State and Local Tax Alert - December 2016

December 2016

Ohio Supreme Court Holds That Physical Presence Isn’t Necessary For Imposition of Commercial Activity Tax


On November 17, 2016, the Ohio Supreme Court decided Crutchfield Corp. v. Testa, Slip Opinion No. 2016-Ohio-7760, Newegg, Inc. v. Testa, Slip Opinion No. 2016-Ohio-7762, and Mason Cos., Inc. v. Testa, Slip Opinion No. 2016-Ohio-7768.  The court held that a taxpayer’s physical presence in Ohio is not a necessary condition for imposing the Commercial Activity Tax (“CAT”).  In addition, the court held that the CAT’s $500,000 sales-receipts presence standard satisfies the substantial nexus requirement of the “dormant” Commerce Clause under the United States Constitution, even if a taxpayer does not maintain a physical presence with the state.


Crutchfield Corporation (“Crutchfield”) is a company based in Virginia that sells consumer electronics through the Internet from locations outside of Ohio and ships its products using the U.S. Postal Service or common-carrier delivery services.  During the periods at issue, Crutchfield did not employ any personnel and did not maintain any facilities in Ohio.  Crutchfield’s sole business in Ohio consisted of shipping goods from outside of the state to its consumers in Ohio.  Newegg, Inc. and Mason Cos., Inc. included similar fact patterns and were companion cases to Crutchfield.
The Ohio tax commissioner originally issued multiple quarterly CAT assessments from 2005 to 2012, which imposed the CAT on revenue Crutchfield earned from its Internet sales of electronic products that it shipped into the state.  The CAT is a tax for the privilege of doing business in Ohio and is imposed on the Ohio taxable gross receipts of companies doing business in the state.  Crutchfield contested the assessments and argued that the assessments violated the substantial nexus standard of the Commerce Clause because the company lacked a physical presence in the state.  On February 26, 2015, the Ohio Board of Tax Appeals (“BTA”) affirmed the assessments and noted that it lacked jurisdiction to invalidate an Ohio tax statute on constitutional grounds.  The taxpayers subsequently appealed the decision to the Ohio Supreme Court.
Crutchfield’s Arguments
On appeal to the Ohio Supreme Court, Crutchfield argued that it lacked a substantial nexus with Ohio due to its lack of physical presence in the state.  Crutchfield maintained that a physical presence is necessary to create substantial nexus under the Commerce Clause for the imposition of the CAT, and relied on the U.S. Supreme Court’s ruling in Quill Corp. v. North Dakota, 504 U.S. 298 (1992).  In addition, Crutchfield argued that the decision in Tyler Pipe Industries, Inc. v. Washington State Dept. of Revenue, 483 U.S. 232 (1987) effectively imposed a physical presence requirement on business privilege taxes measured by gross receipts such as the CAT (and the Washington Business and Occupation Tax in Tyler Pipe).
Ohio Supreme Court Holding and Analysis
The Ohio Supreme Court first held that, although a physical presence in the state may provide a sufficient basis for finding substantial nexus in the state, the Quill physical presence requirement does not apply to a business privilege tax such as the CAT.  According to the Ohio Supreme Court, as long as imposition of a business privilege tax is based on an adequate quantitative standard that ensures that the taxpayer’s nexus with the state is substantial, then such tax may be imposed under the Commerce Clause even if the taxpayer lacks a physical presence.  The court held that the $500,000 sales-receipts threshold under Ohio Rev. Code § 5751.01(I)(3), which Crutchfield met during the periods at issue, was an adequate quantitative standard for constitutional CAT purposes.
In reaching this conclusion, the court interpreted the Quill decision’s physical presence requirement as limited to sales and use taxes.  In addition, the court noted that gross receipts taxes on an interstate seller should be comparable constitutionally to a net income tax, because the legal and economic incidence of both types of taxes are imposed on the seller.  Conversely, the economic incidence of a sales or use tax is imposed on the consumer.  The court stated that following the Quill decision, most state courts have explicitly rejected the extension of the Quill physical presence standard to taxes based on or measured by net income.  The court found the affirmation of the economic presence nexus in net income tax cases as supporting its conclusion that the physical presence standard does not apply to the CAT.  In response to Crutchfield’s argument that Tyler Pipe effectively imposed the Quill physical presence standard on business privilege taxes, the court held that the most accurate characterization of Tyler Pipe is that a taxpayer’s physical presence is a sufficient, but not necessary, condition for imposing a business privilege tax.
In the absence of a physical presence requirement, the court then evaluated the CAT’s constitutionality and its burden on interstate commerce.  In its analysis, the court relied on Pike v. Bruce Church, 397 U.S. 137 (1970), noting that when a state statute “regulates even-handedly to effectuate a legitimate local public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits.” The court found that the burdens imposed by the CAT on interstate commerce were not “clearly excessive” in relation to Ohio’s legitimate interest in imposing the tax evenhandedly on the receipts of in-state and out-of-state sellers.  In addition, the court noted that the state attempted to remove the possibility of the CAT being excessive by setting a minimum sales-receipts threshold.  Therefore, the court held that the $500,000 sales-receipts threshold complies with the substantial nexus requirement and affirmed the BTA’s decision imposing the CAT assessments.  The dissenting opinion argued that the CAT was indistinguishable from the taxes at issue in Quill and Tyler Pipe, and the sales-receipts threshold should have been held unconstitutional.

