Different Nexus Standards • Due Process Standard • Different standard of substantial nexus than under the Commerce Clause • See Comptroller of the Treasury of Maryland v. Wynne , 135 S.Ct. 1787, 1798- 1799, (2015) (“the fact that a State has the jurisdictional power to impose a tax says nothing about whether that tax violates the Commerce Clause”). • May be an economic presence standard. • But still need to establish that activities are directed to the taxing state. • See J. McIntyre Machinery Ltd. v. Nicastro , 131 S.Ct. 2780 (2011)(activities in destination state that are intended to invoke or benefit from the protection of the state) 16
States’ Adoption of Factor Presence • Gross Receipts Tax • Ohio CAT: Ohio Revised Code, 5751.02 • Sales threshold is $500,000 • 2oo6: Texas margin tax: Texas Tax Code Section 171.0011 • No sales threshold in TX if national sales greater than $1 million • The hole in the dike: 2015 Legislation • Washington B&O Tax: Wash. Rev. Code Ann. Sections 82.04.220 et seq. (S.B. 6138, adopted 7/2/15) • Threshold is $267,000 for wholesale sales and sales of services 17
States’ Adoption of Factor Presence • Gross Receipts Tax 2015 legislation • Nevada Commerce Tax: Nevada Senate Bill No. 483, adopted 7/1/15, 32 Revenue and Taxation Code, Section 363C.200 • Threshold is $4,000,000 of NV sales • Income tax and gross receipts tax-2015 • Tennessee Business Tax: Tennessee House Bill 644, codified in TN Code Sections 67-4-717 and 67-4-2004 • Threshold is same as MTC Factor Presence test. 18
States’ Adoption of Factor Presence • Income tax • CA was one of the first state to adopt factor presence test for income tax • Adopted in 2011 and codified in Cal. Rev. & Tax Code Section 23101 • Adopted MTC Factor Presence Test and permits adjustment for inflation. • See also AL, CO, CT, MI, and NY discussed on Slide 27 • Sales tax (Based on sales alone and subject to challenge): • South Dakota: Senate Bill 106, which amended S.D. Codified Laws § 10-45 and 10-52, effective May 1, 2016 • Alabama: Sales and use Tax Rule Number 810-6-2-.90.03 19
States’ Adoption of Factor Presence • Sales tax: Pure mailing of catalogs into state or distribution of materials on the Internet • See e.g. CT General Statutes § 12-407(15) adopted post- Quill • See statutes adopted pre- Quill , including North Dakota • Sales tax (Affiliates, Click through and Reporting Nexus statutes) • Establish tax collection and reporting obligations without a pure physical presence of employees, agents/representatives or property 20
21
Challenges • All based on Substantial Nexus under Commerce Clause • Ohio Supreme Court CAT cases : Newegg, Inc. v. Joseph W. Testa, Tax Commissioner of Ohio (2015); Crutchfield, Inc. v. Joseph W. Testa, Tax Commissioner of Ohio (2015); and Mason Companies, Inc. v. Joseph W. Testa, Tax Commissioner of Ohio (2015). • AL and SD sales tax cases • Various state income tax cases 22
Special Issues Regarding Services • Critical question: Does service provided from outside the state where the user is located of the benefit is received satisfy the Commerce Clause Transactional Nexus Requirements and the Due Process Test of Substantial Nexus • This is an emerging issue for providers of services, including cloud services and digital goods. • How does the provider know where the benefit of the service is received and the digital good is received ? 23
Challenges To Factor Presence Nexus Laws Matthew P. Schaefer, Brann & Isaacson mschaefer@brannlaw.com Edward Bernert, BakerHostetler ebernert@bakerlaw.com 24
Economic Nexus for State Income Tax Matthew P. Schaefer, Brann & Isaacson mschaefer@brannlaw.com 25
Economic Nexus for State Income Tax • State courts have generally held that physical presence is not required for state corporate income taxes. • A number of States have adopted “factor presence” thresholds for sales, property and payroll that define when a company is required to report income tax in the jurisdiction, regardless of whether the company has any physical presence in the state. • Public Law 86-272 (appearing at 15 U.S.C. § 381) still applies, however, when determining whether an out- of-state retailer is required to report state income tax. 26
Income Tax: State Court Litigation • Underlying the adoption of “factor presence” standards, including a principle that a minimum level of sales attributable to a state is a proper basis on which a State may require a non-domiciliary company to report corporate income taxes, is the premise that a physical presence in the State is not required for purposes of corporate income taxes. • One of the earliest cases to endorse this principle was Geoffrey v. South Carolina Tax Commission , 437 S.E.2d 13 (S.C. 1993). • The issue in Geoffrey was whether an out-of-state trademark holding company that licensed trademarks to an in-state affiliate and received royalties based on use of the marks by the affiliate in the state, but had no physical presence there, was subject to state income tax. • The Court held that the company had sufficient minimum contacts with South Carolina for purposes of Due Process, because it purposefully directed its activities at the State by licensing marks for use there. • In addition, the Court held that the Commerce Clause did not require that the company have a physical presence in the state, and that the presence of intangible property was alone sufficient to establish nexus. 27
Income Tax: State Court Litigation (cont.) • Although the South Carolina Supreme Court in Geoffrey suggested that it was “well settled” that a taxpayer need not have a physical presence in a jurisdiction to be subject to state income tax, the authority cited by the Court for this assertion was very limited. • The Court primarily cited a New Mexico Court of Appeals decision, American Dairy Queen Corp. v. Taxation & Revenue Dep’t , 605 P.2d 251 (1979), which contained no analysis and only supported the concept that having intangible property used by the third-party to generate income in a state might be a sufficient basis for imposing income tax. • The South Carolina Supreme Court also cited the U.S. Supreme Court’s decision in International Harvester Co. v. Wisconsin Dep’t of Taxation , 322 U.S. 435 (1944), but an overly board reading of International Harvester was recently rejected by the Ohio Supreme Court in Corrigan v. Testa , 2016-Ohio-2805. 28
