    [House Hearing, 112 Congress]
    [From the U.S. Government Publishing Office]

                BUSINESS ACTIVITY TAX SIMPLIFICATION ACT OF 2011

    =======================================================================

                                    HEARING

                                   BEFORE THE

                       SUBCOMMITTEE ON COURTS, COMMERCIAL
                             AND ADMINISTRATIVE LAW

                                     OF THE

                           COMMITTEE ON THE JUDICIARY
                            HOUSE OF REPRESENTATIVES

                          ONE HUNDRED TWELFTH CONGRESS

                                 FIRST SESSION

                                       ON

                                   H.R. 1439

                                   __________

                                 APRIL 13, 2011

                                   __________

                               Serial No. 112-41

                                   __________

             Printed for the use of the Committee on the Judiciary

          Available via the World Wide Web: http://judiciary.house.gov

                      U.S. GOVERNMENT PRINTING OFFICE
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                           COMMITTEE ON THE JUDICIARY

                          LAMAR SMITH, Texas, Chairman
    F. JAMES SENSENBRENNER, Jr.,         JOHN CONYERS, Jr., Michigan
        Wisconsin                        HOWARD L. BERMAN, California
    HOWARD COBLE, North Carolina         JERROLD NADLER, New York
    ELTON GALLEGLY, California           ROBERT C. ``BOBBY'' SCOTT,
    BOB GOODLATTE, Virginia                  Virginia
    DANIEL E. LUNGREN, California        MELVIN L. WATT, North Carolina
    STEVE CHABOT, Ohio                   ZOE LOFGREN, California
    DARRELL E. ISSA, California          SHEILA JACKSON LEE, Texas
    MIKE PENCE, Indiana                  MAXINE WATERS, California
    J. RANDY FORBES, Virginia            STEVE COHEN, Tennessee
    STEVE KING, Iowa                     HENRY C. ``HANK'' JOHNSON, Jr.,
    TRENT FRANKS, Arizona                  Georgia
    LOUIE GOHMERT, Texas                 PEDRO R. PIERLUISI, Puerto Rico
    JIM JORDAN, Ohio                     MIKE QUIGLEY, Illinois
    TED POE, Texas                       JUDY CHU, California
    JASON CHAFFETZ, Utah                 TED DEUTCH, Florida
    TIM GRIFFIN, Arkansas                LINDA T. SANCHEZ, California
    TOM MARINO, Pennsylvania             DEBBIE WASSERMAN SCHULTZ, Florida
    TREY GOWDY, South Carolina
    DENNIS ROSS, Florida
    SANDY ADAMS, Florida
    BEN QUAYLE, Arizona
    [Vacant]

          Sean McLaughlin, Majority Chief of Staff and General Counsel
           Perry Apelbaum, Minority Staff Director and Chief Counsel
                                     ------

           Subcommittee on Courts, Commercial and Administrative Law

                     HOWARD COBLE, North Carolina, Chairman

                   TREY GOWDY, South Carolina, Vice-Chairman

    ELTON GALLEGLY, California           STEVE COHEN, Tennessee
    TRENT FRANKS, Arizona                HENRY C. ``HANK'' JOHNSON, Jr.,
    DENNIS ROSS, Florida                   Georgia
    [Vacant]                             MELVIN L. WATT, North Carolina
                                         MIKE QUIGLEY, Illinois

                          Daniel Flores, Chief Counsel

                          James Park, Minority Counsel

                                C O N T E N T S

                                  ----------

                                 APRIL 13, 2011

                                                                       Page

                                    THE BILL

    H.R. 1439, the ``Business Activity Tax Simplification Act of
      2011''.........................................................    13

                               OPENING STATEMENTS

    The Honorable Howard Coble, a Representative in Congress from the
      State of North Carolina, and Chairman, Subcommittee on Courts,
      Commercial and Administrative Law..............................    11
    The Honorable Steve Cohen, a Representative in Congress from the
      State of Tennessee, and Ranking Member, Subcommittee on Courts,
      Commercial and Administrative Law..............................    23
    The Honorable John Conyers, Jr., a Representative in Congress
      from the State of Michigan, and Ranking Member, Committee on
      the Judiciary..................................................    24

                                   WITNESSES

    The Honorable Bob Goodlatte, a Representative in Congress from
      the State of Virginia
      Oral Testimony.................................................     1
      Prepared Statement.............................................     4
    The Honorable Robert C. ``Bobby'' Scott, a Representative in
      Congress from the State of Virginia
      Oral Testimony.................................................     6
      Prepared Statement.............................................     7
    Corey Schroeder, Vice President and CFO, Outdoor Living Brands,
      Inc. (Richmond, VA), on behalf of the International Franchise
      Association
      Oral Testimony.................................................    26
      Prepared Statement.............................................    28
    R. Bruce Johnson, Chairman, Utah State Tax Commission (Salt Lake
      City, UT), on behalf of the Federation of Tax Administrators
      Oral Testimony.................................................    37
      Prepared Statement.............................................    39
    Joseph Henchman, Tax Counsel and Director of State Projects, The
      Tax Foundation (Washington, DC)
      Oral Testimony.................................................    50
      Prepared Statement.............................................    52

                                    APPENDIX
                   Material Submitted for the Hearing Record

    Prepared Statement of the American Bankers Association...........    68
    Letter from Bill Himpler, Executive Vice President, American
      Financial Services Association (AFSA)..........................    72
    Prepared Statement of the American Homeowners Grassroots Alliance    73
    Letter from Senator Jim Buck, Indiana, Public Sector Chairman,
      Tax and Fiscal Policy Task Force, and Jonathan Williams,
      Director, Tax and Fiscal Policy Task Force, American
      Legislative Exchange Council...................................    76
    Prepared Statement of the American Trucking Association..........    77
    Prepared Statement of Mark Louchheim, President, Bobrick Washroom
      Equipment, Inc., North Hollywood, CA, on behalf of the National
      Association of Manufacturers...................................    83
    Letter from Arthur R. Rosen, McDermott Will & Emergy LLP,
      Counsel, the Coalition for Rational and Fair Taxation..........    88
    Prepared Statement of the Computing Technology Industry
      Association (CompTIA)..........................................   105
    Prepared Statement of Michael Petricone, Senior Vice President,
      Government Affairs, Consumer Electronics Association...........   113
    Letter from Joseph R. Crosby, COO & Senior Director, Policy,
      Council On State Taxation (COST)...............................   115
    Letter of Support from Mark B. Wieser, Founder and Chairman,
      Fischer & Wieser Specialty Foods, Inc..........................   119
    Prepared Statement of David Rolston, President and CEO, Hatco
      Corporation, on behalf of the North American Association of
      Food Equipment Manufacturers (NAFEM)...........................   127
    Prepared Statement of Ivan Petric, Vice-President, Hope Trucking,
      Inc............................................................   130
    Prepared Statement of the National Association for the Specialty
      Food Trade, Inc. (NASFT).......................................   134
    Prepared Statement of the National Foreign Trade Council, Inc.
      (NFTC).........................................................   137
    Letter from Rebecca Boenigk, CEO & Chairman, Neutral Posture.....   139
    Prepared Statement of the New York Bankers Association (NYBA)....   141
    Prepared Statement of the Organization for International
      Investment (OFII)..............................................   143
    Prepared Statement of Kathryn Wylde, President & CEO, Partnership
      for New York City..............................................   148
    Letter and Article from Marjorie B. Gell, Associate Professor,
      The Thomas Cooley Law School...................................   150
    Prepared Statement of Carey J. (Bo) Horne, Past President, and
      Katherine S. Horne, Past Vice President, ProHelp Systems, Inc..   154
    Letter from Joan Maxwell, President, Regular Marine, Inc.........   168
    Prepared Statement of the Securities Industry and Financial
      Markets Association (SIFMA)....................................   170
    Prepared Statement of Vernon T. Turner, Vice President, Corporate
      Tax, Smithfield Foods, Inc.....................................   171
    Prepared Statement of the Software Finance & Tax Executives
      Council (SoFTEC)...............................................   174
    Material from Carley A. Roberts, Chair, Taxation Section, The
      State Bar of California........................................   178
    Letter from Scott George, Chief Executive Officer, Tennessee
      Commercial Warehouse (TCW).....................................   198
    Letter from Rebecca J. Paulsen, Vice President, State Tax, U.S.
      Bancorp........................................................   199
    Prepared Statement of the United States Council for International
      Business (USCIB)...............................................   203

