Expanding a Small Business Across State Lines
Unlike many countries, a company, once it is organized, can only do business in the State of incorporation.
In many countries, a company, once it is organized, has the power to do business throughout the national territory. The situation is different in the US where a corporation, a limited liability company, or another form of entity is, by its charter, only allowed to “do business” in the State where it is organized.
A. When is this “Doing Business” Criterion Met?
To conduct activities in another State, a company must seek the authorization of the Department of State in the State where it is planning to expand.
This process is designated by terms such as “qualification,” “request for authority,” or terms of like import. Although the authorization should be obtained before expansion activities are initiated, the request may be submitted as soon as the need for the authorization is ascertained, but penalties may then be assessed in certain States.
“Doing business” or “conducting activities” are terms of art that do not necessarily reflect the language used by savvy business people. In general, not much guidance is to be found in the statutory language as to when a company crosses the threshold into “doing business” in a particular State.
For example, the New York State Business Corporation Law, in section 1301, simply contains a negative listing of activities that do not require qualification, such as maintaining bank accounts or holding corporate meetings in another State.
The Commerce Clause of the U.S. Constitution prevents States from regulating strictly interstate commerce or subjecting it to conditions or authorizations. It, therefore, follows that the mere selling by a vendor, located in State 1, to a customer, located in State 2, does not constitute “doing business” in State 2, that would require the vendor to register in State 2, without any other indication of a more substantial presence in State 2.
To use, again, New York State as an example, based on a memorandum published by the Office of General Counsel of the New York State Department of State, and citing case law, “To be doing business in this State [New York] implies corporate continuity of conduct…”
Although the standard for determining this may require legal analysis, precautionary registration in a State without considering whether it is necessary is not advisable as this would constitute an admission that the company is, in fact, “doing business” in that State, and might result in the unnecessary assessment of corporate and/or franchise taxes.
In most States, the presence of an employee, even working out of his or her own home, constitutes “doing business.” Conversely, sales solicitation by an independent contractor (sales representative) is not “doing business”, provided that the sales representative has no authority to enter into contracts on behalf of the vendor-principal. However, the existence of an independent sales representative in another State will trigger the obligation of the principal to register as a vendor for sales tax purposes,
States will also find that an out-of-state company is doing business in that State if it owns or leases property in that State, or maintains an inventory in that State, or delivers products into the State using the company’s own trucks.
B. Even Seemingly Innocent Activities within a State Have Resulted in Companies’ Being Held Present in that State
Certain States also find that occasional visits to sites or customers in their State constitute “doing business.” The interstate commercial activity protected by the Commerce Clause and Public Law No. 86-272 is thus based on a fairly passive business model of a company receiving orders in one State and delivering goods through common carriers to another State, without much more involvement.
To determine the extent of activities in their State, departments of revenue will routinely send questionnaires to out-of-state companies or vendors when such departments become aware of sales activities within their borders.
Upon receipt of such questionnaires, companies should review and answer the questions with the assistance of legal counsel. Similarly, deployment and expansion into another State should be discussed with legal counsel as such initiatives can have corporate and/or sales tax consequences. About ten years ago, a company turned to my firm for assistance in a dispute it was having with a State’s Tax Authority.
The company had hastily and improperly completed a business activities questionnaire, which included a question on occasional visits to the State. The client—a manufacturer– had only one distributor in the State in question – which in and off itself should not have had any tax consequences – but the client had apparently answered positively to a survey question as to whether it made occasional visits to the State.
As it happened, the owner of the manufacturer had developed a close friendship with the owner of the distribution company and visited him on occasion when the former was in town. The consequence of the client’s apparent innocent representation to that State was that it was thereafter required to file several years of tax returns, at significant cost and expense. Our firm won on appeal to the State Board of Appeals by convincing it that the manufacturer was not, in fact, “doing business” in the State.
Just two years ago, the same State again claimed that the manufacturer was required to file another set of returns. Although we pointed out that this issue had been previously been resolved in the client’s favor, the client, again, was required to retain an accountant to prepare returns for different periods, and ended up being assessed significant taxes based on the client’s alleged presence in the State.
We, again, prevailed on appeal but not before the client had to pay yet more money to defend its position.
The Take Away
The lesson to be learned from the above is that expansion into a State, other than the State of organization, needs to be analyzed to ensure that the company will be compliant with State qualification rules. Furthermore, sales methods, although they may seem a prerogative of business managers, should be periodically reviewed with legal counsel as to their potential tax consequences.
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