Is a Privacy Battle Brewing? The Department of Commerce Pushes Back On Commercial Privacy Regulation

In an unusual move, the Department of Commerce has chimed in on the question of Internet data privacy, issuing a 78-page report from its Internet Policy Task Force.  While the Chairman of the FTC has welcomed the new report, the business-oriented tone of the Commerce report suggests that a battle is brewing.  Indeed, the report offers strong support for a “voluntary, multi-stakeholder process” that includes businesses as important, cooperative partners, while the FTC treats voluntary efforts by industry -- and industry itself -- almost contemptuously.  While Commerce defers to the FTC as the primary enforcement authority, it also stages what appears to be a power grab to take a leadership role in defining how industry will or will not be regulated in the areas of privacy and information security.

Income Tax Nexus in a Digital World

We have written extensively in this blog about nexus for sales tax and gross receipts tax purposes.  All but a few states have an income tax.  In addition to the Due Process Clause and Commerce Clause standards of nexus, out-of-state companies are protected from income tax of other states by a federal statute, Public Law 86-272, which is found at 15 U.S.C. § 381.  P.L. 86-272 provides an exemption only for state income tax and sets forth a fairly clear, but somewhat limited, standard for the exemption.

The exemption applies if a company’s activities in another state include only the solicitation of sales of tangible personal property by an employee, representative, or independent contractor for delivery of inventory located outside the state to residents of the state, if orders are accepted outside the state.  The exemption also extends to maintenance by an independent contractor of an office in the state.  Thus, while solicitation activities of an out-of state company in a state would create nexus under the Commerce Clause and Due Process Clause standards, if the solicitation is limited to the sale of tangible personal property and, subject to the other limitations in the underscored portions above, the company would be exempt from the state’s income tax.

There have been a number of cases defining solicitation (See, e.g., Wisconsin Department of Revenue v. William Wrigley, Jr., 112 S.Ct. 2447 (1992)). And the MTC has issued guidelines, which many states have adopted, defining protected and unprotected activities under P.L. 86-272.  See Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States under Public Law 86-272 (Multistate Tax Commission, Third Revision adopted July 27, 2001).

The cases and guidelines make it clear that if a company solicits the sale of services as well as tangible personal property, the exemption of P.L. 86-272 does not apply. See, e.g., Amway Corp., v. Director of Revenue, 794 S.W.2d 666 (Mo. 1990).  Thus, a pertinent issue under P.L. 86-272 is whether the items being sold by an out-of-state company constitute tangible personal property or services.

Do As I Say, Not As I Do: The FTC "Do Not Track" Initiative Could Cripple E-Commerce

Just as governments – including our own – are pursuing aggressive new initiatives to gather information about our individual browsing habits and electronic communications for law enforcement purposes, the FTC has decided to advise Congress on sweeping initiatives to prevent direct marketers from engaging in far less invasive practices that present none of the grave risks attendant to enhanced government surveillance.  Indeed, many of the commercial practices targeted by the FTC actually benefit consumers by assisting Internet sellers to configure their web sites, adjust their product offerings, and tailor advertising to the specific needs and interests of consumers.  While the FTC shrilly intones that consumer information about Internet browsing has been used by an unidentified "some" in "an irresponsible or even reckless manner," it fails to acknowledge forthrightly that the vast majority of direct marketers use such information solely to better serve their customers, and that new laws and FTC initiatives are unlikely to faze the tiny group of Internet pirates who misuse consumer data.

Although most headlines have focused on the FTC's proposal for a "do not track" list, the FTC report is about much more than that.  It foretells a highly aggressive new regulatory strategy that may change the landscape of Internet privacy without any concern for the cost impact on industry or a realistic assessment of the privacy interests of consumers.  It sweeps so broadly against business as to suggest that–if the FTC has its way–even entirely benign and non-intrusive information collection practices that do not track individual consumers will be sharply curtailed.  At the same time, new and intrusive requirements will be injected multiple times into virtually every consumer experience on the Web.  If you do business on the Internet, you need to know what the FTC is hoping to unleash on eCommerce.

The Perils of Responding to Nexus Questionnaires

A company should be very careful in determining whether to respond to the nexus questionnaire and how to respond to the questionnaire.   After all, any response is a statement to a government agency, which must be truthful and will be an admission on the part of the company.  A response that is inaccurate or a response that is not well thought out is worse than not responding at all.  In general, there is no obligation to respond to a nexus questionnaire, so the benefit of responding to a questionnaire may not be significant, yet the potential adverse consequences may be significant.

The problem in responding to a nexus questionnaire is highlighted by a recent case involving Barr Laboratories, in which the Michigan Court of Appeals held that the answers on a nexus questionnaire that indicated that the taxpayer’s employees visited Michigan between two and nine times during the year created a factual issue as to whether or not the company had nexus.   See Barr Laboratories, Inc. v. Department of Treasury (Mich. App. 2010).  The questionnaire indicated that the employees visited Michigan to solicit sales, but all sales were approved in New York.  Apparently that response overstated and mischaracterized Barr Laboratories’ connection to the state.  After an assessment by the Michigan Department of the Treasury of about $500,000, Barr Laboratories commenced a suit to abate the assessment.   In a summary judgment motion, Barr Laboratories submitted an affidavit of its Vice President of Taxation, which contradicted the responses in the questionnaire.  The affidavit stated that the visits to Michigan were only to gather information, and not to solicit sales, and were less frequent than stated in the questionnaire.   But the response to the questionnaire precluded Barr Laboratories from prevailing in the summary judgment motion, and the response was probably the basis for the assessment in the first place.

Amazon Wins First Amendment Challenge to North Carolina DOR Information Request

Amazon.com LLC (“Amazon”) has prevailed in its highly-publicized court challenge to a demand by the North Carolina Department of Revenue for information regarding purchases made by Amazon’s North Carolina customers during the period August 1, 2003 to February 28, 2010. The Federal District Court for the Western District of Washington (where Amazon is headquartered) issued a ruling on October 25, 2010, in Amazon.com LLC v. Kenneth R. Lay, in his capacity as Secretary of the North Carolina Department of Revenue, Case No. C10-664 MJP. The ruling enjoins the North Carolina DOR from requiring that Amazon provide the Department with names and addresses of its North Carolina customers and details regarding the products they purchased from Amazon.

The Department, in connection with an investigation of Amazon’s possible liability for uncollected use tax on sales to North Carolina residents, had requested that Amazon provide it “all information for all sales to customers with a North Carolina shipping address” for the six-and-a-half year period under examination. Amazon provided the DOR detailed records of products shipped to North Carolina for the entire period, but refused to provide the names or personal information of its customers purchasing such products. When the Department pressed for the information, Amazon sued in federal court, asserting that the Department’s request violated the First Amendment by chilling the exercise of the freedom of speech of Amazon’s customers (and of Amazon itself). On October 25, the Court agreed.

New York’s “Other Affiliate” Nexus Law

By now, many of our readers may be aware of the New York “Affiliate” Nexus law, which provides for a presumption of nexus under certain circumstances; i.e. where a remote seller uses a New York resident (an “affiliate”) to link to its website and pays commissions of more than $10,000 per year to such New York affiliate as a result of sales the affiliates facilitate. See N.Y. Tax Law § 1101(b)(8)(k); and Amazon.com v. New York State Department of Taxation and Finance, 23 Misc. 3d 418, 82 N.Y. S.2d 842 (2009) (on appeal to the New York Court of Appeals).

In 2009, the New York Assembly enacted another law to address a second kind of “affiliate.” This time, the definition of affiliate is based upon the more common usage of the term in which the affiliate is related to the out-of-state company by an ownership interest. The law is found in Tax Law §1101(b)(8)(i)(1). In particular, the statute, when enacted, provided two separate “conditions” or situations for establishing that a remote seller is deemed a vendor required to collect sales and use tax based upon the activities of the seller’s New York affiliate. In the first condition, the out-of-state seller is deemed a vendor required to collect sales and use tax if any person or entity owns, directly or indirectly, more than 5% of the retailer, and a New York sales tax vendor uses a trademark, service mark or trade name in New York that is the same as that used in New York by the remote seller. This condition is designed to address multi-channel vendors, and is similar to statutes adopted in other states.