                BUSINESS ACTIVITY TAX SIMPLIFICATION ACT OF 2011

                                  ----------

                           WEDNESDAY, APRIL 13, 2011

                  House of Representatives,
                        Subcommittee on Courts,
                     Commercial and Administrative Law,
                                    Committee on the Judiciary,
                                                        Washington, DC.

        The Subcommittee met, pursuant to call, at 1:34 p.m., in
    room 2141, Rayburn Office Building, the Honorable Howard Coble
    (Chairman of the Subcommittee) presiding.
        Present: Representatives Coble, Gowdy, Gallegly, Franks,
    Cohen, Watt, Quigley and Conyers.
        Staff present: (Majority) Travis Norton, Counsel; John
    Hilton, Counsel; John Mautz, Counsel; Allison Rose,
    Professional Staff Member; Ashley Lewis, Clerk; (Minority)
    James Park, Subcommittee Chief Counsel; Norberto Salinas,
    Counsel; and Ann Woods Hawks, Professional Staff Member.
        Mr. Coble. The Subcommittee will come to order.
        We have two panels today. The first includes two long time
    friends from the--from my neighbor to the north, Virginia,
    Representative Bob Goodlatte who represents the Roanoke area,
    and the Valley, I presume, Bob. And Representative Bobby Scott
    who represents the Tidewater area, primarily. Good to have both
    of you here.
        I know Mr. Goodlatte--good to see you, Mr. Cohen.
        Mr. Cohen. Good to be seen.
        Mr. Coble. Mr. Goodlatte I know has embraced this along
    with Representative Boucher when he was here, and now Mr. Scott
    has taken up the case so we have two formidable allies before
    us. We will be glad to recognize each one of you for 5 minutes,
    if possible.
        Mr. Goodlatte, we'll start with you.

     TESTIMONY OF THE HONORABLE BOB GOODLATTE, A REPRESENTATIVE IN
                  CONGRESS FROM THE STATE OF VIRGINIA

        Mr. Goodlatte. Mr. Chairman, thank you very much and
    Ranking Member Cohen and Members of the Subcommittee. I
    appreciate being invited to testify today about the ``Business
    Activity Tax Simplification Act'' which I introduced with my
    friend and Virginia colleague, Representative Scott.
        This legislation will provide a ``bright line'' test to
    clarify state and local authority to collect business activity
    taxes from out of state entities. Many states and some 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
    technology industry, and interstate business-to-business and
    business-to-consumer transactions raise questions over where
    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 received no appreciable benefits from the taxing
    jurisdiction. 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.
        We need a basic, fair, bright line rule in this area.
    Previous actions by the Supreme Court and Congress have laid
    the groundwork for such a bright line rule. In the landmark
    case of Quill Corporation versus 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 purposes of imposing
    business activity taxes.
        In addition, over 50 years ago Congress passed Public Law
    86272 which set clear, uniform standards for when states could
    and could not impose certain taxes on out-of-state businesses
    when the businesses activities in the state were nominal and
    only involved the solicitation of orders for sales of tangible
    property. However, the scope of Public Law 86272 only extended
    to activities related to tangible personal property. Our
    Nation's economy has changed dramatically over the last 50
    years and this outdated statute needs to be modernized.
        The Business Activity Tax Simplification Act updates the
    protections of Public Law 86272 to reflect the changing nature
    of our economy by expanding the scope of those protections from
    just tangible property to include intangible property and
    services.
        In addition, our legislation establishes a clear, uniform
    physical presence test such that an out-of-state company must
    have a physical presence in a state before the state can impose
    corporate net income taxes and other types of business activity
    taxes on that company.
        In our current challenging economic times, it is especially
    important to eliminate artificial government-imposed barriers
    to small businesses. Small businesses are crucial to our
    economy and account for a significant majority of new product
    ideas and innovation. Small businesses are also central to the
    American dream of self-improvement and individual achievement
    which is why it is so vital that Congress enact legislation
    that reduces the excessive and often duplicative tax burdens
    that hinder small businesses and ultimately overall economic
    growth and job creation.
        Unfortunately small businesses are often the hardest hit
    when aggressive states and localities impose excessive tax
    burdens on out-of-state companies. These businesses do not have
    the resources to hire the teams of lawyers that many large
    corporations devote to tax compliance and they are more likely
    to halt expansion to avoid uncertain tax obligations and
    litigation expenses.
        The clarity that the Business Activity Tax Simplification
    Act will bring will ensure fairness, immunize litigation and
    create the kind of--minimize litigation and create the kind of
    legally certain and stable business climate that frees up funds
    for businesses of all sizes to make investments, expand
    interstate commerce, grow the economy and create new jobs.
        At the same time, and it's important to emphasize, this
    legislation will protect the ability of states to ensure that
    they are fairly compensated when they provide services to
    businesses that do have physical presences in the state. In
    addition, the legislation expressly protects the ability of
    states to use all tools at their disposal to aggressively
    combat illegal activities, sham transactions and other abuses.
        Thank you again for the opportunity to speak to the
    Committee today.
        [The prepared statement of Mr. Goodlatte follows:]

                                   __________

        Mr. Coble. Thank you, Mr. Goodlatte.
        And Mr. Scott, if you will suspend just a moment. The Chair
    wants to recognize the presence of Dan Freeman who served a
    long time as parliamentarian for the House Judiciary Committee.
    Good to have you with us, Dan.
        And now I'm pleased to recognize the distinguished--the
    other distinguished gentleman from Virginia, Mr. Bobby Scott.

