Eyes on eCom Law

Pennsylvania DOR Puts Constitutionally-Suspect Affiliate Nexus Interpretation on Hold

2012-02-03T14:33:00.002-05:00

On January 27, 2012, the Pennsylvania Department of Revenue delayed until September 1, 2012 the enforcement of its recently announced (and legally questionable) position regarding affiliate nexus.

We have written frequently about state affiliate nexus statutes and proposed legislation, as well as the challenge brought by our client, the Performance Marketing Association (“PMA”), against the Illinois affiliate nexus statute which took effect in July 2011. All of these affiliate nexus laws are of doubtful constitutionality. Indeed, Brann & Isaacson has argued on behalf of the PMA that the Illinois law impermissibly targets Internet performance marketing as a basis for asserting a use tax collection obligation on out-of-state retailers, in violation of both the Commerce Clause of the United States Constitution and the federal Internet Tax Freedom Act (“ITFA”). In an area of law where the authority of the states to expand their taxing power is very much in doubt, every state that has adopted an affiliate nexus law has done so through the legislative process by enacting a statute that purports to require reporting of use tax by remote sellers with no physical presence in the state.

On December 1, however, the Pennsylvania Department of Revenue determined that it did not require a new affiliate nexus statute in order to require use tax collection by Internet sellers advertising online through websites located in Pennsylvania. Instead, the Department issued Sales and Use Tax Bulletin 2011-01, regarding Remote Seller Nexus. The Department asserts in the Bulletin that a variety of activities, if conducted in the state by, or on behalf of, an out-of-state company, already constitute sufficient nexus under the Commerce Clause and state law to require the remote seller to collect Pennsylvania use tax. Some of the activities cited by the Department have been the basis for a finding of nexus for an out-of-state company in prior court decisions around the country (and, presumably, have long been reflected in the Department’s enforcement practice). The Department, however, also included “affiliate nexus” on the list. The Department will now make a finding of nexus for an out-of-state company even if the company’s only activity is merely having a contractual relationship with a person located in Pennsylvania whose website has a link to the remote seller’s website, if the in-state affiliate receives “consideration” for the contractual relationship with the retailer.

The Department’s very broadly-phrased affiliate nexus provision goes even beyond the expansive language of the 2011 Illinois law challenged by the PMA and, in our view, is plainly unconstitutional. The Department’s stated position also appears to be in violation of the ITFA. It remains to be seen if the Department will issue further guidance on affiliate nexus, or step back from its position altogether. For now, the Department press release states that it is delaying the “deadline” on enforcement until September 1, 2012, in order to give Internet retailers and remote sellers more time to comply. We will keep you posted on developments in Pennsylvania and in the area of affiliate nexus more generally.

Unclaimed Property Laws Often Go Overlooked by E-Marketers, But Many States Are Aggressively Enforcing Them

2011-12-12T11:42:00.001-05:00

One set of legal obligations that are often overlooked by Internet sellers arise under states’ “unclaimed property” laws, sometimes referred to under the arcane label of “escheat.” Black’s Law Dictionary defines escheat as “the preferable right of the state to an estate left vacant, and without there being any one in existence able to make a claim thereto.” Although dense, the definition, once parsed, describes a relatively simple concept: under the laws of nearly every state, a business that is holding property on behalf of a third-party (called the “owner”) is obligated to report and turn over the unclaimed property to the state, after passage of a prescribed “dormancy” period.

Unclaimed property includes customers’ unredeemed gift certificates and gift cards, merchandise credits, and uncashed refund checks. It also includes accounts payable, payroll and benefits, shareholder dividends, and even workers’ compensation funds, among other things. Indeed, any third-party obligation that goes unredeemed may be subject to escheat. For Internet retailers, unredeemed gift obligations can be substantial (although fortunately some state laws include exemptions for gift certificates). Retailers should be aware that expiration dates on gift certificates and gift cards do not apply to states’ right of escheat and that there is no statute of limitations on escheat obligations under most states’ laws.

Essentially, as such property becomes “abandoned” under the applicable dormancy period, the holder of the property (i.e., the retailer) must pay such amounts to the state. As a general rule, the holder is obligated to remit the funds to the state of the last known address of the owner; if the retailer does not have address information for the holder, then the retailer typically must remit the funds to the retailer’s state of domicile (typically, where the retailer is incorporated).

Many states aggressively enforce their unclaimed property laws as a source of revenue. (Among the most active states for unclaimed property audits are Arizona, Delaware, Illinois, Massachusetts, Michigan, New Hampshire, New Jersey, Nevada, Rhode Island, and Tennessee.) Indeed, a number of states are increasing the number of unclaimed property audits they conduct on the belief that there are billions of dollars of unreported unclaimed property. State laws typically impose interest and penalties for failure to report, as well.

Note that there is no nexus rule that limits a state’s constitutional authority to seek to collect unclaimed property from a remote seller. Multi-state audits are common. In addition, many states are now using outside auditors, paid on a commission basis, to pursue collection. Not surprisingly, such “hired-gun” auditors have an incentive to think creatively and to conduct wide-ranging, time-consuming audits that examine records going back decades.

There are strategies for managing unclaimed property obligations and reporting. If you believe your company faces unclaimed property reporting requirements which have not yet been addressed, consult legal counsel for advice on the various solutions available.