Income Tax: State Court Litigation (cont.) • Geoffrey nonetheless spawned a series of cases, particularly in the area of intangible property rights such as trademarks, in which state supreme courts held that a physical presence in the state is not required for purposes of state income taxes. • One more recent such case is KFC Corp. v. Iowa Dep’t of Revenue , 792 N.W.2d 308 (Iowa 2010). • KFC licensed its trademarks to franchisees for use in the State. • The Court undertook to predict how the U.S. Supreme Court would treat the licensing of intangibles to a third-party in the state as a basis for nexus, and concluded that their use in the state by franchises would be regarded as the “functional equivalent” of a physical presence. • The Court further found that the Quill physical presence test should not be “extended” to cases concerning state income taxes. • The Court thus held that “a physical presence is not required under the dormant Commerce Clause of the United States Constitution in order for the Iowa legislature to impose an income tax on revenue earned by an out-of-state corporation arising from the use of its intangibles by franchisees located within the State.” 29
Income Tax: State Court Litigation (cont.) • Another line of cases derived from Geoffrey involves financial institutions, such as banks and credit card companies, that lack a physical presence but offer services to customers in the State. • A leading decision in this line of cases is the West Virginia Supreme Court’s decision in Tax Commissioner v. MBNA America Bank, N.A. , 640 S.E.2d 226 (W.Va. 2006). • MBNA had no real or tangible personal property and no employees located in West Virginia but issued credit cards to customers in the state and realized millions of dollars of income attributable to their accounts. MBNA promoted its business in West Virginia via mail and telephone solicitation. • The West Virginia Supreme Court held that the Quill physical presence standard does not apply to state corporate income taxes and concluded that a “significant economic presence test” is a “better indicator of whether substantial nexus exists for Commerce Clause purposes.” • The decision in MBNA elicited a strong dissent from Justice Benjamin: “There is no precedential support whatsoever for the conclusions reached by the majority decision. None. None at the state level. None at the federal level.” 30
Income Tax: State Court Litigation (cont.) • In recent years, state courts have pulled back somewhat from the very expansive jurisdictional principles of Geoffrey, KFC, and MBNA. • In Griffith v. ConAgra Brands, Inc. , 728 S.E.2d 74 (2012), the West Virginia Supreme Court distinguished Geoffrey, KFC and MBNA in holding that an out-of-state company was not subject to West Virginia income tax merely because products bearing its trademarks were sold in the state. • In Scioto Ins. Co. v. Oklahoma Tax Comm’n , 279 P.3d 782 (Okla. 2012), the Oklahoma Supreme Court rejected the application of the state’s corporate income tax to an out-of- state company, finding that “due process is offended by Oklahoma’s attempt to tax an out of state corporation that has no contact with Oklahoma other than receiving payments from an Oklahoma taxpayer” under a contract not made in the state. • The federal bankruptcy court determined In re Washington Mut., Inc. , 485 B.R. 510 (Bankr.D.Del. 2012), that the Oregon corporate income tax did not apply to a company receiving payments of dividends on intellectual property used in the state. 31
Income Tax: State Statutory Gross Receipts Thresholds • Geoffrey and its progeny laid the groundwork for the Multi-State Tax Commission’s Factor Presence Nexus Standard for Business Activity Taxes. • As it relates to so- called “economic presence” or “economic nexus,” the most significant factor presence standard is a fixed level of “sales” or “gross receipts” that is deemed sufficient for nexus. • The property and payroll factors, by contrast, apply only where a company has a physical presence. • Sales or gross receipts require only that an out-of-state company have customers in the jurisdiction. • A number of states have adopted a sales or gross receipts threshold for corporate net income tax pursuant to which a company is deemed to be engaged in business in the state, and required to report corporate net income taxes, merely by virtue of having a minimum level of sales to customers in the jurisdiction. • Many other states — by far the majority based on informal surveys — purport to require state income tax reporting based on a “economic presence” theory of substantial nexus. 32
Income Tax: Statutory Gross Receipts Thresholds (cont.) • States with “factor presence” gross receipts threshold for corporate net income tax include: • Alabama Income Tax: $500,000 (eff. Dec. 1, 2014) • California Franchise (Income) Tax: $536,446 (currently) (eff. Jan. 1, 2011) • Colorado Income Tax: $500,000 (eff. April 30, 2010) • Connecticut Corporation Business Tax: $500,000 (eff. Jan. 1, 2010) (Note: threshold is framed in the negative – less than $500,000 in receipts does not constitute a substantial economic presence) • Michigan Corporate Income tax: $350,000 (eff. Jan 1, 2012) • New York Franchise (Income) Tax: $1,000,000 (eff. Jan. 1, 2015) • Tennessee Excise (Income) Tax: $500,000 (eff. Jan. 1, 2016) • There has been no significant reported court decision challenging the constitutionality of a “factor presence” sales threshold for corporate net income tax purposes. 33
Income Tax: PL 86-272 Applies to Factor Presence Laws • One reason for the absence of any significant court challenge may be that federal Public Law 86-272 (appearing at 15 U.S.C. § 381), continues to apply to limit the authority of a state to require corporate net income tax reporting by non- domiciliary companies. • P.L. 86-272 provides that a state lacks the authority to impose a net income tax on a person if the only business activities within such state by or on behalf of such a person during the taxable year are • 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 of the State. • The U.S Supreme Court has held that the statute also protects activities that are entirely “ancillary” to the solicitation of orders for tangible personal property. Wisconsin Dep’t of Revenue v William Wrigley, Jr ., 505 U.S. 214 (1992). 34