New York Tax Department “Clarifies” Sales Tax on Reports Derived from Public Documents

The New York Department of Taxation and Finance recently issued a “clarification of existing Tax Department interpretation,” concerning the application of New York’s sales and use tax on “information services” to reports derived from publicly-available documents. For many companies, this “clarification” may well constitute a complete reversal of prior Department advice, as the Department itself has acknowledged.

New York tax law has, for many years, included a broadly-worded tax on “information services” that, by its terms, and under much of the Department’s prior authority, made the service of providing information reports (whether written, electronic, or even oral) taxable, unless the reports were comprised of information that was uniquely “personal” to the recipient. See N.Y. Tax Law § 1105(c)(1). In that regard, even if the particular compilation of information would be of interest only to the recipient, when the source data used to create the report was information that would be useful to many different entities or persons (such as public documents), a report was not deemed to be sufficiently “personal” to be exempt from tax.

The Conservative Approach of Over-Collection of Sales Tax Is Perilous

Many companies (and their advisors) believe there is no harm in “over-collecting” sales tax and, therefore, erring on the side of collection of tax in gray areas.  But that is a very risky course of action, as AT&T recently found out.

It seems that AT&T was collecting sales and use tax on Internet service it provided to customers.  It did so, despite the federal Internet Tax Freedom Act, 47 U.S.C. § 151 n. (1998), as extended and amended by the Internet Tax Nondiscrimination Act, P.L. 108-435 (2004) and the Internet Tax Freedom Act Amendments Act of 2007, P.L. 110-108 (2007), which prohibits states from imposing taxes on Internet access, with the exception of certain grandfathered states.  Even a company of the size of AT&T apparently got it wrong, since it continued to collect tax on Internet access in all states.  Its customers reacted, and commenced a class action law suit against AT&T.

AT&T recently settled the lawsuit with the class action plaintiffs at significant expense to AT&T.  See In re AT&T Mobility Wireless Data Services Sales Litigation, MDL No. 2147, Case No. 10 C 2278 (N.D. Ill. Aug.11, 2010).  While AT&T is not obligated to refund to the plaintiffs any amounts not refunded to AT&T by a state, it is required to seek such refunds.  If it obtains a refund, AT&T, of course, must distribute the amounts it receives to its customers, but it doesn’t have to dip into its own pocket to do so.

So, you say, what is the harm to AT&T?  As part of the settlement, AT&T is required to pay the cost of notice to each member of the class.  Given the size of the class, this likely will be a substantial cost.  In addition, AT&T must pay a contingency fee to the lawyers for the class action plaintiffs, which is generally based on the value of the settlement, and can be millions of dollars.  Thus, far from being an income neutral proposition for AT&T, AT&T’s decision to collect tax created a large expense to it.

The conclusion to be drawn is that retailers need to be very careful to make sure they get it right.  To simply err on the side of over-collection may prove to create substantial exposure.  Rather, the true amount due must be collected.  If a retailer gets in a bind by over-collecting, the state will not compensate the retailer for its additional expenses.

Washington State Partially Modifies Unreasonable “Trailing Nexus” Rule

The Washington Department of Revenue (“DOR”), based on a very thin reed of statutory support, has long taken the position that once an out-of-state business has engaged in activity in Washington sufficient to create nexus with the State, even if it thereafter ceases all activity in the State, the out-of-state company continues to have nexus with Washington for a period of at least four years after ceasing activity there (the remainder of the calendar year plus four more years), for purposes of both Washington’s sales tax and its Business & Occupation (“B&O”) tax. See WAC 458-20-193(7), (8). This “trailing nexus” rule is fundamentally inconsistent with the Commerce Clause’s requirement that an out-of-state company must have a physical presence in a state in order for the state to impose tax collection and reporting obligations on it, as the Supreme Court affirmed in Quill Corp. v. North Dakota, 504 U.S 298 (1992).

This summer, the Washington State legislature revised the Washington B&O tax statute to include a provision which makes it clear that a company which stops doing business in Washington state will now be deemed to have “trailing nexus” for B&O purposes for only the remainder of the calendar year in which it stops doing business and for one additional year. See RCW 82.04.220. Although even a one-year trailing nexus rule is highly suspect as a matter of constitutional law, it is certainly an improvement over the DOR’s four-plus year rule, which the DOR has announced it intends to continue to apply to the Washington sales tax. See DOR Special Notice (September 10, 2010).

Online and multi-channel direct marketers should be aware of this unreasonable, extended nexus provision as creating additional risks and burdens with regard to any business activity or connection involving Washington.

Oklahoma Adopts a Gross Receipts Tax Providing for “Economic Presence” Nexus

Oklahoma has been in the news recently because of its enactment of a controversial sales tax statute, similar to the Colorado statute, that requires companies which do not collect and remit the Oklahoma sales and use tax because of their lack of physical presence to provide notification to Oklahoma purchasers of the purchasers’ obligation to remit sales and use tax.  (See our related blog posts of June 24, July 1, and July 9.) In addition, Oklahoma has recently adopted a Business Activity Tax, which is in lieu of the franchise tax, and which requires any company with sales greater than $500,000 to Oklahoma destinations, regardless of the company’s physical presence in Oklahoma, to pay a tax of 1% of its gross sales revenue to Oklahoma residents.  The Business Activity Tax legislation, like the sales tax legislation, ignores the Quill physical presence test, and bases nexus on the “economic presence” of an out-of-state company; i.e., greater than $500,000 of gross receipts from an Oklahoma source.  The Business Activity Tax, insofar as the tax on gross receipts, does not go into effect until calendar year 2013.

As we wrote in our prior blog posts with regard to other state statutes based on an economic presence, the Oklahoma statute raises significant constitutional concerns.   There is good U.S. Supreme Court precedent that stands for the proposition that the Quill/Bellas Hess physical presence standard of nexus applies to gross receipts taxes.  See Tyler Pipe Industries, Inc. v. Washington Department of Revenue, 483 U.S. 232, 107 S.Ct. 2810 (1987); Commonwealth Edison Company v. State of Montana, 453 U.S. 609, 101 S.Ct. 2946 (1981).

Summer Reading Roundup – Recent Developments Concerning the Scope of the Work Product Doctrine

After finally slogging my way through the closing chapters of Cormack McCarthy’s Blood Meridian ― one of his many brilliant, but despairingly bleak, novels about the western frontier ― I decided I should conclude my summer reading with something more upbeat, like recent court decisions in tax–related litigation.  (In fact, I did read the case while sitting in a deck chair, periodically gazing out over the water on one of the many, perfect late summer days in Maine.)

All kidding aside, the recent decision by the Federal Court of Appeals for the D.C. Circuit in United States v. Deloitte LLP (D.C. Cir. June 29, 2010) reinforces some important principles in the often complex, three–way relationship between businesses, their tax counsel, and their outside accountants, with regard to the confidentiality of tax records prepared by, or in the hands of, a business’s independent auditors.

By way of background, it is, of course, common for accountants, in the context of an annual audit of a corporation, to request information regarding the assessment by a company’s attorneys of one or more legal issues that are potentially material to the audit.   It is important for companies to approach such audit issues carefully, in consultation with tax counsel, because in most jurisdictions there is no “accountant-client” privilege similar to the attorney-client privilege.  For that reason, disclosure of attorney-client communications to a company’s outside auditors is generally held to constitute a waiver of the attorney-client privilege that would otherwise shield such communications from disclosure to third-parties, including federal and state tax officials.

The Deloitte decision addresses the question of whether, separate from the attorney-client privilege, the “work product” doctrine protects documents that reflect the legal advice of a company’s tax counsel disclosed to independent auditors during the course of an internal audit from disclosure by independent auditors to the government. In connection with tax litigation involving Dow Chemical, the IRS sought to compel Dow’s auditor, Deloitte, to produce three documents it withheld from discovery in response to a subpoena.  The first document was prepared by Deloitte during a regular, internal audit of Dow, and summarized a meeting between Deloitte, Dow and Dow’s outside attorneys regarding the prospect of litigation over a particular tax matter.  The other two documents were prepared by Dow’s counsel (in one case, in-house, in the other, outside counsel) and also concerned possible tax litigation.  The IRS contended that the first document could not be work product, regardless of its content, because it was prepared by Deloitte.  The IRS conceded that the other two documents were work product, but argued that Dow waived its work product protection by disclosing the documents to Deloitte.

