Were goods shipped from California to Puerto Rico assigned back to California's sales factor when the seller's Puerto Rico activity was limited to soliciting orders?

Plain-English summary

Legal Ruling 1999-1 treated Puerto Rico as a state for Public Law 86-272 and treated commerce between Puerto Rico and the fifty states as interstate commerce under that federal law.

The hypothetical California manufacturer made sales into Puerto Rico and shipped the products from California by common carrier. Its Puerto Rico activities were limited to soliciting orders for tangible personal property. Public Law 86-272 therefore protected the sales from Puerto Rico net income tax.

Because the seller was not taxable in the destination jurisdiction for this purpose, California's sales-factor rule assigned the Puerto Rico destination sales back to California.

The transaction

Corporation A was a California corporation that manufactured products in California and sold them in Puerto Rico. The products were shipped from California to Puerto Rico by common carrier.

Although Corporation A otherwise had enough connection to be taxable in Puerto Rico under constitutional standards, its in-Puerto-Rico activity was limited to soliciting orders for sales of tangible personal property.

Why Public Law 86-272 applied

Public Law 86-272 restricts a state from imposing a net income tax on income from interstate commerce when the seller's only in-state business activity is qualifying solicitation of orders for tangible personal property, with the orders approved and filled from outside that state.

The ruling addressed two threshold questions:

1. Was commerce between Puerto Rico and the fifty states interstate commerce for this federal protection?

2. Should Puerto Rico be treated as a state for the protection?

FTB answered yes to both.

Puerto Rico as part of interstate commerce

The ruling reviewed Puerto Rico's change from Spanish territory to a United States territory and then to a self-governing commonwealth. It relied on federal cases applying the Commerce Clause and its dormant-commerce protections to commerce involving Puerto Rico.

From those authorities, FTB concluded that commerce between Puerto Rico and the fifty states was within Congress's power to regulate interstate commerce and was interstate commerce for Public Law 86-272.

Puerto Rico treated as a state

The meaning of "state" depended on the purpose of the federal statute. FTB reasoned that Congress enacted Public Law 86-272 to reduce uncertainty for businesses engaged in interstate commerce about when their activities exposed them to state net income tax.

Those concerns applied equally to commerce with Puerto Rico. Treating Puerto Rico as a state also fit the federal statute making generally applicable United States laws effective there and federal decisions treating the Commonwealth as a state in other statutory and constitutional contexts.

California sales-factor result

Revenue and Taxation Code section 25135(a)(2) generally assigned a sale to California when tangible personal property was shipped from California to another state and the seller was not taxable in that destination state.

Because Public Law 86-272 protected Corporation A from Puerto Rico net income tax on the stated solicitation-only activity, the seller was not treated as taxable there for this sales-factor rule. The Puerto Rico destination sales were therefore assigned to California.

Express limitation

The ruling limited its analysis to Puerto Rico because of the Commonwealth's unique status. It said the analysis had no effect on income from commerce between the fifty states and other United States possessions or territories.

What this means for you

Sellers shipping goods from California to Puerto Rico

Under the ruling's facts, solicitation-only activity in Puerto Rico triggered federal protection and California throwback. More extensive activities may change whether Public Law 86-272 applies.

Apportionment professionals

Destination-jurisdiction taxability and California sales-factor assignment were linked. Federal protection from the destination's net income tax caused the sales to return to the California numerator under the cited rule.

Businesses operating in other territories

Do not extend the ruling by analogy alone. FTB expressly declined to decide the treatment of other United States possessions or territories.

Common questions

Q: Did FTB treat Puerto Rico as a state under Public Law 86-272?

A: Yes, for purposes of the federal protection addressed in this ruling.

Q: Was commerce with Puerto Rico treated as interstate commerce?

A: Yes. The ruling concluded that commerce between Puerto Rico and the fifty states was interstate commerce for Public Law 86-272.

Q: Why could Puerto Rico not tax Corporation A's destination sales?

A: The corporation's Puerto Rico activity was limited to protected solicitation of orders for tangible personal property.

Q: Where were the sales assigned for California apportionment?

A: To California under Revenue and Taxation Code section 25135(a)(2).

Q: Did the ruling cover Guam, the U.S. Virgin Islands, or other territories?

A: No. It expressly limited its analysis to Puerto Rico and said it had no effect on other possessions or territories.

