The Perils of Responding to Nexus Questionnaires

A company should be very careful in determining whether to respond to the nexus questionnaire and how to respond to the questionnaire.   After all, any response is a statement to a government agency, which must be truthful and will be an admission on the part of the company.  A response that is inaccurate or a response that is not well thought out is worse than not responding at all.  In general, there is no obligation to respond to a nexus questionnaire, so the benefit of responding to a questionnaire may not be significant, yet the potential adverse consequences may be significant.

The problem in responding to a nexus questionnaire is highlighted by a recent case involving Barr Laboratories, in which the Michigan Court of Appeals held that the answers on a nexus questionnaire that indicated that the taxpayer’s employees visited Michigan between two and nine times during the year created a factual issue as to whether or not the company had nexus.   See Barr Laboratories, Inc. v. Department of Treasury (Mich. App. 2010).  The questionnaire indicated that the employees visited Michigan to solicit sales, but all sales were approved in New York.  Apparently that response overstated and mischaracterized Barr Laboratories’ connection to the state.  After an assessment by the Michigan Department of the Treasury of about $500,000, Barr Laboratories commenced a suit to abate the assessment.   In a summary judgment motion, Barr Laboratories submitted an affidavit of its Vice President of Taxation, which contradicted the responses in the questionnaire.  The affidavit stated that the visits to Michigan were only to gather information, and not to solicit sales, and were less frequent than stated in the questionnaire.   But the response to the questionnaire precluded Barr Laboratories from prevailing in the summary judgment motion, and the response was probably the basis for the assessment in the first place.

The taxpayer in that case made several mistakes.  First, it apparently assumed that the standard under Public Law 86-272 applies in the sales tax context, and therefore that the kind of activity that would otherwise be shielded by this federal statute from income tax liability would also be excluded from sales tax collection obligations.  Second, if it had understood the true state of the law and facts, it might have considered not completing the questionnaire in the first place.  Third, even if it decided to submit the questionnaire, it should have provided more precise answers without characterization of the activities as solicitation.  Stating that the employees solicited sales in Michigan is a difficult admission to overcome, even though the activity that had been undertaken may well not have been solicitation.   Thus, the old saw that “no good deed goes unpunished” certainly holds true in this case.

The lesson to be learned is to treat a response to a questionnaire as if it were court testimony.  In a court case, lawyers prepare, advise and counsel the company.  Responding to inquiries from state tax agencies should not be treated differently.  Advice of counsel regarding whether to respond to the questionnaire and how to respond to the questionnaire should be sought.

I hope all have a good Thanksgiving holiday.