        TESTIMONY OF THE HONORABLE ROBERT C. ``BOBBY'' SCOTT, A
         REPRESENTATIVE IN CONGRESS FROM THE STATE OF VIRGINIA

        Mr. Scott. Thank you, Chairman Coble, Ranking Member Cohen,
    Chairman--former Chairman Conyers and other Members of the
    Committee.
        I appreciate your holding today's hearing on the Business
    Activity Tax Simplification Act introduced by my colleague from
    Virginia, Bob Goodlatte and for providing me the opportunity to
    testify in support of the legislation.
        Business Activity Simplification Act or BATSA has attracted
    strong bipartisan support over the last several Congresses and
    I expect this version to attract the same amount of support.
        BATSA seeks to update a 50-year-old Federal statute that
    determines when states can impose state income taxes on the
    sale of tangible personal good in the state--over the years
    states have adopted a series of business activity taxes that
    are proxies for state income tax, including gross receipts
    taxes, licensing arrangements and other changes--and other
    charges that states frequently seek to impose on out-of-state
    companies.
        Some states have enacted overly aggressive and often unfair
    business activity taxes. Businesses in my state have been
    acutely affected by these aggressive business activity taxes.
    Smithfield Foods, located in Congressman Forbes' district, has
    had its trucks threatened with confiscation by New Jersey tax
    revenue agents simply for driving down the New Jersey Turnpike.
    Virginia based Capital One has joined other financial
    institutions in becoming easy prey for other states and
    localities seeking to increase their tax revenues by targeting
    out-of-state businesses. Other sectors of the Virginia economy,
    such as manufacturing, information technology, franchising,
    media industries all have been targeted with overly aggressive
    business activity taxes in other states.
        There is an urgent need to modernize this decades-old law.
    BATSA would clarify the standard governing state assessment of
    corporate income taxes and comparable taxes on businesses.
    Specifically, the bill will articulate a ``bright line''
    physical presence nexus standard that includes either owning or
    leasing real or tangible property in the state or assigning one
    or more employees to perform certain activities in the state
    for more than 15 days in a taxable year.
        No one is arguing that the business should not be
    responsible for paying taxes where they do business. However,
    BATSA would ensure fairness, minimize costly litigation for
    both state governments and taxpayers, reduce the likelihood of
    a business being double taxed on the same income, and create
    the kind of legal certainty and stability for business
    environment that encourages businesses to make investments,
    expand interstate commerce and create new jobs.
        More importantly, the bill would unsure that businesses
    continue to pay business activity taxes to states that provide
    them with direct benefits and protections.
        I appreciate the Subcommittee's focus on this timely matter
    and look forward to working with you as we pass this important
    legislation, hopefully during this session of Congress.
        [The prepared statement of Mr. Scott follows:]

                                   __________

        Mr. Coble. I thank each of you for being with us. We
    normally don't examine Members, so I assume does anyone have
    questions for the Members? We usually--gentleman from Illinois?
        Mr. Quigley. Just for a point of clarification, how would
    you two gentlemen distinguish most of the taxes you're talking
    about that, as you say, could be very burdensome just for
    driving down the New Jersey Turnpike, for example, and the much
    more controversial aspect of the transaction tax dealing with
    the Internet and how some states and local governments are
    reacting to the fact that their retailers are closing down
    because so much more of those sales are taking place on the
    Internet and the shortfall that it is creating?
        Mr. Goodlatte. Well, if the gentleman would allow? This
    legislation is neutral as between bricks and mortar entities
    and online entities. You'll find pretty much widespread
    business support from both groups.
        As you know, with relation to sales taxes online, there's a
    great division there between those who do business within an
    individual state and required by state law, because they do
    have that nexus with the state, and entities that operate from
    a greater distance.
        This does not address that issue in any way, shape or form.
    It would not limit the ability of the Congress to change the--
    as you know, right now the Congress has never provided the
    necessary finding of nexus to allow a state to require a
    company in another state to collect sales taxes. They're left
    with having to try to collect that from the individual who owes
    the tax and that of course is a too burdensome way to collect
    it.
        Some of us have suggested that the states should work
    together to come up with a single definition of what is taxable
    and perhaps even a single interstate sales tax so that if
    you're a small business doing business online, you're not
    talking about having to know the tax in not just 50 states but
    thousands of sub-jurisdictions that have add on sales taxes. So
    that is a separate, complicated issue and is not addressed
    here.
        Mr. Quigley. Thank you. I yield back.
        Mr. Coble. Any other questions for the Members?
        Mr. Cohen?
        Mr. Cohen. Since we have two fine gentlemen from the
    Commonwealth, I'd like to ask you what you think Mr. Jefferson
    would think of this bill and why.
        Mr. Scott. He would think--I think he would like the bill.
    It's a fine piece---- [Laughter.]
        Mr. Cohen. Great answer.
        Mr. Coble. Mr. Cohen, you asked for that one.
        Gentlemen, good to have both of you with us.
        Trey, did you have any questions?
        Mr. Gowdy. No, sir, Mr. Chairman.
        Mr. Coble. You're excused, gentlemen. Good to be--good to
    have you with us.
        I'll give my opening statement and then I'll recognize Mr.
    Cohen and Mr. Conyers after that and then we'll proceed with
    our other panel.
        Benjamin Franklin once remarked that nothing is certain in
    this world except death and taxes. But while taxes are
    necessary to fund the essential government operations, they
    should not be imposed arbitrarily or unfairly, especially on
    America's small businesses which create the majority of jobs in
    this country.
        The Dormant Commerce Clause prohibits states from imposing
    taxes on entities that lack a substantial nexus to the taxing
    state. In the 1922--strike that. In the 1992 Quill decision,
    the Supreme Court held that a state could not impose a sales or
    use tax on a business that was not physically present in the
    taxing state. Since then some courts have held that the
    physical presence standard does not apply to the imposition of
    net income or other business activity taxes.
        As a result, each state's standard for what constitutes
    substantial nexus for net income taxes varies. Some states like
    Texas and Tennessee hold that the physical presence standard
    applies, but the majority of states allow taxation of net
    income if there is merely an economic nexus between the state
    and the taxpayer.
        Some businesses are thus faced with a lose/lose situation.
    They may hire expensive accountants and tax attorneys to
    decipher the tax laws of the states in which they transact
    business to determine whether they have tax liability, but most
    small businesses lack the resources to do this. Those that do
    find such resources pass the cost on to the consumers in the
    form of higher priced goods and services. Our small businesses
    can reasonably conclude that they are not liable to pay taxes
    in a state because they transact only very limited business
    there, but under this approach, if a state later concludes that
    taxes should have been paid, the business will owe--likely will
    owe penalties in addition to back taxes.
        In my opinion, there's a substantial need for a clear rule
    for what a state may impose in net income or other business
    activity tax. H.R. 1439, the Business Activity Tax
    Simplification Act of 2011, does just that. It clarifies that a
    state may not impose such a tax on a business that lacks
    physical presence in the state.
        BATSA also updates a law Congress passed in 1959 which
    prohibits states from taxing businesses merely because they
    employ salesmen who travel to the states selling tangible
    goods. That was 52 years ago. In the modern American economy
    services and intangible goods play a significant and larger
    role than they did in 1959. There's no good reason, it seems to
    me, to discriminate between tangible and intangible goods in
    this regard, so we ought to update that law.
        It is important to note that BATSA does not require states
    or localities to reduce their taxes, rather it gives small
    businesses some certainty about their tax liability so they can
    adequately budget their resources, and to the extent possible,
    create more jobs.
        This is not the first time this Committee has considered
    BATSA, but state taxation is an important issue and I am
    pleased to take it up once again.
        Again, we thank Mr. Goodlatte and Mr. Scott for having been
    with us. And I am now pleased to recognize the distinguished
    gentleman from Tennessee, Mr. Steve Cohen, the Ranking Member.
        [The bill, H.R. 1439, follows:]

