[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
BUSINESS ACTIVITY TAX
SIMPLIFICATION ACT OF 2005
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
COMMERCIAL AND ADMINISTRATIVE LAW
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
ON
H.R. 1956
__________
SEPTEMBER 27, 2005
__________
Serial No. 109-62
__________
Printed for the use of the Committee on the Judiciary
Available via the World Wide Web: http://judiciary.house.gov
______
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COMMITTEE ON THE JUDICIARY
F. JAMES SENSENBRENNER, Jr., Wisconsin, Chairman
HENRY J. HYDE, Illinois JOHN CONYERS, Jr., Michigan
HOWARD COBLE, North Carolina HOWARD L. BERMAN, California
LAMAR SMITH, Texas RICK BOUCHER, Virginia
ELTON GALLEGLY, California JERROLD NADLER, New York
BOB GOODLATTE, Virginia ROBERT C. SCOTT, Virginia
STEVE CHABOT, Ohio MELVIN L. WATT, North Carolina
DANIEL E. LUNGREN, California ZOE LOFGREN, California
WILLIAM L. JENKINS, Tennessee SHEILA JACKSON LEE, Texas
CHRIS CANNON, Utah MAXINE WATERS, California
SPENCER BACHUS, Alabama MARTIN T. MEEHAN, Massachusetts
BOB INGLIS, South Carolina WILLIAM D. DELAHUNT, Massachusetts
JOHN N. HOSTETTLER, Indiana ROBERT WEXLER, Florida
MARK GREEN, Wisconsin ANTHONY D. WEINER, New York
RIC KELLER, Florida ADAM B. SCHIFF, California
DARRELL ISSA, California LINDA T. SANCHEZ, California
JEFF FLAKE, Arizona CHRIS VAN HOLLEN, Maryland
MIKE PENCE, Indiana DEBBIE WASSERMAN SCHULTZ, Florida
J. RANDY FORBES, Virginia
STEVE KING, Iowa
TOM FEENEY, Florida
TRENT FRANKS, Arizona
LOUIE GOHMERT, Texas
Philip G. Kiko, Chief of Staff-General Counsel
Perry H. Apelbaum, Minority Chief Counsel
------
Subcommittee on Commercial and Administrative Law
CHRIS CANNON, Utah Chairman
HOWARD COBLE, North Carolina MELVIN L. WATT, North Carolina
TRENT FRANKS, Arizona WILLIAM D. DELAHUNT, Massachusetts
STEVE CHABOT, Ohio CHRIS VAN HOLLEN, Maryland
MARK GREEN, Wisconsin JERROLD NADLER, New York
RANDY J. FORBES, Virginia DEBBIE WASSERMAN SCHULTZ, Florida
LOUIE GOHMERT, Texas
Raymond V. Smietanka, Chief Counsel
Susan A. Jensen, Counsel
James Daley, Full Committee Counsel
Brenda Hankins, Counsel
Stephanie Moore, Minority Counsel
C O N T E N T S
----------
SEPTEMBER 27, 2005
OPENING STATEMENT
Page
The Honorable Steve Chabot, a Representative in Congress from the
State of Ohio, and acting Chairman and Member, Subcommittee on
Commercial and Administrative Law.............................. 1
The Honorable William D. Delahunt, a Representative in Congress
from the State of Massachusetts, and Member, Subcommittee on
Commercial and Administrative Law.............................. 3
The Honorable Howard Coble, a Representative in Congress from the
State of North Carolina, and Member, Subcommittee on Commercial
and Administrative Law......................................... 4
The Honorable Bob Goodlatte, a Representative in Congress from
the State of Virginia, and Member, Committee on the Judiciary.. 4
WITNESSES
Mr. Carey J. ``Bo'' Horne, President, ProHelp Systems, Inc.
Oral Testimony................................................. 8
Prepared Statement............................................. 9
Mr. Earl Ehrhart, State Representative, Georgia House of
Representatives, 36th District, National Chairman of the
American Legislative Exchange Council
Oral Testimony................................................. 13
Prepared Statement............................................. 15
Ms. Joan Wagnon, Secretary of Revenue, State of Kansas, and
Chair, Multistate Tax Commission
Oral Testimony................................................. 20
Prepared Statement............................................. 21
Mr. Lyndon D. Williams, Tax Counsel, Citigroup Corp.
Oral Testimony................................................. 25
Prepared Statement............................................. 26
APPENDIX
Material Submitted for the Hearing Record
Response to Post-Hearing Questions from Carey J. ``Bo'' Horne,
President, ProHelp Systems, Inc................................ 44
Supporting Comments for H.R. 1956, the ``Business Activity Tax
Simplification Act of 2005,'' from Carey J. ``Bo'' Horne,
President, ProHelp Systems, Inc................................ 46
Response to Post-Hearing Questions from Lyndon D. Williams, Tax
Counsel, Citigroup Corp........................................ 50
Prepared Statement of the American Bankers Association........... 52
Prepared Statements of Michael Mazerov, Senior Fellow, on behalf
of the Center on Budget and Policy Priorities.................. 53
Letter to the Honorable Chris Cannon from Arthur R. Rosen,
Counsel, Coalition for Rational and Fair Taxation.............. 100
Prepared Statement of the Council on State Taxation (COST)....... 120
CRS Report entitled ``State Corporate Income Taxes: A Description
and Analysis,'' Updated May 11, 2005, Steven Maguire, Analyst
in Public Finance, Government and Finance Division, submitted
by the Honorable William D. Delahunt........................... 126
Letter to the Honorable Chris Cannon from Steve Bartlett,
President and CEO, The Financial Services Roundtable: Industry
Coalition...................................................... 143
Letter to the Honorable F. James Sensenbrenner, Jr., from an
Industry Coalition............................................. 144
Letter to the Honorable Chris Cannon, and the Honorable Melvin
Watt, from John Gay, Vice President, Government Relations,
International Franchise Association (IFA)...................... 148
Prepared Statement of David J. Pettit, President, American
Distribution Centers for the International Warehouse Logistics
Association.................................................... 151
Letter to the Honorable Chris Cannon from Dan Glickman, Chairman
and CEO, Motion Picture Association of America................. 157
Prepared Statement of the National Governors Association,
submitted by the Honorable William D. Delahunt................. 159
Letter to the Subcommittee on Commercial and Administrative Law
from Paul J. Gessing, Director of Government Affairs, National
Taxpayers Union (NTU).......................................... 194
Letter to the Honorable Melvin L. Watt from the Honorable Marc
Basnight, a Senator of the North Carolina General Assembly,
submitted by the Honorable William D. Delahunt................. 196
Letter to the Honorable Melvin L. Watt from the Honorable James
B. Black, a Representative of the North Carolina General
Assembly, and Speaker of the North Carolinia House of
Representatives, submitted by the Honorable William D. Delahunt 197
Letter to the Honorable Melvin L. Watt from the Honorable Michael
F. Easley, Governor, State of North Carolina, submitted by the
Honorable William D. Delahunt.................................. 198
Letter to the Honorable Melvin L. Watt from the E. Norris Tolson,
Secretary, North Carolina Department of Revenue, submitted by
the Honorable William D. Delahunt.............................. 200
Letter to the Honorable Chris Cannon from Richard J.M. Poulson,
Executive Vice President, General Counsel & Senior Advisor to
Chairman, and Vernon T. Turner, Corporate Tax Director,
Smithfield Foods, Inc. (Smithfield)............................ 206
Prepared Statement of the Software Finance and Tax Executives
Council........................................................ 209
Prepared Statement of Chris Atkins, Staff Attorney, the Tax
Foundation..................................................... 213
BUSINESS ACTIVITY TAX
SIMPLIFICATION ACT OF 2005
----------
TUESDAY, SEPTEMBER 27, 2005
House of Representatives,
Subcommittee on Commercial
and Administrative Law,
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to notice, at 1:05 p.m., in
Room 2141, Rayburn House Office Building, the Honorable Steve
Chabot [Member of the Subcommittee] presiding.
Mr. Chabot [presiding]. The Committee will come to order.
Good afternoon, ladies and gentleman. This hearing of the
Subcommittee on Commercial and Administrative Law will come to
order. I am not Chris Cannon, I am Congressman Steve Chabot. I
am actually the Chair of the Subcommittee on the Constitution
of the Judiciary Committee.
Chairman Cannon regrets that he will be unable to be here
this afternoon. The Ranking Member, Mel Watt from North
Carolina, is unable to be here. So his shoes will be filled,
and I am sure quite ably by the gentleman from Massachusetts,
Mr. Delahunt, as well. So he and I will try not to screw this
up too badly in the absence of our colleagues.
Mr. Delahunt. We have the capacity to do that.
Mr. Chabot. I can only speak for myself. I can't speak for
Bill here.
But today we will consider H.R. 1956, the ``Business
Activity Tax Simplification Act of 2005,'' a measure intended
to provide greater clarity for businesses navigating the tax
landscape. This bill was introduced by the gentleman from
Virginia, Congressman Goodlatte, on April 28th of this year,
and it already has 28 cosponsors.
H.R. 1956 is designed to address a fundamental problem
related to interstate commerce. Specifically, when is a State
justified in taxing a business with little or no physical
connection with that State. Congress has examined this issue
from time to time over the years. Recently, with the emergence
of the Internet economy, and the explosion of service
industries, the need for clear, concise taxation standards has
become even more urgent.
In 1959, Congress enacted Public Law 86-272, still in force
today, prohibiting States from imposing a business activity tax
on companies whose only contact with the State is the
solicitation of orders for tangible goods.
But those were simpler days. Since 1959, the economy has
been reshaped dramatically. The emergence of the Internet has
served as a major catalyst of this transformation. Companies
offer not only tangible goods, but intangible property and
services to customers across the country.
But because Public Law 86-272 does not address intangible
goods, the law falls short in addressing the current tax
landscape. In addition, since 1959, many States appear to have
engaged in practices that are at odds with the meaning and
intent of Public Law 86-272.
For example, States have begun to impose a tax on a
company's business activities on gross receipts rather than on
net income. These developments have wreaked havoc on
businesses. These businesses have incurred great expense in
attempting to decipher and in many cases litigating the
appropriate nexus standard for business activity taxes.
H.R. 1956 would provide some certainty to this issue. It
would amend Public Law 86-272 to apply to solicitation
activities in connection with all sales, not just sales of
tangible personal property. It would also cover all business
activity taxes, not just net income taxes.
It establishes a brightline 21-day physical presence
requirement for the imposition of business activity taxes and
would codify the current physical presence standard observed
for years and elaborated by the Supreme Court in 1992 in Quill
v. North Dakota. In Quill, the Court required that in order for
a State to impose a requirement that remote vendors collect and
remit sales taxes for sales made to customers in the State, the
business must have a physical presence within the State.
During the 107th and 108th Congresses, the Subcommittee
considered similar measures also sponsored by our colleague,
Mr. Goodlatte. The bill in the 107th Congress was reported out
favorably by this Subcommittee, though the full Judiciary
Committee did not have an opportunity to consider it prior to
conclusion of that Congress.
In the 108th Congress, this Subcommittee did not have an
opportunity to consider the bill further after a legislative
hearing, examining the issues in the bill. Seeking certainty
amidst the confusion, numerous business associations have
expressed their strong support for H.R. 1956, including the
National Retail Federation, the National Association of
Manufacturers, the Motion Picture Association of America, Inc.,
and the Software and Information Industry Association, to name
only a few.
In considering this legislation, Congress recognizes its
responsibility under the U.S. Constitution to ensure that
States do not unduly burden interstate commerce through the use
of their taxing authority. We also seek to promote a legally
certain and stable business environment that will encourage
businesses to make investments. At the same time, we endeavor
to do so without detracting from reasonable concepts of State
and local taxing prerogatives.
I look forward, as I know all the Members of this panel do,
to the testimony of our highly informed panel before us here
this afternoon. I ask unanimous consent that Members have 5
legislative days to submit written statements for inclusion in
today's record.
I would now yield to the gentleman from Massachusetts, Mr.
Delahunt, to make an opening statement.
Mr. Delahunt. Yes. Thank you, Mr. Chairman.
As you indicated, Mr. Watt, who is the Ranking Member of
this particular Subcommittee, is unavailable because today he
is in Haiti at the invitation of the Secretary of State.
But I do speak for him when I say we believe this bill
addresses very important, interesting and complex issues, and
appreciate the opportunity for us to create a complete
comprehensive and balanced record of the competing views of the
various stakeholders.
We have held hearings on prior iterations of this
legislation. Yet, in the past few months, we have heard
perspectives that have not been presented to this Subcommittee
previously. Knotty policy choices and real-life implications
are associated with this legislation.
The Supreme Court seeks to overturn any Congressional
legislation that urges us to expand. State and local
legislatures advance sound Federalism and tax policy arguments
against BATSA. They argue that in a borderless economy States
must have flexibility to tax economic activity that generates
millions in income for otherwise absent corporations. They
further contend that the bill would undermine the ability of
State and local governments to attract jobs and investment and
would incentivise businesses to establish corporate structures
that avoid legitimate taxation.
The business community as a whole argues that State and
local governments are abusing their power to tax and are
systematically imposing multiple and discriminatory taxes on
minimal activity within their borders. Subsets of the business
community, service industry, retailers, financial institutions
and others present specific, distinct and equally persuasive
arguments in favor of the so-called brightline physical
presence test.
Finally, organizations like the Council on State Taxation
support the enactment of the so-called physical presence nexus
standard but only as a quid pro quo for enhanced State
authority to require remote sellers of tangible goods to
collect and remit sales taxes. This issue has been the subject
of special legislation in the past, filed by myself. We believe
that we must continue to consider carefully the implications of
this bill.
One thing is very clear to us, we must strike a very
delicate balance, particularly in face of mounting unfunded
mandates to ensure that State and local governments are not
unfairly stripped of legitimate revenue to perform their
traditional governmental functions, and that business entities
are not unjustly strapped with illegitimate taxes that could
weaken our overall economy. We hope the focus of this hearing
and future hearings will be on determining where that delicate
balance should be.
Thank you, Mr. Chairman, and I thank the witnesses in
advance of their contribution to this debate. On behalf of Mr.
Watt, I express his regret for not being able to be in
attendance here today, albeit, I would suggest, for an
excellent reason.
Mr. Chabot. Thank you very much. I appreciate your opening
statement. Does the gentleman from North Carolina, Mr. Coble,
like to make an opening statement?
Mr. Coble. Very briefly, Mr. Chairman, I will say that
Chairman Cannon and Ranking Member Watt have been replaced by
superb substitutes.
Mr. Delahunt. We agree.
Mr. Chabot. Take as much time as you like, Mr. Coble.
Mr. Coble. I figured that would get me additional time.
This bill addresses a nagging problem that needs to be
resolved. I oftentimes wonder, Mr. Chairman and Mr. Delahunt,
if the disagreement is whether or not a substantial nexus has
been established, A, or, B, whether anyone doing business in a
State should be taxed. I think our good revenue collectors--I
used to be one, Madam, so I can say that--we want to get our
hands on every dime that is not nailed down. Then there are
other folks who believe that no one should be taxed. Clearly
those two extreme groups, I think, do not resolve the problem.
Mr. Chairman, I look forward--I need to go to another
hearing, but I look forward to as much of this hearing as I can
be able to be here for.
Thank you, Mr. Chairman.
Mr. Chabot. Thank you, Mr. Coble. We especially appreciate
the first part of your statement. Mr. Franks, the gentleman
from Arizona, is recognized if he would like to make an opening
statement.
Mr. Franks. Mr. Chairman, I think Mr. Coble pretty much
expressed my sentiments, so we will go with that.
Mr. Chabot. Thank you very much. I appreciate your comments
and attendance. The Chair notes and welcomes the presence on
the dais of the gentleman from Virginia, Mr. Goodlatte.
Although not a Member of the Subcommittee he is a Member of the
full Judiciary Committee, and he is the sponsor of the
legislation which we are dealing with here this afternoon.
Mr. Goodlatte, we welcome you and are grateful for your
continuing efforts. As many of you know, Mr. Goodlatte is also
the Chairman of the Agricultural Committee, so he is a very
powerful Member of the United States House of Representatives.
The Chair will exercise its discretion in this instance and
would recognize Mr. Goodlatte for a few minutes for any remarks
that he might like to make.
Mr. Goodlatte.
Mr. Goodlatte. Mr. Chairman, thank you very much for
scheduling this hearing on the Business Activity Tax
Simplification Act. I introduced this legislation with my good
friend Rick Boucher of Virginia to provide a brightline of
State and local authority to collect business activity taxes
from out-of-State entities. Many States and local governments
levy corporate income, franchise and other taxes on out-of-
State companies that conduct business activities within their
jurisdictions. While providing revenue for States, these taxes
also serve to pay for the privilege of doing business in a
State.
However, with the growth of the Internet, companies are
increasingly able to conduct transactions without the
constraint of geopolitical boundaries. The growth of the high
tech industry industry and interstate business-to-business and
consumer transactions raises questions over whether multistate
companies should be required to pay corporate income and other
business activity taxes.
Over the past several years, a growing number of
jurisdictions have sought to collect business activity taxes
from businesses located in other States, even though those
businesses receive no appreciable benefits from the taxing
jurisdiction, and even though the Supreme Court has ruled that
the Constitution prohibits a State from imposing taxes on
businesses that lack substantial connections to the State.
