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When Unprotected Conduct Is Protected Under P.L. 86-272

Posted on June 28, 2021
Roxanne Bland

Roxanne Bland is Tax Notes State’s contributing editor. Before joining Tax Analysts, Bland spent 17 years with the Multistate Tax Commission, where she worked with state revenue agency representatives to draft model legislation pertaining to sales and use taxation and corporate income, analyzed and reported on proposed federal legislative initiatives affecting state taxation, worked with legislative consultants and representatives from other state organizations on international issues affecting states, and assisted member state representatives in federal lobbying efforts. Before that, she was an attorney with the Federation of Tax Administrators for over seven years.

In this installment of The SALT Box, Bland examines the meaning of “solicitation of orders” contained in P.L. 86-272 and instances in which a taxpayer’s unprotected conduct is compelled by state or federal law.

P.L. 86-2721 is a federal statute with which state tax professionals are quite familiar. Congress stated its intent — 62 years ago — that the law, enacted in 1959, was meant to be temporary while a commission, appointed by Congress, studied the states’ taxation of business income earned in interstate commerce. The statute deprives states of jurisdiction to tax income earned within their borders if the only business activity consists of solicitation of orders for tangible personal property in which customer orders are sent outside the state for approval or rejection and, upon approval, are shipped or delivered to the customer from out of state. Since P.L. 86-272’s enactment, there has been much litigation in the states over the meaning of “solicitation of orders” — that is, which business activities stepped over the bounds of that term. Guidance from the U.S. Supreme Court was not forthcoming until Wrigley,2 in which the Court ruled that activities that are not the actual requesting of orders but are entirely ancillary to facilitating the requests for orders are protected activities. Those activities, the Court explained, are “those that serve no independent business function apart from their connection to the soliciting of orders.” The Court also ruled on the de minimis question, where the taxpayer engaged in activities that would otherwise cause it to lose its P.L. 86-272 protection. That, the Court said, “depends on whether the [taxpayer’s activities] established a nontrivial additional connection with the state.” The question is not how much or how little earnings the taxpayer’s activities generate; rather, it is whether the taxpayer regularly and systematically engages in the activities.

Stepping Out of Bounds?

There are instances, however, in which an out-of-state taxpayer’s in-state activities arguably go beyond the requesting of orders, yet it retains P.L. 86-272 protection. In these cases, the taxpayer engages in those activities not because it is flouting the law but because state law requires the overreach. Pomco Graphics3 is a good example. Pomco Graphics Inc.’s in-state sales force-sold customized paper goods in New Jersey, including to casinos. In accordance with a state regulation, casino sales required Pomco Graphics to obtain a license. New Jersey attempted to impose its corporate income tax on Pomco Graphics, arguing that procuring the requisite license was not an ancillary activity protected by P.L. 86-272. The New Jersey Tax Court agreed that procuring a license, by itself, is not a protected activity, but here, “it is clearly ancillary to the solicitation of orders. New Jersey may qualify and regulate a person seeking to solicit business from casinos, it may not utilize such laws to disqualify that person from the federal immunity granted by [P.L. 86-272]. It may not do indirectly what it is prohibited from doing directly.”4

Stepping Out of Bounds Redux

Federal law can also protect an out-of-state business from losing P.L. 86-272 protections. The 1930 Perishable Agricultural Commodities Act (PACA),5 amended several times since enactment, protects producers of perishable agricultural products from unfair activities of commission merchants, dealers, and brokers, such as by wrongfully rejecting shipments of those commodities during periods of declining prices. Other wrongful conduct includes failing to promptly pay a produce transaction; rejecting or failing to deliver that produce when there is no reasonable cause; and discarding, dumping, or destroying produce received without reasonable cause. For truck shipments, a receiver or responsible representative is given no more than eight hours to inspect the perishable produce after notice of arrival and the shipment is made available for inspection. If the produce is not accepted, either it is returned to the truck for transportation elsewhere, or the seller may, without taking the produce back, give the purchaser a credit.

PACA was at issue in Procacci Brothers, a recent decision from the New Jersey Tax Court.6 Procacci Brothers Sales Corp., a Pennsylvania corporation based in Philadelphia, is a wholesale produce distributor, purchasing and distributing produce to grocery stores and food service entities. Procacci owns no real property, has no offices, and maintains no inventory in New Jersey. Procacci’s New Jersey customers sent orders to Pennsylvania to be processed, which were fulfilled at Procacci’s Philadelphia warehouse and then shipped to New Jersey purchasers. Most shipments were made via common carrier and, less often, on Procacci’s own trucks.

