Petition for Writ of Certiorari — Capital One One Bank (USA), N.A. v. Commissioner of Revenue of Massachusetts (No. 08-1169)

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Oo 081169 MAR 19 2009

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OFFICE OF THE CLERK

No.

IN THE

Supreme Court of the United States

CAPITAL ONE BANK (USA), N.A.,

F/K/A CAPITAL ONE BANK, AND CAPITAL ONE, N.A..,

AS SUCCESSOR TO CAPITAL ONE F:S.B.,

Petitioners,

Vv.

COMMISSIONER OF REVENUE OF MASSACHUSETTS,

Respondent.

On Petition For A Writ Of Certiorari

To The Supreme Judicial Court Of Massachusetts

PETITION FOR A WRIT OF CERTIORARI

THEODORE B. OLSON

Counsel of Record

THOMAS G. HUNGAR

INDRANEEL SUR

MISHA TSEYTLIN

GIBSON, DUNN & CRUTCHER LLP

1050 Connecticut Avenue, N.W.

Washington, D.C. 20036

(202) 955-8500

Counsel for Petitioners

QUESTION PRESENTED

In National Bellas Hess, Inc. v. Department of

Revenue, 386 U.S. 753 (1967), and Quill Corp. v.

North Dakota, 504 U.S. 298 (1992), this Court held

that the Commerce Clause does not permit a State to

impose a sales or use tax on out-of-state corporations

that have no physical presence in the State, because

such corporations necessarily lack the “substantial

nexus” with the taxing State that is a constitutional

prerequisite to the exercise of the State’s power to

tax the business activities of such out-of-state corpo-

rations. The question presented is:

Whether the Supreme Judicial Court of

Massachusetts erred in holding that a State

may evade the “substantial nexus” require-

ment as explicated in Quill and Bellas Hess

by imposing an income or excise tax on the

very same out-of-state corporations that are

constitutionally immune from sales and use

taxes because they lack a physical presence

in the taxing State.

PARTIES TO THE PROCEEDING

AND RULE 29.6 STATEMENT

The parent company of petitioner Capital One

Bank (USA), N.A. (formerly known as Capital One

Bank) and petitioner Capital One, N.A. (the succes-

sor by merger to Capital One F.S.B.) is Capital One

Financial Corporation, a publicly-traded corporation.

There is no other publicly-held corporation that owns

10 percent or more of the stock of either petitioner.

ill

TABLE OF CONTENTS

Page

Eee IN PRESEN CIDD), ...0..00000..cc0necsersccesscescssccoesese i

PARTIES TO THE PROCEEDING AND

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CONSTITUTIONAL PROVISION INVOLVED ........ 1

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A. Commerce Clause Principles................... 3

B. Factual Back@rounid.............ccccccsssesssressees 5

C. Procedural Background .....................00000 7

REASONS FOR GRANTING THE PETITION ......... 9

I. THE DECISION BELOW

CONFLICTS WITH THIS COURT'S

esd sthgnendakckeossstxenssceseons 9

A. Quill’s Explication Of “Substantial

Nexus” Cannot Be Confined To

The Sales-And-Use-Tax Context........... 10

B. The SJC Contradicted This Court’s

Assessment Of The Economic

Burdens Imposed By Income Taxes ...... 13

C. The Decision Below Conflicts With

This Court’s Rejection Of

Formalism In Commerce-Clause

Se cl cauaaavseacevsenesss 17

D. The SJC Disregarded Quiil By

Ignoring The Constitutionally-

Significant Benefits Of A Bright-

Pe I calito Bef pe tice datsnsebiccicseesevane 18

The SJC Contradicted Quill By

Conflating The Separate Analyses

Under The Due Process And

CI © TIES ooo ccccesnccscesescsccccsessses 19

Il. THE DECISION BELOW

EXACERBATES A GROWING

CONFLICT AMONG STATE

APPELLATE COURTS OVER

APPLICATION OF QUILL TO

pe Gg ee 8, Te ee 21

IL THE QUESTION PRESENTED IS

CRITICALLY IMPORTANT TO

INTERSTATE COMMERCE AND

WARRANTS THIS COURT'S

ep iy 2 Sy 6) Sa 26

A. State Abandonment Of The

Physical-Presence Requirement

Harms The Nation’s Economy............... 26

B. The Problem Has Grown

Dramatically Worse Since The

Denial Of Certiorari In MBNA.............. 30

C. Awaiting Congressional Action

WE Se I oe nvskn kccson bee bccsanescs vnesssncine 33

S| ak BET GURU rasa pct neat np seat Ore edt sR YP I 35

APPENDIX A: Opinion of the Supreme

Judicial Court of Massachusetts .......................0cee08 la

APPENDIX B: Opinion of the Appellate Tax

Board Of MASSACIUSCtES .......00.ccscccccccccoccccscscceccccecses 23a

APPENDIX C: Massachusctts General Laws,

ERY RRR eee tr Oise Omimee anim cere ante 54a

APPENDIX D: Massachusetts General Laws,

I a cael on oun cagbeninbsdanenkaiel 66a

TABLE OF AUTHORITIES

Page(s)

CASES

A&F Trademark, Inc. v. Tolson,

605 S.E.2d 187 (N.C. Ct. App. 2004),

curt, denied, GAG USS. BZi ([O0B).........cccccccccoscccesceses 25

Allstate Ins. Co. v. Watts,

BRE Bey We oe OOS CLOT, LOOL) ......cccccccscossccesscccccsscces 23

Am. Online, Inc. v. Johnson,

No. M2001-00927COA-R3-CV, 2002 WL

1751434 (Tenn. App. July 30, 2002)............. 23

Barclays Bank PLC v.

Franchise Tax Bd. of Cal.,

os canakeanbtsbancdusetseseescsevsncns 12

Bridges v. Geoffrey, Inc.,

984 So.2d 115 (La. Ct. App. 2008)...................seceeees 25

Burger King Corp. v. Rudzewicz,

471 eo whee snkundivawcasdnseeveansans 20

Commonwealth Edison Co. v. Montana,

ss cucbbguluswaniedass canosivennaes 12

Complete Auto Transit, Inc. v. Brady,

Ce cn cd acawnaveobnaceouseasee 4,17

Geoffrey, Inc. v. Okla. Tax Comm'n,

132 P.3d 632 (Okla. Civ. App. 2008)................ccc00e0 25

vil

Geoffrey, Inc. v. S.C. State Tax Comm’n,

437 S.E.2d 13 (S.C.), cert. denied, 510 U.S.

EE ERS IRE POE AL RTE TTI

Goldberg v. Sweet,

A Ee IE GI ai snkpensunisisivanisudenincasasacensunene

Guardian Indus. Corp. v. Dep't of Treas.,

499 N.W.2d 349 (Mich. Ct. App. 1993).............

House v. Mayo,

EE adits lividieisliircarioness

Hughes v. Oklahoma,

RE re TE oi ctkeescdctusdvasssisennsceaseneescoises

Hunt-Wesson, Inc. v.

Franchise Tax Bd. of Cal.,

ee Fe Oe NE ao crseshcindecisrnetaesutsyancsctavancens

J.C. Penney National Bank v. Johnson,

19 S.W.3d 831 (Tenn. Ct. App. 1999), cert.

dented, 631 U.S. GBT (Q000)........eiccrcressarcoovesseess

Japan Line, Ltd. v. County of Los Angeles,

Be Say Oe FTE Sari cat hckesdescdsaacassnexssasesicxeraeis

Kmart Props., Inc. v.

Taxation & Revenue Dep’t of N.M.,

131 P.3d 27 (N.M. Ct. App. 2001), rev'd on

other grounds, 131 P.3d 22 (N.M. 2005)...........

Lanco, Inc. v. Dir., Div. of Taxation,

908 A.2d 176 (N.J. 2006), cert. denied, 127

pe Ms BE A Fh li aiivka ve estas snnnicecayabnsacanesuacniiuie

aie 29

auees 295

Ege) 25

vill

MBNA Am. Bank, N.A. v.

Ind. Dep’t of State Revenue,

Re Be Be I ogo cnc acccksccccendedesoserasersscnss 22, 23

Meadows v. State,

SASS. W 2G T4B.CTONM. LOGS) ...cccccccccccscvcscescccssccceces 23

Nat'l Bellas Hess, Inc. v. Dep’t of Revenue,

es scsaswacdouenuonekereess 1, 4, 20

Nat'l Geographic Soc’y v.

Cal. Bd. of Equalization,

Oe ee Pe CE i iivrcshsarscescsnnstecsccrcacnasss 13, 14, 15

Norton Co. v. Dep’t of Revenue of I1i.,

er ee IED veccngee cin sncxcsssceccaesssuasedestapaves 12, 14

Nw. States Portland Cement Co. v. Minnesota,

Ce ees as baceutenabbewieks 18

Quill Corp. v. North Dakota,

504 U.S. 298 (1992) ............. 1. 2, 4,6, &. 9, 16, 14, 35

14, 17, 18, 20, 21, 22, 28, 33

Reeves, Inc. v. Stake,

ee Us Suvugniabasdavenidesacds 4

Rylander v. Bandag Licensing Corp.,

18 S.W.3d 296 (Tex. App. 2000)................0cc0000 23, 24

Standard Pressed Steel Co. v.

Wash. Revenue Dep't,

ee ee ccaveacuevedecadivceravecenesdecve 13

State v. Quill Corp.,

470 N.W.2d 203 (N.D. 1991) 5

ee eee eee eee eee eee eee eee eee eee ee |

Tax Comm’r v. MBNA Am. Bank, N.A.,

640 S.E.2d 226 (W. Va. 2006), cert. denied

sub nom. FIA Card Servs., N.A. v. Tax

Comm’r of W. Va., 127 S. Ct. 2997 (2007)............08 21

Tyler Pipe Indus., Inc. v.

Wash. State Dep’t of Revenue,

I SI EBs secu baa peuueaceonnianvaentieeekanlineeeed 11

CONSTITUTIONAL PROVISIONS

rE OB ii ceavevnvctseuiotercoonscoccseactecanasasanunnes 1

STATUTES

Be es PA TI) iv cvisscesscnscnsisehsctiestenssosaereeenee l

EMS wasdaiiccbiaiscncevetstcovaseseenscoamarne 26

CAL. REV. & Tax. CODE § 23101(DX2)......ccccosscecssscoers 32

Coml, Greets TATE INO. KS 1G, SF ocicccccsesccsssvsencntemencteanee 32

DIAG. GEN. LAWS CR. GS, FT osccisssercssssscstsccctpeseennennns 7

MASS. GEN. LAWS Chi. 63, § 2 ...cccccccsccsevccscescesconsees 6, 15

MICH. COMP. LAWS § 208.1200(1)............ccssessscossceeees 32

MICH. STAT. ANN. $ 7.5GB04Z)..0.<ssescocccnsssevcsecesseensasens 24

WH. Ch. 263 GELB. 2), Liew 2007 ciccccsvsrcstccssccccscstsaeeee

N.H. REV. STAT. ANN. § 77-A:1, XII .......ccccssscssesserssesd ld

RULES

Fla. Dep't of Revenue, Advisement 07C1-

007, 2007 WL 4577924 (Oct. 17, 2007)...................388

Hamilton, Ohio, Ordinance 191.03(b) (2001)........... 16

ee I GMD os cc cacestdncivsseicessossoencvabetesaesezisns 22

Me. Revenue Servs., Maine Tax Alert (Feb.

BOGS), BOGS Wks STIGATSS .nccccrccsccsccccccsesccccccccscocssccces 33

Mich. Revenue Admin. Bulletin 2007-6

Ne se cpupwasdauacvavecuecsetel

N.Y.C. ADMIN. CODE § 11-603 (2008)..............cc cece ee 16

Or. Dep’t of Revenue Substantial Nexus

Guidelines, OR. ADMIN. R. 150-713.010

rs cssmaanssesesbieccaeuesavesenecutel

OTHER AUTHORITIES

Karen J. Boucher & Shona Ponda, Current

Corporate Income Tax Developments (Part

I), THE TAX ADVISER 166 (March 2009),

http://www.aicpa.org/pubs/taxadv/

NN occ occcscsasecensnosersescncnsescoesees 31

Deloitte Development LLC, California

Budget Legislation Contains Significant

Tax Law Changes (Feb. 27, 2009),

http://www.deloitte.com/dtt/cda/doc/content/

us_tax_multistate_California_FLNAL%2002

Ne rs cahaneihibernssuteaceass 32

Marianne Evans & Sarah McGahan,

Economic Nexus and the Uncertainty of

Quill’s Physical-Presence Test, THE TAX

ADVISER (June 2007), Attp://www.aicpa.org/

PUBS/taxadv/online/jun2007/Clinic9.htm ......0.....: 27

Marjorie Gell, Broken Silence:

Congressional Inaction, Judicial Reaction,

and the Need For a Federally Mandated

Physical Presence Standard For State

Business Activity Taxes, 6 PITT. TAX REV.

__ (forthcoming Spring 2009),

http://works. bepress.com/marjorie_gell/1 ....15, 27, 31

Sanjay Gupta & Lillian Mills, Does

Disconformity in State Corporate Income

Tax Systems Affect Compliance Cost

Burdens?, 56 NAT’L Tax J. 355 (2003)...........0.00.00... 28

June Summers Haas, The Michigan

Business Tax Taxpayer: Jurisdiction to

Tax and the Unitary Business Group,

53 WAYNE L. REV. 1351 (2007 ).......ccccccsccesscccssoscceses 32

Jerome R. Hellerstein & Walter Hellerstein,

STATE TAXATION { 6.30 (3d ed. 1998 &

Ns MI ol tnidacn nites arias cia sh acaeemadenbuberecebsteukons 27

Joseph Henchman, Why The Quill Physical

Presence Rule Shouldn’t Go The Way Of

Personal Jurisdiction, 46 STATE TAX NOTES

ee i EE Fas bubrciss trad eticea lndeenieusedetuduceinevesees 27

KPMG LLP, 2008: Year in Review: The

“Economics” of 2008, in TWIST-Q: A

Quarterly Roundup of This Week in State

Tax (Dec. 2008), http:/hjwww.kpmginfo.com/

TWIST/Quarterly/html/Twist_Q December

ISTE LE ORT OE EE ae NE.

Julie Roman Lackner, Note, The Evolution

and Future of Substantial Nexus in State

Taxation of Corporate Income, 48 B.C. L.

Bs le eda ci di as ccnntccepsguicvininennninens 27

Arthur R. Rosen & Jeffrey S. Reed, Stop the

State Tax Grab, LEGAL TIMEs,

I a oii ss sdeiucksndonets 27

Michael S. Schadewald, FIN 48 Forces

Companies to Wrestle with Uncertain State

Nexus Standards, THE CPA JOURNAL ONLINE

(May 2008), http://www.nysscpa.org/

cpajournal/2008/508/essentials/p42.htim.............06+- 29

Megan A. Stombock, Economic Nexus and

Nonresident Corporate Taxpayers: How

Far Will It Go?, 61 Tax LAW. 1225 (2008) ..16, 27, 28

Chris Sullivan, New Hampshire Adopts

Economic Nexus Standard, 45 STATE TAX

re SI Is, PEE Deccsstrigcsescnstasecsvnscvcvascoseoosss 31

Giles Sutton et al., Attributional Nexus,

Flash Title, and the Chaos in Nexus

Standards, 50 STATE TAX NOTES 491

ee ee sdawenbeueatoasccte!

Emma Vandore, OECD Warns Against

Protectionism, ASSOCIATED PRESS,

eS uiskdcdeannvenauenee

David E. Wildasin, State Corporation

Income Taxation: An Economic Perspective

on Nexus, IFIR Working Paper No. 2009-

08 (Feb. 2009), Attp://www.ifigr.org/

publication/ifir_working_papers/IFIR-WP-

I Noe aL Cla a a bonabnkanced 30

Xill

Edward A. Zelinsky, Rethinking Tax Nexus

and Apportionment: Voice, Exit, and the

Dormant Commerce Clause, 28 VA. TAX

ee SE iach cana Zeaciennipaieninnionernosassesacxieenens

Business Activity Tax Simplification Act of

2007, S. 1726, 110th Cong. (2007) ....................

Business Activity Tax Simplification Act of

2009, H.R. 1083, 111th Cong. (2009)................

Internet Tax Fairness Act of 2001, H.R.

2526, 107th Cong. (2001).........c.cccceseseceeeeeseeeerees

New Economy Tax Fairness Act, S. 664,

ee I ID ssi cnnnisineeconcetevcensencndonsonses

United States Model Income Tax

Convention of November 15, 2006 ....................

deltas 30

ee 29

PETITION FOR A WRIT OF CERTIORARI

Capital One Bank (USA), N.A., formerly known

as Capital One Bank, and Capital One, N.A., as suc-

cessor to Capital One F.S.B., respectfully petition for

a writ of certiorari to review the judgment of the Su-

preme Judicial Court of Massachusetts.

OPINIONS BELOW

The opinion of the Supreme Judicial Court of

Massachusetts (App. la-22a) is reported at 899

N.E.2d 76. The opinion of the Appellate Tax Board

(App. 23a-53a) is not published but is electronically

reported at 2007 WL 1810723.

JURISDICTION

The judgment of the court below was entered on

January 8, 2009. The jurisdiction of this Court is in-

voked under 28 U.S.C. § 1257(a).

CONSTITUTIONAL PROVISION INVOLVED

The Commerce Clause provides:

The Congress shall have Power ... To regu-

late Commerce with foreign Nations, and

among the several States, and with the In-

dian Tribes.

U.S. Const. art. I, § 8. The pertinent Massachusetts

statutory provisions are reprinted in an appendix to

this petition. App. 54a-69a.

STATEMENT

This case presents a recurring question of ex-

traordinary significance to the Nation’s economy.

Notwithstanding this Court’s holdings in National

Bellas Hess, Inc. v. Department of Revenue, 386 U.S.

753 (1967), and Quill Corp. v. North Dakota, 504

U.S. 298 (1992)—namely, that the “substantial

nexus” required by the Commerce Clause is absent

when a State attempts to impose sales or use taxes

on out-of-state corporations that have no physical

presence in the State—a number of state appellate

courts (including the Supreme Judicial Court of

Massachusetts (SJC) below) have now held that

States may easily evade that constitutional prohibi-

tion through the simple artifice of taxing the same

economic activities by means of income or excise

taxes instead of sales or use taxes. Growing num-

bers of state legislatures and tax collectors have cho-

sen to follow that same course. The resulting heavy

burdens on interstate commerce and disincentives

for economic activity that reaches across state lines

will continue to worsen absent this Court’s interven-

tion. Certiorari is warranted to ensure that the prin-

ciples enunciated in this Court’s decisions are not

flouted by revenue-greedy States to the detriment of

interstate business activities and, ultimately, the

Nation’s economy as a whole.