Income Tax: PL 86-272 Applies to Factor Presence (cont.) • Many remote sellers qualify for the protection of PL 86-272, and so are not made subject to corporate income tax reporting obligations as a result of merely having customers in the state and making sales over the minimum sales threshold. • A company that relies on PL 86-272 should always be vigilant with regard to ensuring that its activities do not void the immunity from state income tax under PL 86- 272 immunity, even without “factor presence” nexus standards in play. • State revenue departments may be more aggressive in their enforcement of corporate net income tax reporting obligations with a “factor presence” standard as a ready basis for asserting liability for income tax. • At the same time, company with limited sales in a state may have a new argument, despite in-state activity beyond the protection of PL 86-272, that it is not subject to income taxes because its sales fall below the statutory threshold, depending upon the specific provisions of state law. 35
Ohio Commercial Activity Tax Edward Bernert, BakerHostetler ebernert@bakerlaw.com 36 36
Ohio Commercial Activity Tax The Ohio General Assembly understood that the factor nexus test of the Ohio CAT was an aggressive expansion of claimed nexus. R.C. 5751.31 permitted the Ohio Tax Commissioner to issue a final determination on the application of the bright line and designate the appeal as one that would be made directly to the Ohio Supreme Court. No such final determination has been issued. 37 37
Ohio Commercial Activity Tax More than 11 years after the CAT was enacted, still no meaningful authority for whether the bright line statute is enforceable. The Ohio Board of Tax Appeals has issued decisions but that agency lacks authority to address Constitutional issues. LL Bean case was thought to be the test case but it settled. 38 38
Ohio Commercial Activity Tax Three cases are before the Ohio Supreme Court that squarely address the constitutionality of the bright line test. Crutchfield Corp. v. Testa, Case No. 2015-0386 Newegg Inc. v. Testa , Case No. 2015-0483 Mason Cos., Inc. v. Testa, Case No. 2015-0794 Full disclosure: the presenters for this session represent the taxpayers. All three companies are classic remote sellers with no in-state presence. 39 39
Ohio Commercial Activity Tax The principal issue is whether the bright line test and the reliance solely on the presence of $500,000 of gross receipts in the state violates the Commerce Clause when the remote sellers do not have physical presence in Ohio. Tyler Pipe Industries v. Washington State Dept. of Revenue, 483 U.S. 232 (1987) and other Supreme Court decisions support the remote sellers’ position. The Tax Commissioner argued that income tax decisions from other states stand for the proposition that the physical presence standard should not be “extended” to taxes other than use taxes. 40 40
Ohio Commercial Activity Tax The remote sellers responded that the U.S. Supreme Court has never found nexus for any tax purposes absent in-state physical presence. In any case, for gross receipts tax like the CAT, the Tyler Pipe decision reflects substantial in-state presence and the establishment and maintenance of an in-state market as the controlling standard. If Ohio can impose the CAT under these circumstances, then so could not only other states but cities and other localities as well. 41 41
Ohio Commercial Activity Tax The Tax Commissioner also argued that “cookies” on the customers’ computers and some “harvesting” of data said to occur created a virtual presence that could support taxation. A number of organizations representing the states and taxpayers respectively filed amici briefs. The cases have been fully submitted. The cases should be decided by the end of 2016. 42 42
Sales Tax: South Dakota And Alabama Litigation Matthew P. Schaefer, Brann & Isaacson mschaefer@brannlaw.com 43
Sales Tax Challenges: South Dakota Litigation • In March 2016, the South Dakota legislature passed, and Governed Dennis Daugaard signed into law, Senate Bill 106, “An Act to provide for the collection of sales taxes from certain remote sellers” (“S.B. 106”). • The Act on its face requires any retailer that sells tangible personal property, products transferred electronically, or services for delivery into South Dakota, and that does not have a physical presence in the state, to collect South Dakota sales taxes if, during the current or previous calendar year either: • The seller’s gross revenue from the sale of tangible personal property, any product transferred electronically, or services delivered into South Dakota exceeds $100,000; or • The seller sold tangible personal property, any product transferred electronically, or services for delivery into South Dakota in 200 or more separate transactions. S.B. 106, § 1. 44
Sales Tax Challenges: South Dakota Litigation (cont.) • In enacting the statute, the South Dakota legislature acknowledged that the sales tax collection obligations of S.B. 106 are unconstitutional under existing Supreme Court precedent, i.e., Quill . • The legislative findings for S.B. 106 expressly state that: • established constitutional doctrine “prevents states from requiring remote sellers to collect sales tax;” • the U.S. Supreme Court’s substantial nexus doctrine would need to be changed “to permit the collection obligations of this Act;” and • “a decision from the Supreme Court of the United States abrogating its existing doctrine” would be necessary for S.B. 106 to be enforced. S.B.106 , § 8(7), (10), (11). • The intent of the South Dakota legislature was to create a court case that might allow the Supreme Court to reconsider the Quill physical presence doctrine. 45
