J.C. Penney National Bank v. Johnson

FILED
December 17, 1999

Cecil Crowson, Jr.
Appellate Court Clerk
IN THE COURT OF APPEALS OF TENNESSEE
AT NASHVILLE

J. C. PENNEY NATIONAL BANK, )
)
)
Plaintiff/Appellant, ) Davidson Chancery No. 96-276-I
)
VS. ) Appeal No. M1998-00497-COA-R3-CV
)
RUTH E. JOHNSON, Commissioner )
of Revenue, State of Tennessee, )
)
)
Defendant/Appellee. )

APPEAL FROM THE CHANCERY COURT OF DAVIDSON COUNTY
AT NASHVILLE, TENNESSEE
THE HONORABLE ERNEST PELLEGRIN, SPECIAL CHANCELLOR

MICHAEL D. SONTAG
BRYAN W. METCALF
BASS, BERRY & SIMS, PLC
Nashville, Tennessee
Attorneys for Appellant

PAUL G. SUMMERS
Attorney General & Reporter
MICHAEL E. MOORE
Solicitor General
JOE C. PEEL
Senior Counsel
Office of the Attorney General
Tax Division
Nashville, Tennessee
Attorneys for Appellee

JOSEPH W. GIBBS

Page 1
REBECCA C. BLAIR
BOULT, CUMMINGS, CONNERS & BERRY, PLC
Nashville, Tennessee
DIANN L. SMITH
Committee on State Taxation
Washington, D.C.
JEFFREY A. FRIEDMAN
WILLIAM D. PELTZ
BOBBY L. BURGNER
Committee on State Taxation
Washington, D.C.
Attorneys for Amicus Curiae Committee on State Taxation

JOHN ROBERT JACOBSON
BOWEN, RILEY, WARNOCK & JACOBSON
Nashville, Tennessee
LINDA ARNSBARGER
PAUL H. FRANKEL
NEIL I. POMERANTZ
THOMAS H. STEELE
MORRIS & FOERSTER, LLP
Washington, D.C.
Attorneys for Amicus Curiae VISA U.S.A. INC. and MASTERCARD
INTERNATIONAL, INC.

REVERSED AND DISMISSED

ALAN E. HIGHERS, J.

CONCUR:

DAVID R. FARMER, J.

Page 2
HOLLY KIRBY LILLARD, J.

The J.C. Penney National Bank appeals from the Chancery Court of Davidson

County, which upheld the imposition of franchise and excise taxes against the Bank by the

Tennessee Department of Revenue. For the reasons stated herein, we reverse the

decision of the trial court.

Facts and Procedural History

At all relevant times, the J.C. Penney National Bank 1 (“the National Bank” or “JCPNB”

) was a federally chartered national banking association incorporated under the laws of

Delaware with its principal place of business and commercial domicile in Harrington,

Delaware. Ruth E. Johnson (“Commissioner”) was the Commissioner of Revenue for the

State of Tennessee and was named in this case in her official capacity. The present appeal

arises from the Commissioner’s imposition of franchise and excise taxes against JCPNB

on income allegedly generated by JCPNB’s credit card activities in the State of Tennessee.

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 In order to clarify the positions of the respective parties, we find it necessary briefly to

describe, perhaps to the point of oversimplification, the various entities and procedures

involved in JCPNB’s credit card business.

Through its Delaware offices, JCPNB offers consumer banking services such as

deposit accounts, home mortgage lending, general consumer loans, and automated teller

machine (“ATM”) services. In addition to the normal banking services which it provides,

JCPNB engages in credit card lending through the issuance of Visa and MasterCard credit

cards. 2 JCPNB has been issuing Visa credit cards since 1983, and MasterCard credit

cards since 1984.

JCPNB contracted with the J.C. Penney Company, its parent company, to perform

various marketing and processing services that were necessary to create and maintain

JCPNB’s credit card business. Under that contract, the J.C. Penney Company agreed to

provide services such as credit card solicitation, marketing, statement and payment

processing, customer service, and collection. The J.C. Penny Company, in turn, contracted

with other companies to provide many of these services.

The J.C. Penney Company contracted with Maryland Bank National Association (“

MBNA”), an unrelated corporation domiciled in Texas, to provide the data processing

related to the National Bank’s credit card business. MBNA is a company that offers credit

card processing services to a variety of banks. As transactions were received through the

Visa or MasterCard network, MBNA posted them to the appropriate cardholder account.