Storm Clouds on the Horizon for Direct Marketers Regarding Required Use Tax Collection

2011-12-09T17:18:00.002-05:00

After the introduction in July 2011 of the “Main Street Fairness Act” by three senators from the Democratic Party, federal legislation intended to eliminate the Quill physical presence requirement for state sales and use tax collection has gathered increased support. A group of 10 Senators from both sides of the aisle introduced the “Marketplace Fairness Act” on November 9, 2011. The new bill, S.1832, is sponsored by Senators Mike Enzi (R-WY), Richard Durbin (D-IL), Lamar Alexander (R-TN), Tim Johnson (D-SD), John Boozman (R-AR), Jack Reed (D-RI), Roy Blunt (R-MO), Sheldon Whitehouse (D-RI), Robert Corker (R-TN), and Mark Pryor (D-AR). On October 13, 2011, Representatives Steve Womack (R-AR) and Jackie Speier (D-CA) introduced in the House a similar, but not identical, bill called the “Marketplace Equity Act.”

As we wrote in our post on August 8, the Main Street Fairness Act, which was sponsored by Senators Durbin, Johnson, and Reed, does not provide meaningful measures to simplify the arduous burden of sales and use tax collection. The Marketplace Fairness Act (and its House counterpart) would provide even less simplification than does the Main Street Fairness Act. It is ironic that despite the unfairness of this proposed legislation to catalogers, online retailers, and other direct marketers, the Marketplace Fairness Act is more likely to pass than prior legislative efforts, because of the increased number of sponsors from both political parties, as well as the coalition of states, industry groups, and big retailers (including e-commerce giant Amazon.com), that have announced their support for this new bill. Thus, the alarm bells should be ringing loudly for Internet and other direct marketers.

Critical Additional Feature of the Marketplace Fairness Act

The Marketplace Fairness Act would extend collection obligations well beyond the Main Street Fairness Act to authorize any state that has not adopted the Streamlined Sales and Use Tax Agreement (“SSUTA”), but has adopted negligible simplification measures, to require tax collection by remote sellers.

If adopted, the Main Street Fairness Act would permit states that become members of the SSUTA to require companies without a physical presence in the state to collect sales and use tax in the states. (There are 24 states that are members of the SSUTA). The Marketplace Fairness Act, on the other hand, incorporates this authorization and then expands it to permit any state that implements (in the language of the proposed legislation) “minimum simplification requirements” to require catalogers, online retailers, and other companies that have national annual sales greater than $500,000 to collect the state’s sales tax on sales to residents of the state.

The Marketplace Fairness Act is Anything But Fair

Although the SSUTA provides some protection to remote sellers from the burden and expenses of sales tax collection, the “simplification requirements” of this new bill provide even fewer benefits to catalog and e-marketers, and increased burdens.

There simply is nothing in this new bill that provides meaningful simplification for remote sellers. In other words, there is no provision for uniformity in sales tax laws among states; the simplification is only within the state, and the term “simplification” even within the state is a misleading term, at best.

We have discussed the SSUTA in various posts, which is incorporated, in effect, into that Act. As we have written previously, the SSUTA does not provide significant relief from administrative burdens and expenses of sales tax compliance. Just as under the SSUTA, the Marketplace Fairness Act does not ease the tax burden by requiring common exemptions throughout the states, uniform treatment for shipping and handling charges, and a consistent definition of the selling price for determining the amount subject to sales tax.

Similarly, like the SSUTA, the Marketplace Fairness Act permits the imposition of many combined (state and local) rates within a state based on the destination of the sale, thus potentially permitting a large number of different tax rates on sales to residents of the state, in addition to the thousands of tax rates a remote seller would be required to impose on its sales throughout the country. While the Marketplace Fairness Act specifies that a state must provide adequate software and services to identify the destination local rate and to hold harmless remote sellers from liability for mistakes made by a provider of sales tax administration services, this clause does not eliminate the administrative burden, expense, and risk to a remote seller of billing for, and collecting, sales and use taxes at different rates on its sales throughout the country.

Moreover, the Marketplace Fairness Act adds another layer of complexity that is not even present for the SSUTA. The SSUTA does provide for common definitions of some terms to be used in the sales tax statutes of the member states. The SSUTA also requires uniform rules among the member states for the deduction by a retailer of bad debts. The Marketplace Fairness Act does not require states to adopt such definitions and uniform rules regarding bad debts. The result is that if this new Act were adopted, a remote seller would be potentially subjected both to the definitions and bad debt rules of the SSUTA states and the differing and varying definitions and bad debt rules set forth in the statutes of the more than 20 non-member states.

There is a Real Possibility that the Marketplace Fairness Act Will be Adopted

Unlike prior state efforts to persuade Congress to enact laws eliminating the Quill physical presence test, there is increasing support from both Democrats and Republicans and from diverse industry groups for the Marketplace Fairness Act.

Over the past 20 years, the states have repeatedly caused legislation to be introduced in Congress to abolish the nexus physical presence requirement. The likelihood of successful adoption of the Marketplace Fairness Act, however, differs from prior legislative efforts for several important reasons:

There is significant support from both Democrats and Republicans in Congress.
The states are facing large financial problems (including mounting and huge pension costs), while federal funding for the states is drying up because Congress is not receptive to providing funding to assist the states at the expense of other federal programs or increased taxes.
The legislation is supported by big box retailers.
Well-funded associations such as the National Retail Federation and the International Council of Shopping Centers support the law.
Amazon had been one of the most vigorous opponents of prior legislation. Now, Amazon is offering the service of collecting tax on behalf of other retailers for a fee of 2.9% of the taxes collected.