Citations and references

• 15 U.S.C. § 381 and following (Public Law 86-272)
• Cal. Rev. & Tax. Code § 25135(a)(2)
• Cal. Code Regs., tit. 18, § 25135(a)(6)
• 48 U.S.C. § 734
• U.S. Const. art. I, § 8; art. IV, § 3, cl. 3
• Examining Board of Engineers v. Otero (1976) 426 U.S. 572
• Trailer Marine Transport Corp. v. Vazquez (1st Cir. 1992) 977 F.2d 1
• Porto Rico Brokerage Co. v. United States (1st Cir. 1935) 76 F.2d 605
• Secretary of Agriculture v. Central Roig Refining Co. (1950) 338 U.S. 604
• Puerto Rico Telephone Co. v. FCC (1st Cir. 1977) 553 F.2d 694
• Cordova & Simonpietri Insurance v. Chase Manhattan Bank (1st Cir. 1981) 649 F.2d 36

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 1999-1

Original ruling text

Home

Legal ruling 1999-1

STATE OF CALIFORNIA
Franchise Tax Board - Legal Division
PO Box 1720
Rancho Cordova CA 95741-1720

916 845 3309

FAX: 916 845 3648

Kathleen Connell, Chair
Johan Klehs, Member
B. Timothy Gage, Member

January 6, 1999

Application of Public Law 86-272 (15 U.S.C. sections 381 et seq.) to Commerce between the Commonwealth of Puerto Rico and the Fifty States

Issue

Are sales of tangible personal property shipped from California into Puerto Rico considered California sales for purposes of the California sales factor if the seller’s activities in Puerto Rico are limited to solicitation of orders for the sale of tangible personal property?

Facts

Corporation A is a California corporation that manufactures products in California and sells them in Puerto Rico. Corporation A is taxable in Puerto Rico under U.S. Constitutional standards but its activities there are limited to solicitation of orders for the sale of tangible personal property. The products are shipped from California into Puerto Rico by common carrier.

Law

Public Law 86-272 (15 U.S.C. §381) states in pertinent part:

(a) No State, or political subdivision thereof, shall have the power to impose

. . . a net income tax on the income derived within such State by any person from interstate commerce if the only business activities within such State by or on behalf of such person during such taxable year are either, or both, of the following:

(1) the solicitation of orders by such person, or his representative, in such State for sales of tangible personal property, which orders are sent outside the State for approval or rejection, and, if approved, are filled by shipment or delivery from a point outside the State; . . . .

Analysis

Revenue and Taxation Code section 25135(a)(2) generally provides that a sale of tangible personal property is assigned to California for sales factor purposes if the property is shipped from this state to another state and the seller is not taxable in the destination state. If a seller is protected from taxation under Public Law 86-272 in the destination state, it is not considered taxable in that state. (See 18 Cal. Code of Reg. §25135(a)(6) and example thereunder.) If commerce between the fifty states and Puerto Rico is considered interstate commerce, and if Puerto Rico is considered a state for purposes of Public Law 86-272, the sales in question would satisfy the conditions for protection under Public Law 86-272. Thus, in order to resolve the issue presented, it must be determined whether commerce between Puerto Rico and the fifty states is considered interstate commerce, and whether Puerto Rico is considered a state for purposes of Public Law 86-272.

In 1899, Spain ceded Puerto Rico to the United States in the Treaty of Paris at the end of the Spanish-American War. As a territory, Puerto Rico was subject to Congress’ plenary authority under the territory clause of the Constitution (art. IV, sec. 3, cl. 3) to make all needful rules and regulations respecting the territory. (Examining Board of Engineers v. Otero (1976) 426 U.S. 572 [96 S.Ct. 2264, 49 L.Ed.2d 65, 76].) Over the next 51 years, the autonomy of Puerto Rico increased in stages under a series of acts governing its relationship with the federal government. (Trailer Marine Trans. Corp. v. Vazquez (1st Cir. 1992) 977 F.2d 1, 6-7.) In 1950, Congress enacted Public Law 600, in the nature of a compact, which was approved by the people of Puerto Rico in referendum in 1951.

Pursuant to Public Law 600, the people of Puerto Rico adopted a Constitution in 1952. Shortly thereafter, Congress approved the Constitution and repealed parts of the old Organic Act (the Jones Act of 1917, 39 Stat. 951) under which Puerto Rico had been governed since 1917. The remainder of the Organic Act was renamed the Puerto Rican Federal Relations Act ("FRA"), 48 U.S.C. sections 731 et seq. (Carbitow Corp. v. Occupational Safety & Health Comm’n. (1st. Cir. 1974) 493 F.2d 1064, 1065.) Among the provisions of the FRA, 48 U.S.C. section 734 states in pertinent part:

The statutory laws of the United States not locally inapplicable, . . . shall have the same force and effect in Puerto Rico as in the United States, . . . .