MBNA was also responsible for sending out account statements each month.

The J.C. Penney Company also contracted with Business Services, Inc. (“BSI”), a

wholly owned subsidiary, to provide general marketing and payment processing services. 3

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After MBNA sent monthly statements to the cardholders, the cardholders would send their

payments to a BSI payment processing center in San Antonio, Texas. Also, as part of its

marketing responsibilities, BSI solicited credit card accounts on behalf of JCPNB. These

solicitations were sent via U.S. Mail to potential customers throughout the United States,

including Tennessee. 4 As the first step in the solicitation process, BSI obtained the names

of possible customers. Some names were obtained from a list of people who had a prior

credit history with the J.C. Penney Company. BSI also obtained potential customer names

through the use of mailing lists from various credit bureaus. 5 BSI would then submit the list

of potential cardholders to a national credit bureau who would select those people having a

credit profile consistent with the criteria established by JCPNB. The selected people would

then receive an offer to apply for a credit account with the National Bank.

None of the activities described above occurred in the State of Tennessee, other

than the solicitations being mailed to Tennessee residents. Also, all of the entities involved

in the National Bank’s credit card operation were located outside the State of Tennessee. 6

JCPNB itself maintained no offices or places of business in Tennessee, nor did it have any

employees in the State.

The Visa and MasterCard credit cards issued by the National Bank were “universal

cards.” This name derives from the fact that these cards could be used to purchase goods

and services throughout the world from any retailer who displayed the Visa or MasterCard

logo. 7 A credit card purchase may be made in two ways. The most common transaction

occurs when the cardholder presents the card to a merchant and the merchant swipes the

card through a point of sale terminal. The terminal reads the magnetic strip on the back of

the card and transmits a request for authorization to the issuing bank. Another type of

transaction can occur when the cardholder provides a merchant with his or her account

number and expiration date, but does not physically present the card to the merchant. This

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type of transaction generally occurs when purchases are being made over the telephone or,

in today’s world, via the internet. In either case, a sales slip is generated which the

merchant submits to a merchant bank with whom the merchant has a contract. 8 The

merchant bank will then remit the transaction amount to the merchant minus a discount. The

merchant bank may be located inside or outside Tennessee.

The merchant bank records the information from the sales slip and transmits the

information to a VISA (USA) Inc. or MasterCard International, Inc. interchange center for the

purpose of obtaining payment of the face amount of the slip, less an interchange fee, from

the bank that issued the credit card, which, in this case, was JCPNB. Visa and MasterCard

regularly inform JCPNB of the amount owed by it with respect to sales slips which have

been submitted by all merchant banks. From Delaware, the National Bank transfers funds

to pay these amounts.

The J.C. Penney National Bank charged an annual fee on most Visa and

MasterCard credit card accounts, as well as interest and other fees in connection with the

account. The National Bank then paid an income tax to the State of Delaware based upon

100% of the National Bank’s net income. JCPNB had never filed a franchise or excise tax

return with the Tennessee Department of Revenue, nor had it ever paid any franchise or

excise taxes to the State of Tennessee. However, the Field Audit Division of the Tennessee

Department of Revenue audited JCPNB in 1995 for the period of February 1990 through

January 1994. On November 1, 1995, the Department of Revenue issued an assessment

to the National Bank in the amount of $178,314, which included: $111,725 in franchise and

excise taxes, $27,932 in penalties, and $38,657 in interest. The assessment was based on

the determination that JCPNB was a “financial institution” as defined in T.C.A. §

67-4-804(a)(8) and was subject to franchise and excise taxation under T.C.A. §§ 67-4-806

and 67-4-903. In calculating the taxes, the Department of Revenue applied the single-factor,

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gross receipts apportionment formula applicable to financial institutions found in T.C.A. §§

67-4-815 and 67-4-919.

