Spotlight on Tennessee: Did the Department of Revenue Just Announce Plans to Assert Economic Presence Nexus?

by Baker Donelson

If polled, most practitioners and commentators would likely contend that the State of Tennessee requires an out-of-state company (that is not a financial institution) to have a physical presence in Tennessee before the company is subject to this State's excise and franchise taxes. This position is supported by the Tennessee Court of Appeals' decision in J.C. Penney National Bank v. Johnson. Nonetheless, the Court of Appeals' decision in America Online, Inc. v. Johnson could be read by some, including possibly the Tennessee Department of Revenue (Department), to limit J.C. Penney to the facts and circumstances at issue in the U.S. Supreme Court's Quill Corp. v. North Dakota decision. However, America Online is an unpublished decision and arguably not precedential. Despite this background, did the Department just show its hand in the recently published Revenue Ruling #12-27, dated November 14, 2012? 

Ruling Facts

In Revenue Ruling #12-27, a corporation with no physical presence in Tennessee (Company A) owned, managed and licensed patents. Company A licensed its patents to an affiliate, Company B, which arranged for the manufacture of products by another affiliate, Company C. Company C was granted the right to use the patents to manufacture the products, but did not license the patents. Companies A, B, and C had no physical presence in Tennessee. Company C sold the finished products to Company B and shipped them to Company B's warehouse and distribution facility that was outside Tennessee. Company B entered into a product supply agreement with Partnership D, and shipped the products via common carrier to Partnership D's warehouses in Tennessee and other states. Partnership D sold the products throughout the United States, including Tennessee.

The Department's conclusion that Company A was not "doing business" in Tennessee and was not subject to the excise and franchise taxes is not all that surprising. Company A had no physical presence in Tennessee under J.C. Penney, and the products were ultimately shipped into Tennessee via common carrier under Quill and America Online. While one could be concerned that Partnership D's Tennessee physical presence may be attributed to Company A (or Company B), nothing in the ruling suggests that Partnership D (whose 1 percent partner was Company E, another affiliate of Company A, but whose 99 percent partner was unrelated) engaged in activities in Tennessee that were substantially associated with Company A's ability to establish and maintain a market in Tennessee. The buy/sell product supply arrangement was between Company B and Partnership D, and Partnership D sold the products apparently for its own account, rather for the account of Company B or Company A.

Footnote 3

However, footnote 3 is noteworthy. In that footnote, the Department suggests that "if Company A licensed its patents to an affiliate that used the patents in a manufacturing facility in Tennessee," then Company A could be "doing business" in Tennessee and presumably subject to excise and franchise taxes. While the Department's note is in the context of Tennessee's statutory doing business standard and was not a contention by the Department that such a fact pattern would satisfy Due Process Clause minimum contacts or Commerce Clause substantial nexus requirements, the Department did cite to Praxair Technology, Inc. v. Dir., Division of Taxation. In Praxair the New Jersey Supreme Court held that licensing patents for use in New Jersey and receipt of royalty income from such use satisfied the substantial nexus requirement of the dormant Commerce Clause.


As a result, although Revenue Ruling #12-27 provides helpful guidance to out-of-state companies licensing and using patents to manufacture products outside Tennessee that will be supplied for the Tennessee market, footnote 3 in such Ruling suggests that the Department's administrative policy and audit positions may possibly be shifting to the economic presence nexus theory.

If you would like to discuss this Revenue Ruling or other Tennessee state or local tax issues, please contact one of the following members of the Firm's Tax Department:

Nashville, Tennessee
Scott D. Smith 615.726.7391
Carolyn W. Schott 615.726.7312
Daniel A. Stephenson 615.726.5678

Memphis, Tennessee
William H.D. Fones 901.577.2247
Mary Ann Jackson 901.577.8113
Charles E. Pierce 901.577.2164

East Memphis, Tennessee
James "Josh" Hall  901.579.3126
Christopher J. Coats 901.579.3127

Chattanooga, Tennessee
Carl E. Hartley 423.756.2010
Virginia C. Love 423.209.4118
Sara E. McManus 423.209.4124

Knoxville, Tennessee
L. Eric Ebbert 865.971.5182

Washington, D.C.
James W. McBride 202.508.3467

New Orleans, Louisiana
Robert L. Wollfarth 504.566.8623

Baton Rouge, Louisiana
Alton "Biff" Bayard 225.381.7019

Birmingham, Alabama
Thomas J. Mahoney 205.250.8346
William R.Sylvester 205.250.8372
Adam S. Winger 205.250.8381

Atlanta, Georgia
Nedom A. Haley 404.221.6505
Michael M. Smith 404.589.3419
Michael S. Evans 404.221.6517

Jackson, Mississippi
Stacy E. Thomas 601.351.2484
Jon D. Seawright 601.351.8921
David P. Webb 601.969.4678
C. Tyler Ball 601.351.8959

Orlando, Florida
Donald Christopher 407.367.5402
Richard C. Swank 407.367.5404
Marty Hartley 407.367.5427

Houston, Texas
Brad Chambers 713.286.7193


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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