Cross border taxation risks of international enterprise incorporates two basic themes, one of which is the interpretation of the United States Commerce Clause and the Due Process distinction from jurisdictional analysis. It is one of the two basic aspects that govern the authority of a source and resident country or state to tax international commerce.
In the electronic commerce world the courts have embraced an evolution of Due Process requisite of jurisdiction and of commerce. That analysis for both turns upon the judicial case law evolution that focuses on the contact with the state or country that imposes taxation from their border.
Cross border taxation first domestically grapples with the dual concepts and their importance in understanding the taxation of interstate commerce. As discussed precedent to this segment, one captures the principles of domestic application of these themes and then they are transmuted to international private law. (See TaxConnections, Due Process and Regulation of Commerce-Offshore Financial Centers Cross Border Taxation, subheading Jurisdiction Principles, June 3, 2014)
Commerce Clause and Defining Nexus
The important consideration in a discussion of electronic commerce and cross border taxation confronts issues of analysis of the Due Process clause and the Fourteenth Amendment, the Commerce Clause and whether it creates an unconstitutional burden on interstate commerce; violation of the Commerce Clause. (1) To date the most significant analysis of the Commerce Clause has arisen in domestic cases of sale and use tax imposed by states upon sales made to vendees in their state from out of state vendors. It has been an evolution by factual focus, perhaps beginning significantly with a statement by a court that a tax on the privilege of engaging in an activity in the state cannot be applied to an activity that is part of interstate commerce. That was known as the Spector Doctrine, the underlying philosophy being that interstate commerce enjoyed a free trade immunity. (2)
Subsequent to the established Spector Doctrine, it was rejected and decreed by the United States Supreme Court that it did not address the problems of the Commerce Clause with which the court was concerned. In doing so the court stated that a state tax on the privilege of doing business was not per se unconstitutional when viewed in terms of interstate commerce. That had been the crux of the Spector Doctrine. The basis for this rejection of that doctrine was grounded in the simple concept that it had no relationship to economic realities. (3)
Just as in the Due Process analysis as a jurisdictional requirement, the Supreme Court of the United States sought to determine the application of the Commerce Clause by a justification of the contacts with a particular state. In the leading case, it determined that a state’s attempt to require an out-of-state mail-order house to collect and pay a use tax on goods purchased for use within the state violated the Due Process Clause of the Fourteenth Amendment and created an unconstitutional burden on interstate commerce. It is from this bell weather holding that the concepts of Due Process of the jurisdiction analysis and the deemed violation of the Commerce Clause became entwined; they are to be distinguished in application. (4)
Evolution To Economic Presence
In 1992, the United States Supreme Court revisited this issue of what constitutes what it deemed an appropriate nexus of state connection to impose state taxation and the relation to the Commerce Clause. (5) The Due Process Clause and the Commerce Clause are analytically distinct. (6) The Due Process Clause requires some definite link, some minimum connection between a state and the person, property or transaction it seeks to tax. The income attributed to the state for tax purposes must be rationally related to values connected with the taxing state. (7)
Article I, paragraph 8, clause 3 of the Constitution expressly authorizes Congress to regulate Commerce with foreign nations and among the several states. Nothing is stated regarding the protection of interstate commerce in absence of action by Congress. However, the Commerce Clause is more than an affirmative grant of power, it has a negative sweep as well; by its own force it prohibits certain state actions that interfere with interstate commerce. The negative or dormant Commerce Clause has evolved substantially, particularly as it concerns limitation upon state taxation powers. The nexus requirements of the Due Process and Commerce Clauses are not identical. The standards of the two facets derive from different constitutional concerns and policies. (8) Nexus is at the very core of the analysis of the principles of a state taxing in interstate commerce and its constitutionality.
With respect to jurisdiction, a Due Process nexus analysis requires understanding an individual’s connections with a state, whether they are substantial enough to make legitimate the states exercise of power of the person or entity. The Commerce Clause and its nexus requirement is to be understood with respect to structural concerns about the effects of state regulation upon the national economy, not the concerns about fairness for the individual defendant which is at the core of jurisdictional Due Process.