                                   __________

        Mr. Cohen. Thank you, Mr. Chairman. Three years ago the
    subcommittee on Commercial and Administrative law held a
    hearing on legislation substantially similar to this bill, H.R.
    1439, the ``Business Activity Tax Simplification Act of 2011.''
    At that time I noted the issues that BATSA was trying to
    address were complex ones. What should be the proper scope of a
    state's authority to impose a corporate income tax or other
    similar tax on a particular company based on the company's
    business activity in that state? What role should Congress play
    in defining that scope? And those were the primary issues.
        The constitution requires a sufficient nexus to exist
    between a state and a business' in-state activity in order for
    that state to be able to tax that business. The Supreme Court,
    however, has been ambiguous as to what that nexus is in the
    business activity tax context.
        In 2008 I heard what I thought were some valid concerns
    expressed about the adoption of a physical presence standard as
    the only determinative of whether a given business had
    sufficient nexus with a state for business activity tax
    purposes. I also called upon interested stakeholders to use the
    bill's introduction as an opportunity to reach a consensus on a
    clear and uniform national standard for state taxation of
    business activity. Unfortunately that does not seem to be what
    has occurred in the intervening time. So here we are.
        I agree with proponents of H.R. 1439 that a uniform
    national standard that determines when a state can tax business
    activity will provide useful clarity and reduce the cost of
    doing business. But by expanding the limitations on taxable
    business activity under Federal law, and by once again adopting
    physical presence in a state as the sole basis for what a state
    tax business activity, I am concerned that H.R. 1439, if
    enacted would cost states to potentially lose billions of
    dollars in tax revenue that they should be entitled to. This
    revenue loss in turn threatens to undermine critical state and
    local government services and adversely impact employees.
        The physical presence standard concerns me, because it
    appears to be too restrictive, does not fully capture business
    activity that a state legitimately, constantly should be able
    to tax. Adoption of the physical presence standard threatens to
    prohibit taxation of activities that currently states can tax.
        The standard limits the scope of a state's authority to
    impose a corporate income tax or other business activity in one
    of three situations. Where business is physically present in
    the state or is assigned one or more employees in the state.
    Secondly, where the business uses the service of an agent to
    establish or maintain the market in a state. Or, the business
    leases or owns tangible personal or real property in the state
    during the relevant tax year.
        I fear that this narrowly crafted standard allows
    businesses simply to game the system, by for example, making
    all employees independent contractors or allowing banks to
    conduct online businesses in all states while avoiding taxes on
    such activity, because they lack tangible property in most
    states.
        I feel like a TV show with background action. It's very
    difficult.
        Worse yet, according to a Congressional Budget Office cost
    estimate prepared in 2006 for an earlier, but substantially
    similar version of BATSA, the act would concentrate 70 percent
    of revenue losses in just ten states. One of those states would
    be Michigan, home of the Wolverines. Another would be Texas.
    Whatever. And the other is Tennessee, that matters.
        I noted that at least one alternative to physical presence
    as a uniform standard has been proposed by the Multistate Tax
    Commission. I do not take a view on the merits of that
    alternative proposal. I simply note that--and reiterate my
    point from 3 years ago, which is that while uniform standard of
    business activity taxes and the clarity and certainty it
    provides are valuable, that uniform standard must be one that
    is fair to all who would be impacted. H.R. 1439 does not appear
    to meet that goal.
        With that, I yield back the remainder of my time.
        Mr. Coble. And I apologize to you, Mr. Cohen, for having
    talked behind your back. We had to get some preliminaries out
    of the way.
        Mr. Cohen. It was the physical dance I had to do which was
    more difficult---- [Laughter.]
        But there was the challenge, and I appreciate rising to
    their----
        Mr. Gowdy. Physical presence.
        Mr. Cohen [continuing]. Right, it was physical presence.
        Mr. Coble. The distinguished gentleman from South Carolina
    has no opening statement.
        Mr. Conyers, the distinguished gentleman from Michigan is
    recognized for 5 minutes.
        Mr. Conyers. Thank you, Chairman Coble.
        Ladies and gentleman, imposing a physical presence standard
    would drastically alter the taxing landscape as we know it.
    With respect to past legislation similar to this, surveys have
    estimated that lost state tax revenues might be as high as $8
    billion in the first year following enactment, and that was an
    estimate from several years ago. The impact might be even more
    damaging now.
        If this legislation has a similar negative impact on the
    states I wonder how any of us can support it. The states are
    already getting Federal budget cuts all over the place and now
    we want to make sure that we increase the stress and the dire
    circumstances that they find themselves in. This is legislation
    that might possibly eviscerate some state revenues. We would,
    in effect, be turning our back once again on state governments.
    We would be forcing state governments to eliminate valuable
    governmental programs and services and furlough dedicated
    government workers, some are already doing it. We should
    shudder at the impact of a potential loss of $8 billion on top
    of the lost tax revenue base the states have suffered in the
    last few years.
        I don't know if there is support enough to pass a
    legislative measure which would undercut states' abilities to
    tax activity within its borders. In this case, Congress should
    not step in and impose a damaging physical presence standard
    for activities which a state may have the constitutional right
    already to tax.
        An $8 billion loss to the states which have already
    suffered extensively during this economic downturn, would
    further hamper economic--the economic rebound that people keep
    looking and hoping and praying will occur. And when you
    consider the Federal cuts to state and local assistance, which
    the Ryan budget will obviously lead to, our state and local
    governments would be suffering, in my view unnecessarily, for
    years to come.
        So while Congress must ensure that the states do not burden
    interstate commerce through their taxing authority, the
    authority of states to tax activity within their borders must
    be respected. Why not? And unfortunately the proposal that we
    are examining does not seem to balance these competing
    interests.
        And with that, Chairman Coble, I return any unused time.
        Mr. Coble. I thank the gentleman.
        I am told that there will be an imminent vote on the floor
    in a matter of minutes, but we will go ahead and start.
        I will invite the witnesses, if they will assume their
    seated position at the table and I will introduce the
    witnesses.
        We have a very favorable group of three panelists who will
    be us today.
        Mr. Corey L. Schroeder is vice president and chief
    financial officer of Outdoor Living Brands, a multi-brand
    franchise company dedicated to products and services within the
    outdoor living market. As VP and CFO of Outdoor Living Brands,
    Mr. Schroeder is responsible for the financial reporting and
    management of the business overseeing franchise compliance
    matters and working to support the strategic direction of the
    company.
        Prior to the formation of Outdoor Living Brands, Mr.
    Schroeder served as vice president and CFO of U.S. Structures,
    Inc., also a franchise company.
        Mr. Schroeder holds a bachelors degree in business
    administration with a concentration in finance from the
    University of Richmond and a masters degree in accounting from
    the College of William and Mary. He also holds a designation of
    chartered financial analyst.
        Our second witness is Mr. Bruce Johnson who is the Utah
    governor--in 2009 Utah Governor Gary Herbert appointed Bruce
    Johnson to serve as chairman of the Utah State Tax Commission.
    He has been a commissioner since 1998. The Tax Commission has
    the constitutional duties to administer all--and supervise all
    the tax laws of the state, including property tax, income tax,
    franchise tax, sales tax and all miscellaneous taxes.
        Prior to his appointment, Mr. Johnson litigated numerous
    tax disputes as a private attorney and as a trial attorney for
    the Tax Division of the United States Department of Justice.
        He's a CPA and holds a degree in accounting from the
    University of Utah. Mr. Johnson also served on numerous boards
    and testified before legislative bodies. He was, as well, the
    founding national co-chair of the Streamlined Sales Tax
    Project.
        Our final witness today, Mr. Joseph Henchman. Mr. Henchman
    is a tax counsel and director of state projects at the Tax
    Foundation a nonprofit organization dedicated to educating
    taxpayers about all aspects of tax policy. He joined the Tax
    Foundation in 2005.
        Mr. Henchman's analysis of fiscal trends, constitutional
    issues and tax law developments has been featured in numerous
    print and electronic media, including The New York Times, The
    Wall Street Journal, CNN and Fortune magazine.
        Of particular relevance to this hearing, in 2007 Mr.
    Henchman published an article in a popular state sales
    periodical entitled, ``Why the Quill Physical Presence Standard
    Should Not Go Away--Should Not Go the Way of Personal
    Jurisdiction.''
        Mr. Henchman was graduated from the University of
    California at Berkley with a degree in political science and a
    law degree from the George Washington University.
        Gentlemen, good to have you with us. We operate on a 5-
    minute rule, gentlemen. The panel before you, the green light
    will expire at the conclusion of 4 minutes. And you will see an
    amber light then which is your notice to--if you can start
    wrapping up at that time we would be appreciative. And we try
    to apply that 5 minute rule to us as well on this side of the
    podium.
        Mr. Schroeder, why don't you start us off?

