The Evolution of Sales Tax Nexus Expansion Laws

By Jennifer Jensen, CPA, and Kathryn Thurber, J.D., LL.M.

 

EXECUTIVE
SUMMARY

 

  • Traditionally, courts have ruled that nexus for sales and use tax purposes does not exist where an out-of-state retailer’s contact with the state is limited to direct mail solicitations and product delivery by U.S. mail or common carrier. Fiscal pressures on the states, including growing online sales upon which no sales tax is collected, however, have led states to seek nexus expansion measures such as “click-through” nexus.
  • By the end of 2011, eight states had enacted click-through nexus provisions. Other states have required out-of-state retailers to collect and remit sales tax where the retailer is part of a controlled group with a member that has a physical presence in the state.
  • During the 2011 legislative season, more than 15 states proposed laws expanding sales tax nexus in some way, with eight of those states enacting such laws. In addition, the Multistate Tax Commission has been drafting model legislation on this subject. Some states—most notably California—are looking to Congress to grant authority to tax remote sales.

Over the past three years, driven largely by the need to raise additional revenue, states have increased their sales tax collection efforts. One way they have done so is to expand the activities that create sales tax nexus for out-of-state retailers without a physical presence in the state. This article describes and compares those expansion efforts and, in several instances, the legal challenges to them.

Physical Presence Requirement

For decades, states have worked to develop ways to require out-of-state retailers to collect and remit taxes on sales to in-state customers, although historically, courts have required states to show that sellers have a physical presence or other substantial nexus within a state. In Quill Corp. v. North Dakota, 1 the U.S. Supreme Court ruled that a state cannot require an out-of-state retailer to collect and remit use tax if it does not have a physical presence in, or substantial nexus with, the state. Quill was (and is) a direct marketer of office and business supplies. The company’s only contact with North Dakota was through solicitation materials and shipment of goods into the state by U.S. mail or common carrier. After distinguishing between the nexus standards imposed by the Due Process Clause of the 14th Amendment and those of the U.S. Constitution’s Commerce Clause, the Court reaffirmed that the physical presence requirement it had upheld in National Bellas Hess v. Department of Revenue 2 for use tax purposes was still required to establish Commerce Clause substantial nexus.

Agency Nexus

With the establishment of the physical presence requirement, states began to look for any connection an out-of-state retailer might have that could be construed as a physical presence. Courts have held that, in addition to a seller’s direct physical presence, indirect physical presence also may create nexus for sales and use tax purposes. As a result, the states switched tactics and began to look more closely at whether an independent agent’s operating on behalf of an out-of-state seller establishes a physical presence, or agency nexus.

Further, with the explosion of internet sales, the recent recession, and increased pressure from in-state retailers, a trend is developing among the states to expand the range of activities creating sales tax nexus, specifically through expanded forms of agency nexus.

“Amazon” Laws and “Click-Through” Nexus

In 2008, New York enacted legislation requiring out-of-state internet retailers to collect and remit state sales tax on tangible personal property or services sold through links on websites owned by state residents. 3 The legislation appeared to target popular internet retailers, including Amazon.com and Overstock.com, that previously did not collect New York sales tax from their New York customers. This was the first “Amazon law.”

The law requires out-of-state sellers operating “affiliate programs” in the state to register to collect and remit sales tax. It provides that a “vendor” includes a person making sales of tangible personal property or services to New York customers through an agreement with a New York resident for a commission or other consideration, by which the resident directly or indirectly refers potential customers, by a link on an internet website, to the seller, if the cumulative gross receipts from such sales exceed $10,000 per year. In other words, potential customers reach the out-of-state retailer’s website by clicking on a link on the in-state affiliate’s website (thereby creating “click-through” nexus). The presumption of nexus may be rebutted by proof that the resident with whom the seller has an agreement did not engage in any solicitation in the state on behalf of the seller that would satisfy the nexus requirement of the U.S. Constitution.