The only ray of light in this gloomy picture is that Senators Wyden (D-OR) and Ayotte (R-NH) and Representatives Lungren (R-CA) and Lofgren (D-CA) have introduced resolutions in Congress opposing mandatory collection by online retailers of sales and use tax.

A perfect storm has developed to permit passage of anti-Quill legislation. The current legislation being considered does not provide significant protection to industry members. It is up to direct marketers to let their positions be known.

Nexus of Subsidiary Not Automatically Attributable to Parent Company

2011-10-26T14:25:00.002-04:00

Recently, a number of states have adopted statutes providing that an out-of state retailer is presumed to have nexus in the state by virtue of ownership of a subsidiary that does business in the state. See California (ABX 1, but note its implementation was delayed by AB 155); Colorado (Colo. Rev. Stat. § 39-26-102(3)(b)(II)); and Arkansas (Ark. Code Ann. 26-52-117(b)). While each of these state statutes provides that mere ownership creates only a presumption of nexus, which a retailer can rebut, some commentators have interpreted these laws as attributing the nexus of in-state affiliates to related out-of-state companies.

But an out-of-state retailer’s mere ownership of a company without the company acting as an agent or representative of the retailer will not create nexus for the retailer under the constitutional standard. Quill and a number of cases decided both before and after Quill stand for the proposition that mere ownership of another company that has an in-state presence does not create nexus for the parent, absent the in-state subsidiary engaging in activities on behalf of the parent to create a market in the state for the parent. We wrote an article back in 1996 that discusses the case law. See Defending Against Affiliate Nexus in Sales and Use Tax Collection Liability Cases, State Tax Notes (March/April 1996). In other words, the subsidiary must be acting as an agent or representative of the parent company in the state for the nexus of the subsidiary to be attributed to the parent.

The constitutional standard has not changed since we wrote the article in 1996. In fact, recent position statements issued by the Tennessee Attorney General and the staff of the California Board of Equalization agree that ownership of an in-state company alone does not create nexus for the out-of-state company. The Tennessee statute (Tenn. Code Ann. § 67-6-102(25)(G)), which has been on the books for a number of years, provides that an out-of-state retailer that “maintains, or has within this state, directly or by a subsidiary, sales room or house, warehouse, or other place of business distributing facility or warehouse,” has nexus with Tennessee. Cal. Rev. & Tax Code § 6203(c)(1) similarly provides that “[a]ny retailer maintaining, occupying, or using, permanently or temporarily, directly or indirectly, or through a subsidiary, or agent, by whatever name called, an office, place of distribution, sales or sample room or place, warehouse . . . or other place of business” is required to collect and remit the California use tax.

In Opinion No. 11-71 (dated October 3, 2011), the Tennessee Attorney General opined in a response to a request from the Legislature to interpret the statute that the mere ownership by Amazon.com of a subsidiary that operated a distribution center in Tennessee would not establish nexus for Amazon.com in connection with its sales of products. Something more needs to be established. According to the Attorney General, “nexus is established only if the subsidiary’s in-state activities are significantly associated with the retailer’s ability to establish and maintain a market in Tennessee for sales.” The Attorney General’s opinion cites Tyler Pipe Industries, Inc. v. Washington Department of Revenue, 483 U.S. 232 (1987). In Tyler Pipe, the out-of-state company contracted with sales representatives that conducted in-state solicitation activities on its behalf. These activities, according to the Supreme Court, created nexus because they helped “to establish and maintain a market” in the state. The Tennessee Attorney General’s opinion notes that “the current Supreme Court jurisprudence in this area does not firmly establish whether a subsidiary’s ownership or maintenance of an in-state distributing center or warehouse would be sufficient to create nexus where the subsidiary is not engaged in actual solicitation activities.” See Attorney General’s Opinion No. 11-71 at p. 2.

Similarly, in an October 14, 2011 discussion paper regarding proposed revisions to Sales and Use Tax Regulation 1684, Board of Equalization staff commented on the state of common ownership nexus. The staff agrees with the Tennessee Attorney General that mere ownership does not establish nexus, citing Current, Inc. v. State Board of Equalization, 24 Cal.App.4^th 382 (1994) (a case that we commented on in our 1996 article), and the more recent case of Borders Online, LLC v. State Board of Equalization, 129 Cal. App.4^th 1179 (2005), in which the Court of Appeals held that the activities conducted on behalf of the retailer must “enhance the retailer’s sales to California customers and significantly contribute to the retailer’s ability to establish and maintain a market in California.” See Discussion paper at 5. (We disagree with staff’s conclusion that the standard of performing “services in this state in connection with tangible personal property to be sold by the retailer” satisfies Quill.)

In short, as we wrote long ago, the ownership of a subsidiary alone will not create nexus. The in-state subsidiary must be engaged in activities on behalf of the out-of-state company (parent) in order to create the necessary nexus for the out-of-state company. The law has not changed since we wrote the article. The recent wave of legislation does not alter the test in Quill.

There May Yet Be Life In The Quill Due Process Prong

2011-09-28T15:46:00.002-04:00

In February 2011, we wrote about a case (Gordon v. Holder), in which the federal Court of Appeals for the District of Columbia Circuit vacated the denial of preliminary injunction against the enforcement of the federal Prevent All Cigarette Trafficking Act (PACT Act), P.L. 111-154 (2010). The PACT Act mandates state sales/use tax compliance by “delivery sellers” of tobacco products, regardless of whether the seller has a physical presence in the state. In vacating the denial of the preliminary injunction, the D.C. Circuit also advised the lower court to address on remand the issue of whether the PACT Act’s imposition of “potentially disparate burdens on ecommerce” violates the Due Process Clause of the United States Constitution (even though Congress has the authority to impose such burdens under the Commerce Clause). It appears that the Gordon case remains on remand before the district court as of this writing.

