Monday, April 30, 2012

Yet Another State (Georgia) Adopts a Click-Through Nexus Law

On April 20, 2012, Georgia Governor Nathan Deal signed legislation revising the definition of “dealer” in the Georgia statute. Under Georgia law, a dealer is required to collect and remit sales/use tax on all taxable sales to Georgia residents.

The first change to the dealer definition is to adopt a so-called “click-through nexus” law (or “Internet affiliate nexus” law), along the lines of the New York statute enacted in 2008. Georgia is now the eighth state to adopt a click-through nexus law. As previously reported in this blog, New York was the first state to adopt a nexus click-through statute, followed by Rhode Island, North Carolina, Arkansas, Illinois, Connecticut, California and Pennsylvania. (The California statute is effective only if federal legislation is not adopted, and will go into effect on January 1, 2013). (The Pennsylvania “law,” which is an administrative rule, does not commence until September 1, 2012).

*As previously reported in our blog, on April 25, 2012, the Illinois Circuit Court ruled from the bench that the Illinois “click-though nexus” (or “Internet affiliate nexus”) statute is unconstitutional under the substantial nexus requirement of the Commerce Clause and also violates the federal Internet Tax Freedom Act’s moratorium against discriminatory state taxes on electronic commerce.* (As a ruling of a court in a different state, the Illinois court’s decision striking down the Illinois statute has no direct effect on the Georgia click-through nexus law, but certainly would have some relevance in any review of the statute. )

Much like the New York law, the Georgia statute, HB 386 (LC 34 3484S/AP), provides that a retailer that enters into an agreement with one or more persons who are residents of Georgia under which the resident, for a commission or other consideration based on completed sales, directly or indirectly refers potential customers to the retailer, if the retailer’s cumulative gross receipts from sales by such persons exceed more than $50,000 during the preceding twelve months. (Under the New York law, the threshold is $10,000.) If the retailer enters into such an agreement, a presumption is created that the retailer is a dealer required to collect the Georgia sales and use tax. However, the presumption may be rebutted by submitting proof that the residents with whom the person has an agreement do not engage in any activity within Georgia that is significantly associated with the person’s ability to establish or maintain a market in Georgia during the preceding twelve months. The proof may consist of sworn written statements with the residents attesting to the fact that they have not engaged in any solicitation in the state on behalf of the retailer. It is somewhat unclear when this portion of the statute goes into effect; the earliest date is July 18, 2012 but it may be as late as December 30, 2012.

In short, the Georgia statute is modeled after the New York statute. Like the New York statute, a retailer can overcome the presumption of nexus by a showing that the resident does not engage in any activity in the state to maintain a market in the state. (This is in contrast to the Connecticut and Illinois statutes, which create a per se finding of nexus if the requisite relationship is found to exist).

The new Georgia law also provides for “affiliate nexus,” similar to the recently adopted Utah statute concerning companies related through common ownership, as discussed in my article in this blog dated April 2, 2012. This part of the law goes into effect on October 1, 2012. In particular, if a retailer and any other company under common ownership or control that has substantial nexus in Georgia sells a similar line of products in the state under a similar business name or use substantially similar trademarks or service marks, then a presumption of nexus is created. Again, this presumption can be rebutted by a showing that the in-state affiliate does not engage in any in-state activities on behalf of the retailer that are significantly associated with the retailer’s ability to establish a market.

The new Georgia law does provide a safe harbor for participation in trade show activities of five days or less and if the retailer “did not derive more than $100,000 of net income from those activities during the prior calendar year.” It is unclear whether the term “deriv[ation] . . . of net income” means sales less expenses made at the trade show or whether it means sales remotely made.

In sum, online retailers and other direct marketers should carefully scrutinize their existing relationships to make sure that their companies are not vulnerable to a finding of nexus under the new Georgia law. While such review does not necessarily mean discontinuance of click-through relationships, it does require making sure that any agreement with affiliates is tailored to overcome the presumption if sales through such affiliates are greater than $50,000.