Further review is necessary in this case, for

three reasons. First, the decision below is funda-

mentally inconsistent with this Court’s explication of

the “substantial nexus” requirement in Quill. That

case reaffirmed the physical-presence requirement

and held that a business “whose only contacts with

the taxing State are by mail or common carrier lacks

the ‘substantial nexus’ required by the Commerce

Clause.” 504 U.S. at 311. To be sure, Quill con-

strued the “substantial nexus” requirement in the

context of a use tax, but there is no principled basis

for applying a different constitutional rule to other

types of taxes so far as “substantial nexus” is con-

cerned. The physical-presence requirement should

govern the income tax at issue here, and there is no

warrant for the SJC’s contrary conclusion.

Second, the decision below sharpens a conflict

among state appellate courts over state authority to

tax out-of-state corporations with no in-state physi-

cal presence. While the SJC joins state courts that

have artificially constricted Quill to the sales-and-

use-tax context and adopted a vague economic-nexus

approach for income taxes, other appellate courts

have correctly understood Qui/l as a binding inter-

pretation of the “substantial nexus” requirement that

is fully applicable to income and excise taxes. The

unacceptable result of that growing discord is that

the meaning of the Federal Constitution shifts as

business activity crosses borders, from States that

respect physical presence to those that do not. This

Court’s review is necessary to resolve that conflict.

Finally, the decision below intensifies the al-

ready enormous practical difficulties that multistate

businesses confront in ascertaining and satisfying

their tax obligations to States with which they have

no tangible connection. The problems posed by state

departures from the physical-presence requirement

have grown more severe since the last time this

Court considered the issue two years ago, and indeed

have been exacerbated by this Court’s denial of re-

view at that time. The time to decide the scope of

Quill is now.

A. Commerce Clause Principles

This Court has repeatedly held that the Com-

merce Clause prohibits the States from unduly bur-

dening interstate commerce. “The few simple words

of the Commerce Clause ... reflected a central con-

cern of the Framers that was an immediate reason

for calling the Constitutional Convention: the convic-

tion that in order to succeed, the new Union would

have to avoid the tendencies toward economic Bal-

kanization that had plagued relations among the

Colonies and later among the States under the Arti-

cles of Confederation.” Hughes v. Oklahoma, 441

U.S. 322, 325 (1979).

One burden that States are strongly tempted to

impose is taxation that “impedles] free private trade

in the national marketplace.” Reeves, Inc. v. Stake,

447 U.S. 429, 437 (1980). In Complete Auto Transit,

Inc. v. Brady, 430 U.S. 274 (1977), th’: Court articu-

lated the standard for evaluating v.nen such state

taxes violate the Commerce Clause. Under that test,

a state tax is permissible only if the “tax [1] is ap-

plied to an activity with a substantial nexus with the

taxing State, [2] is fairly apportioned, [3] does not

discriminate against interstate commerce, and [4] is

fairly related to the services provided by the State.”

Id. at 279 (emphasis added).

This case concerns the application of Complete

Auto’s “substantial nexus” requirement to state taxa-

tion of businesses that have no in-state physical

presence. Before Complete Auto, this Court con-

fronted such a tax in National Bellas Hess, Inc. v.

Department of Revenue of Illinois, 386 U.S. 753

(1967), holding that a State could not impose a use

tax on a mail-order company with no in-state physi-

cal presence. The Court explained that imposing

sales and use taxes on out-of-state firms would place

“unjustifiable local entanglements” on _ interstate

commerce.” Id. at 759-760.

In Quill Corp. v. North Dakota, 504 U.S. 298

(1992), this Court eliminated any doubt that Bellas

Hess retained its vitality when analyzed using Com-

plete Auto’s “substantial nexus” terminology. The

North Dakota Supreme Court had held that the

State could impose a use tax on a mail-order office

supply retailer with no in-state outlets or personnel

because, in its view, Bellas Hess’s bright-line re-

quirement had been rendered “obsole[te]” by Com-

plete Auto and “the tremendous social, economic,

commercial, and legal innovations” that had taken

place since Bellas Hess. State v. Quill Corp., 470

N.W.2d 203, 208 (N.D. 1991). This Court reversed,

reaffirming the physical-presence requirement. The

Court held that the Commerce Clause’s “substantial

nexus” prerequisite is not satisfied when the non-

domiciliary taxpayer has no property or personnel

within the State, even though it may transact busi-

ness with state residents through the channels of in-

terstate commerce. 504 U.S. at 314-318.

B. Factual Background

1. At all times relevant here, petitioner Capital

One Bank (now Capital One Bank (USA), N.A.) was

a bank chartered and domiciled in Virginia that of-

fered credit cards to its customers. App. la-3a. Peti-

tioner Capital One F.S.B. (now Capital One, N.A.)

was a federally-chartered savings bank that offered

secured and unsecured credit cards and unsecured

installment and consumer home loans. App. 3a. Pe-

titioners issued general-purpose credit cards to Mas-

sachusetts residents as part of national marketing

efforts. App. 3a-4a. Petitioners did not own or lease

any real property in Massachusetts, nor did they own

any other in-state property. App. 3a. Moreover, pe-

titioners had no employees, agents, or independent

contractors in Massachusetts. Id.

As members of Visa and MasterCard, two asso-

ciations of banks, petitioners were “issuing banks”

that issued credit cards bearing the “Capital One”

name and branded with a Visa or MasterCard logo

as appropriate. App. 4a-5a. Other members of the

associations served as “acquiring banks” that entered

into contractual arrangements with merchants that

accepted Visa or MasterCard. App. 6a-7a. Credit

card transactions were enabled by the transmission

of customer and bank information over electronic

computer and telephone networks that cross state

lines—that is, by the transmission of information

through channels of interstate commerce. /d.

When their customers paid for goods or services

with their credit cards, petitioners effectively guar-

anteed payment to the merchants and thus bore the

risk of non-payment by the customers. App. 7a. Pe-

titioners’ primary assets consisted of unsecured con-

sumer loans arising from customer use of Capital

One credit cards. App. 25a. Petitioners generated

interest and other income through finance charges

on outstanding loan receivables, fees from credit card

transactions, and interest on investments. Id.

Petitioners worked with collection agencies and

attorneys to collect delinquent customer accounts.

App. 7a & n.10. Capital One Services, Inc., an affili-

ate of petitioners’ parent, occasionally engaged at-

torneys in Massachusetts to bring actions against

defaulting customers. App. 29a.

2. The Massachusetts financial institution excise

tax (FIET) statute provides: “[E]very financial insti-

tution engaged in business in the commonwealth

shall pay, on account of each taxable year, an excise

measured by its net income determined to be tax-

able ....” Mass. GEN. Laws ch. 63, § 2 (App. 66a-

69a). FIET liability is based on a percentage of a fi-

nancial institution’s net income. /d.}

! Respondent agreed with petitioners’ characterization of the

FIET as a “tax” on petitioners’ income, even though in Massa-

The FIET applies to any financial institution

that “regularly engagles] in transactions with cus-

tomers in the commonwealth that involve intangible

property and result in income flowing to the taxpayer

from residents of the commonwealth,” even if the

taxpayer has no physical presence in Massachusetts.

MASS. GEN. LAWS ch. 63, § 1 (App. 56a). A financial

institution is presumed to be taxable if it engages in

transactions with 100 residents or has $10 million in

assets or $500,000 in receipts attributable to Massa-

chusetts. Id.

C. Procedural Background

1. Respondent, the Commissioner of Revenue of

Massachusetts, sought to impose the FIET on Capi-

tal One Bank for the years 1995 through 1998, and

on Capital One F.S.B. for the years 1996 through

1998. App. la-2a. After respondent assessed FIET

liability of $1,758,454 against Capital One Bank and

$159,075.25 against. Capital One F.S.B., petitioners

applied for abatement, arguing that the Commerce

Clause prohibited the assessments. App. 8a-9a. Re-

spondent denied petitioners’ applications. App. Qa.

[Footnote continued from previous page}

chusetts there are “historical differences between a tax and an

excise.” App. la-2an.2. In any event, where, as here, a state

tax is measured by a share of a taxpayer’s net income, the

statutory designation of that tax is irrelevant for purposes of

the “substantial nexus” inquiry—regardless of whether the tax

is called an excise, franchise tax, business-license tax, gross-

receipts tax, value-added tax, or capital-stock tax. Cf Hunt-

Wesson, Inc. v. Franchise Tax Bd. of Cal., 528 U.S. 458, 464

(2000) (a “tax on sleeping measured by the number of pairs of

shoes you have in your closet is a tax on shoes”) (internal quota-

tion marks omitted).

2. The Appellate Tax Board upheld respondent’s

denial of abatement. App. 23a-538a. The Board re-

jected petitioners’ claim that Massachusetts could

not, consistent with the Commerce Clause, impose

the FIET on petitioners’ income because they had no

in-state physical presence and therefore lacked a

“substantial nexus” with Massachusetts. App. 30a-

32a.

3. The SJC affirmed. App. la-22a. Petitioners’

core argument, the SJC stated, “is that the board er-

roneously limited to the sales and use tax context the

United States Supreme Court’s holding in Quill...

that the Federal commerce clause precludes a State

from imposing tax obligations on an out-of-State cor-

poration that has no physical presence in the taxing

State.” App. lla.

The SJC disagreed, holding instead that Quill

had a “narrow focus on sales and use taxes for the

physical presence requirement,” a requirement that

“did not apply to the imposition of other types of

State taxes.” App. 17a. The SJC relied heavily on

dicta in Quill, in which this Court remarked that “it

had not, ‘in [its] review of other types of taxes, ar-

ticulated the same physical-presence requirement

that Bellas Hess established for sales and use taxes,”

and that “concerning other types of taxes, [it had]

not adopted a similar bright-line, physical-presence

requirement.” App. 16a-17a (quoting 504 U.S. at.

314, 317 (alterations in original)). In addition, the

SJC reasoned that for “substantial nexus” purposes,

state income taxes on non-domiciliary corporations

are constitutionally distinguishable from sales and

use taxes because the former are per se less burden-

some than the latter: “An income-basecd excise,” the

SJC opined, “typically is paid only once a year... to

one taxing jurisdiction at the State level, and the

payment of such an excise does not entail collection

obligations vis-a-vis consumers.” Jd. at 20a n.17.

Although it rejected physical presence as a pre-

requisite, the SJC identified no method for determin-

ing what degree of connection short of physical pres-

ence counts as a “substantial nexus.” Instead, the

SJC expressed agreement with another court’s con-

clusion that a mere “significant economic presence”

within the state was sufficient to justify income taxa-

tion. App. 20a.

The SJC then announced that the “substantial

nexus” requirement was satisfied in this case, be-

cause petitioners “were providing valuable financial

services to Massachusetts consumers” by “using

Massachusetts banking and credit facilities”; peti-

tioners “addressed customer complaints with the as-

sistance of the Massachusetts Attorney General’s of-

fice”; and petitioners “used the Massachusetts court

system to recover payment for delinquent accounts.”

App. 22a. The SJC thus upheld taxation of petition-

ers’ income under the Commerce Clause (id.), based

in part on the view thai the entire “notion of physi-

cal presence” was “anachronistic” —“even more” so

“today than it was in 1992,” when Quill was decided

(id. at 21a n.18 (quoting 504 U.S. at 327-328 (White,

J., dissenting in part)).

REASONS FOR GRANTING THE PETITION

I. THE DECISION BELOW CONFLICTS WITH

THIS COURT’S PRECEDENTS

The Supreme Judicial Court’s resolution of the

important constitutional question presented is irrec-

oncilable with the reasoning employed by this Court

in Quill and other cases. In particular, the SJC

(1) artificially constricted the physical-presence rule

to the sales-and-use-tax context, overlooking Quill’s

significance as an authoritative construction of Com-

plete Auto’s universal “substantial nexus” require-

ment; (2) improperly ignored the heavy burdens on

interstate commerce imposed by state income taxes,

in an attempt to justify preferential treatment of

such taxes; (3) impermissibly elevated form over sub-

stance in treating sales and use taxes as entirely dis-

tinct from income taxes for purposes of assessing

“substantial nexus”; (4) failed to consider the practi-

cal benefits for interstate commerce of adherence to a

clear physical-presence standard rather than the

SJC’s vague economic-nexus approach; and (5) con-

flated the “substantial nexus” inquiry under the

Commerce Clause with the “minimum contacts” in-

quiry under the Due Process Clause. This Court’s

review is necessary to address the SJC’s profound

misinterpretation of the “substantial nexus” prong,

and to clarify that Quill’s physical-presence require-

ment extends beyond the narrow corner into which

the SJC confined it.

A. Quill’s Explication Of “Substantial Nex-

us” Cannot Be Confined To The Sales-

And-Use-Tax Context

Quill held that the physical-presence require-

ment for state taxation of non-domiciliaries, as ar-

ticulated in Bellas Hess, correctly implements the

constitutional mandate that the taxpayer must have

a “substantial nexus” with the taxing State. Quill

did not explicitly resolve the question whether the

physical-presence requirement extends to taxes other

than sales and use taxes, instead leaving that ques-

tion for later consideration (504 U.S. at 314, 317),

but the Court’s reasoning points inexorably to an af-

firmative answer to that question. Quzd/ reaffirmed

that “a vendor whose only contacts with the taxing

State are by mail or common carrier lacks the ‘sub-

stantial nexus’ required by the Commerce Clause.”

Id. at 311. Indeed, this Court has never construed

the Constitution to authorize a State to impose any

tax on an out-of-state entity that neither owns any

property within the State nor maintains any repre-

sentatives (whether employees or independent con-

tractors) within the State.

The logic of Quill is clear: The Commerce Clause

requires a “substantial nexus” for al/ state taxation,

and a “substantial nexus” requires that a non-

domiciliary corporation have a physical presence in

the State before it may be taxed. Mere contact with

residents of the State through the channels of inter-

state commerce, such as “by mail or common carrier,”

will not suffice. Jd. Connections between a taxpayer

and a State that are equivalent to those present in

Bellas Hess or Quill do not constitute “substantial

nexus,” a principle that logically applies with equal

force to all state taxation of interstate transactions,

whether denominated sales, use, income, or excise

taxes. Accordingly, while Quill applied Commerce-

Clause principles to a use tax, lower courts are not

free to confine the physical-presence requirement to

that context alone.

Defying those principles, the SJC held that Bel-

las Hess and Quill are limited to their facts and that

the physical-presence requirement has a “narrow fo-

cus on sales and use taxes.” App. 17a. No precedent,

however, justifies subjecting sales and use taxes to

sul generis constitutional analysis. Instead, this

Court has regularly cited Bellas Hess when examin-

ing taxes outside the sales-and-use class under Corn-

plete Auto, indicating that the physical-presence rule

applies more broadly. See Tyler Pipe Indus., Inc. v.

Wash. State Dep’t of Revenue, 483 U.S. 232 (1987)

(business and occupation taxes); Commonwealth

Edison Co. v. Montana, 453 U.S. 609 (1981) (sever-

ance taxes); Goldberg v. Sweet, 488 U.S. 252 (1989)

(excise taxes). That is, Bellas Hess and Quill ad-

dressed use taxes, but announced a rule applicable to

state taxation generally. See Commonwealth Edison,

453 U.S. at 626 (citing Bellas Hess in severance-tax

case to support statement that “the interstate busi-

ness must have a substantial nexus with the State

before any tax may be levied on it”) (emphasis in

original). In that respect, Bellas Hess and Quill re-

semble Complete Auto, which addressed sales taxes

but also established a rule applicable to income

taxes. See, e.g., Barclays Bank PLC v. Franchise Tax

Bd. of Cal., 512 U.S. 298, 310-311 (1994).

This Court itself, even before Bellas Hess, ap-

plied the physical-presence requirement to taxes

analogous to the income tax at issue here. In Norton

Company v. Department of Revenue of Illinois, 340

U.S. 534 (1951), [Illinois imposed a gross-receipts tax

(a tax on a firm’s total revenues) on an out-of-state

corporation. This Court explained that “[w]here a

corporation chooses to stay at home in all respects

except to send abroad advertising or drummers to

solicit orders which are sent directly to the home of-

fice for acceptance, filling, and delivery back to the

buyer, it is obvious that the State of the buyer has no

local grip on the seller.” Id. at 537 (emphasis added).

Because the corporation had a Chicago branch, how-

ever, the Court held that Illinois could tax earnings

produced through that branch, but not earnings pro-

duced through direct-mail orders to the firm’s out-of-

state headquarters. J/d. at 537-539. As in Bellas

Hess and its progeny, the dispositive question for

Commerce-Clause purposes in Norton was whether

the taxpayer had a physical presence in the taxing

state.?

The SJC thus had no principled basis for cabin-

ing Quill to the sales-and-use context. The logic of

Quill applies to income taxation as well. This

Court’s review is required to ensure that state courts

give full effect to the necessary implications of the

“substantial nexus” principles enunciated in Quill.

B. The SJC Contradicted This Court’s

Assessment Of The Economic Burdens

Imposed By Income Taxes

The SJC also disregarded this Court’s mandate

that proper analysis of a Commerce-Clause challenge

to a state tax requires consideration of the true bur-

dens imposed by the tax on firms engaged in inter-

state commerce. As this Court explained, the pur-

pose of the “substantial nexus” requirement is to

“limit the reach of state taxing authority so as to en-

sure that state taxation does not. unduly burden in-

terstate commerce.” Quzil/, 504 U.S. at 313.

2 Accord Standard Pressed Steel Co. v. Wash. Revenue Dep't,

419 U.S. 560, 562 (1975) (holding that imposition of gross-

receipts tax on out-of-state corporation was justified, not by

substantial sales in State, but because the corporation had an

“employee ... with a full-time job within the State”); see also

Nat'l Geographic Soc’y v. Cal. Bd. of Equalization, 430 U.S. 551,

557 (1977) (“Standard Pressed Steel held that maintenance in

the taxing State of u single employee ... whose primary re-

sponsibility was to consult with the Washington-based cus-

tomer regarding its anticipated needs for the out-of-state sup-

pliecr’s product[] established a sufficient. relation to activities

within the State producing the gross receipts as to support im-

position of the tax.”).

The Quill Court recognized that when sales and

use taxes are concerned, the obligations imposed on

out-of-state firms would be “unduly burden[some]” in

the absence of a physical-presence rule. Jd. at 313-

316 & n.6. The SJC gave short shrift to those con-

cerns in this case, blithely opining that income taxes

impose less substantial burdens on out-of-state cor-

porations than do sales and use taxes. App. 19a-2la

& n.17. That conclusion conflicts directly with this

Court’s precedents, which make clear that state in-

come taxes place a significantly greater burden on

firms engaged in interstate commerce than do the

sales and use taxes at issue in Quill and Bellas Hess.