The Second Circuit Court of Appeals has now also ruled that a federal law must satisfy a minimum standard under the Due Process Clause before it may purport to authorize the imposition of state use tax collection by remote sellers. Red Earth LLC v. Holder, __ F.3d __, 2011 WL 4359919 (September 20, 2011). In Red Earth, the Second Circuit upheld the granting of a preliminary injunction against the PACT Act’s state tax collection provisions as they apply to certain Native American “delivery sellers” of tobacco products, on the grounds that the Act may be in violation of basic Due Process standards. Although, as the Court noted, the Due Process Clause does not require that a retailer have a “physical presence” in a state before a use tax obligation may be imposed, the Court found that the district court did not err in ruling that PACT Act likely violates the Due Process Clause because it “requires a seller to collect based on its making of [only] one delivery” in the state.

Both the DC Circuit’s February remand order and Second Circuit’s September 20 ruling confirm that a federal law that purports to impose (or allow) state use tax collection obligations on remote sellers must be consistent with the dictates of the Due Process Clause. This mandate includes ensuring that such obligations do not run afoul of the requirement that a retailer must “purposefully avail[] itself of the benefits of an economic market in the state” before it may be subjected to the state’s taxing power. See Quill Corp. v. North Dakota, 504 U.S. at 307-08. Although the Supreme Court in Quill held that the retailer in that case had sufficiently targeted the North Dakota market to eliminate any Due Process concerns, the Supreme Court has recently had reason (in the context of challenges to personal jurisdiction over a defendant in a tort case), to re-evaluate Due Process standards as they apply to companies with no physical presence in the state. See, e.g. J. McIntyre Machinery, Ltd. v. Nicastro, 131 S.Ct 2780, 2792 (2011). It remains to be seen how constitutional Due Process standards may impact federal laws that purport to authorize the imposition of state use tax collection obligations on remote sellers. Stay tuned.

California Governor Signs (Possibly Temporary) Affiliate Nexus Law Repeal

2011-09-23T17:50:00.000-04:00

As we wrote recently, on September 9, the California legislature passed AB 155, which repeals (for at least the next year) the affiliate nexus provisions of the affiliate nexus law (ABX 1-28) enacted in June. The repeal may be only temporary, because the new law provides that if federal legislation overturning Quill Corp. v. North Dakota is not adopted by July 31, 2012, or if such legislation is adopted, but California does not implement the federal law’s requirements by September 14, 2012, then the affiliate nexus provisions of the repealed law, with some modifications described in our prior post, will kick back in on January 1, 2013, under the terms of AB 155.

Although Governor Brown reportedly had some misgivings regarding AB 155, he signed the bill into law earlier today. The law is effective immediately, so for now, California no longer has an affiliate nexus law. Whether federal legislation will be enacted and whether California will implement any such law’s requirements remains to be seen…

British Columbia Repeals HST in Voter Referendum

2011-09-15T16:51:00.000-04:00

As we have written previously, in 2010, both Ontario and British Columbia entered into agreements with Canada to harmonize the Goods and Services Tax (“GST”) and their Provincial Sales Taxes (“PST”) into a single Harmonized Sales Tax, or “HST.” The HST went into effect July 1, 2010, in both provinces.

But, the HST proved unpopular in British Columbia, and on August 26, a majority of voters in British Columbia passed a referendum aimed at extinguishing the HST and reinstating the PST. The transition back to the PST is expected to take “a minimum of 18 months." The reason for the long transition is that the province must develop and pass legislation and regulations to re-implement the PST and put in place systems to administer it, and the federal government and the province must pass transitional rules to return the province to the GST. Additionally, British Columbia must determine how it will refund to the federal government the $1.6 million provided to the province to aid in its initial transition to the HST.

As a result of the transition, British Columbia will again be subject to the 5% federal GST and the PST will return to its former 7% rate. Because the HST was 12% (5% federal component and 7% provincial component), British Columbians and retailers carrying on business in British Columbia will not see any change in the tax rate. However, retailers should be aware that the tax base for the reinstated PST will likely differ from the tax base for the GST. British Columbia anticipates providing quarterly updates as to the re-implementation of the PST and until implementation is complete, the HST will continue to apply.

No similar voter referenda appear to be on the horizon in any of the other harmonized provinces (New Brunswick, Newfoundland and Labrador, Nova Scotia, and Ontario), but we will continue to keep track of and inform our readers of any developments as they arise.

California Affiliate Nexus Law Repealed (At Least Temporarily) In Deal With Amazon

2011-09-12T17:42:00.003-04:00

As we have previously reported, on June 28, California enacted an affiliate nexus law (ABX 1-28). Under the California law, an out-of-state retailer that has contracts with California affiliates to publish online advertisements linking consumers to the retailer’s website would have been required to collect California sales tax (or use tax) on all of its sales to California purchasers, if: (1) the in-state publishers also engaged in solicitation of customers in the state on behalf of the retailer through other means (such as by flyers, telephone calls, or e-mails) targeting California consumers; (2) the publishers of the advertisements were compensated based on sales made by the retailer; (3) over a 12 month period, the retailer realized at least $10,000 in cumulative sales to consumers accessing its site through such online ads; and (4) the retailer had California sales of at least $500,000 during such 12 month period.

