International transactions pose particularly difficult legal risks because the international legal system is basically in its infancy. Foremost on the immediate horizon are the risks associated with electronic commerce and taxation implications when melded with the notion of jurisdiction, specifically the aspect of due process requisite to jurisdiction and the application of the commerce clause.
In order to appreciate cross-border electronic commerce legal risk associated with authority to tax, an underlying foundation of jurisdiction in general in an international context is required. This writing will approach these legal risks with two basic themes that govern the authority of a source and resident country taxation connection. Jurisdiction will first be addressed and in a subsequent segment, the application of the concepts of the commerce clause.
This necessitates a focus upon principles pertaining to in personam jurisdiction and perhaps quasi concepts of prescriptive jurisdiction that have at the core the principles of due process. As these are hereinafter set forth, it is done with the understanding that these are the principles and that there has been an enormous evolution in case law as it pertains to in personam jurisdiction and the reach of in personam jurisdiction cross- border civil litigation and the virtual commerce concepts.
Due process interpretation has been at the core of that evolution. This evolution is beyond the scope of this discussion other than setting the foundation for the present application to cross-border taxation and the underlying due process concept applicable. One cannot appreciate the inter-play of jurisdictional concepts as applied to cross-border taxation without first broaching the particulars of due process as an element of jurisdiction.
The nature of international transactions has its risk management embedded and dependent upon the ability to limit exposures in a contractual agreement, to the taxation asserted by a source or residency country, and corporate planning. It is appropriate in establishing this foundation to first focus upon the basic elements of due process considerations that transmute into international transactions.
Jurisdiction and Legal Risks Generally
Jurisdiction can be divided into three conceptual groupings: judicial jurisdiction, enforcement jurisdiction, and legislative or prescriptive jurisdiction. For the purpose of discussing legal risk of a financial nature, the focus shall be upon judicial jurisdiction and how in cross-border taxation it can possibly meld with prescriptive jurisdiction. This is the point of beginning before one can entertain the concepts pertaining to taxation and analysis of source and resident country concepts that are at the heart of electronic commerce.
Judicial jurisdiction has been described as the authority of a state to subject certain persons or things to the process of its judicial tribunals. It can be distinguished from legislative jurisdiction which is jurisdiction based upon the authority of a state to make laws and then apply them to people and things. Judicial jurisdiction can be differentiated from enforcement jurisdiction, which is more an authority of a state to compel compliance with its laws. (1) To thread the necessary concepts to link judicial jurisdiction to international application and an extension to electronic commerce, an appreciation of the risk significance necessitates a review of the essence of its characteristics.
These concepts are discussed from the perception of the United States with explanatory elaboration of how those domestic notions are transmuted into international law application. Judicial jurisdiction deals with in personam jurisdiction, in rem jurisdiction, and quasi in rem jurisdiction. In personam jurisdiction is the primary type of judicial jurisdiction that links to international concepts.
There are two basic requirements in determining if a United States court has appropriate in personam, in rem, or quasi in rem judicial jurisdiction over a foreign person or foreign asset. The United States court must initially find statutory or constitutional authorization providing the forum court power to exercise jurisdiction over a foreign defendant or its property. Second, though a statute provides requisite legislative authority, such a statutory or constitutional basis must be consistent with the due process clause of the United States Constitution. (2)
This constitutional requirement imposes the rigors of the Fourteenth Amendment that apply to states and the Fifth Amendment making the same standards applicable to federal statutes. This is the essence of due process. It fundamentally means affairs must be conducted in a manner providing reasonable uniform administration of law in a way to promote fairness of litigation.
In personam jurisdiction concepts can be further characterized as either general or specific jurisdiction. Where the requisites are present to grant in personam jurisdiction to a court to adjudicate a claim, there is a secondary question with respect to the characterization of jurisdiction recognized. If pursuant to in personam jurisdiction there is jurisdiction to adjudicate any claim against the defendant, the court recognizes a general in personam jurisdiction.
If adjudication is restricted to only a precise claim, the judicial jurisdiction is specific in personam jurisdiction. (3) When the connecting applications are put in the context of elements of jurisdictional due process and the commerce clause for analysis of the validity of a taxing authority, these distinctions of general and specific in personam jurisdiction are significant.
General and Specific In Personam Jurisdiction
Layering general in personam jurisdiction are two conceptual factors. One is that general in personam jurisdiction occurs when the adjudicating court is the residence or domicile of the defendant. (4) Corporations in the United States are generally deemed to be domiciled in the place of incorporation. They can be perceived as domiciliary or residents of jurisdictions in which they qualify to do business. (5) A European perspective might interchange the place of incorporation with the seat of the corporation and where its management exists.
