Today, Tuesday, July 25, 2017, the US House of Representatives Subcommittee on Regulatory Reform, Commercial and Antitrust Law held a hearing on the No Regulation Without Representation Act of 2017 (HR 2887). HR 2887 seeks to impose a federally established nexus threshold that would limit states from imposing various state and local taxes. Not only would HR 2887 codify the United States Supreme Court decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), which precludes states from imposing sales and use tax collection obligations on vendors without a physical presence in state, it would also preempt state laws from employing other nexus theories (e.g., economic nexus, click-through nexus, marketplace nexus, affiliate nexus, etc.). If enacted, the law would apply to calendar quarters beginning on or after January 1, 2018.
The Basics of the Bill
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The bill would impose a federally established physical presence nexus threshold for most state and local taxes, which would preempt many states’ efforts to expand the definition of nexus. The key operative provision of HR 2287 provides that “a State may tax or regulate a person’s activity in interstate commerce only when such person is physically present in the State during the period in which the tax or regulation is imposed.”
What Constitutes “Physical Presence”?
- “Physical presence” is established only if a person’s activities in the state include:
- Maintaining commercial or legal domicile;
- Owning or leasing real property or tangible personal property (other than computer software);
- Having an employee, agent, or independent contractor providing on-site design, installation, or repair services on a seller’s behalf; or
- Having an employee, exclusive agent, or exclusive independent contractor engaging in activities that substantially assist with establishing or maintaining an in-state market.
- The bill, however, explicitly excludes the following activities conducted in the state from constituting physical presence:
- Fee-based referral agreements with in-state persons for referring customers to the seller through the internet (e.g., “click through” nexus activities)
- Physical presence for less than 15 days in a taxable year;
- Product placement, setup, or other service in connection with delivery of products by a common carrier;
- Internet advertising services by in-state residents not exclusively directed towards, or exclusively soliciting in-state customers;
- Ownership of an interest in an LLC or similar entity with in-state physical presence;
- Furnishing information to customers or affiliates in-state or gathering information in-state that is used or disseminated outside the state; and
- Business activities relating to the purchase of goods or services if the final decision to purchase is made outside the state.
The Ability to Tax or Regulate Interstate Commerce
The bill limits a wide range of state and local taxes, including not only sales and use taxes, but also net income taxes and business activity taxes, including taxes imposed on profits and gross receipts. There appears to be only a handful of taxes that fall outside of the scope of the bill (e.g., ad valorem taxes on the value of a property and insurance premiums taxes). States’ ability to tax the income of owners in an in-state partnership or limited liability company would be limited, as the term “physical presence” will not include an out of state person’s ownership interest in a limited liability company or similar entity organized or with a physical presence in the state.
Another component of HR 2887 is the restriction on states’ abilities to regulate, as the bill provides that regulating a person’s activities is permissible only in instances where the person has a physical presence in the state. Prohibitions on a state’s ability to regulate would not be limited to matters of taxation. The term “regulate” means, “to impose a standard or requirement on the production, manufacture or post-sale disposal of any product sold or offered for sale in interstate commerce as a condition of sale in a state.” However, the following factors must be met before a state’s ability to regulate is prohibited: (1) the production or manufacture must occur outside the state; (2) the requirement must be in addition to the applicable requirements under relevant federal, state, and local law in which the production occurs; (3) federal law must not expressly permit the imposition of the standard or requirement; and (4) the requirement must be enforced by a state’s executive branch or its agents or contractors.
Protection of Non-Sellers
In the case of an imposition of sales, use, or similar taxes for sellers: A state may not impose or assess such taxes or impose an obligation to collect or report information related to such taxes unless a person is either a purchaser or seller that has a physical presence in the state. The term “seller” explicitly excludes marketplace providers, except with respect to sales made through the marketplace of products owned by the marketplace provider. This rule appears to stand for the proposition that a marketplace provider that has a physical presence in a state is shielded from being subject to the imposition of an obligation to collect a sales, use, or similar taxes or report any information with respect thereto.
Eversheds Sutherland Observation: HR 2887 also prevents states from indirectly taxing persons’ income without physical presence in the state by using combined reporting or consolidated returns. This language seems to require a Joyce apportionment methodology as opposed to a Finnigan methodology. “Joyce” and “Finnigan” refer to two different ways of calculating the sales factor numerator in a unitary combined income tax report or consolidated return filed by a group of affiliated corporations that establish a unitary relationship. Under the Joyce rule, receipts from sales of goods in a particular state by a seller that is part of a unitary business are included in the combined filing group’s sales factor for that state only if the seller was subject to tax in the state. In contrast, a state that uses the Finnigan method for calculating the group’s sales factor will treat a unitary group as a single taxpayer for purposes of sharing tax attributes within the group.
HR 2887 provides that the term “tax” means to “impose on a business or its non-resident owners, directly or indirectly, through mechanisms such as combined reporting or consolidated returns, a net income tax or any other business activity tax measured by the amount of, or economic results of, business or related activity conducted in or derived from sources in the State.” It appears that HR 2887 would have the effect of preempting the Finnigan rule, as a state would be allowed to include the apportionment factors only from entities that have nexus with the particular state.
