Cross-border tax work on the United States tends to be organized around one question, which is whether a foreign enterprise has a permanent establishment. The question is well defined, the convention answers it, and a group that gets it right can reasonably feel it has done the work. It has done half of it. The United States levies corporate tax at two levels, and the second level sits almost entirely outside the convention.
The result is a recurring pattern. A European group with a handful of customers and one remote employee concludes, correctly, that it owes no federal tax. Two years later it receives a nexus questionnaire from a state revenue department, and discovers that it has been filing nothing in a jurisdiction that considers it liable, that the liability compounds by year, and that no treaty position answers the letter.
Why the convention stops, in substance, at the federal line
Article 2 of the convention between the United States and the Netherlands lists the taxes to which it applies. For the United States, those are the federal income taxes imposed by the Internal Revenue Code, excluding social security taxes, together with the excise taxes imposed on insurance premiums paid to foreign insurers and with respect to private foundations. Paragraph 2 extends the convention to any identical or substantially similar taxes imposed after the date of signature, in addition to or in place of the existing taxes. State and municipal taxes are not listed, so the articles that allocate taxing rights over business profits do not reach them. The express exception is Article 28, whose paragraph 7 applies the non-discrimination rules of that article, notwithstanding Article 2, to taxes of every kind and description imposed by one of the states or by a political subdivision or local authority of one, while the exchange of information article is confined by its own terms to the taxes the convention covers.
That is not an oversight in drafting. It reflects the constitutional position that the states impose their own taxes under their own authority, and the federal government does not routinely bargain that authority away in bilateral treaties. Whether a state follows a federal treaty outcome is therefore a question of that state’s own law and not of the convention.
The practical consequence is that the concept of a permanent establishment is irrelevant to the state question. A state asks whether the enterprise has nexus with it, and nexus is a standard the state writes, subject only to the limits the United States Constitution and one federal statute impose. California’s statutory test of doing business is a fair illustration: it turns on organisation, commercial domicile, any transaction for the purpose of financial or pecuniary gain, and three factor thresholds. A federal permanent establishment does not enter into it.
Public Law 86-272, and how little it covers
That statute is Public Law 86-272, whose title I is codified at 15 U.S.C. sections 381 to 384. Section 381 provides that no state shall have power to impose a net income tax on income derived within the state from interstate commerce where the only business activities in the state are either or both of two things: the solicitation of orders for sales of tangible personal property, the orders being sent outside the state for approval or rejection and, if approved, filled by shipment or delivery from a point outside the state, and the solicitation of orders in the name of or for the benefit of a prospective customer whose own orders answer that same description. Section 383 defines a net income tax as any tax imposed on, or measured by, net income. Section 381(b) withdraws the protection entirely where the taxing state is the state under whose laws the corporation is incorporated.
Section 381(c) extends the protection to sales or solicitation carried out by independent contractors, and to the maintenance of an office in the state by independent contractors whose activities there consist solely of making sales or soliciting orders for sales of tangible personal property. Section 381(d) defines an independent contractor as a commission agent, broker or other independent contractor selling or soliciting for more than one principal and holding himself out as such in the regular course of his business activities.
Read the words and the limits become obvious. The protection covers tangible personal property, so a software licensor, a consultancy, an engineering firm, a data business and a financial services group are all outside it, whatever their volume. It covers solicitation only, so any activity beyond taking orders removes it. It covers approval and fulfilment from outside the state, so a local warehouse defeats it. And it reaches only net income taxes, which is the gap examined below.
Section 381 carries no amendment since its enactment in 1959, and it defines only two terms, neither of which is solicitation. States have taken that as an invitation, and the argument now runs largely over what counts as solicitation when the seller’s website interacts with the customer’s device inside the state. The New York corporate franchise tax regulation adopted in December 2023 runs the same test over orders solicited via the internet, treats activities beyond solicitation as taxable unless they are de minimis, and states that the exemption does not reach the solicitation of orders for the sale of services or intangible property. That contest is live, and a group relying on the protection should know that its scope is narrower than it was.
Wayfair, and the standard that replaced physical presence
For decades the working assumption was that a state could not require an out-of-state seller to collect its tax without physical presence, on the authority of Quill Corp. v. North Dakota. In South Dakota v. Wayfair, Inc., decided in 2018, the Supreme Court overruled Quill and National Bellas Hess, holding that the physical presence rule of Quill was unsound and incorrect.
The statute before the Court applied to sellers delivering more than 100,000 dollars of goods or services into South Dakota, or engaging in 200 or more separate transactions for delivery into the state, in a year. Those two figures were adopted, in various forms, across the country, and they are the origin of the economic nexus thresholds now published by state revenue departments. They have since moved apart from the statute that produced them. South Dakota has dropped the transaction count, and SDCL 10-64-2 now sets a single test of gross revenue from sales into the state above 100,000 dollars in the previous or current calendar year. A threshold has to be read off the state’s current page, not off the decision.
Wayfair itself concerned sales and use tax rather than income tax. Its practical effect has been wider, because it removed the intellectual foundation of the physical presence argument in both settings. A European company with no office, no employee and no property in a state can now be within its taxing jurisdiction on the strength of what it sells into that state.
Factor presence: what a state means by doing business
A state may also express its nexus test in numbers. California’s is published in detail. The Franchise Tax Board treats a taxpayer as doing business in California if it is organized or commercially domiciled there, or if it engages in any transaction for the purpose of financial gain within the state, or if its California sales, property or payroll exceed published amounts.
For 2025, the most recent year in the Franchise Tax Board’s published table, those amounts are 757,070 dollars of California sales, and 75,707 dollars of California real and tangible personal property or of California payroll. Each test is met at the lesser of the threshold amount and 25 per cent of the corresponding total, and the board is required by statute to revise the amounts every year, so the threshold that matters is the one published for the year under examination rather than the one remembered from the last review.
