Adapting to the Digital Economy: Sales and Use Tax Nexus Developments in 2016

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

Electronic Commerce

Sales and use tax nexus is one of the most exciting and frustrating areas in the tax world. In this article, Ryan's Jeremiah Lynch discusses key developments in that area over the past year, including congressional activity, state activity, and Colorado's unique compliance solution.

Jeremiah Lynch

By Jeremiah Lynch

Jeremiah Lynch is a Principal and Practice Leader for Ryan’s National Tax services out of the New York office where he specializes in providing multi-jurisdictional tax services to clients in a variety of industries.

As the 2016 year comes to a close, we continue to see important developments surrounding sales and use tax nexus. For a time, it looked like we might be close to a congressional solution, but it's been left up to the states to determine their own destinies by establishing guidelines primarily for remote seller/online sales activity. As we look at the past year, we'll review some of the key developments that occurred and some that did not. We'll start with congressional activity that developed in late summer, then look at those states that have expanded their laws to incorporate e-commerce and physical presence statutes. Finally, we'll examine Colorado's unique compliance solution for online sales, which requires online retailers to submit detailed and burdensome reporting on all of their sales to customers in Colorado.

Congressional Proposal

On Aug. 25, 2016, the Chairman of the House Judiciary Committee, Rep. Robert Goodlatte (R-Va.), released a discussion draft of the Online Sales Tax Simplification Act of 2016. In keeping with prior drafts, the goals of this updated draft remain, leveling the playing field for brick-and-mortar sellers, providing compliance simplification, and ensuring tax gets collected on all taxable remote sales. Some of the noteworthy aspects of the draft include, but are not limited to:

  •   removing, under certain circumstances, the physical presence requirement set out in Quill Corp. v. North Dakota, in which the Supreme Court held that a business must have physical presence in a state before the state could require the business to collect use tax on its behalf;
  •   implementing a hybrid-origin approach to sourcing;
  •   limiting audits of a seller's remote sales to the origin state; and
  •   limiting the destination-state's rate for remote sales to a single state-wide rate.

The most significant aspect of the draft is the shift to taxation of remote sellers on an origin basis and not the traditional destination-based method. It was expected the House would review this draft after members of Congress returned from their summer recess. We can only surmise that the election season took on more prominence for members of Congress.

However, there was plenty of activity at the state level. We'll update you in chronological order on the developments that occurred and then finish with the unique approach Colorado developed.

A Look at the States

State legislatures continued to propose changes to sales and use tax laws addressing out-of-state and online sales transactions, whereby affiliate agreements with in-state businesses would treat unregistered out-of-state businesses as doing business in a state. The legislation generally requires the out-of-state businesses to register for sales and use tax, as well as to collect and remit the tax on its sales to in-state customers.

An eclectic mix of states focused on this area in 2016. Arizona, Illinois, Louisiana, Nebraska, South Dakota, Tennessee, and Utah all proposed legislation addressing remote seller/online sales activities.

Louisiana Proposes Affiliate Nexus Provisions

Louisiana H.B. 30 contained amendments to the definition of “dealer” under the sales and use tax laws. Persons that have entered into an agreement with a Louisiana resident or business that refers potential customers for a fee or other consideration will be treated as a dealer. Referral by the Louisiana resident or business may happen via website link, in-person presentation, telemarketing, or similar manner.

The term “affiliate agent” is also added as a Louisiana resident or business that engages in activities that benefit another to the extent of developing or maintaining commercial activity in Louisiana. Again, a person will have entered into an agreement where a fee or other consideration is provided for the affiliated agent's activities.

Nebraska Proposal Would Expand Nexus Provisions to Capture Remote and Online Sales

Nebraska's Legislature introduced L.B. 1087, which would expand the definition for “engaged in business” in Nebraska to include online referral, listing of products, or other facilitation of sales for entities that have nexus with the state.

According to L.B. 1087, a seller would be presumed engaged in business in Nebraska if the total cumulative sales price of products sold to purchasers exceeded $10,000 in the immediately preceding calendar year, and the seller either has a physical presence in or is registered to collect and remit sales tax in a state that is a member of the streamlined sales and use tax agreement. Such a seller would be required to collect and remit sales and use tax unless it could prove that it did not have nexus with Nebraska. The Nebraska Legislature has not yet moved past the introduction stage of the bill, and no other instances or editions of the bill have been introduced.