In particular, this Court has recognized that the

burden on out-of-state firms is greater from income-

based taxes than from sales and use taxes because

the latter require only that firms collect the levies

from purchasers, whereas income taxes require busi-

nesses to pay the tax out of their own earnings and

also to comply with far more complicated and de-

tailed administrative and computational rules. See

Nat'l Geographic, 430 U.S. at 557-558 (concluding

that “(tlhe case for the validity of”? a “use tax” is

“stronger” than that for a tax on an out-of-state cor-

poration’s revenues, because “[t]he out-of-state

seller” bears only “the administrative [burden] of col-

lecting” the use tax); Norton, 340 U.S. at 537

(concluding that “a state imposing a sales or use tax

can more easily meet this burden” of establishing the

requisite nexus “because the impact of those taxes is

on the local buyer or user,” unlike a gross-receipts

tax).

The financial obligation imposed by income taxes

is thus far more onerous than that imposed by sales

taxes, not only because income taxes fall directly on

and must be paid by the out-of-state business out of

its own earnings, but also because income taxation

by multiple jurisdictions can lead to double taxation.

See Nat'l Geographic, 430 U.S. at 557-558 (describing

the “risk of double taxation” as one reason why in-

come taxes are more constitutionally problematic

than sales taxes). The economic-nexus approach

adopted by the court below would greatly exacerbate

the risk of double taxation by making it far more

likely for businesses—even relatively small busi-

nesses doing interstate business- ‘to be subjected to

taxation in multiple States.

The administrative burdens of complying with

numerous and disparate income taxation regimes are

also onerous. Each jurisdiction can have its own ap-

portionment formulae, sourcing definitions, income

classification, depreciation, disclosure requirements,

deductions and various other statutory require-

ments—and these requirements can vary widely

among jurisdictions. For example, the tax at issue in

this case requires compliance with pages of statutory

apportionment rules alone. See Mass. Gen. Laws,

ch. 63, §2 (App. 66a-69a); see generally Marjorie

Gell, Broken Silence: Congressional Inaction, Judi-

cial Reaction, and the Need For a Federally Man-

3 Because of differences in state apportionment rules, a tax-

payer physically located in one State that becomes subject to

another State’s taxing power on an “economic nexus” theory

may be taxed on income that is already being taxed by its domi-

ciliary State. Indeed, Capital One, N.A., faced that situation

here, because the income that Massachusetts seeks to tax was

already taxed by Virginia. Although this Court has kept sub-

stantial-nexus analysis distinct from fair-apportionment analy-

sis, the enhanced risk of double taxation posed by the “economic

nexus” theory confirms the need for a physical-presence re-

quirement in order to avoid unduly burdening interstate com-

merce.

dated Physical Presence Standard For State Business

Activity Taxes, 6 PITT. TAX REV. __, _ (manuscript at

22) (forthcoming Spring 2009) (requiring physical

presence is even more appropriate for business-

activity taxes than for sales and use taxes “because

of the sheer number and complexity of different

types of business activity taxes as compared to sales

and use taxes”). In addition to States, various mu-

nicipalities—including localities of very different

sizes, ranging from New York City (N.Y.C. ADMIN.

CODE § 11-603 (2008)) to Hamilton, Ohio (Ordinance

191.03(b) (2001))—have their own corporate income

taxes.

Consequently, the burden of complying with the

various requirements of the numerous income-taxing

jurisdictions, each with its own unique and often

contradictory requirements, can become a crushing

one for multi-state corporations or small businesses

selling products or services nationwide (for example,

through the Internet). See Megan A. Stombock, Eco-

nomic Nexus and Nonresident Corporate Taxpayers:

How Far Will It Go?, 61 TAx LAW. 1225, 1241 (2008).

Indeed, abandoning the physical-presence require-

ment “would require taxpayers to analyze their ac-

tivities on a jurisdiction-by-jurisdiction, entity-by-

entity, year-by-year, and _ issue-by-issue basis

through extensive record maintenance, timely filings

in support of returns, potential simultaneous audits,

and negotiations and litigations in multiple jurisdic-

tions.” Jd. Adhering to Quill would eliminate the

burdens and uncertainty fostered by the SJC’s ap-

proach.

C. The Decision Below Conflicts With This

Court’s Rejection Of Formalism In Com-

merce-Clause Analysis

The upshot of the SJC’s artificial constriction of

Quill is that States, by designating a tax as an in-

come tax rather than a sales and use tax, will be able

to evade the Constitution’s physical-presence re-

quirement for taxation of out-of-state businesses.

Under the SJC’s view, the very same activities that

are constitutionally insufficient to establish “sub-

stantial nexus” for purposes of the sales tax do suf-

fice to create such a nexus when the State chooses to

impose an income tax instead.

If the SJC’s understanding of Quill were correct,

North Dakota could have responded to invalidation

of its use tax on non-domiciliary catalog retailers by

simply imposing an excise or other tax on the reve-

nues those same retailers earned on sales to North

Dakotans. By simple labeling, the State could freely

manipulate application of the physical-presence re-

quirement affirmed in Quill.

This Court has refused to give States such an

“on-off switch. “Complete Auto emphasized the im-

portance of looking past ‘the formal language of the

tax statute [to] its practical effect,” because “differ-

ently denominated tax[es] with the same economic

effect” must be treated similarly. Quill, 504 U.S. at

310 (quoting 430 U.S. at 279) (alteration in original).

The decision below thus conflicts with Quill and

Complete Auto by resurrecting a thoughtless formal-

ism that applies one method of constitutional analy-

sis to sales and use taxes, while refusing to apply

that same methodology to other taxes, even those

(ike income taxes) that. impose greater burdens on

interstate commerce. This Court’s precedents reject

that misguided approach.

D. The SJC Disregarded Quill By Ignoring

The Constitutionally-Significant Benefits

Of A Bright-Line Rule

Equally inconsistent with Quill is the SJC’s dis-

regard for the benefits of a clear and consistent

bright-line physical-presence rule. This Court em-

phasized that a bright-line rule “firmly establishes

the boundaries of legitimate state authority to im-

pose” tax obligations, “reduces litigation concerning

those taxes,” “encourages settled expectations,” and

“fosters investment by businesses and individuals.”

Quill, 504 U.S. at 315-316. Accordingly, the Court

concluded that “the bright-line [physical-presence]

rule of Bellas Hess furthers the ends of the dormant

Commerce Clause” through “the demarcation of a

discrete realm of commercial activity that is free

from interstate taxation.” Id. at 314-315.

The Court acknowledged that this rule, “[ljike

other bright-line tests,” may “appear[] artificial at its

edges,” but any “artificiality” is “more than offset by

the benefits of a clear rule.” Jd. at 315. Clarity is

particularly important in this context because “[the]

law in this area is something of a ‘quagmire’ and the

‘application of constitutional principles to specific

state statutes leaves much room for controversy and

confusion and little in the way of precise guides to

the States in the exercise of their indispensable

power of taxation.” Jd. at 315-316 (quoting Nw.

States Portland Cement Co. v. Minnesota, 358 U.S.

450, 457-458 (1959)).

Those benefits of the bright-line physical-

presence requirement apply a fortion to income

taxes. But the vague economic-nexus approach

adopted by the court below flies directly in the face of

the Quill Court’s emphasis on clarity and ease of ap-

plication. Asserting that the “concept of ‘substantial

nexus’ is more elastic than ‘physical presence” (App.

22a), the SJC announced that petitioners had a sub-

stantial nexus with Massachusetts without setting

forth any standard that would enable out-of-state

firms to determine what general conduct suffices to

enable the State to tax income. The SJC suggested,

for example, that “us[e]” of “Massachusetts banking

and credit facilities” in the course of “provid[ing] ...

services” to Massachusetts customers alone might be

justification enough (id.), which invites a host of

questions—and raises the prospect that, for example,

the SJC would uphold under the Commerce Clause a

tax imposed on a non-domiciliary firm that merely

cashed checks drawn on a Massachusetts bank.

Thus, the decision below clarifies nothing. Instead it

sows confusion about the taxing power and increases

the compliance burdens imposed on interstate busi-

nesses. Quill’s bright-line rule avoids exactly that

outcome, and the SJC erred in departing from it.

EK. The SJC Contradicted Quill By Conflating

The Separate Analyses Under The Due

Process And Commerce Clauses

The SJC’s “elastic” standard conflicts with Quill

in yet another respect. In concluding that petitioners

had a “substantial nexus” sufficient to justify Massa-

chusetts’ income taxation, the SJC essentially dis-

mantled the fence erected by this Court to separate

the Due Process and Commerce Clause inquiries.

The Court in Bellas Hess held that a use tax on

firms with no in-state physical presence violated

both the Due Process and Commerce Clauses, with-

out drawing a clear distinction between the inquiries

under those distinct provisions. 386 U.S. at 756-760.

Quill reaffirmed Bellas Hess’s Commerce Clause

holding, but not its Due Process holding. In so doing,

this Court explained that “the ‘substantial nexus’ re-

quirement is not, like due process’ ‘minimum con-

tacts’ requirement, a proxy for notice, but rather a

means for limiting state burdens on interstate com-

merce.” 504 U.S. at 313. In other words, the ques-

tion under the Commerce Clause is not whether it is

“fair” to subject a company to taxation in a particular

State, but whether a state tax will place an undue

burden on interstate commerce. /d.

Although the SJC purported to acknowledge the

difference between the Due Process and Commerce

Clause analyses, its truncated nexus discussion

amounted merely to the “fairness” inquiry, looking

exclusively to the benefits that petitioners received

from engaging in business transactions with Massa-

chusetts customers and using state-based services.

App. 22a. The SJC’s reliance, for example, on peti-

tioners’ “soliciting and conducting significant credit

card business” with Massachusetts residents (id.) es-

sentially mimicked the analysis that would have

been appropriate under the Due Process Clause to

determine whether petitioners could be sued in Mas-

sachusetts courts. See, e.g., Burger King Corp. v.

Rudzewicz, 471 U.S. 462, 472 (1985). The SJC

thereby collapsed the Due Process and Commerce

Clause inquiries in exactly the way Quill forbids.

Il, THE DECISION BELOW EXACERBATES A

GROWING CONFLICT AMONG STATE AP-

PELLATE COURTS OVER APPLICATION

OF QUILL TO INCOME TAXATION

The decision below expands the preexisting con-

flict among state appellate courts over the question

whether Quill’s interpretation of the substantial-

nexus prong can be confined to sales and use taxes.

That conflict is now both clear and mature. Indeed,

it has become more pronounced since this Court last

considered the question, and only review by this

Court will resolve the conflict.

In holding that Quill’s interpretation of “sub-

stantial nexus” was dependent on and strictly lim-

ited to the particular tax at issue in that case, the

court. below followed the West Virginia Supreme

Court of Appeals, which reached the same conclusion

in Tax Commissioner v. MBNA America Bank, N.A.,

640 S.E.2d 226 (W. Va. 2006) (“MBNA”), cert. denied

sub nom. FIA Card Serus., N.A. v. Tax Comm’r of W.

Va., 127 S. Ct. 2997 (2007). Volunteering that the

physical-presence test reaffirmed by this Court in

Quill “makes little sense in today’s world,” the West

Virginia court announced that Quill “applies only to

sales and use taxes” and not to other state taxes. Id.

at. 234. In lieu of the Quill test, the court selected an

amorphous “economic presence” standard for assess-

ing “substantial nexus.” Id. The dissent vigorously

criticized the majority’s “strained and inaccurate

reading” of Quill and its reliance on “legal commen-

taries with thinly veiled state-favoring taxing agen-

das,” observing that “[i]t would be a strange constitu-

tional doctrine that would countenance one nexus

standard for sales and use taxes under the Com-

merce Clause, and a more relaxed nexus standard for

corporate net income and other state taxes.” Id. at

236, 239-240 (Benjamin, J., dissenting).

The Indiana Tax Court also recently and explic-

itly sided with West Virginia. See MBNA Am. Bank,

N.A. v. Ind. Dep’t of State Revenue, 895 N.E.2d 140

(2008). Relying on the West Virginia MBNA deci-

sion, the Indiana court upheld the challenged tax be-

cause it viewed “economic presence” as establishing

substantial nexus. Jd. at 144.4

Other state appellate courts have reached the

opposite conclusion, recognizing that the Quill

Court’s rationale cannot arbitrarily be limited to the

particular tax at issue there because the Court was

construing the meaning of the “substantial nexus”

requirement, which applies to all state taxes. Most

saliently, in J.C. Penney National Bank v. Johnson,

19 S.W.3d 831 (Tenn. Ct. App. 1999), the Tennessee

Court of Appeals rejected the State’s bid to cabin

Quill to sales and use taxes, seeing “no basis for con-

cluding that the analysis should be different in the

present case.” Jd. at 839. As the court observed,

none of this Court’s precedents has “upheld a state

tax where the out-of-state taxpayer had absolutely

no physical presence in the taxing state.” Jd. at 842.

The court concluded that the taxpayer—like peti-

tioners here, a non-domiciliary credit card issuer

with no in-state personnel or property—lacked the

substantial nexus required to sustain the franchise

and excise taxes imposed. /Jd. The Tennessee Su-

preme Court denied review, and permitted publica-

tion of the Court of Appeals’ decision. J.C. Penney,

No. M1998-00497-SC-R11-CV (Tenn. May 8, 2000)

4 Indiana Tax Court decisions are directly appealable to the

Indiana Supreme Court. See IND. App. P. R. 63(A).

(per curiam). That order gave the appellate court’s

decision binding statewide precedential effect. See

Meadows v. Staie, 849 S.W.2d 748, 752 (Tenn. 1993)

(published opinions of Tennessee Court of Appeals

may be relied on with same “confidence and reliabil-

ity” as those of Tennessee Supreme Court).°

The direct conflict between the decision below

and J.C. Penney—the functional equivalent of a

judgment by the highest court of Tennessee—makes

this Court’s intervention necessary. In addition,

however, appellate courts in other States have also

rejected the view, adopted below, that Quill’s reason-

ing is limited to the sales-and-use-tax context.

Thus, in Rylander v. Bandag Licensing Corp., 18

S.W.3d 296 (Tex. App. 2000), a case involving a state

franchise tax, the Texas Court of Appeals explicitly

considered and rejected the State’s assertion that

5 The West Virginia (640 S.E.2d at 235) and Indiana (895

N.E.2d at 143) courts acknowledged, but failed to grapple with,

J.C. Penney. The SJC erroneously deemed J.C. Penney to have

been undercut by a later unpublished decision. App. 18a n.16

(citing Am. Online, Inc. v. Johnson, No. M2001-00927COA-R3-

CV, 2002 WL 1751434 at *2 (Tenn. Ct. App. July 30, 2002)

(“AOL”)). But AOL held merely that disputed fact issues fore-

closed summary judgment, because it was unclear to what ex-

tent the taxpayer had personnel or leased components in the

State. 2002 WL 1751434 at *1, *3. Moreover, the unpublished

AOL decision could not have overruled the published J.C. Pen-

ney decision. See Allstate Ins. Co. v. Watts, 811 S.W.2d 883, 886

n.2 (Tenn. 1991) (unpublished decisions have only “persuasive

force”).

6 This Court has often addressed Commerce-Clause issues in

the state taxation context without waiting for the emergence of

a split in authority as pronounced and mature as the one here.

See Cert. Pet. in Hunt Wesson, Inc. v. Franchise Tax Bd. of Cal.,

No. 98-2043, at 15-27 (no conflict asserted); Cert. Pet. in Gen-

eral Motors Corp. v. Tracy, No. 95-1232, at 14 (same).

“Quill Corp. and Bellas Hess should be limited to the

context of sales and use taxes.” Jd. at 299. The court

explained that, “[w]hile the decisions in Quill Corp.

and Bellas Hess involved sales and use taxes, we see

no principled distinction when the basic issue re-

mains whether the state cam tax the corporation at

all under the Commerce Clause.” Id. at 300.

“(W]hen the corporation conducts its activity solely

through interstate commerce and lacks any physical

presence in the state,” the court concluded, “no suffi-

cient nexus exists to permit the state to assess tax.”

Id.

Similarly, in Guardian Industries Corp. v. De-

partment of Treasury, 499 N.W.2d 349 (Mich. Ct.

App. 1993), an in-state taxpayer contended that “be-

cause it was subject to income taxation for sales in”

other, “target” States in which it had solicited busi-

ness, it was entitled under Michigan law to reduce

the amount of its income taxable in Michigan by a

corresponding amount. Jd. at 352-353. The then-

applicable statute exempted sales taxable in another

State from Michigan tax if “that [other] state has ju-

risdiction” to impose the tax. Jd. at 353 (quoting

MicH. STAT. ANN. § 7.558(42)). The dispositive ques-

tion, therefore, was whether income taxation by “tar-

get” States would violate the Commerce Clause. /d.

at 356. The court held that the physical-presence

test controlled the answer: “[A]fter Quz//, it. is abun-

dantly clear that Guardian must show a physical

presence within a target state to establish a substan-

tial nexus to it.” Jd. Remanding for factual devel-

opment, the court explained that “[a] target state

that taxed Guardian’s [sales] solicitation activities

would be in violation of the |Clommerce [C]lause if

Guardian’s employees were never present within the

state.” Id. at 357.

The decision below therefore is irreconcilable

with the reasoning of appellate decisions in Tennes-

see, Texas, and Michigan, each of which holds that

Quill’s interpretation of “substantial nexus” cannot

be confined to the sales-and-use-tax context. This

conflict among state appellate courts is now substan-

tial and mature. Resolution by this Court is neces-

sary.’

Because the constitutional question presented

arises from state taxation, this Court cannot await a

federal circuit conflict before answering it. Taxpay-

ers are barred from raising Commerce-Clause chal-

lenges to state taxes in the lower federal courts, be-

cause the Tax Injunction Act prohibits those courts

from restraining “the assessment, levy or collection

of any tax under State law where a plain, speedy and

7 A distinct question is whether a State may tax non-

domiciliaries (often called intangible holding companies) whose

only assets are intellectual property rights that they license to

corporations—typically commonly-owned—that use those rights

within the State while selling goods or services, and pay royal-

ties to the out-of-state licensor. Some courts addressing intan

gible holding companies have held that the out-of-state licen-

sor’s lack of physical presence does not bar taxation. See

Bridges v. Geoffrey, Inc., 984 So.2d 115 (La. Ct. App. 2008);

Lanco, Inc. v. Dir., Div. of Taxation, 908 A.2d 176 (N.J. 2006);

A&F Trademark, Inc. v. Tolson, 605 S.E.2d 187 (N.C. Ct. App.