In accordance with T.C.A. § 67-1-1801, the National Bank filed this action contesting

the assessment of the franchise and excise taxes on three grounds: (1) the assessment

violated the Commerce Clause of the United States Constitution; (2) the assessment

violated the Due Process Clause of the United States Constitution; and (3) basing the

assessment upon the single receipts factor apportionment formula violated the Due

Process Clause of the United States Constitution. The case was tried in the Chancery

Court of Davidson County on February 9 and 10, 1998. The chancellor issued a

memorandum opinion on October 16, 1998 upholding the assessment. The chancellor

concluded that the assessment was not violative of the requirements of the Due Process

Clause of the United States Constitution, and a sufficient nexus existed between the State of

Tennessee and JCPNB to satisfy the requirements of the Commerce Clause. The

Commissioner filed a motion to alter or amend the order because it did not provide for a

judgment against JCPNB for the disputed tax liability and did not provide for an award of

attorney’s fees and expenses pursuant to T.C.A. § 67-1-1803(d). The chancellor entered a

final order on December 7, 1998, awarding judgment in favor of the Commissioner in the

amount of $178,314, as well as awarding attorney’s fees and expenses to the

Commissioner as the prevailing party. This appeal followed.

On appeal, JCPNB presents a single question for review. That question is whether

JCPNB’s relationship with the State of Tennessee satisfies the “substantial nexus”

requirement of the Commerce Clause.

Law and Analysis

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 Financial institutions “doing business” in the State of Tennessee are subject to

excise and franchise taxes pursuant to T.C.A. §§ 67-4-806(d)(2) 9 and 67-4-903(f)(2) 10. The

Commissioner contends that JCPNB’s credit card activities come within the terms of the

statutory provisions because JCPNB: (1) regularly solicits business from customers in

Tennessee; (2) provides credit card services to its customers; (3) engages in transactions

in which it extends credit to these customers; and (4) receives interest income and fee

income from these transactions and loans. Appellee’s Brief at p. 10. JCPNB, however,

does not challenge the statutes pursuant to which the taxes were imposed. Rather, JCPNB

contends that its contacts with the State of Tennessee, even if sufficient under the

Tennessee statutory scheme, do not provide a sufficient nexus under the Commerce Clause

of the United States Constitution to uphold the assessment.

I.

This case presents a question regarding the limits of Tennessee’s power to tax

out-of-state sellers. Constitutional limitations on this power are found in both the Due

Process Clause of the Fourteenth Amendment and the Commerce Clause of article 1, § 8.

In the trial court, JCPNB challenged the franchise and excise taxes as a violation of both

constitutional provisions. On this appeal, JCPNB has limited its question presented to

consideration of whether the taxes imposed by the State of Tennessee violates the

Commerce Clause. However, JCPNB also claims that the Commissioner has “blurred the

line” between Due Process and Commerce Clause analysis.

Some of the Commissioner’s arguments do, in fact, confuse the analysis between

the Commerce Clause and the Due Process Clause. For example, in arguing that JCPNB

has a substantial nexus with the State of Tennessee, the Appellee’s brief states: “[JCPNB]

is exercising the substantial privilege of doing business in Tennessee. On this basis,

Page 8
sufficient nexus exists and JCPNB is receiving the protections which establish a basis for

finding of nexus.” The Commissioner makes this statement after quoting a passage from

Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425, 100 S.Ct. 1223, 63

L.Ed.2d 510 (1980). 11 However, the phrase “substantial privilege of doing business” is

traditionally used in the area of due process. Additionally, the Mobil Oil case specifically

used the language which Appellee quotes in the context of a Due Process analysis. 12

Therefore, recognizing the confusion that may exist between the parties, we find it

necessary to clarify the specific limitations imposed by both Due Process and the

Commerce Clause.

In Quill Corp. v. North Dakota, the United States Supreme Court considered the

constitutional limitations on a state’s power to tax imposed by both the Due Process Clause

and the Commerce Clause. 504 U.S. 298, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992). The

Court began by noting that the “two claims are closely related.” Id. (quoting National Bellas

Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753, 87 S.Ct. 1389, 18 L.Ed.2d 505

(1967)). However, the Court also pointed out that the two Clauses each pose distinct limits

on the taxing power of the States. Quill, 504 U.S. at 305. Therefore, a State’s power to tax

may be sustained under the Due Process Clause, but imposition of the tax may nonetheless

violate the Commerce Clause. 13 Id. (citing Tyler Pipe Indus., Inc. v. Washington State Dept.

of Revenue, 483 U.S. 232, 107 S.Ct. 2810, 97 L.Ed.2d 199 (1987)).

II.