The other aspect of general in personam jurisdiction is in the factual setting of continuous activities in the forum. A case defining the distinctions of general and specific in personam jurisdiction based upon continuous activity in a forum is Helicopterous Nacionales De Colombia v. Hall. (6) This was not a financial transaction but rather a tortious claim of wrongful death. However, it admirably enunciates the salient considerations in making this jurisdictional distinction by activities. It is worthy of noting that activities discussed in this context become a distinct and pivotal notion when distinguishing between due process of jurisdiction and the elements of the commerce clause. It becomes the connecting focus of cross-border taxation concepts of electronic commerce when analyzed by the United States Supreme Court.
Apart from the two basic notions of general in personam jurisdiction, domicile and continuous presence in the forum, there was an emerging concept of continuous presence and its interaction with due process. This involves a transitory presence within a jurisdiction and the reasonableness in the exercise of jurisdiction. It impacts the exposure of corporate officers as agents for a foreign corporate entity and due process issues. It is often a reference point of exorbitant exercise of jurisdiction.
The case of Amusement Equipment, Inc. v. Mordelt, (7) illustrates an ability to obtain general in personam jurisdiction based upon transitory presence of a corporate officer. Its theory explores the parameters of jurisdictional due process. It brings to the forefront whether it is reasonable to allow judicial jurisdiction over a foreign company obtained by service of process upon an officer of the foreign entity. This approach relies greatly upon the analysis of the particular facts of a case—an analysis that ponders the idea of the agency relationship versus the individual’s unofficial capacity.
Turning to a more confined application of judicial jurisdiction, specific in pesonam jurisdiction is the jurisdiction restricting adjudication to a specific claim. Because of the concept upon which the analysis of jurisdiction is often based, specific jurisdiction could have particular significance to offshore conduit structures. The jurisdiction looks to the stream of commerce within one analysis that lends itself to multi-connected manufactures, distributors, retailers, and the eventual customers. It is a study in liability exposure.
Specific judicial jurisdiction has jurisdictional requirements of two tests: a specific statute authorizing the jurisdiction and a necessity that the adjudicating court, comport to the constitutional demands of due process. Statutes used pursuant to long arm legislation by Federal Courts in international cases are those borrowed from the state law in which the Federal Court is seated. (8) A typical long armed statute providing jurisdiction to a state upon a nonresident would be that of the State of Florida. That long arm state statute provides jurisdiction of the state courts over persons who carry on a business in the state, commit a tortious act within the state, use or possess real property in the state, or breach a contract in the state by failing to perform acts required by a contract specified to be performed in the state. (9)
Using long armed statutes in an attempt to obtain judicial jurisdiction over a non-resident who has breached a contract within the state raises the issue of whether sufficient due process exists to bring the action. An important case illustrating this principle is Gray v. American Radiator Company. (10) The due process issue raised was whether it was reasonable for the original manufacturer to foresee the product would end up in a stream of commerce. The court found it did not violate due process.
The court utilized the stream of commerce concept. The analogy used was of someone standing upstream and dropping a floating object into it. Where the object washes up downstream, it can be said to be within the stream of commerce and foreseeable, reasonable, as well as satisfying due process. This is an important concept because foreign manufacturers, as well as United States manufacturers, structure their product distribution in this manner. An important ancillary aspect is to note that the use of Offshore Financial Center conduits within the corporate structure can be utilized to reduce liability exposure using jurisdictional concepts. This highlights also the source and resident connection which respect to cross-border taxation authority. These factual analysis are a core of the United States Supreme Courts discussion of due process of jurisdiction and application of the theory of the commerce clause to cross-border taxation.
The courts have distinguished the stream of commerce concept in analyzing reasonableness in satisfying due process. Where the activity of the consumer, as opposed to the activity of manufacturers, generates the product of the cause of action to be in the jurisdiction, it is not reasonable to assert jurisdiction over a foreign manufacturer; source and residence states or countries in a cross-border taxation analysis perhaps. That would violate due process. To gain the benefit of the stream of commerce theory, the defendant must purposefully avail himself of the jurisdiction, and the assertion of the jurisdiction must be reasonable. Foreseeability alone is not sufficient to satisfy due process notions. One must establish purposeful availment of the use of the jurisdiction for some business purpose, to obtain advantage from it, or make money from it. That provides the necessary contact. (11)
Courts have held that within certain factual settings sufficient chain of commerce exists in a contractual relationship to satisfy jurisdictional notions of due process. A breach of contract, upon which a cause of action is brought pursuant to a long arm statute, can produce sufficient minimal contacts to grant specific jurisdiction. Specific jurisdiction can be based upon contacts collectively providing reasonableness in a contractual setting. Continuing and wide reaching contacts in a contractual case can be sufficient, particularly where a long-term relationship exists. (12) That factual analysis in a contention of meeting due process in a civil litigation matter may at some point carry great weight in an analysis of the necessary due process in a cross-border taxation, electronic commerce application.
