Merit Decision Guest Post: Court Upholds Application of Ohio’s Commercial Activity Tax. Crutchfield Corp. v. Testa.

Tax is totally not my field. But recognizing the significance of the decision in Crutchfield Corp. v. Testa, I asked my University of Cincinnati College of Law tax colleague Professor Stephanie Hunter McMahon to analyze the decision in the case.  What follows is her superb guest post.

Guest Post on Crutchfield Corp. v. Testa by Stephanie Hunter McMahon

On November 17, 2016, the Supreme Court of Ohio handed down a merit decision in Crutchfield Corp. v. Testa, Slip Opinion No. 2016-Ohio-7760.  In a 5-2 opinion written by Justice O’Neill, joined by Chief Justice O’Connor and Justices Pfeifer, O’Donnell, and French, the court upheld the application of the state’s commercial activity tax (“CAT”) on out-of-state e-commerce businesses without a physical presence in Ohio.  The CAT is imposed for the privilege of doing business in Ohio, but only applies to out-of-state businesses with more than $500,000 in gross sales receipts in Ohio.

The court affirmed the decision of the Board of Tax Appeals upholding the law as applied.  The case was argued on May 3, 2016.

These were the issues:

  1. Does Ohio’s CAT violate the U.S. Constitution’s commerce clause when imposing the tax on businesses that have no physical presence in Ohio?
  2. Is the “bright-line presence” rule in the state’s CAT sufficient to determine if a business has the required substantial nexus with the state to be subjected to a “privilege of doing business”-type tax?

Case Background

The Ohio legislature adopted the CAT in 2005, coupled with the repeal of the state’s corporate franchise tax and local tangible personal property tax for most businesses.  The legislative objective was, in part, to equalize the taxation of in-state and out-of-state businesses.  Ohio was the first state to adopt the bright-line test to subject out-of-state businesses with $500,000 in Ohio gross receipts to taxation, which other states have since adopted.

Three cases involving the application of Ohio’s CAT to California-based Newegg Inc., Virginia-based Crutchfield Corp., and Wisconsin-based Mason Companies, Inc. were consolidated in Crutchfield.  These cases developed from audits of companies believed to have large amounts of Internet sales in Ohio that were not paying the CAT.  Tax determinations governed periods from 2005, when the CAT was enacted, through 2012.  The companies did not dispute the calculation of the tax but did contest the state’s ability to impose the tax.  The BTA ruled in the state’s favor on February 26, 2015.

In each case, the tax commissioner made no factual finding regarding the companies’ physical presence in Ohio, but noted he lacked authority to “adjudicate the constitutionality of th[e] statutes.”  The lead case involved Crutchfield Corporation, which sells and ships consumer electronics into Ohio.  Crutchfield has no Ohio personnel or facilities.  Crutchfield did not file or pay the CAT.

Key Precedent

Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977) (evaluated a state tax under the dormant Commerce Clause with a four-part test.  Relevant to Crutchfield, it held that state taxes can only be applied to a business with a substantial nexus with the taxing state.)

Quill Corporation v. North Dakota, 504 U.S. 298 (1992) (considered substantial nexus for purposes of the state’s use tax (a functional equivalent to the sales tax). Quill required the business to have a physical presence in the taxing state.)

Tyler Pipe Industries, Inc. v. Washington States Dept. of Revenue, 483 U.S. 232 (1987) (recognized that physical presence satisfies the substantial nexus requirement for a privilege tax similar to CAT.)

Case Analysis

Ohio’s CAT is roughly equivalent to a business income tax on a gross (as opposed to a net) basis.  More precisely, the CAT taxes gross sales receipts without deductions for the costs of earning the income.  Per R.C. 5751.02(A), the CAT is imposed “on each person with taxable gross receipts for the privilege of doing business in this state.”

