Ohio Commercial Activity Tax Bright-line Nexus Constitutional-What to do now?
The <a href="https://www.supremecourt.ohio.gov/">Ohio Supreme Court</a> recently held that the bright-line presence nexus standard for Ohio Commercial Activity Tax (“CAT”) does not violate the U.S. Constitution. Many taxpayers have pending audits or appeals at the <a href="https://ohio-bta.modria.com/">Board of Tax Appeals</a> regarding this nexus issue. What should these and other CAT taxpayers do now?
First, it is expected the taxpayer will appeal the unfavorable decision in <em>Crutchfield</em> v<em>. Testa</em> to the U.S. Supreme Court. The Court has refused to hear other cases concerning economic nexus in the past. But this case is unique because it is the first case involving a true remote e-Commerce retailer whose only contact with the state is through advertising and common carrier. Additionally, the Court could take this case to clarify that <em>Quill</em> does not apply to business activity taxes - or it could conclude that <em>Quill</em> is no longer applicable to any state taxes. In any event, taxpayers with pending audits or appeals may wish to wait to see if the U.S. Supreme Court will hear this case before taking any action to resolve their audit / appeal.
Nonetheless, the Ohio Department of Taxation has indicated it will continue to offer settlements at the same level offered before. Agreeing to a settlement, however, requires the taxpayer to forego a refund claim if the U.S. Supreme Court ultimately holds that the CAT’s economic nexus standard is unconstitutional.
Many businesses who meet the bright-line presence standard are not yet paying CAT. These businesses could register and begin complying with the CAT, although doing so without addressing past periods could result in an audit by the <a href="http://www.tax.ohio.gov/">Ohio Department of Taxation</a>. Another option is to enter into a voluntary disclosure agreement with the Department. This requires the taxpayer to pay the CAT plus interest for the current year and 3 previous years. <a href="https://www.ohiostatetaxblog.com/contact/">Contact us</a> to find out if applying for a Voluntary Disclosure Agreement anonymously is the best decision for your business.
Ohio Supreme Court upholds bright-line nexus standard for Commercial Activity Tax; Remote vendors subject to Ohio tax even if lacking physical presence.
In a 5-2 decision, the Ohio Supreme Court found that the $500,000 gross receipts in Ohio standard for creating substantial nexus for the commercial activity tax (CAT) is constitutional. “We hold that given the $500,000 sales-receipts threshold, the burdens imposed by the CAT on interstate commerce are not ‘clearly excessive’ in relation to the legitimate interest of the state of Ohio in imposing the tax evenhandedly on the sales receipts of in-state and out-of-state sellers. As a result, the tax satisfies the substantial-nexus standard under the dormant Commerce Clause…” <a href="http://www.supremecourt.ohio.gov/rod/docs/pdf/0/2016/2016-Ohio-7760.pdf" target="_blank">Crutchfield Corp. v. Testa</a>, 2016-Ohio-7760, ¶56.
The holding that the physical presence standard for sales/use tax collection set forth in Quill does not apply to the gross receipts tax on Ohio business activity creates significant uncertainty for state taxes, both in Ohio and other states. Several other states have enacted similar factor presence nexus standards and this opinion invites more states to follow. See <a href="http://www.mtc.gov/uploadedFiles/Multistate_Tax_Commission/About_MTC/Policy_S_and_R/2002/FactorPresenceNexusStandardBusinessActTaxes.pdf" target="_blank">Multistate Tax Commission, Factor Presence Standard for Business Activity Taxes</a> (approved Oct. 17, 2002). More analysis and commentary to come on this topic.
Third Annual Northeast Ohio State and Local Tax Conference Provides Invaluable Updates on the Current State of Ohio and Multistate Taxes
The third annual Northeast Ohio State and Local Tax Conference was held on November 12, 2015 in Independence, Ohio. Matt Chafin, Chief Legal Counsel for the <a href="http://www.tax.ohio.gov/">Ohio Department of Taxation</a>, led off the Conference with an Ohio Tax Update, providing valuable insight to the Department of Taxation’s posture and recent initiatives. Chafin is the highest-ranking official in the Tax Commissioner’s office and is directly involved in establishing policy.