Sales Tax Challenges: South Dakota Litigation (cont.) • The South Dakota legislature thus authorized the State to bring a declaratory judgment action in state court against any person the State believes meets the gross revenue or transaction thresholds of S.B.106, in order to “establish that the obligation to remit sales tax is applicable and valid under state and federal law.” • When filed, the suit by the State acts as an automatic injunction against enforcement of the law by the State as to any retailer that does not voluntarily register to collect South Dakota sales tax. • By the Act’s express terms, the obligation to report sales tax under S.B. 106 cannot be applied by the State retroactively. • In addition, the obligation only applies on a going forward basis once the injunction triggered by a suit is dissolved. • The statute directs the South Dakota courts to act on the suit as expeditiously as possible and to give the suit priority over all other actions presenting the same issue in any other venue. 46
Sales Tax Challenges: South Dakota Litigation (cont.) • In April 2016, two parallel suits were filed in South Dakota state circuit court. • State of South Dakota v. Wayfair Inc. et al. • State initiated suit against four retailers, including Wayfair, Overstock.com and Newegg. • State requested declaration that the requirements of S.B. 106 are valid as applied to the defendant retailers. • State again acknowledged that S.B. 106 is at odds with existing constitutional doctrine and that a ruling in its favor “will require the abrogation of the United States Supreme Court’s decision in Quill Corp. v. North Dakota , 504 U.S. 298 (1992).” Defendants removed the case to federal court . • 47
Sales Tax Challenges: South Dakota Litigation (cont.) • Second suit • American Catalog Mailers Association and NetChoice v. Gerlac h. • Two trade associations representing remote catalog and Internet sellers filed suit against the South Dakota Secretary of Revenue to prevent enforcement of S.B.106. • Associations sought a declaration that the sales tax reporting obligations of S.B. 106 are unconstitutional under both the Commerce Clause and the Due Process Clause. • The Secretary has answered contesting both jurisdiction and the standing of the plaintiff associations. • Brann & Isaacson represents the retailers and trade associations in these suits. 48
Sales Tax Challenges: South Dakota Litigation (cont.) • State v. Wayfair et al. — now pending in federal court. • In May 2016, the defendant retailers removed the case to the federal District Court for the District of South Dakota. • On July 22, 2016, the State filed a motion to remand the case to state court. • Defendant retailers have requested judgment in their favor in federal court. • Also on July 22, the retailers filed a motion for summary judgment, arguing that: • The requirements of S.B.106 violate the physical presence standard of substantial nexus under the Commerce Clause, as reaffirmed in Quill ; • The gross revenue and transaction thresholds of S.B. 106 would lead to effectively unlimited state taxing jurisdiction; and • S.B.106 would usurp the role of Congress in regulating interstate commerce under the Commerce Clause. • Briefing on both motions will be completed on August 26, 2016. 49
Sales Tax Challenges: Alabama Litigation • In September 2015, Department of Revenue promulgated DOR Rule 810-6-2-.90- .03, which took effect January 1, 2016. • The Rule applies to out-of- state sellers “who lack an Alabama physical presence but who are making retail sales of tangible personal property into the state.” • Under the Rule, an out-of-state seller is subject to Alabama sales and use tax collection obligations without regard to any physical presence in the State, if the seller: • makes at least $250,000 in sales to Alabama customers; and • engages in one or more of the activities which, by statute, purport to require tax reporting in the state under Ala. Code § 40-23-68(b). • The Rule followed the enactment of the so- called “Simplified Sellers Use Tax Remittance Act,” Ala. Code. § 40-23-191 et seq. , which allows sellers that have no physical presence in Alabama to collect and remit a flat 8% sales tax on all sales into Alabama, rather than the combined state and local tax. 50
Sales Tax Challenges: Alabama Litigation (c0nt.) • Newegg, Inc. v. Department of Revenue (Alabama Tax Tribunal Docket No. S 16-613) • In March 2016, the Alabama Department of Revenue sent sales tax assessments to a number of companies it believed were subject to the $250,000 sales threshold. • In June 2016, Newegg filed an appeal with the Alabama Tax Tribunal. • Newegg contends that: • it is not subject to Alabama sales tax reporting requirements because it lacks a physical presence in the state; and • DOR Rule 810-6-2-.90-.03 is inconsistent with the requirements of both the United States Constitution and Alabama law. • Department of Revenue obtained an extension to respond and has not yet filed an answer. • Brann & Isaacson represents Newegg in the appeal. 51
Sales Tax Challenges: The Next Alabama? • Tennessee: Proposed Rule1320-05-01-.129 • On June 16, 2016, the Tennessee Department of Revenue issued a proposed new sales tax regulation that would require out-of-state sellers with more than $500,000 in sales to customers in Tennessee to collect sales tax. • No physical presence is required — a retailer must only “engage in the regular or systematic solicitation of consumers in this state through any means” and meet the $500,000 sales threshold. • The regulation would require out-of-state retailers to commence collecting Tennessee sales tax by June 1, 2017. • A public hearing on the proposed Rule is scheduled for August 8, 2016. • If the rule is approved by the Department of Revenue, it is still subject to be review by the Tennessee Attorney General, who must be satisfied that the regulation is consistent with constitutional requirements. 52