2004); Kmart Props., Inc. v. Taxation & Revenue Dep’t of N.M.,

131 P.3d 27 (N.M. Ct. App. 2001); Geoffrey, Inc. v. Okla. Tax

Comm'n, 132 P.3d 632 (Okla. Civ. App. 2005); Geoffrey, Inc. v.

S.C. State Tax Comm’n, 437 S.E.2d 13 (S.C. 1993). Those cases

are not controlling here, as the SJC acknowledged; they “in-

volved foreign corporations with intangible property ... that

was being used in the taxing State by a licensee.” App. 2la

n.19. By contrast, during the tax years at issue here, petition

ers did not earn income through the in-state use of their intel-

lectual or other property by a commonly-controlled affiliate.

efficient remedy may be had in the courts of such

State.” 28 U.S.C. § 1341. Accordingly, this Court is

the only federal court that can resolve the growing

disagreement and confusion in the state appellate

courts regarding the import of this Court’s decision

in Quill.

IL THE QUESTION PRESENTED IS CRITI-

CALLY IMPORTANT TO INTERSTATE

COMMERCE AND WARRANTS THIS

COURT’S REVIEW AT THIS TIME

As Bellas Hess and Quill recognized, when a

state abandons the physical-presence requirement, it

adversely affects interstate commerce by creating

confusion and placing onerous burdens on multistate

firms. In recent years, those harms have multiplied,

as a growing number of States has adopted amor-

phous and inconsistent economic-nexus tests for in-

come and excise taxes. That trend accelerated after

this Court’s denial of certiorari in MBNA, and is

growing increasingly out of control as ever-more

States seek to increase their revenues at the expense

of out-of-state businesses. Given the current eco-

nomic crisis and Congress’s consistent inaction, only

a ruling from this Court can stop the flood of state

efforts to impose unduly heavy burdens on interstate

commerce.

A. State Abandonment Of The Physical-

Presence Requirement Harms The

Nation’s Economy

The question presented is “one of the most im-

portant unanswered questions facing state taxpay-

ers,”8 because it has major implications for every tax-

payer whose business activities cross state lines. At

present, the lack of sufficiently clear guidance from

this Court regarding the constitutional limits on

state income taxation of out-of-state corporations has

led to a confusing patchwork of inconsistent state

case law, legislation, and administrative determina-

tions adopting widely varying standards for identify-

ing those limits.? State approaches range from con-

tinued insistence on the physical-presence require-

ment to various versions of the economic-nexus ap-

proach, often with different standards applied to dif-

ferent types of entities. 19

This wide variation among the States regarding

what is fundamentally a question of federal constitu-

tional law creates substantial burdens and uncer-

tainty for businesses faced with deciding whether

they are obligated to pay income taxes in multiple

States. See Stombock, supra, at 1231. Particularly

8 Marianne Evans & Sarah McGahan, Economic Nexus and

the Uncertainty of Quill’s Physical-Presence Test, THE TAX AD-

VISER (June 2007).

9 See Point II, supra; Arthur R. Rosen & Jeffrey S. Reed, Stop

the State Tax Grab, LEGAL TIMES, April 14, 2008 at 28 (observ-

ing that “what constitutes ‘substantial nexus’ is unclear and

has provoked a firestorm of fierce debate”); Gell, supra, (manu-

script at 22); Joseph Henchman, Why The Quill Physical Pres-

ence Rule Shouldn't Go The Way Of Personal Jurisdiction, 46

STATE TAX NOTES 387 (Nov. 5, 2007); Julie Roman Lackner,

Note, The Evolution and Future of Substantial Nexus in State

Taxation of Corporate Income, 48 B.C. L. REV. 1387, 1408-1415

(2007).

10 For example, some States have pursued non domiciliary

financial institutions with particular force. See Jerome R. Hel-

lerstein & Walter Hellerstein, STATE ‘TAXATION J] 6.30 (3d ed.

1998 & Supp. 2009).

problematic in this regard are those States, now in-

cluding Massachusetts, that have rejected the tradi-

tional bright-line physical-presence standard in favor

of some version of “economic nexus.” That inherently

vague approach maximizes discretion in the tax col-

lector, provides little or no guidance to potentially

liable multistate businesses, and greatly increases

the risk of double taxation. See Point I.B., supra.

~ Even when two States both say they apply an

“economic nexus” standard, that phrase is so malle-

able that they may mean very different things.

States are thus sowing confusion even as they seri-

ously undermine the Commerce Clause’s restraint on

state taxation. See n.9, supra; n.12, infra; see also

Stombock, supra, at 1231. This growing uncertainty

is exactly the sort of “controversy and confusion” that

has previously been of concern to this Court, offering

“little in the way of precise guides to the States in

the exercise of their” taxation powers. Quill, 504

U.S. at 315 Gnternal quotation marks omitted).

The cost of complying with state income taxes is

already double the cost of complying with the federal

income tax, and such disproportionate compliance

costs will only increase as firms are required to file

in more and more jurisdictions under vague “eco-

nomic nexus” tests. See Sanjay Gupta & Lillian

Mills, Does Disconformity in State Corporate Income

Tax Systems Affect Compliance Cost Burdens?, 56

NAT'L TAX J. 355, 357 (2003). This increased burden

will hit small and medium-sized businesses espe-

cially hard, because those firms do not have the re-

sources to comply with numerous different income

taxation regimes or contest tax assessments in far-

flung jurisdictions. Such businesses may well decide

against expanding their operations to other States or

the Internet, out of a justified fear that they may be

opening themselves up to onerous tax liabilities and

compliance costs.1!1

Moreover, state abandonment of the physical-

presence requirement threatens to disrupt this Na-

tion’s international tax policy. Pursuant to bilateral

tax treaties, the United States has agreed not to im-

pose national income taxes on foreign firms that do

not have a “permanent establishment” in the United

States, in exchange for reciprocal commitments from

our treaty partners. See United States Model In-

come Tax Convention of November 15, 2006, art. 7,

{ 1; see also id. art. 5. As States become more ag-

gressive in enforcing income taxes against foreign-

based corporations with no in-state physical-

presence, that increasingly burdensome taxation will

create tensions with our tax-treaty partners, poten-

tially encouraging them to abandon their physical-

presence commitments, thereby undermining the

United States’ efforts to promote foreign commerce

and harming U.S.-based firms. As this Court has

warned, “a state tax on the instrumentalities of for-

eign commerce may impair federal uniformity in an

area where federal uniformity is essential.” Japan

11 Moreover, state abandonment of the physical-presence re-

quirement hampers business compliance with applicable ac-

counting rules. Under Interpretation Number 48 issued by the

Financial Accounting Standards Board—which sets standards

for preparing audited financial statements in the United

States—a corporation must record a liability for the full amount

of an unpaid tax liability unless it is “more likely than not” that

the corporation will prevail in contesting that liability. Uncer-

tainty over the permissibility and meaning of the vague eco-

nomic-nexus standard makes compliance with this requirement

increasingly difficult and problematic. See Michael S. Schade-

wald, FIN 48 Forces Companies to Wrestle with Uncertain State

Nexus Standards, THE CPA JOURNAL ONLINE (May 2008).

Line, Ltd. v. County of Los Angeles, 441 U.S. 434,

448-449 (1979). The prospect of interference with

tax treaties is an especially dangerous one given the

pressures toward protectionism and economic bal-

kanization during the current economic crisis. See

Emma Vandore, OECD Warns Against Protection-

ism, ASSOCIATED PRESS, March 38, 2009.

B. The Problem Has Grown Dramatically

Worse Since The Denial Of Certiorari In

MBNA

The need for this Court’s review is more urgent

now than it was when this Court denied certiorari in

MBNA in 2007. Academic commentators and practi-

tioners alike have increasingly recognized the prob-

lems created by state adoption of the economic-nexus

approach and the growing uncertainty and confusion

in this area of the law.!12 In addition, the past two

years have seen a headlong rush by revenve-greedy

state legislatures and tax collectors to adopt amor-

phous economic-nexus standards as a means of in-

creasing tax revenues without raising the ire of in-

state taxpayers.

12 See, e.g., Giles Sutton et al., Attributional Nexus, Flash Tt-

tle, and the Chaos in Nexus Standards, 50 STATE TAX NOTES

491 (Nov. 24, 2008); Edward A. Zelinsky, Rethinking Tax Nexus

and Apportionment: Votce, Exit, and the Dormant Commerce

Clause, 28 Va. TAX REV. 1, 15-20 (2008); articles cited supra n.9;

see also David E. Wildasin, State Corporation Income Taxation:

An Economic Perspective on Nexus, IFIR Working Paper No.

2009-08, at 13 (Feb. 2009) (economic analysis concluding that

corporate income taxes imposed on out-of-state corporations

based on in-state sales “impose[} an implicit tanff o[n] imports

from other states, distorting interstate trade and generating

deadweight efficiency losses”).

As one major accounting firm recently observed:

“The ‘rash’ of economic nexus decisions and legisla-

tion ... really kicked off with the 2007 certliorari]

denial(]” in MBNA and “spread like poison ivy in

2008.” KPMG LLP, 2008: Year in Review: The

“Economics” of 2008, in TWIST-Q: A Quarterly

Roundup of This Week in State Tax (Dec. 2008); see

also Gell, supra, (manuscript at 24). Thus, numer-

ous States have adopted economic-nexus approaches

in the past two years. See, e.g., Karen J. Boucher &

Shona Ponda, Current Corporate Income Tax Devel-

opments (Part I), THE TAX ADVISER 166, 166-168

(March 2009). The proliferation of economic-nexus

theories since review was denied in MBNA has oc-

curred notwithstanding this Court’s reminders that

denial of certiorari “imports no expression of opinion

upon the merits of a case.” House v. Mayo, 324 U.S.

42, 48 (1945). These state actions in disregard of

Quill indicate that unless this Court intervenes, the

burdens inflicted on interstate commerce by amor-

phous economic nexus standards will only continue

to grow.

Just weeks after this Court denied review in

MBNA, for example, the New Hampshire legislature

amended the statutory definition of taxable “busi-

ness activity” to include “a substantial economic

presence evidenced by a purposeful direction of busi-

ness toward the state examined in light of the fre-

quency, quantity, and systematic nature of a busi-

ness organization’s economic contacts with the state”

(emphases added). That amendment took effect July

1, 2007. Ch. 263 (H.B. 2), Laws 2007, amending

N.H. Rev. STAT. ANN. § 77-A:1, XII; see Chris Sulli-

van, New Hampshire Adopts Economic Nexus Stan-

dard, 45 STATE TAX NOTES 213 (July 23, 2007) (not-

ing that the legislature “deferred consideration of the

provision while the economic nexus question was

pending before the Supreme Court” and then acted

promptly upon denial of certiorari).

Similarly, Michigan has embraced “a broadly ex-

panded economic presence nexus standard that will

increase the number of businesses subject to... tax”

in the wake of the denial of review in MBNA. June

Summers Haas, The Michigan Business Tax Tax-

payer: Jurisdiction to Tax and the Unitary Business

Group, 53 WAYNE L. REV. 1351, 1351 (2007). In par-

ticular, under the Michigan Business Tax (MBT),

enacted in July 2007 Gust weeks after the denial of

certiorari) and effective January 1, 2008, a person is

considered to have a nexus with Michigan sufficient

to require payment of the MBT if the person “actively

solicits” sales within the State, and has in-state gross

receipts of or exceeding a specified dollar threshold.

MicH. Comp. LAws § 208.1200(1). Michigan has

opined that “[w]hether substantial economic pres-

ence is established depends on the quality and quan-

tity of the taxpayer’s contacts with the taxing state

and the degree to which the taxpayer exploits the

market.” Mich. Revenue Admin. Bulletin 2007-6, at

4 (Dec. 28, 2007). That highly malleable formulation

“is more of a Due Process nexus standard” than a

test under the Commerce Clause. Haas, supra, at

1359.18 ?

13 California made a similar change recently in enacting its

2009-10 budget. Effective January 1, 2011, the State amended

the statutory definition of “doing business” for tax purposes to

cover any taxpayers whose in-state sales exceed the lesser of

$500,000 or 25% of total sales. Senate Bill No. X38 15, §7

(amending CAL. REV. & TAX. CODE § 23101(b\2)) (enrolled Feb.

19, 2009); see Deloitte Development LLC, California Budget

Legislation Contains Significant Tax Law Changes 4 (Feb. 27,

2009) (“The adoption of a doing business standard that relies

Other States likewise have seized upon denial of

review in MBNA as an occasion for issuing regula-

tory guidance asserting authority to tax non-

domiciliary corporations with no in-state physical

presence. Florida, for example, found MBNA “per-

suasive, especially given the fact that the U.S. Su-

preme Court declined to hear the case[].” Fla. Dep’t

of Revenue, Advisement 07C1-007, 2007 WL

4577924, at *6 (Oct. 17, 2007); see also Me. Revenue

Servs., Maine Tax Alert (Feb. 2008), 2008 WL

2764732, at **2-3 (noting denial of review in MBNA,

and stating that Maine “considers taxpayers with

economic nexus alone to be subject to Maine’s income

tax laws”); Or. Dep’t of Revenue Substantial Nexus

Guidelines, OR. ADMIN. R. 150-713.010 (rev. May

2008) (“[s]lubstantial nexus” “does not require a tax-

payer to have a physical presence in Oregon” and

“exists where a taxpayer regularly takes advantage

of Oregon’s economy to produce income for the tax-

payer and may be established through the significant

economic presence of a taxpayer in the state.”).

C. Awaiting Congressional Action Would

Be Futile

Review by this Court should not be further de-

layed based on a speculative hope that Congress

might at some point decide to address the problem

posed by the economic-nexus theory. Questions

about the scope of state taxing powers under the

Commerce Clause are ones “that Congress has the

ultimate power to resolve” (Quill, 504 U.S. at 318),

[Footnote continued from previous page]

solely on having sales in California would appear to effectively

adopt an ‘economic nexus’ standard for California.”).

but Congress has shown no inclination to address the

issue. Accordingly, this Court has both the authority

and the responsibility to ensure compliance with its

precedents, and it is not for the States to legislate

away the bright-line physical-presence requirement.

Rather, if States conclude that the physical-presence

requirement should be abandoned (or limited only to

certain taxes), they are free to present that argument

to Congress through the ordinary political process.

In MBNA, the State argued that the Court

should deny review in order to give Congress a

chance to act. See Br. in Opp., No. 06-1228, at 17-18.

But Congress still has not acted in the two years

since denial of review in MBNA, while the States

have increasingly violated the principles enunciated

in Quill, exacerbating the problems created by the

economic-nexus approach. In fact, in the 17 years

since Quill invited congressional resolution of the

scope of state taxing power over non-domiciliaries,

Congress has not addressed the issue, indicating that

there is no realistic prospect that Congress will do so

in the foreseeable future.!4 This Court should take

this opportunity to ensure that States, in their insa-

tiable demand for more sources of revenue (particu-

larly from politically disenfranchised out-of-state

businesses), do not continue to defy the principles

enunciated in Quill and Bellas Hess.

14 For example, although business-activity-tax simplification

bills have been introduced in recent Congresses, no votes have

ever been cast on the portions of such legislation addressing the

scope of the physical-presence requirement. Business Activity

Tax Simplification Act of 2009, H.R. 1083, 111th Cong. (2009);

Business Activity Tax Simplification Act of 2007, S. 1726, 110th

Cong. (2007); Internet Tax Fairness Act of 2001, H.R. 2526,

107th Cong. (2001); New Economy ‘l'ax Fairness Act, S. 664,

107th Cong. (2001).

CONCLUSION

The petition for a writ of certiorari should be

granted.

Respectfully submitted.

THEODORE B. OLSON

Counsel of Record

THOMAS G. HUNGAK

INDRANEEL SUR

MISHA TSEYTLIN

GIBSON, DUNN & CRUTCHER LLP

1050 Connecticut Avenue, N.W.

Washington, D.C. 20036

(202) 955-8500

March 19, 2009

APPENDIX

APPENDIX A

Supreme Judicial Court of Massachusetts,

Suffolk.

CAPITAL ONE BANK & another!

Vv.

COMMISSIONER OF REVENUE.

Argued Oct. 7, 2008.

Decided Jan. 8, 2009.

Present: MARSHALL, C.J., IRELAND, SPINA,

COWIN, CORDY, & BOTSFORD, JJ.

SPINA, J.

The present. appeal is from a decision of the Ap-

pellate Tax Board (board) affirming the denial by the

Commissioner of Revenue (commissioner) of applica-

tions by the taxpayers, Capital One Bank (Capital

One) and Capital One F.S.B. (FSB) (collectively,

Capital banks), for the abatement of financial insti-

tution excises (FIET).2 Capital One sought abate-

1 Capital One F.S.B.

2 The Appellate Tax Board (board) noted that G.L. c. 63, § 2,

imposes an excise, not a tax, on financial institutions. For an

extensive discussion of the historical differences between a tax

and an excise, see P. Nichols, Taxation in Massachusetts 15-17

[Footnote continued on next page}

ment for the tax years 1995 through 1998, and FSB

sought abatement for the tax years 1996 through

1998. At issue is whether, consistent with the Fed-

eral commerce clause of the United States Constitu-

tion art. 1, § 8, the Commonwealth can impose the

FIET, pursuant to G.L. c. 63, § 2, on financial insti-

tutions? that do not have a physical presence in

Massachusetts. We granted the Capital banks’ ap-

plication for direct appellate review, and now affirm

the board’s decision.4

The board found the following facts, based on the

parties’ detailed stipulation of facts and the testi-

mony and exhibits introduced at the hearing. See

G.L. c. 58A, § 18 (“The decision of the board shall be

final as to findings of fact”); United Church of Reli-

gious Science v. Assessors of Attleboro, 372 Mass.

280, 281, 361 N.E.2d 1254 (1977).

In 1994, Capital One was established as a wholly

owned subsidiary of Capital One Financial Corpora-

[Footnote continued from previous page]

(3d ed. 938). Here, for consistency and ease of reference, we,

like the parties and the board, shall refer to the excise at issue

as the financial institution excise tax (FIET).

3 A “[flinancial institution” includes “any bank, banking asso-

ciation, trust company, federal or state savings and loan asso-

ciation, including all banks for cooperatives organized under

the United States Farm Credit Act of 1933, whether of issue or

not, existing by authority of the United States, or any state, or

a foreign country, or any law of the commonwealth.” G.L. c. 63,

§ 1.

