Editor: Susan Minasian Grais, CPA, J.D.,LL.M.
The Interstate Income Act of 1959, often referred to by its public law designation, P.L. 86-272, prohibits the imposition of state income tax on out-of-state sellers if their in-state activities do not extend beyond soliciting orders of tangible personal property. Because the internet did not exist when this federal law was enacted more than a half century ago, questions have arisen about how its language should be interpreted in a world where out-of-state sellers can solicit orders of tangible personal property through cyberspace.
Seeking to clarify the matter, on Aug. 4, 2021, the Multistate Tax Commission (MTC) approved the fourth revision to its "Statement of Information Concerning Practices of the Multistate Tax Commission and Supporting States Under Public Law 86-272" (the Statement), which added a section on activities conducted over the internet. Generally, the newly revised Statement limits the types of online sales activities that P.L. 86-272 protects.
According to the MTC, the Statement is "intended to serve as general guidance to taxpayers and to provide notice as to how Supporting States will apply the statute." Although the revised Statement has been approved by the MTC, it is not automatically adopted by states. Rather, the Statement provides that Supporting States will need to expressly indicate support through statutory, regulatory, or administrative action for the Statement to be effective in that state.
In February 1959, the U.S. Supreme Court held in Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450 (1959), that Minnesota could impose its corporate income tax on an Iowa corporation that leased a sales office in Minnesota and had employees in Minnesota whose activities were limited to soliciting orders that were accepted at, and filled from, the home office in Iowa. In order to legislatively overturn this holding and with the active support of the business community, Congress enacted P.L. 86-272 later that year in September 1959.
P.L. 86-272 (codified at 15 U.S.C. §381) prohibits a state, and any of its political subdivisions, from imposing a net income tax on an out-of-state seller if the seller's "only business activities" within the state consist of "the solicitation of orders by such person, or his representative ... for sales of tangible personal property ... which ... are sent outside the State for approval or rejection and, if approved, are filled by shipment or delivery from a point outside the State." Thus, even if constitutional nexus exists that would allow taxing an out-of-state business, P.L. 86-272 effectively preempts state income taxation on an out-of-state business whose activities in the state are limited to soliciting sales of tangible personal property as described in the federal law.
In 1986, the MTC adopted the "Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272," which sets forth the MTC signatory states' interpretation of those in-state activities that are conducted by or on behalf of a corporation and fall within or outside the protection of P.L. 86-272. In 1992, the U.S. Supreme Court addressed the scope of the activities protected under P.L. 86-272 in Wisconsin Department of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992) (Wrigley), and listed protected and unprotected activities under its interpretation of the federal statute. Thereafter, the MTC revised the Statement in 1993, 1994, and 2001.
In 2018 the Supreme Court held in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), that a physical presence was not required under the dormant Commerce Clause in order for a state to impose a sales tax collection requirement on an out-of-state seller. Following this ruling, the MTC's Uniformity Committee formed a work group at the request of some of its members to update the Statement "to address changes that have occurred during the past two decades in the economy and the way that business is conducted" (see MTC, "P.L. 86-272 Statement of Information Project," available at tinyurl.com3z8dsuz7). Although the Wayfair Court was not interpreting P.L. ٨٦-٢٧٢, "the Supporting States consider the Court's analysis as to virtual contacts to be relevant to the question of whether a seller is engaged in business activities in states where its customers are located for purposes of the statute," according to the Statement.
After numerous meetings, drafts, and public hearings, the MTC adopted the fourth revision to the Statement on Aug. 4, 2021. While many sections of the Statement were modified, the most significant change is new Section C, "Activities Conducted via the Internet," which was added to Article IV, "Specific Listing of Unprotected and Protected Activities" (hereafter, Art. IV, Section C). Other notable changes to the Statement include the addition of teleworking under the list of unprotected activities, the revisions to the application of the Statement to foreign commerce, and eliminating the application of the Joyce rule (named for Appeal of Joyce, Inc., 66-SBE-070 (Cal. State Bd. of Equalization 11/23/66)) in determining whether the activities of a company conducted in the state exceed the protections of P.L. 86-272.
Unprotected and protected activities conducted via the internet
New Art. IV, Section C, addresses whether an out-of-state business that uses the internet to conduct in-state business activities is engaged in protected activities under P.L. 86-272. Like other out-of-state businesses, internet sellers will fall within the protection of P.L. 86-272 if their only business activity within the state is soliciting orders for sales of tangible personal property where orders are approved at and fulfilled by shipment or delivery from a point outside the state.
Regarding internet activities, the Statement describes a general rule that, "when a business interacts with a customer via the business's website or app, the business engages in a business activity within the customer's state. However, ... when a business presents static text or photos on its website, that presentation does not in itself constitute a business activity within those states where the business's customers are located."
The Statement includes "examples of activities conducted by a business that operates a website offering for sale only items of tangible personal property." For purposes of these examples, the business has no other connection with the customer's state, and orders are approved (or rejected) and the property shipped from outside the customer's state.
Under the Statement, it is the MTC's view that protected activities of a business for purposes of P.L. 86-272 include:
- Providing post-sale assistance to in-state customers by posting a static list of frequently asked questions on the business's website (example 1);
- Placing on in-state customers' computers or other electronic devices "cookies" that gather customer information that is only used for purposes entirely ancillary to soliciting orders for tangible personal property (e.g., remembering items added to a customer's shopping cart during a web session, storing personal information provided by the customer, or reminding customers of items they considered on prior visits to the website) (example 6); and
- Offering only tangible personal property for sale on the business's website, with the website allowing customers to search for items, read product descriptions, purchase items, and select delivery options (assumes that the business does not engage in any of the unprotected activities described later, or any other in-state activities not described in the example) (example 11).