Update: California Senate Moves Tax Bill to Inactive File

As we’ve written previously (here, here, and here), the California legislature has been considering legislation that may impose potentially unconstitutional requirements on out-of-state retailers selling to California customers.

On May 6, the State Assembly passed AB 2078, Colorado-style legislation that would require out-of-state retailers to provide notice to California customers via the retailers' websites and in their catalogues of the customers’ potential use tax obligations. Previous versions of the Assembly Bill had required such retailers to file quarterly reports with the names, addresses and amounts purchased by California customers, and also created a rebuttable presumption that for any controlled group of corporations, if one member was engaged in business in California, all members would be deemed to be engaged in business in California. As passed by the Assembly, however, only the Bill’s provisions requiring that notice of use tax obligations be provided to California customers survived.

The State Senate has since taken up consideration of the Bill and made its own amendments. In the Bill currently before the Senate, the presumptions regarding controlled groups were reinserted, and the notice provisions were kept in. The Senate did not reinsert the reporting requirements of the original Assembly Bill.

However, the State Senate has yet to vote on the Bill. Instead, yesterday, the Senate moved the Bill to the Senate’s inactive file on a motion by one of the State Senators, likely because today marks the last day on the Senate calendar for any bill to be passed before the Senate’s final recess begins. Although the Bill may be moved off the inactive file, it appears that the California Senate will not be voting on it any time soon. In the meantime, we’ll continue tracking any action on the Bill and keep you posted of developments as they arise.

UPDATE, Jul. 5, 2011: California has enacted a new nexus law. 

Magazine Publishers Beware of the New Washington B&O Tax Law

As previously discussed in our blog post dated May 24, 2010, several states have taken the position that the Quill nexus standard applies only to sales and use tax.  State courts in New Jersey (Lanco, Inc. v. Director, Division of Taxation, 188 N.J. 380, 908 A.2d 176 (2006)), West Virginia (Tax Commissioner v. MBNA America Bank, 220 W.Va. 163, 640 S.E.2d 226 (2006)), and South Carolina (Geoffrey, Inc. v. South Carolina Tax Commission, 313 S.C. 15, 437 S.E.2d 13 (1993) (cert denied, 114 S.Ct. 550 (1993)) have held that economic presence (i.e., sales to the state without a physical presence in the state) is sufficient to establish nexus for state income tax.   As written in the May 24 blog post, there are other decisions (e.g. Commonwealth Edison v. Montana, 453 U.S. 609, 101 S.Ct. 2946 (1981)) that apply the Quill/Bellas Hess physical presence test to taxes other than sales tax.

By legislation, other states have adopted a gross receipts tax based on economic presence.  The Ohio Commercial Activity Tax, the Michigan Business Tax and the Texas Margin Tax are examples.  Recently, the State of Washington amended its B&O Tax, which is a gross receipts tax, with regard to the “service classification,” to require an economic nexus standard, based upon the level of service revenues to Washington.  Washington has taken an expansive view of businesses subject to the service revenue classification, which now includes businesses that publish periodicals or magazines with respect to the advertising income that such publications derive.  Since the nexus standard is quite low, this is likely to be a “sleeping dog” for most publishers.

Proponents of Streamlined Sales Tax Legislation Remain Unwilling To Pursue Genuine Simplification, While Exaggerating The Amount Of Uncollected Use Tax on eCommerce Sales

Earlier this month, Massachusetts Congressman Bill Delahunt introduced H.R. 5660, “a Bill to promote simplification and fairness in the administration and collection of sales and use tax, and for other purposes.”  H.R. 5660 represents the latest effort by Congressional allies of the Streamlined Sales and Use Tax Agreement (“SSUTA”) to promote legislation that would overturn the substantial nexus standards that limit states’ power to impose sales and use tax collection obligations on out-of-state sellers, as reaffirmed by the Supreme Court in Quill v. North Dakota

Sadly, H.R. 5660 represents no real promotion of simplification of state sales and use tax systems over the level of improvement introduced in prior bills which fell far short of the mark. Indeed, H.R. 5660 is nearly identical to a bill introduced by Mr. Delahunt in 2007 that endorsed the SSUTA, the shortcomings of which Brann & Isaacson senior partner, George Isaacson, explained to Congress in December 2007.  Among the fundamental steps toward true simplification that the states have still refused to adopt (and that H.R. 5660 fails to require) are a reduction in the number of state and local taxing jurisdictions, a single sales tax rate for all jurisdictions in a state, uniformity in the tax base, and uniformity in the measure of tax for like transactions, to name just a few.

Is Amnesty Really Amnesty?

States frequently announce amnesty programs. In return for settlement of back taxes, taxpayers obtain waiver of penalties and sometimes a reduction of interest. It has now become increasingly common, however, that states provide a stick to go along with the carrot of penalty waiver. Thus, Pennsylvania completed an amnesty period on June 18 in which it provided for waiver of penalties for payment of back taxes. The Governor of the Commonwealth, Ed Rendell, has announced that in the future, an additional 5% penalty will apply to all tax delinquencies that remained after June 18. In addition, he pointed out that the DOR will begin to seek to hold corporate officers personally accountable for taxes businesses owe and take other aggressive means to enforce the taxes.

Back in 2005, California announced a similar program, by which it increased the accuracy penalty from 20% to 40% and assessed an additional 50% “interest penalty” for all those taxpayers who did not apply for amnesty. Other states have followed a similar approach.

Is an offer of relief from liability coupled with a penalty for failure to take the offer really amnesty? Webster’s defines amnesty as a pardon from an authority. The consideration by the taxpayer for such pardon is the payment of back taxes. The sort of punitive measures, however, that some states impose for failure to acknowledge liability is not a pardon. Serious questions of taxpayer fairness are raised. Why should there be an additional penalty and in some cases threat of personal liability when a taxpayer has a legitimate dispute and chooses not to seek “amnesty”? The Due Process Clause of the U.S. Constitution is designed to provide every citizen their “day in court.” Imposing a penalty for the exercise of this due process right seems to be inconsistent with the basic principle of fair dealing that should be the very foundation of our tax system.

Oklahoma (again)!

This post is not a repeat of the successful musical. Rather, it is yet another blog post on the Oklahoma tax statute to supplement our posts of June 24 and July 1. The Oklahoma Tax Commission has recently proposed emergency regulations that purport to implement the notice requirements of the recently-adopted Oklahoma statute. As reported in our blog post of June 24, the Oklahoma statute is “Colorado-like,” inasmuch as it requires notice with each sale to an Oklahoma consumer by a direct marketer that does not have substantial nexus with Oklahoma. However, the statute provides that the notice is not effective until the Tax Commission has adopted regulations implementing the statute. Hence, the proposed regulations circulated by the Tax Commission, which become effective when approved by the governor.

The regulations require that the “required notice” be included (i) on the retailer’s website or in the retailer’s catalog; and (ii) on each invoice provided by the retailer. The regulations also prescribe that if the retailer does not provide invoices, the retailer must send a confirmatory email containing the required notice. The “required notice” must include the following disclosures:(1) the retailer is not required to collect, and does not collect, Oklahoma use tax; (2) the purchase is subject to Oklahoma use tax, unless exempt; (3) the purchase is not exempt because it is made over the Internet, by catalog or other remote means; (4) the State of Oklahoma requires Oklahoma purchasers to report, by filing a consumer use tax return or disclosing the same on the individual income tax return, all use tax due on out-of-state purchases and to pay such tax with the report or return; and (5) the forms and instructions for consumers to report and pay the Oklahoma use tax are available on the Oklahoma Tax Commission web site, www.tax.ok.gov.

B&I Files Constitutional Challenge to Colorado Notice and Reporting Law for The Direct Marketing Association

We've blogged frequently about Colorado's new notice and reporting law (see here and here).

Since our last posts on the topic, Brann & Isaacson's George Isaacson and Matthew Schaefer filed suit in federal district court in Colorado on behalf of The Direct Marketing Association in The Direct Marketing Association v. Roxy Huber.  Filed on June 30, the suit challenges the constitutionality of the new Colorado law.

