the solicitation exemptionto companies performing services and dealing in intangiblesC. There are a number of nexus “safe harbors,” such as anunlimited amount of employees and property in a state withoutcreating nexus, so long as neither is present in the state formore than 21 days within a particular year.D ProvidesD.Pro ides clarityclarit to companiesE. State administrators are opposed. The National GovernorsAssociation has estimated that the bill's enactment would lead tostate revenue losses of 4.7 billion to 8 billion annually.24

New Jersey: Expansion Of NexusOn Foreign CorporationsA NA.N.J.J Admin.Admin Code 18:7-118:7-1.8:8: Foreign corporations subjectto corporation business tax; expanded in 2011 to imposetax on any corporation that solicits business or derivesgross receipts from sources within the stateB. Financial business corporations, banking corporations,credit card companies or similar businesses that have theircommercial domicile in another state are subject to tax ifthey solicit business or receive gross receipts from sourceswithin the state.C. Retroactive application: For privilege periods beginning onor after Jan. 1, 2002D. See Technical Advisory Memorandum 6, issued 1-10-1125

Jaye Calhoun, McGlinchey StaffordRESPONSES FOR CORPORATETAX DEPARTMENTS TOCONSIDER

NNexusReviewsR i1. Nexus review – Be proactive - Don’t wait until you receive anexus survey, a letter from an auditor or a call from a remotestate’s tax department asking why you haven’t filed.2. Not your grandparents’ nexus standard – When can aseller/service provider/business operating over the Internetbe subject to a remote state’s business activity taxes or berequired to collect the remote state’s use taxes? Are DueProcess and Commerce Clause principles still relevant? Whatabout PL 86-272?3. Don’t let your guard down – Watch for new developments.27

Due Process Clause(F i(FairnessConcerns)C) No state “shall deprive any person of life, liberty or propertywithout due process of law.” Requires “some definite link, some minimum connection,between a state and the personperson, property or transaction itseeks to tax.” Quill Corp. v. N.D. (1992): Due process embodies “traditionalnotions of fair play and substantial justice.”28

Commerce Clause(S t i Concerns)(SystemicC) The Constitution was intended to address the problems that arose under theArticles of Confederation (1778) whereby each state was essentially a sovereignnation under the Treaty of Paris (1783).propensitypy of the states to erect pprotectionist trade barriers― Particularlyy the p― Created a national free-trade zone The Constitution gives Congress the power to “regulate Commerce among theseveral States.” Article 1, Section 8, Clause 3 Taxation is regulation.Complete Auto (1977): State taxes sustained if:― Applied to activity with substantial nexus― Fairly apportioned― Do not discriminate against interstate commerce― Fairly related to services provided by the stateQuill (1992): Requires at least some physical presence 29

Wh AreWhatA SStandards?d d ? Public Law 8686-272272― Brown-Forman Distillers Corp. v. Collector of Revenue(La. 1958, denied cert. 1959)― “Missionary men” who assisted with displays― Northwestern States Portland Cement Co.Co v.v Minnesota (1959)― Solicited orders, accepted outside state, leased office space in-state― Business lobbied Congress, arguing administrative burden was undue forinsignificant level of activity. Congress reacted quickly, passing a law intendedas a stop-gap measure and providing for a study known as the Willis Report.Report― Willis Report recommended quantitative rule, based on volume Complete Auto (1977): State taxes sustained if:― Applied to activity with substantial nexus― Fairly apportioned― Do not discriminate against interstate commerceprovided byy the state― Fairlyy related to services p30

Quill Corp. v. North Dakota,504 U.S.U S 2988 (1992)()― Commerce Clause requires a physical presence in the statebefore a state may impose a use-tax collectionresponsibility.― No such physical presence requirement applies,applies for DueProcess purposes― Principles applicable to taxes other than use tax?31

From Physical Presence ToMetaphysical Presence 32Scripto (1960): An agentagent, including an independent agentagent,may create taxable nexus in a state, even though theagent does not work fulltime and the company has nolocalized place of business in the state.St d d PressedStandardPd SteelSt l (1975):(1975) PPresence off an employeelcan create nexus.National Geographic Society (1977): Physical presenceg taxed;; ppresenceneed not relate to the transactions beingof advertising offices/staff created nexus for mail orderbusiness.Tyler Pipe (1987): Independent sales rep supplied requisitenexus by helping the manufacturer to establish andmaintain its market in the state.32