“This one day, comprehensive conference is the only one of its kind in Northeast Ohio,” said <a href="http://www.bdblaw.com/attorneys/steven-a-dimengo/">Steve Dimengo</a>, co-founder of the Northeast Ohio State and Local Tax Conference and partner at <a href="http://www.bdblaw.com/">Buckingham Doolittle & Burroughs LLC</a>. “Every year we are honored to have so many talented tax professionals, from all over the state, who are willing to present at our conference. This is an event we will continue, and continue to improve, for many years to come.”
The Northeast Ohio State and Local Tax Conference covered a wide array of topics, including aligning state tax planning with business incentives, combined reporting, and apportionment trends. The Conference featured well-recognized speakers from both private practice and government taxing authorities. <a href="http://www.bdblaw.com/attorneys/steven-a-dimengo/">Steve Dimengo</a> presented on a variety of topics, including creative maximization of Ohio sales/use tax exemptions, Ohio’s nonresident law after <a href="https://www.ohiostatetaxblog.com/9841"><em>Cunningham</em></a>, and an overview of Ohio sales/use tax updates. Fellow Buckingham partner, Richard Fry, presented an update on the Ohio Commercial Activity Tax and moderated the panel discussion regarding minimizing real property tax and maximizing Ohio tax incentives.
We hope that you will join us for the Fourth Annual Northeast Ohio State and Local Tax Conference in November 2016.
If you have any questions regarding the topics covered at the Northeast Ohio State and Local Tax Conference or if you have any Ohio tax questions, please contact <a href="http://www.bdblaw.com/attorneys/steven-a-dimengo/">Steve Dimengo</a>, <a href="http://www.bdblaw.com/attorneys/richard-b-fry-iii/">Richard Fry</a>, or <a href="http://www.bdblaw.com/attorneys/casey-j-davis/">Casey Davis</a>.
<a href="mailto:[email protected]">Contact us</a>.
Ohio CAT: BTA Predictably Upholds Ohio’s Bright-Line Nexus Standard despite Lack of Physical Presence
The Ohio Board of Tax Appeals (BTA) found L.L. Bean, Inc. to be subject to Ohio commercial activity tax (CAT) because it had greater than $500,000 of Ohio gross receipts from catalog and Internet sales, even though it lacked an Ohio physical presence. <i><a href="http://app.bta.ohio.gov/2010-N-2853.pdf">L.L. Bean, Inc. v. Levin</a></i>, BTA Case No. 2010-2853 (March 6, 2014). This was a simple application of Ohio’s statutory “bright-line presence” standard which deems nexus to exist if a taxpayer has at least $500,000 in calendar year gross receipts from Ohio sources. <a href="http://codes.ohio.gov/orc/5751.01v1">R.C. 5751.01(I)</a>.
Although this provision may be unconstitutional on its face or as applied to L.L. Bean, Inc., there was no doubt the BTA would find that substantial nexus existed since it is without jurisdiction to address Constitutional issues. Such determinations are left for the Ohio Supreme Court, where L.L. Bean recently filed its appeal. <i>See <a href="http://www.supremecourt.ohio.gov/Clerk/ecms/resultsbycasenumber.asp?type=3&year=2014&number=0456&myPage=searchbyentityname.asp">L.L. Bean, Inc. v. Testa</a>,</i> Case No. 2014-0456 (<a href="http://www.sconet.state.oh.us/pdf_viewer/pdf_viewer.aspx?pdf=743214.pdf">Notice of Appeal</a>, March 24, 2014). The BTA’s purpose was simply to create the factual record to be considered by the Supreme Court.
