Courts Take Liberties with "Physical Presence" Test

With no permanent facilities, offices, employees – or even a Washington state phone number – Lamtec Corp. still must pay state taxes, says a new court ruling.

In January, courts in Washington state chipped away at the barrier that once shielded companies from paying taxes where they had no physical presence. The case focused on Lamtec Corp., a Pennsylvania-based industrial-materials manufacturer that also produces products at its New Jersey facility. The company has no permanent facilities, offices, or employees in Washington, nor does it maintain an address or phone number there. Rather, Lamtec sells its products to customers that place orders by telephone.

About two or three times a year, three Lamtec sales employees visit customers in Washington. During such visits, the employees do not solicit sales directly, but answer questions and provide information about the company’s products.

Yet the Washington Department of Revenue (DoR) has assessed tax, interest, and penalties with respect to Lamtec’s activities in Washington. Lower state courts upheld the assessment, and earlier this year, the Washington State Supreme Court ruled in favor of the DoR. (See Lamtec Corporation v. Washington Department of Revenue, Wash., No. 83579-9, January 20, 2011.)

Need for “Nexus”

Washington imposes a business and occupation (B&O) tax “for the act or privilege of engaging in business activities” on every person that has a substantial nexus with the state. In its defense, Lamtec argued that the assessment levied by Washington violates the “negative” or “dormant” commerce clause. Indeed, a tax on an out-of-state corporation must satisfy the requirements of the due process clause and the commerce clause of the U.S. Constitution. Under modern dormant commerce clause jurisprudence, for a state to tax an out-of-state corporation, the tax must be applied to an activity with a substantial nexus with the taxing state. (See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).)

Willens 2-22-11

Lamtec emphasized that an entity has a substantial nexus with Washington only if it has a physical presence in the state. In fact, the company contended that physical presence requires a small sales force, plant, or office in the taxing state. But the court disagreed.

The state court noted that the U.S. Supreme Court has made it clear that an established sales force is sufficient to satisfy the nexus requirement. However, the high court has not held that an established sales force (or a physical presence) is a requirement to establish nexus.

For its part, the DoR drew the court’s attention to cases similar to the Lamtec case, in which courts found sufficient presence for substantial nexus based on contacts with the taxing jurisdiction. To Lamtec’s dismay, the state Supreme Court “found these authorities persuasive.” As a result, the court concluded that a physical presence in the taxing jurisdiction, for purposes of the B&O tax, can be based on periodic visits. Moreover, the court noted, there is “extensive language” in the Supreme Court’s decision in Quill Corporation v. North Dakota (504 U.S. 298 (1992)) — a seminal tax nexus case — that suggests the physical-presence requirement should be restricted to sales and use taxes.

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