House Subcommittee Holds Hearing on State Business Activity Taxes

September 27, 2005. The House Judiciary Committee's (HJC) Subcommittee on Commercial and Administrative Law held a hearing on HR 1956, the "Business Activity Tax Simplification Act of 2005", or "BATSA".

Rep. Bob Goodlatte (R-VA), Rep. Rick Boucher (D-VA), two of the leading technophiles in the House, and others, introduced HR 1956 on April 28, 2005. See also, story titled "House Subcommittee to Hold Hearing on Goodlatte Boucher BAT Bill" in TLJ Daily E-Mail Alert No. 1,219, September 22, 2005.

The Supreme Court ruled in Quill v. North Dakota, 504 U.S. 298 (1992) that state and local taxing authorities are barred under the Commerce Clause from requiring remote sellers without a substantial nexus to the taxing jurisdiction to collect sales taxes for sales to persons within the jurisdiction. The Court added that Congress may extend such authority. Some states now take the position that the holding in Quill only reaches sales taxes, and that states are free to tax businesses with no in state physical presence, based upon their business activities.

HR 1956 requires a physical presence for imposition of business activity taxes (BATs) by states. It provides that "No taxing authority of a State shall have power to impose, assess, or collect a net income tax or other business activity tax on any person relating to such person's activities in interstate commerce unless such person has a physical presence in the State during the taxable period with respect to which the tax is imposed."

The bill sets out in detail minimal activities, such as attending training conferences, that do not constitute physical presence.

The bill also defines "net income tax", and "other business activity tax". The latter means "(i) a tax imposed on or measured by gross receipts, gross income, or gross profits; (ii) a business license tax; (iii) a business and occupation tax; (iv) a franchise tax; (v) a single business tax or a capital stock tax; or (vi) any other tax imposed by a State on a business for the right to do business in the State or measured by the amount of, or economic results of, business or related activity conducted in the State." BAT does not include a "transaction tax".

HR 1956 would protect businesses that sell products over the internet from being subjected to a multitude of taxes, and tax filing requirements, in jurisdictions in which they have no presence.

Carey Bo Horn, the President of ProHelp Systems, Inc., a very small software company based in South Carolina, testified in support of the bill. He wrote in his prepared testimony that his company has annual domestic sales of under $30,000. However, the state of New Jersey taxes his company because it made a sale to a customer in New Jersey in 1997.

He wrote that "Should all 50 States adopt New Jersey's Corporate Business Tax, small software developers selling just one license in every State would owe $30,000 in business activity taxes every year thereafter, with no additional sales anywhere. Should localities follow suit, the results would truly be astronomical. These are powerful reasons to stay out of the software business."

He added that "The victims are generally not capable of fighting, they capitulate to reduce the risk of larger penalties, and they have absolutely no representation in the matter except right here. Why should anyone believe this tax will not soon be increased again, and spread to other States? Without clear protections such as BATSA provides, aggressive States will always seek to stretch the limits and to impose their own creative definitions to justify taxation most citizens would consider unjust."

Lyndon Williams, tax counsel for credit card issuer Citigroup, also testified in support of the bill. Citigroup issues credit cards to customers in all states. Some of these states, where it has no offices, employees or other physical presence, nevertheless assert that they can tax Citigroup for its business activities.

Williams stated that while some states conclude that Quill's physical presence standard applies to BATs, "some state tax administrators and some state courts disagree. They have construed the Quill decision to mean, in essence, that the constitutional standard for taxing an out-of-state corporation depends on the type of tax being imposed. They argue that the Quill decision is limited to sales tax. Interpreted in this manner, the constitutional standard is physical presence (i.e. in-state employees, an office, property) if a sales tax is involved, and economic nexus (i.e. merely having in-sate customers) if an income tax is involved." (Parentheses in original.)

Earl Ehrhart, a state legislator from Georgia and National Chairman of the American Legislative Exchange Council, also offered support for HR 1956. He wrote in his prepared testimony that "We need the help of Congress to ensure that Georgia-based companies arenít being unjustifiably taxed by those states in which they have no physical presence."

"He added that "Today, we see an increased tendency of lawmakers and revenue officials in other states to get aggressive when it comes to raising revenue from out-of-state companies. If our state is making the effort to provide an infrastructure to attract and maintain business in our state, we should be the ones to enjoy the benefits."

The Subcommittee heard from only one witness who opposes HR 1956. Joan Wagnon, Secretary of Revenue for the State of Kansas, and Chairman of the Multistate Tax Commission, wrote in her prepared testimony that the Congress should reject the bill because it is unfair to state tax collectors.

She offered some scenarios involving e-commerce, and how HR 1956 would affect their state tax consequences.

For example, she wrote that "An out-of-state retailer of computers or other electronic devices markets its products to Kansas customers via the Internet. The sale of computers and electronic devices includes warranty contracts. The out-of-state retailer contracts with an independent contractor located in Kansas to provide the warranty service to its Kansas customers. The independent contractor provides similar services to other out-of-state retailers, all of which could be affiliates of one another. Under the independent contractor safe harbor in H.R. 1956, the out-of-state retailer now has no nexus with Kansas."

As another example, she wrote that "A Kansas company providing information and software support services to businesses in Kansas and other states breaks itself into in-state information services company X, in-state software support services company Y, and an out-of-state sales agency Z. Companies X and Y wholesale their services to agency Z, who in turn sells the services to businesses in Kansas, delivering the services via the Internet. Income earned by agency Z on sales of information and software services provided to Kansas customers will not be taxable in Kansas."

She argued that these tax consequences are unfair to the state of Kansas. She argued too that the economy is now "electronic and borderless" and that the physical presence standard is an outdated and "colonial concept". States should be allowed to tax any business with an "economic presence".

See also, HR 3220 (108th Congress), titled the "Business Activity Tax Simplification Act of 2003", and stories titled "Reps. Goodlatte and Boucher Introduce Bill to Limit Business Activity Taxes" in TLJ Daily E-Mail Alert No. 753, October 6, 2003, and "House Subcommittee Holds Hearing on Business Activity Taxes" in TLJ Daily E-Mail Alert No. 899, May 17, 2004.

See also, HR 2526 (107th Congress), titled the "Internet Tax Fairness Act of 2001", and stories titled "Goodlatte and Boucher Introduce Net Tax Moratorium Bill" in TLJ Daily E-Mail Alert No. 229, July 18, 2001, and "House Subcommittee Approves Bill to Limit Business Activity Taxes" in TLJ Daily E-Mail Alert No. 471, July 17, 2002.