Amazon.com responded to ABX 1-28 by supporting a campaign to repeal the new affiliate nexus law by citizens’ referendum, which was reportedly well on the way to gathering the necessary signatures to get the repeal measure on the ballot next year.

Now, political maneuvering between Amazon and the California General Assembly has resulted in a compromise. On Friday, September 9, the General Assembly enacted AB 155, which will become law immediately if Governor Brown signs the bill (as he is expected to do, despite some reported misgivings). AB 155 repeals, at least for a year (on the conditions described below), the California affiliate nexus law (i.e., ABX 1-28 described in the first paragraph), and also provides that the law will not be enforced for the period between June 28 and the effective date of AB 155. The bill also repeals (on the same conditions) the “controlled group” of corporations provisions of ABX 1-28. Those provisions purported to require use tax collection by any out-of-state retailer that is part of a group of corporations that includes a member that performs services in California in connection with tangible personal property to be sold by the retailer.

The repeal of the California affiliate nexus law is contingent upon the enactment by Congress of federal legislation to overturn the “physical presence” nexus requirement of Quill Corp. v. North Dakota, which prohibits a state from imposing a sales/use tax collection obligation on a remote seller or Internet retailer without a physical presence in a state. Amazon has reportedly agreed to lobby for such federal legislation and, in a press statement, said: “This [California] legislation will allow us to continue to work with Congress and the states to obtain a federal resolution to the sales tax issue as soon as possible.”

Here’s how the repeal works (if signed by Governor Brown):

The California affiliate nexus provisions of ABX 1-28 enacted on June 28 are repealed and no longer of any effect, and also will not be enforced with respect to the period from June 28 through the effective date of AB 155 (i.e., the date Governor Brown signs the bill);

If no federal legislation is adopted over-ruling Quill before July 31, 2012, then the California affiliate nexus provisions (as re-stated in AB 155, with one important change, noted below) will become law on September 15, 2012;

If federal legislation overturning Quill is adopted by July 31, 2012, and California does not implement the requirements of such a federal law by September 14, 2012, then the California affiliate nexus provisions (again, as restated in AB 155, with the change noted below) take effect January 1, 2013;

If federal legislation over-turning Quill is adopted by July 31, 2012, and California implements the requirements of such a federal law by September 14, 2012, then the affiliate nexus provisions of AB 155 will NOT take effect.

Note that the affiliate nexus provisions of AB 155 that may later take effect ― in the event that Congress either does not enact federal legislation overturning Quill or California does not act to implement such federal legislation ― have been modified under AB 155 to increase the minimum sales threshold, so that they now will apply only to retailers that have in excess of $1,000,000 in cumulative sales to California residents in a 12 month period (although only $10,000 of those sales need to come from sales referred by in-state web affiliates).

This is a lot to take in, and remote sellers making sales to California residents should consult their legal advisors with any questions. At a high level, as a result of AB 155, e-commerce businesses and direct marketers that engage in online advertising through California affiliates get a temporary reprieve of at least 12 months from the effects of the California affiliate nexus law, and can continue to use California publishers of online advertisements during that period. But, they will likely need to scrutinize their California web affiliate relationships again before September 2012 and keep track of federal and California legal developments until at least January 2013.

The larger issue confronting each remote seller, however, may be whether the compromise struck in California is consistent with their own company’s goals and interests, and with the continued development of e-commerce more generally. Affected online retailers and publishers should stay informed and engaged regarding developments affecting the authority of all states to impose use tax collection obligations on out-of-state businesses. The time for sitting on the sidelines and watching the contest play-out between retail behemoths and the states has passed.

Performance Marketing Association Suit Challenging Illinois Affiliate Nexus Law Now in State Court

2011-08-26T16:34:00.000-04:00

On July 27, the Performance Marketing Association (“PMA”) filed a complaint in the Illinois Circuit Court for Cook County, challenging the new Illinois “affiliate nexus” law (“HB 3659”). In the complaint, the PMA asserts the same claims first raised in its complaint filed in the United States District Court in Chicago on June 1. As detailed in the complaint, the PMA alleges that HB 3659 violates the Commerce Clause and impermissibly discriminates against electronic commerce in violation of the Internet Tax Freedom Act (“ITFA”).

In connection with filing the suit in state court, the PMA has voluntarily dismissed the federal court action. The voluntary dismissal will prevent a protracted dispute with the Defendant, the Director of the Illinois Department of Revenue, regarding whether the federal court has jurisdiction over the case. Brann & Isaacson attorneys George Isaacson and Matt Schaefer are counsel to the PMA in the case.

After An Earlier Veto, Texas Enacts Nexus-Expanding Legislation In Response To Dispute With Amazon Over Distribution Center

2011-08-22T09:43:00.002-04:00

As many readers may be aware, last October, the Texas Comptroller issued a $269 million assessment against Amazon.com for uncollected use tax for the period December 2005 to December 2009. News reports indicated that the assessment was based primarily on the grounds that a related entity, Amazon.com KYDC LLC, operates a distribution center in Irving, Texas (near the Dallas/Forth Worth airport). Amazon disagrees with the assessment, and later sued to obtain the Comptroller’s audit file containing information regarding the basis for the assessment.

July 19 marked the latest volley in the battle between Amazon.com and the State of Texas. Other e-commerce sellers and direct marketers should now ensure that they do not suffer collateral damage.