The Colorado statute, which targets out-of-state retailers, purports to require those retailers to notify Colorado customers of their obligation to self-report use tax and to require those same retailers to turn over confidential purchasing information regarding Colorado customers to the Colorado Department of Revenue. In the complaint, the DMA, the leading global trade association of direct marketing businesses and nonprofit organizations, asserts that the Colorado statute discriminates against interstate commerce, exceeds the State’s regulatory authority over out-of-state businesses, violates the privacy rights of Colorado consumers, infringes the free speech and due process rights of retailers and consumers, and exposes confidential consumer information to the risk of unauthorized disclosure.

We'll continue updating you as developments arise.

Have a safe and happy Independence Day!

Oklahoma Seeks to Expand the Definition of Nexus for Internet and Catalog Retailers

In our blog post last week, we discussed the new Oklahoma sales tax statute, which contains a “Colorado-like” reporting requirement for those Internet and catalog sellers that do not collect and remit the Oklahoma sales and use tax. As a second part of the statute, the Oklahoma legislature also expanded the definition of those companies that are engaged in the business of selling tangible personal property for use in Oklahoma; i.e. those companies required to register to collect and remit the Oklahoma sales and use tax.  This part of the statute, like the reporting requirements section, is not the model of clarity, so there is some ambiguity in the statute.

First, the statute provides for “affiliate nexus” attribution. Thus, under the new law a retailer that otherwise does not have nexus based on its own activities (an out-of-state retailer) is deemed to have nexus if it and another retailer that has nexus with Oklahoma are commonly-owned, and if: (i) the Oklahoma-retailer sells the same or a “substantially similar” line of products under the same trade name as that of the non-nexus retailer (the so-called multi-channel retailer); (ii) the facilities or employees of the Oklahoma retailer are used to advertise, promote or facilitate sales by the out-of-state retailer; or (iii) the in-state retailer has a warehouse or similar place of business in Oklahoma that is used to deliver property to the out-of-state retailer’s customers, as in a drop ship relationship. Additionally, any retailer that is part of a controlled group (as defined under the Internal Revenue Code) faces a rebuttable presumption that it is engaged in business in Oklahoma if a component member of the controlled group is engaged in any of the activities described above. The presumption can be rebutted if the retailer shows that the component member did not do any of those activities on behalf of the retailer. The foregoing provisions are more comprehensive than those of other state statutes, which have some but not all of the provisions regarding common ownership. Colorado’s statute, for example, provides for a presumption of nexus similar to that described for members of controlled groups above and Arkansas’ statute contains a similar provision to that of the first category.

Supreme Court Hands Down Decision in Bilski

After many months of waiting, the Supreme Court has finally issued its decision in Bilski v. Kappos. The decision addresses the patentability of “business methods.” Read more about the decision and its impact on retailers at our sister blog, Eyes on IP.

UPDATE: Our friends have moved -- you can now visit our sister blog at IP Wise. 

Oklahoma’s New “Colorado-Like” Statute

As we have written in several previous posts, Colorado enacted an onerous reporting requirement for those remote sellers that do not collect and remit the Colorado sales and use tax. The Colorado statute requires such remote sellers to provide three types of notices that they do not collect the Colorado sales and use tax, even though they do not have nexus with Colorado under the Quill standard.  Brann & Isaacson, on behalf of the Direct Marketing Association, will be challenging the constitutionality of the statute in a suit to be filed shortly, because the Colorado statute applies to companies that lack nexus.

On June 9, Oklahoma enacted a “Colorado-like” statute, HB 2359, that requires that any retailer that sells tangible personal property to Oklahoma residents must “provide notification on its retail Internet web site or retail catalog and invoices provided to its customers that use tax is imposed and must be paid by the purchaser.” (emphasis added). The statute is Colorado-like in the sense that retailers without nexus are required to provide notice regarding the fact that sales and use tax is due on purchases, but it does not contain the Colorado provisions requiring retailers to provide annual notice (i) to purchasers of the volume of their purchases and that tax should be remitted to the Department of Revenue; and (ii) to the Department of Revenue of their Colorado purchasers and the volume of purchases made during the preceding year. Thus, the Oklahoma statute does not require annual notice to customers of their purchases in the preceding year or an annual report to the Oklahoma Tax Commission, the agency responsible for enforcing the sales tax law, of Oklahoma purchasers from the retailer.

California Reinserts Reporting Requirements; Tennessee’s Proposal to Expand Nexus Dies in Committee

We’ve been tracking developments in affiliate nexus legislation and attempts to impose Colorado-style reporting requirements on vendors in other states. Since our last updates (here and here), there have been further developments of note:

California

On May 14, we wrote that the California Assembly nixed proposed affiliate nexus legislation and Colorado-style reporting requirements before passing its bill onto the State’s Senate.  As in the Assembly’s version, the current iteration of the bill provides that retailers not required to collect use tax provide readily visible notice on their websites and catalogues that use tax is due from the purchaser.  Last week, however, the California Senate amended the bill to reinsert reporting requirements.

Under the amended bill, the “[State Board of Equalization] may require the filing of reports” by any person having possession or custody of information relating to sales of tangible personal property (“TPP”) subject to the tax. § 7055(a) (as proposed) (emphasis added). It is unclear to whom, exactly, this possible reporting requirement applies, but the reports “shall be filed when the board requires” and must include names and addresses of purchasers of TPP, the sales price of the TPP, the date of the sale and “such other information as the board may require.”

The Incredible Shrinking Jurisdiction?

On June 1, 2010, the United States Supreme Court in Levin v. Commerce Energy, Inc., 560 U.S. __ (2010), issued as close as it gets these days to a unanimous decision. Though fractured into four separate opinions, all of the Justices reached the same conclusion: that the United States District Court for the Southern District of Ohio correctly dismissed a state tax-related case. But, the distinction between the majority opinion and a concurrence by the Court’s most conservative Justices reveals that the door to federal court involvement in state tax matters remains open.

For direct marketers, access to federal courts for challenges to the constitutionality of state and local taxes and related enforcement efforts by the states is especially important. Not only are federal courts often more experienced in regards to federal constitutional issues, including Commerce Clause disputes, but they offer at least the appearance of a more neutral playing field since the federal courts are not funded by state tax revenue and are often called upon to play the role of arbiter in jurisdictional battles between the states. Thus, any decision that appears to restrict access to federal courts needs to be reviewed very closely.

Maine Voters Repeal Tax Legislation

Although some votes remain to be counted, it now seems clear that Maine voters have repealed tax legislation in a statewide referendum held yesterday. In a quirk of Maine law, under the State’s Constitution, voters are able to act as a fourth branch of the State’s government by introducing “people’s veto referenda” to repeal previously enacted legislation.

Last Spring, the State enacted tax reform legislation that lowered income tax rates and expanded the sales and use tax to new goods and services, while increasing the meals and lodging tax. The effective date of the legislation was stayed pending yesterday’s vote on the referendum. With over 70% of precincts now reporting in, the referendum seeking repeal of the new law is projected to win approval, and thus it appears none of the provisions of the new law will become effective. Tax professionals can hold off updating their Maine tax research for now…

Supreme Court Declines To Review Retroactive Ban On Refund Claims

So you think a state cannot change its tax laws after the fact to validate an erroneous legal interpretation by its revenue department that caused massive over-reporting of tax? Think again. Indeed, we were reminded earlier this week that, at least in some circumstances, states can retroactively adjust the rules to foreclose even pending claims for tax relief.

The United States Supreme Court on May 24 declined to review a decision by the Kentucky Supreme Court in Miller v. Johnson Controls, Inc., 296 S.W.3d 392 (Ky. 2009). In Miller, the Kentucky Court upheld a state statute enacted in 2000 that retroactively barred refund claims by a group of corporate taxpayers who complied with a policy adopted by the Kentucky Revenue Cabinet, challenged the policy as unlawful, and got it invalidated back in 1994 (by the Kentucky Supreme Court, no less).

Here’s the background: In 1988, the Revenue Cabinet interpreted Kentucky law as prohibiting the filing of unitary income tax returns by corporate taxpayers, and instead required each corporation to file a separate return. The inability to file unitary returns resulted in substantially higher Kentucky taxes for a number of corporations. After the Kentucky Supreme Court ruled in 1994 that unitary returns were allowed under Kentucky law, the taxpayers amended their earlier returns, and sought refunds for the excess tax paid during the earlier years.

