Courts Take Liberties with “Physical Presence” Test

With no permanent facilities, offices, employees – or even a Washington state phone number – Lamtec Corp. still must pay state taxes, says a new co...
Robert WillensFebruary 22, 2011

In January, courts in Washington state chipped away at the barrier that once shielded companies from paying taxes where they had no physical presence. The case focused on Lamtec Corp., a Pennsylvania-based industrial-materials manufacturer that also produces products at its New Jersey facility. The company has no permanent facilities, offices, or employees in Washington, nor does it maintain an address or phone number there. Rather, Lamtec sells its products to customers that place orders by telephone.

About two or three times a year, three Lamtec sales employees visit customers in Washington. During such visits, the employees do not solicit sales directly, but answer questions and provide information about the company’s products.

Yet the Washington Department of Revenue (DoR) has assessed tax, interest, and penalties with respect to Lamtec’s activities in Washington. Lower state courts upheld the assessment, and earlier this year, the Washington State Supreme Court ruled in favor of the DoR. (See Lamtec Corporation v. Washington Department of Revenue, Wash., No. 83579-9, January 20, 2011.)

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Need for “Nexus”
Washington imposes a business and occupation (B&O) tax “for the act or privilege of engaging in business activities” on every person that has a substantial nexus with the state. In its defense, Lamtec argued that the assessment levied by Washington violates the “negative” or “dormant” commerce clause. Indeed, a tax on an out-of-state corporation must satisfy the requirements of the due process clause and the commerce clause of the U.S. Constitution. Under modern dormant commerce clause jurisprudence, for a state to tax an out-of-state corporation, the tax must be applied to an activity with a substantial nexus with the taxing state. (See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).)

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Lamtec emphasized that an entity has a substantial nexus with Washington only if it has a physical presence in the state. In fact, the company contended that physical presence requires a small sales force, plant, or office in the taxing state. But the court disagreed.

The state court noted that the U.S. Supreme Court has made it clear that an established sales force is sufficient to satisfy the nexus requirement. However, the high court has not held that an established sales force (or a physical presence) is a requirement to establish nexus.

For its part, the DoR drew the court’s attention to cases similar to the Lamtec case, in which courts found sufficient presence for substantial nexus based on contacts with the taxing jurisdiction. To Lamtec’s dismay, the state Supreme Court “found these authorities persuasive.” As a result, the court concluded that a physical presence in the taxing jurisdiction, for purposes of the B&O tax, can be based on periodic visits. Moreover, the court noted, there is “extensive language” in the Supreme Court’s decision in Quill Corporation v. North Dakota (504 U.S. 298 (1992)) — a seminal tax nexus case — that suggests the physical-presence requirement should be restricted to sales and use taxes.

Still, Lamtec pointed out that even if a “brick and mortar” physical presence or substantial sales force is not required under the due process and the dormant commerce clauses, the court should still adopt such a standard as a matter of policy “for clarity sake.” But the court refused to accommodate the company’s request.

In another Washington DoR case, Tyler Pipe Industries v. Washington Department of Revenue, 105 Wn. 2d 318 (1986), the pipe manufacturer had its principal place of business in Texas and distributed its products nationwide. Tyler did not have a place of business or employees within Washington but used independent contractors to perform the function of sales representatives. The court concluded that “the crucial factor” governing nexus is whether the activities performed in the state on behalf of the taxpayer are “significantly associated with the taxpayer’s ability to establish and maintain a market in [this] state.” The court found that Tyler had a sufficient economic relationship with Washington to satisfy the nexus requirement despite the fact that it had no employees residing in Washington. The court looked to the actual activities by the in-state sales representatives that helped Tyler establish and maintain its market in Washington.

Using the activity yardstick, the court concluded that to the extent there is a physical presence requirement, it can be satisfied by presence of activities within the state. The court also noted that it does not require a presence in the sense of having a brick and mortar address within the state. The court did not see any “material difference” whether the activities are performed by a staff permanently employed within the state, independent agents contracted to perform the activities within the state, or persons who travel into the state from without. Therefore, the court concluded that the activities whose presence can establish nexus must be substantial and must be associated with the corporation’s ability to establish and maintain its market within the state.

Regarding Lamtec, the contacts made by the company’s sales representatives were designed to maintain its relationships with its customers within Washington, and those activities were significantly associated with the company’s ability to establish and maintain its market. Accordingly, there was substantial nexus, with the result that the DoR had the authority under the commerce clause to impose, in the instant case, a B&O tax.

Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for