This has led to unfairness and uncertainty, generated
contentious, widespread litigation and hindered business
expansion as businesses shy away from expanding their presence
in other States for fear of exposure to unfair tax burdens.
In order for businesses to continue to become more
efficient and expand the scope of their goods and services, it
is imperative that clear and easily navigable rules be set
forth regarding when an out-of-State business is obliged to pay
business activity taxes to a State. Otherwise, the confusion
surrounding these taxes will have a chilling effect on e-
commerce, interstage commerce generally and the entire economy
as tax burdens, compliance costs and litigation and uncertainty
escalate. Previous actions by the Supreme Court and Congress
have laid the groundwork for a clear, concise and modern
brightline rule in this area.
In the landmark case of Quill Corporation v. North Dakota,
the Supreme Court declared that a State cannot impose a tax on
an out-of-State business unless that business has a substantial
nexus with the taxing State. However, the Court did not define
what constituted a substantial nexus for the purposes of
imposing business activity taxes.
In addition, over 40 years ago Congress passed legislation
to prohibit jurisdiction from taxing the income of out-of-State
corporations whose in-State presence was nominal. Public Law
86-272 set clear uniform standards for when States could and
could not impose such taxes on out-of-State businesses when the
business's activities involve the solicitation of orders for
sales.
However, like the economy of its time, the scope of Public
Law 86-272 was limited to tangible personal property. Our
Nation's economy has changed dramatically over the past 40
years, and this outdated statute needs to be modernized. The
Business Activity Tax Simplification Act both modernizes and
provides clarity in an outdated and ambiguous tax environment.
First, the legislation updates the protection of Public Law
86-272. This legislation reflects the changing nature of our
economy by expanding the scope of the protections in 86-272
from just tangible personal property to include intangible
property in all types of services. In addition, our legislation
sets forth clear, specific standards to govern when businesses
should be obliged to pay business activity taxes to a State.
Specifically the legislation establishes a physical presence
test, such that an out-of-State company must have a physical
presence in a State before the State can impose franchise
taxes, business license taxes and other business activity
taxes.
The clarity that the Business Activity Tax Simplification
Act will bring will ensure fairness, minimize litigation and
create the kind of legally, certain and stable climate that
encourages businesses to make investments, expand interstate
commerce, grow the economy and create new jobs. At the same
time, this legislation will protect the ability of States to
ensure that they are fairly compensated when they do provide
services to businesses that do have a physical presence in
their State.
Again, Mr. Chairman, thank you for holding this important
hearing.
Mr. Chabot. Thank you very much. Before I begin with
witness introductions, I ask unanimous consent that the record
will remain open for 5 legislative days for other interested
parties to submit statements for inclusion in the hearing
record.
Also, we have a number of statements from interested
parties on all sides of this issue that I would like to have
submitted for the record. I would ask unanimous consent to
enter these statements into the record.
Hearing no objection, these statements will be entered into
the record.
Now I would like to introduce our very distinguished panel
here this afternoon.
Our first witness is Bo Horne, the President of ProHelp
Systems, Inc., a software development company located in
Seneca, South Carolina. A graduate of the Georgia Institute of
Technology with a degree in electrical engineering, Mr. Horne
founded ProHelp Systems, Inc. in 1984. ProHelp designs,
develops and markets highly complex and specialized product
configuration, engineering and manufacturing software systems
for electrical equipment manufacturers and creates systems
integration software for mid-range and mainframe markets.
Mr. Horne, thank you again for your appearance here today.
We look forward to your testimony in just a couple of minutes
here.
The next witness is Earl Ehrhart, State Representative for
the 36th House District of the State of Georgia.
Mr. Ehrhart has served in the Georgia House of
Representatives since his first election in 1988. He is
Chairman of the House Rules Committee and a Member of the
Appropriations, Banking and State Institutions and Public
Property Committees, and we welcome you here this afternoon,
Mr. Ehrhart.
You currently serve as the national chairman of the
American Legislative Exchange Council, a nationwide bipartisan
group of legislators. In recognition for his leadership, he has
been honored with a Champion of the Free Enterprise System
Award from the Associated Builders and Contractors of Georgia,
and he has been the recipient of the Guardian of Small Business
Award by the National Federation of Independent Business. Mr.
Ehrhart earned his Bachelor's Degree from the University of
Georgia.
When not serving in the legislature, he is the Senior Vice
President of the Facility Group, Inc., an architectural and
engineering firm. Mr. Ehrhart, we congratulate you for your
substantial efforts and look forward to your testimony from a
State perspective here this afternoon.
Our next witness will be Joan Wagnon, Secretary of Revenue
of the State of Kansas. Ms. Wagnon was appointed to her current
position in 2001. Secretary Wagnon is a former six-term State
legislator representing Topeka in the Kansas House from 1983 to
1994. She also was elected as the Mayor of Topeka in 1997 and
served until 2001. Secretary Wagnon is the Chairman of the
Multistate Tax Commission, as well as the Chair of the
Midwestern States Association of Tax Administrators. She is
also a member of the Federation of Tax Administrators board of
directors and is actively involved in several charitable
organizations, including the national board of the Girl Scouts
U.S.A., the Midland Hospice of Topeka and the Downtown Rotary
Club.
Secretary Wagnon earned her Bachelor's Degree from Hendrix
College in Arkansas and her Master's of Education in guidance
and counseling from the University of Missouri.
Secretary Wagnon, welcome, we appreciate your testimony
here this afternoon.
Our final witness is Lyndon Williams, Tax Counsel for
Citigroup, Incorporated. Mr. Williams is responsible for
providing advice and counsel on matters relating to the various
aspects of tax law, including State and local taxation. He
represents Citigroup as global e-commerce tax counsel, working
with the Organization for Economic Cooperation and Development
on tax policy matters involving international taxation. He is
also a member of the tax committees of the Business and
Industry Advisory Committee to the OECD and the United States
Council for International Business.
Mr. Williams earned a Bachelor's Degree in business
administration, majoring in accounting, from Baruch College at
the City University of New York. He received his Master's of
Science Degree in taxation from Pace University Graduate School
of Business in White Plains, New York and his law degree from
Pace Law School. Mr. Williams is a member of the New York State
Bar Association and the President of the Association of Black
Lawyers of Westchester County.
Mr. Williams, thank you very much for your appearance here
this afternoon as well.
We extend to each of you the warm regards and appreciation
for your willingness to participate in today's hearings.
In light of the fact that your written statements will be
included in the hearing record, we would request that you limit
your remarks, if at all possible, to 5 minutes.
You will note that we do have a lighting system up there.
During the first 4 minutes of the 5 minutes, there will be a
green light on. When you have 1 minute to go the yellow light
will come on, and the red light means that you are supposed to
wrap up.
Chairman Cannon's practice has been to tap the gavel at 5
minutes so you will know that your time is up, and we won't
gavel you down at that time but we would appreciate it if you
would wrap it up close to that time if at all possible.
Pursuant to the directive of the Chairman of the Judiciary
Committee, I ask that the witnesses please stand because it is
the practice of the Committee to swear in all witnesses before
the Committee.
[Witnesses sworn.]
Mr. Chabot. Let the record reflect that each of the
witnesses answered in the affirmative, and you may all be
seated.
Mr. Horne, at this time you are recognized for 5 minutes.
TESTIMONY OF CAREY J. ``BO'' HORNE, PRESIDENT,
PROHELP SYSTEMS, INC.
Mr. Horne. Thank you, Mr. Chairman.
Mr. Chabot. If you could turn that on. If you would pull
the mike a little closer to you there. Thank you.
Mr. Horne. I am new at this.
Mr. Chabot. Okay.
Mr. Horne. Thank you, Mr. Chairman, and Members of the
Subcommittee for this opportunity to support H.R. 1956, the
Business Activity Simplification Act. I am Bo Horne, President
of ProHelp Systems, a home-based software business in South
Carolina. It is an honor being asked to address an issue so
vital to small business. I represent no one but my wife, myself
and our small business. We are here today at personal expense
to plead for your support for a bill which clarifies the
reasonable physical presence standard must be applied when
determining nexus for interstate activity.
Our experience clearly shows what happens when the standard
leaves the smallest avenue open to abuse by greedy States. Our
many conversations with people across this country also shows
such abuses are far more common than generally recognized.
Without strong Federal legislation, small businesses will soon
be unable to participate in interstate commerce. We are
speaking up because thousands of small businesses are totally
unaware of today's risks.
In 1997, we sold one copy of our licensed software to a
customer in New Jersey for $695. Because of this single sale,
the State of New Jersey now demands that we pay $600 in taxes
and fees every year the software remains in use, even in years
with no sales, and regardless of any profit. Despite 2 years of
effort and substantial legal fees, New Jersey continues to
press its claim. Should all 50 States adopt New Jersey's
corporate business tax, small software developers selling just
one license in every State would owe $30,000 in business
activity taxes every year thereafter even with no additional
sales anywhere. Should localities follow suit the results would
truly be astronomical. These are powerful reasons to stay out
of the software business.
We have little idea where our customers reside, but we are
proud to have sold software in 32 countries. We have less than
$30,000 per year in domestic sales of licensed software. How
can we provide jobs or even remain in this business if State
taxes exceed total sales?
The issue is not limited to software. New Jersey even
defies protections of the Interstate Income Tax Act of 1959,
which prevents States from imposing income tax for interstate
activities where no physical presence exists. Today, if one of
your constituents ships a box of paper clips to a customer in
New Jersey, he will be subjected to the same tax.
Ours is not an isolated case. We are personally aware of
small business victims in multiple States, including three
represented on this Subcommittee, North Carolina, Wisconsin and
Virginia. We did not search for these victims. Desperate for
help, they found us from testimony we submitted to this
Subcommittee last year or from numerous articles written about
our case. Each of you should understand that small businesses
in your own State are already being wrongfully burdened by
greedy States.
The nightmares are certain to escalate. New Jersey
increased its minimum tax 150 percent in 2002. This tax is
effectively borne only by the smallest participants in
interstate commerce. The victims are generally not capable of
fighting. They capitulate to reduce the risk of larger
penalties, and they have absolutely no representation in the
matter except right here.
Why should anyone believe this tax will not soon be
increased again and spread to other States? Without clear
protection such as BATSA provides, aggressive States will
always seek to stretch the limits and to impose their own
creative definitions to justify taxation most citizens would
consider unjust. No small business can possibly cope with the
widely varying and ever-changing laws of 50 States, the
administrative burdens of keeping records by State, or the
costs of preparing and filing multiple returns, nor can we
afford to pay inflated tax claims or legal fees required to
defend against them.
If Smithfield Foods has difficulty complying with State tax
laws, as Tracy Vernon testified last year, how can small
businesses ever do so? Many small businesses are not yet vocal
with their support for this legislation. Most have no idea they
may be involved in nexus issues or even what nexus means. They
are totally unaware that many States will attempt to tax their
activities. But as information tracking systems become more
powerful and pervasive and as the Internet changes the very
foundations of interstate commerce, small business will be
trapped like a deer in headlights, totally defenseless against
what is certain to happen, unless Congress uses its authority
to protect us.
Mr. Chairman, I would love to continue explaining why small
businesses desperately need your help. My time is up, and I
have provided more in writing, so I will close with one
thought. The growing constraints on our participation in
interstate commerce will ultimately impose economic costs our
country simply cannot afford. Please act on this bill before
more damage occurs.
Again, it has been an honor to speak to you and I will be
happy to answer questions.
[The prepared statement of Mr. Horne follows:]
Prepared Statement of Carey J. (Bo) Horne
Thank you Mr. Chairman, Ranking Member Watt, and members of the
Subcommittee for this opportunity to support H.R. 1956, the Business
Activity Tax Simplification Act. I am Bo Horne, President of ProHelp
Systems, a home-based software business in South Carolina. It is an
honor being asked to address an issue so vital to small business.
I represent no one but my wife, myself, and our small business. We
are here today at personal expense to plead for your support for a bill
which clarifies that a reasonable physical presence standard must be
applied when determining nexus for Interstate activity. Our experience
clearly shows what happens when the standard leaves the smallest avenue
open to abuse by greedy States. Our many conversations with people
across the Country also show such abuses are far more common than
generally recognized. Without strong Federal legislation, small
businesses will soon be unable to participate in Interstate Commerce.
We are speaking up because thousands of small businesses are totally
unaware of the risks.
In 1997, we sold one copy of our licensed software to a customer in
New Jersey for $695. Because of this single sale, the State of New
Jersey now demands that we pay $600 in taxes and fees, every year the
software remains in use, even in years with no sales, and regardless of
any profit. Despite two years of effort and substantial legal fees, New
Jersey continues to press its claim.
Should all 50 States adopt New Jersey's Corporate Business Tax,
small software developers selling just one license in every State would
owe $30,000 in business activity taxes every year thereafter, with no
additional sales anywhere. Should localities follow suit, the results
would truly be astronomical. These are powerful reasons to stay out of
the software business.
We have little idea where our customers reside, but we are proud to
have sold software to customers in 32 countries. We have less than
$30,000 per year in domestic sales of licensed software. How can we
provide jobs, or even remain in this business, if State taxes exceed
total sales?
The abuse is not limited to software. New Jersey even defies
protections of the Interstate Income Tax Act of 1959 (P.L. 86-272),
which prevents States from imposing income tax for Interstate
activities where no physical presence exists. Today, if one of your
constituents ships a box of paper clips to a customer in New Jersey, he
will be subjected to the same tax.
Ours is not an isolated case. We are personally aware of small
business victims in multiple States, including three represented on
this Subcommittee: North Carolina, Wisconsin, and Virginia. We did not
search for these victims. Desperate for help, they found us from
testimony we submitted to this Subcommittee last year or from numerous
articles written about our case. Each of you should understand that
small businesses in your own State are already being wrongly burdened
by greedy States.
The nightmares are certain to escalate. New Jersey increased its
minimum tax 150% in 2002. This tax is effectively borne only by the
smallest participants in Interstate Commerce. The victims are generally
not capable of fighting, they capitulate to reduce the risk of larger
penalties, and they have absolutely no representation in the matter
except right here. Why should anyone believe this tax will not soon be
increased again, and spread to other States? Without clear protections
such as BATSA provides, aggressive States will always seek to stretch
the limits and to impose their own creative definitions to justify
taxation most citizens would consider unjust.
No small business can possibly cope with the widely varying and
ever changing laws of 50 States, the administrative burdens of keeping
records by State, or the costs of preparing and filing multiple
returns. Nor can we afford to pay inflated tax claims or legal fees
required to defend against them. If Smithfield Foods has difficulty
complying with State tax laws, as Tracy Vernon testified last year, how
can small businesses ever do so?
Many small businesses are not yet vocal with their support for this
legislation. Most have no idea they may be involved in nexus issues or
what nexus even means. They are totally unaware that many States will
attempt to tax their activities. But, as information tracking systems
become more powerful and pervasive, and as the Internet changes the
very foundations of Interstate Commerce, small business will be trapped
like a deer in headlights, totally defenseless against what is certain
to happen, unless Congress uses its authority to protect us.
Mr. Chairman, I would love to continue explaining why small
businesses desperately need your help. My time is up, and I have
provided more in writing; so I will close with one thought.
The growing constraints on our participation in Interstate Commerce
will ultimately impose economic costs our Country simply cannot afford.
Please act on this bill before more damage occurs.
Again, it's been an honor to speak to you; and I will be happy to
answer questions.
ADDITIONAL INFORMATION
One very positive aspect of our saga has been the realization that
our representative democracy works far better than we have been led to
believe. We have been treated with courtesy, respect, and great empathy
by the hundreds of representatives, state and federal officials,
attorneys, businessmen, news editors, and private citizens we have
spoken with about our ordeal. Without their enormous support and
encouragement, we simply would not be here today.
All of our Company's work is performed in our home, we are the only
employees (though we have had additional employees in prior years), and
our company is our sole source of earned income. Our company is
incorporated in Georgia and registered in Georgia and South Carolina.
We have elected S Corporation status, operate and pay taxes as such,
and file appropriate returns in Georgia and South Carolina each year.
We pay employment taxes to South Carolina, and we acknowledge nexus in
both Georgia and South Carolina. All work is conducted in South
Carolina via the telephone, the Internet, and the U. S. Postal Service.
The State of New Jersey is asserting a claim of nexus against our
company due to the sale of seven intangible software licenses during
the period 1997-2002. During this period, we generated total revenue
from New Jersey-based customers of $6,132. By year, our sales into New
Jersey for that period were $695, $0, $0, $0, $49, and $5388,
respectively. Those are single dollars, not $K, $M, or $B. Of this
total, $5,133 was derived from the actual license sales and $999 from
additional services performed in South Carolina after the original
sales.
New Jersey acknowledges that its original claim of nexus was based
solely on the existence of these seven software licenses within the
state. New Jersey's claim of nexus will be made as long as any licenses
remain in use within the State, even if we cease accepting all business
from New Jersey customers and generate zero future income from sales
into the State. It is important to note there is nothing special about
our license; it is very similar to ones provided with shrink-wrapped
software commonly available at electronics or office supply stores such
as Best Buy or Staples.
New Jersey's claim of nexus generates a requirement for our company
to pay $500 per year as the New Jersey minimum corporate tax and $100
per year for Corporate Registration fee, every year, even in years when
we have zero sales in New Jersey and have no other business activity in
the State. (If not for the minimum corporate tax and registration fee,
our calculated tax would be less than $1.00 in our best year.)