Two days after the Amazon law was signed, Amazon.com filed suit in New York state court alleging, among other challenges, that the law violates the Commerce Clause and the Due Process and Equal Protection Clauses of the 14th Amendment, both on its face and as applied to Amazon.com, because it imposes tax collection obligations on out-of-state retailers who have no substantial nexus with New York. 4

The trial court ruled against Amazon.com, holding that the statute did not violate the Commerce or Due Process Clauses, both on their face and as applied, and did not violate the Equal Protection Clause as applied. Amazon.com appealed the trial court’s decision. In November 2010, the appellate court found the statute constitutional on its face. 5 The court remanded the case for further fact-finding to determine whether the statute was unconstitutionally applied to Amazon.com under the Commerce and Due Process Clauses. 6

Despite the legal challenge in New York, two more states—Rhode Island and North Carolina—followed New York’s lead and adopted substantially similar vendor presumption language in 2009. In Rhode Island, a retailer that enters into an internet link referral agreement with a Rhode Island resident is presumed to be soliciting business in the state if the cumulative gross receipts from sales to customers referred to the retailer by all residents with this type of agreement exceed $5,000 per year. 7 In North Carolina, the threshold is $10,000 per year. 8 Both states provide that the presumption may be rebutted by proof that the resident with whom the seller has an agreement did not engage in any solicitation in the state on behalf of the seller that would satisfy the nexus requirements of the U.S. Constitution.

Retailer Notification Requirements and Controlled-Group Nexus

In response to opposition to the New York-style vendor presumption law, Colorado and Oklahoma took a different approach to taxing out-of-state sellers. Effective March 2010, Colorado enacted a two-part statute.

First, out-of-state sellers must collect Colorado use tax if they are part of a “controlled group” as defined in Sec. 1563(a) that has a “component member” as defined in Sec. 1563(b) that is a retailer with a physical presence in the state. However, this presumption may be rebutted by showing that the component member did not engage in any constitutionally sufficient solicitation in the state on behalf of the out-of-state seller during the calendar year in question. 9

The second requirement applies to out-of-state retailers that are not required to and do not collect Colorado sales tax and that have total annual gross sales in Colorado of $100,000 or more. In general, out-of-state retailers that do not collect Colorado sales tax are required to give their Colorado customers notice with each purchase that Colorado sales or use tax is due on all purchases that are not exempt from sales tax. This notice may be made on the internet website of the retailer or on an invoice provided to the customer.

Further, the statute requires an out-of-state retailer that does not collect Colorado sales tax to notify Colorado customers annually by first-class mail of their total amount of purchases during the year and the date and category of each purchase. The notification must state that Colorado requires a sales or use tax return to be filed and tax paid on certain purchases. In addition, the out-of-state retailer must file an annual statement for each Colorado customer with the state’s Department of Revenue showing the total amount of Colorado purchases made during the preceding calendar year. Steep penalties were enacted for failure to comply. 10

Soon after the law’s enactment, the Direct Marketing Association (DMA) filed a motion for a preliminary injunction in U.S. District Court in Colorado. The DMA asked the court to enjoin the Colorado Department of Revenue from enforcing the notice obligations imposed on out-of-state sellers, claiming they violate the rights of many DMA members under the Commerce Clause. 11 The court granted the injunction, finding that the DMA demonstrated substantial likelihood of success on its constitutional claims. Currently, the Colorado Department of Revenue is blocked from imposing notification requirements on out-of-state retailers pending resolution of the case.

During the same year, Oklahoma took a somewhat similar approach, enacting a multipart statute that includes a deemed imposition of nexus, a rebuttable presumption of nexus, and a retailer notification requirement. 12 In Oklahoma, an out-of-state retailer is generally deemed to be engaged in the business of selling tangible personal property for use in the state if the retailer holds a substantial ownership interest in, or is substantially owned by, a retailer maintaining a place of business within the state and the out-of-state retailer sells the same or similar line of products as the Oklahoma retailer under the same or similar business name, or the out-of-state retailer holds substantial ownership interest in, or is substantially owned by, a business that maintains a distribution house, sales house, or warehouse in Oklahoma, and delivers property sold by the retailer to consumers. 13 It should be noted that there are no provisions to rebut these deemed nexus provisions.

