Ohio Supreme Court decides physical presence is not a necessary condition for imposing commercial activity tax.
The Ohio Supreme Court recently ruled that Ohio may impose its commercial activity tax (CAT) on out-of-state companies that sell products and services to Ohio customers—even if the companies have no physical presence in the state—if such companies have taxable gross receipts sitused to Ohio of at least $500,000. This ruling is yet another example of the increasing willingness of states to extend taxing jurisdiction to nonresident taxpayers that have business, but no physical presence, in a state.
The US Constitution generally has been interpreted to impose limitations on the ability of states to tax the economic activities of nonresidents. Specifically, under the Commerce Clause, the US Supreme Court has ruled that nonresident taxpayers must have a “substantial nexus” within a state before that state may impose sales and use tax, and that a physical presence in the state—other than solely through the mail or common carriers—is required.
Ohio Supreme Court Decision
On November 17, a split Ohio Supreme Court held that the physical presence standard does not extend to a “business-privilege tax”—even if that tax is measured by receipts from sales of tangible personal property (similar to a sales tax).
In a 5-2 decision, the Ohio high court held that “although a physical presence in the state may furnish a sufficient basis for finding a substantial nexus, Quill’s holding that physical presence is a necessary condition for imposing the tax obligation does not apply to a business-privilege tax. . .” Rather, since the CAT is imposed only on retailers with at least $500,000 in Ohio receipts, the Ohio Supreme Court held that dollar “limit” is sufficient to establish the required substantial nexus for the imposition of a business-privilege tax.
The dissenting judges in the case, by contrast, argued that the silence of the US Congress on nexus issues means that Quill’s “physical presence” requirement should still apply, and that only the US Congress or the US Supreme Court can establish a new rule to determine substantial nexus. The tenor of the dissenting judges’ opinion could signal that this decision may be appealed to the US Supreme Court.
This decision, combined with Ohio’s law that provides that Public Law 86-272 protection does not apply to the CAT, means that Ohio now has a tax that is
- measured by receipts,
- with no physical presence requirement,
- which falls outside the federal protection against the imposition of an income-based tax when a taxpayer’s only presence in the state is a sales force.
The Ohio decision follows many recent (and not so recent) state tax rulings that have expanded the scope of state taxing power—even where there is no physical presence—in the face of federal constitutional constraints. Those rulings include the February 2016 decision in Direct Marketing Assoc. v. Brohl by the US Court of Appeals for the Tenth Circuit that upheld Colorado’s remote seller reporting law, as well as recent actions in several states such as Alabama, South Dakota, and Tennessee that have asserted an economic rather than physical nexus standard for sales and use tax.
Taxpayers that have no physical presence in Ohio that sell goods in the state and pay significant CAT should consider preserving their rights to contest the imposition of the CAT by filing refund claims. Taxpayers with multistate or nationwide economic activities should continue to monitor developments regarding state tax nexus requirements.