NEXUS: Quill Physical Presence Test Should Apply to Gross Receipts Taxes

Since National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967), was decided in 1967, states have attempted to avoid the physical presence test of nexus that the National Bellas Hess case established.  Thus, in the 1980’s, the Pennsylvania Department of Revenue argued that that our client, L. L. Bean, Inc., was required to collect Pennsylvania sales and use tax on all of its sales into the state because the mail order industry had changed since National Bellas Hess was decided.  The Pennsylvania Commonwealth Court squarely rejected this challenge to National Bellas Hess.  L. L. Bean, Inc. v. Department of Revenue, 516 A.2d 820 (Pa. Cmwlth. 1986).

Similarly, the State of California threatened assessment of 300 direct marketers on the ground that they had nexus with California because of their use of 1-800 numbers and acceptance of credit cards.  On behalf of the Direct Marketing Association, Brann & Isaacson sued in federal court, and the Ninth Circuit issued a judgment in favor of the DMA, on behalf of its members, declaring that in the absence of a physical presence in a state, a company is not liable for sales and use tax in that state.  DMA v. Bennett, 916 F.2d 1451 (9th Cir. 1990), cert. denied, 500 U.S. 905 (1991).

The states’ next test case, Quill v. North Dakota, 504 U.S. 298 (1992) (Brann & Isaacson filed an amicus curiae brief on behalf of the DMA in Quill), was yet another unsuccessful effort by the states to overrule and/or limit the physical presence test.

The states’ latest efforts to limit the nexus test under the Commerce Clause by adoption of an economic presence test to measure nexus for gross receipts tax should also be rejected.

Colorado Enacts Law on Gift Cards; Update on Other States’ Cash Redemption Rules

Amidst the hullaballoo over Colorado’s recently enacted affiliate nexus and out-of-state vendor reporting requirements and its recent economic nexus regulation, Colorado also passed a new law regarding gift cards.

Under the new law, signed by Governor Ritter on April 29, issuers of gift cards, including actual cards and electronic cards, must redeem the remaining value of a gift card for cash if there is $5 or less remaining on the card and the holder of the card so requests. Additionally, sellers may not sell gift cards which contain a service fee, dormancy fee, inactivity fee, maintenance fee, or any other type of fee. The new law does not apply to gift cards which are useable with multiple sellers, unless the multiple sellers are affiliated sellers. Violations of the new statute are deemed deceptive trade practices under Colorado law.

Other states have similar laws and/or pending legislation regarding cash refunds for low balances on gift cards and certificates:

California Nixes Affiliate Nexus Legislation; Connecticut’s Attempts Stall

Since our last update on the status of various legislative attempts to introduce Amazon-style affiliate nexus across the country, there have been a few important developments:

California

In the most current iteration of its bill, passed by the State Assembly on May 6, California scrapped proposed affiliate nexus and Colorado-style notice requirements (discussed here by us last month), and instead merely requires out-of-state retailers to provide notice on their websites and in their catalogues that California customers are required to remit use tax.  In the bill analysis provided by the Assembly’s Revenue and Taxation Committee, the Committee rightly noted that under Quill, California is constitutionally prohibited from collecting sales tax from out-of-state retailers with no physical presence in the State.  The Committee also noted that the bill provides no repercussions for non-compliant retailers.  The bill is now before the State Senate.

Connecticut

In Connecticut, the last action taken on H.B. No. 5481, the proposed affiliate nexus legislation, was on April 13.  The 2010 regular session of the State’s legislature adjourned on May 5 without holding any vote on the bill, and it appears that no affiliate nexus legislation will be enacted in the near future.


UPDATE, Aug. 31, 2010:  Please see our most recent post concerning the status of this California Bill here.

UPDATE, Jul. 5, 2011: California has enacted a new nexus law.

Colorado Jumps On The Economic Nexus Bandwagon

Increasingly, eCommerce vendors face potential exposure to state corporate income and similar taxes (such as certain franchise, gross receipts and business activity taxes) in jurisdictions where they have no physical presence, based on the doctrine of so-called “economic nexus.”  Judicial decisions from a number of jurisdictions, such as New Jersey and West Virginia, and recently enacted tax laws, such as the Ohio Commercial Activity Tax (“CAT”) and the Michigan Business Tax (“MBT”), are based on the notion that an out-of-state company may be subject to a state’s corporate tax laws based solely on having significant “economic activity” related to or directed at the state.  The issue of whether the doctrine (and each of its different incarnations) is consistent with the limits on state taxing power imposed by the Commerce Clause of the United States Constitution remains unsettled.  Remote sellers have raised objections and challenges to many of these laws.  However, for now, at least, under laws such as the CAT and MBT, an out-of-state company that makes total sales to customers in the state that exceed a certain prescribed threshold, even without any offices, employees, or property in the state, will be deemed to have “bright line” nexus with the state for corporate tax purposes.

The latest state to jump on the “economic nexus” bandwagon is Colorado.  What is unusual about Colorado’s new standard, however, is that it derives not from a legislative enactment or decision of Colorado’s courts, but rather from a new administrative regulation, Colorado Code of Regulations §39-22-301.1 (effective April 30, 2010), promulgated by the Colorado Department of Revenue.   Under the guise of (re-)interpreting the statutory definition of “doing business” in the state, the Colorado DOR adopted a so-called “factor presence” standard of nexus for corporate income tax purposes which sets certain minimum levels for Colorado payroll ($50,000), property ($50,000) and, most importantly, for eCommerce businesses and Internet sellers, sales ($500,000), over which a company will deemed to be subject to Colorado corporate income tax.  While the establishment of such payroll and property thresholds may relieve certain companies with very limited physical presence in Colorado from having to report Colorado income tax, the determination that vendors having Colorado sales over $500,000 subjects them to Colorado income tax purports to extend significantly Colorado’s taxing power to many out-of-state direct marketers.

While it seems likely that the regulation will, like similar laws in other states, be challenged on constitutional grounds, direct marketers should weigh their options in consultation with counsel and based on their own particular circumstances.  When considered together with Colorado’s new law requiring out-of-state retailers to report the names and addresses of their purchasers to the Department of Revenue for use tax purposes (see our March 11 post), it appears that Colorado lawmakers are prepared to test (or even outright disregard) the time-honored principles of the Commerce Clause.   Stay tuned.

The "Draft" Federal Privacy Bill: Uniformity, But at What Cost?

On May 3, 2010, Representatives Rick Boucher, Democrat of Virginia, and Cliff Stearns, Republican of Florida introduced a “discussion draft” of a bill “[t]o require notice to and consent of an individual prior to the collection and disclosure of certain personal information relating to that individual.”  The bill seeks to provide uniform, national regulation of information collection and disclosure practices for a wide range of companies--governing not only the Internet, but all other channels of interaction between businesses and consumers--and it has already generated controversy.  Not only does it include a definition of private information that goes far beyond all existing laws, it contains strict notice and consent provisions that may be difficult and costly to implement.  It is unclear what triggered the drafting of the bill, nor what compelling public interest would warrant such a degree of intrusion into private business practices.

It is important to keep the draft bill in perspective.  Numerous privacy and security bills have been proposed over the years and Congress has, to date, been unable to pass anything coming close to comprehensive national legislation.  For example, repeated attempts to pass federal security breach legislation have failed, resulting in a plethora of state laws which are both confusing and inconsistent.  If Congress can't bring itself to pass uniform rules dealing with the very real issue of security breaches involving the theft or loss of sensitive personal information, the likelihood of it passing a comprehensive law governing the collection and use of personal information -- a far less serious matter -- seems limited, at best.

Nevertheless, it remains useful to examine the bill and how it addresses key issues that affect eCommerce companies.  Even if the bill fails to gather support in Congress, individual states may feel inspired to adopt some of its provisions.

Should You Be FACTA Compliant? -- June 1, 2010 Deadline for Compliance with the FTC’s Red Flags Rule Approaches

Under the Fair and Accurate Credit Transactions Act (“FACTA”), Congress in 2003 mandated that businesses which extend credit to consumers for personal, family or household purposes must adopt policies and procedures designed to identify instances of possible “identity theft” in connection with transactions/requesting such credit.  The regulations promulgated by the Federal Trade Commission (“FTC”) implementing FACTA’s provisions are referred to as the “Red Flags Rule,” because the procedures adopted by businesses are supposed to identify “red flags” that signal a risk of identity theft in connection with a consumer credit transaction.  After deferring the effective date of the Red Flags Rule four times, the deadline for affected businesses to comply is now June 1, 2010.

