Sales and Use Taxes for E-Commerce Transactions [CPA Journal, The]
(CPA Journal, The Via Acquire Media NewsEdge) Examining Court Decisions and Pending Legislation
Most states impose sales and use taxes on retail sales of certain tangible personal property. Sellers with a physical presence in the state must report their taxable sales and remit the appropriate amount of sales tax. Sellers without a physical presence in the state are not responsible for collecting sales tax, although consumers who purchase goods from outof-state sellers for consumption within their resident state are responsible for paying a use tax to that state. Thus, physical presence^ - or "substantial nexus," from the Latin word nectere, meaning a connection, link, or tie - is a key determinant for calculating a seller's sales tax responsibility. Through legislation, states are challenging the fact that out-of-state sellers are only required to collect sales tax from a purchaser when they have a physical presence in the state. States are broadening the meaning of nexus with regard to electronic commerce (e-commerce) transactions in an attempt to expand the use tax base and increase tax filing requirements.
One reason for states' challenges is their frequent dependence on revenues from sales and use taxes. Exhibit 1 provides a sense of this reliance and how it varies among the 50 states by listing the amount of sales and use taxes, individual income tax, and corporate income taxes collected in 2011. The total sales and use taxes collected exceeds $234 billion (43.9% of the total tax collected). The percentage of sales and use taxes collected varies among the states. For example, neither Montana nor Oregon has a sales or use tax; both states generate revenues from individual and corporate income taxes alone. Washington has no income tax, but relies heavily on revenues from its sales and use taxes, as well as revenues from its business gross receipts tax. With no individual income tax, Florida collects more than $19 billion in sales and use taxes (91% of total taxes) and approximately $1.8 billion in corporate income tax.
Another reason for states' challenges is the rise in e-commerce sales. The U.S. Census Bureau estimates that the total amount of sales in 201 1 was $4.7 trillion; e-commerce represents about 4.6% of those sales ($194.3 billion). For 2011, ecommerce sales increased 16.1% from 2010, compared to only a 7.9% increase in total sales.
CPAs should remain aware of laws and regulations related to sales and use taxes, as well as the evolving landscape associated with sales and use taxes for ecommerce transactions. They should be familiar with the relevant court cases addressing sales and use taxes - which establish a basis for current law and the potential for future changes - and with related information about state and federal activities. CPAs can use web-based resources to keep current on sales and use tax changes for e-commerce transactions.
In the Courts
To date, the obligation to collect sales and use taxes has been dictated by U.S. Supreme Court decisions, such as National Bellas Hess Inc. v. Department of Revenue of the State of Illinois (386 U.S. 753 ), Complete Auto Transit Inc. v. Brady (430 U.S. 274 ), and Quill Corporation v. North Dakota (504 U.S. 298 ). These cases provide brightline tests for cteterrnining whether an outof-state business is required to collect and remit sales or use tax. At issue is the application of the Due Process and Commerce clauses found in the U.S. Constitution. The Due Process Clause, as defined in Miller Brothers Co. v. Maryland (347 U.S. 340 ), "requires some definite link, some minimum connection, between a state and the person [which includes businesses] ... it seeks to tax"; however, this minimum connection is not enough to require interstate businesses to collect and remit sales tax. Under the Commerce Clause, states can require collection and remittance of sales tax only when an interstate business has a physical presence - that is, substantial nexus - within that particular state.
In National Bellas Hess, a Missouribased mail-order business used the U.S. mail or other common carrier to solicit business throughout the nation. The company mailed catalogues to active or recent customers twice per year. In addition, advertising mailers were sent periodically to bom active and potential customers. In 1965, the Illinois Supreme Court found mat National Bellas Hess was required to collect and remit use taxes to the state, as well as keep particular records of transactions.
National Bellas Hess was heard by the U.S. Supreme Court in 1967. The company did not own or lease property in Illinois, and it did not have agents, salespeople, or representatives selling or taking orders. Moreover, its phone number was not listed in Illinois, and it did not advertise by way of billboard, radio, television, or local newspapers. Thus, the Court found no basis to support the Illinois Supreme Court's decision. The U.S. Supreme Court "has never held that a State may impose the duty of use tax collection and payment upon a seller whose only connection with customers in the State is by common carriers or the United States mail." Therefore, National Bellas Hess was not required to collect use tax.
