Client Alert

The South Carolina Department of Revenue (the "Department") recently changed its enforcement policy on what constitutes income tax jurisdiction, or "nexus." But it did so very subtly and (we would contend) in ways that are legally questionable.

In SC Revenue Ruling #08-1, the Department modified a ruling that had served as guidance for out-of-state businesses since 1998 (Revenue Ruling #98-3). These recent modifications strongly suggest that the Department is broadening its interpretation of its income tax jurisdiction, and enlarging the universe of non-South Carolina businesses that are subject to SC income tax. The modifications might even set the stage for combined reporting for multi-state business affiliates.

Businesses Potentially Affected. Out-of-state corporations that are (or thought they were) not doing business in South Carolina should beware, if they own one or more subsidiaries that are either (1) incorporated in South Carolina, or (2) doing business in South Carolina (e.g., a North Carolina manufacturer with a South Carolina sales subsidiary).

SC's Historical Position. The Department’s position had long been that an out-of-state corporation did not have income tax nexus with South Carolina as a result of that corporation’s mere ownership of a South Carolina subsidiary. Because South Carolina is a "separate entity" filing state, the North Carolina company (the manufacturer in the example above) would not have to apportion any of its income to South Carolina for taxation, because it did not have nexus with South Carolina. Instead, only the separate, South Carolina entity would file in South Carolina.

SC's New Position. However, the Department's new enforcement policy appears to be that an out-of-state corporation will have income tax nexus with South Carolina if that out-of-state corporation owns a South Carolina subsidiary that transacts business in South Carolina. The only apparent exception would be where the subsidiary’s business was wholly unrelated (in terms of management, operations, etc.) from the business of the out-of-state parent company.

Ostensible Basis for the New Position. The Department appears to base its new policy upon the 1993 Geoffrey decision (which was the first case in the country to base income tax jurisdiction on merely "economic" presence in the state), but the Department offers no specific reasoning for this position.

Implementing the New Position – Who Files? Under its new interpretation, it is unclear whether the Department will require both the out-of-state corporation and the South Carolina subsidiary to file separate South Carolina income tax returns, or instead attempt to force combined reporting.

Challenging the New Position. We believe that the Department's new interpretation is contrary to South Carolina case law and to the Department’s historical enforcement policy as a "separate entity" state. Furthermore, we believe that such an enforcement policy could violate the federal safe harbor provisions of Public Law 86-272 (which are beyond the scope of this Client Alert) under certain circumstances.

If you have any questions, please contact our State and Local Tax Group.

Neill Edwards (919) 484-2357 email
Jeff Lawyer (336) 747-6611 email
Lyn Odom (864) 255-5407 email
Mark Wiley (336) 721-3605 email