Royalty Companies Geoffrey, Inc. v. South Carolina Tax Comm, 437 S.E. 2d 13 (S.C. 1993),cert. denied, 510 U.S. 992 (1993)― The licensing of a trade name or trademark creates sufficient nexusbetween an out-of-state licenser and the state to meet both the“minimum connection” standard required by the Due Process Clauseand the “substantial nexus” requirement of the Commerce Clause. Lanco, Inc. v. Director, Division of Taxation― Corporation business tax applied to income derived by an out-of-stateintangible holding company from licensing fees attributable to NewJersey.― Follows Geoffrey rationale― Quill does not apply to income taxes.― U.S. Sup. Ct. Denied Cert. on June 18, 2007.33

Credit Card And Financial InstitutionsJJ. CC. PPenney NNationaltilBBankk v. JJohnson,hAAppeallNNo. M1998M1998-00497-COA-R300497 COA R3CV (Tenn. Ct. App. Dec. 17, 1999), appeal denied, Tenn. Sup. Ct. (May 8,2000) ― Tax did not violate the "minimumminimum contactscontacts" standard of the DueProcess Clause.― National Bellas Hess and Quill should apply.Tax Comm'r of W. Va. v. MBNA Am. Bank ― Out-of-state credit card bank has substantial nexus with West Virginiaeven though it does not have a physical presence in the state.state― Court adopts economic nexus standard.― Quill does not apply to income taxes.― U.S.U S Supreme Court Denied Cert.Cert on June 1818, 20072007.34

Credit Card And Financial Institutions (Cont.)MBNA America Bank, N.A. & Affiliates v. Indiana Dept. of Rev. (2008) ― Economic presence was sufficient to establish substantial nexusf an out-of-statefort f t t creditdit carddbbank.k QuillQ ill doesdnott extendt dbbeyonddsales and use taxes.― U.S. Supreme Court – cert. deniedCapital One Bank v. Commissioner of Revenue (MA 2009) ― Out-of-state intangible holding company/credit card bank havesubstantial nexus with MA, based on economic presence.― U.S. Supreme Court – cert. denied35

Economic Presence Nexus Standards:Factor Presence StandardAn out-of-stateAt f t t ttaxpayer doingd i bbusinessiiin a statet t willill hhavesubstantial nexus with the state and be subject to the state’sfranchise and income tax if any of the following thresholds areexceeded in the state during the tax period: ― 50,000 or 25% of the total property― 50,000 or 25% of the total payroll― 500,000 or 25% of the total salesOhio (as part of the CAT) and California (effective Jan. 1,2011) have adopted a “factor presence nexus standard.” 36

What Are Limitations OfEEconomici PPresence NNexus? Sell in home state to a customer in Ohio or Michigan Customer comes into store to buy product and returns to home state Customer comes into store to buy product, and store arranges delivery tocustomer in neighboring state Customer calls and orders product Advertising― Local newspaper with Internet site― National newspaper― Send flyers into a specific state― Send flyers in a nationwide mailing― Radio advertisement― AdvertiseAd ti on a localll televisiont l i i stationt ti― Nationwide television ad― Does the type of advertising matter? Goodwill vs. product solicitation If you have advertising nexus, must the company refuse to sell to customersfrom economic presence states to avoid filing responsibility?37

What Are Limitations Of EconomicPPresenceNNexus? (Cont.)(C) Call center in home state engages in nationwide solicitation 86-272 protected solicitation? Web page invites customers to sellers location in neighboring state Web page invites customers to call to place order Web page allows for online orders Web page provides access to database for a fee― Does it matter if you know location of customer?― Mail out product vs. downloaded product paid via PayPal E-maill salesl solicitationlto purchasedh d e-maill addressddllist, on whichh haddresses are not state-specific Do Internet sellers have to screen customers for home state locationto determinedi whetherh h to sellll to them,hto avoidid filifiling responsibility?ibili ?38