The due process analysis in the area of state taxation of interstate commerce

derives from the rules for in personam jurisdiction expressed in International Shoe Co. v.

Washington, and its progeny. 326 U.S. 310, 66 S.Ct. 154, 90 L.Ed. 95 (1945). International

Shoe, the seminal case in the modern due process era, allows a state to assert personal

Page 9
jurisdiction if the defendant has minimum contacts with the jurisdiction “such that the

maintenance of the suit does not offend ‘traditional notions of fair play and substantial

justice.’” International Shoe, 326 U.S. at 316 (quoting Milliken v. Meyer, 311 U.S. 457, 463,

61 S.Ct. 339, 343, 85 L.Ed. 278 (1940)). Subsequent cases made clear the point that

physical presence in the jurisdiction is not necessary for “minimum contacts” to exist. See,

e.g., Burger King Corp. v. Rudzewicz, 471 U.S. 462, 105 S.Ct. 2174, 85 L.Ed.2d 528

(1985).

In the context of state taxation, the Due Process Clause “requires some definite link,

some minimum connection, between a state and the person, property or transaction it seeks

to tax.” Quill, 504 U.S. at 306 (quoting Miller Brothers Co. v. Maryland, 347 U.S. 340,

344-345, 74 S.Ct. 535, 539, 98 L.Ed. 744 (1954)). Prior to the 1967 decision in National

Bellas Hess, Inc. v. Department of Revenue. of Ill., 386 U.S. 753, 87 S.Ct. 1389, 18 L.Ed.2d

505 (1967), the Supreme Court had found that “definite link” to exist in several cases

involving state use taxes. However, the taxpayer in all those cases had some type of

physical presence in the taxing state. Quill 504 U.S. at 306. The Quill Court noted that the

Bellas Hess decision suggested that physical presence in the State was necessary to

sustain jurisdiction under the Due Process Clause. See Quill 504 U.S. at 306-307.

Applying the reasoning from the International Shoe and Burger King decisions, the Quill

court rejected the notion that due process mandated the physical presence of an

out-of-state seller before a state could tax that seller. The Court held that the Due Process

Clause does not operate to bar enforcement of a use tax against a mail-order house “that is

engaged in continuous and widespread solicitation of business within a state.” Quill, 504

U.S. at 308. In other words, if the contacts were sufficient to subject the corporation to

personal jurisdiction in the forum state, then imposition of a use tax on the corporation’s

business in the state would be sustained in the face of a Due Process challenge. Physical

presence in the state is not necessary. In so holding, the Quill Court noted the policy

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concerns that drive due process analysis. Specifically, the Court stated:

Due process centrally concerns the fundamental fairness of
governmental activity. Thus, at the most general level, the due
process nexus analysis requires that we ask whether an
individual's connections with a State are substantial enough to
legitimate the State's exercise of power over him. We have,
therefore, often identified "notice" or "fair warning" as the
analytic touchstone of due process nexus analysis.

Quill, 504 U.S. at 312.

In the present case, the National Bank’s relationship with the State of Tennessee was

such that the imposition of the franchise and excise taxes was not precluded by due process

considerations. The lack of a physical presence in Tennessee does not mandate a finding

to the contrary. The following passage from Burger King Corp. v. Rudzewicz, cited by the

Quill Court, is equally applicable in the present case:

Jurisdiction in these circumstances may not be avoided merely
because the defendant did not physically enter the forum State.
Although territorial presence frequently will enhance a potential
defendant’s affiliation with a State and reinforce the reasonable
foreseeability of suit there, it is an inescapable fact of modern
commercial life that a substantial amount of business is
transacted solely by mail and wire communications across state
lines, thus obviating the need for physical presence within a
State in which business is conducted. So long as a commercial
actor’s efforts are ‘purposefully directed’ toward residents of
another State, we have consistently rejected the notion that an
absence of physical contacts can defeat personal jurisdiction
there.

Burger King, 471 U.S. at 476. JCPNB has reached out to the citizens of the State of

Tennessee through the solicitations for credit cards that were sent on its behalf. Moreover,

JCPNB has purposefully availed itself of the substantial privilege of doing business in the

State of Tennessee. See id. Clearly, the franchise and excise taxes assessed against

JCPNB are not violative of the rights guaranteed under the Due Process Clause.