Where the United States Supreme Court has had an opportunity to analyze due process concerns in international cases, it has applied identical tests it uses to review domestic cases. However, it should be noted that any case brought against a foreign person has a foreign relations aspect to it making it different than a domestic case. Drawing from the domestic perspective, the Supreme Court has injected an effort to balance interests of a foreign sovereign. The United States District Court has exhibited this leaning to aspects of foreign relations in determining a United States company satisfies due process in its jurisdictional claim over a Greek corporation. (13)
To date the most significant case in the international framework revolves around the stream of commerce theory. In this case, a Japanese company fabricated a valve and sold it to a Taiwanese manufacturer who in turn produced a tire using the valve. It was a cause of action arising out of asserted liability in California. The United States Supreme Court upheld specific in personam jurisdiction.
The manufacturer placed this product into the stream of commerce, not the consumer; again analogize the concept of source country and resident country in terms of taxation. The consensus opinion concluded due process with respect to jurisdiction was satisfied. This was not based on mere foreseeability, rather there is required a substantial connection between a defendant and the forum state establishing requisite minimum contact. This contact must result from the action of the defendant and be purposefully directed to the forum. The taxation cases to date have embraced similar contact and benefit analysis.
But important in this case finding is the court’s indulgence in the balancing of interests of the United States and the sovereign of Japan. The court felt in light of the heavy burden upon an alien defendant and the slight interest of a plaintiff, the exercise by a California court of jurisdiction over the Japanese company may have been unreasonable and unfair. It expressed the jurisprudence that even though minimal contacts are of a degree to be sufficient to support jurisdiction, a court may refuse and base it upon the sensitivity of foreign interests. (14) Importantly these analysis and decisions are in the furtherance of the evolution of the application of due process with respect to jurisdiction.
Though these principles of international jurisdiction are premised upon United States case law, it is significant when intertwined with the concept of Comity. Comity is developing into a type of recognizable international law of the United States. Comity is not necessarily an obligation on the part of one nation to recognize the laws and decrees of another country. It is not just a matter of discretion either. It is a balancing process: a recognition it is to the mutual benefit to interact with one another in a global context, to recognize laws and decrees to the extent that one country is not prejudiced.
Comity is spreading itself out in a greater degree with the development of international law. Tensions created in transnational litigation between the interests of private litigants, foreign affairs, and the Congress serving the United States provide reasons for a necessary balancing. Interest balancing and development of the concept of the doctrine of Comity are intangible components in the evolution of international law.
The segment that shall follow this writing shall address how due process is connected or different in its application of a claim of violation of the commerce clause when one state has imposed a cross-border taxation upon a sister state. This involves the concept that in looking at due process for both jurisdiction and the commerce clause, a distinction is made. As will be seen, the commerce clause and its nexus requirements are formed not so much by concerns about fairness for the individual defendant as by structural concerns about the effects of state regulation on the national economy; the suppression of interstate commerce.
As will be seen, the analysis delves into a required substantial nexus and a relationship between the tax and state-provided services, thereby limiting the reach of state taxing authority to ensure that the state does not unduly burden interstate commerce. Substantial nexus is not like the due process minimum contacts requirement and a proxy for notice, but rather a means for limiting state burdens on interstate commerce. A corporation may have the minimum contacts with a taxing state as required by the due process clause and yet lack the substantial nexus with that state as required by the commerce clause.
1. See Born and West, International Civil Litigation in United States Courts, 2/Judicial Jurisdiction. P. 19, 1991, Kluwer Law and Taxation Publishers, Deventer, The Netherlands.
2. Id. at note 1, page 20.
3. Supra, note 1, at page 25.
4. Milliken v. Meyer, 311 U. S. 457 (1940).
5. See Restatement (Third) Foreign Relations Law of the United States Section 421(2) (e) (1987). Residence can provide general jurisdiction without domicile. Myrick v. Superior Court, 256 F.2d 348 (Cal. Ct. App.), aff’d 41 Cal. 2d 519, 261 P.2d 255 (1953); Merritt v. Hefferman, 142 Fla. 496, 195 So. 145 (1940).
6. 466 U. S. 408 (1984).
7. 779 F. 2d 264 (5th cir. 1985).
8. Federal Rules of Civil Procedure, Rule 4.(e) Process.
9. Fla. Statutes Ch. 48, Process and Service of Process, Section 48.193.
10. 176 N. E. 2d. 761 (Ill. 1961).
11. World-Wide Volkswagen Corp. v. Woodson, 444 U. S. 286 (1980).
12. Burger King Corp. v. Rudzewicz, 471 U. S. 462 (1985).
13. Afram Export Corp. v. Metallurgiki Halyps, S. A., 772 F. 2d 1358 (7th Cir. 1985).
14. Asahi Metal Industry Co. v. Superior Court of California, Solano County, 107 S. Ct. 1026 (1987).