Crowe Financial Services Tax Insights

South Carolina’s Attempt to Clarify Economic Nexus (Sort Of)

Aug. 24, 2016

By Kyu Hyun Chun, J.D., LL.M., and Chris Hopkins, CPA

Economic Nexus The South Carolina Department of Revenue (the Department) recently finalized a revenue ruling that addresses the concept of “economic nexus” – or nexus based on a nondomiciled corporation’s economic activity – for income tax purposes in the state. The approved revenue ruling (SC Revenue Ruling No. 16-11) lacks the clarity and conclusiveness of the previously released draft.

The General Trend Toward Nexus Expansion

The concept of economic nexus for income tax purposes was spearheaded by the South Carolina Supreme Court in the 1993 case Geoffrey, Inc. v. South Carolina Tax Commission. The U.S. Supreme Court declined to review the case, but, in 1992, it ruled in Quill Corp. v. North Dakota that a physical presence was required to force an out-of-state company to collect sales and use taxes.

In Geoffrey, the South Carolina Supreme Court held that a Delaware-domiciled taxpayer that licensed intangibles (for example, trademarks and trade names) for use in South Carolina and derived income from their use had sufficient nexus in the state. It also concluded that a physical presence wasn’t necessary for income tax purposes, noting that the Supreme Court in Quill addressed the physical presence requirement only in the context of sales and use taxes.

Since then, a majority of states have jumped on board the economic nexus train. In general, these states take the position that if a business avails itself of the state’s economic marketplace or otherwise derives income from sources in the state, it has sufficient presence for the state to impose income tax.

For banks and other lending organizations, loan-related receipts historically were sourced according to a five-criteria test based on where the majority of a loan’s solicitation, investigation, negotiation, approval, and administration (SINAA) activities occurred. Along with adopting an economic nexus standard, most states have moved away from this activity-based sourcing of receipts to a market-based approach. Under this approach, receipts are sourced based on the location of the customer or a loan’s collateral.

Summary of South Carolina’s Revenue Ruling

South Carolina’s ruling generally is consistent with the state’s prior Revenue Ruling (SC Revenue Ruling 03-4) that addressed income tax nexus. It’s widely understood that South Carolina subscribes to the theory of economic nexus and the state generally has applied the theory administratively on a very broad basis. The ruling states that it “reflects the Department’s official position regarding income tax nexus at the time of its issuance.”

Section J of the ruling applies specifically to financial activities and transactions. The initial draft indicated that the following activities would, by themselves, create nexus with South Carolina:

  • Issuing credit cards to South Carolina residents
  • Purchasing mortgage loans in the secondary market, where a few of the debtors securing the loans and some of the property are located in the state, and the bank services the loans in South Carolina
  • Foreclosing on one or more parcels of real estate in the state

Notably the draft indicated that the following activities, on their own, would not create nexus:

  • Negotiating and obtaining bank loans from a bank in South Carolina, where the officers of the borrowing entity visit the bank twice a year to discuss business
  • Making loans secured by real estate in the state
  • Making loans secured by tangible personal property in the state
  • Purchasing in the secondary market, as a passive investor, credit account balances of state residents but not servicing the accounts in the state
  • Making personal loans to state residents who cross state lines to obtain the loans
  • Making personal loans to out-of-state residents who subsequently move to the state
  • Making automobile loans to out-of-state residents who subsequently move to the state
  • Packaging and selling credit card and mortgage loans to passive investors throughout the United States

In the final approved version of the ruling, however, the Department equivocated and does not specify whether the following activities on their own would – or would not – result in nexus:

  • Making loans secured by real estate in the state
  • Making loans secured by tangible personal property in the state
  • Purchasing mortgage loans in the secondary market, where a few of the debtors securing the loans and some of the property are located in the state
  • Purchasing in the secondary market, as a passive investor, credit account balances of state residents but not servicing the accounts in the state
  • Making personal loans to state residents who cross state lines to obtain the loans
  • Foreclosing on one parcel of real estate in the state

Keep an Eye Out

Banks that pursue any of the activities in South Carolina that are covered in the revenue ruling should take into account how the resulting economic nexus, if any, will affect their tax obligations. Those that don’t nonetheless should stay apprised of this and other nexus developments around the country. Such developments likely will become more widespread as states continue their never-ending quests to increase revenues.


In This Issue

Authors
Kyu Hyun Chun
hopkins-christ-150
Chris J. Hopkins
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