Capital One Bank and Capital One F.S.B. v. Commissioner of Revenue (June 22, 2007)

COMMONWEALTH OF MASSACHUSETTS

APPELLATE TAX BOARD


CAPITAL ONE BANK AND		v.	COMMISSIONER OF REVENUE
CAPITAL ONE F.S.B.

Docket Nos. C262391 & C262598 	Promulgated:
							June 22, 2007


	These are appeals filed under the formal procedure, pursuant to G.L. c. 62C, § 39 from the refusal of the appellee to abate financial institution excises assessed under G.L. c. 63, § 1 et seq. for 1995 through 1998 ("years at issue").
	Commissioner Scharaffa heard the appeal and was joined in decisions for the appellee by Commissioners Egan, Rose and Mulhern.  Chairman Hammond took no part in the deliberations or decision of these appeals.
	These findings of fact and report are made pursuant to a request by the appellee under G.L. c. 58A, § 13 and 831 CMR 1.32.  

	Paul H. Frankel, Esq., Hollis L. Hyans, Esq., Amy F. Nogid, Esq. and Maxwell D. Solet, Esq. for the appellants.

	Thomas W. Hammond, Esq., John Delosa, Esq., Patricia M. Good, Esq., and Anne P. Hristov, Esq. for the appellee.


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 constitutionality of the financial institution excise ("FIET") and the determination of the appellee Commissioner of Revenue ("Commissioner") that the Banks' in-state activities constituted substantial nexus with the Commonwealth of Massachusetts justifying the imposition of the FIET on them.  
	On the basis of the parties' detailed Stipulation of Facts, exhibits and the testimony 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 Commissioner 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 issue in these appeals are $1,758,454.96 for COB and $159,075 for FSB.
	The Banks timely filed applications for abatement 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.
THE BANKS' MASSACHUSETTS BUSINESS
At all material times, COB was a Virginia chartered credit card bank offering credit card products.  It was established in 1994 as a wholly-owned subsidiary 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, including secured and unsecured credit cards, to individuals and small businesses.  FSB also made unsecured 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 Massachusetts.
As credit card companies doing business in Massachusetts, 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 receivables, fees from credit card transactions described below, and interest earned on investment securities and money market investments.
Using a system called Information-Based Strategy ("IBS"), which used statistical modeling techniques that segment potential customer lists based on credit scores, demographics, and other characteristics, the Banks targeted specific potential consumers in Massachusetts.  As a result of the Banks' marketing efforts in Massachusetts, the number of Massachusetts 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 Massachusetts customers rose from less than 4,000 to more than 7,000 during that period.  The Banks acknowledged 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 income rose from $1,534,525 in 1996 to more than $3,000,000 in both 1997 and 1998.  
The Banks entered into agreements with Massachusetts residents for purposes of issuing "general purpose" credit cards branded with the Capital One trademark and the logo of either Visa or MasterCard.  Visa and MasterCard are associations whose members issued credit cards with the association's logo, acquired merchants that accepted the association's credit cards, or both.  Visa and MasterCard provided services for their members, including the authorization, settlement and clearance of transactions.  
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 "Capital 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 MasterCard 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 members of the Visa and MasterCard associations, the Banks received numerous benefits, including technology 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 follows.  When a customer presents a credit card in payment for goods or services, the cardholder or merchant typically "swipes" the card through a card-reader located at the merchant's place of business.  The credit card information is relayed to an "acquiring bank" with which the merchant has contracted.  The acquiring bank processes, packages and transmits that information to the Visa, MasterCard or other association network.  The association network then relays the transaction information to the cardholder's "issuing bank," in this case, the Banks.  The issuing bank approves the transaction assuming the cardholder has a sufficient credit line and the approval 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 merchant to the acquiring bank, which forwards the request 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 received, and pays the remainder to the merchant.  During the years at issue, the Banks received interchange fees related to Massachusetts customers ranging between $4.2 million and $6.8 million annually.
As issuing banks, the Banks bore the risk of the cardholder's non-payment.  The Banks billed their customers, including Massachusetts customers, directly 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 customers, 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 attorney 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 Massachusetts 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 Massachusetts residents under the Virginia long-arm statute, those judgments were at times domesticated to Massachusetts for further enforcement proceedings.  The Massachusetts Attorney General's Office also helped mediate disputes between the Banks and Massachusetts residents during the years at issue, offering assistance through its Consumer Complaints and Information Section and nineteen Local Consumer Programs located throughout Massachusetts.
The Banks neither owned nor leased real property in Massachusetts.  Further, the Board assumes on this record that the Banks owned no other Massachusetts property and no Bank employee, agent or independent contractor was located in Massachusetts during the years at issue.
The Board found and ruled that the Banks' activities constituted "substantial nexus" with Massachusetts so as to justify imposition of the FIET, irrespective of whether the Banks had a physical presence in Massachusetts during the years at issue.  The Banks' purposeful, targeted marketing of their 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 Massachusetts 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 "Capital One"-branded cards, guaranteed payment to the merchant on behalf of the customer, and their deriving 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 privileges 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 of the Massachusetts Constitution.
Accordingly, for all of the foregoing reasons, the Board issued decisions for the appellee in these appeals.

