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.