On November 23, Washington’s Supreme Court held that a corporation could be held responsible for business and occupation (B&O) taxes on sales occurring out of state if the tangible personal property in question is delivered to a Washington location by some slight connection of the corporation’s in-state offices and activities. Avnet, Inc. earned more than $200 million in revenue from its wholesale sale of goods shipped into Washington from 2003–2005. Approximately $80 million of its gross receipts came from national and drop-shipped sales, on which Avnet did not remit B&O taxes. National sales are wholesale sales from out of state, billed to out-of-state customers, delivered to a customer’s Washington branch. Drop-shipment sales involve an out-of-state customer placing a wholesale order and directing Avnet to deliver the product to its customer in Washington. This is a standard drop-shipment scenario.
The Washington Department of Revenue determined that Avnet’s failure to include national and drop-ship sales in its tax filings resulted in underreporting of B&O tax liability. Avnet argued that taxing such sales violated the dormant commerce clause of the United States Constitution, as well as Rule 193 (in effect during the time in question) of the Washington Administrative Code. At the core of the dispute is whether the activities of Avnet’s Washington office, which employed managers, sales and marketing representatives, engineers, and technology consultants, could sufficiently dissociate itself from the transactions in question. The court determined that while the Washington office was not involved in the specific transactions at issue, the activities were both considerable and significantly associated with the taxpayer’s ability to establish and maintain a market in Washington.
The court went on to indicate that, in light of existing precedent, where there is general contact between the taxpayer’s in-state employees and its customers related to the taxpayer’s products, Avnet cannot make the claim that sales of such products are dissociated from those employees’ activities.
In a dissenting opinion, Justice Sheryl Gordon McCloud argued that there was no significant relationship between Avnet’s Washington office employees and the out-of-state customers or in-state recipients for individual transactions, which should have barred taxation under the dormant commerce clause. Additionally, in the case of third-party drop-shipped sales, an independent entity (the purchaser’s customer), receives the product in Washington, which would run afoul of Rule 193’s requirement that the purchaser or its agent must take physical possession of, or have dominion or control over, the tangible personal property in question. The majority dismissed this issue by arguing that the purchaser’s customer was an agent of the purchaser, which satisfied the above requirement.
Underlying much of the dissent was Justice McCloud’s reiteration that in Washington, ambiguity must be determined in favor of the taxpayer and that the existence of differing precedent indicated some ambiguity regarding the law’s application to the facts in question.
It is important for Ryan clients to note that the Washington Legislature substantially changed the nexus standard for wholesale sales in 2015, so many of the specific issues discussed in this case must now be re-evaluated. The current law utilizes an economic nexus test to determine if a business’s wholesale sales are subject to the B&O tax. In essence, if a business makes more than $267,000 of sales at wholesale and the goods are received in Washington, the nexus requirement has been met and the business will be subject to the tax. While sales made at retail retain a physical presence nexus standard, the Washington Department of Revenue has revised Rule 193 to clarify its position on drop shipments and when goods are received in Washington. With this broadened nexus standard, the Department of Revenue is actively searching for out-of-state businesses that may now be subject to the B&O tax.