The California Franchise Tax Board (FTB) recently released administrative guidance, Technical Advice Memorandum (TAM) 2022-01, to explain its positions on the application of Public Law (P.L.) 86-272 protection in the modern economy for companies with internet transactions.1 The FTB’s TAM does not explicitly adopt the revised statement of information issued by the Multistate Tax Commission (MTC) in August 2021 (the “MTC Statement”).2 However, TAM 2022-01 is generally consistent with the positions set forth in the MTC Statement.
P.L. 86-272 and the MTC Statement
P.L. 86-272 is a 1959 federal law that prohibits a state from imposing a net income tax on the income of a business derived from within a state through interstate commerce if its only business activities within the state consist of the solicitation of orders for sales of tangible personal property.3 This protection only applies to orders that are sent outside the state for acceptance or rejection. If the orders are accepted, they must be filled by shipment or delivery from outside the state.
Since P.L. 86-272 was enacted, businesses have evolved from primarily engaging in sales of tangible personal property via in-person activity to engaging in substantial amounts of electronic commerce through remote means. However, Congress has not updated P.L. 86-272 to reflect how it may apply to more modern business activities. Shortly after the U.S. Supreme Court decided South Dakota v. Wayfair, Inc.4 in 2018, the MTC decided that the emphasis on taxpayer protection under P.L. 86-272, coupled with the growing popularity of more technology-dependent business models, required revisions to its historic statement of information regarding the application of P.L. 86-272.
Following several hearings, the MTC Statement was adopted and released in August 2021, including a new subsection addressing what constitutes protected versus unprotected activities, and the treatment of certain internet-facilitated transactions.5 The MTC Statement establishes the general rule that when a business interacts with a customer via the business’s website or app, it is engaged in “business activity” within the customer’s state, meaning that the activities extend beyond the pure solicitation of orders for sales of tangible personal property, thereby exceeding P.L. 86-272 protection. Alternatively, if the website merely presents static text or photos, there is no engagement or facilitation within the customer’s state. The MTC Statement provides a list of 11 different activities conducted by internet businesses and provides a conclusion as to whether they are protected (or unprotected) by P.L. 86-272.
California’s New Administrative Guidance
The FTB’s recent TAM addresses the same 11 internet activities that are outlined in the MTC Statement, and reaches the same conclusions. Prior to discussing the activities, the FTB’s TAM clarifies that for all of the fact patterns, the business: (i) makes sales to California customers; (ii) is commercially domiciled outside California; and (iii) has no other activities in the state. The FTB analyzes each fact pattern by determining whether business activities are taking place in California; and if so, whether those activities exceed the bounds of P.L. 86-272 protection causing the business to be subject to net income taxation.
While the FTB’s TAM considers the same internet activities as the MTC Statement, it provides more detailed explanations supporting its conclusions, and further considers the application of P.L. 86-272 protection to a business with an employee who regularly telecommutes from California. This guidance is generally consistent with the treatment provided for in the MTC Statement in its unprotected activities section for employees maintaining an “in-home” office in the state.
Similar to the MTC Statement, TAM 2022-01 clarifies that the determination of whether a seller of tangible personal property over the internet is protected by P.L. 86-272 requires the same general analysis as sellers of tangible personal property by other means. Also, the FTB’s TAM appears to follow the MTC’s Statement by explaining that even though the U.S. Supreme Court was not interpreting P.L. 86-272 in Wayfair, “California considers the Court’s analysis as to virtual contacts to be relevant to the question of whether a seller is engaged in business activities in states where its customers are located for purposes of P.L. 86-272.” TAM 2022-01 further follows the MTC Statement by noting that P.L. 86-272 may affect both the determination of whether the state to which tangible personal property is delivered may tax the income of the seller, as well as whether the state from which tangible personal property is shipped may subject the related receipts to that state’s throwback rule for sales factor sourcing purposes.
