On May 31, 2016, the Washington Department of Revenue (DOR) Appeals Division released a Determination (No. 15-0251, 35 WTD 230) denying a German pharmaceutical company’s business and occupation tax (B&O) protest. The administrative law judge (ALJ) ruled that while the nondiscrimination provisions contained in Article 24 of the US-Germany Income tax Treaty (Treaty) “may apply,” the B&O does not discriminate against non-US businesses because it is imposed on any business deriving royalty income from Washington sources and applies equally to foreign and US companies. The ALJ also found that the company could avoid double taxation of the royalty income by excluding income taxed by Washington from its German tax base. While the company also challenged the constitutionality of the 2010 B&O economic nexus law, the ALJ declined to entertain it—citing a lack of authority to rule on the constitutionality of Washington statutes.
Actually, there are really only two issues, but they are big issues.
Arizona’s Transaction Privilege Tax has always been an anomaly in the traditional state sales tax system. Contrary to some commentators, however, the recent amendments do not, and could not, impose an origin tax on Arizona retailers for remote sales delivered out-of-state. That is not to say that these amendments are benign. Oddly, the amendments provide incentives for Arizona residents shipping items out-of-state to purchase these items over the internet rather than visit Arizona retailers in person. Furthermore, these amendments create complexities for Arizona vendors shipping to foreign jurisdictions. Finally, these amendments create additional administrative problems for retailers that are difficult to address with existing software and invite double taxation problems that should not exist in a transaction tax world.
Background: Arizona Transaction Privilege and Use Tax
For retail sales, Arizona, like most states, has two complementary transaction-based taxes, but each tax is imposed on a different entity. The first tax, the Transaction Privilege Tax (TPT), is imposed directly on the retailer. Ariz. Rev. Stat. § 42-5001.13. A retailer will be subject to the TPT on the gross proceeds from a sale if “the location where the sale is made” is Arizona. Ariz. Rev. Stat. § 42-5034.A.9. A retailer subject to the TPT is allowed but not required to collect the amount of TPT it owes from its customers. Ariz. Admin. Code §§ 15-5-2002, 15-5-2210.
The second tax, the Arizona Use Tax, complements and backstops the TPT. The Use Tax is imposed on the use, storage or consumption in the State of tangible personal property purchased from an out-of-state retailer. Ariz. Rev. Stat. § 42-5155. Generally, the purchaser is liable for payment of Use Tax to the State, but a retailer is required to collect Use Tax from a purchaser if the retailer meets the constitutional nexus provisions. Ariz. Rev. Stat. §§ 42-5155, 42-5160. Use Tax is imposed only on transactions where TPT has not been imposed, i.e., a transaction is subject to either TPT or Use Tax, but not both. Ariz. Rev. Stat. § 42-5159.A.1.
The State and its courts have been clear that, while the location of the transfer of title or possession is relevant to the inquiry as to where the sale is made, it is the totality of the retailer’s business activities that identifies the location that may tax the proceeds. Exactly where that line is drawn, however, is not as clear. The Arizona Department of Revenue (DOR) has taken the position that, unless an exemption applies, a seller is subject to the tax if a purchaser buys a product at a store, even if the purchaser does not take possession in the state, and the product is shipped to a location outside of the state. The DOR is apparently taking the position either that the title transfers in the store, which cannot always be the case (a retailer could easily specify that title transfers to the customer outside the store, particularly if the retailer [...]
The Supreme Court granted the petition for certiorari filed by the Maryland Comptroller of Treasury in Comptroller v. Wynne, Dkt. No. 13-485 (U.S. Sup. Ct., cert. granted May 27, 2014). The central issue in Wynne is whether a state must allow its residents a credit for income taxes paid to other states, in a manner sufficient to prevent double taxation of income from interstate commerce, to avoid violating the fair apportionment and discrimination prongs of the dormant Commerce Clause.
Like most states, Maryland taxes its residents on their entire income, wherever earned, and permits a credit for income tax paid to other states, limited to the amount of Maryland tax on the income taxed by other states. But Maryland’s income tax includes both a state and a county tax component, and Maryland permitted a credit for taxes paid to other states only with respect to its state income tax. The state rate was 4.75 percent and the county tax rate applicable to the Wynnes was 3.2 percent (which could vary by county). The county tax was imposed and administered by the state on the same tax base as the state income tax, and residents file a single return that reflects both state and county income taxes. Thus, Maryland provided a credit only against the Maryland state income tax, but not the substantial county income tax, on the income taxed by other states, resulting in a form of double taxation of that income (i.e., by the other state and by the Maryland county).
The Wynnes reported substantial income on their 2006 individual return from business activities in interstate commerce. They owned 2.4 percent of an S corporation doing business in 39 states, and paid income tax to most of those states on the income that flowed through to their individual return. The Wynnes reported $2.7 million of income and $126,636 of Maryland state income tax (not including the county income tax portion) prior to credits, and claimed a credit of $84,550 for taxes paid to other states. The Maryland Comptroller permitted the Wynnes to claim a credit against the state income tax, but not the county portion of the income tax, for taxes paid to other states. Maryland’s highest court, the Court of Appeals, agreed with the Wynnes that they suffered double taxation of the income in violation of the dormant Commerce Clause doctrine that taxation of multistate business requires fair apportionment and no discrimination against interstate commerce, citing Complete Auto Transit v. Brady, 430 U.S. 274 (1977) and other Supreme Court cases.
In its petition for certiorari, the Maryland Comptroller relied upon settled Due Process doctrine that states have plenary power to tax all of the income of their residents. The Comptroller’s petition essentially ignored the Commerce Clause issues raised by the Maryland Court of Appeals.
The U.S. solicitor general filed an amicus curiae brief supporting the Maryland Comptroller’s position, recognizing the different standards imposed by the Due Process Clause and the Commerce Clause but nonetheless contending that the longstanding [...]