Under this arrangement Puerto Rico enjoys unique political status as a self-governing commonwealth under the auspices of the federal government. In many respects, however, its status resembles that of a state, i.e., "[B]oth have in common complete powers of local self-government." (Trailer Marine Trans. Corp. v. Vazquez, supra, 977 F.2d at p. 7, citing Magruder, The Commonwealth Status of Puerto Rico, (1953) 15 U.Pitt.L.Rev. 1, 19 (footnote omitted).)

Article 1, section 8 of the United States Constitution (the commerce clause) states in pertinent part:

The Congress shall have the power . . . To regulate Commerce with foreign Nations, and among the several States, . . . .

The primary purpose of the commerce clause is to foster economic integration and prevent local interference with the flow of the nation’s commerce. (H. P. Hood & Sons v. Du Mond (1949) 336 U.S. 525, 537-8 [69 S.Ct. 657, 664-65, 93 L.Ed. 865].) The domestic portion of the commerce clause concerns the effects of state regulation on the national economy. (Quill Corporation v. North Dakota (1992) 504 U.S. 298 [112 S.Ct. 1904, 119 L.Ed.2d 107].)

In addition to the express grant of congressional power in the commerce clause, the Supreme Court has interpreted a negative implication of the clause, which prohibits states from discriminating against interstate commerce (Philadelphia v. New Jersey (1978) 437 U.S. 617 [98 S.Ct. 2531, 57 L.Ed.2d 475]) or from regulating in such a way as to unduly burden interstate commerce. (Kassel v. Consolidated Freightways Corp. (1981) 450 U.S. 662 [101 S.Ct. 1309, 67 L.Ed.2d 580].) In 1959, Congress enacted Public Law 86-272, 15 U.S.C. sections 381 et seq., pursuant to its power to regulate interstate commerce.

Addressing first the issue of whether commerce with Puerto Rico is interstate commerce under Public Law 86-272, the courts have noted that commerce with Puerto Rico ceased being foreign commerce upon ratification of the Treaty of Paris in 1899. (Porto Rico Brokerage Co. v. United States (1st Cir. 1935) 76 F.2d 605, 609-610.) However, Congress has continued to regulate commerce between the states and Puerto Rico under the interstate portion of the commerce clause in several contexts. For example, in Secretary of Agriculture v. Central Roig Refining Co. (1950) 338 U.S. 604, 616 [70 S.Ct. 403, 409, 94 L.Ed. 381], the court held that the Sugar Act of 1948 applied to Puerto Rico through the commerce clause. In Puerto Rico Telephone Co. v. FCC (1st Cir. 1977) 553 F.2d 694, 701, the court held that Federal Communications Commission regulations applied through the commerce clause to a government-owned utility in Puerto Rico.

Restrictions upon the states imposed by the negative implication of the commerce clause also extend to Puerto Rico. In Trailer Marine Trans. Corp. v. Vazquez, supra, 977 F.2d. 1, 7-8, the court held that the rationale of the negative implication of the commerce clause (full economic integration into the national economy) applies with equal force to Puerto Rico, invalidating a transitory trailer fee on trailers temporarily in Puerto Rico because it impermissibly discriminated against interstate commerce. (See also, United Egg Producers v. Dept. of Agriculture (1st Cir. 1996) 715 F.2d 694, 698.) ["Although not a state, the Commonwealth of Puerto Rico is subject to the constraints of the dormant commerce clause to the same degree as the states."]) In other contexts, Puerto Rico has been prohibited from erecting an "intermediate boundary" separating itself from the rest of the country. (Torres v. Puerto Rico (1979) 442 U.S. 465, 472 [99 S.Ct. 2425, 2430, 61 L.Ed.2d 64].) For these reasons, commerce between the fifty states and Puerto Rico is within Congress’ authority to regulate interstate commerce; and thus, is interstate commerce for purposes of Public Law 86-272.

Analyzing whether Puerto Rico should be treated as a state for purposes of a particular federal statute depends on the aim and character of the statute under consideration. Words generally have different shades of meaning and are to be construed, if reasonably possible, to effectuate the intent of the lawmakers; and this meaning in particular instances is to be arrived at not only by a consideration of the words themselves, but by considering the purposes of the law, and the circumstances under which the words were employed. (Cordova & Simonpietri Ins. v. Chase Manhattan Bank (1st Cir. 1981) 649 F.2d 36, 38, citing Puerto Rico v. Shell Co. (1937) 302 U.S. at p. 258 [58 S.Ct. at p. 169].)