Sales Tax Challenges: The Next South Dakota? • Vermont’s New Economic Nexus Law • In May 2016, Vermont enacted HB 873, copying South Dakota’s “economic nexus” provisions. • The law requires sales tax collection by retailers “not maintaining a place of business or other physical presence in this State,” who sell tangible personal property via remote means (i.e., catalogs, Internet, in-state advertising, etc.) and have made sales in the state during any preceding 12-month period of at least $100,000 or in at least 200 individual sales transactions. • Vermont’s new law, however, only becomes effective if the Quill physical presence standard is overruled. • The statute provides that new thresholds “shall take effect on the later of July 1, 2017 or beginning on the first day of the first quarter after a controlling court decision or federal legislation abrogates the physical presence requirement of Quill v. North Dakota , 504 U.S. 298 (1992).” 53
Sales Tax Challenges: SD and AL Takeaways • Both cases present the constitutionality of pure “economic nexus” standards for state sales tax collection. • South Dakota’s statute would require only that a retailer or service provider have customers in the state, with whom the retailer or service provider communicates via mail or the Internet. • Alabama’s Rule technically requires that a retailer also satisfy one of a number of statutory standards for reporting sales tax, many of which require physical presence, but some of which require only the solicitation of orders or the distribution of catalogs in the state. • Both cases remain months or years away from being presented to the U.S. Supreme Court for review. • The federal District Court in South Dakota may issue a ruling on the merits later this year, setting up a possible appeal to the Eighth Circuit Court of Appeals in late 2016 or early 2017. • South Dakota officials, however, have raised procedural/jurisdictional issues in both the federal court ( State v. Wayfair et al. ) and state court ( ACMA and NetChoice v. Gerlach ). • Alabama DOR has not yet answered Newegg’s appeal; case must proceed from Tax Tribunal through the state court system. 54
Other Nexus-Related Issues Edward Bernert, BakerHostetler ebernert@bakerlaw.com Matthew P. Schaefer, Brann & Isaacson mschaefer@brannlaw.com Martin Eisenstein, Brann & Isaacson meisenstein@brannlaw.com 55
Nexus Issues As To Services Edward Bernert, BakerHostetler ebernert@bakerlaw.com 56 56
Nexus Issues as to Services Factor presence raises additional concerns when the seller is providing services. Assigning services to the states Gross Receipts Taxes: Sales of services must be apportioned where the service is performed. Central Greyhound Lines, Inc. v. Mealey, 334 U.S. 653 (1948). 57 57
Services A gross receipts tax for the transportation of goods that began in New York and ended in New York but involved travel outside that state had to be apportioned outside New York to the extent that part of the transportation service was performed outside New York. 58 58
Services Sales and Use Taxes: A different rule applies for sales and use tax. One state can impose a tax on the entire cost of the service conducted in multiple states. Oklahoma Tax Commission v. Jefferson Lines, Inc. 514 U.S. 175 (1995). ⁻ Per Jefferson Lines, one state can tax the entire price of the bus ticket when the ticket was purchased in-state but the scheduled route crossed state lines. ⁻ While a gross receipts tax on a service must be apportioned among the states in which the service is performed, the sales tax could be charged in full by one state on the total purchase price. 59 59
Services ⁻ Even for sales tax nexus, the performance of the services in the state is the basis justifying the tax. ⁻ The taxable event in Jefferson Lines was “agreement, payment and some of the services in the taxing state.” 514 U.S. at 176 (Emphasis added). ⁻ In Jefferson Lines, Oklahoma argued that the purchase of the ticket was sufficient for Oklahoma to impose tax on the entire transaction. Justice Souter, writing for the Court, however, did not embrace that argument and conditioned the tax on the finding that some part of the service was performed in the state and the other contacts with the state such as agreement and payment tied the transaction to that state. 60 60
Services ⁻ The Court in Jefferson Lines distinguished and did not overrule Central Greyhound — the requirement that non-sales taxes, such as gross receipts tax, must be apportioned remains the law. Earlier, the Supreme Court upheld a telecommunications tax (similar to a sales tax) on interstate calls when the call either originated or terminated in the state and when the call was billed to a service address in the state. Goldberg v. Sweet, 488 U.S. 252 (1989). Justice Marshall, writing for the Court, questioned whether the telecommunication service could have been taxed by a state when the only contact with the transaction was the receipt (termination) of that call. 61 61
Services Taxing interstate sales When the service is performed in one state (State A) and the benefit is enjoyed in another state (State B), arguably only State A can tax the transaction. Consider services performed in-state when tangible personal property associated with the service is delivered out-of-state. ⁻ An example is an item that is repaired, when the repaired item is then delivered out of-state. 62 62
Services ⁻ Reported cases support a conclusion that a tax may be imposed on the providing of the service by the state in which the service is performed despite the delivery of the tangible item out-of-state. ⁻ Indiana was permitted to tax the enameling of products for shipment out-of-state when it was the service being taxed. Department of Treasury of Indiana v. Ingram- Richardson Manufacturing Co. of Indiana, Inc., 313 U.S. 252 (1940). 63 63
Services ⁻ Recently, the Florida Supreme Court upheld sales tax on Florida florists, when the Florida florist accepted orders and had the flowers delivered outside Florida. The Court found that the transaction occurred in Florida where the florist advertised for customers, accepted orders and transmitted the orders to third-party florists. Florida Department of Revenue v. American Business USA Corp.¸ Supreme Court of Florida, No. SC14-2404, May 26, 2016. 64 64
