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Circuit Court Holds Non-Resident Corporate Partners Have Nexus Under Kentucky Statutory Scheme For Corporation Income Tax Purposes

07.06.2007

In Revenue Cabinet (n/k/a Finance and Administration Cabinet, Department of Revenue) v. Asworth Corp. (n/k/a Asworth, LLC), et al., No. 06-CI-00288 (Franklin Cir. Ct., Div. II, Jun. 14, 2007), the Franklin Circuit Court (“Court”) held that Kentucky’s corporation income tax statutory scheme imposed tax upon non-resident corporate partners, even though their only connection with Kentucky was receiving income from investment interests in partnerships located in Kentucky. The Court did not address the Appellees’ contention that Kentucky’s imposition of corporate income tax on the non-resident corporate partners violated the United States Commerce Clause and the Due Process Clause.

The Court held that Asworth Corporation (n/k/a Asworth, LLC), HT-Forum, Inc. (n/k/a HTF, LLC) and D Aviation Services, Inc. (n/k/a D Aviation Services, LLC) (collectively, the “Appellees”), all non-Kentucky corporations, had nexus with Kentucky based on the Court’s interpretation of Kentucky’s corporation income tax statutes. The parties stipulated that during the periods at issue, the Appellees did not own or lease property in Kentucky, and that they did not have any employees who received compensation in Kentucky. The parties also stipulated that the Appellees’ sole connection with Kentucky was the receipt of their distributive share of income from partnerships doing business in Kentucky during the taxable periods.

During the tax years at issue, KRS 141.040 had a “physical presence” test, and imposed corporation income tax on foreign corporations owning or leasing property in Kentucky or having one or more employees receiving compensation in Kentucky. During the involved tax years Kentucky did not impose corporate income tax on partnerships, but imposed tax on partners’ distributive share of income from partnerships. The Kentucky Board of Tax Appeals (“KBTA”) held in favor of the Appellees, and held that because the Appellees had no physical presence in Kentucky they had no nexus with Kentucky for corporation income tax purposes. The KBTA noted in its Decision and Order that KRS 141.206 simply provides the mechanics of the administration of corporate income tax to a non-resident corporate partner, and only applies if the corporate partner is first determined to have physical presence in Kentucky under KRS 141.040.

The KBTA determined that because the Appellees did not have physical presence in Kentucky based on the language of KRS 141.040, it was not necessary that it reach the Appellees’ argument that they did not have nexus under the Commerce Clause or the Due Process Clause. The KBTA further held that it was not necessary that it address the Appellees’ alternative argument that if the Appellees had nexus with Kentucky, they were entitled to use standard three-factor apportionment methodology based on property, payroll and sales, rather than a single-factor apportionment based on sales, as utilized by the Revenue Cabinet (now known as the Finance and Administration Cabinet, Department of Revenue) (“Department”).

The Department argued before the KBTA and the Court that KRS 141.206 was a tax imposition statute and that KRS 141.040 was not applicable to non-resident corporate partners, such as the Appellees. The Department also argued that physical presence was not required for Kentucky to impose the corporation income tax on the Appellees, and that the Appellees’ receipt of income from partnerships doing business in Kentucky satisfied the Commerce Clause’s “substantial nexus” test. The Department further argued that the Appellees were required to use a single-factor apportionment method based on gross receipts.

The Appellees contended that because they had no property or payroll in Kentucky, they were not subject to Kentucky corporation income tax based on the clear language of KRS 141.040. The Appellees further argued that KRS 141.206 merely provided filing mechanics once a non-resident corporate partner was determined to be subject to tax under KRS 141.040 The Appellees also contended that even if the Court held that they had nexus on statutory grounds, they had no nexus on constitutional grounds because they had no physical presence in Kentucky. The Appellees further contended that they were entitled to receive interest on all overpayments, including paid-in taxes, penalties and interest. Finally, the Appellees contended that they were entitled to the immediate payment of refunds. The Court first determined that the issues involved were questions of law because no factual issues were in dispute. The Court then held that the KBTA’s determination that the Appellees did not have nexus with Kentucky pursuant to KRS 141.040 ignored the existence of KRS 141.206. The Court held that if a corporation has no property or payroll in Kentucky, but is a partner in a partnership located in Kentucky, KRS 141.206 governs and imposes corporation income tax on the non-resident partner. The Court therefore concluded that the Appellees had nexus with Kentucky for corporation income tax purposes on purely statutory grounds.

Significantly, the Court did not address the Appellees’ argument that they did not have nexus with Kentucky because physical presence is required under the Commerce Clause before a non-resident may be subjected to corporation income tax. The Court did not address the Appellees’ Due Process argument either.

Instead, after concluding that the Appellees had statutory nexus, the Court addressed the Appellees’ alternative argument regarding apportionment methodology. The Court held that because it had found that the Appellees had “minimum nexus,” the traditional three-factor method of apportionment was proper in order to tax only the income that bore a reasonable relationship to the Appellees’ activities conducted in Kentucky.

The Court then addressed the Appellees’ argument that they were entitled to payment of interest on paid-in interest and penalties, as well as on tax overpayments. The Court reviewed a number of provisions including KRS 141.235 (requiring interest to be paid on tax refunds), KRS 134.580(2) (providing for the payment of interest on any overpayment of tax or any payment where no tax is due) and KRS 131.183 (providing for the payment of interest on any overpayment).

The Court held that the language contained in KRS 134.580(2) contemplates that interest must be paid on assessed penalties and interest, and that the intent of the Kentucky General Assembly in enacting KRS 134.580 and KRS 131.183 was to compensate taxpayers for the use of their money. The Court noted that its determination was consistent with federal interest provisions, which provide for the payment of interest on refunds of tax, penalties and interest. The Court therefore agreed with the Appellees, and held that interest was due on their refunds of tax, penalties and interest to be paid by the Department.

The Court then remanded the case to the KBTA for the calculation of the amount of the tax and interest refund due to the Appellees. The Appellees have filed a Motion To Alter, Amend or Vacate the Order because it did not address: (1) whether Kentucky’s imposition of tax on the Appellees with no physical presence in Kentucky violated the Commerce Clause or the Due Process Clause; and (2) whether the Appellees are entitled to the immediate payment of tax refunds and interest prior to the final appellate disposition of the case. The Appellees also sought amendment or vacating of the Order because it did not contain finality language as required by CR 54.02 (stating that the Order was final and appealable). The Appellees’ Motion also urged the Court to reconsider its holding and conclude that the Appellees do not have nexus under KRS 141.040, the threshold statute that previously required physical presence of a corporation for imposition of Kentucky corporation income tax.

The hearing on the Appellees’ Motion To Alter, Amend, or Vacate is scheduled for August 8, 2007. The authors’ law firm represents the Appellees.

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