In response to the contentious dispute that had developed between the State and Amazon, the Texas legislature introduced a number of bills in its 2011 legislative session intended, in effect, to make clear that Amazon.com is obligated to collect and remit Texas use tax. One version of such legislation made its way to Texas Governor Rick Perry in late May, only to be vetoed by the Governor, who has expressed opposition to Amazon nexus legislation. The Texas legislature, however, re-inserted the nexus-expanding language from the bill Perry vetoed into a broad budgetbill, SB 1, which passed in late June.

Governor Perry, after waiting until the final day on which he could act, signed SB 1 on July 19. The bill includes various revisions to the Texas Tax Code that appear to be intended to subject a retailer to an obligation to collect Texas use tax if the retailer uses a distribution center in the state which is maintained by a related company (or even an agent of the retailer), such as was the case for Amazon. The new provisions are broadly-written and arguably redundant in many respects, suggesting that the legislature wanted to be certain that the new law encompasses any conceivable legal arrangement between a retailer and distribution company. (Or, perhaps more cynically, the legislature wanted to be certain that the law covers whatever legal arrangements Amazon, specifically, may have with its distribution center.) Thus, the law provides that a retailer is “engaged in business” in the State, and thus obligated to collect use tax, if the retailer:

maintains or uses in the state, either directly or indirectly, or through a subsidiary or agent, a distribution center or any other physical location where business is conducted;
derives receipts from the sale of tangible personal property situated in the state;
holds a substantial (50% or greater) ownership interest in, or is owned in substantial part by, a person who maintains a location in the state from which business is conducted, if:

the retailer sells a similar product line under a similar trade name as the in-state entity; or
the in-state entity promotes or facilitates sales or otherwise assists the retailer in maintaining market in the state, including by receiving returns; or

holds a substantial ownership interest in, or is owned in substantial part by, a person that maintains a distribution certain or similar facility in the state and delivers property sold by the retailer to consumers.

See Texas Tax Code § 151.107(a)(1), (3), (7), (8). SB 1 also amends the definition of “retailer” to include a person who, under an agreement with another person, (A) is entrusted with possession of tangible personal property in which the other person has title and (B) is authorized to sell the property without additional action by the person having title.Id. § 151.008(b)(6).

While apparently drafted in a manner intended to target Amazon, Internet retailers and direct marketers that contract with a Texas business or use a Texas location, particularly for distribution purposes, should review the law and consult with their counsel to determine if they may be affected by new definitions. Given the high stakes battle between Amazon and the State, other companies could be caught in the cross-fire or even be targeted themselves. Best not to become an unwitting victim.

Tax Agencies Should Read the Language of the Statute and May Not Expand the Law’s Requirements

2011-08-09T14:46:00.001-04:00

As some of our readers are aware, on June 28, 2011, California’s Governor Brown signed into law a bill (ABX1 28) that provides for “click-through nexus” under certain circumstances. This law is similar to “click-through nexus” legislation adopted in New York, Rhode Island, North Carolina, and Arkansas (which we have written about extensively in the past), inasmuch as it creates a rebuttal presumption of nexus if a company’s annual sales to California exceed $500,000 and if the company’s California sales exceed $10,000 from links or other referrals from companies (“affiliates”) who receive a commission from such referrals.

Unlike the Illinois and Connecticut statutes, which automatically create nexus in the event that sales from affiliates exceed the threshold, the California law provides that the retailer can rebut the determination of nexus based on affiliate relationships. Nevertheless, in a recent notice issued by the California Board of Equalization (Notice L-284, issued July 2011), the Board states that there are only two conditions to a finding that a retailer must be registered for sales and use tax collection: (1) that sales from affiliates exceeded $10,000 in the last 12 months; and (2) that the retailer’s total sales to California exceed $500,000 in the last 12 months. According to the Board, if a business meets the foregoing requirements and is not already registered with the Board, it must complete a “California Certificate of Registration—Use Tax.”

The Board is simply wrong. It misses two sections of the newly-enacted statute. Section 6203(5)(E) provides as follows: “This paragraph shall not apply if the retailer can demonstrate that the person in this state with whom the retailer has an agreement did not engage in referrals in the state on behalf of the retailer that would satisfy the requirements of the commerce clause of the United States Constitution.” This is similar (but not identical) to the clauses in the New York statute that permit the retailer to show that the affiliates do not engage in any solicitation in the state. Similarly, Section 6203(5)(C) provides that “an advertisement on a web site will not create nexus if the person entering the agreement with the retailer also directly or indirectly solicits potential customers in this state through use of flyers, newsletters, telephone calls, electronic mail, blogs, microblogs, social networking sites, or other means of direct or indirect solicitation specifically targeted at potential customers in this state.” Many affiliate relationships are based on advertisements placed on web sites.

In short, it is important to read not only the notices you may receive from a state tax agency, but also to review the underlying legislation and regulations. State tax agencies simply cannot expand a law. Legislatures and Governors adopt laws. State tax agencies are entrusted with enforcing the laws, not creating them.

Bills Introduced in Congress to Override Quill in Favor of Streamlined Sales and Use Tax Agreement

2011-08-08T08:00:00.001-04:00

On July 29, 2011, the so-called “Main Street Fairness Act” was introduced in both houses of Congress. The bills, introduced as H.R. 2701 in the House of Representatives and as S. 1452 in the Senate, are identical. Under the proposed law, Member States in the Streamlined Sales and Use Tax Agreement (SSUTA) would be authorized to require remote sellers (i.e., Internet retailers and other direct marketers with no physical presence in the state) to collect and remit state and local sales and use taxes notwithstanding the substantial nexus standard established by the Supreme Court in Quill Corp. v. North Dakota. There are currently 24 full and associate member states in the SSUTA, representing approximately 36% of the population of the United States. Many larger states, including California, Florida, Illinois, New York, Pennsylvania and Texas are not SSUTA members.