Thursday, April 26, 2012

Court Rules that the Illinois Internet Affiliate Nexus Law is Unconstitutional and Violates the Internet Tax Freedom Act

Yesterday (April 25, 2012), Judge Robert Lopez Cepero of the Illinois Circuit Court for Cook County granted summary judgment in favor of the Performance Marketing Association (“PMA”) in its constitutional challenge to the Illinois "Internet affiliate nexus" statute, Public Act 96-1544 (the “Act”), which took effect in July 2011. Judge Cepero ruled from the bench, after oral argument by the parties’ counsel, that the Illinois law is both unconstitutional under the “substantial nexus” requirement of the Commerce Clause and violates the federal Internet Tax Freedom Act's moratorium against discriminatory state taxes on electronic commerce. The Court will enter a formal order encapsulating its rulings, although Judge Cepero indicated that he does not plan to issue a written opinion, separate from his remarks made on the record at the hearing. The Defendant, the Director of the Illinois Department of Revenue, is said to be reviewing his options, but is expected to appeal the ruling directly to the Illinois Supreme Court. (George Isaacson and Matt Schaefer of Brann & Isaacson represent the PMA in the case.)

Like other “Internet affiliate nexus” laws, the Illinois statute seeks to impose a use tax collection obligation upon out-of-state Internet retailers who enter into contracts with affiliates located in the state, under which the affiliate places a link on its website connecting Internet users to the retailer’s website, and receives commissions or other compensation based on sales made to such customers. Under the terms of the Act, any Internet retailer that realized $10,000 in annual sales from customers who reached its website through links on the sites of Illinois Internet affiliates would be required to collect Illinois use tax. The Court held, however, that the activity described in the Illinois law was not sufficient to create use tax nexus with Illinois for purposes of the Commerce Clause. The Court also held that imposing a use tax collection obligation upon Internet retailers engaged in such online linking relationships, but not on other retailers engaged in similar offline adverting arrangements, is “premature” in light of the ITFA's moratorium, which remains in effect until November 1, 2014.

Wednesday, April 25, 2012

Internet Retailers and Digital Businesses Should Understand the State Tax Risks Associated with Telecommuting Employees

In the increasingly “officeless” environment of the digital workplace, Internet retailers, cloud computing providers and other remote sellers should be aware of the sometimes unexpected state tax consequences associated with employees who telecommute. Although there are few reported court decisions, a vast majority of the states assert that having employees located in the state engaged in non-sales activities who telecommute from home is a sufficient presence in the state to require a company to collect the state’s corporate income or franchise tax. It is also clear that having a telecommuting employee in the state creates meaningful sales and use tax nexus risk, but whether a telecommuting employee will create a "physical presence" in the state sufficient to require the company to collect state use tax may depend upon the nature of the employee’s in-state activities on behalf of the company.

The leading case in the still-developing decisional law on telecommuting is the recently-decided Telebright Corp. v. New Jersey Division of Taxation, 424 N.J.Super. 384, 38 A.3d 604 (App. Div. 2012). In Telebright, the Appellate Division of the Superior Court of New Jersey affirmed a Tax Court decision that the presence in the state of a software developer telecommuting on a daily basis for a Maryland company was sufficient to subject the company to an obligation to report New Jersey Business Corporation Tax (“CBT”). Id., 424 N.J.Super. at 395, 38 A.3d at 611. The employee in Telebright performed no sales functions on behalf of the company (indeed, the Tax Court noted that the company solicited no sales in New Jersey, at all), but she was involved in developing a web-based software application that the company marketed to its clients, a fact that the Appellate Division emphasized in finding that the company both was “engaged in business” under CBT statute and had sufficient nexus with the state for CBT purposes.

Of course, federal law P.L. 86-272 will still protect a company from an obligation to report a state’s corporate income tax, if the company’s in-state telecommuting employees are engaged solely in solicitation of sales for orders of tangible personal property that are approved and filled from outside the state. Many businesses that rely on telecommuting, however, are not protected by P.L. 86-272, because they sell services or computer software applications that may not be deemed “tangible personal property” under state law. Furthermore, employees telecommuting from a state engaged in activities other than solicitation (or activities strictly ancillary to solicitation), will not qualify for P.L. 86-272 immunity. Indeed, more than thirty-five state revenue departments have indicated in response to various surveys that the presence of non-sales, telecommuting employees will subject the company to an obligation to report state income tax.

With regard to state sales and use taxes a direct physical presence in a state through employees will also create a risk of use tax nexus. It is clear that if an in-state employee is engaged in sales solicitation or support activities with respect to in-state customers, s/he can create nexus under established Supreme Court precedent. See, e.g., Tyler Pipe Indus., Inc. v. Washington Dep’t of Revenue, 483 U.S. 231 (1987). Even the activities of non-sales employees, however, should be examined carefully to determine the level of nexus risk to the company when making a business decision about whether to engage telecommuting employees in the state employee to telecommute. In some states, a non-sales employee may not create nexus. For example, the California Board of Equalization has indicated in one Sale and Use Tax Annotation (SUTA 220.0256: “Telecommuting In-State”) (June 21, 1999) that a remote seller that had an employee engaged in web design who telecommuted from his home in California was not “engaged in business” in the state for purposes of California use tax because the telecommuter did not have any contact or involvement with customers in the state. Many other state revenue departments have, however, at least in response to informal surveys, taken a less permissive view. Remote sellers should consult carefully with their tax counsel to understands the use tax risks associated with particular telecommuting arrangements.