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 corporation must have a "physical presence" in a state before 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 invalid, 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 Report 2006-379; Mullins v. Commissioner of Revenue, ATB Findings of Fact and Reports 1997-973, aff'd, 428 Mass. 406 (1998); Gillette Co. v. Commissioner of Revenue,  ATB Findings of Fact and Reports 1996-362, aff'd, 425 Mass. 670 (1997); Lonstein v. Commissioner of Revenue, ATB Findings of Fact and Reports 1988-355, aff'd, 406 Mass. 92 (1989); Tregor v. Assessors of Boston, ATB Findings of Fact and Reports 1978-203, aff'd, 377 Mass. 602 (1979).
	In fact, a taxpayer must raise a constitutional claim with the Board to preserve the right to appellate 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.  Otherwise, the taxpayer waives the right to press the constitutional argument.").  Accordingly, the Board has jurisdiction to determine whether the FIET assessed to the Banks is unconstitutional.
In determining whether the FIET is constitutional, 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 v. State Tax Commission, 376 Mass. 861, 865-66 (1978)); see also Andover Savings Bank v. Commissioner of Revenue, 387 Mass. 229, 235 (1982).  Accordingly, the following analysis proceeds from the presumption that the FIET is valid and that any doubts concerning its interpretation must be resolved 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 concerning 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 FINANCIAL INSTITUTIONS
	Under G.L. c. 63, § 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 section 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 commonwealth; (b) having employees, representatives or independent contractors conducting 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 the taxpayer from residents of the commonwealth; (f) regularly receiving interest income from loans secured by tangible personal or real property located in the commonwealth; or (g) regularly soliciting and receiving deposits from customers in the commonwealth. 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, 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.
The Commissioner relies upon the highlighted subdivision (e), i.e. the Banks were regularly engaged in transactions with Massachusetts customers that involve intangible property and resulted in income flowing to the taxpayer from Massachusetts residents and the highlighted presumption that a financial institution that engaged in transactions with one hundred or more Massachusetts residents, had $10 million or more of assets attributable to Massachusetts sources, or had receipts exceeding $500,000 attributable to Massachusetts sources, for his determination 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 maintain that the Commerce Clause requires their physical, as opposed to economic, presence in the Commonwealth in order to be subject to a tax measured by their net income. 

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, hereafter the "Due Process Clause") and the Commerce Clause.  Each clause "reflect[s] different constitutional concerns.  Moreover, while Congress has plenary power to regulate commerce among the States and thus may authorize actions that burden interstate commerce . . . it does not similarly have the power to authorize violations of the Due Process Clause."  Quill 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 person, property or transaction it seeks to tax.'"  Truck Renting and Leasing Ass'n v. Commissioner of Revenue, 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.'" Id. (quoting Quill, 504 U.S. at 306).  At the center of Due Process jurisprudence lies a concern for the "fundamental fairness of government activity."  Quill, 504 U.S. at 312.
The Banks have not challenged the FIET as violative of the Due Process Clause, nor could they realistically have mounted such a challenge because Massachusetts "has provided the source [for the income at issue] by providing and maintaining the economic 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 fairness 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 "substantial nexus requirement is not, like due process' minimum contacts requirement, a proxy for notice but rather a means for limiting state burdens on interstate commerce."  Quill, 504 U.S. at 313.
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. Commissioner of Revenue, 428 Mass. 418, 421 (1998); Truck Renting, 433 Mass. at 740.
The Banks' principal challenge to the constitutionality of the FIET is the first or "substantial nexus" prong of Complete Auto.  "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 Freightways, 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 substantial nexus in the context of a mail-order company's duty to collect use tax.  Quill, 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.'"  Id. (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, finding the holding "obsolete" under evolving Supreme Court Due Process and Commerce Clause jurisprudence.  Quill, 504 U.S. at 310-12.  Though the Court agreed "with much of the state court's reasoning" (Id. at 302) and acknowledged that Due Process Clause concerns were satisfied (Id. at 308), it reversed the state court, reaffirming National Bellas Hess and finding insufficient nexus due to the taxpayer's lack of physical presence in the state.  Id. 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."  Id. at 311 and 318.  While it followed National Bellas Hess on principles of stare decisis, noting in particular that the National Bellas Hess physical presence rule "has engendered substantial reliance and has become part of the basic framework of a sizeable industry" (Quill 504 U.S. at 317), the Court made clear in two separate 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 Id. 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 requirement"). 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 commercial burdens that result from the application of a state's sales and use tax collection duty and recognized 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 distinctions between the burdens resulting from collecting and remitting sales and use taxes and the payment 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 interstate 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 commerce that the Supreme Court has repeatedly identified in prior opinions.