Further, an out-of-state seller is presumed to be a retailer engaged in business in Oklahoma if it is part of a controlled group of corporations that has a component member, as defined by Sec. 1563(b), that is a retailer engaged in business as described above. This presumption may be rebutted by showing that the component member did not engage in any constitutionally sufficient solicitation in the state on behalf of the out-of-state seller during the calendar year in question. 14

In adopting its retailer notification statute, Oklahoma took a substantially different approach than that taken by Colorado. In Oklahoma, every out-of-state noncollecting retailer not required to collect sales and use tax must notify Oklahoma purchasers that use tax is due on nonexempt purchases and should be paid by the Oklahoma purchaser. The notice may be placed on the retailer’s internet website or its retail catalog and invoices provided to customers. However, out-of-state sellers with total gross sales in Oklahoma in the prior year of less than $100,000 and reasonable expectations of less than $100,000 of Oklahoma sales in the current year are exempt from the notice requirements. Also, unlike in Colorado, the out-of-state retailer is not required to provide end-of-year purchase reports to its customers or to notify the state of its customers’ purchases. 15

Nexus Expansion Laws Spread to Other States

Through 2011, Amazon-type laws had been adopted in eight states: Arkansas, California, Connecticut, Illinois, New York, North Carolina, Rhode Island, and Vermont. Also, Pennsylvania announced in a 2011 bulletin 16 that its sales and use tax law already allows the state to assert click-through nexus. Some states have passed controlled-group or affiliate types of laws but have not passed click-through nexus laws. The following states enacted either an Amazon-type law or other nexus-related law in 2011 with implications for online retailing.

Illinois: Illinois’s law, which was enacted in March 2011 and effective beginning July 1, 2011, amended its definition of “retailer maintaining a place of business” in the state to include a click-through nexus provision with a $10,000-per-year threshold. Notably, unlike those of New York, Rhode Island, and North Carolina, the Illinois statute does not contain a rebuttable presumption. 17 Illinois also imposes a use tax collection obligation on retailers that have a contract with a person located in the state under which the retailer sells the same or substantially similar line of products as the person located in Illinois under the same or substantially similar name, trade name, or trademark; and the retailer provides a commission or other consideration based on the sale of tangible personal property, if the cumulative Illinois gross receipts of the retailer from sales to state residents of tangible personal property under all such contracts exceed $10,000 per year. 18

South Dakota: In March 2011, South Dakota enacted a multipart notice statute substantially similar to Oklahoma’s. 19 Unlike Oklahoma, however, South Dakota included a provision stating that no criminal penalty or civil liability may be applied or assessed for failure to comply with the notification requirements. 20

Arkansas: On April 1, 2011, Arkansas also enacted affiliate nexus provisions similar to Oklahoma’s, creating a nexus presumption based upon members of a controlled group. However, the extent of the presumption and the burden imposed on the out-of-state retailer to rebut that presumption differ significantly. Unlike Oklahoma, where nexus may be asserted to the full extent permissible under the U.S. Constitution, Arkansas chose to assert nexus only where the affiliated person’s activities are significantly associated with the seller’s ability to establish or maintain a market in the state. The law was effective July 27, 2011. 21

Beginning October 25, 2011, Arkansas also adopted a New York-style click-through nexus provision with a $10,000-per-year threshold. In Arkansas, the presumption may be rebutted by submitting proof that the residents with whom the seller has an agreement did not engage in any activity within the state that was significantly associated with the seller’s ability to establish or maintain the seller’s market in the state during the preceding year. This proof can be in the form of written statements, provided and obtained in good faith, from all of the residents with whom the seller has an agreement stating that they did not engage in any solicitation in the state on behalf of the seller in the preceding year. 22

Connecticut: Connecticut was next in adopting a click-through nexus provision with a $2,000-per-year threshold, with no rebuttable presumption. Interestingly, the provision is the first Amazon law to be adopted retroactively. As originally passed, the legislation was to be effective July 1, 2011. Subsequently, Connecticut passed legislation on June 21, 2011, making its Amazon law effective May 4, 2011. 23

Vermont: Vermont adopted its Amazon law on May 24, 2011. 24 The Vermont statute requires retailer notification of use tax obligations substantially similar to that required in Oklahoma. However, like South Dakota’s, Vermont’s statute explicitly states that no criminal or civil penalties will be applied or asserted for failure to comply with the notification statute. Notably, the rule is not effective until 15 or more other states have adopted substantially similar requirements. Currently, seven states besides Vermont have click-through nexus provisions on their books.