We have been advised by the New Jersey Division of Taxation that
the only way to remove our future liability for paying this $600 per
year in tax and fees is to:
(1) stop accepting all orders from New Jersey,
(2) have zero New Jersey income,
(3) terminate all existing software licenses, and
(4) have our customers remove all licensed software from their
systems. We have been advised that we cannot terminate our
nexus in future years by abandoning our license agreements and
giving clear title of the software to our customers.
We have met these requirements, as of December 31, 2003, through
the following actions:
We have terminated all of our national advertising.
Our sales are down significantly as we attempt to refocus our
activity into Georgia and South Carolina only.
We have stopped accepting all orders from New Jersey
locations. We cannot accept any business, of any type, from New
Jersey locations until small business is given the protection
it must have in order to participate in Interstate Commerce on
a free and unhindered basis. In January 2004, we refused to
accept a firm order for $15,000 of remote services from a
Georgia customer who would have made payment through a New
Jersey office. The risk of validating their claims of nexus in
future years was simply too great for us to accept. Needless to
say, this decision hurt our business badly.
We have terminated all software licenses in New
Jersey, and our customers have removed all licensed software
and replaced it with new, unlicensed software. As a result, our
intellectual property no longer receives the protection it must
have in order to insure its viability for future enhancements
and improvements and for our future income.
These actions have combined to significantly reduce and inhibit our
participation in Interstate Commerce, reduce our sales, reduce our
personal salaries, and reduce our payments of badly needed Federal and
South Carolina tax revenues. We have become so concerned about the risk
of our continued participation in Interstate Commerce that we are
asking ourselves: ``Why bother? Can we afford the risk? Should we
terminate the business before it gets worse?''
Our situation, and that of all small businesses participating in
Interstate Commerce, is simply intolerable. Had we sold just one $695
license in 1997 and not derived any further income from New Jersey
customers, we would still be subject to the requirement of paying $600
per year in New Jersey taxes and fees as long as our customer continues
to use the license. To fight this horribly unjust taxation, we have
been forced to spend thousands of dollars in legal fees to defend
ourselves; and we are continually distracted from pursuing our normal
business activities which generate all of our earned income.
Making the situation even worse, New Jersey has since expanded its
regulations to assert nexus against all companies deriving any type of
income from New Jersey customers, regardless of physical presence or de
minimis activity. This latest provision of New Jersey tax regulations
includes the sale of tangible products and is in direct defiance of
Congressional intent and the physical presence standard of Public Law
86-272. Should all 50 states adopt these same provisions, the sale of a
single box of paper clips in each state, at any point in time, would
generate the requirement to file a state tax return in every State and
to pay $30,000 in minimum taxes and fees per year, forever, even in
years when no sales are made in those states, unless crucial steps are
taken promptly to terminate nexus. And, New Jersey does not make that
termination easy.
More importantly, no company can survive by continually paying
taxes on zero profits or by paying taxes greater than total sales.
After our total sales are reduced by amounts not related to licensed
software, by amounts for services, and by international sales, we have
less than $30,000 in total domestic sales of licensed software. How can
we develop, market, support products, and provide jobs, or even remain
in this business, under those circumstances?
New Jersey is not the only State adopting highly aggressive tactics
which threaten small businesses. Such tactics are becoming more
prevalent each year, and BATSA will stop the abuses. BATSA is simply
vital for protecting small businesses by clearly codifying numerous
existing judicial precedents and Congressional intent inherent in
Public Law 86-272 and by providing a uniform and bright-line standard
of physical presence for nexus.
We realize there are multiple sides to every issue; for BATSA,
there are at least three:
Small businesses: Hopefully, we are sufficiently
conveying why the passage of BATSA is so absolutely critical if
small businesses are to participate in Interstate Commerce.
Large businesses: Having worked for and with large
businesses for many years, we understand and support their need
for clarity and simplification of the rules which would allow
them to devote more attention to delivering products and
services instead of defending themselves in legal actions.
The States: Why are they so strongly resisting BATSA?
(a) We totally reject their claims of State sovereignty. Our
Founding Fathers, who created the best form of government our
world has known, wisely understood that Federal regulation
would be vital toward assuring a vibrant National economy and
gave the Congress broad powers to regulate Interstate Commerce.
They included the Commerce Clause to cure a problem that had
already occurred during the Colonial period. It is the exact
problem small businesses face today: greedy States, totally
unconcerned about the National economy. The Commerce Clause
gives this Congress very clear and absolute authority to
regulate this critical area of our economy. Without question,
Congress has absolute jurisdiction to protect the rights of
hundreds of thousands of small businesses attempting to
participate in Interstate Commerce, free from undue burdens
associated with paying taxes in multiple States; and the States
ceded all rights for any claims of sovereignty over this issue
when they joined the Union.
(b) We also reject their wildly exaggerated claims of lost
revenues. Several analyses have been made, but has a single one
ever factored in the loss of hundreds of thousands of jobs,
perhaps millions, because small businesses cannot safely
participate in Interstate Commerce? We can guarantee that tax
revenues obtained from small businesses will begin declining
soon, and many jobs will be lost, unless our problem is
corrected now. No small businessman, once he understands the
risks involved, will dare participate in Interstate Commerce.
The distribution of taxable income may change among the
States, but it should. We do all work from our home; all of our
economic activity occurs there. Shouldn't we pay all our taxes
to South Carolina? Shouldn't this apply equally to large
businesses with no physical presence in a State? If a State's
revenue drops due to passage of this bill, it is because the
State is already engaging in unfair tactics; and its revenue
should and must drop. Many States are already losing a portion
of their own legitimate tax revenues to the greedy States.
(c) A possible threat to States' revenues arises from the
improper use of intangible holding companies. If an intangible
holding company licenses intangible property to an unrelated
company, then it should receive the protection the physical
presence standard provides. If the intangible holding company
operates only to avoid taxation, without other legitimate
business purposes, the States have several remedies they have
traditionally employed to prevent loss of income; and many
States have already enacted one or more of them. So, this issue
is no reason to avoid prompt passage of this bill.
New Jersey is targeting numerous small businesses which sell to
Casinos and therefore must be registered (by the Casino, not the small
business) with the Casino Control Commission (CCC). The CCC even sends
registrants a letter clearly indicating they don't have to do anything
else unless they sell more than $75,000 to a single casino in a single
year. No mention is made of any State requirement to file or pay income
taxes simply because an Interstate sale has been made. We even called,
twice, to verify there were no additional steps for us to take. New
Jersey is also using all other possible types of such independent
registrations to pursue small Interstate businesses.
Further, and it is a matter of public record, Governor McGreevey of
New Jersey was asked by the media during the signing ceremony for its
CBT tax increase about the effect the tax would have on small
businesses. The Governor indicated that New Jersey would not be going
after small businesses. It is now clear that he had little or no
control over his State agencies, was mistaken, or simply lied about
what was soon to begin. New Jersey has thus violated basic requirements
of Due Process and is at least guilty of the entrapment of many small
businesses.
Many scholars and tax experts believe the Supreme Court has spoken
very clearly in numerous decisions regarding Interstate nexus issues
and the Congress has spoken very clearly with the physical presence
standard in Public Law 86-272. Given the problems so obvious today, how
can anyone justify not providing total clarity for all sales? How can
anyone justify our paying any tax to any State except South Carolina or
Georgia, where all of our economic activity occurs?
Customers in other States occasionally seek to buy our products
because similar products are not available in their own State, ours are
superior for their needs, or ours are less costly. Customers buying our
products actually save money by doing so, thereby increasing their own
profits and their own tax obligations within their own States. New
Jersey has provided no services to our Company. We have not attempted
to market explicitly to customers in New Jersey. To the contrary,
customers in New Jersey came to us because our products provide some
advantage to them. Why should such a purchase create a new tax
obligation for our Company? The Congress is going to great lengths to
promote free international trade while this horrible situation
restrains trade within our own borders.
As a private citizen and small businessman, I have concluded the
passage of BATSA is the fair and right thing to do for all business,
both large and small, that it is vital for protecting small businesses,
that it is vital for protecting jobs and our economy, that States'
claims of various harms are ill-advised and simply not true, and that
all sales should be treated equally as intended by the Congress when it
passed Public Law 86-272. Otherwise, very large portions of our economy
(i.e., intellectual property, remote services, and small businesses in
particular) become highly disadvantaged in their conduct of Interstate
marketing activity.
Because physical presence was intended to be the current standard,
BATSA would neither diminish the taxing powers of state and local
jurisdictions nor reduce state and local tax revenues. It will allow
businesses to concentrate on growing our economy and providing jobs,
instead of arguing legal points at great cost, by ensuring no undue
burdens hinder Interstate Commerce.
We beg for your support and prompt passage of this bill, on behalf
of the thousands of small business owners nationwide whose economic
futures rely on it, and on behalf of continued strength in our National
economy.
Mr. Chabot. Thank you very much, Mr. Horne.
Representative Ehrhart is recognized for 5 minutes.
TESTIMONY OF EARL EHRHART, STATE REPRESENTATIVE, GEORGIA HOUSE
OF REPRESENTATIVES, 36TH DISTRICT, NATIONAL CHAIRMAN OF THE
AMERICAN LEGISLATIVE EXCHANGE COUNCIL
Mr. Ehrhart. Thank you, Mr. Chairman and Members of the
Committee. I also found the Chairman and Ranking Member
comments edifying as to my time.
My name is Earl Ehrhart. I am a State Representative in
Georgia, where I chair the Georgia House Rules Committee. I
also serve, as you noted, as the ALEC national Chair.
The American Legislative Exchange Council is the Nation's
largest bipartisan individual membership organization of State
legislators. We have over 2,400 members from all 50 States and
97 members, former members in Congress today.
It is my pleasure to appear before you to present testimony
regarding H.R. 1956, the ``Business Activity Tax Simplification
Act.'' I was elected in Georgia's 36th District to represents
my constituents' interest in Georgia. Part of that
responsibility is to ensure that our State develops a business
climate that expands opportunities for our existing companies
and attracts new business investment.
As a State legislature, however, there's only so much I can
do to help develop a solid business climate in Georgia. Many
entrepreneurs in Georgia do business all over the United States
in our new economy and all over the world. We need the help of
Congress to ensure that the Georgia-based companies aren't
being unjustifiably taxed by those States in which they have no
physical presence. Today we see an increased tendency of
lawmakers and revenue officials in other States to get
aggressive when it comes to raising of revenue from out-of-
State companies. If our State is making that effort to provide
an infrastructure to attract and maintain business in our
State, we should be the ones to enjoy those same benefits.
If we don't curb this aggressive behavior by other States,
we are going to lose our ability to provide a prosperous
business environment in Georgia. H.R. 1956, with its physical
presence, is a good step toward protecting that same ability.
If companies are paying States taxes only where they are
physically present, then we can be comfortable knowing that we
can attract business to Georgia, give them the services we
need, get the taxes we need in return to help pay for those
services and hopefully persuade them to reinvest in our State.
I am not the only State lawmaker who holds that view. As I
mentioned earlier, I am the chairman, the national chairman of
ALEC. ALEC in 2003 approved a model resolution, a resolution on
State and local business activity taxes calling on Congress to
expand and protect the physical requirement. I have passed out
a copy of that for your perusal.
Our resolution states very simply, the physical presence
standard promotes fairness by assuring that businesses that
receive benefits and protections provided by State and local
governments pay their fair share for these services and the
ability of State and local jurisdictions to tax out-of-State
businesses should be limited to those situations in which the
business has employees and/or property in the taxing
jurisdiction and accordingly receives meaningful government
benefits or protections from that jurisdiction. ALEC supports
this approach because it is consistent with our Jeffersonian
principles of individual liberty, limited government and free
markets, and not without interest, it supports Federalism and
not the other way around. States should not be able to tax
those companies that are not physically present in their State.
A more expansive approach, called economic presence by
some, exposes businesses to more taxes, more litigation, but
less money and time to invest and grow the economy. I know some
of my colleagues from other organizations, the MTA, have a
different opinion about this bill. I would like to take just a
moment to address their concerns in particular, tax revenue
losses and tax shelters.
You have heard in the past, and we will hear in the future
that this legislation, physical presence approach in general,
will lead to a substantial revenue loss for States. It has been
argued that we should refrain from acting on this bill because
States will lose revenue needed to pay for schools, roads,
health care and police protection. Just anecdotally, States
have a spending problem and not a revenue problem. Beware of
these revenue estimates. These estimates are based on
assumptions that the State revenue departments can and should
be collecting all the taxes from all the corporations they say
they should. Since the issue of physical presence is unclear,
it is not fair to claim they will lose revenue, merely because
they believe corporations should be paying a certain amount of
taxes based on their questionable interpretation of the law.
As for tax sheltering, again I respectfully disagree that
this bill will make tax sheltering worse. It is important to
remember the tax shelter is in the eye of the beholder. The
U.S. Constitution certainly isn't a tax shelter. H.R. 1956 is
not a tax shelter. I believe the physical presence rule best
embodies the presence that we find in our Constitution and our
laws. I am baffled by my colleagues' insistence that this bill
would only serve to open up our States to more corporate tax
sheltering.
Once again, even if my colleagues are right, the States
have tools to fight these abusive tax shelters. Sham
transactions and those that lack economic substance can
certainly be fought even if H.R. 1956 becomes law. Lawmakers in
other States, Georgia in particular--we have gotten aggressive
with that with addbacks, throwbacks, passive investments, the
single factor taxation that we passed last year in Georgia.
These are tools that we have to accomplish these goals.
In conclusion, Mr. Chairman, thank you for the opportunity
to give the perspective of my constituents, as well as of that
ALEC. The American Legislative Exchange Council is supportive
of the flexibility that the physical presence requirements as
outlined in 1956, and we look forward to working with you in
the days and months ahead to enhance our States' business
climate through a limited government approach.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Ehrhart follows:]
Prepared Statement of the Honorable Earl Ehrhart
INTRODUCTION
Good morning Chairman Cannon, Representative Watt and Members of
the Committee:
My name is Earl Ehrhart, I am a State Representative in Georgia
where I chair the Georgia House Rules Committee. I also serve as the
National Chairman of the American Legislative Exchange Council.
The American Legislative Exchange Council (ALEC) is the nation's
largest nonpartisan, individual membership organization of state
legislators with over 2,400 legislator members from all fifty states
and 97 members in the Congress. It is my pleasure to appear before you
to present testimony regarding H.R. 1956, the ``Business Activity Tax
Simplification Act of 2005.''
GEORGIA
I was elected in Georgia's 36th District to represent my
constituents' interests in the Georgia General Assembly. Part of that
responsibility is to ensure that our state develops a business climate
that expands opportunities for our existing companies and attracts new
business investment.
As a state legislator, however, there is only so much I can do to
help develop a solid business climate in Georgia. Many entrepreneurs in
Georgia do business all over the United States and the world. We need
the help of Congress to ensure that Georgia-based companies aren't
being unjustifiably taxed by those states in which they have no
physical presence.
Today, we see an increased tendency of lawmakers and revenue
officials in other states to get aggressive when it comes to raising
revenue from out-of-state companies. If our state is making the effort
to provide an infrastructure to attract and maintain business in our
state, we should be the ones to enjoy the benefits.
If we don't curb this aggressive behavior by other states, we are
going to lose our ability to provide a prosperous business environment
in Georgia. H.R. 1956, with its physical presence requirement, is a
good step toward protecting our ability to develop the Georgia business
climate my constituents expect me to support in the Georgia General
Assembly.
If companies are paying state taxes only where they are physically
present, then we can be comfortable knowing that we can attract
business to Georgia, give them the services they need, get the taxes we
need in return to help pay for those services, and hopefully persuade
them to reinvest in our state. If businesses are going to be taxed
anywhere they have customers or are making sales, then our efforts to
recruit these companies will be in vain. Instead of reinvesting in the
Georgia economy they will be paying taxes where they have no physical
presence.
This policy is bad for Georgia's economy and bad for my
constituents who need those high paying jobs to support their families
and to realize their dreams. Let's restore sense and clarity to where
our businesses pay their taxes. Simply stated, business should pay
taxes where they hold a physical presence.
AMERICAN LEGISLATIVE EXCHANGE COUNCIL RESOLUTION,
STATE AND LOCAL BUSINESS ACTIVITY TAX
I am not the only state lawmaker that holds this view. As I
mentioned earlier, I am the National Chairman of the American
Legislative Exchange Council, or ALEC. ALEC is a nonpartisan,
individual membership organization of over 2,400 state legislators. In
2003, ALEC approved a model resolution, ``Resolution on State and Local
Business Activity Taxes,'' calling on Congress to protect and expand
the physical presence requirement for the state collection of business
activity taxes. I have attached a copy for your perusal. Our resolution
states:
``the physical presence standard promotes fairness by ensuring
that businesses that receive benefits and protections provided
by state and local governments pay their fair share for these
services''; and
``the ability of state and local jurisdictions to tax out-of-
state businesses should be limited to those situations in which
the business has employees and/or property in the taxing
jurisdiction and accordingly receives meaningful governmental
benefits or protections from the jurisdiction''
ALEC supports this approach because it is consistent with the
Jeffersonian principles of individual liberty, limited government, and
free markets. States should not be able to tax those companies that are
not physically present in their state.
ECONOMIC PRESENCE--A MODEL FOR DISASTER
A more expansive approach, called economic presence by some,
exposes business to more taxes, more litigation, but less money and
time to invest and grow the economy. We have been told, through decades
of congressional action and court rulings, that interstate commerce is
so expansive that it allows Congress to regulate just about any
activity in America. I fear for our Georgia-based companies, if the
states take the same expansive approach to economic presence. Those of
us who advocate a limited government approach, like my colleagues at
ALEC, strongly support the physical presence approach to state business
taxes.