The Supreme Court will now address whether a mere economic presence is sufficient for Ohio to impose the CAT on foreign businesses without a physical presence under the U.S. Constitution’s Commerce Clause substantial nexus requirement enumerated in <i><a href="http://caselaw.lp.findlaw.com/scripts/getcase.pl?court=US&vol=430&invol=274">Complete Auto Transit, Inc. v. Brady</a></i>, 430 U.S. 274, 287 (1977). Other states in similar cases have found that the physical presence requirement in <i><a href="http://www.law.cornell.edu/supct/html/91-0194.ZO.html">Quill Corp. v. North Dakota</a></i>, 504 U.S. 298, 313 (1992) is limited to sales / use taxes. <i>See e.g., Tax Comm’r v. MBNA America Bank, N.A.</i>, 640 S.E.2d 226 (2006) <i>cert. denied</i> <i>FIA Card Services, N.A. v. Tax Comm’r of W. Virginia</i>, 551 U.S. 1141 (2007); and <i>Geoffrey, Inc. v. South Carolina</i>, 437 S.E.2d 13 (1992) <i>cert. denied Geoffrey, Inc. v. South Carolina Dep’t of Rev. and Tax.</i>, 510 U.S. 992 (1993).
Even if the CAT can be imposed on businesses without an Ohio physical presence, questions will remain, such as how is the economic presence to be determined / measured and must the business take affirmative acts to develop the Ohio market or is merely making sales into the state sufficient. Stay tuned as the Ohio Supreme Court’s ruling on this issue will be much more important.
Ohio Commercial Activity Tax Sourcing Rules Provide Planning Opportunities
Generally, taxable receipts for the Ohio commercial activity tax are sourced to where tangible personal property is “ultimately received” or the benefit of services are received. <a href="http://codes.ohio.gov/orc/5751.033">R.C. 5751.033</a>. However, evidenced by guidance published by the Ohio Tax Commissioner, these locations are not always clearly discernable. <a href="http://codes.ohio.gov/oac/5703-29-17">O.A.C. § 5703-29-17</a> (sourcing services). <a href="http://www.tax.ohio.gov/portals/0/commercial_activities/information_releases/cat200517.pdf">Information Release 2005-17</a> (revised April 2006). For example, it is particularly difficult to determine the proper source of receipts from services provided to businesses with locations in multiple states which benefit from the service. The Ohio Tax Commissioner’s guidance allows taxpayers to elect between sourcing receipts from certain services to the recipient’s principle place of business or apportioning the receipts based upon the recipient’s business locations. Businesses with Ohio commercial activity tax obligations may benefit from a review of the commercial activity tax sourcing provisions and careful planning to take advantage of many recognized alternative sourcing rules.
Expecting an Ohio Commercial Activity Tax (CAT) Refund?
Maybe you should… <a href="http://governor.ohio.gov/Portals/0/NEWS-%20Kasich%20says%20businesses%20'ripped%20off'%20by%20CAT%20overpayments,%20begins%20sending%20refunds.pdf">Governor Kasich recently announced</a> a policy change that Ohio will start automatically refunding CAT overpayments reflected in tax filings before the Tax Commissioner. Previously, the state would only issue refunds to taxpayers who filed for a refund within the four-year statute of limitations, even if the state was aware of the overpayment. Explaining the policy change, Governor Kasich said, “We never made an effort to tell businesses when they overpaid their taxes… Instead of covering up and hiding the money, we are making an aggressive effort to determine who gets the refunds.”
Consistent with <a href="https://www.ohiostatetaxblog.com/index.php?option=com_content&view=article&id=140:low-tax-rates-and-incentives-give-ohio-a-business-friendly-landscape-spurring-economic-recovery-and-growth&catid=54:ohio-state-tax-news&Itemid=59">Ohio’s business friendly climate</a>, a hallmark of Kasich’s administration thus far, Ohio will be sending about 3,500 CAT refund checks to businesses, with more refunds to come as additional overpayments are discovered. We expect this practice to rollover into other taxes in the future.
