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Limits Imposed on the Economic Nexus Principle

22 Jul 2012

"Give someone an inch and they'll take a mile." Although this phrase is usually not associated with state taxation, perhaps it should be. More specifically, in the absence of guidance from the United States Supreme Court, states have sometimes taken the inch they have been given in determining what activities are sufficient to constitute nexus for income tax purposes and stretched this inch into a mile. Taxand US discusses the holding in ConAgra Brands, Inc., its limitations on the economic nexus principle, and its impact on taxpayers.

One example of how states have arguably stretched the inch they have been given is the concept of economic nexus. Based on the economic nexus principle, several states have held that a taxpayer must simply have an economic presence in the state (and not a physical presence) to be subject to that state's income tax. While the concept of economic nexus is not novel - Geoffrey, Inc. v. South Carolina Dep't. of Revenue and Taxation, 510 US 992 (1993) was decided in 1993 - a recent court decision out of West Virginia, Griffith, etc. v. ConAgra Brands, Inc. Docket 11-0252, Supreme Court of Appeals of West Virginia (May 4, 2012), is of particular importance because it shows that the economic nexus principle does have its limits.

Taxand US discusses the economic nexus principle in greater detail

Taxand's Take

While the US Supreme Court has addressed the issue of what constitutes substantial nexus for sales and use taxes, it has not done so in the context of other state taxes. Therefore, states have created their own definitions of what activities constitute substantial nexus. Notably, some states have adopted the economic nexus principle, which holds that an entity may have nexus with a state even if it does not have a physical presence. However, taxpayers should keep in mind that just because they do business in a state that adopts the economic nexus principle, this does not mean they automatically have nexus with the state. The ConAgra Brands case demonstrates that taxpayers should analyse their specific facts to determine if nexus exists.

As a final point, taxpayers should be cautious when taking the position that they do not have nexus with a state. Pursuant to Accounting Standards Codification 740-10 (FIN 48), taxpayers may be required to book a reserve for an uncertain tax position based on the belief that they do not have nexus with a state. This determination is fact specific, but it is something that should be considered. Further, since any statute of limitations will not begin to run until the taxpayer files a tax return, this reserve may continue to grow over a number of years.

Your Taxand contact for further queries is:
John Easterday
T. +1 312 288 4015

Taxand's Take Author