TAX REVENUE LOSSES AND TAX SHELTERING
I know some of my colleagues from other organizations have a
different opinion about this bill. I would like to take just a moment
and address their concerns, in particular, tax revenue losses and tax
sheltering.
You have heard in the past, and will hear in the future, that this
legislation--and the physical presence approach in general--will lead
to substantial revenue loss for the states. It has been argued that you
should refrain from acting on this bill because states will lose
revenue needed to pay for schools, roads, health care, and police
protection.
Be wary of these revenue estimates. These estimates are based on
assumptions that the state revenue departments can and should be
collecting all the taxes from corporations they say they should. Since
the issue of physical presence is unclear, it is not fair to claim they
will lose revenue merely because they believe corporations should be
paying a certain amount of taxes based on their questionable
interpretation of the law.
Furthermore, even if my colleagues are correct, and some states do
lose tax revenue if this bill becomes law, I say this is as it should
be. Corporations should pay taxes only in those states where they are
physically present. If my counterparts in other states want to raise
more taxes from corporations, they should do so by encouraging them,
through lower taxes and other means, to locate in their state, or by
raising taxes on their own companies--not by coercing them to pay taxes
even when they are not physically present in their state. This is what
tax competition is all about.
As for the tax sheltering issue, again, I respectfully disagree
with my colleagues that this bill will make tax sheltering worse. It is
important to remember that a tax shelter is in the eye of the beholder.
The U.S. Constitution is certainly not a tax shelter. H.R. 1956 is not
a tax shelter. I believe the physical presence rule best embodies the
principles that we find in our Constitution and our laws. I am baffled
at my colleagues' insistence that this bill would only serve to open up
our states to more corporate tax sheltering.
But once again, even if my colleagues are right, the states have
the tools to fight abusive tax shelters. Sham transactions and those
that lack economic substance can certainly be fought even if H.R. 1956
becomes law. Furthermore, lawmakers in other states are certainly
moving forward with a number of new measures to fight tax shelters,
including disallowance of deductions to passive investment companies,
addback, and the use of throwback in apportionment. Just this year,
Georgia passed an addback amendment in the Georgia House Bill 191. Let
me assure you that the arsenals that states have in our battle against
tax shelters will remain virtually intact if you pass this bill.
CONCLUSION
Mr. Chairman, thank you for the opportunity to give the perspective
of my constituents as well as that of ALEC. The American Legislative
Exchange Council is supportive of the flexibility and physical presence
requirements as outlined in H.R. 1956. We look forward to working with
you in the days and months ahead to enhance states' business climate
through a limited government approach.
Thank you. I would be please to answer any questions you might
have.
ATTACHMENT
Mr. Chabot. Thank you very much.
Secretary Wagnon, you are recognized for 5 minutes.
TESTIMONY OF JOAN WAGNON, SECRETARY OF REVENUE, STATE OF
KANSAS, AND CHAIR, MULTISTATE TAX COMMISSION
Ms. Wagnon. Thank you, Mr. Chairman, Congressman Delahunt,
and Members of the Committee. I appreciate the opportunity to
address you today. I am Joan Wagnon, Secretary of Revenue for
the State of Kansas and Chair of the Multistate Tax Commission.
Today I represent the Commission and its members in our
opposition to 1956, or BATSA, and I would like to make four
points, which are elaborated in my written testimony.
First of all, BATSA's proponents claim it would ensure
fairness and a level playing field, but that is wrong. It will
lead to more nowhere income, corporate income that is beyond
the jurisdiction of any State, and that is hardly fair to the
rest of the businesses that pay taxes on all of their income
and cannot take advantage of tax avoidance opportunities.
Secondly, BATSA will have a severe fiscal impact on many of
the States. Many people on this Subcommittee have served in
State legislatures. How would you have viewed a Federal law
that would have forced you to raise taxes or cut services to
replace lost corporate tax revenues, this Committee charged
with making sure that administrative rules don't raise Federal
taxes? Why would you allow that to happen to the State by
passing this bill?
According to a study released just today by the National
Governors' Association, H.R. 1956 could strip States of
approximately $6.6 billion. That happens because it extends
Public Law 86-272 to a variety of business taxes, not just
corporate income, and shelter some income in safe harbors. NGA
estimates that 11 percent of business activity tax could vanish
as companies take opportunities to restructure and use the
benefits of this bill. We figured in Kansas we would lose $25
million or more each year.
These tax breaks favoring certain kinds of large companies
either force States to shift that tax burden back on property,
sales or income taxes or reduce services like schools and
health care. At a time when there is bipartisan support in
Congress for shutting down tax shelters and closing loopholes
in the Federal corporate income tax, it would be ironic if
Congress enacted a bill to undermine the same critical source
of revenue for the States.
Third, I want to give you some real examples developed by
my Kansas staff of attorneys and auditors of how tax avoidance
planning will work using the safe harbors in this bill to allow
businesses that already have physical nexus in Kansas, and they
will reduce their liabilities.
A manufacturing scenario, we have a tire company in Kansas
that makes tires and sells them nationwide. Currently, all
property income and sales are used to apportion income in
Kansas. Using BATSA's safe harbors the company can reorganize
itself into several entities, one to own the plant facility and
equipment, an out-of-State company to own and lease the
materials used for the tires, and a third to employ the Kansas
factory workers. All remain commonly owned. Under the safe
harbor for manufacturing materials, the out-of-State company
suddenly has no nexus with Kansas and the value of the
materials located at the Kansas plant would be excluded from
the numerator of their property factor, and it reduces the
Kansas apportionment factor and Kansas taxable business income.
This would apply to our aircraft industry and many other
manufacturing.
A retail scenario. Several out-of-State retailers of
computers or electronic devices market their computers to their
customers in Kansas via the catalog and Internet and use an
independent contractor in Kansas to provide the warranty
service to the customers. Under the independent contractor safe
harbor, the out-of-State retailer now has no nexus in Kansas
and we lose revenue which we currently have.
Financial services companies, banks, all are likely to
restructure to benefit from H.R. 1956. Every service that a
bank offers now can be conducted without a customer and a
building. Out-of-State banks or Internet banks free themselves
of their fair share of taxes while the smaller community banks
see their customer bases diminish.
This threat to our tax base is real, not some manipulation
of numbers for shop value in a public hearing. These are real
examples, and they point out the unfairness of allowing
preferential tax treatment for some businesses while others
never gain this advantage.
Finally, for almost 230 years, while maintaining its
jurisdiction over interstate commerce, Congress has
consistently respected the right of States to raise revenues.
Encroachment on State tax authority clearly violates the most
principled value of Federalism on which our Nation was
developed. The economy of the 21st century, as has been noted,
is electronic and borderless. Most businesses can operate
anywhere without physical presence. This bill takes 19th
century tax law and imposes it on a 21st CENTURY economy and
harms our States' abilities.
I ask you not to support it. Thank you.
[The prepared statement of Ms. Wagnon follows:]
Prepared Statement of Joan Wagnon
Mr. Chairman, Congressman Watt, and Members of the Subcommittee:
Thank you for the opportunity to address the Subcommittee
concerning H.B. 1956, the Business Activity Tax Simplification Act of
2005. I am Joan Wagnon, Secretary of Revenue for the State of Kansas. I
have previously served as President of Central National Bank of Topeka,
Mayor of Topeka, Kansas, and as a six-term member of the Kansas House
of Representatives.
Two months ago, I was elected Chair of the Multistate Tax
Commission. The Multistate Tax Commission is an organization of state
governments that works with taxpayers to administer, equitably and
efficiently, tax laws that apply to multistate and multinational
enterprises. Created by the Multistate Tax Compact, the Commission is
charged by this law with:
Facilitating the proper determination of State and
local tax liability of multistate taxpayers, including the
equitable apportionment of tax bases and settlement of
apportionment disputes;
Promoting uniformity or compatibility in significant
components of tax systems;
Facilitating taxpayer convenience and compliance in
the filing of tax returns and other phases of tax
administration;
Avoiding duplicative taxation.
Created in 1967, forty-six states participate in the work of the
Multistate Tax Commission. I am here today representing the Commission
and its members in our opposition to HR 1956.
Overview
In reviewing the provisions of H.R. 1956, and its predecessors, I
found plenty of provisions that troubled me, but I could not figure out
what positive policy goals that the legislation would accomplish. So I
turned to the website of the bill's proponents, www.batsa.org, and
found that they claim it would accomplish four goals: ensure fairness,
minimize litigation, grow the economy, and ensure a level playing
field. In my review of the legislation and in consultation with many
persons whose judgment I trust and value, I find that H.R. 1956
accomplishes none of these goals.
Does it ensure fairness? No.
According to the Congressional Research Service,
legislation such as H.R. 1956 would lead to more ``nowhere
income,'' that is corporate income that is beyond the tax
jurisdiction of any state in our Nation. That's hardly fair to
the rest of the businesses that pay taxes on all their income!
Does it minimize litigation? No.
H.R. 1956 is anything but clear and simple. Any new
set of rules is an invitation to litigate, but this change
would invalidate forty years of judicial interpretation of P.L.
86-272 for no good reason.
Will it grow the economy? No.
The economy suffers when businesses devote
resources to reorganizing and restructuring to take advantage
of tax laws instead of improving productivity. H.R. 1956 will
also alter states' economic development strategies as more and
more businesses seek to minimize physical presence in taxing
jurisdictions. Furthermore, since the taxes affected by this
legislation account for only about 1 percent of the output of
non-farm businesses, it is difficult to see how enactment of
this bill would unleash a great wave of business investment.
Will it ensure a level playing field? No.
In my state of Kansas and in other states as well,
smaller, more local firms will not have the opportunity to take
advantage of the tax planning opportunities that larger,
multistate firms would use under H.R. 1956.
For example, every service a bank offers can now be
conducted without a customer in a bank building. Out of state
banks or internet banks with their larger economies of scale
can free themselves of their fair share of taxes while smaller
community banks see their customer bases dwindle. Mortgage
banking over the internet is just one good example.
It is clear enough that H.R. 1956 will not accomplish what it sets
out to do. What is even worse is the severe impact that it will have
upon the States. Many of you on this subcommittee have served in state
legislatures. Think about that experience as I present three points for
your consideration.
I. H.R. 1956 WILL FORCE OTHER STATE TAXES TO RISE TO REPLACE LOST STATE
TAX REVENUES FROM H.R. 1956.
Section 4 of H.R. 1956 greatly expands Public Law 86-272 which
covers only corporate income taxes, to add gross receipts taxes,
business license taxes, business and occupation taxes, franchise taxes,
single business taxes, capital stock taxes, as well as many others. In
Kansas, H.R. 1956 will apply to our corporate income tax, corporate
franchise tax, and bank privilege tax--a definite expansion of Public
Law 86-272.
According to a study just released by the National Governors'
Association, H.R. 1956 could strip states of $4.8 billion to $8.0
billion in much needed business activity tax revenues, depending on how
widely it is used by businesses. Imagine what will happen to these
states when an estimated $6.6 billion (the midpoint of the estimated
range) in state revenues vanishes. This represents an estimated 11.4
percent of business activity tax collections by states as companies
restructure to take advantage of the benefits authorized by H.R. 1956.
Kansas alone could easily lose $25 million, or more, each year
under H.R. 1956, which is a large loss in our small state. We are
coming out of the recession slowly, and are under court order to
increase funding for schools dramatically. The state cannot afford any
narrowing of our tax base. These tax breaks for a select group of large
companies would simply shift that tax burden back onto property taxes,
sales taxes or income taxes paid by individuals and small businesses in
our states. The only other option for states would be a dramatic
curtailment of essential state services, such as schools, health and
safety programs, etc.
II. H.R. 1956 IS INCONSISTENT WITH CURRENT FEDERAL POLICY BY
PROMOTING TAX SHELTERING.
Congress and the Internal Revenue Service are currently challenging
federal tax sheltering schemes. A report from Center for Budget and
Policy Priorities said, ``At a time when there is strong bipartisan
support in Congress for shutting down tax shelters and closing
loopholes that afflict the federal corporate income tax, it would be
unfortunate and ironic if Congress enacted legislation like H.R. 1956
that would severely undermine the same--and equally critical--source of
revenue for states.'' (``Federal `Business Activity Tax Nexus'
Legislation: Half of a Two-Pronged Strategy to Gut State Corporate
Income Taxes,'' Revised May 9, 2005)
Professor John Swain writes in the William and Mary Law Review
(Vol.45:319-20, October 2003) that ``the physical presence nexus test
motivates taxpayers to avoid physical presence in some jurisdictions
while shifting property and payroll to tax havens.'' The Congressional
Research Service reported that legislation such as H.R. 1956 would
expand ``the opportunities for tax planning and thus tax avoidance and
possibly evasion.'' (``State Corporate Income Taxes: A Description and
Analysis,'' CRS, Updated March 9, 2005).
``Tax sheltering,'' for state business activity tax purposes, means
that income is not being fully reported to each state in a manner that
``fairly represents'' the business activity actually being conducted by
the enterprise in each state in proportion to the property it uses, the
people it employs or the sales it makes in each state. ``Fairly
represents'' is a policy standard established in the Uniform Division
of Income for Tax Purposes Act (UDITPA), as proposed by the American
Bar Association.
HOW DOES H.R 1956 ENCOURAGE TAX AVOIDANCE?
Kansas uses a three factor formula of property, payroll and sales,
and is a combined reporting state with a ``throwback'' rule. (States
with a single factor formula, sales, will have much heavier losses.) If
this law were to pass this year, the immediate impact on our state
would be only $5-6 million, because companies would need to restructure
to take full advantage of the tax avoidance opportunities which exist
in the new law. But they will do this; why else would the proponents
push so hard?
In 1989 Kansas had 33,581 corporate tax payers. Fifteen years later
that number had dropped to 23,160 as taxpayers took advantage over time
of changes in tax law, abandoned the C Corporation and started
utilizing LLC's, LLP's, and a variety of other structures. Similarly,
corporate income tax receipts now account for a much smaller portion
(2.5%) of total state taxes collected by the department and deposited
in the state general fund than they did even a decade ago (8.4%).
The point is that HR 1956 would stimulate another round of tax
planning and tax avoidance, causing states' revenue streams to erode
further.
The following 4 scenarios were developed by a team of Kansas
auditors, attorneys and policy analysts who met recently to evaluate
the fiscal impact of HR 1956. They looked at the manufacturing, retail
and service sectors of the Kansas business tax base, analyzed the
proposed legislation, and then figured out how certain businesses could
lower their taxes using the ``safe harbors'' to allow businesses that
already have physical nexus with Kansas to substantially reduce their
tax liabilities.
Manufacturer scenario
Company A makes tires in Kansas and sells them nationwide. In
order to take advantage of H.R. 1956 safe harbors, company A
breaks itself up into several separate entities: company B
owns/leases the plant facility and equipment in Kansas, company
C, located out-of-state, owns/leases the materials used to make
the tires, and company D employs the Kansas factory workers.
All remain commonly owned. Under the safe harbor for
manufacturing materials (up to the point those materials become
the finished product/inventory), company C has no nexus with
Kansas, and the value of the materials at the Kansas plant
owned/leased by company C would appear to be excluded from the
numerator of the property factor, thus reducing the Kansas
apportionment factor, and Kansas' share of any taxable business
income.
This same scenario could apply as well to an aircraft
manufacturer in Kansas. An affiliated out-of-state entity owns/
leases the materials (up to the point they become the finished
product) being manufactured into aircraft. Another entity owns/
leases the Kansas manufacturing facility, and yet another
employs the Kansas factory workers. The owner of the materials
and unfinished produced items would appear to be shielded from
nexus under an H.R. 1956 safe harbor.
Retailer scenario
An out-of-state retailer of computers or other electronic
devices markets its products to Kansas customers via the
Internet. The sale of computers and electronic devices includes
warranty contracts. The out-of-state retailer contracts with an
independent contractor located in Kansas to provide the
warranty service to its Kansas customers. The independent
contractor provides similar services to other out-of-state
retailers, all of which could be affiliates of one another.
Under the independent contractor safe harbor in H.R. 1956, the
out-of-state retailer now has no nexus with Kansas.
Financial Services Scenario
Kansas financial services company H breaks itself into
companies I and J, which remain in Kansas, as well as broker K,
which is located out-of-state. Broker K services the Kansas
customers of companies I and J via Internet, mail or telephone.
Income earned by broker K on sales of financial services to
Kansas customers will no longer be taxable by Kansas.
Information/software Services Scenario
A Kansas company providing information and software support
services to businesses in Kansas and other states breaks itself
into in-state information services company X, in-state software
support services company Y, and an out-of-state sales agency Z.
Companies X and Y wholesale their services to agency Z, who in
turn sells the services to businesses in Kansas, delivering the
services via the Internet. Income earned by agency Z on sales
of information and software services provided to Kansas
customers will not be taxable in Kansas.
Kansas currently derives 67% of its corporate income tax revenues
from the top 125 companies in tax liability. These companies have
corporate income liability in excess of $300,000 each, and they are
generally multi-state business entities. We can anticipate that some
types of businesses will readily benefit more from the tax planning
opportunities in H.R. 1956 than others. Brick and mortar retailers,
large and small, will probably not be able to reduce their nexus
exposure under H.R. 1956. Manufacturers may already utilize substantial
tax incentives that reduce or eliminate their business tax liabilities.