On its face, FACTA would not appear to apply to many direct marketers or Internet sellers, who most often do not extend credit, themselves, but instead rely on credit cards.  The requirements of FACTA, however, extend to those retailers that sell products or services on installment plans or otherwise extend credit to consumers.  In addition, retailers that offer private label or co-brand credit cards (i.e. the retailer’s name appears on the credit card) may also be affected, even if they do not act as the issuer of the card.  This is because the FTC’s Red Flags Rule also applies to service providers and others who assist creditors (the card issuer) in receiving or processing requests for credit.  Furthermore, FTC staff has indicated their intent to apply the Red Flags Rule very broadly, so that the rule may be applied even to transactions involving the extension of credit to sole proprietorships, on the theory that such transactions involve a risk of identity theft for the individual operating such a business.

Update: Status of 2010 Affiliate Nexus Legislation

As we reported on March 9, New York-style “Amazon” affiliate nexus legislation was introduced in the 2010 legislative sessions of multiple states.  Even as the North Carolina Department of Revenue has introduced a program intended to entice retailers to register for sales and use tax purposes under its existing affiliate nexus statute (see our recent post for further discussion of the issue), other states are moving closer to adopting similar laws.  At the same time, affiliate nexus legislation has died, for this legislative season at least, in several states.  Here’s an update with regard to such legislation in a number of states:

Moving Forward:

• Connecticut: Bill favorably reported out of committee with recommendation that it “ought to pass”
• Minnesota: Committee hearing on bill scheduled for April 20
• Tennessee: Bill recommended for passage by Tax Subcommittee of Ways & Means, but Tennessee Department of Revenue has indicated that it does not believe mere affiliate relationship would be adequate for nexus

In Committee:

• California: Last action (re-referral to Committee on Appropriations) was April 28, 2010
• Illinois: Last action (referral) was March 19, 2010

Dead (it appears) for 2010:

• Iowa: General Assembly adjourned without acting on the bill
• Maryland: General Assembly adjourned without the bill getting out of committee
• Mississippi: Bill died in committee
• New Mexico: Bill tabled
• Vermont: Ways and Means Committee voted not to include affiliate nexus measure in tax legislation
• Virginia: Affiliate nexus legislation tabled in committee

UPDATE, Aug. 31, 2008:  Please see our most recent post concerning the status of the California Bill here. 

North Carolina’s “Carrot and Stick” Approach To Sales Tax Collection

Recently, a number of our clients received a letter from the North Carolina Department of Revenue, which contained an announcement by the Department of a new “Internet Transactions Resolution Program.” North Carolina, which is one of the three states that has adopted an Amazon Affiliate Nexus Law (see my blog post dated March 9, 2010), provides the following “carrot” as part of the Program: if a retailer registers for sales and use tax and agrees to collect and remit those taxes for four years, beginning September 1, 2010, the Department in turn will not assess tax, penalties or interest for the period prior to September 1, 2010.  In addition, the Department states that it will not seek to obtain information regarding names and addresses of the retailer’s customers prior to September 1, 2010.  (It is noteworthy that Amazon has sued the Department of Revenue on the ground that it has sought personally identifiable information from Amazon regarding Amazon’s customers.)

So, now to the “stick.”  The Department also notes in its letter to direct marketers that for those retailers who fail to participate but are “subject to nexus filing requirements,” the Department will assess all applicable tax, interest and penalties and will not waive any penalties.  Thus, the Department is offering the carrot of an amnesty for past tax liability and relief from any demand for customer information from the retailer for periods prior to September 1, 2010, in lieu of the enforcement.

Cybersquatting and the UDRP

Recently, I was a guest lecturer at the trademark law class at the University of Maine School of Law, invited by my colleague, Rita Heimes, director of the Maine Center for Law and Innovation.  I always enjoy an opportunity to discuss trademark law in an academic setting, and it is invigorating to meet aspiring young trademark lawyers.

The topic for my talk was the Uniform Dispute Resolution Policy (“UDRP”). For those unfamiliar with this policy, it helps protect businesses against “cybersquatting.”  For instance, if the owner of the Acme brand discovers that the domain name "acme.com" is registered by someone else, and is being used in bad faith, the UDRP is the most effective tool available for Acme to recover that domain name.  Prior to the creation of the UDRP, the prospects for success in a domain name dispute were uncertain, and the costs were potentially exorbitant.  In the mid to late 1990's, when widespread use of the Internet was first becoming prevalent, it was unclear whether existing trademark doctrine enabled the recovery of a domain name in this manner, and in any event, the only way to find out was to launch an expensive and time consuming lawsuit.  This time period was typified by a “gold rush” for ownership of domain names and many famous brand owners discovered to their dismay that their best option for securing the all-important “.com” domain name was to pay millions of dollars to the prescient person who had beaten them to the punch.

The UDRP was introduced at the insistence of brand owners by the Internet Corporation for Assigned Names and Numbers (“ICANN”), the entity that governs the allocation of Internet "real estate," in order to address the gap left by preexisting law.  Any person registering a domain name must consent to participation in the UDRP’s form of alternative dispute resolution, and agree to abide by the dispute resolution’s results. Typical costs to recover a domain name using this process are between $1500 and $3000, the success rate is very high (around 85%), and the process can be completed in a month or less.  The UDRP has been around for more than 10 years and has been used very effectively by brand owners to recover millions of improperly registered or used domain names.  Accordingly, it no longer qualifies for "cutting edge" status, although it is surprising how many brand owners remain unfamiliar with it.

In the course of preparing my remarks, however, I also had occasion to delve into some of the remaining challenges in this area, and to explore recent noteworthy developments. 

Publishers Should Address State Tax Exposure Regarding the New Agency Pricing Model

As discussed in eBooknewser on April 16, and in TechFlash on April 15, Amazon is now allowing some publishers to set their own prices on e-books sold for the Kindle.  The agency pricing model creates new responsibilities for some publishers in connection with state tax.  Publishers with agency agreements with Apple and Sony, the other main players in the e-book market, also face state tax ramifications stemming from agency pricing agreements.

A publisher becomes a retail seller required to collect and remit sales and use tax on all sales of digital books in each state where digital books are taxable and in which the publisher has nexus.  At this point, of the 45 states and the District of Columbia that impose sales tax, only 24 states actually tax digital products.  But that number is likely to increase as states search for additional revenue.

California Follows Colorado Down the Rabbit Hole

As we wrote last month, Colorado recently enacted legislation requiring retailers that do not collect Colorado sales tax to provide a list of their Colorado customers and the amount of Colorado purchases to the State Department of Revenue on an annual basis. Retailers must also inform purchasers of their duty to remit use tax and provide purchasers an annual statement of their purchases.

In that entry, Matt Schaefer wrote, “Voters in other states beware.” In fact, just days before Colorado’s bill was signed into law, the California Assembly introduced its own, similar legislation: AB 2078, as amended April 5, 2010. The bill is currently before the Assembly’s Committee on Revenue and Taxation. If passed in its current form, California would institute Colorado-type reporting requirements which, like Colorado’s law, are potentially in violation of Quill, discriminate against interstate commerce, and certainly invade consumers’ privacy.

New York Threatens to Discontinue Long-Standing Promotional Material Exemption

As a result of the U.S. Supreme Court’s decision in D. H. Holmes Co., Ltd. v. McNamara (486 U.S. 24 (1988)), a number of states began taxing promotional materials printed outside of the state and distributed within the state.  New York was one of those states until March 1, 1997.  At that time, New York enacted an amendment to New York Tax Law Section 1115(n) to exempt promotional materials distributed in the State.  The exemption has been broadly interpreted to include the finished product as well as mechanicals, layouts, artwork, photographs, and other pre-press services and materials, and also includes services relating to mailing lists.  In a search for revenue, New York now threatens to remove this exemption.  If passed, New York Assembly Bill - A.9710-B Budget Article VII – Part R would eliminate the exemption provided in Section 1115(n).

