Ohio Supreme Court Upholds the Factor Presence Nexus Rules for the Commercial Activity Tax

The Ohio Supreme Court has determined that a physical presence is not a necessary condition to levy a business privilege tax.

In the June 2015 edition of the SALT Newsletter, we examined Ohio’s factor presence nexus rules for the Commercial Activity Tax (“CAT”), which require an out-of-state taxpayer with at least $500,000 in annual Ohio receipts to file and pay the CAT, even when that taxpayer has no other activity or presence within Ohio. Due to the fact that these factor presence nexus rules ignore a taxpayer’s physical presence, their constitutionality has been subject to challenge, and we reported on two cases challenging Ohio’s rule that had been appealed to the state supreme court: Crutchfield v. Testa and Newegg v. Testa.

On Nov. 17, 2016, the Ohio Supreme Court (the “Court”) issued slip opinions on these cases in advance of the formal opinion publication. [1] In the opinions, the Court ruled 5-2 that the factor presence nexus rule requiring companies having at least $500,000 in annual receipts from Ohio customers to file and pay the CAT satisfies the Constitution’s requirement of substantial nexus, thereby upholding the factor presence nexus law.

In differentiating itself from the decision in Quill v. North Dakota, where the U.S. Supreme Court ruled that a physical presence was a necessary condition for a state to impose sales and use taxes, the Court opined that no physical presence was required for the imposition of a business privilege tax (such as the CAT). While a physical presence may provide a sufficient basis for finding substantial nexus, it is not a necessary condition for levying a privilege tax as long as such tax is imposed subject to a quantitative standard that ensures the taxpayer’s nexus with the state is substantial. In other words, receipts from customers in a state is sufficient standard on its own to create taxing nexus when those receipts exceed a meaningful level, such as $500,000

It is worth noting that in the dissenting opinion, a minority of the judges expressed that they see no meaningful difference between sales and use taxes and business privilege taxes when determining substantial nexus, meaning that a physical presence should still be required. Since Congress has not acted on its power to regulate interstate commerce, and since the last word from the U.S. Supreme Court was that physical presence is necessary to create substantial nexus, they argued that states do not have the power to impose a business privilege tax based solely on deriving receipts from customers in the state.

These decisions continue the trend among most states over the last couple of decades to impose economic nexus for taxes other than sales and use taxes on the basis that Quill’s physical presence nexus requirement applies only to sales and use taxes. We anticipate that other states will continue to attack Quill and will point to these Court decisions in support of their position until such time as the U.S. Supreme Court addresses this issue or Congress does through nexus legislation. 

While these taxpayers may decide to appeal to the U.S. Supreme Court, other taxpayers with at least $500,000 in Ohio receipts should continue to file and pay their Commercial Activity Tax (or initiate a voluntary disclosure agreement if the required filings and payments have not been made) based on the Court’s ruling. If desired, protective refund claims may be filed in case the U.S. Supreme Court reverses these decisions. 

Aprio has experience assisting companies with nexus issues and with state voluntary disclosure processes to ensure that they are compliant with state tax requirements and do not have any state tax exposure. We constantly monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter. 

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the November/December 2016 SALT Newsletter. To view the newsletter, click here.

[1] Slip Opinion Nos. 2016-Ohio-7760 & 2016-Ohio-7762

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