Without those incentive programs, however, manufacturers would be
strongly motivated to restructure under H.R. 1956. Out-of-state
Internet businesses, and service providers that can provide at least a
portion of their services from remote locations (or restructure
themselves to do so) will obviously be interested in taking advantage
of H.R. 1956. These are not the only examples--but they reflect the tax
system I know best, Kansas.
Our research says this threat to our states' tax bases is real--not
some manipulation of numbers for shock value in a public hearing. The
NGA report says the tax loss is too large to ignore. These examples,
from real companies, point out the unfairness of allowing this kind of
preferential tax treatment for some businesses to occur, while the vast
majority of retail or small businesses in your states will never gain
this advantage.
III. H.R. 1956 DOES GREAT DAMAGE TO OUR FEDERAL SYSTEM OF GOVERNMENT.
H.R. 1956 runs roughshod over federalism, placing Congress in the
position of imposing a smorgasbord of federally-mandated state tax
exemptions that would preempt hundreds of existing state and local laws
and rules. For almost 230 years, while maintaining its jurisdiction
over interstate commerce, Congress has consistently respected the right
of states to raise revenues. H.R. 1956 would overturn the current
constitutional ``doing business'' standard for state business activity
taxes.
The ``doing business'' standard has been successfully defended in
the courts of many states. In fact, the Supreme Court of the United
States had denied certiorari in at least two instances where a state
court has upheld the ``doing business'' standard. H.R. 1956 would have
the effect of reversing these state court decisions. Such encroachment
on state tax authority clearly violates the most basic principles of
federalism upon which our Nation was built.
Conclusion
The economy of the 21st Century is electronic and borderless. Most
businesses can operate anywhere and anytime without the encumbrance of
physical presence. Technological developments have completely reshaped
the manner in which business is conducted. Consequently, the business
that utilizes modern technology to maximize a state's market may have
no less of a presence in the state than the business that establishes a
physical presence.
That is why the current standard of economic presence, taking into
account property, sales and payroll, is fair. As Professor Swain points
out, ``equity is enhanced by economic nexus because economic nexus
ensures that similarly situated taxpayers are treated the same, both
within each state and nationally.''
H.R. 1956 takes 19th Century tax law and imposes it upon the 21st
Century electronic, borderless economy. It replaces economic presence
with ``headquarters-only'' taxation. It is a colonial concept of
taxation wherein a company can receive the benefits a state offers
without making a fair payment.
How does a multistate company with economic presence in a state
receive benefits that state has to offer? It benefits from an enhanced
market when a state's residents are educated by a state educational
system paid for by state revenues. It benefits when it can adjudicate
disputes in a state court system paid for by state revenues. It
benefits when its trucks travel on that state's roads with that state's
law enforcement officers keeping the road safe to transport that
company's goods.
There is no compelling need for federal preemption of state and
local law by switching from a system that works to a system that does
not work. The Multistate Tax Commission, and its participating states,
are always at work promoting fairness and uniformity. As a report from
the Andrew Young School of Policy Studies at Georgia State University
recently concluded, ``To the credit of member states united by the
Compact, the MTC has faithfully pushed the need for uniformity and
cooperation against the competitive nature of states and the forceful
challenge of corporate taxpayers.'' (Hildreth, Murray, and Sjoquist,
``Cooperation or Competition: The Multistate Tax Commission and State
Corporate Tax Uniformity,'' August, 2005).
Mr. Chairman, Congressman Watt, Members of the Subcommittee, thank
you for the opportunity to present this testimony. Please do not
support H.R. 1956.
Mr. Chabot. Thank you very much.
Mr. Williams, you are our last witness here today.
TESTIMONY OF LYNDON D. WILLIAMS, TAX COUNSEL, CITIGROUP CORP.
Mr. Williams. Thank you, Mr. Chairman and Members of the
Subcommittee. My name is Lyndon Williams. I am tax counsel for
Citigroup. On behalf of Citigroup, I want to thank the
Subcommittee for holding this hearing today on H.R. 1956, the
``Business Activity Tax Simplification Act of 2005.'' I
appreciate the opportunity to testify in support of this
legislation.
Citigroup is one of the largest financial institutions in
the world with 140,000 employees located in the United States
and nearly 300,000 employees worldwide. Citigroup provides a
diverse range of products and services to consumers, including
banking services, credit cards, loans and insurance.
I am sure you are familiar with Citi Cards, for example.
Citi Cards is one of the leading providers of credit cards in
the United States with close to 80 million customers. Citigroup
paid hundreds of millions of dollars in State business activity
taxes annually in States where we have a physical presence and
significant number of employees.
Unfortunately, a number of other States believe that the
physical presence standard should not apply to them. They are
seeking to enforce an economic nexus regime that forces a
national bank to pay tax in States where, for example, its
credit card customers reside. The fact that 100 percent of the
bank's taxable income might be taxed in other jurisdictions
where it is physically present would not matter. This is
precisely the circumstance in which Citigroup's credit card
bank finds itself.
Citigroup's major credit card issuer is established in
South Dakota, where it employs over 3,000 South Dakota
residents. It occupies buildings that exceed 425,000 square
feet on 70 acres of land. Our employees benefit from the State
school systems, the roads and bridges, the fire and police
services and other municipal services. The company attributes
all of its taxable income to South Dakota, but some States
believe that the same income should also be taxed again where
the bank's credit card customers reside.
Our customers reside in every State. Under the commerce
clause, Congress must ensure the free flow of goods and
services among the States. A State tax against a corporation
operating through interstate commerce requires substantial
nexus.
The Supreme Court in Quill v. North Dakota, a case
involving State sales and use tax collection responsibility,
held a substantial nexus means that the out-of-State company
must have physical presence in the taxing State. While many
State courts agree with the Quill's physical presence nexus
standard--also applies to BAT, the business activity tax, some
tax administrators and some State courts disagree. They argue
that the Quill decision is limited to sales tax, meaning that a
physical presence standard applies for sales tax and an
economic presence standard would apply for income tax.
This construction of the commerce clause creates a
hodgepodge of taxing standards leading to protracted litigation
at significant cost to taxpayers and to State tax
administrators. We believe H.R. 1956 goes a long way toward
resolving these problems. The bill codifies the physical
presence standard. A State or locality may not impose business
activity taxes unless the business has a physical presence in
that jurisdiction. H.R. 1956 would also modernize Public Law
86-272.
The law prohibits States from imposing an income tax on
out-of-State sellers of tangible personal property if nexus
arises solely from solicitation of customers' orders for goods
that are approved and shipped from points outside the State.
The U.S. economy has undergone significant changes in 46 years
since this law was enacted. H.R. 1956 extends the long-standing
protections of Public Law 86-272 to all sales and transactions,
not just sales of tangible personal property.
In conclusion, H.R. 1956 would make clear, for example,
that Citigroup's credit card bank is taxable in South Dakota
and in all or all other States in which the bank has a physical
presence. This is a far more appropriate, equitable and
predictable standard for our business and for State revenue
authorities than the tug of war that exists today.
We applaud Congressman Goodlatte and Boucher for their
efforts and their perseverance in putting forward this
legislation. We ask this Subcommittee to move this legislation
forward as soon as possible so that the business community and
tax administrators in the States have certainty and uniformity
in the imposition and collection of business activity taxes.
Thank you.
[The prepared statement of Mr. Williams follows:]
Prepared Statement of Lyndon Williams
My name is Lyndon Williams and I am a tax counsel in the tax
department of Citigroup, specializing in corporate tax issues,
including state taxation issues. On behalf of Citigroup, I want to
thank Chairman Cannon, Congressman Watt, and the other members of this
subcommittee for holding this hearing today on H.R. 1956, the
``Business Activity Tax Simplification Act of 2005 (BATSA).'' I very
much appreciate the opportunity to testify in support of this
legislation and to discuss why the BATSA is so important to Citigroup
and to the financial services industry in general.
Citigroup is one of the world's largest financial institutions,
with 140,000 employees located in the United States and nearly 300,000
employees worldwide providing services to more than 200 million
customers in all fifty states and in over 100 countries. While
Citigroup engages in a variety of financial service businesses and
offers many products and services to its customers, my primary focus
today is Citigroup's consumer business. In the United States, Citigroup
provides a diverse range of products and services to consumers,
including banking services, credit cards, loans, and insurance. I'm
sure you are familiar with Citi Cards, for example. Citi Cards is one
of the leading providers of credit cards in the United States with
close to 80 million customers and 119 million accounts. Consumers spend
roughly $229 billion annually through our credit cards, which
constitutes about 2 percent of the nation's Gross Domestic Product
(GDP).
Citigroup subsidiaries operating throughout the United States pay
hundreds of millions of dollars in state business activity taxes, in
addition to state premiums taxes paid by its insurance businesses,
payroll taxes, real and tangible personal property taxes, sales and use
taxes on the purchase of goods and services and other miscellaneous
taxes.
We believe we pay our fair share of state income taxes in those
states where we have a significant number of employees and physical
presence, and utilize the resources provided by the states in which we
have these attributes. Unfortunately, as explained in more detail
below, a number of other states believe that the physical presence
standard should not apply. Instead, they prefer to impose business
activity tax on companies solely because businesses provide products
and services to customers in their states. This incongruity of taxing
standards obviously causes a number of problems, including multiple
taxation of the same income. Only Congress can act to provide a uniform
standard that will clarify and simplify state business activity tax
regimes for companies operating in interstate commerce.
BACKGROUND
The taxable income of a multi-state corporation is generally
attributable to those states where the company has a physical presence,
such as employees, an office, and other tangible property. Some states
have asserted that, in addition, a multi-state corporation must pay
taxes in those states where it does not have any physical presence
because some of its customers might reside in their states. Economic
presence generally refers to situations in which an out-of-state
corporation does not own or lease real or tangible property, and does
not have employees or facilities in the taxing state, but engages in
solicitation of customers within that state creating some minimum
connection between the state and the taxpayer.
For example, under an economic nexus regime, a national bank that
issues credit cards to customers residing in states other than where
the bank maintains offices, employees, or property would be forced to
file tax returns and pay taxes in those states where it issues credit
cards to customers, as well as where it has a physical presence. The
fact that 100-percent of the bank's taxable income might have been
subject to taxation in the jurisdictions where it is physically located
would not matter because the bank would be required to pay tax again on
the same income in the states where its customers reside or move to,
even though the bank has no physical presence in those states.
This is precisely the circumstance in which Citigroup's credit card
bank finds itself. Citigroup's major credit card issuer is incorporated
in South Dakota. The company employs over 3,000 South Dakota residents,
and is among the largest private employers in the state. It has resided
in South Dakota for nearly 25 years. It occupies buildings, including
offices and a daycare center, that exceed 425,000 square feet on 70
acres of land. Citigroup is the single largest taxpayer to the state of
South Dakota, and the employees in South Dakota benefit from the school
systems, the roads and bridges, the fire and police services, and other
substantial services, infrastructure, benefits, and protections of the
state. The company apportions 100-percent of its taxable income to
South Dakota. In addition, some states assert that the same income is
subject to tax in jurisdictions where the bank's credit card customers
reside, and our credit card customers reside in every state in the
nation.
H.R. 1956 would make it clear that Citigroup's credit card bank and
similarly situated businesses are taxed where they have a physical
presence. The substantial taxes paid by the bank to the jurisdictions
where it is physically located is justified by the police and fire
protection, the roads and bridges, the sewer and water systems, and
other municipal services that the corporation and its employees enjoy.
In addition, the bill would provide predictability and certainty to the
bank as to what its tax liabilities are and to which states those tax
liabilities have been rightfully incurred.
SUBSTANTIAL NEXUS: PHYSICAL PRESENCE VS. ECONOMIC PRESENCE
Under the Commerce Clause of the constitution, Congress is vested
with the responsibility to ensure the free flow of goods and services
among the states. Thus, a state tax levied upon products and/or
services conducted through interstate commerce meets constitutional
muster only if an out-of-state corporation has ``substantial nexus''
with the taxing state. There has been much dispute and litigation over
what is meant by ``substantial nexus.'' The U.S. Supreme Court in Quill
Corp. v. North Dakota, 504 U.S. 298 (1992), a case involving sales and
use tax collection responsibility, held that ``substantial nexus''
means that the out-of-state company must have some physical presence in
the taxing state for the tax collection responsibility to be
constitutionally valid. Many state courts have concluded that the
physical presence nexus standard of Quill also applies to business
activity taxes, finding no support in the Commerce Clause for different
nexus standards depending on the type of tax involved.
Yet, some state tax administrators and some state courts disagree.
They have construed the Quill decision to mean, in essence, that the
constitutional standard for taxing an out-of-state corporation depends
on the type of tax being imposed. They argue that the Quill decision is
limited to sales tax. Interpreted in this manner, the constitutional
standard is physical presence (i.e. in-state employees, an office,
property) if a sales tax is involved, and economic nexus (i.e. merely
having in-sate customers) if an income tax is involved.
This construction of the Commerce Clause produces different results
not only depending on the type of tax involved but also the type of
industry involved. This is because Public Law 86-272 prohibits states
from imposing an income tax on the out-of-state seller of tangible
property if nexus arises solely from the solicitation of customers'
orders for goods that are approved and shipped from points outside the
state. Therefore, as a practical matter, the physical presence standard
would control in the case of manufacturing.
On the other hand, service and other significant non-manufacturing
industries are not explicitly protected by Public Law 86-272, creating
a disparity among industries operating in interstate commerce.
This disparity in the taxation of activities conducted in
interstate commerce may lead to protracted litigation at significant
costs to taxpayers and state tax administrators. It has also lead to
great uncertainty and unpredictability in the manner in which multi-
state businesses are taxed and inconsistency with international
standards applicable to many of these multi-national businesses.
THE PROVISIONS OF H.R. 1956
We believe H.R. 1956 goes a long way towards solving these
problems, which are becoming increasing vexing for companies and taxing
authorities alike.
Physical Presence Standard. H.R. 1956 codifies the physical
presence standard by providing that a state or locality may not impose
business activity taxes unless businesses have ``physical presence'' in
the jurisdiction. The required physical presence is a bright line test
that establishes tax jurisdiction where an out-of-state business has
employees, property, or the use of third parties to perform certain
activities within a taxing state for greater than 21 days during a
taxable year.
For instance, H.R. 1956 would permit a business to send employees
into a state for 21-days in any year and not give rise to an obligation
for that state's income tax. H.R. 1956 thus would let employees perform
transitory assignments and not trigger unintended tax obligations.
Guidance on what activities a firm can conduct within a state that will
not trigger that state's taxing power will provide certainty to
businesses and tax administrators and will reduce compliance and
enforcement costs.
H.R. 1956 attributes the physical presence of a person in the state
to an out-of-state business if that out-of-state business uses the
services of the in-state person for more than 21 days to establish or
maintain market in the state, unless the in-state service provider
performs functions for more than one business entity during the year.
The ownership relationship between the out-of-state person and the in-
state person is irrelevant for purposes of this provision. The
legislation recognizes that to the extent that a separate company is
independently conducting business in a state for which it is
compensated by an out-of-state entity, the economic income earned in
the state will be subject to tax.
Modernization of Public Law 86-272. The U.S. economy has undergone
significant changes in the 46 years since Public Law 86-272 was
enacted. Many of the companies, products, and services that make the
U.S. economy so vibrant today were not even imagined when this law was
enacted. Thus, H.R. 1956 extends the longstanding protections of Public
Law 86-272 to all sales or transactions, not just to sales of tangible
personal property.
H.R. 1956 also modernizes Public Law 86-272 by addressing the
efforts of some states to avoid the restrictions imposed by Congress in
Public Law 86-272. Specifically, some states have established taxes on
business activity that are measured by means other than the net income
of the business. Two examples of these new state business activity
taxes are the Michigan Single Business Tax, which imposes a tax on a
company's business activities in the state, not on net income, and the
New Jersey Corporation Business Tax, which was amended in 2002 to
impose a gross profits/gross receipts tax. In other words, New Jersey
has effectively circumvented the Congressional policy underlying the
enactment of Public Law 86-272 by imposing a non-income tax on
businesses that could otherwise be protected by the Public Law. While
other states may not enact such a targeted end-run around Public Law
86-272, it is likely that states will increasingly turn to non-income
based business activity taxes. H.R. 1956 addresses this by ensuring
that Public Law 86-272 covers all business activity taxes, not just net
income taxes.
RELATIONSHIP TO INTERNATIONAL TAXATION
The United States and its tax treaty partners have, for decades,
adopted and implemented the physical presence standard for determining
the tax jurisdiction of multinational corporations. This standard is
embodied in the ``permanent establishment'' concept, which is a long-
standing principle of the U.S. tax treaty regime, and is part of the
OECD model treaty.
The ``permanent establishment'' rule provides that neither country
that is a party to a bi-lateral tax treaty will impose an income tax on
a business from the other country unless that business maintains a
substantial physical presence in the taxing country. Using the U.S.
Model Treaty provisions as an example, a foreign business must have a
``fixed place of business [in the United States] through which the
business of an enterprise is wholly or partly carried on'' before the
United States may impose a tax on that business. A fixed place of
business includes a place of management, a branch, an office, a
factory, a workshop, etc. In addition, a deemed permanent establishment
may arise if an in-state agent (other than an agent of an independent
status) is acting on behalf of an out of-state enterprise where the in-
state agent habitually exercises authority to conclude contracts that
are binding on the out-of-state enterprise. The activities of an in-
state independent agent acting in the ordinary course of its own
business are not deemed a permanent establishment of the out-of-state
enterprise.