Commercial Activity Tax Revenue Derived From Motor-Vehicle Fuel Sales Must Be Used For The Benefit Of Ohio's Highway System
The Ohio Supreme Court in <em><a href="http://www.supremecourt.ohio.gov/ROD/docs/pdf/0/2012/2012-Ohio-5776.pdf">Beaver Excavating Co. v. Testa</a></em> recently ruled that the allocations of receipts from <a href="http://www.tax.ohio.gov/commercial_activities.aspx">Ohio’s commercial activity tax (CAT)</a> derived from sales of motor vehicle fuel is unconstitutional. Pursuant to the Ohio Constitution, tax revenue derived from, or “related to,” motor-vehicle fuel sales must be used for improving, repairing or maintaining the state highway system, or related purposes. However, CAT revenue is allocated to the state’s general fund, and funds for the benefit of schools and local governments. Therefore, the CAT is unconstitutional as applied to receipts from motor-fuel sales to the extent the revenue is used for nonhighway purposes. The Court carefully distinguished its decision in <em>Ohio Grocers Assn. v. Levin</em> <a href="https://www.ohiostatetaxblog.com/index.php?option=com_content&view=article&id=51:ohio-supreme-court-upholds-cat-as-applied-to-food-sellers-&catid=45:ohio-cat&Itemid=59">where it held that the CAT, as applied to grocers and other food retailers, was a privilege-of-doing-business tax, not an excise tax levied on the sale of food for off-premises consumption which is also prohibited by the Ohio Constitution</a>.
The Court, with the parties’ support, exercised discretion to apply its holding prospectively. Accordingly, fuel vendors are not entitled to a refund of CAT previous paid on receipts from motor-vehicle sales. Further, the Tax Commissioner will continue to collect the CAT from such vendors, but will hold the amounts derived from motor-vehicle fuel sales until the General Assembly amends the CAT’s expenditure statute to allocate revenue derived from motor-vehicle fuel sales to highway purposes.
Recent Legislation Affecting Ohio Commercial Activity Tax (CAT)
The following changes to the <a href="http://tax.ohio.gov/divisions/commercial_activities/index.stm">CAT</a> were enacted pursuant to <a href="http://www.legislature.state.oh.us/bills.cfm?ID=129_HB_508">H.B. 508</a> effective September 6, 2012, except as noted below:
<li><span style="text-decoration: underline;">Annual Exclusion</span> (effective January 1, 2013): Under previous law, quarterly taxpayers were required to use $250,000 of the annual exclusion each quarter, with the unused portion thereof carried forward for up to three subsequent periods. This allowed the exclusion to be carried forward to quarters in the next tax year in some circumstances. Now, quarterly taxpayers must use the $1 million exclusion on the taxpayer’s first quarter return. The unused exclusion may be carried forward for only the current tax year.</li>
<li><span style="text-decoration: underline;">Rate Changes</span>: Removes the tax commissioner’s obligation to reduce the CAT rate based upon revenue actually collected during test periods since the last test period ended June 30, 2011. The tax commissioner did not adjust the rate.</li>
<li><span style="text-decoration: underline;">Exemption for Surplus Lines Insurers</span>: “Surplus lines insurers,” who are not licensed to do business in Ohio, are exempt from the CAT to the extent their gross premiums are subject to the unauthorized insurance tax.</li>
<li><span style="text-decoration: underline;">Registration Fee Eliminated</span>: The previous registration fee – $20 per person fee ($15 if registered online) with a maximum $200 per consolidated / combined group – is eliminated. Instead, a portion of the taxpayer’s first CAT payment is credited to the “Revenue Enhancement Fund” to cover the state’s cost to administer the CAT and implement tax reform measures.</li>
<li><span style="text-decoration: underline;">Registration Information</span>: A taxpayer is no longer required to provide certain information on its CAT registration – its state or country of incorporation, names and addresses of corporate officers and agents, and the taxpayer’s annual accounting period. However, taxpayers are now required to include their organizational type and that of each member of the taxpayer’s combined or consolidated group, and the date the taxpayer is first subject to the CAT.</li>
Ohio CAT: What is the significance of the Tax Commissioner’s L.L. Bean determination?