     TESTIMONY OF COREY SCHROEDER, VICE PRESIDENT AND CFO, OUTDOOR
         LIVING BRANDS, INC. (RICHMOND, VA), ON BEHALF OF THE
                  INTERNATIONAL FRANCHISE ASSOCIATION

        Mr. Coble. Mr. Schroeder, I know either your mic is not on
    or is not close to you.
        Mr. Schroeder. How is that?
        Mr. Coble. That's better.
        Mr. Schroeder. Thank you. Thank you again for providing me
    the opportunity to voice my support for the Business Activity
    Tax Simplification Act of 2011. And thank you also to
    Congressmen Scott and Goodlatte, from my home state of
    Virginia, for introducing the bill.
        I'm speaking today on behalf of Outdoor Living Brands
    located in Richmond, Virginia. We currently operate three
    franchise brands with 181 locations in 34 states and have 28
    employees.
        I'm also here today on behalf of the International
    Franchise Association, the largest and oldest franchising trade
    group representing more than 90 industries, more than 13,000
    members nationwide. And according to a study done for the IFA
    by Price Waterhouse Coopers, there are over 825,000 franchise
    businesses across 300 different business lines providing nearly
    18 million American jobs and generating over $2.1 trillion for
    the American economy.
        The Business Activity Simplification Act of 2011 addresses
    a significant issue within the franchise community relating to
    state income tax reporting. Franchise businesses face a very
    confusing and ever changing set of rules regarding the
    obligation to file state corporate income taxes. The primary
    issue is the different and changing definitions of nexus to
    establish--established with various states for our business
    activities.
        Once nexus is established we must begin filing state
    corporate income tax returns for that portion of our revenue
    that we generate from that state. Like Outdoor Living Brands,
    most franchisors do not own any real property in the states
    which our--in which our franchisees operate. We only have, in
    my case, a physical presence in the State of Virginia.
        However, central to the concept of our business in
    franchising is the relationship with our franchisees and
    primarily our shared trade identity of our brand. We license
    that trade identity and that intellectual property and business
    plan to local entrepreneurs, as well as support them in growing
    and building their business and providing jobs in their local
    markets and their various states.
        Many states, however, now are concluding that the very
    existence of our brand and our intellectual property or even
    the physical existence of our training manuals in their states
    is establishing nexus. And I understand the desire for states,
    in this fiscal environment, to need to generate and want to
    generate revenue from out-of-state businesses, however, the
    local outcome of this view on nexus, for a company like Outdoor
    Living Brands, is that we would file 34 different state tax
    returns and less than 10 percent of our revenue would be taxed
    in the state of Virginia where we operate.
        Franchising is already a very heavily regulated business
    model and my small firm spends close to $100,000 a year in
    legal, accounting and tax advisory fees. It does not--that does
    not include the time of myself or the folks on my team, and
    these are precious resources that we would like to be using to
    help grow our franchisees and our businesses.
        Currently my firm files income taxes in six states. With
    various nexus and standard enforcement practices changing I
    expect the costs and administrative burden of this particular
    issue to continue to grow. My most recent experiences with it
    was with the State of South Carolina and Minnesota who both
    sent me business activity questionnaires. These lengthy
    questionnaires, to which I answered no to almost every activity
    described, were in the end determined that it was simply the
    existence of my franchise agreement and the royalty revenue
    derived in that state that required nexus and I had to file
    several years of past returns.
        One state in particular, South Carolina, a South Carolina
    revenue agent described for me how he found our business by
    creating a mass mailing list of franchise companies like mine,
    using a marketing website service that the franchising industry
    it commonly uses to sell franchises.
        As a franchisor I have very little visibility on what the
    nexus rules are in each state and when they change and why they
    change. And South Carolina's activity was based on a court case
    that happened in that state.
        Iowa just recently announced a similar change due to a
    court case. And I expect I will be getting a questionnaire from
    them and I will deal with them in--as the questionnaire comes
    up.
        And this raises the issue of managing this issue. For a
    small business like mine, managing this issue is rife with
    uncertainty created by this environment. I could proactively
    engage another tax advisor and have them go seek out all the 34
    states where I have franchisees and determine which ones would
    have nexus with me. I am sure that the states would gladly
    agree that I have nexus. And then I could pay that tax advisor
    even more to continue to fill out more and more tax returns in
    the various states.
        I could be passive, which is what I think most franchisors
    in my situation do, where we wait for the next franchise
    activity questionnaire to come in and we respond to it
    accordingly.
        To sum up, earlier in my career I worked in investment
    banking and I advised a number of private businesses in a lot
    of different industries with far broader business activities in
    different states than what we experience in franchising. And
    franchising is the only business I have come across where we
    face this level of complexity and this burden of state tax
    compliance.
        So, I hope this testimony has been helpful in illustrating
    the difficulty that franchise businesses face across the
    country related to this. And I hope we can work together to
    pass the Business Activity Simplification Act.
        Thank you.
        [The prepared statement of Mr. Schroeder follows:]

                                   __________

        Mr. Coble. Thank you, Mr. Schroeder.
        Mr. Johnson?

        TESTIMONY OF R. BRUCE JOHNSON, CHAIRMAN, UTAH STATE TAX
    COMMISSION (SALT LAKE CITY, UT), ON BEHALF OF THE FEDERATION OF
                           TAX ADMINISTRATORS