South Dakota Remote Sellers Legislation Signed by Governor

South Dakota was another state that passed legislation requiring remote sellers to collect sales and use tax. S.B. 106 was signed by the governor back in March and would require any seller that does not have physical presence in South Dakota but that sells tangible personal property, products electronically transferred, or services for delivery into South Dakota to remit sales tax if 1) the seller's gross revenue from such transactions exceeds $100,000 in the previous or current calendar year, or 2) the seller made more than 200 separate transactions by selling tangible personal property, products electronically transferred, or services for delivery into South Dakota in the previous or current calendar year. The bill also provided for an expedited declaratory judgment and review process to address any federal constitutional issues.

Utah Proposed Nexus Provisions for Remote Seller Affiliates

Utah H.B. 235, also known as the “Remote Transactions Parity Act,” was introduced in the Utah House of Representatives on Jan. 28, 2016, designed to capture affiliate advertising, referral, or other similar facilitation of online sales on behalf of remote sellers. The Utah Legislature indicates that the bill received an “amendment recommendation” and a “favorable recommendation” from the House Revenue and Taxation Committee on Feb. 24, 2016. On Feb. 25, the Legislature submitted an amendment to the legislation, which limits the presumption of nexus to affiliates of remote sellers with sales greater than $50,000 in the preceding 12-month period. The bill did not pass this session, but we can expect to see Utah revisit this issue in 2017.

Illinois Changes Affect Remote Sellers

The state of Illinois updated provisions in the regulation to reflect prior changes. This change became effective on Sept. 12, 2016.

Under 35 ILCS 105/2, out-of-state retailers are presumed to be maintaining a place of business in Illinois and required to collect use tax on sales to Illinois customers if the following conditions are met:

  •   The retailer has a contract with a person located in the state under which the person, for a commission or like consideration, refers potential customers to the retailer by providing a promotional code or other mechanism that allows the retailer to track purchases referred by such persons;
  •   The cumulative gross receipts from sales of tangible personal property by the retailer to customers who are referred to the retailer by all persons in the state under such contracts exceed $10,000 during the preceding four quarterly periods; and
  •   The retailer does not prove that such contacts are insufficient to meet the nexus standards of the U.S. Constitution.

The rebuttable presumption allows a retailer by “maintaining in its records documentation that shows that persons with whom the retailer has agreements have not engaged in solicitation activities on behalf of the retailer in Illinois that are sufficient to meet the nexus standards of the United States Constitution during the preceding 4 quarterly periods,” to show that nexus does not exist.

Tennessee Adopts New Rule

A new economic nexus rule has been implemented by the state of Tennessee and is scheduled to go into effect on March 1, 2017. This new rule establishes that out-of-state dealers are required to register and collect and remit Tennessee sales and use taxes if they have substantial nexus with the state. Under this new rule, substantial nexus is established through the regular and systematic solicitation of sales from Tennessee customers that result in more than $500,000 during the previous 12-month period in sales to Tennessee residents. Such dealers must register by March 1, 2017 and begin collecting and remitting sales and use taxes beginning July 1, 2017. If a dealer meets the $500,000 threshold after March 1, 2017, the dealer must register and begin collecting and remitting tax within 90 days of meeting the threshold. However, such dealers will not need to collect for tax periods prior to July 1, 2017. Further details can be found in Tennessee Rule 1320-05-01.129.

Arizona Issues General Guidance

The department issued an advisory ruling on nexus for out-of-state businesses. Absent the existence of physical presence, an out-of-state business may still have nexus for purposes of Arizona Transaction Privilege Tax if its activity in the state falls within one of Arizona's taxable business classifications, and it has substantial nexus. Substantial nexus is determined based on the following factors: 1) type of activities performed in the state, and 2) how often or how long the activity occurs. Activities that may establish nexus include, but are not limited to:

  •   having an employee present in Arizona for more than two days per year;
  •   maintaining an office or other place of business in Arizona;
  •   maintaining an inventory of products in Arizona;
  •   having an independent contractor or other non-employee representative/agent present in Arizona for more than two days a year, who acts on the business's behalf to promote the business's commercial interests.