Services There are cases that permit a state to tax a service performed wholly outside the state. In Western Wireless Corp. v. Sioux Falls Cellular Communications Company, 665 N.W. 2d 73 (2003); cert denied, U.S. Case No. 03-59, a use tax was imposed on the billing service that was performed out-of-state. – The cellular company recorded the cellular activity of South Dakota customers on equipment located in South Dakota. The telecommunications company sent the recorded information to the out-of-state billing company, which used the recorded information to generate bills in electronic form that were sent to a subcontractor in California where the invoices were printed and then mailed from California to South Dakota . 65 65
Services ⁻ The South Dakota Court upheld the tax and found a connection with the state presumably based on the location of the equipment in South Dakota used in recording the information, the receipt of the tangible bills in South Dakota and the use of the bills in the conduct of the in-state telecommunications service. ⁻ The taxpayer sought review by the U.S. Supreme Court, which refused to accept certiorari. 66 66
Services ⁻ The Western Wireless decision relies on the activities in South Dakota of the customer and not the service provider to claim nexus over the transaction although the provider of the service — the electronic billing service company — performed none of the service in South Dakota and was not responsible for the collection of data by Western Wireless or the mailing of the paper bills by another contractor to South Dakota residents. 67 67
Services Central Trust Company v. Limbach , Ohio BTA Case No. 90-Z- 1644 and 90-Z-524 (two cases), May 7, 1993, held that computer training conducted in New York is taxable in Ohio when attendee returns to Ohio and “uses” the training in Ohio. 68 68
Services The need for transactional nexus When imposing taxes on services provided across state lines, the case law requires that there be nexus over the transaction and not just the actor. Allied-Signal, Inc. v. Div. of Taxation, 504 U.S. 766 (1992). Due Process requires that there be a rational relationship between the tax and the thing being taxed. In Norfolk & Western Railway Co. v. State Tax Commission , 390 U.S. 317 (1968), the U.S. Supreme Court found that a state may not tax tangible or intangible property “ unconnected” to the state. 69 69
Services – In Norfolk & Western , the taxpayer showed that Missouri’s property tax formula was improperly subjecting the value of railcars that were in Virginia to Missouri tax and struck down the formula in that case as not being rationally related and lacking a connection between the state and the railcars. A service should not be subject to tax even when the customer or the service provider has nexus with the state when the service itself has no connection to the taxing state 70 70
Services Different nexus issues exist for different taxes Subjecting interstate services to business taxes such as income and gross receipts taxes poses different questions than subjecting services to sales or use tax. These differences are in addition to the issue described elsewhere in this outline that a state cannot require a seller to collect use tax unless the seller has a physical presence in the state while the physical presence requirement is challenged by some states as inapplicable to taxes other than use tax. 71 71
Services Other Nexus-related issues for sellers of service that vary by tax Credit for tax paid. ⁻ The state in which the service is performed certainly can subject that service to use tax. The fact that the destination state asserts a use tax may nevertheless not result in double taxation because states customarily provide a credit when sales and use tax has already been paid to another state on the transaction. ⁻ If the state where the service is performed charges sales or use tax , then the customer’s state may accept the credit and not impose the use tax a second time. 72 72
Services ⁻ For gross receipts and corporate income taxes, however, no such credits are customary. The real possibility of double taxation arises especially when states use inconsistent methods of sourcing sales. See below. Use in-state. ⁻ In the Western Wireless and the Central Trust cases described above, the state’s argument seemed to be that the purchaser was using the service in the separate business being conducted by the purchaser in the state. The position reflects the nature of the use tax as being imposed on the purchaser. 73 73
Services – In the case of a gross receipts or income tax, however, the taxpayer is the one providing the service and not the purchaser of the service. – The activities of the purchaser are not properly attributed to the provider of the service. – Unless part of the service is performed in the state, arguably there is no connection between the service and the state to warrant a tax on the service provider. 74 74
Services Sellers of services may not know the location of the customer’s receipt or benefit from the service. The service provider may not know where the service is received or the benefit of the service is realized by the customer. ⁻ No requirement exists that the service provider needs to know where the customer receives or benefits from the service, especially when no tangible personal property is transferred in conjunction with the service. 75 75
Services In Town Fair Tire Centers, Inc. v. Massachusetts Commissioner of Revenue, Massachusetts Supreme Judicial Court, No. SJ. 10360, August 25, 2009, the Commissioner had demanded that a tire dealer with a physical presence in Massachusetts be required to collect Massachusetts use tax on transactions wholly conducted at tire stores in New Hampshire (a state with no sales tax) when the taxpayer was charged with “knowing” that the motor vehicles were destined to return to Massachusetts. 76 76
Services ⁻ The Commissioner of Revenue focused on the fact that customers were identified as possessing Massachusetts addresses and the motor vehicles on which the tires were mounted reflected Massachusetts license plates and inspection stickers. ⁻ The taxpayer had collected tax on sales made in Massachusetts but not on the sales made in its New Hampshire locations. ⁻ The Massachusetts Supreme Judicial Court on appeal applied state law and found an absence of a legal presumption that the tires would be used in Massachusetts despite the fact that the tires were installed on automobiles registered in Massachusetts . 77 77
