No Surprises in Ohio CAT Nexus Oral Argument

By and on May 4, 2016

Oral argument before the Ohio Supreme Court took place on May 3 in the three cases challenging Ohio’s Commercial Activity Tax (CAT) nexus standard.  Crutchfield, Inc. v. Testa, Case No. 2015-0386; Mason Cos. Inc. v. Testa, Case No. 2015-0794; Newegg, Inc. v. Testa, Case No. 2015-0483.  Ohio imposes its CAT on a business that has more than $500,000 in annual gross receipts in the state, even if the business has no physical presence in the state.  These three taxpayers have challenged this standard as violating the Commerce Clause substantial nexus test.

The oral argument in the cases proceeded as expected.  The majority of the time for both parties was taken up by questions from the bench.  Several judges quizzed the taxpayers’ counsel about the assertion that no business was conducted in Ohio.  The judges focused on activities such as products being received by customers in Ohio and software being placed on customers’ computers in Ohio to facilitate ordering or to track customer activity in Ohio.  The taxpayers’ counsel vigorously disagreed with this construction of the facts – noting that whatever happened in Ohio, all of the taxpayers’ actions occurred elsewhere.  He stated that the activities called out by the judges were no different than receiving and reviewing a catalog in the state.

The taxpayers’ counsel repeatedly cited to Tyler Pipe as the controlling law in this case – noting that before a state could impose a tax on a business, that business had to do something in the taxing state (or have something done on its behalf) that helped it establish and maintain a market in the state.  According to the taxpayers’ counsel, it was not enough that a market exists in the taxing state; the taxpayer had to be doing something in the taxing state.  He asserted that the taxpayer conducted no business activities in the state and thus Tyler Pipe prevented the state from imposing the CAT on them.  This became the taxpayers’ mantra throughout the argument.

The taxpayers’ counsel also noted the ballooning of tax jurisdictions since Quill.  He stated that at the time Quill was decided, the US had 6,000 taxing jurisdictions; today there are 19,000 municipalities and another 2,300 counties, in addition to the states.  At least one judge, however, may believe the relevant comparison is the number of gross receipts jurisdictions.  This judge seemed to question whether that much more limited number of tax obligations was so difficult to comply with.  The counsel for the state emphasized how much easier it was to comply with the CAT as compared to a sales tax.  He explained the sales tax was a transaction by transaction analysis with various exemptions and other unique rules that needed to be applied.  The CAT on the other hand, he argued, is a simple, quarterly, add up of Ohio receipts and you are done tax.

Not surprisingly, some judges noted that the economic and technological environment has significantly changed since Quill and the other nexus cases relied on by the taxpayers.  The judges asked numerous questions regarding whether the Supreme Court of the United States has ever addressed an e-commerce scenario.  There was a funny exchange in which one judge likened what the taxpayers were doing as “spying.”  The taxpayers’ counsel noted that whatever spying was being done was being done in other states.  The counsel for the state of course disagreed, and noted the involvement of an in-state computer (the customer’s).  After discussing the relevance of the “spying” activity, several of the judges seemed to agree that Quill was “ancient.”

Perhaps the most interesting part of the argument was the belief by several judges that the Supreme Court would review the decision regardless of who won.  The counsel for the state disagreed.   He noted that the Supreme Court has previously had nexus petitions before it, but has denied them all.  There was also some discussion about states moving beyond Quill for sales tax collection nexus purposes, but the counsel for the state noted that the CAT is not a sales tax.  At least one judge questioned whether the CAT really is a sales tax.

Of course, the issue of Congressional involvement was brought up on numerous occasions.  Several judges throughout the argument asked whether Congress was not the appropriate body to decide the proper standard in this case.  They asked whether Congress was allowed to pass a law addressing the issue and also noted that it had not yet done so.  It was not clear whether the judges who wanted to defer to Congress would side with the taxpayers’ position or the state’s regarding the existing nexus rule for the CAT.

A significant amount of discussion involved the concept of “fairness.” Some judges noted that the intent of the CAT when it was enacted was to fix problems with the previous tax system by broadening the pool of taxpayers but at a much lower rate.  The question of whether the taxpayers were in competition with in-state companies was also raised and the judges focused on the question of leveling the playing field.  The judges also raised questions about whether the taxpayers were paying tax on their sales in other states. Ultimately, both the judges and the taxpayers’ counsel seemed to agree that any constitutional adjustments related to leveling the playing field was up to Congress.

The state concluded on a strong note – emphasizing the heavy burden a taxpayer has to show a statute is unconstitutional.  He stated the burden is “beyond a reasonable doubt.”

Analysis of the Argument

There were no “Aha moments” and the judges were very well prepared.  The one issue of concern was a problem with the entire argument structure.   All participants – counsel for both sides and the judges – frequently failed to distinguish between two very different issues.  There was a confusing fluidity between (1) whether the taxpayers’ actions – such as having companies place cookies on customers’ computers – created physical presence and (2) whether physical presence was the test at all.  Much of the argument centered on what the taxpayers were doing in the state, not whether an economic nexus standard was constitutional.  Furthermore, it was not clear from the argument whether the judges thought activities such as placing cookies on a customer’s computer or collecting marketing information from a customer’s computer in Ohio met the physical presence standard, an economic presence standard or some general “doing business in the state” standard.  This latter concept is not a Commerce Clause nexus standard that has been articulated by the Supreme Court, but nevertheless was the go-to phrase throughout the argument to describe what the taxpayers were or were not doing.

Finally, the award for the best quote of the day goes to the counsel for the state.  In a brief humorous exchange regarding whether the CAT was interesting, during which a judge suggested it was not, the counsel for the state noted: “We all have different filters for beauty.”

To watch the argument, visit

Diann Smith
Diann Smith focuses her practice on state and local taxation and unclaimed property advocacy. Diann advises clients at any stage of an issue, including planning, compliance, controversy, financial statement issues and legislative activity. Her goal is to find the most effective method to achieve a client's objective regardless of when or how an issue arises. Diann emphasizes the importance of defining a client's objective - whether it is finality of a frequently audited issue, quick resolution of a stand-alone tax liability, or avoiding competitive disadvantages in the application of a tax. The defined objective then governs the choice of the path to a solution. Read Diann Smith's full bio.

Stephen P. Kranz
Stephen (Steve) P. Kranz is a tax lawyer who solves tax problems differently. Over the course of his extensive career, Steve has acquired specific skills and developed a unique approach that helps clients develop and implement holistic solutions to all varieties of tax problems. He combines strategic thinking with effective skills for the courtroom, the statehouse and the conference room. Read Stephen Kranz's full bio.




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