The Due Process Clause, however, is only the first consideration in determining

whether a state may tax an out-of-state seller. Having recognized that the Due Process

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Clause does not preclude imposition of the franchise and excise taxes on JCPNB, we must

consider the limitations imposed by the Commerce Clause.

III.

The Commerce Clause expressly authorizes Congress to “regulate Commerce with

foreign Nations, and among the several States.” U.S. Const. art. I, § 8, cl. 3. In addition to

this affirmative grant of power, the “negative” or “dormant” Commerce Clause also serves to

prohibit state actions that interfere with interstate commerce. See Quill, 504 U.S. at 309

(citing South Carolina State Highway Dept. v. Barnwell Bros., Inc. 303 U.S. 177, 185, 58

S.Ct. 510, 514, 82 L.Ed. 734 (1938)). Simply stated, the fact that the Commerce Clause

grants Congress the specific power to regulate interstate commerce necessarily carries the

negative implication that the states may not act to interfere with interstate commerce.

The earliest cases in this area strictly limited the state’s rights to tax interstate sales.

See, e.g., Leloup v. Port of Mobile, 127 U.S. 640, 648, 8 S.Ct. 1380, 1384, 32 L.Ed. 311

(1888)(“no state has the right to lay a tax on interstate commerce in any form”). Subsequent

decisions by the Court moved away from the absolute limits imposed on state taxation and

began to distinguish between “direct” and “indirect” burdens on interstate commerce. This

line of cases culminated with the decision in Freeman v. Hewit, 329 U.S. 249, 67 S.Ct. 274,

91 L.Ed.265 (1946), in which the Court formally embraced the distinction and struck down

an Indiana tax as a direct tax on interstate sales.

Dormant Commerce Clause jurisprudence in the area of state taxation changed

dramatically with the decision in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 97

Page 12
S.Ct. 1076, 51 L.Ed.2d 326 (1977). The Complete Auto decision rejected the line of cases

which had held impermissible the direct taxation of interstate commerce by the states. 14

Complete Auto enunciated a four-part test, which provided that a state tax on an out-of-state

seller will be sustained so long as 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, and (4) is fairly related to the services provided by the state.”

Complete Auto Transit, Inc. 430 U.S. at 279.

The question in the present case is whether JCPNB’s relationship with the State of

Tennessee satisfies the “substantial nexus” requirement found in the first prong of the

Complete Auto test. That question, in turn, raises the question of what is meant by the term “

substantial nexus.” As an initial matter, we can say that substantial nexus under the

Commerce Clause is not the same as minimum contacts under the Due Process Clause.

See Quill, 504 U.S. at 313 (“Thus, the ‘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”). Although stating that proposition in the abstract

seems to be simple enough, the actual analysis can be much more confusing. The problem

is that phrases such as “minimum contacts” and “substantial nexus” do not really mean

anything. There is no definitive line that marks a minimum contact, nor is there a specific

point at which a substantial nexus exists. The analysis in this area is necessarily done on a

case-by-case basis. However, we are guided by the recognition that the Commerce Clause

imposes a greater limitation on Tennessee’s right to tax JCPNB than does the Due Process

Clause. With the distinctions between the two clauses in mind, we turn to the question of

whether a substantial nexus exists to sustain the franchise and excise taxes imposed by the

Commissioner.

IV.

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 We do not consider the fact that JCPNB was “doing business” in Tennessee to be

dispositive of the present issue. If that were the case, we would have obliterated the

distinction between the Due Process Clause and the Commerce Clause. Instead, we must

attempt to delineate that level of “presence” in the State of Tennessee that will justify the

imposition of the types of taxes that are the subject of this appeal. This “presence” must, in

order to satisfy the Commerce Clause, be more than merely “doing business” in the State of

Tennessee. JCPNB relies on Bellas Hess and Quill to argue that physical presence is

required. The Commissioner, on the other hand, argues that physical presence is not a

formal requirement and the validity of a state tax should be determined under the Complete

Auto test. The Commissioner refers to this as “contemporary Commerce Clause

jurisprudence.” The fundamental flaw in the Commissioner’s argument is that Complete

Auto does not set a different standard than that contemplated in Bellas Hess and Quill.

