The United States Supreme Court has denied the petitions for certiorari filed by MBNA America Bank and Lanco, which asked for review of the decisions of the West Virginia Supreme Court and the New Jersey Supreme Court that limited application of the U.S. Supreme Court’s decision in Quill (i.e., an entity’s physical presence in a state is required to meet the “substantial nexus” prong of the dormant Commerce Clause) to state sales and use taxes. Lanco, Inc. v. Director, Division of Taxation, Dkt. # 06-1236; FIA Card Services, f/k/a MBNA America Bank v. Tax Commissioner of the State of West Virginia, Dkt. No. 06-1228. Both petitions were filed at approximately the same time and both cases were sent to conference (where the Justices review the documents) on June 14, 2007. The denial of review leaves the decisions in West Virginia and New Jersey intact; hence, the Quill bright-line physical presence standard does not apply to business income and franchise taxes in those states. Importantly, the denial says nothing about what the constitutional rule actually is, whether the Court would agree with the standard set forth in the MBNA and Lanco cases were it to have heard those cases, and how other states will interpret the “substantial nexus” standard on a prospective basis.
In Tax Comm’r of the State of W. Va. v. MBNA America Bank N.A., Docket No. 33049 (W.Va. Nov. 21, 2006), the West Virginia Supreme Court held that the state could impose its business franchise tax and corporation net income tax on a non-physically present corporation. In its opinion, the West Virginia court determined that the standard for demonstrating Commerce Clause “substantial nexus” for purposes of income and franchise taxes was “significant economic presence.” The West Virginia test involved an examination of both the quality and quantity of the company’s economic presence. In Lanco, Inc. v. Director, Div. of Taxation, 908 A.2d 176 (N.J. 2006), the New Jersey Supreme Court similarly held that the Quill physical presence test did not apply to corporate income and franchise taxes. Unfortunately, unlike West Virginia, the New Jersey Supreme Court offered no alternative test for the determination of what constitutes “substantial nexus.
Following the taxpayer losses at the highest courts in New Jersey and West Virginia, both MBNA and Lanco filed petitions for certiorari with the United States Supreme Court. There was significant support from many sectors of the business community for the Supreme Court taking the cases. MBNA had seven amicus briefs filed by business associations in support of its request for review and Lanco had thre
In order to obtain review by the United States Supreme Court, a petition for certiorari must receive the votes of at least four Justices to take the case. Thus, for both the MBNA and Lanco petitions, at least six Justices did not think the issue was appropriate for review by the Court. The Supreme Court in recent years has consistently accepted fewer and fewer cases for review each year. This year, (as of June 11th), only 20 cases have been accepted for review while a total of 34 is usually needed to fill the Court’s fall calendar.
It is always pure speculation as to why the Court denies certiorari in a case. The denials in these cases could mean several things:
a) The Justices agree with the result reached by the state courts (however, the Supreme Court generally does not accept cases merely because the Court thinks the lower court reached the wrong result because it incorrectly interpreted the facts or misapplied the law); or
b) The Justices want to let the issue percolate further to see if a conflict develops between state courts of last resort as to the correct constitutional standard. The idea is that if all of the states agree on one standard, there is no reason for the Supreme Court to get involved. Thus, if in the future a state court determines that the Quill physical presence standard is the rule for all taxes, not just sales/use taxes, such a decision would be directly at odds with MBNA and Lanco and would give the Court a reason to resolve the issue to maintain a uniform constitutional standard across the country. (Both MBNA and Lanco argued in their briefs that a conflict already existed by citing to other decisions, like the J.C. Penney National Bank case in Tennessee, which seem to reach different results, albeit at an intermediate court); or
c) The Justices are never going to address the nexus issue again because they believe that it is a question best left for Congress to decide. In Quill, the Court stated “[the nexus issue is one that] Congress may be better qualified to resolve be that ‘the better part of both wisdom and valor is to respect the judgment of the other branches of the Government’." This may indicate that the Court has closed its door to this particular issue.
In the absence of any explanation for these denials of certiorari, it is certain that taxpayers and states will reach different conclusions as to the meaning of same.
Congressional Role in Nexus Debate?
