<i>Crutchfield v. Testa</i>—Can States Tax Online Interstate Retailers Based on Their Virtual Presence?

Crutchfield v. Testa—Can States Tax Online Interstate Retailers Based on Their Virtual Presence?

On May 3, 2016, the Supreme Court of Ohio heard oral argument between Crutchfield Corporation—a major electronics retailer based in Virginia—and Ohio Tax Commissioner Joseph Testa regarding whether Ohio can tax an out-of-state company based on sales of goods to Ohio consumers over the internet.


The case arose when the Ohio Department of Taxation issued 27 tax assessments totaling more than $209,000 for Crutchfield relating to periods from 2005 to 2012. The basis for the tax assessment is the Ohio Commercial Activity Tax ("CAT"), which imposes a bright-line jurisdictional reach on businesses: As long as a company has $500,000 or more in annual sales from Ohio customers, as measured by gross receipts, then the company is liable for CAT. Because CAT imposes a tax on out-of-state businesses, it must satisfy the "substantial nexus" test created by the U.S. Supreme Court in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977), and its progeny.

Taxing Authority's Virtual Presence Theory

At its core, Crutchfield engages with concerns about the national and intrastate economies as well as the continuing efficacy of physical presence tests in the Internet Age. As Crutchfield noted in its briefing before the Court, it maintains no physical presence (i.e., no sales force, offices, plants, persons, internet servers, or other physical attributes) in Ohio, and thus it lacks a substantial nexus with the state and cannot be lawfully taxed. The Commissioner countered with a near novel theory that through caches, cookies, and a mobile application, Crutchfield has a physical presence because Ohio users must store such software on their Ohio-based computers and phones in order for Crutchfield's "virtual store" to exist.

Interestingly, this assertion may contradict the views of the Supreme Court of the United States in Quill Corp. v. North Dakota (91-0194), 504 U.S. 298 (1992). "… Quill also licensed software to some of its North Dakota clients…. Although title to 'a few floppy diskettes' present in a State might constitute some minimal nexus, in National Geographic Society v. California Bd. of Equalization, 430 U.S. 551, 556 (1977), we expressly rejected a '"slightest presence" standard of constitutional nexus.' We therefore conclude that Quill's licensing of software in this case does not meet the 'substantial nexus' requirement of the Commerce Clause." Quill, supra, n.8.

Other Battlegrounds

Ohio is not the only place where this battle over interstate taxing requirements in the Internet Age is being waged. In February 2016, the Tenth Circuit held that Colorado's sales tax reporting requirements on out-of-state sellers did not violate the dormant Commerce Clause. Direct Mktg. Ass'n v. Brohl, 814 F.3d 1129, 1134 (10th Cir. 2016). In March 2016, South Dakota passed a new law requiring out-of-state retailers with sales of more than $100,000 in South Dakota or that conduct 200 or more transactions there to collect and remit sales taxes to state authorities. South Dakota's law is the subject of recent dueling lawsuits initiated by both the state taxing authority and internet retailer trade associations seeking declarations about the enforceability and constitutionality of the law. See, e.g., South Dakota v. Weyfair, Inc. et al., No 32 CV 16-000092 (April 28, 2016); American Catalog Mailers Ass'n et al. v. Gerlach, 32 CV 16- (April 29, 2016). And Alabama may not be far behind. In October 2015, Alabama expanded its sales and use tax law to require out-of-state retailers that sold more than $250,000 and that advertised on the internet to register, collect, and remit tax.


States are frustrated with limitations on their ability to tax out-of-state sellers to in-state customers. Creative tax administrators are pursuing various "outreach" techniques to tax those vendors. Regardless of how Crutchfield is decided, companies doing interstate business over the internet would do well to thoughtfully evaluate their remote state tax liability with their tax professionals in light of newly expanding state taxing efforts.

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