Physical Presence Not Required to Meet Commerce Clause “Substantial Nexus” for Income Tax.
On November 21, 2006, the West Virginia Supreme Court of Appeals (the “Court”), the state’s highest court, issued an opinion in a de novo review of a lower court decision that held that the Commerce Clause “substantial presence” test did not require a physical presence for purposes of the state’s Corporation Net Income Tax. Tax Comm’r of the State of W. Va. v. MBNA America Bank, N.A., Docket No. 33049 (W.V., November 21, 2006).
At issue was whether West Virginia could constitutionally subject a foreign corporation to the Corporation Net Income Tax when the corporation had no physical presence in West Virginia but derived income from customers located in the state.
MBNA America Bank, N.A. (“MBNA”), a Delaware-based bank, was principally engaged in issuing and servicing MasterCard and VISA credit cards, promoting its business via mail and telephone solicitation. During the two years at issue (1998 and 1999), MBNA derived approximately $8 million and $10 million in gross receipts, respectively, from West Virginia customers.
MBNA had previously paid tax to West Virginia and filed refund claims for the two years based principally on MBNA’s assertion that the state did not have jurisdiction to impose an income tax on a corporation that lacked physical presence in the state. The refund claims were denied by the Tax Commissioner, but the Office of Tax Appeals (“OTA”) ruled in favor of MBNA. The Tax Commissioner appealed the OTA decision to the Circuit Court of Kanawha County, which held that physical presence was not necessary to show “substantial nexus” under the Commerce Clause. MBNA appealed the decision to the Court, which reviewed the constitutional issue de novo and held that the “substantial nexus” requirement did not require physical presence for income taxes.
The Court based its decision on four principal rationales.
- First, the Court found that U.S. Supreme Court’s reaffirmation of physical presence for sales and use taxes in Quill Corp. v. North Dakota, 504 U.S. 298, 112 S. Ct. 1904 (1992) was based on stare decisis (the legal principle of following prior rulings on the same legal issue when the facts are the same) and had engendered substantial reliance on the physical presence standard for sales and use taxes over the years. Implicit in this was the Court’s analysis that the physical presence standard might not have been adopted by the U.S. Supreme Court but for the substantial reliance on the physical presence standard over the years.
- Second, the Court believed that in Quill Corp. v. North Dakota the U.S. Supreme Court intended to limit the physical presence requirement only to sales and use taxes when it noted it had not articulated the same physical presence standard for taxes other than sales and use taxes
- Third, the Court noted that the compliance and administrative burdens associated with sales and use taxes were greater than for income taxes (considerably more jurisdictions with varying rates, more frequent reporting, etc.).
- The Court believed that the physical presence standard laid down in 1967 in National Bellas Hess, Inc. v. Department of Revenue, 386 U.S. 753, 87 S.Ct. 1389, 18 L.Ed.2d 505 (1967) made little sense today in light of the proliferation of e-commerce.
The Court then fashioned its own qualitative and quantitative test for satisfying the “substantial nexus” requirements, which it termed “significant economic presence.” Under this test, MBNA was deemed to have met the Commerce Clause requirements through its continuous and systematic market solicitation (qualitative) and significant revenues from West Virginia customers (quantitative).
MBNA has 90 days from the decision to file a petition for certiorari with the U.S. Supreme Court.
West Virginia is now the third state whose highest court has sanctioned an economic nexus approach to taxing corporations without physical presence. South Carolina and New Jersey have previously repudiated the physical presence requirement for income taxes.