        Mr. Johnson. Chairman Coble, Vice Chairman Gowdy, Ranking
    Member Cohen and Members of the Committee, thank you for the
    opportunity to address this issue today. I am Bruce Johnson,
    chair of the Utah State Tax Commission. Today I am testifying
    on behalf of the Federation of Tax Administrators which is an
    association of tax administration agencies in each of the 50
    states, the District of Columbia and New York City.
        This is not a greedy states versus poor taxpayer bill. This
    is a bill about large multistate businesses versus small local
    businesses and how a state can allocate its tax base and its
    tax burden among the entities doing business in the state. That
    is what it is about. It is also a bill about Federal preemption
    of state sovereignty and when it is appropriate for the Federal
    Government to limit a state's sovereign power to raise its
    revenue as it sees fit through its local elected officials.
        We have already heard some discussion about the estimated
    revenue impact of this bill. The Congressional Budget Office
    said it would result in a $3 billion annual revenue loss,
    that's the 2005 predecessor of this bill. The NGA has
    substantially larger estimates. But that is not revenue that is
    going to go away, that is revenue that is going to be shifted
    if we can't tax the fair share of interstate businesses that do
    business in our state. That tax is going to be shifted to our
    local businesses and our local taxpayers. It is going to have a
    devastating impact on small business.
        The U.S. Supreme Court has held that a company meets the
    jurisdictional standard of substantial--or sufficient contacts
    if it is doing business in the state or otherwise engaged in
    establishing and maintaining a market in the state. This bill
    purports to establish a physical presence standard which has
    never been the law for income taxes or business activity taxes.
    But I suggest it is not even a physical presence standard. If
    you look at Public Law 86-272, which the proponents of the bill
    seek to expand, 86-272 allows a business to have permanent
    employees in a state, driving company cars on state roads, and
    as long as they are not engaged in activities other than the
    solicitation of sales, that physical presence has to be ignored
    and the state can't tax that business even though it clearly
    has physical presence there.
        This bill would seek to extend that preemption not only to
    the solicitation of sales of tangible personal property, but to
    the solicitation of services, to the solicitation of sales of
    intangible property, to the gathering of information in a
    state, to the furnishing of information to customers in the
    state. It would say that 15 days in the state is not physical
    presence. That may be a reasonable de minimis test for many
    taxpayers, but it also says if the activity of the business,
    the physical presence is for a limited or transient business
    purpose, it can be longer than 15 days.
        Now I don't know what a limited or transient business
    purpose is. And I don't see how that provides clarity to our
    taxpayers. In a multi-level company that manufacturers,
    distributes and retails, is a warehouse in the state just a
    limited purpose? It may well be under this law.
        Moreover, activities of subsidiaries can easily be ignored
    with a little bit of structuring. I had the privilege of
    representing taxpayers for over 17 years and I can tell you
    that under the provisions of this bill I could substantially
    reduce the tax obligations of many taxpayers in Utah that have
    a physical presence through the--merely by setting up a
    subsidiary, a toy company could--that has a 5-percent profit
    margin in the state could set up an intangible holding company
    in Delaware, charge a 2-percent royalty and cut its taxes in
    Utah by 40 percent even though it continued to have a store in
    Utah. It could set up a 3-percent royalty and cut its taxes by
    60 percent, even though it continued to have physical presence
    in Utah.
        I acknowledge the need for more clarity. This bill
    unfortunately is fatally flawed in many ways and I urge you to
    oppose the bill. Thank you.
        [The prepared statement of Mr. Johnson follows:]

                                   __________
        Mr. Coble. Thank you, Mr. Johnson.
        Mr. Coble. Mr. Henchman?

    TESTIMONY OF JOSEPH HENCHMAN, TAX COUNSEL AND DIRECTOR OF STATE
             PROJECTS, THE TAX FOUNDATION (WASHINGTON, DC)

        Mr. Henchman. Thank you. Mr. Chairman, Ranking Member
    Cohen, Ranking Member Conyers and Members of the Subcommittee.
    I appreciate the opportunity to testify today on legislation
    pending before you on state tax actions that impact interstate
    commerce.
        Let's say you have a retired congressman, he hires a
    research assistant, he decides to write his memoirs. So he
    rents a little office in a business park in Virginia. He hires
    a research assistant, a Virginian. He buys some computers and
    some printers from a Virginia company. And every day for a year
    he sits in that Virginia office writing his memoirs. And at the
    end of the year he sells the finished manuscript to a New York
    publisher.
        Where did he earn that income? An economist will tell you
    that the congressman earned the income where he invested his
    capital and his labor, which is, in this case, Virginia. This
    is what is known as the ``benefit principle,'' the idea that
    the taxes people pay are linked to the government services they
    receive. In other words, individuals and businesses should pay
    taxes where they work and live and jurisdictions should not tax
    those who don't work and live there.
        While a physical presence rule for taxation is the norm in
    the international context and is the historical norm
        for state taxation here in the United States, we at the Tax
    Foundation have been monitoring increasingly aggressive state
    efforts to reject this rule so as to shift tax burdens away
    from residents toward non-residents.
        This is not entirely new. States have always had this
    incentive, to the detriment of the national economy. In fact in
    the time of the founding the use of tolls and taxes by states
    in this regard were a primary reason why we had the
    Constitutional Convention in the first place. And out of that
    convention it was decided that the free flow of goods and
    services is so important and it matters more than letting
    states tax certain types of transactions, that you, the
    Congress, have been empowered to preempt some state actions in
    that regard, for restraining the states from enacting laws that
    disrupt the national economy by discriminating against
    interstate commerce.
        It is not a power to use lightly, but it rests with you
    because states have no incentive to get together and resolve
    this on it own. On the contrary, each state thinks it can get a
    bigger share of the national tax pie by adopting an aggressive
    nexus standard. But these--this leaves us all poorer because
    all businesses, large and small, must deal with complex tax
    regulations, uncertainty about what activities create tax
    obligations in different states, lack of uniformity between
    different states in tax rules and formulas and generally
    wasting significant amounts of time, wealth and brain power
    navigating tax compliance rather than doing more productive
    things.
        These state actions deter new investment by domestic and
    foreign businesses who want no part of this quagmire and take
    their dollars and their jobs overseas. State spending
    overwhelming, if not exclusively, exists to benefit the people
    who live and work in the state. Education, health care, roads,
    police protection, the reasons states do these things is to
    benefit the residents. Residents should be willing to pay for
    these services that they demand. Instead, what we see are many
    states offering tax credits and waivers to select residents,
    businesses and individuals, while insisting on going off out-
    of-state corporations that engage in sales in the state. This
    is backwards and it is a violation of good tax policy. A
    physical presence standard for business activity taxes would
    correct this and be in line with the benefit principle which is
    a fundamental view of taxation.
        As a country we have gone from the artisan to Amazon.com.
    But this sophistication of technological progress does not
    change the fact that state services are still based on physical
    geographic borders, so the tax system should be too.
        And state fiscal pain does not justify overruling timeless
    constitutional principles, such as the idea that states
    shouldn't be allowed to burden interstate commerce and impose
    uncertainty in the national economy.
        Sometimes small businesses call up my office, as I am sure
    they call up the other members of the panel, asking if I engage
    in activities in a state, what would create nexus. And the only
    reason answer I have for them is to send them this. This is
    BNA's annual survey of state tax actions. It is the
    questionnaire that Mr. Schroeder talked about where they ask I
    think it is over 100 questions of, would this activity create
    nexus, would this activity create nexus. This is--this should
    not be how we do our system. There has to be a better way.
        Thank you.
        [The prepared statement of Mr. Henchman follows:]