It is also reported that Pennsylvania is thinking of eliminating its exemption, too.  Other states, such as California, Michigan and Ohio, provide exemptions for promotional materials distributed in the state, and thus far have not sought to eliminate the exemptions.  In fact, I recently argued and won a case against the Board of Equalization at the California Court of Appeal, PeoplePC v. California BOE, in which the Court ruled that California’s printed sales message exemption applies not only to promotions printed on paper, but also to promotions printed on CDs.

As Matt Schaefer wrote in this blog last month, states have begun putting pressure on companies to collect use tax on promotional materials, even on sales to clients with no physical presence in such states.  Let’s hope that there is not also a trend to eliminate the exemption for printed sales messages where direct marketers are still protected.

Are You Selling "Children's Products"?

When Congress passed the Consumer Product Safety Improvement Act (the “CPSIA”) in 2008, it included a new definition of what constitutes a "children's product." Along with that new definition came a host of onerous testing, certification, and product design/composition standards. If the products you're selling fall into this category, your legal obligations expand dramatically to include third-party certification, substrate testing for lead, prohibitions on phthalates, product tracking labels, and more.  And so, the question of "What is a children's product?" becomes extraordinarily consequential for wholesalers, retailers, "private labelers," and importers.

As is traditionally the case with "age grading" of products, the CPSIA's definition generalizes things to the point of providing very little practical guidance on many products.  Under the new regime, a "children's product" is "a consumer product designed or intended primarily for children 12 years of age and under." While it is one thing to say roughly which products are intended for children who are two, or four, or six, or even eight, products of interest to many twelve-year-olds also appeal to older teens and even adults. Is a product primarily intended for twelve-year-olds if it broadly appeals to teenagers, for example? How closely must you parse the demographics of potential customers to figure out whether your audience is likely to be "primarily" twelve-year-olds? Coupling this with analysis of design aims and product "intentions" makes matters even more complex.

Into this analytical quagmire, the Consumer Product Safety Commission (“CPSC”) has now dropped 50 pages of industry guidance, including a brand new proposed regulation.  Once you dive in, it doesn't take long to realize that some of the products you thought were children's items may not be. Worse yet, some products that you reasonably might have concluded were "not designed or primarily intended for children 12 years" or younger may well be viewed very differently by the CPSC.  In other words, the CPSC has raised as many questions as it answers.

Message to State and Local Governments: Leave Regulation of Interstate eCommerce to Congress

Two recent, related developments should serve to remind state and local government and tax officials that under our Constitution’s Commerce Clause, it is Congress ― not states and localities ― that has the power “to regulate Commerce...among the several States.”  Art. I, Sec. 8, Cl. 3.

On January 25, 2010, the Supreme Court issued its decision in Hemi Group, LLC v. City of New York, 130 S.Ct. 983 (2010), rejecting an attempt by the City of New York to use the Racketeer Influenced and Corrupt Organizations Act (“RICO”) to punish a New Mexico-based online seller of cigarettes for allegedly costing the City millions of dollars in lost sales and use tax revenue on cigarettes purchased by New Yorkers.  The City did not claim that Hemi Group was obligated to collect and remit the $1.50 per pack New York City use tax on cigarettes. Rather, the City claimed that the Hemi Group failed to comply with its legal obligations under the federal Jenkins Act (15 U.S.C. §§ 375-378), which requires out-of-state cigarette sellers to register and file a report with state tobacco tax administrators listing the name, address and quantity of cigarettes purchased by New York state residents.  The State of New York had an agreement to share such information with the City of New York.  Hemi Group’s failure to comply, the City argued, meant that it received no information from the State about cigarette purchases by City residents from Hemi Group, and therefore could not bill them for any use tax that the residents failed to self-report and pay. According to the City, Hemi Group’s violation of the Jenkins Act also constituted a RICO violation that harmed the City through the loss of use tax revenues.

Maine Adopts Finnigan for Determining Sales Sourced to Maine for Corporate Income Tax

Maine is a unitary state for purposes of the corporate income tax. As is true for other states (e.g., California, Illinois and South Carolina), Maine adopted the Joyce approach for sourcing of sales by entities within a unitary group that did not have nexus with Maine under PL 86-272. See Appeal of Joyce, Inc., No. 66-SBE-070 (Cal. SBE, Nov. 23, 1966). This means that Maine-destination sales by an entity without nexus would not be included in the numerator of the sales apportionment factor.

However, in recently adopted legislation, P.L. 2010, c. 571, § GG, which is effective for tax years beginning on or after January 1, 2010, Maine adopted the Finnigan approach, which was first announced by the California Board of Equalization in 1988. See Appeal of Finnigan Corporation, No. 88-SBE-022 (Cal. SBE, Aug. 25, 1988) (Finnigan I); Opin. on Pet. for Rhrg., No. 88-SBE-022-A (Cal. SBE, Jan. 24, 1990) (Finnigan II). Finnigan rejected Joyce and provided that sales by a member of a unitary group to California are included in the numerator of the combined group’s sales apportionment factor even though the entity does not have nexus with California. It is noteworthy that California later renounced the Finnigan approach and has resorted back to the Joyce approach. See Appeal of Huffy Corporation , No. 99-SBE-005 (Cal. SBE, Apr. 22, 1999). See also FTB Reg. 25106.5. What makes this result particularly severe for unitary businesses is that Maine uses only the single apportionment factor of sales.

Michigan on the Hunt: The Department of Treasury’s Nexus Enforcement Efforts

Recently, many direct marketers and online retailers received a letter from the Michigan Department of Treasury notifying them of the “carrot and stick” approach the Department of Treasury is taking regarding the enforcement of the Michigan sales and use tax, the Michigan Business Tax (“MBT”), which was adopted on January 1, 2008, and the Michigan Single Business Tax (“SBT”), a tax on gross receipts which was repealed effective December 31, 2007.

The carrot that Michigan has offered is not very big. If a company comes forward to sign a voluntary disclosure agreement, makes payment of taxes and interest for the four year period prior to the filing, and agrees to begin collecting and paying each of these taxes on a go forward basis, it is relieved of liability for penalties, and Michigan will limit its lookback period for tax and interest to four years prior to the filing. No tax, penalty, or interest would be due for any period prior to that.

What’s Next For Sales Tax (a/k/a Use Tax) On Direct Mail?

Direct marketers know that successful eCommerce strategies often depend upon reaching customers offline as well as online. Direct mail, including the distribution of catalogs, remains one of the most effective ways of driving traffic to a website. Indeed, given the reluctance of some consumers to give out their e-mail addresses, and the protections afforded consumers from unwanted solicitation under anti-SPAM, Do-Not-Call and other consumer privacy laws, traditional “snail mail” marketing techniques remain an important way for Internet sellers to communicate directly with customers.

Although several larger states (including California, New York, and Pennsylvania) provide exemptions from tax for certain types of direct mail, the vast majority of jurisdictions treat direct mail as taxable. And in all states, including those that provide exemptions, there are myriad other complex legal issues affecting taxability, including sourcing rules, taxability of postage, “direct mail” certificates, and nexus considerations, each of which make determining the proper sales tax treatment of direct mail transactions challenging. Add the fact that mailings go to recipients in many, if not all 50 states (and countless localities), each of which has its own tax law, and the difficulty of properly applying tax to any particular direct mail transaction multiplies exponentially.

Welcome Eyes on IP Readers

We'd like to thank the folks at our sister-blog, Eyes on IP, for their warm welcome to the world of blogging and for introducing us to all their readers.

To our new friends referred by Eyes on IP, we hope that you take some time to look around our blog and that you find something useful.  As we note in our introduction, our blog is devoted to providing legal insight to the world of eCommerce, including topics such as tax, privacy and data security, FTC compliance, state abandoned property laws, product safety, and consumer protection.  Please consider yourselves welcome, and let us know if you have any questions, comments, or feedback. 

To our faithful Eyes on Ecom Law readers, take a moment to check out our colleagues at Eyes on IP.  They provide a bird's eye view of the wide world of intellectual property...with an eye to how intellectual property matters to business.  Insights abound at Eyes on IP.

UPDATE: Our friends have moved -- you can now visit our sister blog at IP Wise.

Facebook: Not Just For Friends?