The Ohio Tax Commissioner’s recent Final Determination upholding the Ohio Commercial Activity Tax (Ohio CAT) assessments against L.L. Bean has received much national attention lately, but for the wrong reason. L.L. Bean’s primary argument against application of the Ohio CAT is that the bright-line nexus standard in <a href="http://codes.ohio.gov/orc/5751.01">R.C. 5751.01(H)(3)</a> violates the Commerce Clause of the United States Constitution. However, the Tax Commissioner, as stated in the Final Determination, does not have jurisdiction to decide the constitutionality of a statute. Therefore, he had no choice but to apply the statute as written, which clearly states that any business with greater than $500,000 of annual Ohio gross receipts must pay the Ohio CAT.
However, what the Tax Commissioner did not state in the Final Determination against L.L. Bean is more interesting. When enacting the Ohio CAT, the Ohio General Assembly provided for a direct appeal to the Ohio Supreme Court if the primary issue raised by the taxpayer is the constitutionality of the bright-line nexus standard under <a href="http://codes.ohio.gov/orc/5751.31">R.C. 5751.31</a>. However, in order for such an appeal to be available, the Tax Commissioner’s final determination must expressly provide for a direct appeal to the Ohio Supreme Court. The Final Determination against L.L. Bean, however, did not provide for such an appeal. So, why did the Tax Commissioner fail to include this language? There could be many reason, including that the Tax Commissioner does not believe this case is the best test case to determine whether the Ohio CAT’s bright-line nexus standard is constitutional. Additionally, since evidence cannot be presented for the first time at the Ohio Supreme Court, there is some concern that, unless there is a complete stipulation of facts, the direct appeal route may violate the taxpayer’s Due Process rights.
Instead, L.L. Bean must first appeal the Final Determination to the Ohio Board of Tax Appeals (BTA), which also does not have jurisdiction to address constitutional issues. Further, although a record of the relevant facts will be established during the BTA proceeding, a resolution at the BTA will take many years due to its current backlog. Therefore, a determination on the merits as to whether the Ohio CAT’s bright-line nexus standards are constitutional is not likely for at least 5 years, unless, of course, the Tax Commissioner allows a different taxpayer the direct appeal to the Ohio Supreme Court.
Ohio CAT: Considerations for Combined and Consolidated Groups
Entities having “substantial nexus” with Ohio and <span style="text-decoration: underline;">more than</span> 50% common ownership are required to file Ohio Commercial Activity Tax (“CAT”) returns as a combined taxpayer, unless an election to file as a consolidated group is made. A group may elect to file CAT returns as a consolidated taxpayer if the group has <span style="text-decoration: underline;">at least</span> 80% or 50% common ownership. In both cases, the combined or consolidated group will file CAT returns as a single taxpayer.
In deciding whether to file CAT returns as a combined or consolidated group, the following two factors should be considered:
<li>Potential group members lacking “sufficient nexus” with Ohio; and</li>
A combined group only includes entities with “substantial nexus” with Ohio, as defined by <a href="http://codes.ohio.gov/orc/5751.01">Section 5751.01(H)</a> of the Ohio Revised Code. Conversely, when making a consolidated election, the taxpayer voluntary elects to include all members with the requisite common ownership, regardless of whether each has sufficient nexus with Ohio. Accordingly, if a group with more than 50% common ownership has substantial gross receipts from members without “substantial nexus” with Ohio, it may be advantageous to forego a consolidated election, thereby excluding such member(s)’ gross receipts.
Unlike combined taxpayers, gross receipts received by one member of a consolidated group from another member are excluded from the group’s Ohio gross receipts for the CAT. Essentially, Ohio has provided taxpayers with an incentive to elect to file as a consolidated group by excluding intra-group transactions. Further, an interesting situation could arise where certain members of a required combined group can make an 80% consolidated election, with other members of the required combined group having between 80% and 50% common ownership. In this situation, the 80% consolidated taxpayer is entitled to exclude intra-group transactions (remember, limited only to those entities included in the 80% consolidated group). Additionally, the other required combined group members may still be able to avoid CAT obligations if the particular entity has less than 80% common ownership and lacks “substantial nexus” with Ohio.
A consolidated election remains effective for eight calendar quarters and automatically renews thereafter for another eight calendar quarters, unless the group notifies the tax commissioner of cancellation of its election. Click <a href="http://dw.ohio.gov/tax/dynamicforms/searchresults_cat.asp">here</a> for Ohio CAT forms.
