A number of states ask about Certificates of Authority on their sales and use tax registration forms and/or during their voluntary disclosure agreement (VDA) programs. While the potential need for a Certificate of Authority is certainly not new, it appears that some states have taken a more aggressive stance in ascertaining who should be registered and then holding firm on compliance in their efforts to identify additional revenues. As a result, we are seeing an increased number of questions about the topic. A frequent question that arises in one form or another is, “Do I really need to ask for ‘permission’ to do business?” The short answer, at least according to the states, is yes. However, the short answer may not be the right answer for you. Before addressing how you get to the “right” answer, let’s review some of the basic concepts underlying a Certificate of Authority. What is it? What is the process to procure it? What is the basic theory behind it? What are the potential ramifications of electing not to secure it? And, what are the costs associated with obtaining and maintaining a certificate? Then, with a better understanding of certificates, we’ll return to our central question.
What is a Certificate of Authority?
A Certificate of Authority to Transact Business is the proof that a state has granted you the authority to transact business within its borders. The process of asking for permission is usually called “foreign corporation qualification” or “foreign corporation registration.” It is called foreign corporation qualification because you are considered a domestic corporation in the state in which you are incorporated, and a foreign corporation everywhere else. Contrary to the somewhat common misconception, it has nothing to do with being from another country. The governmental agency that regulates the process is usually the Secretary of State. It is important to note that while we are mainly addressing corporations in this article, most states have the same requirements for the other types of business entities as well.
The process to obtain a certificate.
The process to obtain a Certificate of Authority is slightly different in every state. The majority of states require that you get a Certificate of Good Standing (COGS) or its equivalent from your state of incorporation. The certificates may or may not have to be certified depending on the state. Some states require certified copies of the Articles of Incorporation instead of the COGS.
Another requirement is checking for name availability. In other words, you need to find out if the name of your corporation as registered in your home state is available in the target state. If your name is not available, you will have to use an assumed name that is available. You will also need to find a registered agent. Each state has different rules on the guidelines for registered agents. A registered agent is your official representative in a state for purposes of receiving service of process and any official Secretary of State correspondence.
Once you have designated a registered agent, you will need to fill out your application and submit it to the state with the COGS and the application fee. State fees vary, but usually average around $100. There are companies that can assist with this process including Peisner Johnson & Company.
The theory behind Certificates of Authority.
The rationale the states have put forth for the requirement to obtain authority to do business is the need to protect domestic organizations from unfair competition. They also want to place domestic and foreign organizations on equal footing. The states’ ability to do so is apparently well settled and dates back to the 1869 U.S. Supreme Court Case of Paul v. Virginia, 75 U.S. 7 Wall. 168. In this case, the court found that “corporations are not citizens ... They are creatures of local law, and have not even an absolute right of recognition in other States, but depend for that and for the enforcement of their contracts upon the assent of those States, which may be given accordingly on such terms as they please.” It is specifically important to take notice of the language of the statement that refers to the enforcement of contracts.
The potential ramifications of electing not to obtain the Certificate of Authority.
The potential ramifications of electing not to obtain the Certificate of Authority vary by state, and each state usually has multiple ramifications. Perhaps the most serious ramification relates to a company’s ability to use the courts in that state to enforce their contracts, and the other ramification relates to potential assessments of fines and penalties. Many states will say that without their particular Certificate of Authority, you are prohibited from using the state court system. Some states go a step further and say that contracts you have entered into are invalid and unenforceable. Most states also have civil fines and or penalties, and a few have criminal fines and penalties. Some states cap the dollar amounts of these, but a large number do not. We have seen some fines and penalties add up to the $50,000 - $75,000 range. This can be a serious issue.
The downside of obtaining a Certificate of Authority.
After hearing the negatives of not getting a certificate, you may ask if there are any downsides of compliance, and the answer is yes. The most obvious downside of obtaining certificates is the costs associated with doing so and their maintenance. Once you have your Certificate of Authority, you will need to renew it annually in most cases. The renewal process usually consists of filing an annual report and paying a fee.
Also, the holding of a certificate in and of itself could be a nexus creating event in some states and could subject you to other taxes; most notably income and franchise taxes.
Do I really need to ask for “permission” to do business?
Again, the short answer to the permission to do business question, at least according to the states, is yes. The long answer, however, takes into consideration that each state defines “doing business” -- or as some call it, “transacting business” -- differently. The problem is that those definitions sound more like, “I’ll know it when I see it,” rather than a true definition. To the best of my knowledge, no state publishes a list of activities that are considered doing business for purposes of requiring a Certificate of Authority. Some states have a very limited list of activities that are not considered doing business. Most often, the only guidance that most states will give you is that you should consult with your attorney about your activities and whether they constitute doing business in the state.
In summation, the answer to the question is: it depends. If a state determines that your activities fit their interpretation of doing business, then their answer would be yes. We do not intend to take on the role of your attorney, nor can we state whether or not your activities definitely cross the threshold. But we do believe, given the downsides of failing to obtain a Certificate of Authority when when one was required, that a conservative approach may be desirable. Many clients of ours after considering the possible downsides, decided to err on the side of caution and tend to get registered in their larger states. But, by all means, do feel free to check with your attorney.