4 We acknowledge the amicus brief filed by Multistate Tax

Commission in support of the board, and the amicus brief filed

by the Council on State Taxation in support of Capital One

Bank and Capital One F.S.B.

tion (COFC), a Delaware corporation. Capital One is

a Virginia-chartered credit card bank that offers

credit card products. FSB was established in 1996,

also as a wholly owned subsidiary of COFC. Itis a

federally chartered savings bank that offers con-

sumer lending and deposit products, including se-

cured and unsecured credit cards, to individuals and

small businesses. FSB also makes unsecured in-

stallment loans and has a consumer home loan busi-

ness.

The commercial domicil for each bank is Vir-

ginia, where credit approval activities occurred.

During the tax years at issue, the Capital banks nei-

ther owned nor leased any real property in the

Commonwealth. Further, the board assumed, based

on the record before it, that the Capital banks owned

no other Massachusetts property,° and no employee,

agent, or independent contractor of the Capital

banks was located in Massachusetts during the tax

years at issue. As credit card issuers doing business

in the Commonwealth, the Capital banks had been

required to file quarterly credit card issuer’s reports

S The board noted that it was unclear whether credit card

readers used by merchants were the property of the Capital

banks, the merchants, or some other entity. Further, the record

was not clear as to whether the cardholders, the Capital banks,

or both had ownership of the credit cards themselves. The

board stated that because its decision was not dependent on the

Capital banks’ ownership of property or other physical presence

in Massachusetts, the ownership of the credit cards and the

card readers was immaterial.

with the Massachusetts division of banks. See G.L.

c. 140, § 114C, inserted by St.1987, c. 595, § 1.6

COFC is the owner of the trademark “Capital

One,” which it provided to the Capital banks, with-

out license or royalty, for placement on their credit

cards. Using a system called “Information-Based

Strategy,” which employs statistical modeling tech-

niques to segment potential customer lists based on

credit scores, demographics, and other characteris-

tics, the Capital banks targeted specific potential

customers nationwide, including customers in the

Commonwealth. As pertinent here, the Capital

banks then entered into agreements with Massachu-

setts residents for the issuance of “general purpose”

credit cards branded with the “Capital One” trade-

mark and the logo of either Visa U.S.A. Inc. (Visa), or

MasterCard International (MasterCard).’ Pursuant

6 In 1996, the filing requirement for a credit card issuer's re-

ports was changed from quarterly to semiannually. See St.

1996, c. 359, § 2. Subsequent legislation deleted this filing re-

quirement from G.L. c. 140, § 114C, altogether. See St. 2002, c.

455, § 1.

7 Visa and MasterCard are structured as open associations

whose members issue Visa-branded or MasterCard-branded

payment cards, acquire merchants that will accept such pay-

ment cards, or do both. Visa and MasterCard provide services

for their members, including the authorization, settlement, and

clearance of transactions. With certain limited exceptions,

Visa’s membership is open to any institution that is eligible for

Federal Deposit Insurance Corporation deposit insurance or

share insurance. As of 2005, Visa had approximately 14,000

members in the United States, including over 12,000 Visa card

issuers (and had similar membership numbers during the tax

years at issue). MasterCard’s membership is generally open to

any organization that is authorized to engage in financial

[Footnote continued on next page]

to these agreements, the Capital banks would ad-

vance funds on behalf of their customers for transac-

tions in which the customers used a “Capital One”

Visa-branded or MasterCard-branded credit card to

make purchases of goods and services from mer-

chants nationwide. The Capital banks also would

allow customers to obtain cash advances at Capital

banks nationwide displaying the Visa or MasterCard

logo, or at bank automated teller machine (ATM) ki-

osks displaying the Visa or MasterCard logo, or at

ATM kiosks displaying the PLUS or CIRRUS logo, if

such logo also appeared on the credit card. The

Capital banks’ customers agreed to repay the ad-

vanced funds, subject to finance charges and other

fees set forth in their credit card agreements.

As members of the Visa and MasterCard associa-

tions, the Capital banks paid fees to those associa-

tions relating to credit card transactions nationwide,

including transactions by the Capital banks’ Massa-

chusetts customers. In return, the Capital banks re-

ceived numerous benefits from the Visa and Master-

Card associations, including technology and equip-

ment necessary to process credit card transactions.

On a larger scale, the Capital banks were able to ac-

cess a nationwide interconnected credit infrastruc-

[Footnote continued from previous page]

transactions under the laws or government regulations of the

country in which it is organized or principally engaged in busi-

ness, subject to additional requirements set out in MasterCard

bylaws and rules.

8 The PLUS name is a trademark owned by Visa Interna-

tional Service Association and licensed to Visa. The CIRRUS

name is a trademark owned by MasterCard.

ture that provided enormous value both to their own

businesses and to the Capital banks’ customers.

A typical credit card transaction proceeded as fol-

lows. When a Massachusetts customer presented a

“Capital One” Visa-branded or MasterCard-branded

credit card in payment for goods or services, the

cardholder or merchant would “swipe” the card

through a card reader located at the merchant’s

place of business. The credit card information would

be relayed to an “acquiring bank” with which the

merchant had contracted for the handling of credit

card transactions. The acquiring bank verified,

processed, and transmitted the credit card informa-

tion to Visa or MasterCard, which, in turn, relayed

the transaction information to the cardholder’s “issu-

ing bank” (here, the Capital banks), which then

checked the cardholder’s credit line and account

status. Assuming that the cardholder had sufficient

credit, the issuing bank approved the transaction,

and such approval was sent by the issuing bank

through the association network to the acquiring

bank, which relayed the approval to the merchant at

the point of sale. This process occurred in one rapid

series of events. Subsequently, payment requests

were sent by the merchant to the acquiring bank,

which forwarded them to the issuing bank for reim-

bursement. The issuing bank paid the acquiring

bank the amount requested, less an “interchange

fee.” The acquiring bank then retained its own proc-

essing fee from the amount received, and paid the

remainder to the merchant.2 During the tax years at

9 To put these fees in perspective, the board noted that in a

typical Visa or MasterCard transaction, the issuing bank re-

[Footnote continued on next page]

issue, the Capital banks received interchange fees

related to Massachusetts customers ranging between

$4.2 million and $6.8 million annually.

By issuing credit cards with the “Capital One”

logo to Massachusetts customers, the Capital banks

essentially were guaranteeing payment to merchants

of the amounts charged by those customers, if ap-

proved. The Capital banks bore the risk of a card-

holder’s nonpayment. In the event of such nonpay-

ment, the Capital banks worked with collection

agencies!0 and Massachusetts attorneys to collect

delinquent accounts, which included the filing of civil

actions on behalf of the Capital banks in Massachu-

setts courts. When necessary, the Capital banks ob-

tained garnishments or liens against their custom-

ers’ personal property, and, on two occasions, secured

writs of execution against Massachusetts real prop-

erty. If legal proceedings were commenced in Vir-

ginia against Massachusetts residents under the

Virginia long-arm statute, Va. Code Ann. § 8.01-

328.1 (2007), the resulting judgments were, at times,

domesticated to Massachusetts for further enforce-

ment proceedings. In addition, the Massachusetts

Attorney General’s office, through its consumer com-

[Footnote continued from previous page]

tained an “interchange fee” of approximately 1.4 per cent of the

transaction price, and the acquiring bank retained an addi-

tional fee of approximately .6 per cent. Consequently, a total of

=pproximately 2.0 per cent of the transaction amount, known as

the “merchant discount,” would be paid to the issuing and ac-

quiring banks. See United States v. Visa U.S.A., Inc., 344 F.3d

229, 235 (2d Cir. 2003).

10 None of the collection agencies used during the tax years at

issue was located in Massachusetts.

plaints and information section, helped resolve dis-

putes between the Capital banks and Massachusetts

residents during the tax years at issue.

As a result of the Capital banks’ marketing ef-

forts in the Commonwealth, the number of Massa-

chusetts residents carrying Capital One credit cards

rose from 196,645 in 1995 to 465,571 in 1998, and

the number of Massachusetts residents carrying FSB

credit cards rose from 3,845 in 1996 to 7,363 in 1998.

In total, the Capital banks spent more than $20 mil-

hon, through its marketing efforts, to acquire Com-

monwealth residents as customers during the tax

years atissue. Capital One’s outstanding receivables

from accounts held by Massachusetts cardholders

grew from $72,162,796 in 1995 to $113,655,624 in

1998. FSB’s outstanding receivables from accounts

held by Massachusetts cardholders grew from

$11,457,826 in 1996 to $16,588,914 in 1998. Capital

One’s income, derived from interest, fees, and penal-

ties associated with the use of its credit cards by

Massachusetts residents, rose from $22,319,653 in

1995 to $57,941,377 in 1998. FSB’s income, derived

from the same sources, rose from $1,534,525 in 1996

to $3,483,093 in 1998.

On February 28, 2000, in response to notification

from the commissioner that they had not filed FIET

returns for the tax years at issue, the Capital banks

provided the Department of Revenue (department)

with apportionment and other relevant information.

On August 6, 2000, the department issued to the

Capital banks separate notices of intention to assess,

followed shortly thereafter by notices of assessment

for the tax years at issue. The amounts of the as-

sessments were $1,758,454 for Capital One, and

$159,075.25 for FSB. The Capital banks filed timely

applications for abatement of the FIET. See G.L. c.

62C, § 37. The commissioner denied the applica-

tions, and the Capital banks appealed to the board

pursuant to G.L. c. 62C, § 39.

In affirming the commissioner’s denial of the

abatements, the board stated that the Capital banks’

activities in Massachusetts constituted a “substan-

tial nexus” with the Commonwealth that justified

imposition of the FIET for the tax years at issue, In

particular, the board based its determination on the

Capital banks’ purposeful, targeted marketing of

their credit card business to Massachusetts custom-

ers; their required filing of quarterly credit card is-

suer’s reports with the Massachusetts division of

banks; their use of the Massachusetts court system

and the Massachusetts Attorney General’s office to

collect delinquent accounts and resolve disputes;

their use of sophisticated networks, including the

Visa and MasterCard associations and Massachu-

setts acquiring ‘»anks, which linked the Capital

banks with Massachusetts customers and mer-

chants, and by which the Capital banks, through

their customers’ use of “Capital One” branded credit

cards, guaranteed payment to the merchants on be-

half of the customers; and their receipt of hundreds

of millions of dollars in income from millions of

transactions involving Massachusetts residents and

merchants.!! The board stated that, pursuant to its

11 The Capital banks contend that the record does not show

that they actually filed any credit card issuer's reports with the

Massachusetts division of banks or initiated contact with the

Attorney General's office. The Capital banks may not, in fact,

have filed any reports pursuant to G.L. c. 140 § 114C, but the

statutory language suggests that they were required to do so.

In addition, even if the Capital banks did not initiate any con-

[Footnote continued on next page]

10a

reading of Quill Corp. v. North Dakota, 504 U.S. 298,

112 S. Ct. 1904, 119 L.Ed.2d 91 (1992) (Quill), a fi-

nancial institution’s “physical presence” in the taxing

State was not required to establish “substantial

nexus” for purposes of the State’s imposition of an

income-based tax on that institution. Consequently,

the board concluded that the Commonweaith’s as-

sessment of the FIET on the Capital banks was con-

stitutional under the Federal commerce clause. 1?

A decision by the board will not be modified or

reversed if the decision “is based on both substantial

evidence and a correct application of the law.” Bos-

ton Professional Hockey Ass’n v. Commissioner of

Revenue, 443 Mass. 276, 285, 820 N.E.2d 792 (2005).

We presume that a tax is constitutionally valid

unless the party challenging it establishes its inva-

lidity “beyond a rational doubt.” Andover Sav. Bank

v. Commissioner of Revenue, 387 Mass. 229, 235, 439

N.E.2d 282 (1982). While we give deference to the

board’s expertise in interpreting the tax laws of the

Commonwealth, see French v. Assessors of Boston,

383 Mass. 481, 482, 419 N.E.2d 1372 (1981), we ap-

[Footnote continued from previous page]

tact with the Attorney General’s office, Massachusetts consum-

ers filed complaints against them with that office, and the Capi-

tal banks responded to those complaints.

12 The board also concluded that the privileges associated with

the Capital banks’ right. to do business in Massachusetts and

the Capital banks’ sale of financial services in the Common-

wealth were “commodities,” and that the FIET was a “reason-

able” excise on such commodities under the Massachusetts

Constitution. See Part 2, c. 1, § 1, art. 4, of the Constitution of

the Commonwealth. The Capital banks have not challenged

this determination in the present appeal, so we need not con-

sider it further.

lla

ply our independent judgment as to both the law and

the facts on constitutional issues. See Opinion of the

Justices, 328 Mass. 679, 687, 106 N.E.2d 259 (1952).

The thrust of the Capital banks’ appeal is that

the board erroneously limited to the sales and use

tax context the United States Supreme Court’s hold-

ing in Quill, supra at 317-318, 112 S. Ct. 1904, that

the Federal commerce clause precludes a State from

imposing tax obligations on an out-of-State corpora-

tion that has no physical presence in the taxing

State. In the Capital banks’ view, this physical pres-

ence requirement should be equally applicable to a

State’s assessment of an income-based excise, like

the FIET. The Capital banks contend that the board

disregarded the reasons stated in Quill for upholding

a “bright-line” test for tax liability and the benefits of

such a clear standard. Contrary to the board’s de-

termination, the Capital banks continue, sales and

use taxes do not impose a more significant burden on

interstate commerce than income-based taxes such

that the two types of taxes should be treated differ-

ently under the commerce clause. For these reasons,

the Capital banks argue that the FIET should be

deemed unconstitutional as inconsistent with the

Federal commerce clause. We disagree.

Pursuant to G.L. c. 63, § 2, “every financial insti-

tution engaged in business in the commonwealth

shall pay, on account of each taxable year, an excise

measured by its net income determined to be taxable

under [G.L. c. 63, § 2A,] at the [designated] rate.”13

13 General Laws c. 63, § 2A ( ), provides that “[i]f the finan-

cial institution has income from business activity which is tax-

able both within and without this commonwealth, its net in-

[Footnote continued on next page]

12a

The Capital banks have not asserted that they are

not “financial institutions” for purposes of imposition

of the FIET. See G.L. c. 63, § 1 (defining “[flinancial

institution”). As pertinent to the factual circum-

stances here, the phrase “engaged in business in the

commonwealth” includes “regularly engaging in

transactions with customers in the commonwealth

that involve intangible property and result in income

flowing to the taxpayer from residents of the com-

monwealth.” Jd. These activities “shall be pre-

sumed, subject to rebuttal, to be conducted on a regu-

lar basis within the commonwealth, if any of such

activities are conducted with one hundred or more

residents of the commonwealth during any taxable

year or if the taxpayer has ten million dollars or

more of assets attributable to sources within the

commonwealth, or has in excess of five hundred

thousand dollars in receipts attributable to sources

within the commonwealth.” Jd. The Capital banks

have challenged the imposition of the FIET only on

constitutional grounds; they have not rebutted the

statutory presumption that they have regularly en-

gaged in business in Massachusetts.

A State’s ability to tax businesses like the Capi-

tal banks, that operate in interstate commerce, “is

constrained by the Federal government’s broad

power to regulate interstate commerce under the

commerce clause.”!4 Aloha Freightways, Inc. v.

[Footnote continued from previous page]

come shall] be apportioned to this commonwealth by multiplying

its net income by the apportionment. percentage.”

14 Because the Capital banks have challenged the constitu-

tionality of the FIET under only the commerce clause, that is

the focus of our consideration. Nonetheless, we point out that a

[Footnote continued on next page]

13a

Commissioner of Revenue, 428 Mass. 418, 421, 701

[Footnote continued from previous page]

State’s ability to tax businesses operating in interstate com-

merce also is constrainec. by the due process clause of the Four-

teenth Amendment to the United States Constitution. Al-

though unconstitutional taxation claims under the due process

and commerce clauses are closely related, see National Bellas

Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753, 756, 87

S. Ct. 1389, 18 L.Ed.2d 505 (1967), they are separate and “pose

distinct limits on the taxing powers of the States.” Quill Corp.

v. North Dakota, 504 U.S. 298, 305, 112 S. Ct. 1904, 119

L.Ed.2d 91 (1992) (Quill). The due process clause and the

commerce clause address different constitutional concerns. Due

process focuses on “the fundamental] fairness of governmental

activity” and requires consideration “whether an individual’s

connections with a State are substantial enough to legitimate

the State’s exercise of power over him.” Z/d. at 312, 112 S. Ct.

1904. Thus, the due process clause requires “some definite link,

some minimum connection, between a state and the person,

property or transaction it seeks to tax.” Miller Bros. v. Mary-

land, 347 U.S. 340, 344-345, 74 S. Ct. 535, 98 L.Ed. 744 (1954).

See International Harvester Co. v. Wisconsin Dep’t of Taxation,

322 U.S. 435, 441-442, 64 S. Ct. 1060, 88 L.Ed. 1373 (1944) (“A

state may tax such part of the income of a nonresident as is

fairly attributable either to property located in the state or to

events or transactions which, occurring there, are subject to

state regulation and which are within the protection of the

state and entitled to the numerous other benefits which it con-

fers”). See also Truck Renting & Leasing Ass’n v. Commissioner

of Revenue, 433 Mass. 733, 736, 746 N.E.2d 143 (2001). “In con-

trast, the Commerce Clause and its nexus requirement are in-

formed not so much by concerns about fairness for the individ-

ual defendant as by structural concerns about the effects of

state regulation on the national economy.” Quill, supra. Con-

sistent with the due process clause, a State may have the au-

thority to impose a tax based on minimum contacts, but the im-

position of such a tax may unconstitutionally' burden interstate

commerce because the taxpayer lacks a “substantial nexus”

with the taxing State. See id. at 308, 313, 112S. Ct. 1904.

14a

N.E.2d 961 (1998). The commerce clause authorizes

Congress to “regulate Commerce ... among the sev-

eral States.” Art. 1, § 8. The United States Supreme

Court has consistently held that the commerce

clause includes “a further, negative command,

known as the dormant Commerce Clause, prohibit-

ing certain state taxation even when Congress has

failed to legislate on the subject.” Oklahoma Tax

Comm'n v. Jefferson Lines, Inc., 514 U.S. 175, 179,

115 S. Ct. 1331, 131 L.Ed.2d 261 (1995). See Quill,

supra at 309-312, 112 S. Ct. 1904 (discussing evolu-

tion of dormant commerce clause).

Consistent with the commerce clause, a State

may impose a tax on a business engaged in interstate

commerce where the tax “[1] is applied to an activity

with a substantial nexus with the taxing State, [2] is

fairly apportioned, [3] does not discriminate against

interstate commerce, and [4] is fairly related to the

services provided by the State.” Complete Auto

Transit, Inc. v. Brady, 430 U.S. 274, 279, 97 S. Ct.

