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A recent decision from the Oregon Supreme Court highlights the importance of understanding potential state and local tax obligations as a national or multi-state tobacco distributor. The Court in Santa Fe Natural Tobacco Company v. Department of Revenue 372 Or 509 (2024) determined the appellant, a New Mexico corporation, was liable to pay state income taxes because the actions of its representatives went beyond the safe harbor limitations of P.L. 86-272 by doing more than soliciting orders in Oregon. We explain the case in more detail below.
Limitations on Interstate Taxation Under the Commerce Clause and Federal Law
The authority of states to impose taxes on interstate commerce is generally restricted under the Commerce Clause of the U.S. Constitution in order to protect taxpayers from multiple taxation. However, past Supreme Court decisions loosened some of those restrictions until Congress eventually enacted P.L. 86-272, which creates a safe harbor from state income tax for businesses whose only in-state activities are the “solicitation of order”, which are then approved and shipped from a point outside the state. The safe harbor also extends to solicitation of orders from indirect customers (i.e., people who order from the business’s in-state direct customers but not from the business itself).
The Supreme Court has further interpreted what business activities are permissible under the safe harbor for solicitation of orders. Namely, activities that fall short of making an actual order and that only serve the business purpose of soliciting orders. See Wisconsin Dept. of Revenue v. William Wrigley, Jr., Co., 505 U.S. 214 (1992). The Court in Wrigley, for example, ruled that independent business functions such as salespersons replacing stale gum without cost or using agency stock checks to sell gum to retailers who agreed to install display racks were not protected under the safe harbor.
How Santa Fe Went Beyond the Immunity for “Solicitation of Orders” Under Section 381 According to the Oregon Supreme Court
Santa Fe Natural Tobacco Company (Taxpayer) is a New Mexico corporation that sold branded tobacco products to wholesalers who would subsequently sell to Oregon retailers. The Taxpayer had reported no taxable income from 2010 to 2013 claiming its immunity under P.L. 86-272. After an audit, the Oregon Department of Revenue assessed significant tax liabilities for each year ranging from a low of $395,947 to a high of $771,122. The Department of Revenue denied the Taxpayer’s immunity claim, arguing its pre-book orders equated to the facilitation of actual sales because of their effect on the Taxpayer’s incentive agreements with its wholesalers.
The Taxpayer’s employees had two methods for its business activities with indirect retail customers in Oregon. The first was through a sell sheet order where the employee would complete the order form on the retailer’s behalf, but it was up to the retailer to submit the order and to purchase tobacco products from the wholesaler.
The second method was a pre-book order, which the Taxpayer’s employees would also complete for the retailers. The Taxpayer’s employees would have the retailer immediately sign the order form and personally submit it to the wholesaler by phone, email, hard copy, etc. However, the act of submitting a pre-book order to the wholesaler activated the Taxpayer’s Distributor Incentive Program Agreement. The Incentive Agreement effectively required the wholesaler to accept and process the order otherwise they would incur substantial economic penalties per the agreement. The Taxpayer even referred to pre-book orders as a “guaranteed order” in its training materials with sales representatives. The Oregon Supreme Court reasoned the Taxpayer’s pre-book order method went beyond the scope of soliciting orders by facilitating an actual sale under the mechanics of its wholesaler agreements.
Consult with a Tobacco Tax and Licensing Professional Today
Santa Fe is a cautionary tale for multi-state tobacco distributors on their state and local tax exposure under certain solicitation practices. The case demonstrates that immunity from state income tax under Section 381 often requires a case-by-case analysis that closely looks at the totality of circumstances surrounding a representative’s solicitation of orders. It’s unclear if a small change in the facts could have led to a more favorable outcome for the Taxpayer in this case. For example, the pre-book orders may not have risen to a facilitated sale if the sales representatives had left it up to the retailers to submit the order form to the wholesaler.
State income taxes can be a sneaky business cost for tobacco distributors unaware of their business practices that trigger nexus within a jurisdiction. If you or a client have questions about their tax exposure following an audit, assessment, or investigation, our experienced tobacco tax and licensing professionals can provide rigorous defense services geared toward a proactive resolution of your matter before a tax authority or governing agency.