Services It is unresolved whether the state identified through the customer’s address can require the seller to collect use tax or pay the destination state’s income or gross receipts tax based solely on the address of the customer being in that state. The prospects for conflicts in sourcing services among the states are very real State statutes source services in distinct ways: • Place where the service is performed; • Where the majority of the costs of performance are incurred; 78 78
Services • Where the benefit is received; • Where the service is received; • Where the service is delivered; and • Where the customer is located. Thus, even among states that use market-based sourcing, it is difficult to determine the extent to which these tests overlap. 79 79
Services Mediation ⁻ The American Bar Association, State and Local Tax Committee has recommended to the Multistate Tax Commission (MTC) that taxpayers that are subjected to different sourcing methodologies on their transactions be permitted to request non-binding mediation to resolve the conflict. ⁻ Unfortunately, it does not appear that the proposal will be accepted by the MTC. 80 80
Services Planning considerations – Companies selling tangible personal property can qualify for protection under P.L. 86-272, which is a federal statute (15 U.S.C. §§381-384) that prohibits states from imposing net income tax on remote sellers: • that limit activities within the state to solicitation; • when the sale is approved from outside the state; and • when the product is shipped from outside the state. 81 81
Services P.L. 86-272 protection is not available to remote sellers providing services. Accordingly, companies must focus on how the product is being classified — sale of tangible personal property or service. The classification in distinguishing between selling tangible personal property and services also impacts how the thing is sourced. 82 82
Services Thus, companies should focus on how the invoices and agreements describe the thing being provided and the impact on the classification of the thing as tangible personal property or a service. When providing services potentially subject to use tax for the customer in various states, obtain and retain certificates confirming multiple points of usage from the customer where available to transfer the use tax reporting to the customer. 83 83
Services A company relying on safe harbors when sourcing sales such as relying on the place to which the invoice is sent, needs to stay alert to the possibility that states may require due diligence in determining where the service is delivered or benefit is received before the service provider is permitted to rely on the address provided by the customer. 84 84
“Affiliate” and “Click Through” Nexus Laws Edward Bernert, BakerHostetler ebernert@bakerlaw.com 85 85
“Affiliate” and “Click Through” Nexus Laws “ Affiliate ” nexus Affiliate nexus is not a defined concept. “Click through” nexus is sometimes referred to as “affiliate” nexus but for purposes of this presentation, we will look at states with “ click-through ” statutes separately . 86 86
“Affiliate” Nexus For our purposes, we will assume that an “affiliated person” is one that is a member of an “affiliated group,” when the group has a member that has nexus with the state but the individual taxpayer in question does not separately have nexus. One definition of an affiliated group would be two or more persons related in such a way that one person owns or controls the business operation of another member of the group. “Control” can be defined in various ways by the states but could be based on ownership, e.g. that one member of the group owns 50% or more of another member. 87 87
“Affiliate” Nexus One person or entity can extend the reach of a seller by acting as an agent in a particular state for the seller. The use by a remote seller of an unrelated independent contractor soliciting on behalf of a remote seller can create nexus in the state in which the contractor is doing business. Scripto Inc. v. Carson , 362 U.S. 207 (1960). Traditionally, the creation of nexus arises by the actions of the agent on behalf of the remote seller rather than the common ownership. 88 88
“Affiliate” Nexus Some states assert that if one entity has nexus with the state, then other commonly-owned entities have nexus as well even if the in- state entity is not representing the remote seller in the state. The Ohio statute in R.C. 5741.01 has provided for affiliate nexus for many years but it appears that Ohio has never assessed on that basis. Florida uses membership in an affiliated group to create nexus. Florida Statutes § 212.0596. Louisiana declares that nexus is presumed to apply to affiliates of retailers with operations in Louisiana. See Louisiana Rev. Statutes Ann. § 47:302(V)(1)(c). 89 89
“Affiliate” Nexus California expanded the nexus requirements by utilizing a “commonly controlled group” and “combined reporting group” but focuses on members of a commonly-controlled group that assist the in-state company to establish or maintain a California market for sales of products, including but not limited to design and development of products, or solicitation of sales of personal property on behalf of the in-state companies. See Regulation 168 4 , Collection of Use Tax By Retailers. Statutes that provide for nexus based on the fact standing alone that a related entity has nexus with the state are of doubtful Constitutional validity. 90 90
“Click - Through” Nexus Click-through nexus Sometimes called “Amazon laws” establishing a presumption of nexus when an in-state person posts a link on a website that directs the potential customer to the remote seller’s website. The statutes typically presume that the in- state person was “soliciting” on behalf of the remote seller. I t is burdensome to overcome the presumption that in-state person was soliciting. 91 91
“Click - Through” Nexus In Overstock.com, Inc. & Amazon.com LLC v. New York Department of Taxation and Finance, 20 NY 3d 586 (2013), the New York Court of Appeals upheld the statute against a challenge on the face of the statute. The taxpayers were denied review by the United States Supreme Court. 92 92