                                   __________

        Mr. Coble. Thank you, gentlemen for your testimony. We
    appreciate you being with us. We will now examine the
    witnesses.
        Mr. Schroeder, how has the uncertainty and lack of
    predictability concerning different states' nexus requirements
    affected your small business?
        Mr. Schroeder. Yeah. In my case it is simply a matter of
    management time and attention and as well as the cost and
    expense of trying to comply. We spend, as I mentioned, you
    know, over--almost a $100,000 a year in our already highly
    regulated business, and that is dollars and time and attention
    that is not spent on growing our business, launching new
    franchisees or developing new business concepts. And it is
    simply a matter of I don't know what the rules are, I probably
    could benefit from that and it would take even more of my time
    to figure out which of the 34 states I operate in I should be
    filing state tax returns in.
        Mr. Coble. Thank you, sir.
        Mr. Johnson, is it your position that states should be
    entitled to discriminate against a company based on whether it
    sells tangible goods or intangible goods and services?
        Mr. Johnson. That is certainly not my position, Mr. Chair.
    In fact that is imposed on us by Public Law 86-272. And again--
    --
        Mr. Coble. Now we--Mr. Johnson, would you oppose
    modernizing Public Law 86-272?
        Mr. Johnson. Well, if a physical presence is what is
    sought, and I don't believe a physical presence test is
    appropriate, I don't believe we should go back to the way the
    last--business was conducted in the last century to impose
    taxes in the new century, but if you want a physical presence
    standard, you have to repeal 86-272, because 86-272 allows a
    physical presence and protects it from taxation, as long as the
    activities are limited to the solicitation of sales of tangible
    personal property.
        So if a physical presence is sought, then repeal of 86-272
    is required.
        Mr. Coble. Well I thank you, sir.
        Now Mr. Henchman, speaking of physical presence, why do you
    believe that a physical presence standard for net income and
    other business activity taxes is consistent with the holding of
    Quill? If you do believe that.
        Mr. Henchman. I do believe that. The Quill decision, of
    course, by its own terms was restricted to sales taxes. And as
    Congressman Goodlatte's answer to Representative Quigley
    earlier indicated, this bill does not address sales taxes one
    way or the other, because I know different people have
    different views on that. It just deals with business activity
    taxes and the view that the physical presence--and for me it
    just comes down to the basic economics as I said in my
    testimony. The residents of a state benefit from the services
    provided by a state. And to the extent a state is providing
    benefits to nonresidents, maybe they ought to be voted out of
    office because the reason you get elected to office is to
    provide benefits to your residents that vote for you. And those
    are the people that should be paying taxes to support those
    services.
        Mr. Coble. I thank you, gentlemen.
        The Chair recognizes the distinguished gentleman from
    Michigan. I yield back my time, by the way. Mr. Conyers is
    recognized for 5 minutes.
        Mr. Conyers. Thank you, Chairman Coble.
        Mr. Johnson, is--are there any tax avoidance opportunities
    that we ought to frankly talk about here? It has been said that
    we might create tax planning opportunities to eliminate tax--
    state taxation revenues that are earned in a state. Can you
    amplify?
        Mr. Johnson. Yes. Thank you, Congressman.
        As I indicated, I practiced for 17 years representing
    businesses, many of them large businesses. And if this bill
    were passed in its current form it would be malpractice for me
    not to recommend a number of structuring techniques.
        One of the simplest would be to take the issue of a toy
    store, Toys R Us, for example. And I use that example because
    it is the subject of some well known litigation. For any
    retailer----
        Mr. Conyers. Does some of that litigation----
        Mr. Johnson [continuing]. Doing business in the state----
        Mr. Conyers. Does some of that litigation involve tax
    avoidance?
        Mr. Johnson. Yes, it does. By creating an intangible
    holding company and charging a royalty, then a company can
    essentially eliminate its profits in a state or reduce them
    dramatically by paying a royalty to a holding company in
    Delaware or offshore and deducting the royalty which can
    completely eliminate its profit margin in the state. That would
    be a simple example.
        Another example would be creating a--if I had a business
    that was selling software for payroll and software for accounts
    receivable, for example, and part of my business model was to
    be able to repair and install that software and say I got a
    third of my revenue from each of those things, I would simply
    create three different subsidiaries. The repair subsidiary
    would then become subject to Utah tax. I could structure the
    sales of the payroll subsidiary and the sales of the accounting
    subsidiary to be exempt from Utah tax. I could cut my Utah tax
    in--by two-thirds by the simple expedient of creating three
    separate subsidiaries.
        Mr. Conyers. Any Federal tax opportunities involved?
        Mr. Johnson. Well, the Federal tax--this same kind of
    planning goes on at the Federal level.
        Mr. Conyers. It could be local or Federal taxes?
        Mr. Johnson. Yes.
        Mr. Conyers. Okay.
        Mr. Johnson. But this would provide a blueprint for
    legitimized--and tax planning is something we recognize is
    legitimate.
        Mr. Conyers. Well----
        Mr. Johnson. A company has no moral obligation----
        Mr. Conyers [continuing]. Look, we just left the Wall
    Street debacle and there were some tax organizations that
    didn't do very well in those investigations.
        Mr. Johnson. There is definitely a line that can be
    crossed. But this would authorize many of these techniques.
        Mr. Conyers. Well, you have sufficiently disturbed me with
    this information.
        Thanks, Chairman.
        Mr. Coble. Thank you, Mr. Conyers.
        I say to my Members, we are going to have a vote here soon.
    I think we can probably wrap this up.
        I am now recognizing the distinguished gentleman from South
    Carolina.
        Mr. Gowdy. Thank you, Mr. Chairman.
        Mr. Coble. I almost demoted you, Trey.
        Mr. Gowdy. And California would never allow me to set foot
    in that state, Mr. Chairman, I don't think. I am sure I have
    warrants pending.
        Mr. Henchman, the substantial nexus test, how--what are the
    elements of it, how is it applied today?
        Mr. Henchman. It is laid out in the--for--in this case it
    is laid out in the bill and essentially--it is essentially
    property and payroll. And I do want to indicate that it is a
    substantial nexus test, not the sufficient context test used
    for personal jurisdiction, as Mr. Johnson indicated, that is a
    completely less--that is a lower standard that the Supreme
    Court has never held to be the case for tax purposes.
        Mr. Gowdy. Are there limits to Congress' ability to
    regulate state tax structures?
        Mr. Henchman. This bill does not address that, so----
        Mr. Gowdy. In your judgment, are there limits to what we
    can do with respect to state tax structures?
        Mr. Henchman. Well, the Constitution permits the Congress
    to regulate commerce as it sees fit.
        Mr. Gowdy. Yeah, but that is a very amorphous, increasing
    elastic----
        Mr. Henchman. It is.
        Mr. Gowdy [continuing]. Term.
        Mr. Henchman. It is. And in terms of preempting certain
    state activities, I think even a limited reading of the
    Commerce Clause finds that power existing with Congress. There
    are----
        Mr. Gowdy. Mr. Johnson, you----
        Mr. Henchman [continuing]. Probably a lot of things you
    could----
        Mr. Gowdy. Let me ask, Mr. Johnson. What are the limits as
    you see them? Because I didn't write the note down and at my
    age my memory slips, but you questioned, perhaps or maybe I
    misunderstood you, whether Congress would have the authority to
    do certain things with respect to state tax structures or
    perhaps--I don't want to put words in your mouth. What do you
    think about it?
        Mr. Johnson. I think there are certainly--I think there are
    certainly steps that Congress could take that would be so
    extreme that they could be struck down as unconstitutional.
    P.L. 86272 has not been challenged, to my knowledge, so I
    don't--our position is not that this bill would be
    unconstitutional, our position is that just because the Federal
    Government may have the authority to impose this bill doesn't
    mean it is a good idea.
        Mr. Gowdy. What remedy would you propose?
        Mr. Johnson. I would echo the comments of Congressman
    Cohen. I would like to see the businesses get together with the
    states and have a brighter line standard. I think it should
    include sales, but I think there should be some clear de
    minimis standards.
        I tried to propose something in Utah and I didn't get much
    support from anyone, either on the business side or from my
    legislators on it. But I--as someone who, again, has
    represented taxpayers, I do think more certainty in the area
    would be appropriate. And I would encourage states to adopt
    brighter line standards. But I think the states should be able