Similar bills have been introduced in past sessions of Congress, including in 2003, 2006, 2007 and 2010. Brann & Isaacson Senior Partner, George Isaacson, has testified with regard to such prior legislation in 2003, 2006, and 2007 that the SSUTA has not achieved the goal of genuine simplification and uniformity of states sales and use tax systems. The requirements imposed on states by the current Congressional bills are substantially identical to prior versions and, in some respects, are even less demanding for states. In addition, H.R. 2701 and S. 1452 contain no express minimum level or “small seller” exemption that would protect smaller retailers from the obligation to collect use tax in all member states. Instead the bills defer to small seller exemptions established by the SSUTA states themselves.

We will keep you apprised of further developments regarding the bills.

California Adopts New Nexus Statute

2011-07-01T16:18:00.004-04:00

On Tuesday, Governor Jerry Brown signed into law California’s new nexus legislation. The law, which took effect immediately, expands the scope of activities requiring out-of-state retailers to collect and remit California sales and use tax by expanding the definition of “retailer engaged in business” in California.

The newly amended section 6203 of the California Revenue and Tax Code provides that a retailer engaged in business in the State includes any retailer that:

has substantial nexus with the State within the meaning of the Commerce Clause;

is a member of a commonly controlled group of corporations that includes another member which performs services for the out-of-state retailer in California (including the design and development of TPP sold by the out-of-state retailer or the solicitation of sales on behalf of the out-of-state retailer); or

enters into an agreement under which a person in California refers potential customers to the out-of-state retailer via the internet or other means in exchange for a commission or other consideration.

Similar to other state’s so-called “click-through” laws, California excludes from the definition of retailer out-of-state retailers that do not meet certain referral and sales threshold requirements. In California’s case, an out-of-state retailer will only be considered a retailer engaged in business in the State if all sales by the retailer from in-state referrals exceed $10,000 for the preceding 12 months and if the retailer has at least $500,000 in total sales to California customers.

However, unlike other states, California’s click-through law actually applies to affiliate referrals regardless of the channel through which the out-of-state retailer receives its referrals. While states like Illinois only include internet referrals in their nexus statute, California’s statute covers referrals from internet, television, radio, print, and other media in making the determination as to whether an out-of-state retailer is engaged in business in the State.

Also, unlike other state statutes, California’s new law states that, in the case of click-through, web-based affiliates, the in-state affiliate will only create nexus for the out-of-state retailer if, in addition to placing a link on its website, the affiliate also directly or indirectly solicits sales on behalf of the retailer through in-person, print, or electronic solicitation specifically targeted to potential California customers.

Finally, unlike other click-through states (with the exception of Illinois and Connecticut), the California statute does not specifically refer to any presumption of nexus which may be rebutted by the out-of-state retailer. However, the statute does make it clear that the affiliate nexus provisions will not apply if the out-of-state retailer can show that its affiliates made no referrals in the State sufficient to satisfy the Commerce Clause.

Keeping in mind the statute has already gone into effect, retailers should make sure to consult with their tax advisors soon. With that said though, we also advise our readers to have a safe and festive July 4^th holiday!

Connecticut Amends Its Affiliate Nexus Law To Mirror Illinois

2011-06-23T16:44:00.001-04:00

We have written frequently in recent months about affiliate nexus legislation introduced this legislative session in a number of states, and enacted recently in Illinois, Arkansas, Connecticut and, on a deferred basis (to take effect only after 15 states have adopted similar legislation) Vermont. (A similar bill has been passed in California, but has not yet been signed by Governor Brown.) Nearly every such bill has closely paralleled the affiliate nexus law adopted in New York in 2008, which provides for a presumption of nexus that can be rebutted by a retailer if the retailer can establish that its in-state affiliates have not engaged in any active solicitation in the state, but have merely posted online advertisements on behalf of the retailer that link to the retailer’s website. Illinois was the only state to adopt a law without such a rebuttable presumption.

The Connecticut legislature has now amended the affiliate nexus statute it passed in May 2011, to eliminate the rebuttable presumption and, instead, to closely mirror the Illinois law. Connecticut HB 6652, signed by Governor Malloy on June 21, repeals the affiliate nexus statute adopted in May, and instead modifies the definition of “retailer” (as well as the definition of “engaged in business in the state”) to classify as a Connecticut retailer any company that has affiliate relationships with persons in Connecticut pursuant to which the affiliates refer customers to the retailer in return for commissions or other consideration based on sales, via an online link or otherwise. The retailer must realize cumulative gross receipts of at least $2,000 on sales to Connecticut customers as a result of such referrals in order to be “engaged in business in the state.” In addition, HB 6652 makes the change in the definitions of “retailer” and “engaged in business” retroactive to May 4, 2011 – prior to the date on which the previously enacted affiliate nexus law was even adopted.

It warrants mention that the Connecticut legislature amended its affiliate nexus statute after the Performance Marketing Association filed suit in federal court in Chicago challenging the constitutionality of the Illinois law. Brann & Isaacson represents the PMA in that action.