In 1977, in Complete Auto Transit, the U.S. Supreme Court provided the following criteria, the presence of which would allow the states to tax interstate businesses without violating the Commerce Clause:
* Substantial nexus exists within the taxing state.
* The tax is fairly apportioned, meaning mat the taxing state does not try to tax interstate activities conducted outside of the state.
* The tax does not ^scriminate against interstate commerce in favor of intrastate commerce.
* The tax is fairly related to the services provided by the taxing state, such as police protection and the use of roads.
Quill Corporation is possibly the most well-known case concerning sales and use taxes. Quill is a mail-order company that sells office equipment and supplies, soliciting business through the use of catalogs, mailers, advertisements in national periodicals, and telephone calls. The company had no property or personnel in North Dakota; therefore, it lacked substantial nexus in the state. In 1987, North Dakota changed its law to define a retailer as "every person who engages in regular or systematic solicitation of a consumer market in th[e] state." Regular or systematic solicitation was defined as three or more advertisements within a 12-month period. These changes in the law required mail-order companies to collect use tax, mus shifting the burden from the consumer to the seller. The trial court ruled in Quill's favor, but its decision was reversed by the North Dakota Supreme Court, which stated that advances in computers "greatly eased" the burden to comply with sales and use tax collections. In addition, the court found National Bellas Hess to be outdated and noted mat the mailorder industry had grown significantly since the National Bellas Hess decision.
Quill tested both the Due Process and the Commerce clauses. The North Dakota Supreme Court found that the out-of-state retailer did have a minimum connection with the state because it targeted North Dakota residents (3,000 in total) and because a considerable amount of revenue was collected ($1 million). These activities satisfied the Due Process Clause even though Quill lacked actual presence in the state, according to the court.
The U.S. Supreme Court, however, found that Quill's activities did not satisfy the Commerce Clause, which requires substantial nexus, as outlined in Complete Auto Transit. Such substantial nexus is not created by a vendor mat merely communicates with customers through the use of a common carrier or U.S. mail; rather, substantial nexus requirements can be met if the company employs individuals and independent contractors to work in the state, delivers into the state by means other than common carrier or U.S. mail, visits in-state businesses by using employees of the outof-state business, or owns property in the state. Once a company is deemed to have substantial nexus, the state can require the collection and remittance of sales tax. According to the U.S. Supreme Court in Quill, the purpose of the Commerce Clause is to restrict the powers of the states to tax interstate businesses.
Nexus and Brick-and-Mortar Retail
The expansion of interstate commerce into e-commerce has generated additional questions about what constitutes nexus and, in turn, what conditions must exist in order to require a seller to collect sales or use tax on e-commerce sales. For example, the following two California cases involving online and brick-and-mortar companies resulted in two different decisions.
In Borders Online LLC v. State Board of Equalization (129 Cal. App. 4th 1179 ), the appellate court affirmed the lower court's ruling that Borders Online had substantial nexus and mat the state was correct in assessing and collecting sales tax. The court relied upon the following for its decision:
* Borders Online and Borders Books (instate stores) have an agency relationship. Both entities are owned by Borders Group Inc. and have a common board of directors. Borders Online authorized Borders Books to process Borders Online sales returns, and it advertised this convenience online. Borders Books sales receipts included a message encouraging shoppers to visit Borders.com.
* The activities of Borders Books, on behalf of Borders Online, were intended to establish and maintain a market for sales at Borders Online. Borders Online enticed customers to buy online by providing, if needed, an easy means of returning online sales to Borders Books; thus, the sales process is not limited to "sales," but also includes the activity of sales returns. By accepting returns of online purchases at the brick-and-mortar stores, substantial nexus was created.
In Barnesandnoble.com LLC v. State Board of Equalization (Case No. CGC-06456465 [Ca. Sup. Ct. Oct 12, 2007]), the court ruled in favor of the taxpayer, finding that there was no agency relationship between the online company and the brickand-mortar stores. The basis for the court's decision was the following:
* The two companies were separate entities and shared no common directors or officers.
* Neither company had control over the other.
* The online coupons distributed by the brick-and-mortar stores were designed and paid for by Barnesandnoble.com.
* The brick-and-mortar stores did not accept online sales returns, solicit online sales, or accept online sales orders.