Kmart Properties, Inc. v. Taxation and Revenue Dep't, 139 N.M. 177, 185 (2001).  See also Tax Commissioner 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 regulations, extensive record-keeping, and frequent remission to the government, are greater than those of income-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 consumer, creative tax planners can exempt entire industries from income taxation.  Accordingly, it is illogical for a court to apply the same analysis to the constitutionality of income taxes as it does to sales and use taxes."

Cory D. Olson, Follow the Giraffe's Lead - Lanco, Inc. 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 Supreme Court's careful limitation of Quill to the sales and use tax context: "[i]n Quill . . . the Court upheld a 'physical-presence requirement' before a State, consistent 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 operations.  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 controlling authority in the instant appeals is Complete Auto and its query of whether the FIET is "applied to an activity with a substantial nexus with" Massachusetts.  Aloha Freightways, 428 Mass. at 421 (quoting Complete Auto, 430 U.S. at 279).  "Substantial nexus" comprises contacts of varied character and not merely those of a physical nature.  For example, in a case virtually identical to the present appeals involving the taxation under a similar bank excise 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 "[r]ather 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 promotion" 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, despite finding that the taxpayer had no real or tangible personal property or real estate located in the state, had "no trouble concluding that MBNA's systematic and continuous business activity in this State produced significant gross receipts attributable to its West Virginia customers which indicate a significant 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 Tennessee court seemed to retreat from a bright-line physical 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 omitted], has held fast to a bright-line test requiring an out-of-state company to have a 'physical presence' in this state in order to have a substantial nexus with it.  We think, however, that that reading of J.C. Penney would simply substitute "physical presence" 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 suggestion . . . 

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 taxing 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 imposition of an income-based tax on out-of-state corporations with no in-state real or tangible personal property 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 trademark assets within the taxing jurisdiction.  See Geoffrey, 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 licensed to its parent for use in retail stores, including stores in the South Carolina, for a royalty fee of one percent of net sales.  Id. at 15.  The court held that "by licensing intangibles for use in this State and deriving income from their use here, Geoffrey ha[d] a 'substantial nexus' with South Carolina."  Id. 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 connection 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 licensees' business in this state."). 
	In another case involving the imposition of an income-based tax on an out-of-state trademark holding company with no in-state tangible property or representatives, the New Mexico Court of Appeals held that Quill does not extend the physical presence requirement to income taxes, ruling that: 
The Commerce Clause analysis of New Mexico income tax is controlled, not by Quill's physical presence, but by the overarching substantial nexus test announced in Complete Auto Transit. . . . [T]he use of [the taxpayer's] marks within New Mexico's economic market, for the purpose of generating substantial income for the [the taxpayer], establishes a sufficient nexus between that income and the legitimate interests of the state and justifies the imposition of a state income tax.

Kmart, 139 N.M at 186. 

	North Carolina, in a case involving nine trademark holding companies, also adopted the reasoning of Geoffrey, finding that "under facts such as these where a wholly-owned subsidiary licenses trademarks to a related retail company operating stores located within North Carolina, there exists a substantial 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 approvingly in a recent New Jersey court decision that upheld an income-based tax on a foreign trademark holding company with "no physical presence in the state and deriv[ing] income from a New Jersey source pursuant only to a license agreement with another 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 "[w]e 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 purposes. . . . "First, the tone in the Quill opinion 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 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 augmented to cover other types of tax.