Two features of that structure deserve attention. The percentage alternative means a small company can cross the threshold on a modest absolute figure, because a company with three million dollars of total sales meets the 25 per cent test at 750,000 dollars. And the property and payroll thresholds are an order of magnitude lower than the sales threshold, so a single well-paid employee working from a home in California can create the liability on his own.
Alongside the income measure sits a fixed charge. Every corporation incorporated, registered or doing business in California must pay the 800 dollar minimum franchise tax, payable whether the corporation is active, inactive or operating at a loss. The exceptions are narrow. The first taxable year is free of it for a corporation that incorporates or qualifies to do business in the state on or after 1 January 2000. That relief does not extend to limited partnerships, limited liability companies or limited liability partnerships, which are three of the eight entity types the subdivision excludes, and it does not reach a corporation that reorganises solely to avoid the charge. There is no franchise tax either for a tax year of 15 days or less in which no business was conducted. It is a small number that becomes an unpleasant one when multiplied by the years in which nothing was filed.
The taxes that are not income taxes at all
Public Law 86-272 protects against a net income tax. A tax measured on gross receipts rather than on net income sits outside that protection by definition, because it is not imposed on or measured by net income within the meaning of section 383. The Washington business and occupation tax is the plainest case: it is calculated on the total value of products sold or the total income the business earns, and no deduction is allowed for labour, materials, taxes or other costs of doing business.
For a business with thin margins, the difference is severe. A tax of a fraction of a per cent on gross receipts is a modest number expressed as a rate and a large number expressed as a share of profit. A distributor operating on a five per cent margin pays a materially higher effective rate under a gross receipts tax than a software company on the same revenue.
Sales and use tax runs on its own track again. It is a tax on the customer that the seller is obliged to collect, and failure to collect it converts the seller into the debtor. Unlike income tax, it is not reduced by the absence of profit, and it accumulates on revenue that has already been received and spent. Each of these charges is set state by state, at rates and thresholds that differ and are revised on their own timetables, so the exposure has to be tested against the current schedule in every state where the group has customers.
Apportionment, and the profit counted more than once
Where a company has nexus in several states, each of them taxes a share of the same income, determined by an apportionment formula the state selects. Nothing requires the formulas of two states to be consistent with each other, and the shares need not add to one hundred per cent.
California apportions the business income of most trades by the sales factor alone. The three factor formula of property, payroll and sales survives only where an apportioning trade or business derives more than 50 per cent of its gross business receipts from one or more qualified business activities, so it is the whole business that moves to three factors, and only above that threshold. For taxable years beginning on or after 1 January 2025 the qualified activities are agricultural and extractive activity; for years before that the list also included savings and loan and banking or financial business activity, which still matters for an earlier year under examination. California sources sales of tangible personal property to the state where the property is delivered or shipped to a purchaser other than the United States government, and it sources services to the extent the purchaser receives the benefit in the state and intangibles to the extent the property is used there. Where the other state sources by cost of performance instead, the two rules point in different directions, and a group can find the same receipt sourced to two states under two different rules, and taxed in both.
Throwback and throwout rules add a further layer. Where a state applies a throwback rule, sales into a state that cannot tax the seller are returned to the state of origin and taxed there. California treats a sale as made in California where the property is shipped from an office, store, warehouse, factory or other place of storage in the state and either the purchaser is the United States government or the taxpayer is not taxable in the state of the purchaser. The effect is that the protection of Public Law 86-272 in one state can increase the tax base in another.
Registration, trailing nexus and coming forward
The compliance obligations do not begin with the tax return. A foreign corporation may not transact intrastate business in California without first obtaining a certificate of qualification from the Secretary of State, which requires it to name an agent on whom process may be served and to give a principal office address, and the tax registration follows from that. Employment obligations run in parallel and independently, and on much smaller figures: California treats an employing unit with one or more employees as an employer once it pays wages of more than 100 dollars in a calendar quarter, and requires it to register within 15 days of becoming one.
Nexus, once established, does not always end when the activity ends. A state may apply a trailing nexus period, so that a company remains within the filing obligation for a defined period after the activity that created the exposure has stopped. Washington deems a person to have substantial nexus if the test is met in the current or the immediately preceding calendar year, and a person who met it in the preceding year is taxable for the current year in its entirety. The exposure therefore has a tail, and a group that closed a state office two years ago may still owe returns for it.
The route back is a voluntary disclosure agreement. States operate programs under which a taxpayer that comes forward before it is contacted can settle a limited number of past years. Washington limits the look back to the prior four years plus the current year, waives up to 39 per cent in penalties, imposes statutory interest on everything due, and accepts an anonymous application provided the business identity is disclosed when the department asks for it. Full benefits require that the department has not already made contact for enforcement purposes, and the four year limit falls away where retail sales or use tax was collected and not remitted. A nexus questionnaire on the desk is the end of the option, which is why the sequence matters more than the amount.
How to budget for it
The federal analysis and the state analysis are separate exercises, and only the first is answered by a treaty. A group entering the United States should treat the state question as a distinct workstream with its own map: where the customers are, where the employees are, where inventory sits, what is sold and whether it is tangible.
That map costs very little to produce at the outset and is expensive to reconstruct four years later from invoices and payroll records. It also gives the group something more useful than a tax number, which is a view of where its United States business is actually being conducted. The tax follows from that, and so does most of the rest of the structure.
This article is informational and does not constitute tax or legal advice. The treatment of any structure depends on its facts and on the law of each jurisdiction involved. Each engagement is subject to scope and applicable regulation.