Rather, Bellas Hess and Quill specifically address the first prong, or the substantial nexus

requirement, of the Complete Auto test. See Quill, 504 U.S. 311. In that regard, the Bellas

Hess/Quill decisions are entirely consistent with the Complete Auto test. Both Bellas Hess

and Quill are clear in their holding that in the context of a use tax, physical presence is

required in order to satisfy the substantial nexus requirement of Complete Auto.

The only real issue is whether there is any reason to distinguish the present case

from Bellas Hess and Quill. The Commissioner argues that those cases are distinguishable

because they involved use taxes, whereas the present case involves franchise and excise

taxes. We must reject the Commissioner’s argument. While it is true that the Bellas Hess

and Quill decisions focused on use taxes, we find no basis for concluding that the analysis

should be different in the present case. In fact, the Commissioner is unable to provide any

authority as to why the analysis should be different for franchise and excise taxes. 15 It is

certainly true that the Quill Court expressed some reservations about the vitality of the Bellas

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Hess decision. See Quill, 504 U.S. at 311 (stating that the Bellas Hess decision might be

different were the issue to arise for the first time today). However, we are not in a position to

speculate as to how the Supreme Court might decide future cases. We are only able to rely

on past decisions. Any constitutional distinctions between the franchise and excise taxes

presented here and the use taxes contemplated in Bellas Hess and Quill are not within the

purview of this court to discern. As such, we feel that the outcome of this case is governed

by Bellas Hess and Quill, as those decisions interpret the first prong of the Complete Auto

test.

JCPNB argues that the present case is “almost identical” to the facts in Quill. In

many respects, that assertion is correct. JCPNB is a Delaware corporation with no offices

or agents in Tennessee, just as the taxpayer in Quill had no offices or employees in North

Dakota. See Quill, 504 U.S. at 302. Also, JCPNB did not physically engage in any activities

in Tennessee connected with its credit card business. Similarly, Quill solicited business in

North Dakota through catalogs, flyers, and other advertisements and delivered those goods

via mail or common-carrier, thereby having no physical presence in North Dakota. Id.

In response to JCPNB, the Commissioner asserts several arguments in support of

finding that JCPNB does, in fact, have a substantial nexus with Tennessee. First, she

argues that the credit cards which JCPNB issued were tangible physical property over

which JCPNB maintained ownership, thereby giving JCPNB a physical presence in

Tennessee through those cards. 16 Additionally, she argues that the presence of the J.C.

Penney retail stores in Tennessee provides the requisite substantial nexus. We will deal

with each of these arguments in turn.

During the tax years in question, JCPNB had between 11,000 and 17,000 accounts

with Tennessee residents. The chancellor found that the actual credit cards constituted “

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tangible property for substantial nexus purposes.” In reaching that decision, the chancellor

found it persuasive that the cards remained the property of JCPNB. While we agree that a

credit card is tangible in that it can be seen and touched, we do not agree that the presence

of the credit cards in Tennessee is constitutionally significant. Additionally, we do not find it

relevant that JCPNB retained ownership of the cards.

Credit cards, in and of themselves, are virtually worthless. The “value” of these cards

is found in the right which the card represents, namely the credit account. The card is

merely representative of the customer’s right to charge goods and services. The actual

card is not even necessary to the transaction. 17 It merely serves as a convenient article on

which to record the necessary information regarding the customer’s account. As the

chancellor correctly determined, the real asset is the intangible account which the card

represents. Those accounts were located, for tax purposes, in the State of Delaware and

not subject to a Tennessee tax. Therefore, we do not agree with the chancellor’s

determination that the physical presence of the JCPNB credit cards constituted a basis for

finding substantial nexus.18

The Commissioner also argues that JCPNB had a physical presence in Tennessee

by virtue of the fact the J.C. Penney Company, JCPNB’s parent, owned and operated the

J.C. Penney retail stores in Tennessee. This argument lacks merit because the retail stores

were not affiliated with JCPNB’s Visa and MasterCard credit card operations. 19 The retail

stores conducted no activities which assisted JCPNB in maintaining its credit card

business in Tennessee. The record shows that one could not apply for the JCPNB credit

cards at the J.C. Penney retail stores, nor could individuals make a payment on their Visa or

MasterCard account at the retail stores. Therefore, we reject the Commissioner’s

arguments which contend that a substantial nexus exists based on the presence of the J.C.

Penney retail stores in Tennessee.