The CAT defines taxable gross receipts for sales of tangible personal property as property received by a purchaser in Ohio after all transportation has been completed.  Therefore, filling orders initiated on computers in Ohio and arranging for delivery in Ohio qualify as “taxable gross receipts” under the CAT.  Using taxable gross receipts as the measure for calculating the tax, CAT is imposed on “persons with substantial nexus with this state” which is defined as a “bright-line presence” that is automatically met if a person has $500,000 of taxable gross receipts in Ohio.

Regardless of the statutory language, Crutchfield argued it lacks the “substantial nexus” with Ohio required by the federal dormant Commerce Clause, which it read as imposing the requirement of a “physical presence” in the state.  Two key Crutchfield employees, its senior vice president of finance and director of Internet marketing, testified before the BTA that the company actively intended to avoid a nexus with any state but Virginia.

The state responded with two arguments.  First, the state argued the substantial nexus test of the dormant Commerce Clause does not, in fact, require a physical presence for a privilege tax. Second, if the substantial nexus requires a physical presence, the acceptance of “cookies” so the company can track consumers’ movements on the website and downloading the Crutchfield application on mobile devices constitute a tangible personal property presence in the state.

The constitutional issue was deferred at the BTA level, as the BTA lacks jurisdiction to decline to apply statutes on constitutional grounds.  The Supreme Court of Ohio reviewed the issue de novo and, although the BTA received evidence as to the issue of constitutionality, it was up to the Supreme Court of Ohio to resolve the question.

The court agreed with the state’s first argument and did not address the second.   In oral arguments, the judges appeared uncomfortable with the state’s discussion of the physical presence through the use of cookies and storage of software, and it was not surprising that the court declined to address these issues.  In its opinion, the court noted conflicting expert opinion regarding whether the Internet involved a physical presence before moving on.

In Crutchfield, the court accepted a broad CAT.  Although the issue was not raised in oral arguments, the opinion focused on how the privilege of doing business test does not have an in-state activities requirement. Noting R.C. 5751.02(A) provides that the “[p]ersons on which the commercial activity tax is levied include, but are not limited to, persons with substantial nexus with this state” (emphasis added in opinion), the court noted the legislative intent was that the bright-line test requires substantial nexus but the tax  “not even be bound by that expansive definition.” [¶24]

To reconcile this conclusion with Quill, the Supreme Court of Ohio distinguished the sales/use tax and income/privilege taxes and applied a different test for substantial nexus to each.  Accepting that Quill requires a physical presence to have the requisite Complete Auto substantial nexus for a use tax not to violate the dormant Commerce Clause, the court narrowly limited the case to the use tax.  In its stead, the court finds the CAT is in the same constitutional category as an income tax, which it asserts has traditionally not had a physical nexus requirement. The court interpreted Complete Auto as “abolish[ing] the prohibition against levying a tax on the privilege of engaging in interstate commerce, and the [United States] Supreme Court’s articulation of the substantial-nexus test was not intended to resurrect it.” [¶34]  Therefore, Ohio does not need a “local incident” to have a substantial nexus for anything but a use tax.

Under the theory of Crutchfield, physical presence is sufficient but not necessary to establish the substantial nexus required by Complete Auto for an income or income-like tax.  The Supreme Court of Ohio accepted the $500,000 threshold as satisfying the substantial part of the substantial nexus requirement of Complete Auto because it is a quantitative standard (a “necessary” feature to the court) and sufficiently large to ensure the tax is not “clearly excessive” in its burdens on interstate commerce.


Justice Kennedy dissented with an opinion joined by Justice Lanzinger.  For the dissent, the issue was one of state regulation of interstate commerce, which is prohibited by the dormant Commerce Clause.   Applying Quill, the dissent did not accept a distinction between sales and income taxes and interpreted “Tyler Pipe’s reliance on physical presence as more indicative of a requirement than an option.” [¶67]  Therefore, according to the dissent, until the United States Supreme Court overturns Quill, only Congress can do what the Ohio legislature did.

