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California Franchise Tax Board attacks PL 86-272 safe harbor

By Valerie Sasaki and Jacob Landsberg

Earlier this month, California became the first state to publicly adopt the Multistate Tax Commission’s (“MTC”) August 2021 interpretation of Federal Public Law 86-272 (“PL 86-272’) in Technical Advice Memorandum 2022-01. (“TAM,” To access the TAM, click here) where it provided business scenarios and the tax treatment of the scenario.

The federal law, PL 86-272 (codified at 15 USC §§381-384) creates a safe harbor for companies that are doing business in other states. PL 86-272 was first enacted in 1959. It says that a state may not impose a tax based on net income on companies whose only activity in a state is the solicitation of sales of tangible personal property. Many states that have corporate income taxes have been trying to erode the protection that PL 86-272 affords to businesses, especially in the wake of the Supreme Court’s decision in South Dakota v. Wayfair in 2018.

We were concerned when we saw the MTC’s proposed rule come out in the fall of 2021, and we’re even more concerned now that California appears to be adopting the proposal. The new interpretation, if sustained in court, will greatly increase the number of companies that have to pay California’s state net income tax.

The MTC recommends the new interpretation of “doing business” the Supreme Court adopted in South Dakota v. Wayfair, Inc.: a company “may be present in a State in a meaningful way without that presence being physical in the traditional sense of the term.” Wayfair, 138 S. Ct. 2080, 2095 (2018). Many practitioners believe that Wayfair rejected the concept of judicial precedent in favor of a nexus interpretation that allows states to tax online commerce.

In the most recent TAM, California listed 12 business scenarios and its interpretation of the tax treatment for each of those scenarios. If a business engages in more than mere solicitation and delivery, there is no income tax immunity under PL 86-272. California’s TAM lists two scenarios that it says exceed the protection of PL 86-272 and will create income tax liability for the company at issue in California:

A business that regularly provides post-sale assistance to California customers via either electronic chat or email that customers initiate by clicking on an icon on the business’s website. (Example 2)

There are several questions the TAM does not address, for example: what about chat “bots?” These are computer programs that simulate human conversation. Many companies use them on their web sites to resolve customer service matters. It is a grey area that if a business does not staff its chat function with individuals but instead an algorithm and artificial intelligence is responding to client questions, is presence established? Another technological issue is treatment of phone support. Will that qualify as solicitation? Under the new interpretation, the treatment of phones is absent, but it is not significantly different than an email or chat function.

Finally, we are concerned that company-supported user forums may create taxable presence with California. These are online venues that are designed to allow end users of products to interact with other users – some of whom may be physically located in California. Does the company’s support and hosting of those forums create taxable presence with California?

We have heard from our own clients and peers that litigation over California’s new TAM is likely and will be monitoring this area for its impact on our Oregon and Washington business customers. If California applies the TAM in audits and the courts sustain that application, this represents a massive expansion of the number of businesses California can and will tax.

A business has a website that invites viewers in California to apply for non-sales positions with the business. The website enables viewers to fill out and submit an electronic application, and also to upload a cover letter and resume. (Example 4)

This example appears to be aimed at the strong trend we’ve witnessed around “digital nomad” workers during the COVID-19 pandemic. Tax directors and CFOs of businesses should confer with their human resources departments to confirm that they are not accidentally creating nexus with California by trying cast a broad net for qualified employees.

Businesses should be aware that California did not clarify to which tax years the Technical Advice Memo will apply. It is possible California will treat it as prospective guidance and it will be used for 2022 and forward. It is also possible that California may choose to apply these standards retroactively, to prior tax years. In either event, businesses should continue to monitor this evolving situation.