Warning: The Multistate Tax Commission’s diluted version of Public Law 86-272 is spreading to Ohio
Under Public Law 86-272 (“P.L. 86-272”), codified at 15 U.S.C. 381 et seq., states may not impose a net income tax on the “income derived within such State * * * from interstate commerce” if the taxpayer’s only business activities in the state involved (i) solicitation of orders for sales of tangible personal property, which are (ii) sent outside the state for approval and, (iii) if approved, are filled by shipment or delivery from a point outside the state. In the age of internet sales, revenue departments and taxpayers alike must ask: what constitutes “business activity within such State” under the federal statute?
Take an example: You sit at your computer in Ohio and initiate an online chat with a company outside the state that previously sold you a set of tools—and that company sold you the tools by fulfilling an order you submitted through the company’s website out of state, with the company having no physical presence in Ohio. Now you want to have a virtual “chat” with a company representative about the proper use of some of the tools. Is the company doing business in your state just by having its representative—from outside Ohio—”chat” with you about the tools you purchased? If the online “chat” is a business activity in Ohio, it defeats the protection of P.L. 86-272, because customer assistance can be interpreted as going beyond a mere solicitation of orders.
According to the Multistate Tax Commission (“MTC”), the answer is yes: the online chat is a business activity in the customer’s state. MTC addressed such issues in the 2021 updated version of its “Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272” (“MTC Statement”). More generally, the MTC Statement says that “when a business interacts with a customer via the business’s website or app, the business engages in a business activity within the customer’s state.” Under the MTC Statement, another interaction that could trigger tax consists of an out-of-state business’s placing internet “cookies” onto a customer’s in-state computer that gather information for purposes other than those closely related to the solicitation of orders.
ZHF Observation: The MTC distinguishes interactive from “static” websites, claiming that a static presentation of text or photos “does not in itself constitute a business activity within those states where the business’s customers are located.” However, in focusing on this distinction, the MTC has made the unwarranted assumption that the interactivity it references has a locus “within the customer’s state.” While the customer’s activity takes place in the state, it is not at all clear that any activity of the business takes place there. This is true regarding both cookies and online chats (often powered by AI rather than human beings), neither of which evidence purposeful direction toward, let alone activity within, a particular state. Thus, the reasoning of the MTC Statement is incomplete at best.
Pass-through entities selling tangible personal property into Ohio may think that P.L. 86-272 protects them from Ohio taxation—but they should pay close attention to the “community spread” of the revised MTC Statement among the states. In some audits the Ohio tax commissioner has indicated that Ohio ”follows the MTC guidelines in determining which activities are protected by Public Law 86-272.” Such entities may be engaging in online activities that are deemed to be business activity in Ohio under the MTC Statement.
ZHF Observation: In some comments on the proposed update to the MTC Statement, the Council on State Taxation (COST) pointed out the analogy between an interstate business’s interaction with in-state customers by direct telephone contact and interaction through a computer internet connection. Certainly, Congress knew about interactive telephone conversations between in-state and out-of-state persons when it enacted P.L. 86-272 in 1959, and likely did not contemplate that such contacts constituted “in state activity” by the interstate business. We agree with COST’s point, and believe that by analogy to old-style telephone calls, high-tech “chats” should not be deemed “in state activity” under P.L. 86-272.
P.L. 86-272 is a federal law whose protections are not subject to limitation by state revenue agencies
A recent decision from California’s Superior Court in San Francisco rejected that state’s adoption of the updated MTC Statement—but did so on strictly procedural grounds. Background: During 2022, California’s Franchise Tax Board (“FTB”) adopted two measures to incorporate the updated MTC Statement into California law: FTB issued Technical Advice Memorandum 2022-01 (“TAM”), and FTB updated its own Publication 1050 to incorporate MTC’s changes to its statement. In Am. Catalog Mailers Assn. v. FTB, Case No. CGC-22-601363, the association challenged FTB’s actions as (1) contrary to P.L. 86-272, which preempts state authority under the Supremacy Clause, (2) violative of California’s Administrative Procedure Act (“APA”) in that FTB failed to follow notice and comment requirements prescribed by the APA, and (3) contrary to due process to the extent the updates were applied to earlier transactions rather than prospective transactions. In the Superior Court’s December 2023 decision, which was later upheld when the court denied FTB’s motion to vacate on February 13, 2024, the court ruled that the TAM and the updated Publication 1050 were “void” as “underground regulations” that were adopted without compliance with the notice and comment requirements under the state’s APA.
To date, we are not aware that FTB has taken an appeal. But even if FTB acquiesces in the court’s ruling and does adopt a regulation that incorporates the updated MTC Statement, taxpayers should not be discouraged. Quite simply, P.L. 86-272 is a federal restriction on state taxing authority, and state agencies have no authority to limit federal-law protections whether or not they adopt formal regulations.
ZHF Observation: In Ohio, the state Supreme Court has long held that “ ‘an administrative rule that is issued pursuant to statutory authority has the force of law unless it is unreasonable or conflicts with a statute covering the same subject matter.’ ” Nestle R&D Ctr., Inc. v. Levin, 122 Ohio St.3d 22, 2009-Ohio-1929, ¶ 40, quoting State ex rel. Celebrezze v. Natl. Lime & Stone Co., 68 Ohio St.3d 377, 382 (1994). Note that one essential predicate of the “force of law” of an administrative rule in Ohio is the “statutory authority” of the agency to promulgate such a rule. Absent that authority, the rule is merely the state agency’s expression of how it sees the law, and does not itself qualify as law. Because we are not aware of any federal delegation of rulemaking authority to state revenue agencies that relates to P.L. 86-272, we think that any administrative rule in Ohio that attempts to define the scope of taxpayer protection under P.L. 86-272 will not be binding—just as the administrative rule in Nestle was not controlling because it exceeded the agency’s regulatory authority. See also Adams Fruit Co. v. Barrett, 494 U.S. 638, 649 (1990).
We urge taxpayers to be on alert for any reliance by the Ohio Department of Taxation on the MTC Statement in the context of audits and assessments. When an interstate business does confront an Ohio tax assessment that may violate P.L. 86-272, the taxpayer should rely on the direct authority of P.L. 86-272 and seek to overturn the assessment through petition or appeal. Please consult with our knowledgeable ZHF professionals concerning your particular situation.