The intent of Congress in enacting Public Law 86-272 was to deal with the uncertainty encountered by businesses engaged in interstate commerce regarding the amount of contact necessary to support the imposition of state taxes based upon income. (Sen.Rep. No. 658, 86th Cong., 1st Sess., p. 2549 (1959).) Congress clearly intended that Public Law 86-272 apply only to interstate commerce, and not to foreign commerce. (Remarks of Senator Talmadge, 86 Cong.Rec. 16472 (1959).) This debate took place in the context of the previously cited cases holding that commerce with Puerto Rico ceased being foreign commerce upon ratification of the Treaty of Paris (Porto Rico Brokerage Co. v. United States, supra, 76 F.2d at 609-610), and upholding congressional regulation of commerce with Puerto Rico under the interstate commerce clause (Secretary of Agriculture v. Central Roig Refining Co., supra, 338 U.S. at 616). Thus, congressional concerns in enacting the statute have equal application to commerce between Puerto Rico and the fifty states. Its action is also consistent with the restrictions imposed upon Puerto Rico by the negative implication of the commerce clause, and in furthering the dual goals of fostering economic integration and preventing local interference with the flow of commerce. For these reasons, Puerto Rico should be considered a state for purposes of Public Law 86-272.

This analysis is consistent with decisions in numerous other contexts in which Puerto Rico has been held to be a state under federal law. For example, see Calero-Toledo v. Pearson Yacht Leasing Co. (1974) 416 U.S. 663, 670-675 [94 S.Ct. 2080, 40 L.Ed.2d 452] [Puerto Rico is a state for purposes of Three-Judge Court Act]; Tenoco Oil Co. v. Dept. of Consumer Affairs (1st Cir. 1989) 876 F.2d 1013, 1017, n.9 [defining Puerto Rico as a state for purposes of the takings clause of the Fifth Amendment]; Cordova & Simonpietri Ins. v. Chase Manhattan Bank, supra, 649 F.2d 36 [defining Puerto Rico as a state for purposes of the Sherman Antitrust Act]; First Federal Svgs. & Loan Assn. of Puerto Rico v. Ruiz de Jesus (1st Cir. 1981) 644 F.2d 910 [Puerto Rico is a state for purposes of the Federal Deposit Insurance Corporation]; and Ramirez v. Puerto Rico Fire Service (1st Cir. 1983) 715 F.2d 694 [Age Discrimination in Employment Act of 1967 applied to employees of the Commonwealth of Puerto Rico as state employees]. Considering Puerto Rico a state for purposes of Public Law 86-272 is also consistent with 48 U.S.C. section 734 of the FRA, supra, which mandates that the statutory laws of the United States not locally inapplicable shall have the same force and effect in Puerto Rico as in the United States.

In the words of the Supreme Court, "the purpose of Congress in the 1950 and 1952 legislation was to accord to Puerto Rico the degree of autonomy and independence normally associated with States of the Union . . .." (Examining Board of Engineers v. Otero, supra, 426 U.S. 572, 594.) These decisions and the resulting analysis comport with the tendency of the Federal government to increasingly treat Puerto Rico as a state under a variety of circumstances since the enactment of the FRA. ("I hereby direct all Federal departments, agencies, and officials, to the extent consistent with the Constitution and laws of the United States, henceforward to treat Puerto Rico administratively as if it were a State. . .." (Memorandum of President Bush, Nov. 30, 1992, 57 F.R. 57093, 48 U.S.C.A. section 734, supp. at p. 3.)

Accordingly, commerce between Puerto Rico and the fifty states is interstate commerce for purposes of Public Law 86-272, and Puerto Rico should be treated as a state for purposes of Revenue and Taxation Code section 25135.

Holding

Puerto Rico has no jurisdiction to tax Corporation A’s Puerto Rico destination sales because Corporation A’s activities there are limited to solicitation of orders for the sale of tangible personal property. Consequently, Corporation A’s Puerto Rico destination sales will be assigned to California for apportionment factor purposes pursuant to Revenue and Taxation Code section 25135(a)(2).

Because of the unique status of Puerto Rico as a commonwealth, the analysis of this ruling shall apply only to income derived from commerce between the fifty states and Puerto Rico, and shall have no effect on analysis of the taxability of income derived from commerce between the fifty states and other possessions or territories of the United States.

Drafting Information

The principal author of this ruling is Norman Scott of the Franchise Tax Board, Legal Branch. For further information regarding this ruling, contact Mr. Scott at P.O. Box 1720, Rancho Cordova, CA 95741-1720

Last updated: 09/24/2025