Numerous bills have been introduced in Congress defining the correct standard for state taxing jurisdiction for both sales/use taxes and income/franchise taxes (with varying standards required in the bills) since the 1992 Quill decision, but none has progressed very far. In some cases, this lack of movement evidenced a certain apathy by Congress on the issue; in other cases, the bills had bad timing because other issues with higher priority took Congress’ attention; and, most recently, individual members have been unable to agree on the correct standard so no bill has reached a pivotal stage. Congress’ inaction does raise the question of whether the Supreme Court should have taken these cases, if only to spur some type of action by Congress. It was only after the Supreme Court decided Northwestern States Portland Cement Co. v. Minnesota in 1959, which allowed states to impose corporate income tax on businesses merely soliciting sales in the state, that Congress quickly jumped in to change that rule and passed P.L. 86-272, basically reversing the Court’s holding. Thus, the political realities may be that even though Congress may be the “best” government branch to decide the issue, it would take some prodding by the Court to jump-start Congress into action.
On the other hand, perhaps the Court’s denial of review of these cases will be the exact impetus Congress needs to finally take the issue seriously. With the diminished expectation that the Supreme Court will resolve the issue, Congress will undoubtedly be lobbied again to legislate a solution to the significant issues faced by corporate taxpayers as a result of aggressive economic presence nexus audits and policies. At a minimum, taxpayers will seek from Congress a means to mitigate expensive compliance costs, and the substantial uncertainty they currently face in the preparation and interpretation of financial statements.
Staking Out Post-Litigation Tax Positions
Ultimately, no conclusions regarding the Supreme Court’s view of the merits should be drawn by its denial of review in MBNA and Lanco. However, it is inevitable that with this denial seemingly tolerating the states’ position that the Quill bright-line physical presence standard does not apply to business income or franchise taxes, many states read into the denial support of an economic presence nexus standard enforcement. The only thing that is clear is that a denial of certiorari cannot be used as support or precedent for any legal application.
Finally, in a glass half-full world, some interested parties may actually be relieved that the Court did not take these cases. Among some observers, there was a concern that should the Court accept these cases, it might actually support the states’ interpretation that Quill is limited to sales/use taxes. Such observers see continued uncertainty as a better result than a certain “bad” result from the United States Supreme Court which would apply everywhere.
Business taxpayers are left with a real dilemma – what is the nexus standard for taxes other than sales/use tax collection (and similar taxes). Even the MBNA and Lanco cases do not give much guidance. It appears that the standard is clearly not a bright-line test and may move into a much more subjective case-by-case, fact-by-fact analysis. In a FIN 48 world, this puts corporate taxpayers in a difficult position. The Court’s denial has left business taxpayers in an uncomfortable position – trying to interpret “substantial economic nexus” in West Virginia; trying to figure out what the standard is in New Jersey (knowing that its not physical presence but not knowing what it is); trying to determine what the standard is in states like South Carolina and Oklahoma which, through their courts’ respective Geoffrey decisions, have held that out-of-state intangible holding companies with no physical presence in the state had nexus with the state by reason of the use of their intellectual property such as trademarks and trade-names in the state but which decisions said nothing about cases like MBNA, which have no taint of a tax shelter device or the licensing of intangible property in the state; and finally trying to figure out what the standard is in states that have not expressed a rule.
For financial statement reporting purposes, the Supreme Court’s denial of certiorari may be a triggering event that permits a company to review the appropriate nexus level. Specifically, a company that has remained steadfast to the proposition that physical presence is the appropriate standard for state corporate income taxation might reconsider their judgment based on the Supreme Court’s denial of certiorari. While there remains a possibility that a company's facts are distinguishable from those of the companies in the MBNA or Lanco cases, it is clear that in similar factual situations physical presence is not necessary for a company to be subject to corporate income taxation in West Virginia or New Jersey.
As indicated above, taxpayers will likely continue to engage in a tiered analysis of their nexus risks and compliance obligations. First, not all states apply an economic presence standard and some even explicitly adopt a physical presence standard. Second, even in those states that do apply an economic presence standard, the standard is a facts and circumstances test. Merely having customers in the state may not be enough to create nexus. Taxpayers that engage in careful and nuanced reviews of their actual contacts with the state will continue to compare the quality and quantity of those contacts to their overall business operations. This type of analysis will serve both their tax compliance needs and their