Case Syllabus


Ohio Leading the Way to the United States Supreme Court

When Ohio enacted the CAT in 2005, its bright-line presence test based on significant financial gross receipts was a change from requiring a physical presence. Crutchfield is the first challenge of that test to get to the state’s supreme court.  L.L. Bean, Inc. challenged the test in 2014, but the company settled.  From the oral arguments, the court was troubled about the changes the Internet has had on business in much the same way as commentators have who confronted the difference between brick-and-mortar businesses versus e-commerce.  The door to equal taxation, however, has long seemed barred from state action by Quill.  Ohio’s success in Crutchfield in equalizing the taxation of in-state and out-of-state businesses may lead other states to adopt the test.

When Justice Lanzinger asked if the case would likely go to the United States Supreme Court,  Assistant Attorney General Daniel Fausey stated, for the tax commissioner, that he did not think the Court would accept cert.  The opinion certainly opens the door to review.  The court notes that the bright-line test “invites the constitutional challenge on its own terms” and wrote an opinion that squares up the issues for review.  If the Court does not take the call, Ohio is an example of how states can raise revenue in this period of limited revenue.  If the Court accepts the case, Crutchfield opens the door for the Court not only to review the privilege of doing business tax but, possibly, sales and use taxes.

Concluding Observations

Crutchfield is an important Ohio case with national significance because it opens the door to states taxing out-of-state e-commerce previously thought not taxable under Quill.  It does not purport to overturn or ignore Quill but narrows its application by bifurcating tax treatment of income tax (or a privilege tax) and the use tax (or sales tax).  Therefore, e-commerce retains some tax advantage over brick-and-mortar businesses but less than what it previously had.  And while Ohio collects revenue, it gives the United States Supreme Court an opportunity to revisit the physical presence requirement.

Even the dissent notes that it may be time to overturn Quill.  Only two Justices remain on the U.S. Supreme Court from the time of that decision, one of whom, Justice Kennedy, has written it may be time for reconsideration.  However, by accepting the state’s claim not to need a physical presence rather than accepting computer sales as a physical presence, the majority may have created a path for the Supreme Court to retain Quill for sales taxes, often a much larger source of state revenue.

The case also highlights the strangeness of the dormant Commerce Clause tax jurisprudence.  The dormant commerce clause is intended to prevent “undue burdens” on interstate commerce.  Its current interpretation, however, creates a significant pro-interstate commerce result.  Under existing doctrine, residents can evade their state’s sales taxes because states struggle to enforce the use tax.  One study from the University of Cincinnati found that although 60% of households in Ohio made at least one on-line purchase in 2010, less than 1% of state income tax returns included the use tax.[1]  If Crutchfield had come out the other way, e-commerce businesses would also be able to avoid business-level tax, and thereby offer goods at lower prices than could brick-and-mortar stores.

The issue of how states tax interstate business activity is not going away, particularly as states continue to face revenue demands.  Last year in Comptroller of the Treasury of Maryland v. Wynne, 135 S.Ct. 1787 (2015), the United States Supreme Court addressed states taxing income earned and taxed in other states.  Although the CAT does not currently overreach to tax more than the receipts generated in Ohio, with this precedent states may take increasingly aggressive approaches to recoup the sales tax revenue lost by Quill.  And as warned by Crutchfield’s attorneys in a parade of horribles, every taxing district in the country might impose such a tax.  Luckily for us, as shown in Hillenmeyer v. Cleveland Bd. Of Rev., 144 Ohio St.3d 165, 2015-Ohio-1623, the Supreme Court of Ohio is up to the task of demanding fair apportionment of income between the states.

On a lighter note, although it appears to me the court reached a reasonable and practicable outcome on this taxing matter, tax is not every justice’s favorite subject. Discussing the language of the statute in oral arguments, Justice Pfeifer joked about his difficulty in finding elegance in taxes.  He stated only “geeks who make their living doing tax work think of it in terms of elegance.”  An underlying distaste of tax cases may be one reason why the United States Supreme Court might avoid hearing Crutchfield.



[1] Economic Center, University of Cincinnati, Economic Analysis of Tax Revenue From E-Commerce in Ohio, 2011.

This entry was posted in Guest Posts, Merit Decisions, Ohio Supreme Court Watch. Bookmark the permalink.