State Business Activity Taxes Need Clarification, One Standard, Witnesses Say

Daily Tax Report

February 15, 2008

Stakeholders Feb. 14 urged Congress to establish standards outlining when states can levy business activity taxes on out-of-state businesses, saying without a clarification, small businesses growth will be inhibited by oft-changing taxes levied at each state's will. David Rolston, the president and chief executive officer of Hatco Corp., Milwaukee, testifying on behalf of the North American Association of Food Manufacturers, said lawmakers should make sure small businesses "only pay taxes in states where we have a physical presence and receive government services."

The testimony came at a hearing of the House Small Business Committee, which was examining new legislation (H.R. 5267), and where its members said statutory changes are necessary to keep small businesses alive and growing.

"Having to pay unpredictable taxes inhibits the growth potential for small businesses and our economy at large," said committee Chairwoman Nydia Velazquez (D-N.Y.).

"State revenue collectors are taxing America's small businesses to death through the business activity tax," said committee ranking member Steve Chabot (R-Ohio).

Bill Would Set National Guidelines

The bipartisan legislation, long sought by corporations but sharply criticized in the past by state groups and governments, is particularly focused on setting national guidelines for when a business would be considered to have physical nexus with a state, with one general guideline being that a company must use employees or services in a state for 15 days or more in a calendar year before it is liable to pay business activity taxes to that jurisdiction (26 DTR G-5, 2/8/08).

The bill, by Reps. Rick Boucher (D-Va.) and Bob Goodlatte (R-Va.), pays special attention to whether digital commerce, Internet use, the movement of intangible goods and software, and like activities would create physical presence in a state. It takes the position that, in general, those activities should not create undue tax burdens.

The witnesses described situations in which particular states declared their businesses had created nexus and then came after them for taxes, with Barry Godwin, the controller at Stingray Boat Co., Hartsville, S.C., saying the activities of the state of New Jersey in 2007 amounted to "extortion."

Stingray, he explained, builds fiberglass boats and ships them throughout the United States and internationally. In July 2007, a New Jersey revenue agent called Godwin to explain that one of his trucks had been stopped at a weigh station and could not move until he paid a fee based on his past seven years of sales into New Jersey.

Godwin said his company decided to pay the fee to allow the driver and truck to leave New Jersey after consulting with another boat company that had been in litigation with New Jersey for two years at a cost of more than $140,000. Godwin said Jersey officials said the act of delivering boats in their state created the nexus. "I didn't have a choice," he said. Rolston said his company chooses to make a "strictly economic decision" and picks the easiest and cheapest resolution of the matter.

Tara Bradshaw, spokeswoman for the Coalition to Protect Interstate Commerce, said the "entrepreneurial spirit upon which this great country was founded and which allows large and small businesses alike to be the engine of growth for our economy, is being jeopardized as an increasing number of states clearly are overreaching in their efforts to collect state business activity taxes."

Recommendations for Changes

"The way states are imposing burdensome rules, and changing them every year--first it is an unfair tax on intellectual property and secondly it has created a subsidy for lawyers and accountants," said Stephen Joost, chief financial officer of Firehouse Restaurant Group Inc., Jacksonville, Fla., testifying for the International Franchise Association.

Joost said neither he nor his company opposes paying taxes, but they oppose spending hundreds of thousands of dollars to figure out how to pay their taxes because they have to hire "an army of accountants and lawyers" to do it.

He recommended Congress create a single set of rules defining what constitutes nexus and how it would be applied in all 50 states. Nexus also should be defined in a more "conservative and common sense way," he said. "The fact that if I merely step foot in a state creates a taxing event is incredulous," he said.

Witnesses said that, in some cases, they had to scale back their operations in certain states and in other cases they begrudgingly continue operations, despite the loss of money that lowers their profit margins.

Velazquez asked if the codification of physical presence would result in increased tax avoidance or sheltering by corporations and, therefore, a decrease in state revenues, but Peter Johnson, a senior economist and vice president for the Direct Marketing Association, said he did not believe that would be the case.

"There is no question in my mind whatsoever that a clear boundary is to everyone's benefit, including obviously the states, who would then be able to tax properly the resulting revenue from increased activity by small businesses," Johnson said.

The committee did not have opponents of the legislation testify. States have vigorously opposed the bill over time, arguing it would rob them of their taxing sovereignty, their ability to combat abuses, and their ability to raise needed revenues and provide services used by the business community.

The Multistate Tax Commission, meanwhile, sent a letter Feb. 13 to the House Judiciary Committee, which has jurisdiction over the legislation, to express opposition to the measure, saying a nexus threshold "even loosely based on the current text of [H.R. 5267] would foster inequity between big and small business, and thus create an unbalanced environment where giant multistate and multinational corporations could compete, without paying taxes, with local businesses."

"I have never sat at a hearing on highway robbery before," said Rep. Todd Akin (R-Mo.). Text of the MTC letter is in TaxCore.

Prepared testimony from the hearing is available at http://www.house.gov/smbiz/hearings/hearing-02-14-08-business-tax/hearing-02-14-08-business-tax.htm.

By Heather M. Rothman