Are There Limits To Economic Nexus? 39New Jersey economic nexus case Quark, Inc. v. Director, Div. of Taxation, N.J. Tax Court DocketNo. 005744-2003 (Aug. 13, 2009) New Jersey’sJersey s Taxation Department assessed its corporateincome tax on two software companies, citing Lanco (188 N.J.380) as its authority. Both software companies had very modest sales in the state( d th(underthe MTC’MTC’s 500 500,000000 salesl ththreshold).h ld) N.J. Tax Court rejected the Taxation Department’s argument,finding this case is different than Lanco (intangible propertyvs. tangiblegcopyrightedpy gpproperty).p y) No affiliation with an entity that had a physical presence inNew Jersey; this was an operating entity, not a holdingcompany created to generate a tax benefit.

P di IIssuesPending How do the states react to the denial of certiorari by theSupreme Court in nexus cases? Will states become more creative in expanding whatconstitutes substantial nexus? Will states expand use of economic nexus to foreigncommerce?40

V lVoluntaryDi lDisclosureAgreementsAOffers:1. Limitation of exposure – Some states will agree to limit exposure tocurrent and future years, and some may agree to limit prior yearexposure to several years. There is generally no statute of limitationsfor non-filed returns.2. Penalty (and sometimes full or partial interest) waiver – Penaltywaiver is typical, but interest may also be eliminated or reduced.3. Increased opportunity to manage audit activity – Returns may ormay not be audited when filed. But, a voluntarily filed return is akinto a self-audit, and taxpayers generally do better on self-audit.4. May also avoid possibility of prosecution41

Voluntary Disclosure Agreements (Cont.)Requirements:1. No previous contact by state – Voluntary disclosure proposalsare not considered voluntary if the state already has thetaxpayer on its radar. Have returns ready to go in order tomaintain the option when it is likely that the state willdiscover the nonnon-filingfiling business.business2. Made anonymously – Requires using a third-party professional(attorney/accountant) to approach the state3. If accepted – The taxpayer must usually file the returns, paythe tax and any interest within a brief period of time fromacceptance.42

AAmnestyPProgram ParticipationP i ii1. Very popular with states in hard economic times - The California FranchiseTax Board’s most recent tax amnesty program brought in 350 million. In2004, California ran a “voluntary compliance initiative” that brought in 1.3billion. A prior, more widely available program in 2005 brought in 3.2 billion.2.Usually carrot-and-stick Approach – Post-amnesty penalties can besignificant, and lookback periods are not limited for those taxpayers thateither didndidn’tt participate or simply were not aware of the programprogram. This isparticularly troubling in states where economic nexus standards are beginningto take hold.3.qmust be met – Failure to meet the strict requirementsqofStrict requirementsa state’s program could result in the untenable situation in which a taxpayerhas made complete disclosure without gaining amnesty protections andbenefits.44.M tbMustbe compliantli t goingi fforwardd43

AApportionmentiSStrategies/Issuesi /I1. Single-sales-factor states – Economic nexus theoriescombined with single-sales-factor states create issues for nonresidents.2. Consider seeking the right to apportion within states inwhich the business already has a physical presence3. Sales of services and intangibles – Market-sourcing statescreate opportunities/problems.4. Property and payroll44

Mike Shaikh, Reed SmithDEVELOPMENTS ON THEHORIZON

DDevelopmentslO ThOnThe HHorizoniU S Business Activity Tax Simplification Act (BATSA),U.S.(BATSA) HR 1439 46 Physical presence standard for all business activity taxes Applies P.L. 86-272 to all sellers, including sellers of intangibleproperty Includes more qualitative de minimis activities beyondsolicitation Defines physical presence (14-day rule) Recent developments House Judiciary Committee approved legislation on July 7,2011. Now on House of Representatives floor Similar legislation is expected in the Senate.

―BISYS was a banking information, data processing company. BISYS does business in New Jersey. Division claimed BIS and BISYS were unitary, and thus BIS was subject to tax in New Jersey Court held there was no unitary relationship. No nexus in New Jersey BIS LP, Inc. v. Director, Division of Taxation, 25 N.J. Tax 88 (2009), aff'd