A physical presence standard places an appropriate limit on states
gaining taxation powers over out-of-state firms and conforms to common
sense notions of fair play. It is significant that the OECD has
recently studied the issue and concluded that the ``permanent
establishment'' rule should remain the proper standard for
international tax treaties even with the proliferation of electronic
commerce. The policy reasons underlying such a conclusion are clear in
maintaining the free flow of commerce among trading partners.
CONCLUSION
Congress has a responsibility under the Commerce Clause to provide
a uniform standard under which multi-state companies are taxed by
different states. H.R. 1956 would codify the physical presence nexus
standard. The bill would make it clear, for example, that Citigroup's
credit card bank is taxable in South Dakota and in any other state in
which the bank establishes a physical presence. This is a far more
appropriate, equitable, and predictable standard for our business and
for state revenue authorities than the tug of war that exists today.
H.R. 1956 describes minimum levels of activity that a business
could conduct in a state and not trigger liability for tax in that
state. Clear guidance on what activities a company can conduct within a
state that will not trigger that state's taxing power will provide
certainty to businesses and tax administrators and will reduce
compliance and enforcement costs. BATSA also would bring Public Law 86-
272 up to date to reflect an economy that has changed dramatically
since 1959, thus treating products and services offered by all
businesses in a fair and equitable manner.
Versions of H.R. 1956 have been introduced in the last several
Congresses, and we applaud Congressmen Bob Goodlatte and Rick Boucher
for their perseverance in this effort. In the meantime, a number of
states have taken aggressive action to tax companies like Citigroup
based on the economic activities of its customers rather than the
physical presence of its employees and its businesses, creating a
hodgepodge of taxing standards and an increased tax and compliance
burden for companies that serve customers nationwide. We ask this
subcommittee to move this legislation forward as soon as possible so
that we in the business community and tax administrators in the states
have certainty and uniformity in the imposition and collection of state
business activity taxes.
Mr. Chabot. Thank you very much, Mr. Williams.
I would like to commend all four witnesses, actually, for
coming in right on time at the 5 minutes. It is quite
impressive. It takes hard work to get it down to 5 minutes.
Some people ignore it. So I really want to commend you for
doing that and for the excellent testimony you gave.
Members of this panel will now have 5 minutes to ask
questions, and I recognize myself for 5 minutes for this
purpose. Let me start with you if I can, Mr. Horne. Is the
current State taxation and taxing situation such that many
small businesses fear for the viability of their businesses.
Mr. Horne. I think the main problem today is that small
businesses are unaware of the environment in which they
operate. We are naive. We had no idea of this problem until we
were trapped by New Jersey. But it is a very, very frightening
environment once you are trapped. And I had one young woman
victim from another State, actually, Mr. Goodlatte's State. She
tracked me down and called me. She was in tears, so desperate
for help, to try to learn how to deal with this nightmare. So,
I mean, I don't know what else to say.
Mr. Chabot. Thank you. Let me turn to you, Representative
Ehrhart, now. In your opinion, what do you think would happen
if Congress does not act and does not enact H.R. 1956 or
similar legislation? Do you foresee a problem with States
asserting greater taxation authority over companies with even
less of a connection in a State than those that are taxed now?
Mr. Ehrhart. I think with a new economy certainly you will.
Those who have the proclivity to seek out anything that moves,
taxing whatever they may be able to get their hands on, or they
will be taxing our memory very soon--not to be flippant, Mr.
Chairman--but I think you are going to find just across the
board, if Congress doesn't act, you are going to find States
getting more and more aggressive. You are going to have local
municipalities and maybe county governments, who take this as
almost carte blanche to begin to tax, based on whatever type of
direct tax they can apply to an out-of-State, out-of-area
business.
With the new economy, we are just going to bring the bad
old tax laws into the new economy. I just think that is bad
policy. We in Georgia have tried to stay away from that. We
stay with the basic nexus under Public Law 86-272.
Mr. Chabot. Thank you very much. Secretary Wagnon, let me
ask you, if I can now, what is your response to stories from
companies such as ProHelp Systems here, in
Mr. Horne's case, or Smithfield Foods, whose deliveries are
being stopped at the roadside and whose businesses are being
severely disrupted by States demanding payment for BATs?
Shouldn't there be a reasonable standard for such companies?
Ms. Wagnon. I guess my response is threefold--and I don't
wish to be flippant, but I would like Mr. Horne to come to
Kansas. We don't treat our small business people like that. He
can certainly sell his goods and services there. We have an
exclusion, a de minimis standard in our franchise tax, so he
would fall under that de minimis standard and wouldn't even be
taxed.
I guess in a broader sense I spend a lot of time in the
Kansas legislature working with NFIB, and I have not heard a
single story similar to the one that I have heard from him in
any other complaints. They are far more concerned about
property taxes and some other things like that.
I guess finally, I would say, I think small business is
really going to be the loser in all of this, if we allow the
very large multistate corporations to develop a lot of nowhere
income or to shift their income in such ways that States are
faced with this huge loss. You look at what NGA has proposed in
their study and at $6.6 billion of State tax revenues that will
be lost.
Well, you all know that we are not going to cut $6.6
billion worth of services, and so that burden is going to fall
back onto the taxpayers that probably have fewer tax planning
resources, sub-S corporations, individual income tax, property
tax, sales tax. So I think it is a very bad move to push that
burden back onto the very people that he is trying to help.
Mr. Chabot. Thank you. Mr. Williams, how would H.R. 1956,
the bill that we are considering here, the Goodlatte bill,
create tax certainty for businesses?
Mr. Williams. Well, it creates tax certainty because it
establishes one standard, one standard for businesses, whether
small or large businesses, that operate in interstate commerce,
and that standard would be physical presence. It would be a
clear standard, and it would be a standard that is predictable
and certainty would be clear from that standard.
Mr. Chabot. Thank you very much. I have only got 8 seconds
left. So rather than ask another question, I will give back my
time, and I will yield to the gentleman from Massachusetts, Mr.
Delahunt, for 5 minutes.
Mr. Delahunt. Yes. Thank you, Mr. Chairman. This is a
thorny issue, as I said in the opening statement, I think there
are arguments to be made on each side. I think that the example
put forth by Mr. Horne is--I thought you responded well to
that. I would suggest that possibly this Congress could
consider a small business exemption to deal with the problem
presented by Mr. Horne, so that small businesses would be
protected.
At the same time, I have huge concerns about the revenue
that is necessary for the local and State governments. Now, I
am sure that there are some that don't believe that local and
State governments should even impose taxes, but I think we have
seen, particularly recently in the aftermath of the natural
disasters that occurred in the Gulf States, that it doesn't
work, it is unrealistic.
And yet at the same time I think there's a consensus that
we are in a new economy, and we have to be creative, and we
should do some thinking out of the box, so to speak. But what I
find frustrating is that doesn't appear to be happening. What
we are hearing now are the same arguments presented. Can anyone
tell me whether there is any discussion going on about
presenting a consensus to the Congress in terms of creating an
articulable standard, other than physical presence, that would
be satisfactory to the business community and at the same time
satisfactory to the local and State jurisdictions that so badly
need some revenue?
Ms. Wagnon. I would be happy to take a shot at answering
your question, sir, if that would be appropriate.
Mr. Delahunt. Is there somewhere, some file that I can have
some confidence in?
Ms. Wagnon. A little bit. For the last 5 years the States
have gotten together in a remarkable effort to try to organize
the streamline sales tax.
Mr. Delahunt. I am very familiar with it.
Ms. Wagnon. I have been right in the middle of that, as
many of us have. It has taken a huge amount of energy. But that
kind of organization, where States come together, design a
solution, in concert with business, is the appropriate way for
that to happen. The Multistate Tax Commission, which has also
been a partner in the streamline sales tax, has been working on
a factor presence, nexus standard, for economic nexus, that
would take into account the realities. It also has that
$500,000 de minimis standard that you referred to, which
totally solves Mr. Horne's problems.
I think if we leave this hearing and determine that
streamline is now up and running, and this may be the next area
where we turn our attention, that may be a good idea.
Mr. Delahunt. I would really encourage that.
Representative.
Mr. Ehrhart. Congressman Delahunt, one of the pieces being
left out of that particular equation, and you certainly have
taken into consideration in your remarks, is what do the people
of this country think and what do they want for their new
economy, because they are the participatory part of that. And
every sampling of public opinion, especially with respect to
SSTP, has been that they don't want to move toward taxing that
the way it was--the way other goods and services have been
taxed. The people do feel like the tax bill burden on
themselves and even on their businesses obviously is too large.
We should move towards--and I think 1956 does that with their
de minimis standards. It really doesn't get outside the nexus
that we have.
Mr. Delahunt. I hear what you're saying, but let me just
read the conclusion of the Congressional Research Service,
which is a branch of the Library of Congress, in its analysis
of H.R. 1956. ``The new regulations as proposed in H.R. 1956
would have exacerbated underlying inefficiencies because the
threshold for businesses, the 21-day rule, higher than
currently exists in most States, would increase opportunities
for tax planning leading to more income. In addition, expanding
the number of transactions that are covered by P.L. 86-272 also
expands the opportunity for tax planning, and thus tax
avoidance and possibly evasion.''
I know there's no easy answer here, but this is a
nonpartisan, independent agency.
I see the red light is on.
Mr. Chabot. The gentleman's time has expired. If you'd like
to respond briefly.
Mr. Ehrhart. Just very quickly. I also read that particular
report, and the part that was relevant to me was that it says,
as a result, BATs actually provides States with more
opportunity to tax interstate commerce than would be available
under the ALEC majority report recommendation. So it seems to
take both sides of the issue even there, which is generally the
case in many of these things.
Mr. Chabot. The gentleman's time has expired.
The gentleman from North Carolina Mr. Coble is recognized.
Mr. Coble. Thank you, Mr. Chairman.
Mr. Chairman, as you accurately pointed out, we have a
distinguished panel, and I thank you all for being here, as the
Chairman indicated.
Ms. Wagnon, when I indicated at the outset that tax
collectors grab every thin dime that's not nailed down, I
didn't mean that against you personally. I was acknowledging
the fact that county and tax collectors have a job to do, and
they should lawfully grab every thin dime that's not nailed
down. But I am confident, folks, that there are some taxing
authorities or jurisdictions that have unfairly and/or overly
aggressively sought payment of business activity taxes without
basis. Do you all agree with that generally.
Mr. Horne. I certainly do.
Mr. Coble. Having said that, if we don't pass or enact
1956, Secretary Wagnon, how would you address that problem of
overaggressiveness or unfair solicitation?
Ms. Wagnon. Well, I didn't respond to your question about
did I agree with you because I'm not so knowledgeable about
every State. I'm not aware that States are exceeding laws that
are legitimately passed by their own State legislatures. I
think tax departments do collect that which is due and owing
because that's their job, but they collect them under laws that
the legislature has allowed them to do. And so the question
then becomes are some States' laws more aggressive than others.
What the Multistate Tax Commission is trying to do is to get to
that standard of uniform laws that we can recommend for all
States that balances that fairness.
Mr. Coble. My time is running. I drew my conclusion based
upon the testimony that we heard here this afternoon regarding
the overaggressiveness.
Let me talk to my friend from Georgia.
Ms. Wagnon. Certainly.
Mr. Coble. I assume, Mr. Ehrhart, that you would agree
that--well, strike that. I shouldn't insert words into your
mouth. Do you agree that in some cases challenging assessments
through State courts is unfair to out-of-State businesses?
Mr. Ehrhart. Certainly it is, because especially under the
commerce clause, and then you go back to Quill, our previous
precedent, you have the situation where business is at least
entitled to the same treatment in every court in every State.
You can't set up a different standard in each State. That would
be completely unjust.
Mr. Coble. I'm inclined to agree with that, too. But let me
ask you this, Mr. Ehrhart, any of you, would you all support
making Federal courts available to hear State assessment cases?
That may be a slippery slope that we may be approaching. I'm
not suggesting that I endorse that, but I'd be glad to hear
what you all think to that.
Ms. Wagnon. No.
Mr. Coble. Mr. Williams.
I didn't mean to cut you off, Mr. Ehrhart.
Mr. Ehrhart. I was going to state I thought Quill was very
eloquent with respect to the physical presence standard. I
think that's applicable here and in SSTP.
Mr. Coble. Mr. Williams.
Mr. Williams. This is an issue involving in the
Constitution, and clearly the availability of the judiciary is
very important at all levels, and if Federal courts were
available, I believe that that would be another avenue for
businesses to have redress to these issues that are very
important to the U.S. Economy as well as to businesses
navigating in interstate commerce.
Mr. Coble. Mr. Horne.
Mr. Horne. I would certainly like to be able to deal with
New Jersey with a South Carolina lawyer in South Carolina in
Federal court as opposed to a New Jersey lawyer in a New Jersey
court.
Mr. Coble. Ms. Secretary, you want to be heard as well?
Ms. Wagnon. If I might expand upon my answer. These cases
and the misunderstanding that exists about what Quill did or
did not say about substantial nexus are making their way
through the court systems right now. The Lanco case is on
appeal; the ANF case is being appealed to the United States
Supreme Court. To bypass a State court on a issue of State law,
I believe, is a constitutional problem.
Mr. Coble. Mr. Chairman, knowing of your affinity for
beating the red light, I yield back my time.
Mr. Chabot. I appreciate the gentleman yielding back.
The gentleman from Arizona Mr. Franks is recognized for 5
minutes.
Mr. Franks. Thank you, Mr. Chairman.
I understand I have a little different type of microphone
up here. So everyone can hear me?
I know, Mr. Horne, that a lot of times these kinds of
concerns from Congress come only after a great deal has already
happened at the State level, but there's been just a trend in
the testimony with most of the members of the panel today that
it seems that the States are becoming more aggressive in
asserting the authority to impose business activity taxes. Do
you agree with that statement? Is it a recent phenomenon; is it
something you see as an escalating issue?
Mr. Horne. I think it's a growing phenomenon, and I've got
some examples if you'd like me to cite them for you.
Mr. Franks. Do you think it's something becoming pervasive,
and they see this as a new idea, and they think this is a way
to----
Mr. Horne. Absolutely, absolutely.
Mr. Franks. Mr. Ehrhart, probably the most compelling part
of Ms. Wagnon's testimony to me was the assertion that there
was a 10th amendment or States rights issue here, or
constitutional issue. Can you tell me if you think that 1956
infringes on State sovereignty?
Mr. Ehrhart. I think it's exactly the opposite. I think it
protects the federalist principles, and ALEC, being a
federalist-based organization, it stands the world on the head.
Obviously there's always been a tension between the commerce
clause and the basic 10th amendment provisions, but the
practical realities of that have withstood the test of time
with precedent after precedent being set in statute and in
Supreme Court precedent with respect to--you can't have an
impractical--every State taxation that's different for every
company. I mean, it would become an amazing hodgepodge of every
jurisdiction. You could not spend enough money as a small
business to begin to understand the tax policy in all 50 States
and every county in every State, and that's the practical
reality. How are you going to get to that point? It's like the
only intangible tax we used to have in Georgia, took 8 years to
get rid of it. It's one of those taxes that costs more to
administer than it brought in.
This is the same kind of thing. It's going to take States
huge amounts of legal time and effort to track this down. It's
going to be more expensive to administer than it is to--
actually how much money they bring in. So I don't think there's
any tension at all; I think this is the federalist position,
one we take.
Mr. Franks. Ms. Wagnon, I have to be fair and give you a
chance at that. Let me ask you if I could ask you to also
include in your answer, Mr. Ehrhart testified that 1956 will
foster economic growth and job creation in the States because
businesses will have a little better idea of what their capital
risks are or their capital associated with taxation is. And I
know that in Arizona that is true. We have taken into
consideration every way that we can the impact of our tax code
upon businesses coming into Arizona in just about any form. It
has resulted in a broadening of the tax base and an increase in
the revenues. And so I guess I throw a couple of those things
related to the sovereignty and economic growth that this may
create in the States.
Ms. Wagnon. I'm joined in my opinion that this is a threat
to State sovereignty by the National Governors Association and
the National Conference of State Legislatures, Federation of
Tax Administrators, and the Multistate Tax Commission. So I'm
not alone in that opinion. And we do believe that Congress has
done a good job of staying out of the States' business while
protecting interstate commerce.
With respect to economic development, we sit in our
legislature, and I know other States as well sit in their
legislatures, every day in session and try to figure out ways
to remain competitive as we compete with each other for the
best companies and for the best way to do business. States are
far more in danger these days of giving away too much of their
tax base in order to be competitive than to be out being a
threat to business, looking for ways just to raise their taxes.
And so I think we need to be careful in this debate not to
characterize States as the villain or business as the villain.
I think we need to just recognize that the changing in economy
is looking for balance, and this bill does not provide that
balance.
Mr. Franks. Mr. Williams, I think I may have one more
question here in my time. The physical presence nexus, do you
believe that that is the appropriate standard for business
activity taxes, and tell me why, what is your rationale for
that, and just give us a little insight on what other possible
criteria there might be.
Mr. Williams. Thank you, Congressman.
