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Isolated and sporadic contacts by equipment installers do not create requisite degree of "physical presence" for manufacturer
Eleven in-state visits in 48 months by an out-of-state equipment manufacturer's installer technicians do not satisfy the bright-line "physical presence" test for substantial nexus. More than a "slightest presence" is required to satisfy the Commerce Clause. These contacts are found to be "isolated and sporadic" and, therefore, insufficient to allow the taxing state to insist that the vendor collect use tax.
In the Matter of the Appeal of Intercard, Inc. Kansas Supreme Court, December 8, 2000
In a treatise-like opinion that contains a singularly succinct statement of current Commerce Clause jurisprudence, the Kansas Supreme Court says that 11 in-state visits in four years by an equipment maker's installers do not make for constitutionally mandated "physical presence," sufficient to require the company to collect use tax. This substantial-nexus controversy is noteworthy for having attracted the attention of the Multistate Tax Commission, the Committee on State Taxation, and the Direct Marketing Association, each pressing its point of view as a "friend of the court."
The company in question is Intercard, Inc., a Missouri-based manufacturer and marketer of electronic data cards and card readers. The Intercard system allows a customer to use a card to purchase photocopies. The company sells its products to more than 400 of the ubiquitous Kinko's copy stores nationwide, including a number in Kansas.
Intercard delivers its products to customers via common carrier (UPS). On occasion, a Kinko's purchaser asks Intercard to send a technician to its store to wire a card reader. During the period at issue (April 1992 through March 1996), Intercard technicians made 11 visits to Kinko's locations in Kansas to install card readers. These visits occurred during 3 out of the 48 months in the audit period, none after March 1994 (halfway through the audit period), and the technicians spent a total of 44 hours with the Kansas customers. (Wiring a card reader typically took approximately four hours.)
The technicians' visits were limited to installation; Intercard did not send employees or agents into Kansas to solicit sales. The company's executives negotiated a master contract for cards and card readers with their Kinko's counterparts in California and Missouri.
Isolated and sporadic: The Department of Revenue insists that the presence of Intercard's installers in Kansas establishes nexus sufficient to require the company to collect Kansas use tax (an obligation that apparently no other state has sought to impose on Intercard). Intercard protested the Department's assessment, and the Kansas Board of Tax Appeals determined that the company did not have substantial nexus. Calling Intercard's contacts with Kansas "isolated and sporadic," the Board declared that the technicians' "eleven visits to Kansas during the four-year audit period do not transcend the slightest physical presence test of Quill [citation omitted] and National Geographic [citation omitted]."
Appealing to the Kansas Supreme Court, the Department avers that the Board incorrectly "applied a substantial physical presence requirement and improperly minimized the significance of Intercard's installation activities in Kansas." The Department adds that the Board's finding that Intercard's contacts were "very minor activities in [Intercard's] business, both in time spent and revenue generated," is contrary to the facts. The Multistate Tax Commission, in its amicus brief supporting the Department, argues that Intercard's local activities exceed Quill's "safe harbor," which protects a vendor whose only connection with the taxing state is by common carrier or mail. The Direct Marketing Association weighs in for Intercard, asserting that its connection with Kansas "is insubstantial" and warning that "if random, fortuitous physical contacts are sufficient to constitute a substantial nexus, interstate commerce will suffer as companies face burdens of calculating and collecting sales and... use taxes for a myriad of jurisdictions."
Physical presence primer: The Kansas high court painstakingly reviews numerous U.S. Supreme Court and state court opinions construing the contacts which may constitute "substantial nexus." The court devotes much discussion to the New York Court of Appeals's decision in Orvis. The court there explained that in discerning whether an out-of-state seller must collect use tax on in-state sales, anything more than the "slightest" physical presence in the taxing state is enough to establish substantial nexus. ("We do not read Quill... to make a substantial physical presence of an out-of-state vendor in New York a prerequisite to imposing the duty upon the vendor to collect use tax from its New York clientele.") The New York court found that even sporadic visits to local customers by the seller's employees satisfied this standard. (See Orvis Co. v. Tax Tribunal, 86 NY2d 165, 654 N.E.2d 954 (1995).)
The Kansas court concludes its survey of substantial nexus notions with this concise summary:
[T]he Commerce Clause requires a taxing state to have substantial nexus with an out-of-state business to impose use tax collection and remittance duties. See Complete Auto, 430 U.S. at 279. Substantial nexus requires a finding of physical presence in the taxing state. Bellas Hess, 386 U.S. at 758. The continuous physical presence of offices and employees in a taxing state is sufficient to impose a use tax collection duty even though the in-state presence is unrelated to the transaction being taxed. National Geographic, 430 U.S. at 560. Mail order sales without more are a "safe harbor" for out-of-state vendors. Bellas Hess, 386 U.S. at 758. A slightest presence is not sufficient to establish a substantial nexus, National Geographic, 430 U.S. at 556, but some states have found that "more than a slightest presence" is sufficient. Orvis, 86 N.Y.2d at 178. The physical presence requirement may turn on the presence in the taxing state of a small sales force, plant, or office. Quill, 504 U.S. at 315.
Without elaborating on how much physical presence is needed to create substantial nexus -- except to agree that a "slightest presence" is not enough -- the Kansas Supreme Court upholds the Board of Tax Appeals's determination, reiterating its conclusion that "Intercard's 11 incursions to install card readers in Kansas were isolated, sporadic, and insufficient to establish a substantial nexus to Kansas."
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Review Observations:The Board, in its decision dismissing the assessment, seemed to attach some significance to the fact that Intercard's installers were asked to come into Kansas by its Kinko's customers: "[These visits] were in response to customer requests; had there been no requests, [Intercard] would have had no physical contacts with the state. [Intercard] initiated none of the contacts and did not use the contacts to promote the sales of its products." The Kansas Supreme Court does not mention this circumstance in confirming the Board's conclusion.
"Nexus forever" is a thorny issue which the court does not need to address in this instance (because it agrees that Intercard never possessed the requisite physical presence to require it collect Kansas tax). But Intercard's experience dramatically demonstrates the potential problem. As mentioned above, while the audit of Intercard covered four years, all of the company's contacts with Kansas -- on which the Department premised its assessment -- ceased midway through that period. In other words, for the last two years of the audit period, Intercard had no physical presence -- slight, substantial, or in between -- in the state. Suppose, however, that Intercard's (or some other taxpayer's) activities in the first two years were sufficient to create substantial nexus with Kansas. Would Intercard (or the other similarly-situated taxpayer) be forever obligated to collect Kansas use tax? If not, when and how would that obligation end? Questions, it seems, for another case.
(from Sales & Use Tax Review , Vol. 8 No. 4. © 1991-2001, Corporate Tax Publishers, Inc. All rights reserved.)