More on “Nexus” and “Substance”

Two legal issues crop up when operating a Nevada corporation which might have some activities in a foreign jurisdiction: “nexus” and “substance”. Without getting into a full-blown legal definition for the purposes of this discussion, nexus can be considered equivalent to the related word, “connection”. And for purposes of this discussion we can consider the legal issue of “substance” to mean “physical presence”.

We have previously pointed out a list of conditions under which a Nevada corporation is not considered to be “doing business” in a foreign jurisdiction. It may, for instance, use an independent contractor to effect sales outside of Nevada, as long as each sale is not considered final until accepted in Nevada. If, however, a Nevada corporation has significant nexus in (connection to) another jurisdiction, in many cases the tax-hungry foreign state will seek to extend its tax laws to compel the Nevada corporation to pay some taxes in the state where the contractor is effecting sales.  A Nevada corporation with little presence in Nevada but which provides all sorts of equipment to an independent contractor working in, say, California could find itself under attack from the California Franchise Tax Board.

So far, at least, there are very few examples of small, private situations undergoing such scrutiny. However, in cases where the amounts of revenue derived from the foreign jurisdiction are large enough to present a “target of opportunity”, various states are becoming increasingly aggressive in extending their tax tentacles. In auditing such a situation the home-state taxation authority will pose many questions relating to the “substance” (physical presence) of the Nevada corporation in Nevada.

Actual audit questions in establishing the substance of the Nevada corporation in Nevada can be very detailed and probing, including but not limited to the following:  employees (compensation, responsibilities, payroll returns); identification of officers and compensation; copies of phone bills; actual payments made on notes; list of suppliers and professional-service providers; where decisions are made regarding investments; copies of corporate records including minutes and resolutions; banking (copies of all bank statements, checks and deposit slips).

The Nevada Department of Taxation uses the following criteria to evaluate nexus in Nevada: use of an office, distribution house, warehouse, service enterprise or other place of business; maintenance of a stock of goods; solicitation of orders by employees or independent contractors; regular engagement in the delivery of property in this state, other than by common carrier or United States mail; or regular engagement in any activity in connection with the leasing or servicing of property which is located within this state.

From the foregoing it should be obvious that it is always best to remain small in order to keep the bureaucrats out of your private business affairs whenever possible.  And if and when your business grows to become a substantial potential target, it may become necessary to broaden its Nevada base, in order to retain more “substance” in Nevada relative to “nexus” in the foreign jurisdiction.

The bottom line on this discussion is that a Nevada corporation must have more substance in Nevada than it has nexus in another jurisdiction.  In the case of an independent contractor in California, say, the corporation could have NO nexus in California, so any substance at all in Nevada is more than sufficient. Where “foreign” (other-state) nexus is established (because the Nevada corporation is actually “doing business” there) it will be necessary to have significant substance in Nevada. But most such situations are easily resolved through the use of two “arm’s length” entities.