1076, 51 L.Ed.2d 326 (1977) (Complete Auto). See

Truck Renting & Leasing Ass’n v. Commissioner of

Revenue, 433 Mass. 7338, 740, 746 N.E.2d 148 (2001).

By permitting States to tax purely interstate com-

merce, the United States Supreme Court affirmed

the principle that “interstate commerce may be made

to pay its way.” Complete Auto, supra at 281, 284, 97

S. Ct. 1076. See Commonwealth Edison Co. v. Mon-

tana, 453 U.S. 609, 623624, 101 S. Ct. 2946, 69

L.Ed.2d 884 (1981), quoting Colonial Pipeline Co. v.

Traigle, 421 U.S. 100, 108, 95 S. Ct. 1538, 44 L.Ed.2d

1 (1975) (“It was not the purpose of the commerce

clause to relieve those engaged in interstate com-

merce from their just share of [the] state tax burden

even though it increases the cost of doing business”).

15a

The Capital banks’ challenge to the constitution-

ality of the FIET focuses solely on the first prong of

the Complete Auto test, namely whether the Capital

banks’ activities had a “substantial nexus” with Mas-

sachusetts.15 To satisfy this requirement, “[t]he

business must have some constitutionally sufficient

degree of contact with the taxing State before the

State can impose any tax on it.” Aloha Freightways,

Inc. v. Commissioner of Revenue, supra. It is a stan-

dard that is designed to prevent overreaching by

States. Id. at 423, 701 N.E.2d 961. “(T]he ‘substan-

tial nexus’ requirement is not, like due process’

‘minimum contacts’ requirement, a proxy for notice,

but rather a means for limiting state burdens on in-

terstate commerce.” Quzill, supra at 313, 112 S. Ct.

1904.

The roots of a “physical presence” requirement

under commerce clause analysis were firmly estab-

lished in National Bellas Hess, Inc. v. Department of

Revenue of Ill., 386 U.S. 753, 87 S. Ct. 1389, 18

L.Ed.2d 505 (1967) (Bellas Hess), which involved a

constitutional challenge to a State’s assessment of a

use tax on goods purchased for use in the taxing

State from an out-of-State mail order merchant that

had no in-State retail outlets, sales representatives,

or property. The United States Supreme Court con-

cluded that a State’s assessment of a use tax in such

circumstances created an unconstitutional burden on

interstate commerce because the merchant’s only

15 Because the Capital banks’ challenge to the constitutional-

ity of the FIET under the commerce clause pertains only to the

first prong of the Complete Auto test, we limit our discussion to

that requirement.

16a

connections with the taxing State were by mail or

common carrier. Id. at 758-759, 87 S. Ct. 1889. The

Court’s reasoning for its decision was based, in sig-

nificant part, on the fact that the many local varia-

tions in rates of use tax, in allowable exemptions,

and in administrative requirements would impede

the free conduct of interstate business. Jd. at 759-

760, 87 S. Ct. 1889. The very purpose of the com-

merce clause, the Court stated, “was to ensure a na-

tional economy free from such unjustifiable local en-

tanglements.” Id. at 760, 87 S. Ct. 1389.

Twenty-five years later, the United States Su-

preme Court reaffirmed in Quill, supra at 317-318,

112 S. Ct. 1904, that, with respect to the imposition

of sales and use taxes, the constitutionally sustain-

able measure of contact required for substantial

nexus under the commerce clause was “physical

presence” in the taxing State. The Court made a

point of stating that “[wlJhile contemporary Com-

merce Clause jurisprudence might not dictate the

same result were the issue to arise for the first time

today,” id. at 311, 87 S. Ct. 1389, the Bellas Hess

bright-line physical presence requirement was not

inconsistent with the four-part Complete Auto test,

which the Court described as “continuling] to govern

the validity of state taxes under the Commerce

Clause.” Quill, supra at 310, 112 S. Ct. 1904. Noth-

ing, however, in Quill suggested that physical pres-

ence is required for the imposition of other types of

taxes, including an income-based excise such as the

FIET. To the contrary, while not repudiating the

Bellas Hess rule, the Supreme Court stated in Quill

that it had not, “in [its] review of other types of

taxes, articulated the same physical-presence re-

quirement that Bellas Hess established for sales and

use taxes.” Jd. at 314, 112 S. Ct. 1904 (stating that

17a

Court’s commerce clause jurisprudence “now favors

more flexible balancing analyses”). Moreover, when

summarizing the precedent established in Bellas

Hess, the Court reiterated that, in cases “subsequent

to Bellas Hess and concerning other types of taxes, [it

had] not adopted a similar bright-line, physical-

presence requirement.” /d. at 317, 87 S. Ct. 1389.

See Truck Renting & Leasing Ass’n v. Commissioner

of Revenue, supra at 740 n. 18, 746 N.E.2d 1483 (not-

ing that, in Quill, Supreme Court did not extend

physical presence requirement for imposition of use

or sales tax on out-of-State vendor to other types of

taxes). Cf. Borden Chems. & Plastics v. Zehnder, 312

Ill.App.3d 35, 44, 244 Ill.Dec. 477, 726 N.E.2d 73

(2000) (declining to extend Quill’s physical presence

requirement to income-based taxation, but recogniz-

ing that such requirement would have been satisfied

by taxpayer at issue); Couchot v. State Lottery

Comm’n, 74 Ohio St.3d 417, 425, 659 N.E.2d 1225,

cert. denied, 519 U.S. 810, 117 S. Ct. 55, 186 L.Ed.2d

18 (1996) (same).

The language of the Supreme Court’s decision in

Quill explicitly emphasized, on more than one occa-

sion, a narrow focus on sales and use taxes for the

physical presence requirement, and suggested that

this requirement was limited to those specific as-

sessments and did not apply to the imposition of

other types of State taxes. We will not expand the

Court’s reasoning beyond its articulated boundaries,

particularly where the Court, itself, has limited its

holding to a particular form of taxation.

In a case similar to the present one, the West

Virginia Supreme Court of Appeals considered in

Tax Comm’r of W. Va. v. MBNA Am. Bank, N.A., 220

W.Va. 163, 164-166, 640 S.E.2d 226 (2006), cert. de-

nied sub nom. FIA Card Services, N.A. v. Tax

18a

Comm’r of W. Va., ___ U.S. ___, 127 S. Ct. 2997, 168

L.Ed.2d 719 (2007) (MBNA), whether imposition of

that State’s business franchise and corporation net

income taxes on MBNA America Bank, a Delaware

corporation with no physical presence in West Vir-

ginia, violated the substantial nexus requirement of

the commerce clause. The principal business of

MBNA America Bank was issuing and servicing Visa

and MasterCard credit cards, which it promoted in

West Virginia by mail and telephone solicitation. Jd.

at 164, 640 S.E.2d 226. After considering the evolu-

tion of the Supreme Court’s interpretation of the

dormant commerce clause, the court in MBNA con-

cluded that “Quill’s physical-presence requirement

for showing a substantial Commerce Clause nexus

applie[d] only to use and sales taxes and not to busi-

ness franchise and corporation net income taxes.”

Id. at 169, 640 S.E.2d 226.16

In reaching its conclusion, the West Virginia Su-

preme Court of Appeals opined that (1) the United

States Supreme Court’s decision in Quill was based

16 Contrast J.C. Penney Natl Bank v. Johnson, 19 S.W.3d 831,

842 (Tenn. Ct. App. 1999), cert. denied, 531 U.S. 927, 1218S. Ct.

305, 148 L.Ed.2d 245 (2000) (stating that, while it was not

court’s purpose “to decide whether ‘physical presence’ is re-

quired under the Commerce Clause,” lack of substantial nexus

did not justify assessment of franchise and excise taxes on out-

of-State credit card company), questioned in America Online,

Inc. v. Johnson, No. M2001-00927COA-R3-CV, 2002 WL

1751434 (Tenn. Ct. App. July 30, 2002) (noting that in J.C.

Penney Nat'l Bank v. Johnson, supra, it might have been more

accurate for court to say that “the Supreme Court had rejected

state taxes on interstate commerce where no activities had been

carried on in the taxing state on the taxpayer's behalf” [empha-

sis in original]).

19a

primarily on stare decisis and on the fact that the

precedent established in Bellas Hess had engendered

substantial reliance by the mail order industry, cir-

cumstances that did not compel application beyond

the context of sales and use taxes; (2) the Supreme

Court appeared to have expressly limited the scope of

Quill to sales and use taxes; and (3) the Supreme

Court’s decisions in Bellas Hess and Quill were

based, in part, on the fact that compliance with spe-

cific administrative regulations associated with the

collection of sales and use taxes unduly burdened in-

terstate commerce, but that the collection of fran-

chise and income taxes did not appear to cause simi-

lar compliance burdens.1!7 Jd. at 169-170, 640 S.E.2d

17 Contrary to the Capital banks’ assertion, the board’s finding

that sales and use taxes impose special burdens on interstate

commerce was not based on faulty logic. In its discussion of

these burdens with respect to an out-of-State mail order com-

pany, the United States Supreme Court observed in National

Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753,

759, 87S. Ct. 1389, 18 L.Ed.2d 505 (1967), that if one State can

impede “the free conduct of [such company’s] interstate busi-

ness,” then “so can every other State, and so, indeed, can every

municipality, every school district, and every other political

subdivision throughout the Nation with power to impose sales

and use taxes.” As a result, the Court stated, “(t]he many

variations in rates of tax, in allowable exemptions, and in ad-

ministrative and record-keeping requirements could entangle

{the mail order company] in a virtual welter of complicated ob-

ligations to local jurisdictions with no legitimate claim to im-

pose ‘a fair share of the cost of the local government.” Jd. at

759-760, 87 S. Ct. 1389, quoting Freeman v. Hewit, 329 U.S.

249, 253, 67 S. Ct. 274, 91 L.Ed. 265 (1946). Similarly, in Quill,

supra at 313 n. 6, 112 S. Ct. 1904, the Supreme Court noted

that upholding one State's imposition of a use tax on an out-of-

State mail order company could unduly burden interstate com-

[Footnote continued on next page]

20a

226. The court further stated that the physical pres-

ence test “makes little sense in today’s world” where,

for example, “electronic commerce now makes it pos-

sible for an entity to have a significant economic

presence in a state absent any physical presence

there.”18 Jd. at 171, 640 S.E.2d 226. The analysis

set forth in MBNA is persuasive. !9

[Footnote continued from previous page]

merce where “sinilar obligations might be imposed by the Na-

tion’s 6,000-plus taxing jurisdictions.” Such burdens associated

with the imposition of sales and use taxes are not inconsequen-

tial. An income-based excise, on the other hand, typically is

paid only once a year (except when quarterly estimated taxes

are required), to one taxing jurisdiction at the State level, and

the payment of such an excise does not entail collection obliga-

tions vis-a-vis consumers. See Tax Comm'r of W. Va. v. MBNA

Am. Bank, N.A., 220 W.Va. 163, 170-171, 640 S.E.2d 226

(2006), cert. denied sub nom. FIA Card Serus., N.A. u Tax

Comm’'r of W. Va., __. U.S. ___, 127 S. Ct. 2997, 168 L.Ed.2d

719 (2007). Determinations about whether the Capital banks

are subject to the FIET, in the first instance, and how to appor-

tion income from business activity that is taxable within the

Commonwealth are the sorts of decisions that, more broadly,

can confront all taxpayers, local or out-of-State, when calculat-

ing, reporting, and paying taxes on their income. While the

making of these determinations is certainly more complex for’

large corporate taxpayers, it is part of the cost of doing business

and is not, in our opinion, unduly burdensome on interstate

commerce, particularly where such taxpayers, like the Capital

banks, are earning substantial income from their business ac-

tivities in Massachusetts and where the common usage of com-

puter technology and specialized software has eased the admin-

istrative burdens of tax compliance.

18 In a separate opinion in Quill, Justice White stated: “Per-

haps long ago a seller's ‘physical presence’ was a sufficient part

of a trade to condition imposition of a tax on such presence. But

in today’s economy, physical presence frequently has very little

[Footnote continued on next. page]

2la

Like the West Virginia court, we conclude that

the constitutionality, under the commerce clause, of

the Commonwealth’s imposition of the FIET is de-

[Footnote continued from previous page]

to do with a transaction a State might seek to tax. Wire trans-

fers of money involving billions of dollars occur every day; pur-

chasers place orders with sellers by fax, phone, and computer

linkup; sellers ship goods by air, road, and sea through sundry

delivery services without leaving their place of business.... [A]n

out-of-state direct marketer derives numerous commercial

benefits from the State in which it does business [and the Court

should not, under the commerce clause,] attempt to justify an

anachronistic notion of physical presence in economic terms.”

Quill, supra at 327-328, 112 S. Ct. 1904 (White, J., concurring

in part and dissenting in part). This observation is even more

true today than it was in 1992.

19 In its determination, the board cited several post-Quill de-

cisions that upheld the imposition of income-based taxes on out-

of-State corporations that had no tangible physical presence in

the taxing State. See, e.g., Geoffrey, Inc. v. South Carolina Tax

Comm’n, 313 S.C. 15, 23-24 & n. 4, 437 S.E.2d 138, cert. denied,

510 U.S. 992, 114 S. Ct. 550, 126 L.Ed.2d 461 (1993) (stating

that Quill did not extend physical presence requirement beyond

sales and use taxes, and concluding that licensing intangible

property for use in taxing State established substantial nexus

for imposition of income-based tax). See also Lanco, Inc. v. Di-

rector, Div. of Taxation, 188 N.J. 380, 383, 908 A.2d 176 (2006)

(per curtam), cert. denied, US. __, 127 S. Ct. 2974, 168

L.Ed.2d 702 (2007); Kmart Props., Inc. v. Taxation & Revenue

Dep't, 139 N.M. 177, 185-186, 131 P.3d 27 (Ct. App. 2001), reu’d

on other grounds, 139 N.M. 172, 131 P.3d 22 (2005); A & F

Trademark, Inc. v. Tolson, 167 N.C.App. 150, 159-163, 605

S.E.2d 187 (2004), cert. denied, 546 U.S. 821, 126 S. Ct. 353,

163 L.Ed.2d 62 (2005). While these cases ure instructive with

respect to their analysis of Quill, they are not directly on point

factually, because all involved foreign corporations with intan-

gible property (trademarks, trade names, and service marks)

that was being used in the taxing State by a licensee.

22a

termined not by Quill’s physical presence test, but by

the “substantial nexus” test articulated in Complete

Auto. Accordingly, we turn to the facts of the present

case to determine whether Capital One and FSB had

a substantial nexus with this Commonwealth during

the tax years at issue.

While the concept of “substantial nexus” is more

elastic than “physical presence,” it plainly means a

greater presence, both qualitatively and quantita-

tively, than the minimum connection between a

State and a taxpayer that would satisfy a due proc-

ess inquiry. See note 14, supra. Simply put, the test

is “substantial” nexus, not “minimal” nexus. In addi-

tion to their consumer lending activities, the Capital

banks were soliciting and conducting significant

credit card business in the Commonwealth with

hundreds of thousands of Massachusetts residents,

generating millions of dollars in income for the Capi-

tal banks. In essence, the Capital banks were pro-

viding valuable financial services to Massachusetts

consumers, for which the Capital banks were com-

pensated in the form of interest payments, inter-

change fees, and finance charges. They could not

provide such services in the Commonwealth without

using Massachusetts banking and credit facilities.

In addition, the Capital banks addressed customer

complaints with the assistance of the Massachusetts

Attorney General’s office, and, when necessary, they

used the Massachusetts court system to recover

payment for delinquent accounts. Based on the find-

ings of the board, we conclude that the Capital

banks’ activities in Massachusetts established a sub-

stantial nexus with the Commonwealth and, there-

fore, the assessment of the FIET on the Capital

banks comported with the Federal commerce clause.

Decision of the Appellate Tax Board affirmed.

23a

APPENDIX B

Appellate Tax Board

Commonwealth of Massachusetts

CAPITAL ONE BANK

AND CAPITAL ONE F.S.B.

COMMISSIONER OF REVENUE

Docket Nos. C262391 & C262598

June 22, 2007

FINDINGS OF FACT AND REPORT

In these appeals, the appellants, Capital One

Bank (“COB”) and Capital One F.S.B. (“FSB” and,

together with COB, the “Banks”), challenge the con-

stitutionality of the financial institution excise

(“FIET”)! and the determination of the appellee

Commissioner of Revenue (“Commissioner”) that the

Banks’ in-state activities constituted substantial

1 Both parties adopted the acronym “FIET” for the excise at

issue, based on their description of the excise as the “financial

institution excise tax.” The Board notes that G.L. c. 63, 2 im-

poses an excise, not a tax, on financial institutions. See P.

NICHOLS, TAXATION IN MASSACHUSETTS 16 (3rd ed.

1938). For consistency and ease of reference, however, the

Board also refers to the excise as the “FIET.”

24a

nexus with the Commonwealth of Massachusetts jus-

tifying the imposition of the FIET on them.

On the basis of the parties’ detailed Stipulation

of Facts, exhibits and the iestimony introduced at

the hearing of these appeals, the Appellate Tax

Board (“Board”) made the following findings of fact.

I. JURISDICTION

In response to a notification from the Commis-

sioner that they had not filed FIET returns for the

years at issue, the Banks provided the Commissioner

with apportionment and other relevant information

on or about February 28, 2000. The Commissioner

issued separate Notices of Intention to Assess to

COB and FSB on August 6, 2000. The Commissioner

then issued Notices of Assessment dated September

6, 2000 and September 12, 2000, to COB and FSB,

respectively. The amounts of the assessments at is-

sue in these appeals are $1,758,454.96 for COB and

$159,075 for FSB.

The Banks timely filed applications for abate-

ment of the FIET with the Commissioner on July 10,

2001, which he denied on July 20, 2001. The Banks

then timely filed their appeals with the Board on

September 17, 2001. On the basis of the foregoing,

the Board found and ruled that it had jurisdiction to

hear and decide these appeals.

Il. THE BANKS’ MASSACHUSETTS BUSINESS

At all material times,2 COB was a Virginia char-

tered credit card bank offering credit card products.

2 Unless explicitly stated otherwise, all factual findings relate

to the years at issue.

25a

It was established in 1994 as a wholly-owned sub-

sidiary of Capital One Financial Corporation

(“COFC”), which is a Delaware corporation. COB’s

commercial domicile was in Virginia, where credit

approval activity took place.

FSB was a federally chartered savings bank that

offered consumer lending and deposit products, in-

cluding secured and unsecured credit cards, to indi-

viduals and small businesses. FSB also made unse-

cured installment loans and had a consumer home

loan business. It was established in 1996 as a

wholly-owned subsidiary of COFC.