Lanco, 879 A.2d at 1239-40.
	The Washington Court of Appeals, in a case involving 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.3d 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 business and occupation tax for the privilege of engaging in business within the City of Seattle.  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 Commission, 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 requirement of Quill is not applicable to the case sub judice"); Borden Chemicals and Plastices, L.P. v. Zehnder, 726 N.E.2d 73, 80 (Ill. App. Ct. 2000) ("Plaintiff argues that in Quill, the Supreme Court 'left open' the question of whether a physical presence is required in order to satisfy the substantial nexus requirement in other tax cases.  We disagree.").
	On the basis of the foregoing, the Board ruled, consistent with the overwhelming weight of authority 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 sophisticated marketing campaign that targeted Massachusetts customers and by use of the Visa and MasterCard network, which included Massachusetts retailers and their "acquiring banks" as well as Massachusetts consumers armed with "Capital One"-branded credit cards.  The customer's use of the Capital One cards provided the user with instant buying and borrowing 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 merchant 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 enabled the transactions from which the Banks derived substantial revenue to occur.  Accordingly, like the Geoffrey-line of cases, the use of Capital One's intangible 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, 139 N.M at 186.
	The Banks' expert witnesses, who offered opinions from an economic and policy perspective that the physical presence of a corporation should be required before an state may exact a tax, were unpersuasive.  It is the policy of the Legislature as embodied in the language of the FIET, and the legal precedents of the Supreme Court, the Supreme Judicial Court and state courts of competent jurisdiction that govern the question of whether the FIET is constitutional and whether the Banks were appropriately assessed the FIET for the years at issue.  As the Supreme 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 policy-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 judicial generalizations exceeding the concrete circumstances which they profess to summarize.

Wisconsin v. J.C. Penney, 311 U.S. 435, 445 (1940).
	For all of the foregoing reasons, the Board ruled that the FIET is constitutional under the Commerce Clause.

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 reasonable duties and excises, upon any produce, goods, wares, merchandise, and commodities, whatsoever, brought into, produced, manufactured, 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 discriminatory, arbitrary, whimsical or irrational."  American Uniform Co. v. Commonwealth, 237 Mass. 42, 45 (1921).  "The court cannot declare a tax or excise 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.  Id.  The provision that an excise must be "reasonable" was not designed to give the judiciary the right to revise the Legislature's decisions in regard to the policy and expediency of an excise.  Id.
	The FIET is imposed uniformly on financial institutions engaged in business in Massachusetts.  Through their Massachusetts business activities, financial institutions such as the Banks avail themselves of the Commonwealth's laws, protections, and privileges, and thus the FIET is not unequal, plainly or grossly oppressive or contrary to common right.  The FIET is not arbitrary or irrational, as it is directly related to the privileges that financial institutions receive from the right to engage in business and to sell their services in Massachusetts.  Greenfield Sav. Bank v. Commonwealth, 211 Mass. 207, 210 (1912).
	The FIET, which is based on net income apportioned to Massachusetts, is also reasonably calculated.  See Andover Sav. Bank 387 Mass. at 236 ("[T]he value of transacting business as a savings bank or cooperative bank lies . . . in the benefits that are enjoyed by the depositors and borrowers.").  The court held in Andover Savings the income-based portion of an excise was reasonable as "[i]t measures the value of the bank's investment function according to the returns that are realized for the benefit of its depositors . . . Greater precision in measuring the value of the privilege is not constitutionally required."  Id.
	The FIET also satisfies the constitutional requirement that an excise be levied upon produce, goods, wares, merchandise or commodities.  See Opinion of the Justices to the Governor, 408 Mass. 1201, 1213 (1990).  The FIET taxes the commodity of the right and privilege of doing business and the sale of financial services in the Commonwealth. See Greenfield Sav. Bank, 211 Mass. at 210.
	"The power to determine what callings, franchises, or privileges, or, to use the language of the Constitution, 'commodities,' shall be subjected to an excise, and the amount of the excise belongs exclusively to the Legislature."  Connecticut Mut. Life Ins. Co., 133 Mass. at 163.  "The language of the Constitution of Massachusetts is general, and may well be held to authorize the laying of excises upon all such gainful employments and privileges as are created or may be regulated by law, and commonly have been considered legitimate subject of taxation in other States and countries."  Minot v. Winthrop, 162 Mass 113, 122 (1894).  
The term "'[c]ommodity' . . . includes the privilege and convenience of transacting a particular business; and, upon persons carrying on such business, it has never been questioned that the Legislature may levy an excise, or provide that a license must be obtained in order to transact it."  Commonwealth, by Commissioner of Sav. Banks v. Lancaster Sav. Bank, 123 Mass. 493, 495 (1878).  For purposes of the Massachusetts Constitution, a commodity "will perhaps embrace every thing which may be a subject of taxation," and, more specifically, it "has been applied by our legislature, from the earliest practice under the Constitution, to the privilege of using particular branches of business or employment."  President, Dirs., & Co. of the Portland Bank v. Apthorp, 12 Mass. 252, 256 (1815).
The sale of services is a commodity and can be constitutionally taxed as an activity that may be regulated by Massachusetts, even if it is not in fact regulated.  Opinion of the Justices, 408 Mass. at 1213 (citing Minot, 162 Mass. at 122).  The word "commodity" is not limited to tangible personal property, and includes those benefits, privileges, and activities that may be regulated by the Commonwealth.  Id.  Therefore, the FIET, an excise upon the sale of financial services and the privilege to do business in Massachusetts, falls within the Legislature's authority under Massachusetts Constitution Part II, c. 1, § 1, Art. 4.
The FIET clearly manifests the Legislature's intent to impose an excise on financial institutions as compensation for the convenience and privilege of conducting business, and falls within the parameters of the Massachusetts Constitution.  The Banks have substantially benefited from their right to do business in Massachusetts, receiving almost $360 million in accounts receivable from Massachusetts customers during the years at issue.  The Banks have used the Commonwealth's infrastructure and laws to facilitate transactions with Massachusetts merchants and customers, and participated in the Visa and MasterCard networks, which included acquiring banks in Massachusetts.  They have also acquired revenue by charging fees to Massachusetts customers in exchange for financial services, and therefore a reasonable excise may fairly be imposed on them.  The fees were "sources of emolument and profit, not strictly called property, but which are rather to be considered as the means of acquiring property, from which a reasonable revenue may be exacted by the legislature."  Portland Bank, 12 Mass. at 255.  In exchange for these privileges, the state has imposed a reasonable excise on the Banks.
The Banks have set forth no persuasive argument or evidence that the FIET was unreasonable or improperly imposed under the Massachusetts Constitution.  The Banks have therefore failed to meet their burden of showing that the FIET was unconstitutional.  See Boston v. Keene Corp., 406 Mass. 301, 305 (1989) ("The party challenging the statute's constitutionality must demonstrate beyond a reasonable doubt . . . that there are no 'conceivable grounds' which could support its validity.").
CONCLUSION
On the basis of the foregoing, the Board ruled that the FIET is constitutional under the Constitutions of both the United States and Massachusetts.  The Banks each clearly fall within the plain terms of the FIET: as banks, they are "financial institutions" and they meet the statutory presumption of being "engaged in business" by conducting activities "with one hundred or more residents of the commonwealth," and received "in excess of five hundred thousand dollars in receipts attributable to sources within the commonwealth." 
In fact, the number of Massachusetts 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 Massachusetts customers rose from less than 4,000 to more than 7,000 during that period.  COB's receivables related to Massachusetts customers grew from $72,162,796 to $113,655,624 during the years at issue, while FSB's Massachusetts receivables grew from $11,457,826 to $16,588,914.  These receivables attributable to Massachusetts customers resulted in income of over $154 million for COB and $8.8 million for FSB for the years at issue.  These figures vastly exceed the statutory amounts.
Therefore, the Board ruled that the FIET is constitutional and validly imposed on the Banks for each of the tax years at issue.   Accordingly, the Board issued decisions for the appellee in these appeals.