Yes, I do, I believe the physical presence standard is the
proper standard that should apply. Most of the arguments that
have been made, including the revenue projections that have
been made, labor under an assumption of what's called tax
sheltering, which we've heard here. But States do have tools,
they do have an arsenal of tools that's within State laws and
that can be created within State laws to address those issues.
And we haven't heard an argument as to why those State laws are
not sufficient to address the concerns that have been raised in
opposition to this bill, but I must say that the issue of
whether or not a business is able to conduct activities in
interstate commerce is a unique issue that Congress must focus
upon, because States do have individual competing interests in
terms of their own budget and revenue concerns. And we believe
that the physical presence standard provides certainty,
predictability, and allows all business to pay taxes where they
are located and where they receive benefits and protection.
Mr. Franks. Well said.
I yield back.
Mr. Chabot. Thank you. The gentleman's time has expired.
The gentleman from Maryland Mr. Van Hollen is recognized
for 5 minutes.
Mr. Van Hollen. Thank you, Mr. Chairman. I thank the
witnesses. I apologize for being late. I didn't have an
opportunity to hear your testimony. I've been trying to look
through it and listen carefully to the questions.
Just with respect to whether or not States are being more
aggressive in terms of trying to collect these taxes, I think
it's important that we probably try and get CRS or somebody to
take a look at that. As I understand what CRS has written, at
least in the materials we've got, is that State tax collections
from corporate incomes taxes have decreased recently. Now, that
can be a combination of factors, people can lower tax rates,
but it doesn't appear anyway that they're making up in a big
way by being overly aggressive, at least on a uniform basis.
Obviously you can look at individual States.
Let me just make sure, I want to understand Representative
Ehrhart. Now you're here testifying on behalf of yourself as a
representative of the Georgia State Legislature.
Mr. Ehrhart. On behalf of 2,400 members of the ALEC
organization, a bipartisan group of legislators, as chairman of
the organization, and as I myself.
Mr. Van Hollen. Has the Georgia State Legislature, the
house or State senate taken a position on this legislation?
Mr. Ehrhart. Not specifically to the legislation, but what
we do is we stick with Public Law 86-272. I spoke with our
revenue commissioner and his staff before I came up here, and
we create the nexus and standards, and it's basically physical
presence that was done under the congressional act in 1959.
Mr. Van Hollen. Has the State of Georgia, the legislature
in Georgia as it's represented through NCSL, has the State
legislature voiced an opinion?
Mr. Ehrhart. Not on the NCSL provisions. Most of the
members in Georgia belong to both organizations, as a matter of
fact.
Mr. Van Hollen. But NCSL, you're aware, is opposed to this
legislation.
Mr. Ehrhart. We tend to generally take different positions
on tax policy.
Mr. Van Hollen. As well with the National Governors
Association?
Mr. Ehrhart. We're generally more in line with them. In
this instance they are.
Mr. Van Hollen. In this case you're on the opposite side.
I guess we've talked about the 10th amendment issue, and
obviously there are differences of opinion, but it seems to me
that those two organizations, NGA and NCSL, are certainly as
protective of States rights, especially when it comes to these
areas, as other organizations. You don't think that they're a
good custodian of State rights?
Mr. Ehrhart. No, I would not, not on 10th amendment issues,
no, sir.
Mr. Van Hollen. Is it your testimony that--let me ask you
this: Taking the State of Georgia, is this going to lead to a
net increase or decrease, or will it be neutral because of the
way you currently collect?
Mr. Ehrhart. I would expect it would be a net increase for
the State of Georgia if 1956 passes because of the economic
development side. Businesses will have some certainty, and that
is that type of economic theory that if you make it attractive
for business to do business, they will create more revenue and
more productive capacity.
Mr. Van Hollen. Are their any analyses that have been done
in the State of Georgia as to whether this would be a net gain
or loss for the State of Georgia?
Mr. Ehrhart. Not at this time.
Mr. Van Hollen. So you're speculating then based on the
perceived business development. I just want to understand what
the basis of the answer is.
Mr. Ehrhart. Based on the philosophical premise of the ALEC
organization.
Mr. Van Hollen. Let me ask you, Ms. Wagnon, what was the
number you gave for what--your projected net loss?
Ms. Wagnon. In Kansas, 25 million.
Mr. Van Hollen. Do you have a figure, an estimate from NCSL
or elsewhere, as to what the aggregate loss in State revenue
would be?
Ms. Wagnon. For all the States, $6.6 billion.
Mr. Van Hollen. $6.6 billion.
I understand, Mr. Ehrhart, you believe it's just the
opposite; that because of the economic development potential,
you're actually going to gain revenues.
Mr. Ehrhart. There are two sides. They're still at war.
Mr. Van Hollen. Let me just say in closing, this obviously,
as has been said, it's an issue where I think that we should be
able to come up with a reasonable approach and a bipartisan
approach on this issue. Obviously you want some predictability
if you're a business as to whether or not if you engage in
certain kinds of economic transactions with the State, whether
you're going to be subject to their corporate income tax. On
the other hand, clearly it seems to me there are some, clearly
many, cases where people are clearly engaged in enterprises and
business within a State even though they're not physically
present in a State, and seems to me that too narrow a test
doesn't allow that State to recoup what I think would be its
share of various costs from businesses doing transactions in
the State. So I just associate my remarks with Congressman
Delahunt and some of the points he made. I think that there is
room, and the Chairman and others, that we can work something
out. Thank you very much.
Mr. Chabot. Thank you. The gentleman's time is expired.
We're going to go to a second round, but the Members have
agreed we're going to reduce our 5 minutes down to 3 just for a
little wrap-up here, and I'll yield myself 3 minutes at this
time.
Mr. Horne, let me go to you first, if I can. Getting back
to your specific case, could you tell us again what was the tax
that was being imposed upon you; and secondly, what are the
expenses that you have incurred thus far as a result of New
Jersey's attempt to get this tax from you?
Mr. Horne. If I understand your question correctly, the tax
New Jersey was applying to us was a business activity tax in
the form of a minimum tax. New Jersey has a minimum tax of
$500. In our case, if you use the calculated tax with New
Jersey rates, in our best year, if I recall correctly, our tax
was, I think, $0.83. That quickly escalates to $500, plus the
requirement to register our company in the State; therefore,
it's basically $600 per year in order to sell anything in that
State. That's the way their income tax form reads.
Mr. Chabot. How much have you spent thus far as a result
of, approximately, trying to battle this thing?
Mr. Horne. In terms of legal fees, I think we're somewhere
in the area of $3-, $4-, $5,000. I don't recall the exact
number. We've tried to keep the fees down as much as we can.
Our attorney did give us a favorable rate. But far more
important than the legal fees was the impact on our business.
It took us, my wife and myself, approximately 100 hours of our
time to come up with the fact that we'd only sold seven
licenses in the State of New Jersey. As a small business we do
not keep records by State. We had no choice other than to go
through individual pieces of paper for the last 7 years in
order to identify the fact that we'd only sold seven licenses,
consisting of a total--with associated services, I think the
number was $6,133 over a 6-year period, and 3 of those years
the numbers were zero. In one it was $49. It took us about 100
hours of time to come up with those numbers.
Mr. Chabot. Thank you.
Rather than ask another question, my time is ready to
expire, so I'll yield back.
The gentleman from Massachusetts is recognized for 3
minutes.
Mr. Delahunt. I want to just make a comment. I agree with
you, Madam Secretary, and I disagree with you, Representative.
I think the States can really sit down and hammer out a
simplified, coherent system that addresses this problem. I
think they've already done that dealing with the SSTP. And I
would encourage you to do it.
I said this at the last hearing: This is going nowhere,
okay? Some might believe that it's going somewhere, but it will
not pass, and I think it's important that we all work together
to make it happen.
The case presented by Mr. Horne, I think, is an egregious
example. We support you, Mr. Horne, and it's got to be
addressed. At the same time, economic activity should be
implicated into a fair and equitable formula.
Mr. Williams, which of those States that you alluded to
that don't embrace the physical nexus standard--give me two or
three quickly.
Mr. Williams. Sure. Tennessee, Massachusetts, and Indiana.
Mr. Delahunt. Let's take Massachusetts, for example. What
is the revenue that is generated by Citibank in South Dakota?
Mr. Williams. Well----
Mr. Delahunt. If you know.
Mr. Williams. I don't know what the actual revenues that
are generated by Citibank in South Dakota.
Mr. Delahunt. Do you know what they are in Massachusetts?
Mr. Williams. I don't have the actual numbers with me.
Mr. Delahunt. Would you agree with me that the business
activity, economic activity, the profits to the bottom line
generated in Massachusetts are substantially greater than those
generated in South Dakota?
Mr. Williams. I'm not an economist, but I could not----
Mr. Delahunt. How many people live in South Dakota? Do you
know?
Mr. Williams. I understand your question, but I want to
make sure you understand this also, that----
Mr. Delahunt. I want you to answer my question. That's the
game that we play here.
Mr. Williams. Sure.
Mr. Delahunt. You can answer my question.
Mr. Williams. I don't know how many people live in
Massachusetts, nor do I know----
Mr. Delahunt. Six million. I know that there aren't 6
million people in South Dakota. I daresay that there is
significantly more economic activity and profit resulting
from--resulting to Citigroup as a result of economic activity
in Massachusetts.
What I'm suggesting to you--and I understand you represent
a corporation, and your responsibility is to make as much
profit as possible. And that's good; that's our system. But
those of us that are here as policymakers and you're asking us
to do something have a much more expansive, broad
responsibility in terms of public policy. Taxation is about
public policy, and what we want to do is work on--work together
to see whether we can achieve a fair and equitable solution so
that no State is disadvantaged and that no business is
disadvantaged.
Mr. Chabot. The gentleman's time has expired.
The gentleman from Arizona is recognized for 3 minutes.
Mr. Franks. Mr. Chairman, thank you.
It occurs to me that we wouldn't be having this debate if
it weren't for the fact that this is interstate commerce. I
mean, there has to be, and that should be considered very
strongly on any sovereignty argument, and it also occurs to me
that the States will be the first ones to be grateful for the
clarity that this represents, because I think it will end up
being something that will foster the economic growth in those
States and ultimately affect their bottom line revenue in a
favorable way. That's a perspective that I have on that.
But, given that, Mr. Williams, why should the Public Law
86-272 be modernized. There's a reason; you understand I'm
asking you this for a reason. It seems that New Jersey
especially has kind of undermined the will of Congress in that
legislation, pretty clearly, and how would 1956 solve this
circumventing of that public law? Can you give us a little
insight on that?
Mr. Williams. Well, the way that New Jersey actually
changed their law--the 86-272 was intended to address business
activity taxes. The statute, I believe, says net income taxes.
So what has happened is that States like New Jersey have
changed the tax to something that is not called a net income
tax, another base, and on that basis assert that Public Law 86-
272 would not apply just by changing the type of tax that's
being assessed.
We believe that the modernization of Public Law 86-272
would, first of all, address that issue. It would make sure
that all taxes related to business activity regardless of how
they are called would be within the scope of Public Law 86-272.
In addition to that, we would not have conflicting standards
for one type of industry versus another, where for
manufacturers you have one type of--you have Public Law 86-272;
a nonmanufacturing industry, which is a significant portion of
the U.S. Economy, are not protected by this statute. We believe
the modernization would allow for a level playing field and
would allow businesses to conduct interstate commerce in a
smooth and efficient way.
Mr. Franks. Thank you, Mr. Williams.
Mr. Chairman, I guess I would just suggest here in closing
that our economy doesn't work just on competition, it works on
a framework of trust and a framework of predictability among
business leaders and those that are involved in business. And
for us to be able to present that clear framework for them is,
in my judgment, going to be a positive thing for the economy
across the board and certainly will ultimately, as I say, favor
the States in their revenue collection because it would broaden
the base we collect. Sometimes we forget it's all about
productivity, and we get so caught up in some of the
nomenclature, that productivity is the bottom line, and I think
this is the primary reason for such a bill.
Mr. Chabot. The gentleman's time has expired.
Before we recognize the gentleman from Maryland, I'd ask
unanimous consent to enter into the record some documents
submitted by the gentleman from Massachusetts and the
accompanying documents. Without objection, so ordered.
[The information referred to can be found in the Appendix.]
Mr. Chabot. The gentleman from Maryland Mr. Van Hollen is
recognized for 3 minutes.
Mr. Van Hollen. Thank you, Mr. Chairman. I'm not going to
take up all of that time, but since I last asked the question,
Mr. Ehrhart, I came across some documentation that says that
the Georgia Department of Revenue recently reported the passage
of this bill would reduce State revenue by $30.9 million. Are
you familiar with that State Department of Georgia Revenue
estimate?
Mr. Ehrhart. I'm not familiar with that, no, sir.
Mr. Van Hollen. I think as we discuss this and the impact
of this legislation, it's important to have facts and analyses
and the basis for analyses and the basis for economic
projections. We've got a swing here from a $6 billion loss to
the States, and apparently, according to the Georgia Department
of Revenue, including a $30.9 million loss to the Georgia, to a
projection really, as far as I understand, based on an
assumption that it's going to be a net revenue producer.
What would be very helpful if we really are going to go
down this road is to get the economic analyses that shows
exactly how, if your contention is this is going to add revenue
to States, just to show how you get there and come up with a
number that you project based on that analysis. Apparently I
think that the States, the individual States--and I know NCSL
and NGA have done a number of analyses, and they base it on
certain assumptions, and we'll have to take a look at the
reasonableness of those assumptions, but at least they have an
analysis.
So I would welcome you to present this Committee a hard
analysis of how it is that you think this change in law will
increase revenue and exactly what you project it to be.
Mr. Ehrhart. I'll be more than happy to do that.
Also, with respect to the Department of Revenue and their
assumptions, as Mr. Delahunt did point out, we are the
policymakers in our respective areas, and fortunately so,
because generally the assumptions of State agencies don't
always pan out.
I'm looking forward to being able to provide you with those
cost-benefit analyses because those assumptions, I would be
more than willing to stipulate, are based on one side of the
equation and don't take into account the others. But I'm
looking forward to presenting you with the other side and the
overall balance.
Mr. Van Hollen. I would like that because my experience--I
was in the State Legislature of Maryland for 12 years, and we
had a Department of Physical Services, actually did a very good
job, and whose analyses were always closer to the mark with
respect to the physical impact of legislation than the
individual legislators, on both sides of the aisle, because
they were drawn from a professional cadre of people who tried
to look at the facts rather than just the ideology, again on
both sides of the aisle. So I would welcome an analysis that
shows that.
Thank you, Mr. Chairman.
Mr. Chabot. Gentleman yield back? The gentleman's time has
expired.
I want to thank the panel for their excellent testimony
here this afternoon. Each and every one, I think, has done a
very good job. If there's no further matters coming before this
Committee, we're adjourned. Thank you.
[Whereupon, at 2:30 p.m., the Subcommittee was adjourned.]
A P P E N D I X
----------
Material Submitted for the Hearing Record
Response to Post-Hearing Questions from Carey J. ``Bo'' Horne,
President, ProHelp Systems, Inc.
Supporting Comments for H.R. 1956, the ``Business Activity Tax
Simplification Act of 2005,'' from Carey J. ``Bo'' Horne, President,
ProHelp Systems, Inc.
Response to Post-Hearing Questions from Lyndon D. Williams, Tax
Counsel, Citigroup Corp.
Prepared Statement of the American Bankers Association
The American Bankers Association (ABA) appreciates the opportunity
to comment to the House Judiciary Subcommittee on Commercial and
Administrative Law on H.R. 1956, the Business Activity Simplification
Act, which ABA strongly supports.
ABA, on behalf of the more than two million men and women who work
in the nation's banks, brings together all categories of banking
institutions to best represent the interests of this rapidly changing
industry. Its membership--which includes community, regional and money
center banks and holding companies, as well as savings associations,
trust companies and savings banks--makes ABA the largest banking trade
association in the country.
H.R. 1956 would apply a uniform standard to an emerging
multiplicity of state taxation laws affecting businesses that offer
services or products in more than one state. An increasing number of
states have passed or are considering passing legislation lowering the
threshold of what constitutes a ``substantial nexus'' of business
activity. Each state defines and applies their own nexus to determine
when a business operating from another state is required to pay income
tax in their state. Some state legislatures have concluded that just
one customer residing in their state should count as a sufficient nexus
for them to apply business income tax to a business operating from
another state.
H.R. 1956 would codify in federal law that an actual physical
presence in a state is required to create a substantial nexus. H.R.
1956 also includes a bright-line test that would establish a minimal
amount of activity a business must perform in a state before it is
subject to income taxes and additional paperwork.
Clearly, additional taxes cost businesses revenue they could
otherwise invest in employees, innovation, or to better serve their
customers. However, inconsistent standards adopted by multiple states
compound the problem by creating business uncertainty, increasing
litigation costs, and driving up compliance costs. HR 1956 would reduce
these compliance and legal costs, and provide the certainty that the
financial services industry needs to operate efficiently. It is also
important to note that many smaller companies, such as community banks,
do not possess the substantial resources required to comply with a
proliferation of disparate state tax laws and as a result suffer
disproportionately. There are more than 3,200 banks and thrifts with
fewer than 25 employees; nearly 1,000 banks and thrifts have fewer than
10 employees. Many of these community banks operate near state borders
and serve customers from more than one state.