Thus, for online companies working with separate brick-and-mortar locations, care needs to be taken in defining that relationship, which will determine nexus. The following section provides an illustration of nexus in relation to an online-only retail company, Amazon.com.
Nexus and Online-Only Retail
The most important terms for e-commerce businesses are "affiliate nexus" and "clickthrough nexus." Affiliate nexus occurs when an out-of-state vendor does not have physical presence in a state but does have a related company there, such as a brother, sister, parent, or subsidiary. Click-through nexus occurs when a link to an out-of-state vendor is posted on a website owned by an instate business or individual. Amazon.com illustrates both types of nexus.
Affiliate nexus. A subsidiary of Amazon.com owns a Texas distribution center that fills orders for Amazon. Amazon.com took the perspective that the distribution center did not create nexus because it simply shipped goods; however, the substance of using a related company to fill Amazon.com orders indicates that Amazon, the parent company, does have substantial nexus. Without going to court, Amazon.com and Texas reached an agreement: starting July 1, 2012, Amazon.com began collecting sales tax. In other states - such as North Dakota, Kansas, and Kentucky - Amazon.com directly owns distribution or customer service centers, and it collects sales tax without any apparent special agreement with the states. Likewise, Amazon.com collects sales tax in its home base of Washington state.
Click-through nexus. Click-through nexus is an agreement between an out-ofstate vendor and an in-state business or individual to provide a link to the vendor's website. Amazon.com has such agreements with individuals in states that include Illinois, Colorado, New York, and (California; thus, if a customer uses the link in order to buy from Amazon.com, Amazon will pay a commission to the owner of the website. States have viewed these relationships as the creation of a sales force within the state, and therefore consider it a physical presence. But because click-through nexus would not be considered physical presence under Quill, such states have had to pass legislation to redefine nexus.
New York was the first state to pass legislation (effective April 23, 2008) stating that click-through nexus establishes a basis for collecting tax. Amazon.com opposed the bill, based on the defense that the agreements were solely for advertising and directing traffic to Amazon's website. Both the New York trial court and appellate court ruled against Amazon.com, finding that the click-through nexus legislation was not unconstitutional because it did not violate the Commerce Clause. This leaves Amazon.com with no further recourse except appealing to the U.S. Supreme Court. Thus, Amazon.com collects and remits sales tax in New York, even though it lacks physical presence under Quill. Many states have followed New York's example and have passed legislation - now commonly referred to as "Amazon Laws" - defining substantial nexus to include click-through nexus.
State-Level Reporting Requirements
Some states are passing legislation that requires out-of-state sellers - that is, sellers that do not have substantial nexus - to take some responsibility in the collection of use tax. But this attempt to shift responsibility has been met with resistance from sellers. For example, Colorado passed a bill requiring that out-of-state sellers notify purchasers that a use tax was due, and that a use tax return must be filed. In addition, the law required sellers to provide purchasers and the state with a report on purchases, including dates, amounts, and items purchased. Failure to file reports would result in a penalty of $5-$10 per notice or report not filed. This law was challenged in Direct Marketing Association v. Huber (2011 WL 250556 [D. Colo. 2011]), and the court declared the law unconstitutional based, in part, on Quill. The case law prohibits Colorado from placing a unique burden on out-of-state retailers.
Other states, such as California and Tennessee, have also been unsuccessful in requiring reporting requirements similar to Colorado's law. North Carolina was denied the ability to require Amazon.com to provide the state with lists of its customers' purchases. In Amazon.com v. Lay (2010 WL 4262266 [W.D. Wash. 2010]), the court found that such a requirement violated the First Amendment. Some states have been successful in requiring out-of-state sellers to notify purchasers of use tax law. Oklahoma and South Dakota have laws that require sellers to notify purchasers (e.g., on websites or invoices) that use tax is due and payable to the state by the purchaser. Although the laws vary among the states, it can be expected that state laws will continue to increase the reporting requirements for out-of-state sellers.
Even though individual states are passing their own legislation, states are also working together to streamline the various state tax systems and create a level playing field for intrastate businesses, interstate businesses with a physical presence, and interstate businesses without a physical presence, in all types of industries.