COFC was the owner of the trademark “Capital

One” and provided the trademark to the Banks,

without license or royalty, to appear on credit cards

which the Banks issued to customers in Massachu-

setts.

As credit card companies doing business in Mas-

sachusetts, the Banks were required to file quarterly

credit card issuer’s reports with the Massachusetts

Division of Banks.

During the years at issue, the Banks’ primary

assets consisted of consumer loans using Capital One

credit cards as the credit extension vehicle. The

Banks also issued certificates of deposit and accepted

secured credit card savings deposits. Both COB and

FSB generated interest and other income through

finance charges assessed on outstanding loan receiv-

ables, fees from credit card transactions described

below, and interest earned on investment securities

and money market investments.

Using a system called Information-Based Strat-

egy (“IBS”), which used statistical modeling tech-

niques that segment potential customer lists based

on credit scores, demographics, and other character-

26a

istics, the Banks targeted specific potential consum-

ers in Massachusetts. As a result of the Banks’ mar-

keting efforts in Massachusetts, the number of Mas-

sachusetts residents carrying COB credit cards rose

from slightly fewer than 200,000 to more than

460,000 during the years at issue and FSB’s Massa-

chusetts customers rose from less than 4,000 to more

than 7,000 during that period. The Banks acknowl-

edged spending between $50 and $100 per individual

cardholder on marketing; at more than 400,000

cardholders in Massachusetts, the Banks spent an

estimated $20 million-plus to acquire Massachusetts

residents as customers during the periods at issue.

The acquisition of Massachusetts customers has

resulted in millions of dollars in income to the

Banks; COB’s receivables related to Massachusetts

customers grew from $72,162,796 to $113,655,624

during the years at issue, while FSB’s receivables

from Massachusetts accounts grew from $11,457,826

to $16,588,914. COB’s income from Massachusetts

customers rose from $22,319,653 in 1995 to

$57,941,377 in 1998, while FSB’s Massachusetts in-

come rose from $1,534,525 in 1996 to more than

$3,000,000 in both 1997 and 1998.

The Banks entered into agreements with Massa-

chusetts residents for purposes of issuing “general

purpose” credit cards branded with the Capital One

trademark and the logo of either Visa or Master-

Card. Visa and MasterCard are associations whose

members issued credit cards with the association’s

logo, acquired merchants that accepted the associa-

tion’s credit cards, or both. Visa and MasterCard

provided services for their members, including the

authorization, settlement and clearance of transac-

tions.

27a

Under the credit card agreement, the Banks

agreed to advance funds on behalf of their customers

for transactions in which the customer used the

“Capital One” Visa-branded credit card or the “Capi-

tal One” MasterCard-branded credit card to make

purchases of goods and/or services from merchants or

other service providers nationwide. The Banks also

agreed to allow customers to obtain cash advances at

banks nationwide displaying the Visa or MasterCaz

logo or at. bank automated teller machines (“ATMs”)

displaying the Visa or MasterCard logo, or at ATMs

displaying the PLUS or CIRRUS logo, if the logo also

appeared on the card.?

The Banks were members of the Visa and

MasterCard associations and paid them fees relating

to credit card transactions nationwide, including

those relating to credit card transactions engaged in

by the Banks’ Massachusetts customers. As mem-

bers of the Visa and MasterCard associations, the

Banks received numerous benefits, including tech-

nology and equipment necessary to process credit

transactions. As members, the Banks were able to

tap into a nationwide interconnected infrastructure

that provided enormous value to their business and

their customers, who received a credit card that

could be used virtually anywhere, including within

the Commonwealth.

A typical credit card transaction proceeds as fol-

lows. When a customer presents a credit card in

payment for goods or services, the cardholder or mer-

3 The PLUS name is a trademark owned by Visa Interna-

tional Service Association and licensed to Visa. The CIRRUS

name is a trademark owned by MasterCard.

28a

chant typically “swipes” the card through a card-

reader located at the merchant’s place of business.

The credit card information is relayed to an “acquir-

ing bank” with which the merchant has contracted.

The acquiring bank processes, packages and trans-

mits that information to the Visa, MasterCard or

other association network. The association network

then relays the transaction information to the card-

holder’s “issuing bank,” in this case, the Banks. The

issuing bank approves the transaction assuming the

cardholder has a sufficient credit line and the ap-

proval is sent by the issuing bank via the network to

the acquiring bank, which relays the approval to the

merchant. Payment requests are sent by the mer-

chant to the acquiring bank, which forwards the re-

quest to the issuing bank. The issuing bank then

pays the acquiring bank the amount requested, less

what is called an “interchange fee.” The acquiring

bank then retains its own fee from the amount re-

ceived, and pays the remainder to the merchant.4

During the years at issue, the Banks received inter-

change fees related to Massachusetts customers

ranging between $4.2 million and $6.8 million annu-

ally.

As issuing banks, the Banks bore the risk of the

cardholder’s non-payment. The Banks billed their

customers, including Massachusetts customers, di-

4 In a typical Visa or MasterCard transaction, the acquiring

bank retains 1.4 percent of the purchase price as an inter-

change fee and the issuing bank 0.6 percent as its fee; accord-

ingly, a total of 2.0 percent of the merchant’s sale price, known

as the “merchant discount,” is paid to the issuing and acquiring

banks. See United States of America vu. Visa, U.S.A., 344 F.3d

229, 235 (2d Cir. 2003).

29a

rectly and the cardholders had a number of days to

pay the statement in full. Interest was charged on

unpaid balances at a rate set by the Banks in their

contracts with customers. By issuing credit cards

with the “Capital One” logo to Massachusetts cus-

tomers, the Banks were essentially guaranteeing

payment to merchants of the amounts charged by the

Banks’ customers.

In the event of non-payment by its customers,

the Banks worked with collection agencies and at-

torney networks to collect delinquent accounts.

These agencies and attorneys provided collection

services to the Banks related to their Massachusetts

customers, and instituted legal proceedings on behalf

of the Banks in Massachusetts courts. Capital One

Services, Inc. (“COSI”),° a subsidiary of COFC that

provided advertising, marketing, administrative and

management services to the Banks, engaged Massa-

chusetts attorneys to bring actions against customers

in default on behalf of the Banks.

In furtherance of the Banks’ collection efforts in

Massachusetts, the Banks obtained garnishments or

liens against personal property and secured writs of

execution against Massachusetts real estate. If court

actions were brought in Virginia against Massachu-

setts residents under the Virginia long-arm statute,

those judgments were at times domesticated to Mas-

5 Another COFC subsidiary, Oakstone Ventures, Inc, was

created to identify non-bank business opportunities because the

Banks were prohibited from engaging in such activities. Be-

ginning in 1998, OCakstone had an office in Boston, Massachu-

setts and an Oakstone employee participated in discussions

with the Banks concerning strategies for the provision of finan-

cial services, including credit card strategies, in Massachusetts.

30a

sachusetts for further enforcement proceedings. The

Massachusetts Attorney General’s Office also helped

mediate disputes between the Banks and Massachu-

setts residents during the years at issue, offering as-

sistance through its Consumer Complaints and In-

formation Section and nineteen Local Consumer

Programs located throughout Massachusetts.

The Banks neither owned nor leased real prop-

erty in Massachusetts. Further, the Board assumes

on this record that the Banks owned no other Massa-

chusetts property® and no Bank employee, agent or

independent contractor? was located in Massachu-

setts during the years at issue.

The Board found and ruled that the Banks’ ac-

tivities constituted “substantial nexus” with Massa-

chusetts so as to justify imposition of the FIET, irre-

spective of whether the Banks had a physical pres-

ence in Massachusetts during the years at issue.

The Banks’ purposeful, targeted marketing of their

6 It is unclear on the present record whether the card readers

used at the merchant locations were the property of the Banks,

the merchant, or some other entity. Further, the record is not

clear as to whether the card holders or the Banks or both had

an ownership in the credit cards themselves. Because the

Board's ruling in these appeals is not dependant on the Bank's

ownership of property or other physical presence in the Com-

monwealth, the ownership of the card reader and cards is im-

material.

7 The Banks argue that the collection activities of their inde-

pendent contractors dis not establish physical presence because

they are de minimis and they did not “expand the market” for

the Banks’ business. Again, because the Board's ruling of sub.

stantial nexus is not dependant on physical presence, resolution

of this issue is not necessary.

3la

credit card business to Massachusetts customers,

their required quarterly filing of Credit Card Issuer’s

Reports with the Massachusetts Division of Banks,

their use of Massachusetts court system and the

Massachusetts Attorney General’s Office to collect

delinquent accounts and resolve disputes with Mas-

sachusetts customers, their use of a sophisticated

network, including Visa and MasterCard as well as

Massachusetts acquiring banks, which linked them

with Massachusetts customers and merchants and

by which they, through the customers’ use of “Capi-

tal One”-branded cards, guaranteed payment to the

merchant on behalf of the customer, and their deriv-

ing of hundreds of millions of dollars in income from

millions of transactions involving Massachusetts

residents and merchants constituted substantial

nexus with Massachusetts.

The Board further found and ruled that the privi-

leges related to the Banks’ right to do business and

its sale of financial services in the Commonwealth is

a “commodity” and the FIET is a “reasonable excise”

upon that commodity for purposes ofthe Massachu-

setts Constitution.

Accordingly, for all of the foregoing reasons, the

Board issued decisions for the appellee in these ap-

peals.

OPINION

These appeals raise the issue of whether, as a

matter of law, the Commerce Clause of the United

States Constitution (U.S. CONST. art. I, § 8, cl. 3,

hereafter “Commerce Clause”) requires that a corpo-

ration must have a “physical presence” in a state be-

fore that state may impose an excise measured by

the corporation’s net income. The Banks also argue

that the FIET is an unreasonable, and therefore in-

32a

valid, excise under MASSACHUSETTS CONST. Pt.

II, C. 1, § 1, Art. 4.

The Board’s authority to rule on constitutional

claims in determining the legality of tax assessments

is clear. See, e.g. WB&T Mortgage Company Inc. v.

Assessors of Boston, ATB Findings of Fact and Re-

port 2006-379; Mullins v. Commissioner of Revenue,

ATB Findings of Fact and Reports 1997-973, affd,

428 Mass. 406 (1998); Gillette Co. v. Commissioner of

Revenue, ATB Findings of Fact and Reports 1996-

362, affd, 425 Mass. 670 (1997); Lonstein v. Commis-

sioner of Revenue, AT'B Findings of Fact and Reports

1988-355, aff'd, 406 Mass. 92 (1989); Tregor v. Asses-

sors of Boston, ATB Findings of Fact and Reports

1978-203, affd, 377 Mass. 602 (1979).

In fact, a taxpayer must raise a constitutional

claim with the Board to preserve the right to appel-

late consideration of the issue. New Bedford Gas &

Electric Light Co. v. Assessors of Dartmouth, 368

Mass. 745, 752 (1975) (“To raise a constitutional

question on appeal to this court from the board, the

taxpayer must present the question to the board and,

in so doing, make a proper record on appeal. Other-

wise, the taxpayer waives the right to press the con-

stitutional argument.”). Accordingly, the Board has

jurisdiction to determine whether the FIET assessed

to the Banks is unconstitutional.

In determining whether the FIET is constitu-

tional, the Board’s analysis must be guided by the

principle that “[a] tax measure is presumed valid and

is entitled to the benefit of any constitutional doubt,

and the burden of proving its invalidity falls on those

who challenge the measure.” Opinion of the Justices,

425 Mass. 1201, 1203-1204 (1997) (quoting Daley vu.

State Tax Commission, 376 Mass. 861, 865-66

33a

(1978)); see also Andover Savings Bank v. Commis-

sioner of Revenue, 387 Mass. 229, 235 (1982). Ac-

cordingly, the following analysis proceeds from the

presumption that the FIET is valid and that any

doubts concerning its interpretation must be re-

solved in favor of an interpretation that renders it

constitutional.

The Board’s analysis begins with a review of the

FIET statute, followed by a discussion of relevant

federal, Massachusetts and other state cases con-

cerning the taxation of interstate commerce under

the Commerce Clause, and concludes with a review

of the Massachusetts constitutional requirements

concerning reasonable excises.

I. MASSACHUSETTS TAXATION OF FINAN-

CIAL INSTITUTIONS

Under G.L. c. 68, § 2, “every financial institution

engaged in business in the commonwealth shall pay,

on account of each taxable year, an excise measured

by its net income determined to be taxable under sec-

tion two A at the [designated rate].” The Banks do

not challenge that they are financial institutions for

purposes of § 2 and the remainder of the FIET.

For purposes of the FIET, “engaged in business”

is defined in G.L. c. 63, § 1 as:

(a) having a business location in the com-

monwealth; (b) having employees, represen-

tatives or independent contractors conduct-

ing business activities on its behalf in the

commonwealth; (c) maintaining, renting or

owning any tangible or real property in the

commonwealth; (e) regularly engaging in

transactions with the customers in the

commonwealth that involve intangible

property and result in income flowing to

34a

the taxpayer from residents of the com-

monwealth; (f) regularly receiving interest

income from loans secured by tangible per-

sonal or real property located in the com-

monwealth; or (g) regularly soliciting and re-

ceiving deposits from customers in the com-

monwealth. With respect to the activities

described in clauses (d) to(g), inclusive,

activities shall be presumed, subject to

rebuttal, to be conducted on a regular

basis within the commonwealth, tf any of

such activities are conducted with one

hundred or more residents of the com-

monwealth during any taxable year or if

the taxpayer hcs ten million dollars or

more of assets attributable to sources

within the commonwealth, or has in ex-

cess of five hundred thousand dollars in

receipts attributable to sources within

the commonwealth.

The Commissioner relies upon the highlighted

subdivision (e), 1.e. the Banks were regularly en-

gaged in transactions with Massachusetts customers

that involve intangible property and resulted in in-

come flowing to the taxpayer from Massachusetts

residents and the highlighted presumption that a fi-

nancial institution that engaged in transactions with

one hundred or more Massachusetts residents, had

$10 million or more of assets attributable to Massa-

chusetts sources, or had receipts exceeding $500,000

attributable to Massachusetts sources, for his deter-

mination that the Banks were “engaged in business”

in, and had nexus with, Massachusetts.

The Banks do not contest that they fall within

the explicit terms of the FIET. Rather, they main-

tain that the Commerce Clause requires their physi-

35a

cal, as opposed to economic, presence in the Com-

monwealth in order to be subject to a tax measured

by their net income.

Il. CONSTITUTIONALITY OF FIET UNDER

THE COMMERCE CLAUSE

Constitutional limitations on a state’s power to

tax interstate commerce stem from both the Due

Process Clause (U.S. CONST. amend. XIV, § 1, here-

after the “Due Process Clause”) and the Commerce

Clause. Each clause “reflect[s}] different constitu-

tional concerns. Moreover, while Congress has ple-

nary power to regulate commerce among the States

and thus may authorize actions that burden inter-

state commerce... it does not similarly have the

power to authorize violations of the Due Process

Clause.” Quzll Corp. v. North Dakota, 504 U.S. 298,

305 (1992).

In the context of taxation, “to survive due process

scrutiny, there must be ‘some definite link, some

minimum connection, between a state and the per-

son, property or transaction it seeks to tax.” Truck

Renting and Leasing Ass’n v. Commisstoner of Reve-

nue, 433 Mass. 733, 736 (2001) (quoting Horst v.

Commissioner of Revenue, 389 Mass. 117, 182

(1983)). Additionally, the “income attributed to the

State for tax purposes must be rationally related to

‘values connected with the taxing State.” Jd. (quot-

ing Quill, 504 U.S. at 306). At the center of Due

Process jurisprudence lies a concern for the “funda-

mental fairness of government activity.” Quill, 504

U.S. at 312.

The Banks have not challenged the FIET as vio-

lative of the Due Process Clause, nor could they real-

istically have mounted such a challenge because

Massachusetts “has provided the source [for the in-

36a

come at issue] by providing and maintaining the eco-

nomic setting out of which [the Banks reap their]

profit.” Truck Renting, 433 Mass. at 739 (quoting

American Refrigerator Transit Co. v. State Tax

Comm’n, 395 P.2d 127, 131 (Or. 1964).

Unlike the Due Process Clause, the Commerce

Clause is “informed ‘by structural concerns about the

effects of state regulation on the national economy’

and, specifically, any burden on interstate commerce

caused by a State tax obligation” rather than fair-

ness for the individual entity that is taxed. Truck

Renting, 433 Mass. at 740 (quoting Quill, 504 U.S. at

312). Accordingly, the Commerce Clause’s “substan-

tial nexus requirement is not, like due process’

minimum contacts requirement, a proxy for notice

but rather a means for limiting state burdens on in-

terstate commerce.” Quill, 504 U.S. at 318.

A state may, consistent with the Commerce

Clause, impose a tax on a company engaged in

purely interstate commerce provided that the tax:

“[1] is applied to an activity with a substantial nexus

with the taxing state, [2] is fairly apportioned, [3]

does not discriminate against. interstate commerce,

[4] and is fairly related to the services provided by

the State.” Complete Auto Transit, Inc. v. Brady, 430

U.S. 274, 279 (1977). In permitting states to tax

purely interstate commerce, Complete Auto overruled

the Spector Motor Services, Inc. v. O’Connor, 340

U.S. 602 (1951) and Freeman v. Hewitt, 329 U.S. 249

(1946), line of cases, thus reaffirming the principle

that “interstate commerce may be made to pay its

way.” Complete Auto, 430 U.S. at 284, 289 n.15.

Massachusetts has consistently applied the Complete

Auto test. See Aloha Freightways, Inc. v. Commis-

stoner of Revenue, 428 Mass. 418, 421 (1998); Truck

Renting, 433 Mass. at 740.

37a

The Banks’ principal challenge to the constitu-

tionality of the FIET is the first or “substantial

nexus” prong of Complete Auto.2 “The ‘substantial

nexus’ requirement ‘seeks to prevent overreaching by

States, and limits a State’s ability to tax businesses

operating within interstate commerce which lack a

sufficient connection to the taxing state.” Truck

Renting, 433 Mass. at 740 (quoting Aloha Freight-

ways, 428 Mass. at 423). To satisfy the “substantial

nexus” requirement, the “business must have some

constitutionally significant degree of contact with the

taxing State before the State can impose any tax on

it.” Aloha Freightways, 428 Mass. at 421.