South Carolina: In June 2011, following negotiations with an online retailer, South Carolina enacted a law addressing the use of a distribution facility in the state by an out-of-state entity. 25 The law creates a “distribution facility nexus exemption” and provides that owning, leasing, or utilizing a distribution facility, including a distribution facility of a third party or affiliate, within South Carolina is not considered in determining whether a person has a physical presence in South Carolina sufficient to establish sales and use tax nexus if the following apply:

  1. The person or the person’s affiliate places a distribution facility in service after December 31, 2010, and before January 1, 2013;

  2. The person or the person’s affiliate makes, or causes to be made through a third party, a capital investment of at least $125 million after December 31, 2010, and before December 31, 2013;

  3. The person or the person’s affiliate creates at least 2,000 full-time jobs with a comprehensive health plan for those employees, after December 31, 2010, and before December 31, 2013; and

  4. After meeting the requirements of item 3, the person or the person’s affiliate maintains at least 1,500 full-time jobs and with a comprehensive health plan for those employees until January 1, 2016.

The law is set to sunset on the earlier of January 1, 2016; when the person fails to meet the requirements set out in the law; or on the effective date of any law enacted by Congress that allows a state to require that its sales tax be collected and remitted even if the taxpayer lacks substantial nexus. 26 South Carolina requires out-of-state retailers taking advantage of this exemption to inform customers of their use tax obligations, similar to Arkansas’s notification requirement. 27

California: Arguably the most significant development occurred on June 29, 2011, when California enacted a bill, effective immediately, requiring certain retailers to collect taxes on remote sales. The law specifically includes as a retailer engaged in business in the state any retailer that is a member of a commonly controlled group and is a member of a combined reporting group that includes another member that, pursuant to an agreement, performs services in the state in connection with the tangible personal property sold by the retailer. These services include, but are not limited to, the design and development of tangible personal property sold by the retailer, or the solicitation of sales of tangible personal property on behalf of the retailer. 28

California includes as a retailer engaged in business in the state any retailer that enters into agreements with a person in the state who, for a commission or other consideration, refers potential purchasers to the retailer by an internet-based link or website. This click-through nexus provision applies only where the retailer had total California sales of more than $10,000 in the preceding 12 months that originated from such referral agreements and, within the same time period, total cumulative California sales of more than $1 million. 29

An agreement under which a retailer purchases advertisements from a person in California is not such a referral agreement, unless the advertisement revenue paid to the person in California consists of commissions or other consideration that is based on the sales of tangible personal property. 30

The click-through nexus provision does not apply if the retailer can demonstrate that the person in California with whom the retailer has an agreement did not engage in referrals in the state on behalf of the retailer that would satisfy the requirements of the Commerce Clause. 31 Consequently, the State Board of Equalization is granted the authority to impose nexus requirements to the fullest extent allowable under the U.S. Constitution.

Shortly after the law was signed, Amazon filed a petition with the California attorney general’s office to begin the process of holding a voter referendum on the remote sales tax collection law. However, California lawmakers and Amazon reached a compromise. In exchange for Amazon’s dropping referendum efforts, lawmakers passed A.B. 155, which repealed the remote sales tax nexus law retroactively to June 28, 2011. Included in the legislation is a provision that would reinstate the remote sales nexus law effective September 15, 2012, if federal legislation that grants states the authority to require remote sellers to collect and remit sales and use taxes is not enacted on or before July 31, 2012. Even if such a federal law is enacted, if California does not elect to implement it by September 14, 2012, then the state nexus provisions would become effective on January 1, 2013.

The intent of the compromise is to provide online and brick-and-mortar retailers a one-year grace period to lobby Congress to pass a uniform collection regime.

Texas: Enacted July 19, 2011, and effective January 1, 2012, a Texas law asserted sales tax nexus based on the activities of affiliate members, similar to those of Colorado, Oklahoma, South Dakota, and California. 32

Beyond Amazon Laws

Most recently, the District of Columbia on September 14, 2011, enacted a law set to take effect October 1, 2011, to require sales and use tax collection on internet sales. The legislation requires every remote vendor not qualifying as exempt to collect and remit sales tax on sales made via the internet to a purchaser in the District. 33 A remote vendor is a seller, whether or not it has a physical presence or other nexus within the District, selling, via the internet, property or rendering a service to a purchaser in the District. 34

The law requires the District to take certain steps before remote vendors have to begin collecting sales tax. For example, the District government has 120 days from the effective date of the legislation to establish a structure to support the collection of tax on remote sales, including a registration system for remote vendors, a means by which remote vendors may determine the current District sales and use tax rate and transaction taxability, and the date that the collection of remote sales taxes would commence. 35 The District has not yet taken these steps even though the 120 days has passed. Consequently, remote vendors are not yet complying with this law.

Conclusion

It appears the trend to expand sales tax nexus standards to include remote out-of-state retailers is set to continue on its current upward trajectory. The 2011 legislative season saw more than 15 states proposing laws to expand sales tax nexus in some manner, with nine states enacting those laws. In its July 2011 annual meeting, the Multistate Tax Commission directed its sales and use tax uniformity subcommittee to begin drafting an associate nexus statute based on New York’s Amazon law. Further, since January 1, 2012, 16 bills have been introduced in various state legislatures specifically addressing the expansion of sales and use tax nexus. Although many states are modeling their legislative language after laws enacted in New York, Oklahoma, and Colorado, there are many variations built upon these prior laws and several new nuances.

In addition, the federal government has also become much more involved. On November 30, 2011, the U.S. House Judiciary Committee held an oversight hearing on the constitutional limitations on states’ authority to collect sales taxes in e-commerce. Congress currently is considering three remote sales tax proposals: the Main Street Fairness Act (S. 1452 and H.R. 2701), the Marketplace Equity Act (H.R. 3179), and the Marketplace Fairness Act (S. 1832).

 

Footnotes

1 Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

2 National Bellas Hess, Inc. v. Department of Rev., 386 U.S. 753 (1967).

3 N.Y. Tax Law §1101(b)(8)(vi).

4 Amazon.com, LLC v. New York State Dep’t of Tax. and Fin., 877 N.Y.S.2d 842 (2009).

5 Amazon.com, LLC v. New York State Dep’t of Tax. and Fin., 913 N.Y.S.2d 129 (2010).

6 Id.

7 R.I. Gen. Laws §44-18-15(a)(2).

8 N.C. Gen. Stat. §105-164.8(b)(3).

9 Colo. Rev. Stat. §39-26-102(3)(b)(II).

10 Colo. Rev. Stat. §39-21-112(3.5).

11 The Direct Marketing Ass’n v. Huber, No. 1:10-cv-01546-REB-CBS (D. Colo. 1/26/11).

12 Okla. L. 2010, ch. 412, §1.

13 Okla. Stat. tit. 68, §1401(9)(b).

14 Okla. Stat. tit. 68, §1401(9)(d).

15 Okla. Stat. tit. 68, §1406.1; Okla. Admin. Code §710:65-21-8.

16 Pa. Dep’t of Rev., Sales and Use Tax Bulletin 2011-01 (12/1/11).

17 35 Ill. Comp. Stat. 105/2(1.1).

18 35 Ill. Comp. Stat. 105/2(1.2).

19 S.D. Codified Laws §10-63.

20 S.D. Codified Laws §10-63-9.

21 Ark. Code §26-52-117.

22 Id.

23 Conn. Gen. Stat. §§12-407(a)(12)(L) and (15)(A)(x).

24 Vt. Stat. tit. 32, §§9704(9)(I) and 9783.

25 S.C.L. 2011, Act 32, §3.

26 S.C. Code §12-36-2691.

27 S.C. Code §12-36-2692.

28 Cal. Rev. & Tax. Code §6203.

29 Id. The original threshold amount of total cumulative California sales was $500,000 under Section 6203. The amount was changed to $1 million by the subsequent legislation (A.B. 155) that also changed the effective date of the click-through nexus rules.

30 Cal. Rev. & Tax. Code §6203.

31 Id.

32 Tex. Tax Code §151.107(a)(4).

33 D.C. Code §47-3932.

34 D.C. Code §47-3931(3).

35 D.C. Code §47-3932.

 

EditorNotes

Jennifer Jensen is a director and Kathryn Thurber is an associate with PricewaterhouseCoopers LLP in Washington, DC. For more information about this article, please contact Ms. Jensen at jennifer.jensen@us.pwc.com.

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