According to the Statement, unprotected activities of a business include:
- Regularly providing post-sale assistance to in-state customers through an electronic chat or email that customers initiate by clicking on an icon on the business's website (example 2);
- Soliciting and receiving online applications for its branded credit card through the business's website (example 3);
- Placing on the business's website an invitation to viewers in the customer's state to apply for nonsales positions within the business (the example states that the website enables viewers to fill out and submit an online application and submit a résumé and cover letter) (example 4);
- Placing on in-state customers' computers or other electronic devices cookies that gather customer search information for use in adjusting production schedules and inventory amounts, developing new products, or identifying new items to offer for sale (example 5);
- Remotely fixing or upgrading in-state customers' previously purchased products by transmitting code or other electronic instructions to those products over the internet (example 7);
- Offering and selling extended warranty plans through the business's website to in-state customers who purchase the business's products (example 8);
- Contracting with a marketplace facilitator to facilitate the sale of the business's products on the marketplace facilitator's online marketplace, where the marketplace facilitator maintains inventory, including that of the business, at fulfillment centers in a state in which the business's customers are located (example 9); and
- Contracting with in-state customers to stream videos and music to electronic devices for a charge (example 10).
The MTC makes clear in the Statement that "soliciting orders for sales" refers specifically to sales of tangible personal property and that any prior references to "company" have been changed to "business."
Other changes in the newly revised Statement include the following:
- Amending Article I, "Nature of Property Being Sold," to clarify that P.L. 86-272 only protects solicitations to sell tangible personal property (formerly "personal property") and does not protect (1) transactions involving intangible property (formerly "intangibles"); or (2) the sale or delivery, and solicitations for the sale or delivery, of any type of service that is not "entirely ancillary" (formerly "ancillary") to soliciting orders for sales of tangible personal property (formerly "ancillary to solicitation");
- Amending Article II, "Solicitation of Orders and Activities Ancillary to Solicitation," to make clear that P.L. 86-272 does not protect activities that (1) go beyond soliciting orders for sales of tangible personal property; (2) are entirely ancillary to solicitation; and (3) are not de minimis (i.e., activities that, when taken together, establish only a trivial connection with the taxing state);
- Amending Article IV, "Specific Listing of Unprotected and Protected Activities," by adding to the list of unprotected activities those performed by a regularly telecommuting employee, unless the activities are soliciting orders for sales of tangible personal property or are entirely ancillary to soliciting sales of such tangible personal property;
- Amending Article V, "Independent Contractors," to provide that P.L. 86-272 does not protect the activities of an independent contractor, who, on behalf of a seller, performs unprotected activities such as performing warranty work or accepting returns or products; and
- Amending Article VII, "Miscellaneous Practices," as follows:
- Revising Section A, "Application of Statement to Foreign Commerce," to streamline the language and clarify that states electing to apply P.L. 86-272 to foreign commerce must consistently apply P.L. 86-272 in determining whether a foreign seller's activities are protected or if sales into a foreign jurisdiction will be thrown back to the state;
- Revising Section C, "Registration or Qualification to Do Business," to streamline the language and include protecting a trade secret or corporate name as an example of when a business seeking to use or protect any additional benefit under state law will forfeit P.L. 86-272's protections by engaging in other unprotected activity; and
- Eliminating Section E, "Application of the Joyce Rule," under which only the in-state activities conducted by or on behalf of a company are considered in determining whether the company's in-state activities exceed the protection of P.L. 86-272.
The Statement also includes a new Addendum II, the MTC's factor presence nexus standard for business activity taxes, which was approved by the MTC on Oct. 17, 2002 (as noted above, the Statement was last revised in 2001). Under the MTC's model factor presence nexus standard, an out-of-state taxpayer doing business in a state will have substantial nexus with the state and be subject to the state's franchise and income tax if the taxpayer exceeds any of the following thresholds in the state during the tax period: (1) $50,000 or 25% of the total property; (2) $50,000 or 25% of the total payroll; or (3) $500,000 or 25% of the total sales.
Assuming states adopt this guidance, taxpayers will need to consider the following questions:
- How will states interpret the revised Statement in light of existing state laws and prior court precedent (i.e., Wrigley)?
- Is a state's adoption of the revised Statement constitutional and otherwise lawfully binding?
- Will Congress update or repeal P.L. 86-272?
- Could the Statement motivate Congress to reintroduce the Business Activity Tax Simplification Act or propose similar federal legislation intended to modernize P.L. 86-272?
- Does P.L. 86-272 apply to alternative business taxes such as the Ohio commercial activity tax, the Oregon corporate activity tax, the Texas revised franchise (margin) tax, or the Washington state business and occupation tax?
- Will states that adopt the revised Statement also adopt the MTC's factor presence nexus standard?
In states that adopt the MTC's revised Statement, out-of-state businesses that conduct activities over the internet, and whose activities were previously protected under P.L. 86-272, should consider evaluating their in-state activities and determine whether such activities continue to fall within that protection. In particular, businesses may consider whether business activity transacted over the internet constitutes in-state business activity in the state within the meaning of the Statement. Given the new examples outlined by the MTC, particular attention should be paid to cookie content and accepting online applications (e.g., for nonsales jobs, for branded credit cards) in the customers' states. In almost all states, the applicable statute of limitation has not yet begun to run where income tax returns were not filed, if it is subsequently determined such a filing responsibility exists.
Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C. For additional information about these items, contact Ms. Grais at 202-327-8788 or email@example.com.
Contributors are members of or associated with Ernst & Young LLP.