The growth of Internet sales has been a welcome development for many companies over the past two decades. The worldwide web presents a growth opportunity for some businesses that would never have been possible in the past.

However, taxation of income from these sales has become a relatively muddled arena. Many state legislatures have not come to grips with exactly how to handle these cross-border sales while their “bricks and mortar” constituent retailers are crying “foul.” One example is where local businesses are required to add sales tax to the price of products while non-resident sellers ship their products across many state lines with no added charges.

Residency Question

Up to now, in many states, sales taxes were only charged on goods sold by retailers that have some physical presence in a state. A sales force, distribution center, or retail outlet would qualify for residency. Thus, even though a company may have their headquarters elsewhere, any product sold in that state to consumers would be required to charge sales tax.  For state income tax purposes, the physical presence test had to be met as well for a state to impose that tax on the entity.

Nexus: How Does it Apply to Sales Across State Lines?

The concept of nexus, as it applies to taxation, refers to whether a business has sufficient presence to warrant having to charge sales tax or be required to pay income tax for doing business in that state.  Nexus may occur if a company has either a temporary or permanent presence such a warehouse, sales and service staffing, or branch office. The situation may also be enforced if employees attend trade shows or maintain consigned inventory in the state.

However, according to the Sales Tax Institute, states have differing definitions of “presence” or nexus. One variation is that the length of time before an enterprise may be considered to have a presence seems to differ among the states.

Time and other factors add to the inconsistency of this taxation problem.

Ohio Cross-Border Taxation

In Ohio, a recent Ohio Supreme Court decision added another yellow flag to the already in and out-of-state confusion. According to an article in Crain’s Cleveland Business by Peter DeMarco, the internet evolution has shed considerable light on the topic of nexus and the definition of the physical presence of retailers. 

Up to now, Ohio courts have usually supported the idea of no sales tax (Ohio no longer has a franchise or income tax on business entities) unless the seller has a clear physical presence in the state.

Commercial Activity Tax in Ohio

However, there is still the question of “commercial activity tax” or CAT based upon the cumulative gross receipts from any out-of-state companies selling into Ohio. The Ohio Supreme Court has determined that the state may impose these taxes on products and services sold to Ohioans without respect to the enterprise’s presence.

The justification by the Court is that the tax acts as payment for the right to do business in Ohio.

Commercial Activity Taxes are not assessed on individual transactions, as sales taxes are. These are charged as an end-of-the-year tax on gross receipts from products and services sold in Ohio. The tax commences at the $150,000 level of gross receipts.

Note that these taxes will likely become part of selling prices to Ohio consumers so retailers can retain their standard margins. In essence, the CAT will still act somewhat like a sales tax.

CAT has been in place for resident and non-resident companies since 2005. The recent Court ruling was a result of a challenge to the constitutionality of the CAT by a businesses that had no physical presence in Ohio.  Applying this tax to out-of-state internet retailers may be viewed as a “leveling-the-playing-field measure” and, of course, another source of revenue for the state.

Growing the CAT

Other states may be viewing this court decision as a way to implement similar taxes. Already Washington, Texas, and Florida, according to DeMarco, have implemented similar schemes with different names like business and occupation tax, franchise tax, or margin tax.

Differing interpretations and revenue basis for taxing out-of-state income will no doubt complicate business taxation even further.

Information in this article is based off content from Peter DeMarco's article in Crain's Cleveland Business.