[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.
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    \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).
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    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



                                 
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