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Massachusetts Supreme Court Affirms Nexus Decision in Capital One Case

Tax Development Mar 17, 2009

The Supreme Judicial Court of Massachusetts (“Court”) recently affirmed a decision of the Appellate Tax Board that denied requests for abatement of the financial institution excise tax (FIET) for two consumer banks that had no physical presence in Massachusetts. In a unanimous decision, the Court ruled that the FIET could be constitutionally imposed on a bank with no physical presence in the state, as long as the bank had established, through its activities, substantial nexus with the state.

The taxpayers in the case were two related financial institutions, Capital One Bank, a credit card company, and Capital One F.S.B., a federally chartered savings bank. Both companies were commercially domiciled in Virginia. The institutions did not own or lease any physical property in Massachusetts, nor did they have any employees, agents, or independent representatives located in the state during the tax years at issue. The banks offered credit cards and other financial services to residents of Massachusetts and filed mandatory quarterly credit card issuer reports with the Massachusetts division of banks.

In 2000, the companies were informed by the Massachusetts Department of Revenue (“Department”) that they were required to file FIET returns. In response, the banks provided the Department with apportionment data and other information for the purpose of demonstrating the lack of a physical presence in Massachusetts. Nonetheless, both companies were assessed for the tax, along with interest and penalties. After an application for abatement was denied, the taxpayers appealed to the Massachusetts Appellate Tax Board (“Board”).

The Board affirmed the Department’s denial, ruling that the activities of the banks established “substantial nexus” with the state. The Board noted that the banks actively marketed credit cards to would-be customers in the state, filed the quarterly credit card issuer reports, used the state’s court system when necessary to collect on delinquent accounts, processed credit card payments using banks located in the state through Visa and MasterCard associations, guaranteed payments to merchants in the state on behalf of their customers, and received substantial income from transactions involving Massachusetts residents and merchants. The Board further ruled that the physical presence test established in Quill Corp. v. North Dakota, 504 U.S. 298, was limited to sales and use taxes and was not applicable to the FIET.

In their appeal to the Court, the taxpayers argued that the Board had misinterpreted the Quill case by limiting its application solely to sales and use taxes and contended that the physical presence test should apply to income-based taxes as well because both state taxes are equally burdensome on interstate commerce. The Court disagreed, ruling that the constitutionality of the state’s imposition of the FIET should instead be determined by the “substantial nexus” test articulated in Complete Auto Transit v. Brady, 430 U.S. 274. The Court cited, as support, the ruling in Tax Comm’r of W. Va. v. MBNA Am. Bank, N.A., 220 W.Va. 163, which similarly maintained that the Quill physical presence test applied only to sales and use taxes. The remaining question was whether the banks’ activities in Massachusetts were sufficient for establishing substantial nexus with the state. The Court agreed with the Board that they were, and therefore, the decision was affirmed.

Ryan expects this case to be appealed to the United States Supreme Court and will closely monitor any developments as they occur.