Alabama Scholastic case: Historic sales and use tax nexus issues with an eye toward Wayfair

By Brad Brown, CPA, Atlanta; Jamie C. Yesnowitz, J.D., LL.M., Washington; Chuck Jones, CPA, J.D., Chicago; Lori Stolly, CPA, Cincinnati; and Metisse Lutz, J.D., LL.M., Denver

Editor: Greg A. Fairbanks, J.D., LL.M.

A recent Alabama Court of Civil Appeals decision held that the business model used by a prominent classroom bookseller did not create use tax nexus in Alabama during a lengthy audit period at issue (Alabama Dep't of Rev. v. Scholastic Book Clubs, Inc., No. 2161077 (Ala. Civ. App. 9/7/18)). In doing so, the court provided the litigants an opportunity to weigh in on how the U.S. Supreme Court's groundbreaking decision in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), could apply in the case, implying that future sales tax nexus cases may result in substantially different results.

Background

Scholastic focused on whether the activities of Scholastic Book Clubs Inc. (SBC) gave rise to use tax nexus requiring registration, collection, and remittance of use tax on taxable transactions. SBC, a seller of books and classroom supplies to students and classrooms via catalogs distributed by teachers, did not have actual physical presence in Alabama. SBC's sales to Alabama consumers arose from orders placed by the teachers or the parents of the teachers' students. These orders were placed onto forms sent to SBC, fulfilled at SBC's Missouri warehouse, and sent back to classrooms for distribution. SBC was owned by Scholastic Inc. (Scholastic), which contracted with Alabama to provide the state with math textbooks beginning in 2012.

SBC's sales model attracted the scrutiny of the Alabama Department of Revenue, which ultimately issued an assessment against SBC for over $815,000 in unpaid use tax and interest, for SBC's tax periods from April 1, 2007, to March 31, 2013. The department's assessment relied upon a statute providing that certain activities performed by an out-of-state seller involving significant in-state contacts created an Alabama use tax filing obligation (Ala. Code §40-23-68(b)).

SBC appealed the assessment, arguing that it did not have an obligation to collect and remit use tax to the state of Alabama because it did not have actual physical presence in the state. The Alabama Tax Tribunal affirmed the department's assessment on the basis that SBC was using classroom teachers to solicit sales and perform other activities on behalf of SBC in Alabama (Scholastic Book Clubs, Inc. v. Alabama Dep't of Rev., No. S. 14-374 (Ala. Tax Trib. 3/25/16)).

SBC appealed the tribunal's decision, and the Montgomery (Ala.) Circuit Court held in SBC's favor, vacating the department's assessment of use tax against SBC (Scholastic Book Clubs, Inc. v. Alabama Dep't of Rev., No. CV-16-900562 (Montgomery Cir. Ct. 8/18/17)). The circuit court based its determination primarily on the grounds that SBC's Alabama contacts were not included within any of the enumerated categories of activities described in the Alabama nexus statute under Alabama Code Section 40-23-68(b). Specifically, Alabama teachers and parents were acting on behalf of students in placing orders rather than on behalf of SBC. Further, the teachers' and parents' activities could not be considered acts of sales agents or representatives or be described under a "catchall" provision within the Alabama nexus statute.

Court of Civil Appeals decision

The department appealed the circuit court decision to the Alabama Court of Civil Appeals, which reviewed the arguments raised by the parties in the circuit court, along with an argument dealing with Alabama's related-party nexus statute (Ala. Code §40-23-190(b)) that was not addressed by the trial court or tribunal. With respect to the related-party argument, the department contended that Scholastic maintained an Alabama presence through its contract with the state of Alabama as a textbook provider, and that Scholastic and SBC used a substantially similar name, trade name, and trademark to develop, promote, and maintain an Alabama market. SBC rebutted this argument, stating that SBC and Scholastic were entirely separate and that any in-state activities attributable to Scholastic could not be applied to SBC. The department also argued that SBC was a statutory affiliate of Scholastic (Ala. Code §41-4-116(a)) and, as a result, maintained a duty to register, collect, and remit sales, use, and lease tax to Alabama.

The Court of Civil Appeals found no basis for reversing the judgment of the circuit court with respect to the activity nexus, related-party nexus, or affiliate nexus statutes. The court noted that SBC did not retain employees or agents under contract in Alabama and that SBC did not receive and accept orders from Alabama residents within the state of Alabama. Therefore, SBC had no specific obligation to collect use tax based on its activities.

The Court of Civil Appeals likewise rejected the department's argument that the related-party nexus statute applied because of Scholastic's in-state activities, as the department did not argue or explain how the assessment against SBC would be upheld on that basis. Finally, the Court of Civil Appeals held that since the department had not demonstrated that SBC was subject to the obligation to collect and remit use tax under the activities nexus statute, there was no basis to reverse the judgment and reinstate the assessment under the affiliate nexus statute.

Court's brief foray into Wayfair

During the Court of Civil Appeals' review of the record, it asked both parties to submit briefs addressing the effect, if any, of Wayfair on nexus-creating activities in Alabama, even though the audit period in question occurred well before the Wayfair decision. SBC opined that the application of Wayfair was unnecessary, as the case should be decided solely on Alabama statutory grounds in effect well before Wayfair. The department, in its brief, put forth the contention that the decision in Wayfair strengthened its position, as Wayfair established the test to determine what constitutes substantial nexus and would allow Alabama to tax an entity with extensive business connections and economic presence in the state.

Ultimately, the Court of Civil Appeals did not reach the question of the department's potential reach under Wayfair, as the department was unable to show that in SBC's case, "its specific interpretation and application of the Alabama taxing statute" imposed an obligation to collect use tax on SBC. In addition, the Court of Civil Appeals refused to express an opinion on whether, under a different interpretation of the Alabama taxing statutes, Alabama could constitutionally impose use tax obligations on SBC in light ofWayfair.

Conclusion

Scholastic has a long history of state and local tax litigation concerning whether a jurisdiction can impose a sales and/or use tax on it as an out-of-state seller, with somewhat mixed results. In the pre-Wayfair world of nexus, statutes designed to require out-of-state sellers to collect and remit sales tax have not always been successful from the states' perspective. The Alabama courts' statutory interpretation proves that distinctive fact patterns (as reflected in the SBC's business model) and nonuniform sales tax nexus statutes will result in inconsistent nexus findings on a multistate basis, even in jurisdictions that have expanded concepts of what constitutes nexus.

It is interesting that the Court of Civil Appeals asked both parties to comment on the application of Wayfair so soon after that decision, even though it would have been difficult for the Court of Civil Appeals to hold that Wayfair could be applied retroactively to SBC. Given that sales-and-use-tax controversies can take several years to reach high-level state courts, it stands to reason that, soon enough, courts will be wrestling with the applicability of pre-Wayfairstatutes that have tried to impose nexus based on tangential connections to states, under the argument that Wayfair prospectively has changed the game. Companies that are currently challenging the historic nexus statutes at the audit level and in litigation are already beginning to grapple with how they will deal, going forward, with state statutes imposing broad economic nexus standards that have quickly been enacted in light ofWayfair.

EditorNotes

Greg Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington..

For additional information about these items, contact Mr. Fairbanks at 202-521-1503 or greg.fairbanks@us.gt.com.

Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.

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