The taxation of Canadian motor carriers by U.S. states operates much like a minefield. There are 48 different continental states, and each has its own rules for taxing truckers from outside its borders.
The underlying concept, however, is the same everywhere. There is no U.S. federal corporation law, and individual states have the exclusive right to grant corporate charters. As a result, they also have the right to exercise control over foreign corporations that operate within their borders. The level of business activity within the state will determine if the corporation has to register (it’s usually called “qualification” or “authorization”) and/or pay state taxes.
Most Canadian carriers are not required to register with any state. In general, formal qualification is only required when a corporation has employees, inventory, facilities, or some other tangible presence in the state. International carriers based in Canada usually do not rise to that level of activity and, if they do, they usually establish a separate U.S. company for that purpose.
But there is a different, lower threshold used to determine whether a foreign corporation is subject to taxation. Individual states cannot tax activities that relate solely to interstate or foreign commerce, but they can tax business activities conducted within their borders. The argument for such a tax is that the state is granting a privilege to allow the foreign corporation to act as a corporation within the state, even though the state did not grant the original charter.
It is not a strict income tax, per se, but a tax on the privilege of allowing the corporation to exercise its corporate existence – or corporate “franchise” – in the state. (This is where the term “franchise tax” originates. )
How do you determine this threshold? The legal term used in tax law is “nexus,” which relates to a specific level of business activity within the state, as opposed to interstate or foreign commerce. But the issue is complicated because every state seems to have a different nexus formula.
For example, a Canadian carrier is subject to New York State tax after it makes more than two pickups or deliveries within the state in any tax year. In contrast, Pennsylvania requires 12 pickups or deliveries and 50,000 revenue miles within the state before the nexus is reached. Many states have vague standards, stating that there is no nexus if the amount of in-state activity is “nominal”, “de minimis”, or words to that effect.
Michigan, meanwhile, has not yet issued a definitive standard for foreign carriers. And the issue is very important because most carriers have a mix of pass-through miles and delivery/pickup miles in any state. Once the nexus standard has been reached, the state uses all miles, including pass-through miles, in calculating the share of business that can be allocated to the state.
A couple of border states have been regarded as safe havens in the tax mine field, and Michigan has counted itself among them. For more than 10 years, the state has maintained that Canadian carriers are exempt from the Michigan Single Business Tax.
Don’t think these states are acting out of charity. They have taken these positions because of interpretations of the specific wording of state tax laws. Canadian carriers have benefited from the fact that many state tax laws use the U.S. federal corporate income tax return as a basis for calculating state tax liability. Since Canadian carriers are exempt from federal income tax under the Canada/U.S. Tax Treaty, a reasonable reading of these tax statutes implied that Canadian carriers owed no state tax, either. This is actually the conclusion reached by Michigan (and, apparently, Ohio). Michigan formally announced its interpretation approximately 10 years ago, and has not pursued Canadian motor carriers unless they happen to have a “permanent establishment” within state boundaries.
As a starting point, all out-of-state and foreign motor carriers were subject to the Michigan Single Business Tax if they conducted business within the state, and if the amount of business income due to Michigan was significant enough. However, the state never had a well-defined standard for the first part of the equation. In practice, it looks like it was the second part of the equation that mattered more, and any business activity in Michigan – even one pickup or delivery – would trigger the tax if the gross amount that was due to the state exceeded a certain amount. In 1990 that amount was $40,000, but it quickly rose to $250,000 in 1995.
So, as a practical matter, the rule in Michigan was that there was a nexus, and a foreign carrier was subject to tax if its allocation of gross receipts exceeded $250,000. The formula looks at all revenue miles driven in Michigan as a percentage of all revenue miles everywhere. But since Canadian carriers were exempt from federal tax, the state announced that the Single Business Tax didn’t apply to Canadian carriers even if they met the nexus.
That changed Jan. 1. Michigan did not change its nexus standard, but it did alter the technical loophole that made reference to U.S. federal income as the basis for calculating the tax. Now, if a Canadian carrier meets the nexus standard, it will have to create a hypothetical U.S. federal income tax return, and calculate a tax based on the percentage of taxable net income that’s allocated for Michigan. Currently, the tax rate is 2.3 per cent of net income allocable to Michigan.
The new law does raise some questions. Canada’s trucking industry (namely the Canadian Trucking Alliance) has been applying pressure over the ambiguity of the nexus standard.
It appears clear that a carrier merely passing through Michigan is engaged in purely interstate commerce, and not subject to state tax. But what level of in-state activity triggers the nexus? The state has not yet issued new regulations or explanatory bulletins on these points, but has promised to do so.
In the meantime, Canadian carriers with a high percentage of miles in Michigan, or high overall revenues, should investigate whether the change in Michigan law triggers a requirement to pay the Michigan Single Business Tax for tax years beginning after Jan. 1, 2000. n
– Daniel Joyce can be reached at Hirsch and Joyce, Attorneys at Law, at 716-564-2727.
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