Washington Department Of Revenue Rules On Application Of Economic Nexus To B&O Tax

The Appeals Division of the Washington Department of Revenue has held that a business with more than $250,000 in total annual service-taxable receipts in Washington has substantial nexus in Washington for purposes of the state's Business & Occupation (B&O) Tax.1

Background

The business, a web hosting company physically located outside Washington, provided services to Washington customers. The business delivered products and services over the Internet and had aggregate sales of $920,000 in Washington from 2005 to 2011. In 2012, the Department contacted the business by requesting a Washington Business Activities Questionnaire be completed. The business complied, reporting that its Washington income annually exceeded $250,000 in 2010, 2011 and 2012. The Department assessed the business for an unreported amount of B&O Tax under the service and other activities classification, along with associated penalties and interest. The business appealed the assessment.

B&O Tax "Doing Business" Standard

The B&O Tax is imposed on businesses "for the act or privilege of engaging in business" in Washington.2 In this matter, the business was not subject to any of the specific classifications contained within the B&O Tax, and so the Department was requested to address whether the business was subject to the service and other activities classification.3 In doing so, the Department pointed to the B&O Tax broadly defining the term "business" to include "all activities engaged in with the object of gain, benefit, or advantage to the taxpayer or to another person or class, directly or indirectly."4 Despite this expansive definition, the Department was required to consider whether any constitutional limitations could otherwise restrict the application of the B&O Tax to a business that did not have physical presence in Washington.

Commerce Clause Analysis

The Department's administrative law judge (ALJ) who presided over the appeal began the constitutional analysis by identifying the nexus requirements arising from the U.S. Constitution's Commerce Clause and Due Process Clause. Under the Commerce Clause, four elements must be met for a state to impose tax on a business located outside the state. The tax must: (i) be applied to an activity with substantial nexus with the taxing state; (ii) be fairly apportioned; (iii) not discriminate against interstate commerce; and (iv) be fairly related to the services provided by the state.5

In this matter, the business argued that...