Thursday, April 5, 2012

Federal Court Declares Colorado Use Tax Notice and Reporting Law Unconstitutional

Good news for Internet retailers and other direct marketers. Last Friday, March 30, 2012, Judge Robert Blackburn of the Federal District Court for the District of Colorado, entered summary judgment in favor of the Direct Marketing Association (DMA) in its suit challenging a 2010 Colorado notice and reporting law. The Court declared the law unconstitutional and permanently enjoined and restrained the State from enforcing it. (The Court had previously suspended enforcement of the law in January 2011, pending entry of a final judgment in the case. George Isaacson and Matt Schaefer of B&I represent the DMA in the case.)

The Colorado law sought to impose three principal requirements upon retailers that do not collect Colorado sales tax. First, the Act required affected out-of-state retailers to give notice to their Colorado customers, in connection with each sale, that the customer must report Colorado use tax (the “Transactional Notice”). Second, the Act required affected retailers to send annually to each customer that purchased more than $500 of goods for delivery to Colorado, a summary of the customer’s purchases for the year (the “Annual Purchase Summary”). Third, of perhaps greatest concern to retailers, the Act required remote sellers to submit a report to the Colorado Department of Revenue, by March 1 of each year, listing the name, billing and shipping addresses, and total amount of purchases of all customers who purchased goods for delivery to Colorado (the “Customer Information Report”). The Court struck down each of these requirements as unconstitutional under the Commerce Clause.

The Court’s ruling is particularly important because Judge Blackburn found in favor of the DMA on both counts of its complaint challenging the law (and its implementing regulations) under the Commerce Clause. In other words, Judge Blackburn agreed with the DMA that the statute and regulations violate the Commerce Clause because they both: (a) discriminate against out-of-state retailers who do not collect Colorado sales tax, by imposing upon them burdens that are not imposed on Colorado retailers; and (b) place undue burdens upon retailers with no physical presence in the state, consistent with the Supreme Court’s landmark decision in Quill Corp. v. North Dakota.

On the issue of whether the Colorado law discriminates against interstate commerce in violation of the Commerce Clause, the Court ruled that, by singling out retailers that do not collect Colorado sales tax for differential burdens, the law imposes its notice and reporting obligations solely upon out-of-state retailers. The Court expressly rejected the Department’s argument that the law is non-discriminatory because out-of-state retailers could “choose” to collect Colorado sales tax and thereby avoid the notice and reporting burdens imposed by the Act. The Court found that, by conditioning an out-of-state retailer’s reliance upon its constitutional rights on a requirement that the retail accept a different burden, unique to out-of-state retailers, the purported “choice” offered by the Act “does not eliminate, but instead, highlights the discrimination” against out-of-state retailers with no physical presence in the state. The Court also found that the Department had offered no evidence to show that the law's goal of increased tax compliance by Colorado purchasers could not be achieved through reasonable non-discriminatory alternatives, such as those suggested by the DMA.

The Court also agreed with the DMA that the law imposes improper and burdensome regulations upon retailers with no physical presence in the state, in violation of the Commerce Clause principles embodied in Quill. Judge Blackburn wrote:

“Looking to the practical effect of the Act and the Regulations, as Quill instructs, I conclude that the burdens imposed by the Act and Regulations are inextricably related in kind and purpose to the burdens condemned in Quill. The Act and the Regulations impose these burdens on out-of-state retailers who have no physical presence in Colorado and no connection with Colorado customers other than by common carrier, the United States mail, and the internet. Those retailers are protected from such burdens on interstate commerce by the safe-harbor established in Quill.”

The Court’s application of the Quill physical presence nexus standard to a law that does not impose use tax collection obligations upon remote sellers, but instead purports to impose related, but different regulatory burdens, is a potentially significant development with regard to the constitutional protections afforded to remote sellers against states seeking to extend their regulatory authority beyond state borders.

The State of Colorado is expected to appeal the District Court’s ruling to the Federal Court of Appeals for the Tenth Circuit.

Monday, April 2, 2012

What is an “Affiliate Nexus” Statute?