Additional examples of substantial nexus creating activities can be found in Arizona Transaction Privilege Tax Ruling TPR 16-1.

Colorado Establishes a New Approach for Online Sales Tax Compliance

In a decision that will significantly impact Colorado taxpayers who buy goods from online retailers, on Feb. 22, 2016, the U.S. Court of Appeals for the Tenth Circuit (Appellate Court) reversed the district court's summary judgment, finding that the state of Colorado's notice and reporting requirements did not unduly burden or discriminate against interstate commerce.

In 2010, the state of Colorado imposed notice and reporting obligations on out-of-state retailers, who, until then, had not been obligated to collect sales tax. These obligations include:

  •   sending a “transactional notice” to purchasers informing them that they may be subject to Colorado use tax;
  •   sending purchasers who buy goods from the retailer totaling more than $500 an “annual purchase summary,” which includes the dates, categories, and purchase amounts and reminds purchasers of their obligation to pay use tax; and
  •   sending the Colorado Department of Revenue (department) an annual “customer information report” listing customers' names, addresses, and total amounts spent.

Direct Marketing Association (DMA) challenged the law, arguing it was unconstitutional because it unduly burdened and discriminated against interstate commerce. The district court agreed with DMA and permanently enjoined the department from enforcing the law. The department appealed. This reversal by the appellate court removes the district court's injunction and allows the department to enforce the aforementioned notice and reporting requirements. Please see Direct Marketing Association v. Brohl, No. 12-1175 (10th Cir. 2016) for the full opinion.

When it comes to sales and use taxes, the e-commerce industry has proven to be a complex and challenging issue for states. As such, it is not surprising that states have taken steps to close the loop on tax collection and remittance. What is worth noting, however, is the uniqueness of Colorado's approach. While other states have chosen to address this issue by passing “click-thru” or “affiliate” nexus laws, which impose tax collection obligations on remote sellers who enter into agreements through which customer traffic is directed to them via links on residents' websites, Colorado has instead chosen to require remote sellers to provide the state with purchaser information on qualifying sales as set out above. The state has indicated it plans on enforcing this decision and will require retailers to send information to the state and, in turn, may use this information to send use tax notices to Colorado purchasers. Colorado's law impacts both remote sellers and Colorado purchasers. It results in an additional administrative burden for remote sellers and possibly privacy implications to consumers.

It remains to be seen whether the U.S. Supreme Court will hear the case. If the U.S. Supreme Court does not take the case, this will be the law of the land in Colorado.

Summary

As we close out 2016, we'll have another year pass with no congressional solution to sales and use taxes on e-commerce sales or a U.S. Supreme Court decision. In our opening section, we mentioned these were an eclectic mix of states, but in reality they reference a cross section of our country. When customers in very rural locations can order and have next day delivery on purchases, it can cost far more to deliver the item than any sales tax that might be due. Thus, keeping sales tax costs low as part of being competitive remains important to retailers. As we look forward to next year, state and local budgets will likely determine if we see more proposed legislation being explored to impose sales tax on online retailers. It will be important to watch if Congress looks at this issue again when the new term begins as the last proposal had an origin basis as part of the solution, which defies all the known rules regarding sales tax being imposed on a destination basis. Given that the Cubs won the World Series, we can no longer say wait until next year. We can say with confidence that as e-commerce continues to grow, we'll see state and local tax jurisdictions eyeing what they view as their share of the e-commerce economy. In 2017, we also expect to see states taking a very strong interest in newer industries such as the “sharing economy.” Regardless if the vehicle you ordered to pick you up at the airport comes with a driver or not, there will be sales and use tax implications. It's clear that sales and use taxes go hand-in-hand with this modern economy. In fact, if there is any trend you can count on, it's that as technology creates new services, states will try to figure out how to tax them. Without clear guidance from Congress on a solution, it should come as no surprise that states will continue to step up to the plate and take a swing at all those e-commerce sales on their own.

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