The nexus doctrine has been the authority upon which the Supreme Court of the United States has upheld sales and use taxes where a taxpayer has had some minimal physical presence within the jurisdiction. That has been the case even thought transactions leading up to the imposition of the tax were not linked to physical presence. (9) Physical presence has been at the core of the Supreme Court’s dormant Commerce Clause analysis in early sales and use tax cases.
However physical presence in the narrow sense has not appeared as a decisive factor in cases involving state income taxation. It has been viewed that an income tax could be supported if the activities form a sufficient nexus between the tax and transactions within a state for which the tax is an exaction. (10) This thread couples collectively factors such as frequency, quantity, and the systematic nature of a taxpayer’s economic contacts with a state to determine if there is economic presence sufficient to establish nexus and subject the activity to that state’s taxation. It is often stated as the economic presence concept as it underpins the lack of the traditional physical presence.
Commerce Clause and Four-Part Test of Application
The United States Supreme Court has accepted a four-part test as governing issues which when met, will support the rigors of the Commerce Clause demands of taxation upon interstate commerce. A tax will be sustained against a Commerce Clause challenge where the following is satisfied. The tax must be applied to an activity with a substantial nexus with the taxing state, the tax must be fairly apportioned, it must not discriminate against interstate commerce, and it must be fairly related to the services provided by the taxing state. (11)
The second and third element of meeting the demands of the Commerce Clause, prohibit taxes that pass an unfair share of the tax burden onto interstate commerce. The first and fourth elements of meeting these demands require a substantial nexus and a relationship between the tax and state provided services, limiting the reach of the state taxing authority to insure that state taxation does not unduly burden interstate commerce. The substantial nexus required is a means for limiting state burdens on interstate commerce. A taxpayer may have limited minimum contacts with a taxing state that would satisfy notions of Due Process, yet lack the substantial nexus with that state in meeting the requirements of the Commerce Clause. (12)
The court has acknowledged that there has been an evolution of the Commerce Clause and its application. Jurisprudence in its view favors a more flexible balancing analyses. It has acknowledged that it does not reject across the board what some refer to as bright-line tests. Because it has not articulated on physical presence requirements established in prior precedents for sales and use tax analysis, a silence should not imply a repudiation of those precedent doctrines. Undue burdens on interstate commerce can on a case-by-case analysis provide valuable demarcation of a discrete realm of commercial activity that is free from interstate taxation. (13)
There is an important benefit in allowing a flexibility of analysis. The courts readily acknowledge that this area of our law is something of a quagmire. The application of constitutional principles to specific state statutes does not lend itself to the guidelines of states exercising their indispensable power of taxation. The underlying reason it evolved in this inexact manner has resulted from Congress not having undertaken a regulatory guidance of taxation among the states and the states need to recover some return for the substantial benefits they afford commerce. (14) As a result, the Supreme Court has sought to limit state taxation power by applying the dormant premise of the Commerce Clause.
Utilizing this dormant premise of the Commerce Clause, the Supreme Court of Iowa has upheld the imposition of a state income tax upon a foreign corporation that had no tangible physical presence and derived its income from the use of the corporation’s intangible property within the state. (15)
In so doing, it noted that the Supreme Court of the United States has upheld sales and use taxes pursuant to the application of the nexus doctrine when the taxpayer had some minimal physical presence within the jurisdiction. Its analysis threaded its way around the dominant theme that physical presence was a focus in sale and use taxation analysis, concluding that it was not as an important a factor in the analysis of a state income tax under the dormant theory of the Commerce Clause. (16)
In summary there have been a number of cases that brought forth the issue and distinction of where the guidance was for physical presence and the authority of states to impose taxes other than sales and use taxes upon out of state entities. The Supreme Court has steadfastly denied certiorari that embraced the exact issue of the necessity of physical presence. The guidance therefore would be that corporate structural planning should anticipate that the basis of not having a corporate physical presence will not avert the assertion of state income tax in the application of the Commerce Clause. (17) Electronic commerce as will be seen in subsequent segments will introduce even more removed concepts of physical presence where a review of Due Process as utilized in the jurisdiction application will bring to light possibly more complex analysis. That complex analysis of the Due Process theme makes interpretation of the Commerce Clause in its applicability to interstate taxation without the predictability and certainty that are necessary for prudent corporate planning.