Without business certainty, financial service providers are forced
to offer fewer products at higher costs. Financial service providers
might also cease doing business in those states where additional tax
burdens exist. Therefore, states that aggressively tax out-of-state
businesses could have the effect of reducing choices available to
consumers in those states. Reduced competition would restrict consumer
access to credit and increase credit costs in those states, which could
have even broader negative effects on individual state's economies and,
possibly, the economy of a larger region.
For example, almost all large consumer purchases (e.g., cars,
homes, boats, etc.) are accomplished through the use of loans. A
growing number of everyday purchases are performed with credit cards.
Many of these services are offered by banks located outside of one's
home state or by banks located in multiple states. Healthy national
competition for customers ensures that customers receive the highest
quality products at the best prices. But when banks or credit card
companies discontinue or restrict their services to a particular state,
local consumers and citizens have fewer options for obtaining credit
and less access to innovative products. This depresses economic growth
and ultimately hurts the state tax receipts of business actually
located within the affected jurisdiction.
ABA is grateful to Congressman Goodelatte and Congressman Boucher
for re-introducing the Business Activity Simplification Act in the
109th Congress and Chairman Cannon for holding a hearing on this
important legislation. We look forward to working with the Committee on
this important legislation.
Prepared Statements of Michael Mazerov, Senior Fellow, on behalf of the
Center on Budget and Policy Priorities
Letter to the Honorable Chris Cannon from Arthur R. Rosen, Counsel,
Coalition for Rational and Fair Taxation
Prepared Statement of the Council on State Taxation (COST)
CRS Report entitled ``State Corporate Income Taxes: A Description and
Analysis,'' Updated May 11, 2005, Steven Maguire, Analyst in Public
Finance, Government and Finance Division, submitted by the Honorable
William D. Delahunt
Letter to the Honorable Chris Cannon from Steve Bartlett, President and
CEO, The Financial Services Roundtable: Industry Coalition
Letter to the Honorable F. James Sensenbrenner, Jr.,
from an Industry Coalition
Letter to the Honorable Chris Cannon, and the Honorable Melvin Watt,
from John Gay, Vice President, Government Relations, International
Franchise Association (IFA)
Prepared Statement of David J. Pettit, President, American Distribution
Centers for the International Warehouse Logistics Association
Letter to the Honorable Chris Cannon from Dan Glickman, Chairman and
CEO, Motion Picture Association of America
Prepared Statement of the National Governors Association, submitted by
the Honorable William D. Delahunt
Letter to the Subcommittee on Commercial and Administrative Law from
Paul J. Gessing, Director of Government Affairs, National Taxpayers
Union (NTU)
Letter to the Honorable Melvin L. Watt from the Honorable Marc
Basnight, a Senator of the North Carolina General Assembly, submitted
by the Honorable William D. Delahunt
Letter to the Honorable Melvin L. Watt from the Honorable James B.
Black, a Representative of the North Carolina General Assembly, and
Speaker of the North Carolinia House of Representatives, submitted by
the Honorable William D. Delahunt
Letter to the Honorable Melvin L. Watt from the Honorable Michael F.
Easley, Governor, State of North Carolina, submitted by the Honorable
William D. Delahunt
Letter to the Honorable Melvin L. Watt from the E. Norris Tolson,
Secretary, North Carolina Department of Revenue, submitted by the
Honorable William D. Delahunt
Letter to the Honorable Chris Cannon from Richard J.M. Poulson,
Executive Vice President, General Counsel & Senior Advisor to Chairman,
and Vernon T. Turner, Corporate Tax Director, Smithfield Foods, Inc.
(Smithfield)
Prepared Statement of the Software Finance and Tax Executives Council
The Software Finance and Tax Executives Council (SoFTEC) is an
organization comprised of major software companies and its mission is
to provide software industry focused public policy advocacy on tax and
finance issues. Taxation of interstate commerce is an issue in which
software companies have long held a keen interest because their
customers deploy their products in every state and most every locality.
SoFTEC advocates policies that promote fairness, efficiency and
certainty in the interstate taxation of software transactions. Because
H.R. 1956, the subject of this hearing, goes to the heart of these
policies, SoFTEC has been following it very closely.
1. OVERVIEW OF THE SOFTWARE INDUSTRY AND SOFTWARE DISTRIBUTION:
The software industry is a human capital-intensive industry.
Software companies rely on the personnel in their research and
development departments to design and test new products and new
versions of existing products to remain competitive. Once the research
and development team has completed a new product or a new version of an
existing product, the marginal cost of making each successive copy
approaches zero. There is no need to build a factory to manufacture
software products.
Computer software is a product that can be distributed using a
variety of techniques. Software is available in retail stores where
customers can purchase a prepackaged copy. Copies of computer software
can be delivered electronically using the Internet or other network.
Software companies can distribute their products to large customers by
delivering a single copy of a computer program along with a license to
make a given number of copies or a license to a make any number of
copies necessary to meet the customer's needs. Additionally, a customer
might receive a single copy along with a license allowing it to be
loaded on to a computer server that can be accessed by the customer's
employees from multiple locations. Last, it is not necessary to deliver
to the customer a copy of the computer program at all; the software
company might load its product onto its own server and allow customers
to access the software's functionality remotely. Software distribution
techniques are constantly changing as technology advances.
Some software companies enter into partnerships with other
companies that specialize in the delivery of comprehensive business
solutions with software as one component. For instance, one of these
third-party vendors might license different software from several
companies, combine the various software with computer hardware and
market the package. The third-party will remit a royalty to the
software company based on each sale. The software company may not know
who the third-party's customers are or where they are located.
For a variety of legal and business reasons, software companies
generally do not ``sell'' copies of their products to their customers.
Instead, they distribute copies of their products subject to a license
agreement. Under the terms of these end user license agreements, the
customers receive the contractual right to use the software while the
software company retains legal title to the copy. The license agreement
may also provide the customer with the right to make copies of the
computer program for use within the customer's business. The license
agreement generally prohibits the transfer by the customer of any of
the copies outside of the business and are prohibited from ``reverse
engineering'' or ``decompiling'' the software which could expose trade
secrets.
As can be seen, with regard to a number of these software
distribution techniques, the software company loses control over where
the customer might use copies of its products. If the customer receives
a license to make a certain number of copies or any number of copies
for use anywhere in its business, the customer takes control over where
best to use the copies. Nevertheless, the software company will retain
an ownership interest in every one of those copies no matter where the
customer chooses to use them. Likewise, if the software company puts
its products on its own server and allows the customer's employees
remote access to the software's functionality, the software company
cares not a fig where the customer or its employees might be located
when accessing the software. The same is true when the customer loads
the software on its own server and allows its employees access to the
software from multiple locations; the software companies does not know
where those employees are located when they access the software, nor
should they care.
2. CONSTITUTIONAL NEXUS STANDARDS FOR BUSINESS ACTIVITY TAXES:
The law is clear that a state cannot impose a tax on an out-of-
state business unless that business has a ``substantial nexus'' with
the taxing state.\1\ The Supreme Court, on at least two occasions, in
the context of sales and use taxes, has construed this ``substantial
nexus'' requirement as requiring that the out-of-state business have
``more than de minimis'' physical presence in the taxing state.\2\
---------------------------------------------------------------------------
\1\ See e.g., Complete Auto Transit, Inc. v. Brady, 430 U.S. 274
(1977) (A state tax on out-of-state businesses has been sustained
against a Commerce Clause challenge ``when the tax is applied to an
activity with a substantial nexus with the taxing State, is fairly
apportioned, does not discriminate against interstate commerce, and is
fairly related to the services provided by the State.'').
\2\ See National Bellas Hess, Inc. v. Department of Revenue. of
Ill., 386 U.S. 753 (1967), Quill Corp. v. North Dakota, 504 U.S. 298
(1992).
---------------------------------------------------------------------------
An older line of Supreme Court precedents holds that taxpayers
acquire a substantial nexus with another state through continuous and
systematic contacts with the state.\3\ The Supreme Court later added
the requirement that the contacts must be related to the establishment
and maintenance in the state of a market for the putative taxpayer's
products.\4\ However, in all of these cases, the taxpayers had an
actual physical presence in the taxing state. In addition, all of these
cases were decided prior to the Quill case, which separated the
Commerce Clause analysis from the Due Process clause analysis and held
that a physical presence was required in order to require out-of-state
businesses to collect sales and use taxes under the Commerce Clause.
---------------------------------------------------------------------------
\3\ See International Shoe Co. v. Washington, 326 U.S. 310 (1945);
Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450
(1959); Scripto Inc. v. Carson, 362 U.S. 207 (1960).
\4\ See Tyler Pipe Industries Inc. v. Washington State Dep't of
Rev., 483 U.S. 232, 250 (1987).
---------------------------------------------------------------------------
Many state revenue department claim that under current law, any
company ``doing business within a state'' must pay business activity
taxes on income earned in the taxing state, even if the company has no
physical presence in the state. As authority for this theory, they
often cite two older Supreme Court cases--Shaffer v. Carter, 252 U.S.
37 (1920) and New York Ex Rel. Whitney v. Graves et al., 299 U.S. 366
(1937). Even a cursory reading of these cases reveals that neither
stands for any such proposition.
Shaffer v. Carter involved the attempt by Oklahoma to tax income
from oil and gas wells located in Oklahoma and owned by a Chicago
resident. The Supreme Court held that the Due Process clause does not
bar a state from imposing an annual tax on net income derived by
nonresidents from property owned by them within the state. The Court's
holding centered squarely on Oklahoma's jurisdiction over property
within its borders and the fact that the income it was attempting to
tax derived from such property. Those states seem to be taking language
in the opinion about a state's right to tax nonresidents ``doing
business in the state'' out of context to support their claims that
physical presence is not required for business activity tax nexus
purposes. However, this case did not involve a naked claim by Oklahoma
of the right to impose business activity taxes on companies ``doing
business in the state'' with no physical presence. All of the income at
issue in the case arose from the sale of oil and gas extracted from the
ground in Oklahoma.
State revenue departments likewise misconstrue the holding in New
York Ex Rel. Whitney v. Graves. Here, Mr. Whitney, a Massachusetts
resident, and his partners owned a seat on the New York Stock Exchange.
In 1929, the exchange granted each of its members a ``right'' to one-
fourth of a new membership. Mr. Whitney sold this right and New York
assessed a tax on the profits from the sale. The Supreme Court upheld
the tax and, in doing so, applied an exception to the general common
law rule that the situs of intangible property is, for tax purposes,
the owner's domicile. The Court's decision was based on the unique
characteristics of seats on a stock exchange, and its holding stands
for the proposition that the situs of seats on a stock exchange, for
tax purposes, is the state in which the exchange is located. Nothing
more can be inferred from this decision.
On the other hand, numerous recent state level cases have construed
the Quill physical presence requirement to be applicable to business
activity taxes.\5\ Only South Carolina has taken the position to date
that the presence of intangible property in the state alone is
sufficient to establish nexus.\6\ While the Supreme Court has not yet
ruled on whether the Quill ``physical presence'' test extends to
business activity taxes, there are no cases in which the Court has
upheld a state business activity tax where the out-of-state company had
absolutely no physical presence in the taxing state. Even more
importantly, there is no rational justification for the proposition
that the Supreme Court's ``substantial nexus'' requirement should
equate with physical presence for sales and use tax collection
purposes, but that a lower standard (i.e., ``economic nexus'') should
apply for business activity taxes.
---------------------------------------------------------------------------
\5\ See J.C. Penny Nat'l Bank v. Johnson, 19 S.W.3d 831 (Tenn. Ct.
App. 1999), appeal den. (Tenn. 2000), cert. den. 531 U.S. 927, 212
S.Ct. 305 (2000); Rylander v. Bandag Licensing Corporation, 18 S.W.3d
296 (Tex. App. 2000), Motion for Rehearing Denied March 8, 2001; 9.4
Percent Manufactured Housing Service v. Department of Revenue, No.
Corp. Inc. 95-162 (Ala. Admin. Law Div. Feb.7, 1996); MeritCare
Hospital v. Commissioner of Revenue, No. C2-94-12818, (D.C. Minn. Sept.
22, 1995).
\6\ Geoffrey, Inc. v. South Carolina Tax Commission, 313 S.C. 15
(1993).
---------------------------------------------------------------------------
Thus, a fair reading of the current state of the law, as
interpreted by the state courts rather than state tax administrators,
is that in order for a state to assert a claim for business activity
taxes against an out-of-state business, that business must have some
physical presence in the taxing state. Some states such as South
Carolina and Oregon reject the existing physical presence requirement
with regard to business activity tax nexus and are seeking to expand
their right to tax out-of-state businesses that have only an economic
presence in the state. This is exactly why there is a critical need for
the enactment of bright line standards for business activity tax nexus.
3. IMPACT OF AN ``ECONOMIC NEXUS'' STANDARD ON SOFTWARE DISTRIBUTION:
As indicated above, many state revenue departments construe their
``doing business'' tax statutes as requiring nothing more than the
existence of a customer in their state in order to impose a business
activity tax on an out-of-state business otherwise having no employees
or property within their state. As indicated above, we believe that
those states exceed their constitutional authority to project their
taxing power outside their borders. As shown below, such a low nexus
standard would wreck havoc on common software distribution techniques
and make any attempt at tax compliance overly burdensome.
Many businesses deploy software throughout their business. Large
businesses present in many states and localities generally take
delivery of computer software at a single location and they make copies
and deploy them where needed. Alternatively, the software company could
deliver multiple copies of its products leaving the customer free to
send such copies wherever the need arises. The software company many
times will have no knowledge where the customer has deployed the
software.
An economic nexus standard would give state and local revenue
departments the ability to claim that a software company owes business
activity taxes wherever the customer has an employee using the
software. Such a standard, were it to become widespread, would require
that software vendors build into their license agreements elaborate
provisions requiring that the customer closely track the deployment of
the software throughout its business and submit reports to the software
company. The software company would then have to use those reports to
figure out where it owed tax. On audit, the software company would bear
the risk of the accuracy of its customers' reports. An economic nexus
standard would cause a software company to be doing business in nearly
every jurisdiction where its customers are doing business.
An economic nexus standard also would give states a reason to claim
that the retention of ownership by software companies to the copies of
computer programs constitutes the ownership of property sufficient to
rest a claim of liability for business activity tax. Yet, as explained
above, the software company typically has no information as to where
the customer may be using the copy of the software. Making the software
company liable for business activity tax in every jurisdiction where
its customers may be using its software would impose an unreasonable
burden on interstate commerce.
4. EFFECT OF H.R. 1956 ON SOFTWARE COMPANIES:
Section 2 of H.R. 1956 would expand the scope of Public Law 86-272.
Currently, P.L. 86-272 provides that states cannot impose an income tax
against an out of state company whose only activities in the taxing
state consists of sending employees into the state who solicit order
for sales of tangible personal property where the orders are sent out
of state for acceptance and the goods are shipped into the state by
common carrier. The business model contemplated by P.L 86-272 is the
door-to-door salesperson common in the late 1950's when the statute was
enacted.
P.L 86-272 only applies to companies that engage in ``sales'' of
``tangible personal property.'' Many states claim that P.L. 86-272 does
not apply to software transactions either because software is not
tangible personal property or because software is licensed and not
sold. Other states skirt P.L. 86-272 by enacting taxes other than
income taxes.
H.R. 1956 would modernize P.L. 86-272 by eliminating its limitation
to sales transactions; it would apply to all ``transactions,''
including license transactions. It would eliminate the limitation to
tangible personal property by expanding it to include all forms of
property and services. Last, it would broaden P.L. 86-272 so that it
applied to all types of business activity taxes, not just income taxes.
This would close a major loophole that has limited the effectiveness of
P.L. 86-272 in recent years. The amendments to P.L. 86-272 would make
it more effective for software companies because they have large sales
forces that regularly solicit orders, send them out of state for
acceptance and fill them by shipment from out of state.
Section 3(a) of H.R. 1956 would codify into federal law the
judicially mandated ``physical presence'' standard and would put an end
to the ``economic nexus'' standard claimed by many state revenue
departments. This provision is the keystone of the legislation. This
provision would eliminate claims against software companies for
business activity taxes based on access by employees of a customer to
software functionality. As explained above, some software companies
deliver a copy of a computer program to a customer, the customer loads
the copy onto a server, and employees of the customer, wherever they
might be located, can remotely access the software functionality. In
addition, some software companies put their software onto their own
servers and allow their customers' employees remote access to the
software. Under a physical presence standard, neither of these software
business models would give rise to a taxable presence in the
jurisdiction from where the software functionally is remotely accessed.
We are concerned however about the provisions of Section 3(b) which
puts meat on the bones of the term ``physical presence.'' Under Section
3(b)(3), a business would have a physical presence in every state in
which it owned tangible personal property for more than 21 days. Our
concern is with respect to garden-variety software transactions where
the software company retains title both to the copies of the software
that are transferred to the customer and the copies which the customer
might make under license for internal use. We believe that Section
3(b)(3) of the Bill would give software companies a taxable presence in
all jurisdictions where a copy of its software might be located.
We believe that the Bill should be amended to make clear that
retention of ownership of copies of computer software delivered to end
users is not ownership of property for purposes of Section 3(b)(3) of
the Bill.
5. CONCLUSION:
With the one exception noted immediately above, we believe that
H.R. 1956, the Business Activity Tax Simplification Act of 2005 would
go a long way towards eliminating uncertainty in with regard to where
companies engaged in interstate commerce are liable for business
activity taxes. We look forward to working with the committee as the
Bill moves through the Congress.
Prepared Statement of Chris Atkins, Staff Attorney, the Tax Foundation