Alert January 13, 2009

Massachusetts Supreme Judicial Court Decides Massachusetts May Tax a Financial Institution That Has No Physical Presence in Massachusetts

In Capital One Bank. v. Commissioner of Revenue, Dkt. No. SJC-10105 (Jan. 8, 2009), the Massachusetts Supreme Judicial Court (the “SJC”) decided that Massachusetts may impose its financial institution excise on an out-of-state financial institution that does not have a physical presence in Massachusetts if the financial institution has “substantial nexus” with the Commonwealth.  The bank’s principal claim was that imposition of the excise violated the Commerce Clause of the U.S. Constitution.  Under well-established U.S. Supreme Court case law, one of the requirements for a state tax to comply with the Commerce Clause is that the taxpayer have “substantial nexus” with the taxing state.  The Court, in Quill Corp. v. North Dakota, 504 U.S. 298, 317-318 (1992), reaffirmed an earlier decision that, with respect to the imposition of sales and use taxes, the constitutionally sustainable measure of contact required for substantial nexus under the Commerce Clause was “physical presence” in the taxing State.  Here, the bank argued that the physical presence requirement is not limited to the sales and use tax context but is also required before the state can impose an income-based tax, like the Massachusetts financial institution excise, on an out-of-state entity. 

The SJC disagreed.  It determined that

The language of the Supreme Court’s decision in Quill explicitly emphasized, on more than one occasion, a narrow focus on sales and use taxes for the physical presence requirement, and suggested that this requirement was limited to those specific assessments and did not apply to the imposition of other types of State taxes. We will not expand the Court’s reasoning beyond its articulated boundaries, particularly where the Court, itself, has limited its holding to a particular form of taxation.

The SJC then turned to the facts before it in Capital One Bank to determine whether the bank had substantial nexus with Massachusetts during the tax years at issue.  It noted that “[w]hile the concept of ‘substantial nexus’ is more elastic than ‘physical presence,’ it plainly means a greater presence, both qualitatively and quantitatively, then the minimum connection between a State and a taxpayer that would satisfy a due process inquiry.  Simply put, the test is ‘substantial’ nexus, not ‘minimal’ nexus [internal reference omitted].” 

In this case, based upon the Appellate Tax Board’s findings of fact, the SJC determined that the bank did have substantial nexus with Massachusetts because of its deliberate and targeted exploitation of the Massachusetts economic market and use of the Commonwealth’s governmental infrastructure and resources.