State Legislative Impact/Preemption
The US Supreme Court has not decided a nexus case since Quill (1992). In Direct Marketing Association v. Brohl, Case No. 12-1175 (10th Circ. Feb. 22, 2016) (DMA), the US Court of Appeals for the Tenth Circuit determined that Colorado’s notice and reporting requirements did not violate the Commerce Clause because such requirements neither discriminated against nor unduly burdened interstate commerce. (See Evershed Sutherland’s previous coverage of this case.) When DMA was before the US Supreme Court a year earlier on procedural grounds, Justice Anthony Kennedy penned a concurrence that has been seen by many as the impetus of the “kill Quill” movement. Justice Kennedy noted that “[g]iven these changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill. A case questionable even when decided, Quill now harms States to a degree far greater than could have been anticipated earlier….It should be left in place only if a powerful showing can be made that its rationale is still correct.” (See Evershed Sutherland’s previous coverage of this case.) In response, states have taken legislative efforts to force remote vendors to collect sales tax – and to provoke a legal challenge that could end up reviewed by the US Supreme Court. The chart below shows how HR 2887 could affect these recent state nexus expansion legislation.
Click here to view table.
Summary of Testimony
Subcommittee Chairman Marino (R-PA) opened the hearing by expressing his concern regarding the “dangers of extraterritorial legislation.”
Rep. Conyers (D-MI) stated that he believes that HR 2887 would “eviscerate the 10th Amendment and override the powers of all 50 states by expanding the physical presence standard to all taxes and all regulations.” Rep. Conyers also voiced his support of Remote Transactions Parity Act of 2017 (HR 2193) (RTPA) and urged Rep. Marino and Rep. Goodlatte (R-VA) to consider moving forward with RTPA, as opposed to HR 2887.
Rep. Collins (R-GA) stated that he could not support the bill as it codifies Quill and “impliedly closes the door on any opportunities to address any issues in a way that weighs the needs of states, their citizens, online retailers, local businesses, and the economy as a whole.” Rep. Collins stressed that Congress needed to act on the remote taxation issue and do so in a way that was clear and fair. Rep. Jayapal (D-WA) noted that the bill was the most coercive and intrusive that she has seen and would undermine the constitutional right of states to protect citizens.
Rep. Goodlatte, a cosponsor of this bill, focused his statement on the bill’s restriction on states’ ability to regulate. The Congressman closed with the statement that, while he respects states’ rights to be laboratories of democracy, he felt that they should “experiment on their own citizens and not everyone else’s.”
Witnesses Neil Dierks, CEO of the National Pork Producers Council, Chad DeVeaux, Esq., associate at Atkinson, Andelson, Loya, Ruud & Romo, and Andrew Moylan, Executive Vice President of the National Taxpayers Union Foundation expressed support for the bill.
Mr. Dierks testified that he supports HR 2887 as he believes the bill would reign in states regulating extraterritorial activities.
Mr. Moylan testified that states’ power must stop at border’s edge. He stated that the bill was an important first step as it helps “to clear up this morass of state level litigation where states are passing knowingly unconstitutional bills in order to draw litigation … [which] throw[ ]businesses into turmoil.”
The Honorable Deb Peters, President-elect of the National Conference of State Legislatures, Senior Assistant Majority Leader of the South Dakota Legislature testified against the bill. Ms. Peters expressed her opinion that HR 2887 represented an erosion of state sovereignty. She added that she did not believe this bill codified Quill, as she felt that it goes beyond physical presence standards. She testified how the 15-day physical presence threshold would be catastrophic for South Dakota and many of its localities that rely on special events and the collection of sales tax revenue. Ms. Peters provided an example of the annual Sturgis Motorcycle Rally, a ten-day event where retailers come to the state and set up shops to sell a variety of items. Her concern was that many vendors operating at the event would not be subject to any regulation or tax rules, which would take away the sales tax revenue that these localities rely on for the year.
Brief Comparison of No Regulation Without Representation Act of 2016 vs. No Regulation Without Representation Act of 2017
Last July, Congressman Sensenbrenner introduced the No Regulation Without Representation Act of 2016 (HR 5893) in the US House of Representatives, which died at the end of the legislative session. While substantially similar in some sections, there are noticeable differences in the bills that make the 2017 bill far more impactful. For starters, the scope of the 2017 bill is significantly broader than the bill introduced in 2016. Whereas the 2016 version applied nexus standards only to sales/use taxes, the 2017 version applies nexus standards to additional state and local taxes such as net income taxes and business activities taxes (e.g., gross receipt taxes or franchise taxes). The 2017 version also introduces the concept of limiting states’ ability to regulate sales of products produced or manufactured in another state.
On April 27, 2017, two remote seller bills were introduced – the Marketplace Fairness Act of 2017 (S976) (MFA) and the RTPA. The MFA and the RTPA contain similar core principles, as both would allow – not prohibit - states to mandate out-of-state sellers and online vendors to collect sales tax. The MFA seeks to authorize states meeting certain requirements to require remote sellers whose gross annual receipts on remote sales in the United States exceed $1 million to collect their state and local sales and use taxes. On May 18, 2017, the Committee on Banking, Housing, and Urban Affairs held a hearing on the MFA. The Committee has taken no further action to date.
Similar to the MFA, the RTPA also seeks to create sales and use tax collection obligations for remote sellers; however, this bill contains several key differences and additional provisions. One difference is that RTPA has a phased in threshold for the obligation to collect state and local sales and use taxes, starting at a $10 million sales threshold in year one, ratcheting down to $5 million in year two, $1 million in year three, and no threshold in year 4. Additionally, sellers that sell on electronic marketplaces are not subject to collection requirements. Similar to HR 2287, the RTPA specifies when a company is not a remote seller; and, therefore has a physical presence. These instances include (1) presences for more than 15 days in a state; (2) using an agent to establish or maintain the market in a state if the agent does not perform business services in the state for any other person during the taxable year; or (3) leasing or owning tangible or real property. The RTPA was referred to the Subcommittee on Regulatory Reform, Commercial and Antitrust Law on May 5, 2017. A hearing has not yet been scheduled for the RTPA.