Unprotected Activities
According to TAM 2022-01, the following activities in California (many of which are facilitated through a business website) do not receive P.L. 86-272 protection because they are considered business activities within the state that do not constitute, and are not entirely ancillary to, the in-state solicitation of orders for sales of tangible personal property:
- Having an employee telecommute on a regular basis from within California to perform management and accounting tasks;6
- Providing post-sales assistance to California customers by electronic chat or email that customers initiate by clicking on an icon on an internet website;
- Soliciting for and receiving online applications for a business-branded credit card via the website from California customers;
- Enabling internet website viewers in California to apply for non-sales positions through submission of an electronic application and an upload of a cover letter and resume;
- Placing internet “cookies” onto the computers or other electronic devices of California customers to gather customer search information used to adjust production schedules and inventory amounts, develop new products, or identify new items to offer for sale;
- Remotely fixing or upgrading products previously purchased by California customers by transmitting code or other electronic instructions to those products over the internet;
- Offering and selling extended warranty plans via internet website to California customers who purchased the business’s products;
- Contracting with a marketplace facilitator that facilitates the sale of the business’s products on the facilitator’s online marketplace; and
- Contracting with California customers to stream videos and music to electronic devices.
Protected Activities
The following three activities were identified in TAM 2022-01 as still being protected by P.L. 86-272:
- Providing post-sale assistance to California customers by posting a list of static frequently asked questions (FAQs) with answers on the website;
- Placing internet “cookies” onto the computers or other devices of California customers that gather information only used for purposes entirely ancillary to the solicitation of orders for tangible personal property;7 and
- Offering for sale only items of tangible personal property on the website
Commentary
California’s new administrative guidance on the application of P.L. 86-272 to transactions conducted over the internet attempts to provide clarification to out-of-state businesses to determine whether their activities subject them to California’s income or franchise tax. As a result of this guidance, some internet-based businesses that previously thought their activities were protected by P.L. 86-272 may suddenly learn that the FTB may not agree with their historical position. Noticeably, TAM 2022-01 does not contain any effective date or limiting principle regarding how it may be applied by the FTB in auditing prior years. Furthermore, the TAM does not address the FTB’s existing P.L. 86-272 guidance provided in FTB Publication 1050, which correlated to the prior version of the MTC Statement interpreting P.L. 86-272. As a result, the interaction between the new TAM and FTB Publication 1050 remains uncertain, and it would not be inconceivable to see the FTB retract or amend Publication 1050 in the near future.
The development and issuance of the MTC Statement in 2021 was an effort to encourage uniformity among the states in applying P.L. 86-272 to internet transactions. While the FTB’s new TAM examines the same 11 different types of internet activities that are considered in the MTC Statement (and reaches the same conclusions regarding P.L. 86-272 protection), the FTB’s guidance does not actually reference or mention the MTC in any way. Under the MTC Statement, a “supporting state” is a state that “adopts or otherwise expressly indicates support for this Statement by legislation, regulation or other administrative action.” The release of the TAM in this manner may call into question whether California formally is a “supporting state” of the MTC Statement due to the lack of any explicit reference to the MTC in TAM 2022-01.
It is too early to tell whether the method in which California has responded to the MTC Statement will be followed by other states, particularly those that had a significant influence over the MTC project that concluded in 2021. Consequently, taxpayers should monitor whether other states issue parallel guidance on P.L. 86-272 protection as applied to internet transactions, and also note the possibility that some state tax agencies may adopt internal policies on the application of P.L. 86-272 to internet transactions in lieu of formal published administrative guidance. Lastly, it has been many years since a federal court has weighed in on the application of P.L. 86-272, and many commentators may question the ability of state administrative guidance to shape (or change) how a federal law should be applied.
1 Technical Advice Memorandum (TAM) 2022-01, California Franchise Tax Board, Feb. 14, 2022.
2 Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law 86-272, Multistate Tax Commission, revised Aug. 4, 2021. For further discussion of the MTC Statement, see GT SALT Alert: Top SALT Stories of 2021.
3 Pub. L. No. 86-272, 15 U.S.C. §§ 381-384.
4 138 S. Ct. 2080 (2018).
5 Specifically, the MTC Statement added subsection C, Activities Conducted Via the Internet. This was the first revision to the MTC’s policy position on this subject since July 27, 2001.
6 However, P.L. 86-272 protection would apply if the activities of the employee telecommuting from California constitute solicitation of orders for sales of tangible personal property or are entirely ancillary to solicitation.
7 For example, the cookies are used to remember items that customers have placed in their shopping cart, to store personal information customers have provided to avoid the need to re-input the information when they return to the seller’s website, and to remind customers what products they have considered during previous sessions.
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