Decades ago, Congress put limits on states’ ability to assert taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
nexus over businesses with limited connections to the state. A recent Minnesota Supreme Court decision holds that, at least as far as Minnesota’s tax authority is concerned, the federal Interstate Income Act of 1959 doesn’t mean much at all. The ruling further complicates the already complex tax framework under which multi-state firms must operate, putting them at risk of higher compliance costs.
In an affirmation of a tax court decision, the Minnesota High Court ruled that immunity from income and franchise tax in the state under 15 U.S.C. § 381 applies to a very narrow set of circumstances, and Uline, the petitioner in this case, would be liable for franchise tax for the years 2014 and 2015.
This statute, also known as Public Law 86-272 or the Federal Interstate Income Act, is a federal law that restricts a state from imposing a net income-based tax on the income of a foreign corporation earned within its borders from interstate commerce, if the corporation’s only business activity within the state consists of the solicitation of orders of tangible personal property. (It’s important to note here that, in this context, “foreign” applies to any out-of-state business, not just international businesses.) The act allows a business to go, or send representatives, into a state to solicit orders for goods without being subject to a net income tax on that basis alone.
Uline relied on the text of the act, asserting that it conducted market research—its only activity in the state—during those years primarily for solicitations for sales and that any other ancillary benefits of its activities were minimal. The revenue department disagreed with this claim, imposing franchise taxes on the company, a move affirmed by the tax court subsequently on appeal. The High Court now has reaffirmed nexus and applicability of tax in such situations, making it easier for the state to impose levies on out-of-state firms that are preparing to potentially do business in the state. According to the court, because the market research appeared intensive and the results accessible to non-sales personnel within the company, the activity would not qualify as de minimis to solicitation of sales, preventing it from meeting the standards for exemption as laid out by the Supreme Court in the 1992 case Wisconsin Department of Revenue v. William Wrigley, Jr., Co.
As a result, companies that seek to gauge Minnesota as a potential market for their products must be very careful and ensure that all their activities are directly linked to prospecting for sales if they want to avoid tax liability. This is likely to affect small-to-midsize manufacturers the most, as they may have no contacts in the state other than the solicitation of sales, with their products either picked up by wholesalers or transported into the state by common carrier. Most larger businesses with activity in the state are already likely to have in-state activity that defeats the narrow protections of P.L. 86-272.
That said, further restricting the applicability of the federal law will have a chilling effect on nascent business operations. While the ruling potentially broadens the scope of taxable activities for out-of-state companies and could lead to increased tax revenue for the state (as it may now have a stronger basis to tax companies engaging in similar activities within its borders), businesses operating across state lines in Minnesota will likely face higher compliance costs.
Companies will need to carefully evaluate their in-state activities to determine if they create a taxable nexus. This could involve more detailed record-keeping and potentially hiring additional legal and tax professionals to ensure compliance. They might also reconsider their business strategies to minimize tax liabilities. For instance, they may limit certain in-state activities or restructure their operations to avoid creating a taxable nexus. This could affect how businesses interact with customers and conduct market research. The lack of an objective standard in the law or the case decision lends uncertainty to the entire process.
Smaller businesses might be disproportionately affected by the ruling. Larger corporations typically have more resources to manage complex tax compliance requirements and are less likely to benefit from P.L. 86-272 in the first place, whereas smaller businesses might struggle with the additional burden. This could create a competitive disadvantage for the former.
The ruling also sets a legal precedent that other similarly inclined states might follow. This could lead to more aggressive tax enforcement and potentially more litigation as businesses challenge state tax assessments. The legal landscape for state taxation of out-of-state businesses could become more complex and contentious. However, this depends on whether the company decides to appeal the ruling further, in federal court. The decision might also prompt calls for clearer federal legislation regarding state taxation of interstate commerce, unless further clarity is obtained via the federal judiciary.
Minnesota’s ruling comes against the backdrop of efforts by several other states to erode the protections of P.L. 86-272 by asserting that a company can lose its protection through its online offerings (e.g., by having an interactive website that could algorithmically take a consumer’s location into account, or by posting job listings to which individuals in a given state could apply). These reinterpretations make the federal law nearly a dead letter.
P.L. 86-272 was always intended to be a stopgap, with Congress adopting more robust definitions later. That never happened. With a changing economy—the law is about companies selling tangible products, but our economy is increasingly service-oriented—and state-level tests to the ongoing validity of the law, perhaps the time has come for Congress to update and expand upon these protections, which are designed to limit states from imposing substantial tax remittance and compliance burdens on businesses with only the most minimal of contacts with the state.
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