BDO Insights

  • Out-of-state taxpayers with no physical presence in Ohio, but who meet or exceed the $500,000 sales-receipts threshold, should evaluate their nexus exposure for purposes of the Ohio CAT.  As part of such evaluation, taxpayers should consider whether to participate in Ohio’s voluntary disclosure program.
  • While the taxpayers in these companion cases will likely seek review by the United States Supreme Court, the Ohio Supreme Court has upheld the CAT’s $500,000 sales-receipts threshold as substantial nexus.  Taxpayers that do not maintain an Ohio physical presence, but that meet or exceed the sales-receipts threshold, will need to file CAT returns for current and future tax periods.  Such taxpayers, however, should consider filing protective refund claims should the United State Supreme Court issue a writ of certiorari and decide in favor of the taxpayers.    
  • While Crutchfield et al. could support other states with similar sales-receipts thresholds for purposes of establishing nexus for their gross receipts taxes (e.g., Washington’s $250,000 sales-receipts threshold), the ruling of the Ohio Supreme Court appears limited to taxes on or measured by net income and gross receipts.  The Quill physical presence standard is under attack in multiple states with regards to sales and use taxes (e.g., Alabama, South Dakota, Tennessee, and Vermont).  See the Alabama BDO SALT Alert, the South Dakota BDO SALT Alert, the Tennessee BDO SALT Alert, and the Vermont BDO SALT Alert that discuss the economic nexus standards in those states.  These states argue that the physical presence standard is outdated for the current remote retailing environment and technology and are attempting to assert jurisdiction to impose sales and use tax collection obligations on remote sellers having only a sales-receipts threshold “contact” with the state.  The distinctions drawn by the Ohio Supreme Court in Crutchfield et al. between business privilege taxes and sales and use taxes appear to preclude the cases from supporting these state sales and use tax economic presence nexus efforts.  


For more information, please contact one of the following regional practice leaders:

West:   Atlantic:
Rocky Cummings
Tax Partner

  Jeremy Migliara
Tax Managing Director

Paul McGovern
Tax Managing Director
  Jonathan Liss
Tax Managing Director

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Tax Partner

  Angela Acosta
Tax Managing Director

Matthew Dyment
Tax Principal

  Nick Boegel
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  Joe Carr
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Tax Managing Director

  Mariano Sori
Tax Partner

Scott Smith
Tax Managing Director

  Richard Spengler
Tax Managing Director

Tony Manners
Tax Managing Director


Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner