Recent Trends and Developments in Sales and Use Taxation

By Karl Nicolas, J.D., LL.M.

Editor: Karen Nakamura, CPA

In 2007, total state and local business tax revenues grew by 5.7% from the previous year to more than $577 billion. While taxes on corporate and individual business income represented less than 15% of this amount, general sales and use taxes on business inputs grew by over 4%, totaling more than $132 billion. This amount represented approximately 23% of the total state and local business tax burden, ranking second only to property taxes imposed on business property.1 Despite these significant increases, many states either reported or anticipated record budget deficits.2 Accordingly, business taxpayers may well expect further increases in their state tax assessments.

State and local indirect taxes (i.e., nonincome-based taxes), while representing the largest portion of state tax revenue, typically are viewed by taxpayers as a fixed cost of doing business. For this reason, taxpayers can expect states to look primarily to indirect tax increases as a way to raise revenue in a less politically damaging manner. As such, it is imperative that taxpayers monitor their overall indirect tax costs and outlays and closely track state activities with respect to such taxes. In particular, taxpayers should pay close attention to the following areas in which state legislatures and departments of revenue have focused their attention in recent years, potentially resulting in substantially greater tax burdens for businesses and consumers.

Expanding the Concept of the "Responsible Person"

Although the application of sales and use taxes generally is straightforward, determining who must collect and pay the tax to the state (i.e., who is the "responsible person" for sales and use tax purposes) often creates significant confusion for remote sellers. In Quill v. North Dakota,3 the U.S. Supreme Court affirmed the principle that a state can have taxing jurisdiction over an entity only if there is substantial nexus between the entity and the state. For use tax collection purposes, such nexus exists between a remote seller and the state seeking to impose a collection obligation if the seller has some physical presence within the state. If no such connection exists, it is incumbent upon the in-state purchaser to self-assess and remit the applicable use tax to the state, thereby expanding the pool of responsible persons for indirect tax reporting purposes.

State departments of revenue generally prefer to limit the number of entities reporting and paying the tax by placing the collection burden on the vendor.4 Understandably, vendors prefer to reduce the administrative costs and burdens associated with such collection, particularly for states where they maintain a limited presence. As such, many remote sellers have taken affirmative steps to limit their nexus exposure, thereby limiting their legal obligations with respect to sales and use tax collection.

Attributional Nexus

To combat such tax planning, a number of states have attempted to expand the concept of substantial nexus beyond direct physical presence by applying alternative nexus theories. Most notably, states often seek to attribute nexus based on the in-state activities of an entity acting on behalf of a remote seller (e.g., an in-state agent, affiliate, or unrelated "promoter") to "establish and maintain a market" for the remote seller's goods.5

The ultimate determination of whether a third party's in-state activities will create sufficient nexus to require an out-of-state seller to collect use tax still must be made based on the particular facts and circumstances. Significant factors may include:

  1. The nature of the relationship between the in-state actor and the out-of-state seller;
  2. The specific activities performed in the state "on behalf" of the out-of-state seller; and
  3. Whether the arrangement appears designed to avoid tax liability. 6

In addition, many states have narrowed the threshold, both legislatively and through increased assessments against remote sellers, of what will trigger a claim of attributional nexus. 7

Since 2000, no fewer than five states have enacted or proposed legislation or issued directives implementing attributional nexus standards.

For example, in Idaho, a new law enacted in March 2008 specified that a retailer has "substantial nexus" with the state if:
  1. The retailer and an in-state business maintaining one or more locations within Idaho are related parties; and
  2. The retailer and the in-state business use an identical or substantially similar name, trade name, trademark, or goodwill to develop, promote, or maintain sales, or the in-state business provides services to, or that inure to the benefit of, the out-of-state business related to developing, promoting, or maintaining the in-state market.

Before this change, the law required that the retailer be "owned or controlled by the same interests which own or control any retailer engaged in business in the same or similar line of business in this state" in order for nexus to attach.8 New Jersey enacted a substantially similar law in 2006.9

Arizona recently issued a ruling that details when remote sellers will be viewed as having substantial nexus with the state for purposes of the Arizona transaction privilege and use taxes. 10 In the ruling, the Arizona Department of Revenue explained that if activities performed in the state on behalf of the seller are significantly associated with the ability to establish and maintain a market in the state for its sales, then liability for the privilege tax—or for use tax collection—would attach.

The department specifically noted that an "overarching attempt to create a ‘unified face' or singular ‘brand recognition' among consumers, despite the actual separate corporate existences of [in-state and out-of-state] subsidiaries," essentially would create an alter-ego scenario and would confer nexus on the out-of-state party. The department also explained that it would consider a number of factors in making its determination, including:

  • Cross-promotion and advertising of remote subsidiary and in-state subsidiary locations, catalogs, and websites by in-state subsidiaries;
  • The ability to return and exchange merchandise acquired through different subsidiaries at in-state retail store locations and to receive credit for the return or exchange that can be applied to new transactions across subsidiaries;
  • The acceptance of remote subsidiary orders by a retail subsidiary at in-state locations when a product is unavailable at the in-state location;
  • The order fulfillment of merchandise ordered by customers from a remote subsidiary through in-state retail or marketing subsidiaries; and
  • Other in-state sales and marketing efforts that promote the operations of remote subsidiaries to in-state retail customers.
New York
In New York, a new law provides that persons making sales of taxable tangible personal property or services are presumed to be soliciting business through an independent contractor or other representative if they enter into an agreement with a New York resident under which the resident, for a commission or consideration, directly or indirectly, refers potential customers, via a link on an internet website or by other means, to the seller. 11 This presumption applies if the cumulative gross receipts from sales by the seller to in-state customers that are referred to the seller by all residents under such agreements exceed $10,000 during the preceding four quarterly periods, ending on the last days of February, May, August, and November.

Under the new law, a seller will be deemed to have met the condition of having an agreement with a New York State resident when the seller enters into an agreement with a third party that has entered into an agreement with the New York resident to act as the seller's representative. An agreement to place an advertisement will not give rise to the presumption. However, "placing an advertisement" does not include the placement, directly or indirectly, of a link on a website linking to the website of the seller, when the consideration for placing the link is based on the volume of completed sales generated by the link. 12

Court Cases

State departments of revenue have had varied success in advancing the concept of attributional nexus through the courts. In California, a superior court ruled that a Delaware-based online retailer that sold books over the internet was not liable for use taxes on sales made to California despite the in-state presence of bookstores owned by an affiliate. 13

In a similar case, 14 the California Court of Appeal affirmed a State Board of Equalization (SBE) ruling that an out-of-state retailer of tangible personal property via the internet was obligated to collect and remit California sales and use tax based on the willingness of its authorized representative within the state (an affiliated "brick and mortar" retail establishment) to accept returned merchandise, which activity the SBE determined constituted substantial physical presence within the state. 15 The representative's activity on behalf of the retailer was deemed sufficient to consider the retailer as being "engaged in business" in the state because the activity constituted "selling" and was an integral part of the retailer's selling efforts.

The Louisiana courts have also addressed the issue of attributional nexus. In Louisiana v. Dell International, Inc. ,16 an out-of-state computer catalog sales company with no direct physical presence in Louisiana was found to have nexus with the state based on the in-state activities of a third-party repair company that provided warranty repair services to the sales company's customers. In reversing a lower court ruling that the sales company lacked nexus because no agency relationship existed between the sales company and the repair company, the Louisiana Court of Appeal concluded that the contractual relationship between the vendor and the corporation, as well as the nature and extent of the services provided by the corporation, offered sufficient evidence that the repair company's services directly affected the sales company's ability to establish and maintain a market in Louisiana.

The court also noted that the sales company should not be allowed to hide behind the fact that it hired a third party to provide in-state services or to label that third party as independent to destroy nexus with Louisiana, thereby contravening the law. On substantially similar facts, the New Mexico Court of Appeals reached the same conclusion. 17

However, in another matter involving the in-state activities of an affiliate, a federal district court found that an online retailer with no physical presence in Louisiana did not have substantial nexus with the state based on the activities of a related in-state bookstore. 18 In reaching this conclusion, the court found that the bookstore's activities on behalf of the online retailer (e.g., crosspromotional advertising, selling gift cards that could be used to purchase items online, and a preferential return policy) were insufficient to attribute the bookstore's physical presence to the online retailer.

Businesses that sell taxable goods and services across state lines can expect state taxing authorities to continue their efforts to impose a collection obligation based on the slightest in-state presence. As states become desperate to avoid losing sales and use tax revenues to consumer noncompliance, vendors must take affirmative steps to ensure that the tax and compliance burdens are not shifted to them. However, through proper planning and maintaining an awareness of their presence and activities, businesses can effectively shield themselves from unexpected assessments. 19

Department of Revenue Activities

State legislatures and departments of revenue have also taken increasingly aggressive positions with taxpayers, both actively and passively. Specifically, many state taxing authorities have begun to inundate taxpayers with information requests, such as nexus questionnaires and "self-audit" reports, in an effort to have the taxpayer discover and disclose unreported tax liabilities for the state. Most states have also eschewed amnesty programs as a way to foster compliance, instead favoring aggressive auditing. 20 However, it is state inaction that is perhaps most troubling for taxpayer compliance efforts, as states place limitations on refund claims, reduce refund statute of limitation periods, increase administrative requirements to "perfect" claims, or simply take no action on filed claims. 21

Refund Denials

State denials of taxpayer refunds also have become more systematic, as evidenced by the treatment of refunds for taxes paid on bad debts. Specifically, for sellerfinanced transactions, retailers typically will remit the entire amount of tax due on the transaction and include the tax remitted in the total amount financed. In most cases, retailers that offer financing, either through private label credit cards or other mechanisms, will sell the account receivable to a financial institution at a discount, factoring in a bad debt component. In the event that the customer/debtor subsequently defaults on the account, or if the account otherwise becomes worthless or uncollectible, sales and use taxes remitted to the state may be recoverable. However, there is no uniform rule among the states as to which party, the retailer/assignor or the financial institution/ assignee, may claim such refunds.

States are increasingly denying such refund claims or are enacting legislation to limit recovery by holders of worthless debt. For example, California had proposed a bill to limit the person allowed to claim a deduction for bad debt to the retailer that paid the tax. 22 Under current California law, a retailer that has previously paid sales/use tax is allowed to take a deduction for the amount found to be worthless and charged off. If the account is held by a lender, the lender is also entitled to a deduction or refund of sales/use tax previously reported and paid by the retailer on the account.

In 2007, Michigan enacted a similar law, effectively overturning a decision by the state court of appeals that allowed recovery by a third-party finance company. 23 At present, a majority of states, including New York, 24 New Jersey, and Massachusetts, bar recovery of sales taxes paid on financed sales that are in default by any party other than the retailer that made the sale.

By shifting a greater portion of the compliance burden to the taxpayer, the states have created a situation in which, absent close monitoring by taxpayers, they may receive a windfall of tax revenue by default. Accordingly, taxpayers need to pay close attention to their sales and use tax payments and, where overpayments occur, file timely refunds. Once refund claims are submitted, taxpayers must closely monitor the department's action—or nonaction— with respect to the claims and follow up as necessary. In the case of debtor/consumer default, it is imperative that the proper party claim any potential refund for sales taxes paid and remitted to the state. Ultimately, strict compliance on the part of the taxpayer may not be sufficient if refund claims are not closely tracked.

Tax Base Expansion

Short of increasing the pool of potential taxpayers, increasing tax rates, or limiting taxpayer relief, states often seek to increase their tax revenue by increasing the scope of the tax base. Although such an action ultimately may have a greater impact on taxpayers' overall tax burdens, it generally is safer from a political standpoint because transactional taxes often are an assumed cost of doing business and can be passed down the supply chain to the ultimate consumer. Nevertheless, there are significant issues and difficulties associated with such expansion, as illustrated by two lines of developments: (1) the attempt by state legislatures and revenue agencies to tax a broad range of services and (2) challenges to the determination of sales price for tax base purposes.

Broad-based sales taxation of services is rare, and many attempts to expand the tax base to include services have failed spectacularly. In 1987, Florida enacted a broad-based sales tax on a number of services. Massachusetts followed suit in 1990. The common features of these measures were that each sought to tax services performed outside the state when benefit was enjoyed within the state, and each was repealed shortly after enactment. 25

Nevertheless, state legislatures continue to view sales and use taxes on services as the next potential state tax revenue windfall. Most recently, in November 2007, Maryland enacted a new law26 making a broad range of computer services subject to the state's sales tax, effective July 1, 2008, and running through June 30, 2013. However, the tax was repealed on April 8, 2008, three months before becoming effective, by a bill that also reinstated language specifically exempting custom computer software services and certain sales of optional computer software maintenance contracts from the sales and use tax. 27 As such, while services remain a tempting target for taxation by the states, in practice expanding the tax base in such a high-profile manner remains a difficult task.

States have also looked toward expanding the tax base on transactions that already are subject to tax, an approach that is less politically sensitive because it does not appear to be a new tax. For example, a number of states recently have challenged whether taxes on hotel rooms booked through third-party online resellers should be applied at the wholesale rate charged to the reseller or at the retail rate charged to the ultimate consumer. The lawsuits, which have been brought by a number of municipalities, have met with varying success.

In South Carolina, the first state in which such an action has been brought against an online reseller, two cities have claimed that resellers illegally charge their customers tax on the full retail price of the rooms while remitting tax only on the wholesale rate paid to the hotel. 28 The resellers in turn argue that the tax does not apply to them because they are not located in the taxing jurisdictions and do not provide the accommodations. While this case has not been resolved, similar lawsuits in other jurisdictions continue to work through the state and federal courts. 29

Because the tax base remains static in a number of states, sellers need to closely monitor developments so that their sales and use tax compliance systems remain up to date and taxes are properly charged and collected. Timely updates can mean the difference between proper reporting and deficiency assessments. And, while service providers generally are immune from tax collection requirements, this situation can change quickly. As such, all taxpayers need to remain cognizant of the market and sufficiently adaptable to change.


In sum, business taxpayers can expect their indirect tax expenses, from both tax outlay and cost of compliance standpoints, to increase over the next year as the state fiscal environment remains bleak. However, it is important to remember that tax compliance involves avoiding both underpayments and overpayments. Taxpayers must make certain that their compliance systems properly account for taxes due and are flexible enough to adapt when state tax laws or business operations change. Apart from that, it is imperative that taxpayers monitor their operations with an eye toward state tax compliance so that the correct amounts of taxes are collected and paid.

This article represents solely the opinion of the author and not Ernst & Young LLP or any of its associated firms. The author accepts full responsibility for its content.

Editor Notes

Karen Nakamura is director of tax knowledge management with PricewaterhouseCoopers LLP in Washington, DC. She is chair of the AICPA Tax Division's State & Local Tax Technical Resource Panel. Karl Nicolas is a senior manager in the National Tax Department—State & Local Taxation Practice at Ernst & Young LLP in Washington, DC. For more information about this column, contact Mr. Nicolas at

1 Phillips, Cline, and Neubig, Total State and Local Business Taxes: 50-State Estimates for Fiscal Year 2007 (Ernst & Young and Council on State Taxation 2008), available at

2 McNichol and Lav, 29 States Face Total Budget Shortfall of at Least $48 Billion in 2009 (Center on Budget and Policy Priorities, August 2008).

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

4 The reasons for this general position are varied. Most notably, businesses typically have better compliance records than individual consumers, a fact that explains the common description of use taxes as "taxes on honesty." See McLure, "Rethinking State and Local Reliance on the Retail Sales Tax: Should We Fix the System or Discard It?" 2000 BYU L. Rev. 77.

5 See Tyler Pipe Indus., Inc. v. Washington State Dept. of Rev. , 483 U.S. 232 (1987).

6 See Hellerstein and Hellerstein, State Taxation ¶19.02 (Warren, Gorham & Lamont 2002).

7 See AL Laws 2003, Act 2003-390 (H.B. 650) (6/16/03); AZ Dept. of Rev., Transaction Privilege Tax Draft Ruling TPR 04-__ (8/4/04); IN Laws 2004, H.B. 1365 (3/17/04); KS Laws 2003, H.B. 2416, effective July 1, 2003.

8 2008 ID Sess. Laws ch. 49 (H.B. 360), enacted March 3, 2008, effective July 1, 2008, adding ID Code §63-3615A and amending ID Code §63-3611(2)(e).

9 2006 NJ Laws ch. 44 (A-4901) (7/8/06), adding NJ Rev. Stat. §54:32B-2(i)(2).

10 AZ Dept. of Rev., Transaction Privilege Tax Ruling 08-1 (7/30/08).

11 2008 NY Laws ch. 57 (A. 9807C/S. 6807C), effective April 23, 2008, adding NY Tax Law §1101(b)(8)(vi). A bill recently introduced in the U.S. Senate (S. 3670) would serve to repeal the new law by codifying the physical presence standard and limiting the instances in which a nonresident online retailer could be required to collect tax.

12 NY Dept. of Tax'n and Fin., TSB-M-08(3)S (5/8/08).

13, LLC v. State Bd. of Equalization, No. CGC-06-456465 (Cal. Super. Ct. 10/11/07).

14 Borders Online v. State Bd. of Equalization, 129 Cal. App. 4th 1179 (Cal. Ct. App. 2005).

15 But see SFA Folio Collections, Inc. v. Tracy, 73 Ohio St. 3d 119 (1995) (acceptance of returned merchandise and distribution of catalogs by in-state affiliate of mail order retailer did not create a substantial nexus).

16 Louisiana v. Dell Int'l, Inc., 922 So. 2d 1257 (La. Ct. App. 2006), reh'g denied, La. App. 2004-1702 (La. Ct. App. 3/30/06).

17 Dell Catalog Sales, L.P. v. Taxation and Rev. Dept. , No. 26,843 (N.M. Ct. App. 6/3/08). But see Dell Catalog Sales v. Department of Rev. Servs., 834 A.2d 812 (Conn. Super. Ct. 2003) (finding that the relationship between sales company and repair company did not create nexus for an out-of-state sales company).

18 St. Tammany Parish Tax Collector v., Inc., 481 F. Supp. 2d 575 (E.D. La. 2007).

19 However, thorough planning will not be effective in limiting vendor liability if it does not comport with the actualities of the business's operations. See, Inc. v. Director, Div. of Tax'n, 23 N.J. Tax 624 (N.J. Tax Ct. 2008) (operation of nexus isolation structure for online seller disregarded due largely to lack of substance).

20 See Naghavi, Fishman, and Nicolas, "Legislation and Audits: Changing Trends?" 34 The Tax Adviser 755 (December 2003).

21 See, e.g., NC Gen. Stat. §105-241.7(c) (providing that if the NC Department of Revenue does not respond to the taxpayer's amended return or claim for refund within six months after the date on which it is filed, the department's inaction is considered a proposed denial of the requested refund).

22 2008 CA A.B. 1839, introduced January 24, 2008, passage refused May 27, 2008.

23 2007 MI Laws PA 104 (H.B. 5096) and PA 105 (H.B. 5097) (10/1/07). See also Daimler Chrysler Servs. N. Am., LLC v. Department of Treasury, 723 N.W.2d 569 (Mich. Ct. App. 7/25/06).

24 Refunds for transactions financed by a third party or for debts that have been assigned to a third party are generally not allowed in New York. However, if the debt is transferred to a captive finance company by its retail vendor, the debt will not be treated as having been assigned to a third party in certain instances (NY Tax Law §1132(e-1); 20 NY Regs. §534.7). Specific provisions also apply to private label credit card issuers (NY Tax Law §1132(e-3)).

25 See Fee, Murphy, and Mortenson, BNA Tax Management Multistate Tax Portfolios 1310-2d: Sales and Use Taxes: Services, 02.B (2001).

26 2007 MD Laws S.B. 2, signed November 19, 2007.

27 2008 MD Laws ch. 10 (S.B. 46), enacted April 8, 2008. To make up for the revenue that will be lost due to the repeal, the legislature approved an income tax surcharge for individuals with taxable income over $500,000.

28 City of Charleston v., LP, 520 F. Supp. 2d 757 (D.S.C. 2007).

29 Actions have been brought in California, Florida, Georgia, Illinois, Kentucky, New Mexico, New York, North Carolina, Ohio, and Texas.

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