In Quill, the Supreme Court revisited the issue

of substantia! nexus in the context of a mail-order

company’s duty to collect use tax. Quzll, 504 U.S. at

301. The taxpayer in Quill was an out-of-state mail

order house “whose only connection with customers

in the State [was] by common carrier or the United

States mail.” Jd. (quoting National Bellas Hess 386

U.S. 753, 758 (1967)). The Supreme Court of North

Dakota had declined to follow National Bellas Hess,

a case with similar facts and issues as in Quill, find-

ing the holding “obsolete” under evolving Supreme

Court. Due Process and Commerce Clause jurispru-

dence. Quill, 504 U.S. at 310-12. Though the Court

agreed “with much of the state court’s reasoning” (/d.

at 302) and acknowledged that Due Process Clause

concerns were satisfied (/d. at 308), it reversed the

8 The Banks raise only the “substantial nexus” prong in their

Petitions to this Board. Although the Banks’ brief miakes

oblique reference to the remaining prongs, the Banks offered no

evidence or cogent argument that the FIET fails under prongs

two through four of Complete Auto.

38a

state court, reaffirming National Bellas Hess and

finding insufficient nexus due to the taxpayer’s lack

of physical presence in the state. Jd. at 318-19.

In preserving the National Bellas Hess bright-

line physical presence test as to the duty to collect

sales and use taxes, the Court in Quill observed that

“contemporary Commerce Clause jurisprudence

might not dictate the same result were the issue to

arise for the first time today” and invited Congress to

“decide whether, when, and to what extent the

States may burden interstate mail-order concerns

with a duty to collect taxes.” Jd. at 311 and 318.

While it followed National Bellas Hess on principles

of stare decisis, noting in particular that the Na-

tional Bellas Hess physical presence rule “has en-

gendered substantial reliance and has become part of

the basic framework of a sizeable industry” (Quill

504 U.S. at 317)°9, the Court made clear in two sepa-

rate instances that it has not extended the “bright-

line” physical presence test to taxes other than sales

and use tax. See Quill 504 U.S. at 314 (“we have not,

in our review of other types of taxes, articulated the

same physical-presence requirement that Bellas Hess

established for sales and use taxes”) and 7d. at 317

(“although in our cases subsequent to Bellas Hess

and concerning other types of taxes we have not

adopted a similar bright-line, physical presence re-

9 The Court went on to note that “a bright-line rule in the

area of sales and use taxes also encourages settled expectations

and, in doing so, fosters investments by businesses and indi-

viduals. [footnote omitted]. Indeed, it is not unlikely that the

mail-order industry’s dramatic growth over the last quarter

century is due in part to the bright-line exemption from state

taxation created in Belias Hess.” Quill, 504 U.S. at 316.

39a

quirement”). Further, the Court noted that “our

Commerce Clause jurisprudence now favors more

flexible balancing analyses.”

In addition to the settled expectation of the mail

order industry and principles of stare decisis, the

Court in Quill also focused on the particular com-

mercial burdens that result from the application of a

state’s sales and use tax collection duty and recog-

nized the inherent burden a taxpayer could face “if

similar obligations might be imposed by the Nation’s

6,000-plus taxing jurisdictions” to collect a use tax.

Id. at 313 n.6. There are, however, significant dis-

tinctions between the burdens resulting from collect-

ing and remitting sales and use taxes and the pay-

ment obligation of an income-based tax. As one state

court has observed:

It is also evident from Quill that a sales and

use tax can impose a special burden on inter-

state commerce beyond just the payment of

money. Unlike an income tax, a sales and

use tax can make the taxpayer an agent of

the state, obligated to collect the tax from the

consumer at the point of sale and then pay it

over to the taxing entity. Whereas, a state

income tax is usually paid only once a year,

to one taxing jurisdiction and at one rate, a

sales and use tax can be due periodically to

more than one taxing jurisdiction within a

state and at varying rates. See Id. at 313 n.6.

Thus, collecting and paying a sales and use

tax can impose additional burdens on com-

merce that the Supreme Court has repeat-

edly identified in prior opinions.

Kmart Properties, Inc. v. Taxation and Revenue

Dep't, 1389 N.M. 177, 185 (2001). See also Tax Com-

40a

missioner of the State of West Virginia v. MBNA

America Bank, N.A., 640 S.E. 2d 226, 233 (2006)

(recognizing that the compliance burdens of sales

and use tax collection and remission, including

knowledge of a multitude of administrative regula-

tions, extensive record-keeping, and frequent remis-

sion to the government, are greater than those of in-

come-based taxes). Further, a commentator has

noted that:

Sales and use taxes and income taxes are

functionally different and ultimately have

different effects on taxed entities. Simply

put, income taxes carry fewer administrative

burdens for the taxpayer and pose less of a

threat to interstate commerce. Unlike a

sales or use tax, which is paid by every con-

sumer, creative tax planners can exempt en-

tire industries from income taxation. Accord-

ingly, it is illogical for a court to apply the

same analysis to the constitutionality of in-

come taxes as it does to sales and use taxes.”

Cory D. Olson, Follow the Giraffe’s Lead - Lanco, Ine.

v. Director, Division of Taxation Gets Lost In The

Quagmire That Is State Taxation, 6 MINN J.L. SCI.

& TECH. 789 (2005).

Accordingly, while Quill reaffirmed that physical

presence is required in the context of a mail-order

seller’s sales and use tax obligation, there is neither

a Supreme Court nor Massachusetts precedent that

supports the proposition that physical presence is

required to impose an income-based tax such as the

FIET. In fact, Massachusetts has recognized the Su-

preme Court’s careful limitation of Quill to the sales

and use tax context: “fiJn Quill... the Court. upheld a

‘physical-presence requirement’ before a State, con-

4la

sistent with the commerce clause, could subject an

out-of-State vendor to a use or sales tax. The Court

did not extend this rule to other types of tax.” Truck

Renting, 433 Mass. 733, 741 n.13 (2001) (emphasis

added). See also Aloha Freightways, 428 Mass. at

423 n.4 (“Under Aloha’s argument, the only State an

interstate carrier could be found to have ‘nexus’ with

would be one in which it maintains a base of opera-

tions. The requirement of ‘nexus’ does not provide

such tax immunity to interstate carriers.”).

With the physical-presence test of Quill properly

limited to the sales and use tax context, the control-

ling authority in the instant appeals is Cornplete

Auto and its query of whether the FIET is “applied to

an activity with a substantial nexus with” Massa-

chusetts. Aloha Freightways, 428 Mass. at 421

(quoting Complete Auto, 430 U.S. at 279). “Substan-

tial nexus” comprises contacts of varied character

and not merely those of a physical nature. For ex-

ample, in a case virtually identical to the present ap-

peals involving the taxation under a similar bank ex-

cise statute of an out-of-state credit card company

with no physical presence in the taxing state, the

Supreme Court of Appeals of West Virginia held that

“{rlather than a physical presence standard, this

Court believes that a significant economic presence

test is a better indicator of whether substantial

nexus exists for Commerce Clause purposes.” MBNA

America Bank, 640 S.E.2d at 234.

The court in MBNA America Bank found that the

taxpayer “continuously and systematically engaged

in direct mail and telephone solicitation and promo-

tion” in the taxing state and derived “significant

gross receipts” from customers located in the state.

Id. at 235-36. In light of these facts, the court, de-

spite finding that the taxpayer had no real or tangi-

42a

ble personal property or real estate located in the

state, had “no trouble concluding that MBNA’s sys-

tematic and continuous business activity in this

State produced significant gross receipts attributable

to its West Virginia customers which indicate a sig-

nificant economic presence sufficient to meet the

substantial nexus prong of Complete Auto.” Id. at

236.

In the only other case involving the taxation of

an out-of-state credit card company without physical

presence cited by the parties, the Tennessee Court of

Appeals appears to hold fast to the Quill physical-

presence test, but a later case by that same court

suggests otherwise. In J.C. Penney National Bank v.

Johnson, 19 S.W.3d 831 (Tenn. Ct. App. 1999), the

court ruled that Tennessee could not tax an out-of-

state bank offering, among other services, credit-card

lending and ATM services, because the bank “did not

have a physical presence in Tennessee through its

affiliates.” Id. at 841.

However, several years later, the same Tennes-

see court seemed to retreat from a bright-line physi-

cal presence requirement for substantial nexus or to

at least clarify its ruling in J.C. Penney. In America

Online, Inc. v. Johnson, 2002 Tenn. App. LEXIS 555

(2002), the court, addressing whether an internet

service provider with no property or employees in

Tennessee could be subject to an income-based tax,

stated that

[t]his case is all about the nexus prong of the

test. The chancellor held that the Supreme

Court’s decisions in this area, as interpreted

by this court in J.C. Penney [citations omit-

ted], has held fast to a bright-line test requir-

ing an out-of-state company to have a ‘physi-

43a

cal presence’ in this state in order to have a

substantial nexus with it. We think, how-

ever, that that reading of J.C. Penney

would simply substitute “physical pres-

ence” for “nexus” [footnote omitted] as the

first prong of the Complete Auto Transit

test. As we read the cases, neither [the

U.S. Supreme Court nor the Tennessee

Court of Appeals] has made that sugges-

tion...

We do not think that it is conclusive that

AOL does not have offices or employees in

the state or that it does not own or rent real

property here.... Where...activities are

“being conducted in the taxing state that

substantially contribute to the taxpayer’s

ability to maintain operations in the tax-

ing state,” a substantial nexus does exist.

America Online 2002 Tenn. App. LEXIS at *2, *3

(quoting J.C. Penney, 19 S.W. 3d at 841) (emphasis

added).

Other state courts have also upheld the imposi-

tion of an income-based tax on out-of-state corpora-

tions with no in-state real or tangible personal prop-

erty or employees. A year after the Quill decision,

South Carolina became the first state to uphold an

income-based tax solely on the presence of trade-

mark assets within the taxing jurisdiction. See Geof-

frey, Inc. v. South Carolina Tax Commission, 437

S.E.2d 13 (S.C. 1993). The out-of-state taxpayer in

Geoffrey held several valuable trademarks that. it l-

censed to its parent for use in retail stores, including

stores in the South Carolina, for a royalty fee of one

percent of net sales. /d. at 15. The court held that

“by licensing intangibles for use in this State and de-

44a

riving income from their use here, Geoffrey ha[d] a

‘substantial nexus’ with South Carolina.” /d. at 18.

See also Secretary, Department of Revenue v. Gap

(Apparel), Inc., 886 S.2d 459, 462 (La. Ct. App. 2004)

(“While Apparel may not have a physical presence in

Louisiana, its intangible property clearly has a con-

nection with Louisiana.... it is clear that the marks

licensed by Apparel have been used in Louisiana in

such a way as to become an integral part of the licen-

sees’ business in this state.”).

In another case involving the imposition of an in-

come-based tax on an out-of-state trademark holding

company with no in-state tangible property or repre-

sentatives, the New Mexico Court of Appeals held

that Quill does not extend the physical presence re-

quirement to income taxes, ruling that:

The Commerce Clause analysis of New Mex-

ico income tax is controlled, not by Quill’s

physical presence, but by the overarching

substantial nexus test announced in Com-

plete Auto Transit... .(T)he use of [the tax-

payer’s] marks within New Mexico’s eco-

nonuc market, for the purpose of generating

substantial income for the [the taxpayer], es-

tablishes a sufficient nexus between that in-

come and the legitimate interests of the state

and justifies the imposition of a state income

tax.

Kmart, 1389 N.M at 186.

North Carolina, in a case involving nine trade-

mark holding companies, also adopted the reasoning

of Geoffrey, finding that “under facts such as these

where a wholly-owned subsidiary licenses trade-

marks to a related retail company operating stores

located within North Carolina, there exists a sub-

45a

stantial nexus with the State sufficient to satisfy the

Commerce clause.” A&F Trademark, Inc. v. Tolson,

605 S.E.2d 187, 195 (N.C. Ct. App. 2004).

The A&F Trademark decision was cited approv-

ingly in a recent New Jersey court decision that up-

held an income-based tax on a foreign trademark

holding company with “no physical presence in the

state and derivling| income from a New Jersey

source pursuant only to a license agreement with an-

other corporation that conducts a retail business” in

the state. See Lanco, Inc. v. Director, Division of

Taxation, 879 A.2d 1234, 1235 (N.J. Super. Ct. App.

Div, 2005). The court held that “(wle are satisfied

that the physical presence requirement applicable to

use and sales taxes is not applicable to income tax

and that the New Jersey Business Corporation Tax

may be constitutionally applied to income derived [ ]

from licensing fees attributable to New Jersey.” Id.

at 1242. Quoting from the A&F Trademark opinion,

the court declined to extend Quill beyond the sales

and use tax context:

The North Carolina Court of Appeals stated

three reasons for declining to adopt the

broader reading of Quill as requiring a

physical presence for income tax pur-

poses.... “First, the tone in the Quill opin-

ion hardly indicates a sweeping endorsement

of the bright-line test it preserved, and the

Supreme Court’s hesitancy to embrace the

test certainly counsels against expansion of

it.”... The [United States Supreme] Court

further observed the physical-presence test,

though offset by the clarity of the rule, was

“artificial at its edges.”... In addition the

Court twice noted that in other types of

taxes, it had never articulated the same

46a

physical-presence requirement adopted in

Bellas Hess... the Court’s choice to abstain

from rejecting the Bellas Hess rule for sales

and use taxes fails to argue persuasively that

the rule should, for lack of rejection, be aug-

mented to cover other types of tax.

Lanco, 879 A.2d at 1239-40.

The Washington Court of Appeals, in a case in-

volving the income-based taxation of an out-of-state

automaker that claimed to have no physical presence

in Washington, held that “[a]ny corporation that

regularly exploits the markets of a state should be

subject to its jurisdiction to impose an income tax

even though not physically present.” General Motors

Corp. v. City of Seattle, 25 P.8d 1022, 1029 (Wash.

Ct. App. 2001). The court held that the tax at issue

was constitutional, finding that

[t]he tax at issue here is neither a sales or

use tax, nor is it a franchise tax. It is a busi-

ness and occupation tax for the privilege of

engaging in business within the City of Seat-

tle. The automakers certainly exploit the

market in the City, regardless of where they

are physically located. We decline to extend

Quill’s physical presence requirement in this

context.

Id. at 1029. See also Couchot v. State Lottery Com-

mission, 659 N.E.2d 1225, 1230 (Ohio 1996) (“There

is no indication in Quill that the Supreme Court will

extend the physical-presence requirement to cases

involving taxation measured by income derived from

the state.... Thus, the physical-presence require-

ment of Quill is not applicable to the case sub ju-

dice”); Borden Chemicals and Plastices, L.P. v.

Zehnder, 726 N.E.2d 73, 80 (Ill. App. Ct. 2000)

47a

(“Plaintiff argues that in Quill, the Supreme Court

left open’ the question of whether a physical pres-

ence is required in order to satisfy the substantial

nexus requirement in other tax cases. We dis-

agree.”).

On the basis of the foregoing, the Board ruled,

consistent with the overwhelming weight of author-

ity from the Supreme Court and those jurisdictions

that have addressed the question, that the physical-

presence requirement in Quill is not applicable to an

income-based excise such as the FIET. Rather,

guided by the above precedents, the Board ruled that

the Banks’ deliberate and targeted exploitation of the

Massachusetts economic market and its use of the

commonwealth’s governmental infrastructure and

resources constitute “substantial nexus” under the

Complete Auto test.

The Banks’ derived substantial economic gain

from the Massachusetts market through a sophisti-

cated marketing campaign that targeted Massachu-

setts customers and by use of the Visa and Master-

Card network, which included Massachusetts retail-

ers and their “acquiring banks” as well as Massachu-

setts consumers armed with “Capital One”-branded

credit cards. The customer’s use of the Capital One

cards provided the user with instant buying and bor-

rowing power and informed merchants that the

Banks were guaranteeing prompt payment for the

goods or services purchased by the customers, since

the Banks assumed all credit risk and paid the mer-

chant its charges, less the “merchant discount”

charged by the Banks and the acquiring banks. It

was the financial resources and stability of the

Banks, as represented by the Capital One logo on the

credit cards, together with the Visa and MasterCard

networks of which the Banks were a part, that en-

48a

abled the transactions from which the Banks derived

substantial revenue to occur. Accordingly, like the

Geoffrey-line of cases, the use of Capital One’s intan-

gible property - the Capital One trademark on the

cards - within the Massachusetts economic market to

generate substantial revenue further supports the

Board’s ruling that there was substantial nexus.

See, e.g., Kmart, 1389 N.M at 186.

The Banks’ expert witnesses, who offered opin-

ions from an economic and policy perspective that

the physical presence of a corporation should be re-

quired before an state may exact a tax, were unper-

suasive. It is the policy of the Legislature as embod-

ied in the language of the FIET, and the legal prece-

dents of the Supreme Court, the Supreme Judicial

Court and state courts of competent jurisdiction that

govern the question of whether the FIET is constitu-

tional and whether the Banks were appropriately as-

sessed the FIET for the years at issue. As the Su-

preme Court has observed:

Nothing can be less helpful than for courts to

go beyond the extremely limited restrictions

that the Constitution places upon the states

and to inject themselves in a merely negative

way into the delicate processes of fiscal pol-

icy-making. We must be on guard against

imprisoning the taxing power of the states

within formulas that are not compelled by

the Constitution but merely represent judi-

cial generalizations exceeding the concrete

circumstances which they profess to summa-

rize.

Wisconsin v. J.C. Penney, 311 U.S. 435, 445 (1940).

49a

For all of the foregoing reasons, the Board ruled

that the FIET is constitutional under the Commerce

Clause.

Ill. THE FIET IS A REASONABLE EXCISE ON

A COMMODITY

Massachusetts Constitution Part II, c. 1, § 1, Art.

4 provides in pertinent part that:

full power and authority are given to the

general court... to impose and levy reason-

able duties and excises, upon any produce,

goods, wares, merchandise, and commodities,

whatsoever, brought into, produced, manu-

factured, or being within the same...

Accordingly, an excise must meet two requirements:

it must be reasonable and it must be levied upon

produce, goods, wares, merchandise or commodities.

An excise is unreasonable if it is “unjustly dis-

criminatory, arbitrary, whimsical or irrational.”

American Uniform Co. v. Commonwealth, 237 Mass.

42, 45 (1921). “The court cannot declare a tax or ex-

cise illegal and void, as being unreasonable, unless it

is unequal, or plainly and grossly oppressive, and

contrary to common right.” Connecticut Mut. Life

Ins. Co. v. Commonwealth, 133 Mass. 161, 163

(1882). Wide discretion is given to the Legislature in

determining what is subject to an excise, as well as

its amount and the standard or measure to be

adopted as its foundation. 7d. The provision that an

excise must be “reasonable” was not designed to give

the judiciary the right to revise the Legislature’s de-

cisions in regard to the policy and expediency of an

excise. Id.

The FIET is imposed u

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