    to do so based on their own elected legislators. And I would
    encourage the business community to work with the states in
    accomplishing that.
        Mr. Gowdy. Mr. Henchman, what would be your perspective on
    that remedy?
        Mr. Henchman. Well, I would say there is no incentive the
    states will ever do that. And on the contrary, the incentive is
    to move away from apportionment--away from uniformity. And we
    have seen that in apportionment, where back in the '50's
    Congress and through the Willis Commission threatened, look,
    this is a mess in apportionment, and so you guys just need to
    adopt a standard otherwise we are going to do it for you. And
    it took until a bill nearly being passed by Congress for the
    states to get together and adopt a uniform standard.
        And since Congress has moved to other matters, the states
    have now wandered off and now we have all these different
    apportionment standards. That is the way states go on these
    things. It is going to take Congress or the courts to impose
    uniformity, the states are not going to do it on its own.
        Mr. Gowdy. Mr. Schroeder, I am from South Carolina and if I
    can help you navigate that form, I will be happy to try and
    help, but thank you for doing business in South Carolina.
        And with that I would yield back the remainder of my time,
    Mr. Chair.
        Mr. Coble. I thank the gentleman from South Carolina.
        The gentleman from Tennessee, Mr. Cohen is recognized.
        Mr. Cohen. Thank you, sir.
        Are all of you all familiar with the Section 4 of this H.R.
    1439? Mr. Johnson, you are?
        Mr. Johnson. Pardon me?
        Mr. Cohen. Section 4, the new section in H.R. 1439?
        Mr. Henchman. The Joyce Finnigan Provision I think?
        Mr. Johnson. Yes.
        Mr. Cohen. You're familiar with it then. What do you think
    about it, sir? It was not in the prior Business Activities
    Simplification Act.
        Mr. Johnson. Well----
        Mr. Cohen. How does that impact state governments?
        Mr. Johnson. To--a simple example would be the--under the
    prior versions of the bill the technique I talked about where
    you would set up an intangible holding company for trademarks,
    that would not have worked in Utah, because we are a combined
    state. We would have taken the position that both the trademark
    holding company and the retailer are a single business entity
    as long as one of them has nexus in the state, the other one
    wouldn't. So that technique would not have worked under prior
    bills.
        Under this bill it will work because we are required to
    consider each individual member of the combined group,
    individually, for purposes of determining whether or not it has
    nexus under this provision. So this is a dramatic expansion of
    the preemption.
        Mr. Cohen. So you are against it?
        Mr. Johnson. I am very much against it.
        Mr. Cohen. Yeah, I would think so.
        Mr. Henchman, where are you on this?
        Mr. Henchman. The--what is at issue here is basically two
    different interpretations of how you calculate nexus for
    different states, it is known as the Joyce standard and the
    Finnigan standard. The Joyce standard brings in--does not bring
    in entities for which the state doesn't have nexus, the
    Finnigan standard does.
        We view the Finnigan standard as the more aggressive one
    and the Joyce one as not. And this statute would enshrine the
    Joyce standard which limits state taxation to those entities
    that are actually have nexus with the state.
        Mr. Cohen. Mr. Schroeder, are you familiar with this?
        Mr. Schroeder. I am sorry, I didn't hear.
        Mr. Cohen. Are you familiar with this section of the law?
        Mr. Schroeder. I am not in detail, but judging from what I
    am hearing is, you know, what we are looking for as a small
    business is simply a bright line test that helps us establish
    where do we have nexus and understanding why, because we want
    to make sure we spend as much of our resources as possible
    helping our franchisees grow and to grow their business and we
    need some clarity and reduction of uncertainty to be able to do
    that.
        Mr. Cohen. Now you are a franchisor.
        Mr. Schroeder. Right.
        Mr. Cohen. And you are here because you are a member of the
    franchise association, but you don't necessarily representative
    the franchise association. Is that correct?
        Mr. Schroeder. Correct.
        Mr. Cohen. All right. So you do not know the--but the
    franchise association is 100 percent consistent with your
    position?
        Mr. Schroeder. Yes.
        Mr. Cohen. Okay. I got you.
        I yield back the remainder of my time. Thank you.
        Mr. Coble. Thank you.
        Trent, if you can keep it fairly brief I think we can get
    out of here, if you will do that.
        Mr. Franks. I will move it, Mr. Chairman.
        Mr. Coble. The distinguished gentleman from Arizona, Mr.
    Franks.
        Mr. Franks. All right. Mr. Johnson, what is your response
    to the stories from companies such as Outdoor Brands that small
    businesses facing this kind of Hobson's Choice of either hiring
    expensive accountants to decipher the various state laws or the
    state nexus rules or roll the dice and just make the best
    conclusion they can and sometimes end up having a major tax
    liability. I mean isn't that sort of a textbook example of kind
    of taxation without--that is unduly burdens to interstate
    commerce?
        Mr. Johnson. Well, as I stated, Congressman Franks, I have
    some sympathy for that position and I think the states have
    been somewhat derelict in not providing clearer standards. And
    I think a clear standard, for example, might include a de
    minimis amount of sales. If you don't have more than $250,000
    worth of sales into the state, for example, that might be a
    good bright line.
        But with regard to franchises, franchise--the whole idea of
    a franchise is that when I am driving through Colorado or
    Wyoming or South Carolina and I see a franchise that I am
    familiar with from Utah, I am more likely to go to that
    business. I am more likely to participate there, patronize that
    business because it has built up good will in the state. So to
    say that a franchisor doesn't benefit from the market created
    in Utah, I think frankly is not correct.
        Mr. Franks. Well, Mr. Henchman let me just ask you one
    question here sort of a combination question.
        I know that some states are already using the physical
    presence standard for net income and business activity taxes,
    even though I don't think the Supreme Court has ever required
    it. So touch on that.
        And then also the recent Iowa Supreme Court decision held
    that Kentucky--a Kentucky franchiser had a physical presence in
    Iowa because the franchisee was using the franchisor's
    intellectual property to, you know, pursuant to a franchisor
    contract arrangement. And that is--boy, that is something that
    is very hard for a business to--you know, I came from a small
    business background----
        Mr. Henchman. Right.
        Mr. Franks [continuing]. And sometimes businesses don't
    know whether to jump or go blind. And tell me, what do you
    think about that and what is the answer to it.
        Mr. Henchman. Sure. I mean Mr. Johnson and I think some of
    the members have talked about tax planning. There is also
    issues of this is just how they have designed the business. I
    mean if somebody is structuring their business with the intent
    of avoiding taxes they owe, then Mr. Johnson and his fellow tax
    commissioners have the legal power to go after them. I mean you
    can do (inaudible) reporting, you can do unitary, you do a
    whole bunch of other--and you can prosecute them.
        If it is just made up to avoid taxes you can go after them
    and nothing in this bill stops that. But with people who
    legitimately structured their business in that way, they face a
    lot of problems the way the system is set up now.
        Mr. Franks. Yeah. Well Mr. Chairman, I will just make a
    comment and I am through. It seems to me, you know, the IRS and
    tax agencies are always saying that businesses and individuals
    have every right to pay as little taxes as they can, within the
    clear confines of the law. But when the confines of the law are
    just completely murky it is not fair to businesses or
    individuals and it is the responsible of Government to make
    those lines clear. And of course, in my judgment, also to
    somehow find ourselves somewhere in the vicinity of the
    Constitution at the same time.
        So with that I yield back.
        Mr. Coble. I thank the gentleman.
        Good news for the witnesses, we won't keep you here all the
    rest of the afternoon waiting for us to return. I thank you all
    for your testimony. Your written statements will be made part
    of the record.
        We appreciate those in the audience for your presence today
    as well.
        Without objection all Members will have 5 legislative days
    to submit to the Chair additional written questions for the
    witnesses which we will forward and ask the witnesses to
    respond as promptly as they can do so with their answers that
    may also be made a part of the record. Without objection all
    Members will have 5 legislative days to submit any additional
    materials for inclusion in the record.
        And this hearing stands adjourned.
        [Whereupon, at 2:35 p.m., the Subcommittee was adjourned.]

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                   Material Submitted for the Hearing Record