Streamlined Sales and Use Tax Agreement
As of August 1, 2011, 24 states (21 fullmember states and 3 associate-member states) have adopted the Streamlined Sales and Use Tax Agreement (SSUTA). The map in Exhibit 2 shows the categories by state. In March 2000, with the support of the National Governors Association and the National Conference of State Legislatures, states formed the Streamlined Sales and Use Tax Project (SSUTP). The purpose of the project was to simplify the collection and administration of sales and use taxes by businesses and the states.
Some of the objectives of the agreement include state-level administration, a uniform tax base, and simplified tax rates. One way to simplify state-level administration is to make the state "the central point of administration" Qittp://www.streamlinedsalestax .org/index.php page=faqs). Because businesses register with the state, rather than with all of the different jurisdictions within the state (i.e., counties and cities), the number of sales and use tax returns that a business must file is reduced. States with a uniform tax base classify products and services using the same definitions. For example, a confectioner no longer needs to determine whether one of its products is considered a candy or a cookie in the states where it does business; the business' s product will either be classified as a candy or a cookie in all states that have signed the SSUTA. Another objective is to reduce the number of sales tax ates for different items and services within the state. Each streamlined state is allowed one state-level sales tax rate and one local jurisdiction rate. In addition, the state can have a second state sales tax rate for a narrow list of items. Wim a streamlined sales and use tax system in existence among many states, businesses are more likely to be compliant without incurring excessive costs.
In addition to state legislation and the SSUTA there has also been sales and use tax legislation introduced at the federal level. The Main Street Fairness Act - introduced on July 29, 2011, in both houses of Congress - would allow fullmember states of the SSUTA to require collection and remittance of use tax from remote sellers (i.e., interstate businesses that lack physical presence in that state). According to this bill, states would not be required to have a single sales tax or use tax rate per jurisdiction, which is currently required in the SSUTA to create less burdensome and more simplified tax systems for all businesses, especially remote sellers.
The Marketplace Equity Sales Tax Bill was introduced in the House of Representatives on October 12, 2011. This bill does not require states to be full members of the SSLJTA in order to require remote sellers to collect and remit use tax. Instead of relying on the work done by the SSUTP to centralize compliance at the state level, provide uniformity in definitions used for products and services, and simplify states' sales tax rate, the bill establishes new rules for the states. Sylvia Dion - creator, author, and publisher of the State and Local Tax 'Buzz" blog - stated that the bill does not establish a body like the Streamlined Sales Tax Governing Board to monitor whether states are complying with the requirements of the act ("The Marketplace Equity Act: The New Competition on the Block," Sales Tax Support blog, October 25, 2011, http:// www.salestaxtaxsupport.com/blogs/ sales-use-tax/internet-tax-ecommerce/ the-marketplace -equity- act- meacomparison-mam-street-fairness-act-msfa/).
Compromise legislation known as the Marketplace Fairness Act was introduced in the Senate on November 9, 2011. This bill allows full-member states of the SSLJTA to require remote sellers to collect and remit use tax. In addition, states meeting other criteria specified within the bill can require remote sellers to comply, even if the states do not satisfy the requirements of the SSUTA.
These bills are making little progress toward passage - potentially because it is an election year - and are currently in committees. (To track the status of any of the bills, see the website GovTrack.US, listed in Exhibit 3.) It is time to settle whether out-of-state vendors without physical presence, as defined by Quill, are required to collect and remit sales and use taxes to any state. The states might be readier than the federal government to solve this nexus issue, as evidenced by their passage of legislation to collect additional tax revenues and alleviate state budget deficits.
The future of the collection of sales and use taxes on e-commerce transactions is in a state of flux. Some state governments, looking to increase revenue, have expanded the definition of substantial nexus and have shifted the use tax responsibility to out-of-state sellers. In certain cases, courts have neutralized mis push; in others, states have collected sales tax based on a click-through nexus. Thus, physical presence, as defined by the U.S. Supreme Court in Quill, might not apply in today's Internet environment. As the sales and use tax issues evolve, tax professionals should keep current on businesses' DCe-commerce activities, along with state and federal developments in this area.
Bonnie K. Klamm, PhD, CPA, is a professor, and Jäl M. Zuber, PhD, CPA, is an assistant professor, both in the accounting, finance, and information systems department at North Dakota State University, Fargo, N. Dak.
(c) 2012 New York State Society of Certified Public Accountants
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