Some of you may have read the headline in CCH’s State Tax Day on March 27, 2012, “Affiliate Nexus Bill Enacted,” and wondered whether this describes yet another state that provides that nexus is established by virtue of a link from a web site “affiliate” to a remote seller’s web site. The State Tax Day article describes a statute signed into law on March 24, 2012 by Utah Governor Gary R. Hebert. The Utah law, H.B. 384, Laws 2012, however, does not provide for nexus on the basis of a link to a web site. Rather, the law provides that nexus is established for a remote seller based upon certain specified relationships between the remote seller and affiliated entities; i.e. parent, subsidiaries or other companies under common ownership. In other words, the law has no click–through nexus provisions, so the Utah statute does not specify that a company has nexus simply because a blogger or other internet site links to the company’s web site and receives commissions from the company sales that resulted from such a link.

There are two types of “affiliate nexus” statutes. The first type is of the Utah variety, in which the word “affiliate” means the companies are affiliated through common ownership. Several states have adopted statutes of this type, in part in response to the localized distribution model Amazon has begun to implement in which an affiliate of opens a distribution center in a state and drop ships to’s customers. Texas, for example, enacted S.B. 1, Laws 2011 (effective January 1, 2012), that provides that a retailer is engaged in business in Texas if an affiliate distributes goods to the retailer’s customers from a distribution center in the state. The new law in Utah (as does a proposed law in Virginia, SB 597), provides that a remote seller is engaged in business in the state if its affiliate has a place of business or employee in the state that advertises, promotes or facilitates sales by the remote seller. Such a provision in not controversial from a constitutional perspective, in that if the Utah–based affiliate operates as an agent or representative of the remote seller to make a market for the remote seller in Utah, the physical presence requirement of Quill is probably satisfied. (Please note that the proposed Virginia law reference above, SB 597, has an effective date of September 1, 2013, as part of an arrangement with Amazon to permit Amazon to open a fulfillment center in that state without being liable for taxes prior to that date. Similar arrangements for a delayed effective date, combined with Amazon opening a distribution center in the state, were reportedly agreed upon between Amazon and lawmakers in both Indiana and Tennessee, as well.)

The second type of “affiliate nexus” statute, which is more controversial from a constitutional perspective, is a click–through nexus statute in which the “affiliate” has no ownership connection to the remote seller, but refers potential customers to the remote seller’s web site. Thus far, seven states have adopted click through nexus statutes: Arkansas, California, Connecticut, Illinois, New York, North Carolina and Rhode Island. In addition, Pennsylvania has adopted a regulation, Sales and Use Tax Bulletin 2011-01 (issued December 1, 2011 with a delayed effective date of September 1, 2012) with similar provisions. The click–through nexus laws are of two kinds. In the first kind, modeled after the New York law, a contract or other arrangement with a resident of the state by which the resident receives a commission from a remote seller for referrals to the seller creates a presumption of nexus if the annual sales from such arrangements exceed a certain threshold. All but the Connecticut, Illinois and Pennsylvania laws contain a presumption, which may be rebutted by a showing that the in–state company does not engage in any other solicitation or other promotional activity in the state on behalf of the remote seller. While there are potential arguments to challenge the constitutionality of these “presumptive nexus” laws, many remote sellers prefer to avoid the expense of litigation and structure their relationships with affiliates to be able to show that the affiliates do not engage in activities on their behalf in the various states that have adopted nexus presumption statutes.

The Connecticut, Illinois and Pennsylvania laws do not permit a remote seller to introduce evidence that the affiliates do not conduct in–state services on their behalf. These statutes, therefore, raise serious constitutional questions. While I will not discuss those in detail, because they are the subject of pending litigation of which Brann & Isaacson represents the plaintiff in a constitutional challenge, I note that a critical feature in the New York appeals court’s decision in LLC v. New York State Dep’t of Taxation and Finance, 81 A.D.3d 183, 913 N.Y.S.2d 129 (App. Div. 2010) that the New York statute was constitutional, is that under the New York law the out–of–state company could avoid a nexus determination by presenting evidence that the online affiliate did not conduct solicitation in New York.

I should also point out that there are a number of state legislatures that are reviewing proposed nexus click–through statutes. They include Georgia, Kansas, Minnesota, Mississippi , and New Jersey. The Georgia Bill, H.B. 386, has both types of “affiliate nexus” provisions and has been adopted by both the House and Senate, but is awaiting approval or rejection by the Governor. As of the writing of this blog, none of the other proposed laws has been enacted.