“Click - Through” Nexus Illinois created a click-through nexus standard that was even broader than the New York statute because the existence of “affiliates” created nexus and not simply created a presumption that the affiliates were marketing on behalf of the remote seller. In a case argued by Brann & Isaacson, the Illinois Supreme Court in Performance Marketing Association, Inc. v. Hamer, 2013 Il 114496 (2013) struck down the statute in reliance on the Internet Tax Freedom Act . Illinois has amended the statute in an effort to address the challenge by extending the reach beyond performance marketing done over the internet to avoid violating the Internet Tax Freedom Act. 93 93
“Click - Through” Nexus A number of states currently have click-through nexus statutes with similar although not identical terms including: Arkansas, California, Connecticut Georgia, Illinois Louisiana, Maine, Michigan, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Rhode Island, Tennessee, Vermont,, Washington and Puerto Rico. The click-through nexus statutes typically apply to the collection of the state’s use tax but the Washington statute specifically applies to the B&O tax as well as the use tax. Other states may administratively interpret their nexus statutes to include click-through nexus. 94 94
State Notice And Reporting Requirements Matthew P. Schaefer, Brann & Isaacson mschaefer@brannlaw.com 95
Other Nexus-Related Issues: Notice and Reporting Laws • Rather than redefining the circumstances under which out-of-state retailers may be required to collect and remit sales taxes, a small group of states (CO, KY, LA, OK, SD, VT ) have enacted statutes requiring non-collecting retailers to comply with consumer use tax notification and information reporting statutes. • Requirements of such laws include one or more of the following: • Transactional Notice: In connection with each purchase for delivery into the state, the retailer is required to notify the customer that even though the retailer is not required to collect sale tax, the purchaser is obligated to self-report use tax on the transaction. • Annual Purchase Summary: The retailer is obligated to send each purchaser making more than a defined minimum level of purchases (e.g., $500) within a calendar year an annual statement that lists the total amount of the customer’s purchases from the retailer during the prior year and informs that customer that s/he is require to self-report use tax. • Customer Information Report: The retailer is required file annually a report with the state revenue department including the name, all shipping addresses, and total amount of purchases of every customer making purchases for delivery in the state. 96
Other Nexus-Related Issues: Notice and Reporting Laws (cont.) • Colorado Notice and Reporting Statute • Colo. Rev. Stat. § 39-21-112(3.5). • First statute of its kind, enacted in 2010. • Imposed all three requirements: Transactional Notice, Annual Purchase Summary, and Customer Information Report. • Included substantial penalties for non-compliance ($5 per transactional notice not given, $10 per annual purchase summary not timely sent, and $10 per name not provided on timely customer information report. • Direct Marketing Association sued the state Secretary of Revenue in 2010 to enjoin enforcement of the statute, resulting in suspension of the statute and the longest-running litigation concerning the limitations on state authority under the Commerce Clause: DMA v. Brohl. 97
Other Nexus-Related Issues: Notice and Reporting Laws (cont.) • Direct Marketing Association v. Brohl • Filed by the DMA in the federal District Court for the District of Colorado in 2010, challenging the Colorado notice and reporting law on the grounds that it discriminates against and unduly burdens interstate commerce in violation of the Commerce Clause. • District Court entered a preliminary injunction against enforcement of the law in January 2011. • District Court granted the DMA summary judgment on both of its claims that the law was unconstitutional and entered a permanent injunction against its enforcement in March 2012. • Secretary of Revenue took an interlocutory appeal to the United States Court of Appeals for the Tenth Circuit. 98
Other Nexus-Related Issues: Notice and Reporting Laws (cont.) • Direct Marketing Association v. Brohl. • On appeal from the entry of the permanent injunction by the District Court, the Tenth Circuit in 2013 declined to reach the merits of the DMA’s Commerce Clause claims. • Instead, the Court of Appeals held, on its own initiative, that the federal Tax Injunction Act, 28 U.S.C. § 1341 (“TIA”), barred the District Court from exercising jurisdiction over the DMA’s Commerce Clause claims, and ordered that the DMA’s Commerce Clause claims be dismissed. • In February 2014, The DMA filed a petition for a writ of certiorari with the United States Supreme Court on the TIA issue. • The Supreme Court accepted review. • In March 2015, reversed the Tenth Circuit’s jurisdictional ruling 9 - 0,and remanded the case for further proceedings. DMA v. Brohl , 135 S.Ct. 1124 (2015). 99
Other Nexus-Related Issues: Notice and Reporting Laws (cont.) • Direct Marketing Association v. Brohl. • The parties re- argued the merits of the DMA’s Commerce Clause claims in September 2015. • In February 2016, the Tenth Circuit reversed the District Court’s grant of summary judgment, finding that the Colorado notice and reporting law does not violate the Commerce Clause. 814 F.3d 1129 (10 th Cir. 2016). • The Court concluded that the law, which applies only to retailers located outside of Colorado, was not discriminatory on its face because it did not use “words of geographic distinction” to define the class of retailers subject to the statutory notice and reporting obligations. • The Court also concluded that the DMA had not proven that the law discriminates in its effect because in-state, Colorado retailers are required to comply with the separate obligations of reporting sales tax. • Finally, the Court held that the Quill physical presence rule applies only to state sales and use tax reporting obligations, and not to notice and reporting requirements. 100
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