1. U.S. Const., Art. I, par. 8, cl. 3.
2. Spector Mortor Service v. O’Connor, 340 U.S. 602 (1951); Freeman v. Hewit, 329 U. S. 249 (1946).
3. Complete Auto Transit, Inc. v. Brady, chairman, Mississippi Tax Commission, 430 U.S. 274 (Sup. Ct. 1977).
4. National Bellas Hess, Inc. v. Department of Revenue of The State of Illinois, 368 U.S. 753 (Sup. Ct. 1967).It was in this case that the assertion was made that a tax by the state violated the Due Process Clause of the Fourteenth Amendment and created an unconstitutional burden upon interstate commerce. It acknowledged that those two contentions were closely related, noting that the test whether a particular state exaction is such as to invade the exclusive authority of the Congress to regulate trade between the states, that the requirements of due process in that area was similar. In so doing, it noted that the Court has held that state taxation falling on interstate commerce can only be justified as designed to make such commerce bear a fair share of the cost of the local government whose protection it enjoys. That contacts with the forum state differs in the approach of the jurisdiction analysis of jurisdictional due process.
5. Quill Corp. v. North Dakota, by and through Its Tax commissioner, Heitkamp, 504 U.S. 298 (1992) With respect to the understanding of the constitutional requirements of Due Process and the Commerce Clause, they differ fundamentally in several ways. The Due Process Clause and the Commerce Clause reflect different constitutional concerns. Congress has the plenary power to regulate commerce among the States and authorize state actions that burden interstate commerce, it does not similarly have the power to authorize violations of the Due Process Clause. That is one fundamental distinction.
6. Id. at 5. The Due Process and Commerce Clause conceptions are not always sharply separable in addressing these applications. To some extent they overlap. If there is a want of due process to sustain a tax imposed by a state, by such fact alone any burden the tax imposes on the commerce among the states becomes undue. However thought overlapping, the two conceptions are not identical. There may be more than sufficient factual connections, with economic and legal effects between the transaction and the taxing state to sustain the tax as against due process objections. And yet it may fall because of its burdening effect upon the commerce. That said, the two notions cannot always be separated and the clarity of consideration and decision would be promoted if the two issues are approached where they are presented. That is at least tentatively as if they were separate and distinct, not intermingled.
7. Moorman Mfg. Co. v. Bair, 437 U.S. 267 (Sup. Ct. 1978).
8. Supra at note 5.
9. Scripto, Inc., v. Carson, Sheriff, Et Al., 362 U.S. 207 (Sup. Ct 1960).
10. Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450 (Sup. Ct. 1959).
11. Complete Auto Transit, Inc. v. Brady, Chairman, Mississippi Tax Commission, 430 U.S. 274 (Sup. Ct. 1977).
12. Supra at note 5.
13. Supra at note 5.
14. Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450 (Sup. Ct. 1959).
15. KFC Corporation, Appellant, v. Iowa Department of Revenue, Appellee, 792 N.W. 2d 308 (Sup. Ct. of Iowa 2010).
16. Id. at 15.
17. See, A & F. Trademark , Inc. v. Tolson, 167 N. C. App. 150, 605 S.E. 2d 187 (2004), cert. denied 546 U.S. 821, 126 S. Ct. 353; Geoffrey, Inc. v. S.C. Tax Comm’n, 313 S. C. 15, 437 S.E. 2d 13, (cert. denied, 510 U.S. 992, 114 S. Ct. 550, 125 L.Ed. 2d 451 (1993). Also see Tax Comm’r v. MBNA Am. Bank, N.A., 640 S.E. 2d 226 (W. Va. 2006, cert. denied, 551 U.S. 1141 (2007) which held that a foreign corporation had a substantial economic presence in West Virginia and a substantial nexus. That nexus is based upon having customers in the state. This case went to the length to distinguish physical presence distinction by indicating it was applicable to sale and use tax, but not income tax. It was a foreign corporation with no presence, no tangible property or intangible property within the state. The novelty that KFC Corporation, Appellant, v. Iowa Department of Revenue, Appellee, 792 N.W. 2d 308 (Sup. Ct. of Iowa 2010) established was that it maintained a nexus by virtue of intangible property.