					APPELLATE TAX BOARD


				 By:	___________________________________
					Frank J. Scharaffa, Commissioner


A true copy,

Attest:____________________________
	  Assistant Clerk of the Board

 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 imposes 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."
 Unless explicitly stated otherwise, all factual findings relate to the years at issue.
 The PLUS name is a trademark owned by Visa International Service Association and licensed to Visa.  The CIRRUS name is a trademark owned by MasterCard.
 In a typical Visa or MasterCard transaction, the acquiring bank retains 1.4 percent of the purchase price as an interchange fee and the issuing bank 0.6 percent as its fee; accordingly, 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 v. Visa, U.S.A., 344 F.3d 229, 235 (2d Cir. 2003).
 Another COFC subsidiary, Oakstone Ventures, Inc, was created to identify non-bank business opportunities because the Banks were prohibited from engaging in such activities.  Beginning in 1998, Oakstone had an office in Boston, Massachusetts and an Oakstone employee participated in discussions with the Banks concerning strategies for the provision of financial services, including credit card strategies, in Massachusetts.
 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 Commonwealth, the ownership of the card reader and cards is immaterial.
 The Banks argue that the collection activities of their independent 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 substantial nexus is not dependant on physical presence, resolution of this issue is not necessary.
 The Banks raise only the "substantial nexus" prong in their Petitions to this Board.  Although the Banks' brief makes 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.
 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 individuals.[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 Bellas Hess."  Quill, 504 U.S. at 316.

ATB 2007-544