The Obama Administration is considering sending federal officers undercover on Facebook and other popular social networking sites. This effort raises a number of interesting questions, some legal, some not. For example, would the feds work with Facebook, or simply register, and silently patrol the social network looking for leads? If they went with the cooperative approach, just how much help could Facebook provide given its privacy policy and terms of use? Would it unlock the kingdom based upon an informal request, or would it require a subpoena or search warrant to comply? And, if the government decided to slip into the system without alerting Facebook, would it be required to follow Facebook's terms of use -- such as providing real names and contact information? What are the consequences if a person "tricks" someone into being their friend?

A confidential Department of Justice presentation obtained by the Electronic Frontier Foundation sheds some light on these issues, and also provides useful guidance in the crafting of privacy policies and terms of use by eCommerce companies, including those who provide social networks or online communities.

Think You’re Safe Storing or Releasing “Anonymized” Data? Think Again.

Anonymity is increasingly difficult to safeguard, and direct marketers that collect, maintain, share, and use customer information should take note of a recent class action settlement by Netflix than stemmed from the company's disclosure of an "anonymized" customer database.

Most federal and state privacy and data security statutes focus on the protection of "personally identifiable information," such as names, addresses, telephone numbers, financial account numbers, social security numbers, and email addresses. In response to such laws, many companies strip personally identifiable information from databases containing sensitive information. Once stripped of identifiers, the theory goes, the risks of identity theft or violations of consumer privacy rights resulting from disclosure of the data (whether purposeful or not) are eliminated. Some companies may even conclude that the data may be shared for marketing or "data mining" purposes without violating their privacy policies or applicable laws.

According to the Electronic Privacy Information Center, however, "computer scientists have revealed that this 'anonymized' data can easily be re-identified, such that the sensitive information may be linked back to an individual."

Gift Cards: The Sleeping Dog

Many of you may have read about the federal Credit Card Accountability, Responsibility, And Disclosure Act of 2009 (the “CARD Act”). While the CARD Act largely regulates the terms and conditions for credit cards, it also provides certain protections for purchasers of gift cards that will go into effect on August 22, 2010. But many people may not be aware that the CARD Act does not preempt or otherwise supersede state laws on gift cards, either before August 22 or afterwards.

There are many states that have gift card laws that bar the use of expiration dates on purchased gift cards, prohibit or set restrictions on imposing inactivity fees or other charges with regard to gift cards, and/or require disclosures regarding fees and expiration dates. Some of these laws are enforceable by the attorneys general of the states and/or through suits brought by consumers.

Thoughts from the NEMOA Spring Conference: Perils for Vendors from Affiliate Endorsements

Today was Day 3 of the New England Mail Order Association Spring Conference in Boston. It was a great conference with lots of opportunities for benchmarking and networking. A number of industry gurus were present, including George Michie from The Rimm-Kaufman Group, who gave a great talk on paid search issues that this lawyer found compelling.

Marty Eisenstein and I moderated a round table discussion on emerging online affiliate issues. There was quite a bit of interest in new FTC guidelines regarding testimonials and endorsements. These new guidelines have the potential to impact seriously a number of business practices that are quite common among reputable online merchants.

Colorado's HB 1193 Risks Constitutional Violations and Threatens Consumer Privacy

The assault on eCommerce by short-sighted state legislators and tax officials continues. By now, many of you have heard or read about the new Colorado law (HB 1193) enacted in February, that imposes certain sales tax notice and reporting obligations upon each “retailer that does not collect Colorado sales tax.” Under the law, most non-collecting retailers are required:

(a) beginning effective March 1, 2010, to inform their Colorado purchasers of the purchaser’s duty to remit use tax on certain purchases under Colorado law;

(b) beginning in January 2011, to provide Colorado purchasers an annual statement of all of their Colorado purchases from the retailer; and

(c) beginning in January 2011, to file annually with the Colorado Department of Revenue a list of all purchasers and the amount of their Colorado purchases.

Harmonized Sales Tax Expands to Ontario and British Columbia on July 1, 2010

In the past year, both Ontario and British Columbia entered into agreements with the Canadian federal government to harmonize the Goods and Services Tax (“GST”) and Provincial Sales Taxes (“PST”) into a single Harmonized Sales Tax or “HST.” The HST will be effective July 1, 2010, and will be administered by the Canada Revenue Agency (“CRA”).  Ontario and the federal government have already passed legislation implementing the HST.  British Columbia has yet to pass its own implementing legislation, but has already taken steps towards harmonization with the federal government.

LifeLock: $12 Million to Settle Data Security False Advertising Claims

The company whose advertising campaign included displaying their CEO's social security number on the side of a truck has reached a settlement to pay $12 million to the FTC and 35 states who charged LifeLock, Inc. with false representations about the effectiveness of its services. In an official press release, FTC Chairman Jon Leibowitz said that “[w]hile LifeLock promised consumers complete protection against all types of identity theft, in truth, the protection it actually provided left enough holes that you could drive a truck through it.”

But the case against LifeLock didn't end there. The FTC and the states also charged LifeLock with making false claims about its own data security practices. According to the FTC, LifeLock failed to live up to the following representations:

The WISP Has (Finally) Landed: MA's Data Protection Law Now In Effect

After a seemingly unending series of delays and modifications, Massachusetts's data protection regulation finally went into effect on March 1, 2010. A copy of the regulation can be obtained here. Unlike the data protection laws of most states, the Massachusetts regulation requires holders of data to put in place a comprehensive set of written measures to protect confidential information (also known as a "WISP," or “written information security policy”), and to update their WISPs on an annual basis. The required contents of the WISP are outlined in the regulation, and cover topics ranging from encryption to vendor agreements.

Thumbnail: The new regulation applies to all persons and companies who either own or license personal information about residents of Massachusetts, and applies both to electronic and paper records. While the opening clause of the regulation appears to limit its coverage to "customer information" and "consumers," the balance of the regulation does not distinguish between information about customers, consumers, employees, or other categories of persons. If past experience with the administrative process in Massachusetts is any guide, it will be a long and winding road before we get any formal guidance as to the regulation’s scope.

“Amazon Affiliate Nexus” Statutes: A Business-Savvy Alternative

Tax and trade journals report about each new state that is considering adopting an “Amazon Affiliate Nexus” statute, patterned after the New York statute adopted in 2008. As of this writing, North Carolina and Rhode Island have each enacted a New York-type online affiliate nexus statute, and several other states, including California, Connecticut, Illinois, Maryland, Minnesota, Tennessee, Vermont and Virginia are considering whether to adopt similar statutes. Should an online retailer discontinue its affiliate relationships in those states? Should the online retailer begin collecting and remitting sales and use tax in states with such statutes even where it has no physical presence? Should the online retailer challenge the statute in court by suing the state and disputing the constitutionality of the statute, as was done by Amazon.com and Overstock.com in New York? There are clearly problems with each approach. If the retailer elects to discontinue its online affiliate relationships, the retailer may hurt its business. Besides, the retailer may not have identified all of its affiliates, each of which contributes to a presumption of nexus under the statute, and thus may face a risk of nexus in any event. On the other hand, a retailer’s collection of the sales and use tax means remitting the sales and use tax on all of its sales in the state, even if the affiliate-generated transactions are only a small percentage of its sales. Least attractive of all may be the litigation approach, which can take a long time to reach resolution and which has an uncertain outcome.

Welcome to Eyes on eCom Law

Welcome to Eyes on eCom Law, a blog devoted to providing legal insight to the world of online and direct marketing. The attorneys at Brann & Isaacson have been advising direct marketers on all aspects of their businesses for more than 35 years, and have served as Tax Counsel for the Direct Marketing Association for the past 20 years. As direct marketing has evolved from traditional mail order to online and multi-channel marketing, we have continued to guide clients through an ever-changing landscape of legal issues. We know firsthand that both "pure-play" online and multi-channel direct marketers face their own set of unique legal challenges in areas such as tax, privacy and data security, Federal Trade Commission compliance, state abandoned property laws, intellectual property, product safety, and consumer protection.

With our breadth of practice and depth of experience, Brann & Isaacson has the expertise necessary to identify and explain the significance of new legal developments relevant to eCommerce. For "e-tailers" of every size and business model, it can be a difficult task to navigate eCommerce’s myriad legal intricacies. We hope that this blog will serve as a resource to help the direct marketer manage its business and to make sense of the legal developments and challenges (and even opportunities) facing the industry. Please feel welcome to ask questions, make comments and send us feedback!