The Connecticut Department of Revenue recently issued an Informational Publication (Publication) on September 23, 2010, to provide guidance on its new “economic nexus” standard, effective for tax years beginning on or after January 1, 2010. Connecticut’s new economic nexus standard states that:

Any company that derives income from sources within this state, or that has a substantial economic presence within this state, evidenced by a purposeful direction of business toward this state, examined in light of the frequency, quantity and systematic nature of a company’s economic contacts with this state, without regard to physical presence…shall be liable for the tax… Conn. Stat. L. 2009 § 90 (emphasis added).

The Publication:

  • Sets forth those activities that will constitute “substantial economic presence” and will result in a corporation being subject to Connecticut corporate income tax.
  • Provides that the substantial economic presence in Connecticut must be attributable to the purposeful direction of business activities toward the state, and those activities are evaluated “based on the frequency, quantity, and systematic nature of the business’s economic contacts in Connecticut.”
  • Provides a bright-line test for determining when these activities will result in substantial economic presence: when the company has receipts from business activities of $500,000 or more attributable to Connecticut sources during a taxable year. Even if a company has less than $500,000 in receipts, the Commissioner may still assert that a company has a filing and tax payment obligation if it has nexus with the state through some other means. 
  • Addresses when the use of an intangible in the state will result in a Connecticut tax liability pursuant to the new economic nexus standard.  The use of an intangible will result in Connecticut tax liability if:
    1. The intangible property generates, or is otherwise a source of, gross receipts within the state for the corporation, including through a license or franchise;
    2. The activity through which the corporation obtains such gross receipts from its intangible property is purposeful (e.g., a contract with an in-state company); and
    3. The corporation’s presence within the state, as indicated by its intangible property and its activities with respect to that property, result in it having $500,000 or more of receipts attributable to Connecticut sources during a taxable year To determine if a taxpayer has $500,000 or more of receipts from the use or sale of intangibles in the state, Connecticut’s existing market-sourcing rules must be used. Under these rules, receipts from intangibles are sourced to Connecticut if the receipts are from: rentals and royalties from properties situated within the state; royalties from the use of patents or copyrights within the state; net gains from the sale or other disposition of intangible assets managed or controlled within the state; and all other receipts earned within the state.
  • The Publication further provides that passive investment income derived from Connecticut is not considered in subjecting a company to economic nexus.   

“Factor presence” tests—like Connecticut’s—have been growing in popularity since the Multistate Tax Commission approved a model regulation on October 17, 2002, which provides for such a standard. Washington state enacted a similar factor presence test earlier this year with respect to its Business & Occupation Tax, and a similar standard in California for corporate income tax purposes becomes effective January 1, 2011. However, the factor presence nexus standard is not without controversy, and legal challenges to these standards likely are on the horizon.