Procacci procured its stock indirectly through an auction that took place in New Jersey. The auctioneer set the price for all produce to be sold. The pricing information was provided to buyers with a “seat” at the auction and who were not permitted to disseminate the information to individuals outside the auction. Enforcement of the rule was apparently lax because pricing information was routinely leaked to those outside the auction, including to a Procacci employee, who would then relay the information to the sales team. There was no evidence, however, that the employee was in New Jersey when he obtained the pricing information. Following the auction, Procacci purchased produce from auction buyers to resell to its customers.

There was also a question concerning the pallets Procacci used to deliver produce to its customers. The company generally used pallets provided by a third party, with which Procacci would enter into an agreement for the pallets’ use. Procacci would deliver its goods on these pallets, but only to customers that also had agreements with the third party. The third party would retrieve its pallets from the customer. Thus, once Procacci delivered the produce on the third party’s pallets, it no longer bore responsibility for their return to the third party. If a customer did not have an agreement with the third party, Procacci would deliver produce on brown wood pallets. In this event, the brown wood pallet used by Procacci would be exchanged for a pallet from the customer, and there was always an equal exchange of one brown wood pallet for another.

Procacci’s New Jersey activities were obviously protected under P.L. 86-272 and PACA. Procacci obtained the pallets by an agreement with the third party, which most likely stated that the pallets remained the property of the third party. Also, once the pallets were left with the customer, Procacci had no further responsibility for them. As for the brown wood pallets, the equal exchange of pallets between Procacci and its customer means that the pallet in Procacci’s possession became the property of the customer. In either case, it is beyond doubt that Procacci owned no property in the state. Therefore, Procacci’s use of the pallets did not cause it to lose the protection of P.L. 86-272.

Procacci also does not lose P.L. 86-272 protection by virtue of taking back or providing a credit for produce rejected by the customer under PACA. Interestingly, the tax court, after analyzing the facts under P.L. 86-272, concluded that because of PACA, the activity was protected conduct because it was ancillary to the solicitation of orders. This seems odd. There is no reason to think that taking back produce is any more ancillary to the solicitation of orders than replacing a retailer’s stale gum, an activity the Wrigley Court found outside the protection of P.L. 86-272. Rather, PACA requires Procacci to take back produce rejected by the customer. Even if it does so regularly and systematically, Procacci is compelled by federal law to do so. That is why doing so is protected under P.L. 86-272, and not because the activity is ancillary to the solicitation of orders.7

Conclusion

The meaning of “solicitation of orders” contained in P.L. 86-272, the 62-year-old temporary statute that limits a state’s jurisdiction to tax the net income of an out-of-state corporation when its only activity in the state is the solicitation of orders, bedeviled states and taxpayers for decades until the Supreme Court’s decision in Wrigley. Although Wrigley clarified the matter, there continues to be instances in which the issue arises, particularly in cases in which a would-be taxpayer’s unprotected conduct is compelled by state or federal law. When state law is at issue, whether P.L. 86-272’s protection is lost depends on whether the state has a legitimate interest in regulating the conduct. If so, the activity is unprotected, and the state may assert tax jurisdiction over the actor. If the state’s interest is only to make an end run around P.L. 86-272, however, the statute trumps the state’s law, and the conduct remains protected. When federal law compels conduct that would otherwise cause an out-of-state company to lose P.L. 86-272 protection, a state cannot consider that conduct to assert taxing jurisdiction. Although those cases may become rarer as time goes by, as long as there are states and taxpayers, there is little doubt that those matters will continue to be litigated.

FOOTNOTES

1 15 U.S.C. section 381.

3 Pomco Graphics Inc. v. Director, Division of Taxation, 13 N.J. Tax 578 (N.J. Tax Ct. 1993).

4 Contrast Pomco Graphics with the Supreme Court’s decision in Heublein, in which it said that “Congress of course did not enact in [P.L. 86-272] a statute which a state can deliberately invade by requiring a firm to undertake more than mere solicitation. When a state enacts a regulatory scheme that serves legitimate state purposes other than assuring that the state may tax the firm’s income, it is not evading [P.L. 86-272]; it is pursuing permissible ends in a manner than Congress did not address.” Heublein Inc. v. South Carolina Tax Commission, 409 U.S. 275 (1972). In Pomco Graphics, it is hard to imagine that New Jersey promulgated its casino license regulation solely for the purpose of forcing similar out-of-state firms to forfeit P.L. 86-272 protection.

5 7 U.S.C. section 499(a), et seq.

7 Procacci also involved a question of whether a corporation sending its own trucks into New Jersey to pick up produce from a related entity during a single audit year was unprotected activity under P.L. 86-272. Although this activity did not occur often, the tax court found it regular and systematic to the point where P.L. 86-272 protection was lost.

END FOOTNOTES

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