Law and the Border: Law and U.S. State Taxation Requires State-By-State Analysis

by Daniel Joyce

Some Canadian carriers continue to be perplexed about the issue of State (as opposed to Federal) taxation in the U.S. Most carriers are aware of the tax treaty between Canada and the United States, which provides an exemption from a U.S. Federal Income Tax on the business activities of Canadian transportation companies engaged in international commerce. This treaty has been a feature of both the North American Free Trade Agreement and the U.S.-Canada Free Trade Agreement that preceded NAFTA.

However, as a general rule, there is no applicable treaty relating to the ability of an individual state to tax the business activities of a Canadian company within its borders. The U.S. system of federalism, with 50 state governments and one federal government, creates a dual system of government regulation in many contexts. For example, the Federal Motor Carrier Safety Administration and Department of Transportation have jurisdiction over operating authorities and safety regulation of carriers in international and/or interstate commerce, while each individual state has control over such matters with respect to activities within the state.

The exemption from corporate income tax at the federal level does not exempt a Canadian transportation company from taxation at the state level, if the activities of a transportation company are sufficient to create a taxable connection or “nexus” with that state.

The authority to impose a tax relates to the authority of a state to grant a corporate charter.

The corporate form of doing business provides shareholders with broad legal immunity from the debts and liabilities of the corporation. When an out-of-state corporation comes in and conducts business in a second state, the second state grants the corporation the privilege of operating as a corporation within its borders. The grant of this privilege forms the basis for the authority to tax out-of-state corporations.

What level of activity is sufficient to trigger state taxation? There is no single rule that applies in all states. Under the U.S. Constitution, the federal government has sole jurisdiction over interstate commerce, and an individual state cannot regulate or tax activities that are purely interstate.

In the transportation industry, the key factors in the analysis of nexus are the number of pickups and deliveries in the state, and the number of overall miles driven in the state.

The logic behind these factors is that a pickup or delivery is a local, rather than interstate, activity, and that repeated trips in and/or through the state eventually give rise to enough of an in-state presence to be taxable.

The rules can vary broadly from state to state such that a company with relatively light activity in one state may be subject to tax, and yet not be subject to tax in a second state in which its activities are even greater. The reason for these differences is that each state is trying to establish a Constitutionally permissible nexus threshold that does not place an unfair burden on out-of-state corporations.

Politicians are loath to raise taxes, and a state tax department would much rather cast a broader net, thereby increasing the number of taxpayers, than to increase the tax on the existing taxpayer base. Also, with no clear definition as to where to draw the line, state tax departments pay attention to the regulations and court decisions in other states, to get a feel for how low the nexus line can be drawn, in order to trigger the maximum number of taxpayers.

An example can be drawn from the concept of telecommuting, where a person may work from a remote location by a computer, for an employer situated elsewhere. Companies in New York City, for example, may have employees living in New Jersey or Connecticut, who work from home.

The question is whether the New York company has now subjected itself to the tax jurisdiction of those other states because of its telecommuting employees.

In 2001, 32 states said that telecommuting creates nexus. In 2004, that number has increased to 40.

Canadian carriers should understand that state taxation of this nature is not discrimination against Canadians. States apply the nexus rules equally to all out-of-state businesses; the New York nexus rules apply equally to a Canadian carrier in exactly the same way they do to a Pennsylvania or Florida or California carrier.

Since the transportation business is by definition a mobile one, all transportation companies need to understand the concept of state taxation, and make sure they are aware of the nexus rules in the states in which they enter, regardless of the degree of activities. n

– Daniel Joyce can be reached at Hirsch and Joyce, Attorneys at Law, at 716-564-2727.

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