Ohio CAT: Identifying Businesses with "Bright-Line" Nexus
The Ohio Department of Taxation (the “Department”) is focused on increasing registration and compliance with the commercial activity tax (the “CAT”), which replaced Ohio’s corporate franchise, personal property and personal income taxes (although the final phase-out of the personal income tax has been delayed). As part of the Department’s <a href="index.php?option=com_content&view=article&id=54:ohio-department-of-taxation-increasing-audit-staff&catid=54&Itemid=59">addition of 100 revenue generating employees</a>, a nine person Nexus Unit in the Department’s CAT Division was created with the primary purpose of registering taxpayers for the CAT.
The Nexus Unit, started in November, 2009, identifies and contacts businesses believed to have greater than $500,000 of annual Ohio gross receipts, thereby meeting the definition of <a href="http://tax.ohio.gov/divisions/communications/information_releases/CAT/CAT200502.stm ">“bright-line” nexus</a>. One way the Nexus Unit is identifying such businesses, making sales into Ohio but not necessarily with a physical presence in the state, is by creating a database of accounts payable from taxpayers audited for Ohio sales and use taxes. This allows the Department to identify taxpayers with “bright-line” nexus merely through audits of the business’ Ohio customers. In addition, the Nexus Unit is using several types of information publicly available, such as SEC filings and Forbes lists, to identify businesses skirting their CAT obligations.
A penalty of up to 60% of the delinquent liability may be imposed upon those who receive notice from the Department instructing them to register for the CAT, but fail to do so. This steep penalty can be avoided by participating in the <a href="http://tax.ohio.gov/divisions/communications/information_releases/CAT/cat200801.stm">CAT’s Voluntary Disclosure Program</a>. This program requires the business to register for the CAT and pay its delinquency, while avoiding applicable penalties. However, the Voluntary Disclosure Program is not available after having been contacted by the Department.
Please <a href="index.php?option=com_contact&view=category&catid=12&Itemid=61">contact us</a> if you desire our assistance in making a Voluntary Disclosure to the Department.
Ohio Supreme Court Upholds CAT as Applied to Food Sellers
<p align="left">The Ohio Grocers Association sought a declaratory judgment that the Commercial Activity Tax (CAT) violated Ohio's constitutional prohibition against excise taxes levied or collected upon the sale or purchase of food for off-site consumption. Commencing in 2005, Ohio's tax landscape changed substantially by phasing out the personal property and corporate franchise taxes, while phasing in the CAT. Essentially, the CAT replaced these taxes by imposing a low rate/large base tax upon all businesses with Ohio gross receipts (with no tax being imposed upon businesses with less than $150,000 of gross receipts, and a flat $150 tax imposed on businesses with between $150,000 and $1 million of gross receipts).</p>
<p align="left">The "measuring stick" for the CAT, as the Court phrased, includes as a factor, food sales, even though the Ohio Constitution prohibits an excise tax on the sale of food for off-premises consumption. However, the Court dismissed the contention that because certain factors are used to measure one's tax base, that the tax is imposed upon sales of the subjects of those factors. Furthermore, as a tax on the privilege of doing business, the Court respected the legislature’s choice to <em>value </em>the privilege, in part, by sales of food. Giving it substantial deference, the Court concluded that the CAT was a permissible tax on the privilege of doing business, and that using food sales as one factor in valuing this privilege did not render the tax unconstitutional.</p>
<p align="left">As evidenced by numerous associations urging the Court to uphold the CAT as applied to food sellers, this decision is good news for Ohio residents and businesses (other than food sellers). If held unconstitutional, millions of dollars of tax revenue collected since the CAT’s inception would be refunded. Additionally, the State, in a time where its budget is already tight, would need to find ways to fill the large gap of expected revenue from food sellers. This would likely have resulted in additional burdens upon Ohio residents and other business through tax rate increases and/or re-instituting the personal property or corporate franchise taxes. Instead, the burden imposed by the CAT, as intended, will continue to be borne by all businesses having Ohio gross receipts.</p>