Page 16
 Finally, the chancellor concluded that a substantial nexus existed based on “the

activities of the affiliates and third parties working on JCPNB’s behalf.” In reaching this

conclusion, the chancellor relied on Tyler Pipe Indus. v. Washington State Dep’t of Rev., 483

U.S. 232, 107 S.Ct. 2810, 97 L.Ed.2d 199 (1987) and Scripto v. Carson, 362 U.S. 207, 80

S.Ct. 619, 4 L.Ed. 2d 660 (1960). We are unable to agree with the chancellor’s reasoning.

Both Tyler Pipe and Scripto involved one crucial element which is absent in the present

case. In those cases, activities were being conducted in the taxing state that substantially

contributed to the taxpayer’s ability to maintain operations in the taxing state. Simply put,

the taxpayer in those cases had a physical presence in the taxing state that is lacking in the

present case.

In Scripto, the Georgia taxpayer employed independent contractors who solicited

business in the State of Florida, the taxing state. See Scripto, 362 U.S. at 211 (“Each

salesman . . . is actively engaged in Florida as a representative of Scripto for the purpose of

attracting, soliciting and obtaining Florida customers”). The real issue in Scripto was

whether it made any constitutional difference that the individuals hired to solicit business

were employed as “independent contractors” rather than as regular employees. The court

refused to find any meaningful difference between the labels used to describe the

employees. See id. at 211 (holding the distinction between regular employees and

independent contractors to be without constitutional significance).

Similarly, in Tyler Pipe, the Supreme Court found that a substantial nexus existed to

justify the imposition of a business and occupation tax by the State of Washington. 20 In Tyler,

the solicitation was “directed by executives who maintain their offices out-of-state and by an

independent contractor located in Seattle .” Tyler Pipe, 483 U.S. at 249 (emphasis added).

The Court, agreeing with the Washington Supreme Court, found the crucial factor to be the

Page 17
fact that the activities which allowed the taxpayer to establish and maintain a market actually

took place in the State of Washington . Id. at 250 (emphasis added). The Court

concluded by stating, “the activities of Tyler’s sales representatives adequately support the

State’s jurisdiction to impose its wholesale tax on Tyler.” Id. at 251. Here, as in Scripto, the

distinguishing factor was the physical presence of the taxpayer in the taxing state.

A review of the facts of the present case convinces this court that JCPNB did not

have a physical presence in Tennessee through its affiliates. Neither BSI nor MBNA actually

performed any services on behalf of JCPNB in the State of Tennessee. The solicitation,

which was the most important function in allowing JCPNB to maintain its business, took

place through the U.S. Mail, which, under the holding in Quill, does not allow a finding of

substantial nexus. In short, the activities which allowed JCPNB to conduct its credit card

operation did not occur in the State of Tennessee. 21 As such, we believe the chancellor’s

reliance on Scripto and Tyler Pipe was misplaced as those cases are clearly

distinguishable.

It is not our purpose to decide whether “physical presence” is required under the

Commerce Clause. However, the Commissioner has pointed to no case in which the

Supreme Court of the United States has upheld a state tax where the out-of-state taxpayer

had absolutely no physical presence in the taxing state. The Commerce Clause requires a

greater relationship than does the Due Process Clause. If we were to uphold the tax

assessment against JCPNB, we believe that we would be unjustifiably overlapping the two

clauses. While we are confident that the tax assessment satisfies due process, we fail to

see the substantial nexus necessary to sustain the tax under the Commerce Clause.

Scripto, Inc. v. Carson, is, by the Supreme Court’s own words, the furthest extension of a

state’s right to tax an out-of-state seller. However, Scripto involved facts that are not present

in this case. Specifically, the Georgia company in Scripto employed individuals in the State

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of Florida, the taxing state, to solicit business. Therefore, if Scripto is the furthest reach of a

state’s power to tax, and there is even less of a relationship in this case than was present in

Scripto, we conclude that a substantial nexus is lacking to uphold the tax assessment

against JCPNB.

Conclusion

For the reasons stated herein, we reverse and dismiss the decision of the trial court,

which upheld the imposition of franchise and excise taxes against JCPNB. Costs of this

appeal are taxed to the appellee, Ruth E. Johnson, Commissioner of Revenue, State of

Tennessee, for which execution may issue if necessary.

HIGHERS, J.

CONCUR:

FARMER, J.

LILLARD, J.

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