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August 4, 2015
Wholesalers Soon To Be Taxable Under Economic Nexus In Washington
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So, can state tax compliance get any more complex?  Yes.  Yes it can.  Effective September 1, 2015, Engross Substitute Senate Bill 6138 (ESSB 6138) provides that wholesalers that sell into or out of Washington will no longer be subject to the physical presence rules of Quill;[1] instead, they will be subject to economic nexus rules (similar to the rules that have applied to services, royalties and financial income since June 1, 2010).  This is some good news if you are an instate wholesaler, making interstate sales to non-Washington jurisdictions.  On the other hand, this is bad news for out-of-state wholesalers, making inbound sales into Washington that exceed $267,000 in a tax year.

What Are the Effects of ESSB 6138?

The statute breaks down into two primary analytical components.  First, the taxpayer must determine where to “source” the sales.  This determines whether Washington has the potential to tax the sale.  Second, for the out-of-state wholesaler, if those Washington-sourced sales are more than $267,000 annually, then the Business and Occupations (“B&O”) tax applies.  If they are $267,000 or less, then the tax does not apply.  Because the statute, as it presently exists, does not make taxability at the destination state a predicate for sourcing, the instate sellers will not have a tax obligation in Washington on any of their outbound sales, whether or not they exceed $267,000.

Because the rules governing Washington’s B&O tax system are not the same as the state income tax, this could also result in the out-of-state wholesalers bearing two business taxes.  They, in effect, get two helpings of ipecac.  One tax will be the income tax at the taxpayer’s location.  That’s one helping.  The other tax will be the B&O tax in Washington where the taxpayer consumes very few government services (because it’s not physically present in the state to receive police, fire, environmental, instate college tuition and so forth that the gross receipts tax purchases and provides for taxpayers).  That’s the second helping.

For the instate wholesalers, they source their sales to the out-of-state destinations.  They, in effect, get two scoops of ice cream.  They will not pay a Washington gross receipts tax on those sales sourced out of state.  That’s one scoop. If they don’t exceed “mere solicitation”[2] in destination states, they will pay no income tax in those states either. That’s two scoops.

How Are the Gross Receipts Sourced?

ESSB 6138 relies on RCW 82.32.730 to source the sales.  These are the sourcing rules from the Streamlined Sales and Use Tax Agreement.  The statute sets forth a “cascading” set of rules to source the sale:

  1. At the seller’s location when the buyer takes possession at the seller’s location.
  2. At the buyer’s location when the buyer does not take possession at the seller’s location.
  3. When 1) and 2) do not apply, then the purchaser’s address in the seller’s business records.
  4. When 1), 2) and 3) do not apply, then the address for the purchaser gave the seller purchase (including the address of a purchaser's payment instrument, if no other address is available) when use of this address does not constitute bad faith.
  5. When 1), 2), 3) and 4) do not apply, then  the location is from which tangible personal property was shipped (rules vary a bit if digital products are involved).

In most situations, 2) will apply.  When it does, then for an out-of-state wholesaler, if the aggregated annual sales exceed $267,000, then that wholesaler has economic nexus and must pay wholesaling B&O tax to Washington State.  The instate wholesaler selling to destination states … regardless of whether it has economic nexus in those states … will pay no wholesaling B&O tax because Washington’s sourcing sales have been allocated the sales to another state.

Isn’t There Irony When Viewed Through the Lens of the Commerce Clause? 

The U.S. Supreme Court says that the Commerce Clause permits a state to tax a portion of a taxpayer’s interstate sales to compensate it for the government services that it provides to that out-of-state seller.  So, it is ironic that the instate wholesaler, with a warehouse, equipment and employees, that consumes nearly every government service that Washington offers, 365 days per year, compensates the state for none of those government services[3] because it pays no gross receipts on these out-of-state sourced sales.  Yet, the out-of-state wholesaler, which has no physical presence in the state on any day of the year, pays on 100% of its Washington-sourced sales.  Clearly, this taxing scheme shifts the tax burden to the out-of-state businesses so that they subsidize the instate businesses that actually consume the services.  Isn’t precisely what the Commerce Clause should prevent?

Speaking of the Commerce Clause, does this tax pass constitutional scrutiny?  The legislation itself raises that question in ESSB 6138, Sec. 201 because it acknowledges that the U.S. Supreme Court has never stated whether physical presence nexus is required for a business tax.  To rationalize its decision to extend economic nexus to wholesale sales, it notes that Quill only address sales tax collection.  So, to its way of thinking, whether physical presence is required is an open question. 

However, Complete Auto[4] does still apply and substantial nexus is only a part of the required analysis.  It provides a four-prong test that a state tax must satisfy before the Commerce Clause permits tax on interstate sales.  The taxpayer must have substantial nexus with the state, the tax must be fairly apportioned, the tax cannot be facially discriminatory and the tax must be fairly related to the government services. 

Putting aside the substantial nexus question, is it possible that the tax is facially discriminatory when instate wholesalers selling in interstate commerce pay no B&O tax but the out-of-state wholesaler pays B&O tax?  Does a single sales apportionment factor measure the activity in the state that generates the gross receipts if the out-of-state wholesaler has no physical presence in Washington?  Is the tax fairly related to the services provided when the instate wholesaler pays no B&O tax even though it can consume every government service, while the out-of-state wholesaler without physical presence pays B&O tax when, logically, it can consume a very limited number of Washington’s government services?

[1] Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

[2] See Public Law 86-272

[3] It is true that such businesses pay other taxes like the property tax, sales and use tax, real estate excise tax and other excise taxes, but the tax under scrutiny is the B&O tax.  The U.S. Supreme Court does not look at the totality of taxes; it analyzes the specific tax applied.

[4] Complete Auto Transit v. Brady, 430 U.S. 274 (1977)


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