The Lone Star State Follows a Different Path Regarding Nexus

2011-06-09T17:10:00.005-04:00

Bucking the trend of other states, Texas’ Governor recently vetoed proposed legislation to expand the scope of the Texas sales and use tax law regarding collection of sales and use tax. The proposed legislation—HB 2403—was approved by both houses of the Texas legislature, but vetoed by Governor Perry on May 31. This legislation was not as aggressive as that in other states that have recently adopted nexus legislation. (Illinois, Connecticut, Arkansas and Vermont are examples). It merely provided that a retailer has nexus with Texas if it has an affiliated company that operates a distribution center in Texas or if an affiliated company located in Texas performs services on behalf of the retailer or sells under the same brand name as the retailer. This was in part directed at the Amazon situation in which an affiliate of Amazon.com operated a distribution center in the state of Texas (that reportedly led to a $269 million assessment of sales tax by the Texas Comptroller of Public Accounts).

A piece of good news for sellers of digital goods does result from the legislature’s work on the bill. The legislation, as introduced, also provided that use by a remote seller of a website on a server in Texas from which digital goods are sold or delivered creates nexus. However, the House Committee that first reviewed the bill removed the language before submitting the bill to the full House for a vote. This may signify that such activity does not create nexus in Texas. But, before embarking on any such activity in Texas, a seller of digital products should examine carefully the Texas law and applicable constitutional cases in light of the proposed sales activity.

It is also noteworthy that Texas is not yet done. The legislature has before it in committee a Bill—HB 1317—that would be similar to the recently-enacted Arkansas and Connecticut laws that provide for a presumption of nexus for any retailer that pays a commission or other consideration to a company located in Texas which provides a link to the retailer’s website. While the legislature adjourned on May 31, it was back in session last week and this week to consider various budget-related issues, and may reconvene yet again. It may be that this click-through legislation would be deemed legislation that the legislature will be permitted to consider under its authorization for reconvening.

Stay tuned to developments in Texas.

UPDATE: SB1, currently under review by the legislature, has been amended to include the nexus legislation vetoed by the Governor on May 31, as discussed above. We will track the progress of the Bill and keep you posted concerning any further developments.

Performance Marketing Association Files Lawsuit Challenging Illinois Affiliate Nexus Law

2011-06-02T15:48:00.002-04:00

Performance Marketing Association, Inc. (“the PMA”), the leading trade association in the United States representing the interests of businesses, organizations, and individuals using and supporting performance marketing methods, filed a lawsuit yesterday in Federal District Court in Chicago against the Director of the Illinois Department of Revenue, Brian A. Hamer. The lawsuit challenges the constitutionality of the Illinois affiliate nexus law, HB 3659. Brann & Isaacson attorneys George Isaacson and Matthew Schaefer are counsel to the PMA in connection with the suit.

The case is captioned Performance Marketing Association, Inc. v. Hamer, Federal District Court, Northern District of Illinois, case no. 1:11-cv-03690. A copy of the PMA’s Complaint is available here.

In its complaint, the PMA asserts that HB 3659 unlawfully targets the business of online performance marketing in order to expand Illinois’ regulatory authority beyond its borders. We have previously written about HB 3659 several times, including here and here. The PMA alleges that the law, which goes into effect July 1, 2011, violates the Commerce Clause of the United States Constitution, and the federal Internet Tax Freedom Act (“ITFA”), by using the relationships between Illinois publishers of online advertisements and out-of-state advertisers as grounds for imposing use tax collection and reporting obligations on Internet retailers located outside the state. The enactment HB 3659 has damaged thousands of Illinois publishers through the loss of advertising contracts with Internet retailers.

Under the Commerce Clause, and in accordance with the United States Supreme Court decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), a retailer without a “substantial nexus” with Illinois, defined as a business location or some other physical presence in the state, has no obligation to collect Illinois use tax. HB 3659 purports to make the mere display of online advertisements through an Illinois publisher sufficient “physical presence” in the state to require out-of-state retailers to register and collect Illinois use tax. Retailers using other forms of non-local advertising, however, are not similarly required to register and collect Illinois use tax.

In response to the enactment of the bill, many out-of-state Internet retailers have terminated their relationships with Illinois publishers to avoid the effect of HB 3659. As a result, HB 3659 has caused thousands of Illinois publishers to lose valuable contracts and advertising revenue. No additional use tax revenue will be collected and remitted by retailers who terminate their advertising contracts, although they can continue to reach Illinois consumers through other forms of advertising.

The PMA challenges the Illinois affiliate nexus law on the three separate grounds, asserting that HB 3659: (1) violates the Commerce Clause’s “substantial nexus” requirement, by attempting to impose tax obligations on out-of-state Internet retailers based solely on the display of online advertising by Illinois publishers; (2) improperly seeks to regulate interstate commerce occurring entirely outside of Illinois, by including within its sweep transactions between non-Illinois retailers and non-Illinois consumers, thus creating a per se violation of the Commerce Clause; and (3) discriminates against electronic commerce in violation of the federal Internet Tax Freedom Act by imposing an obligation to collect Illinois use tax on retailers who complete sales through online performance marketing, but not imposing a similar obligation on retailers who accomplish transactions through other forms of non-local advertising. The PMA has asked the federal District Court to declare HB 3659 unconstitutional and in violation of the ITFA. Under the applicable rules, the State has 21 days to file an answer to the PMA’s Complaint.

We will keep you posted on further developments.

May News Roundup: Michigan Repeals MBT; Louisiana Proposes Click-Through Nexus Legislation

2011-05-27T14:47:00.000-04:00

On Wednesday, Governor Snyder signed into law Michigan’s new corporate income tax, which will replace the Michigan Business Tax. The new corporate income tax, effective January 1, 2012, uses a single factor (sales) for apportionment purposes and has a flat rate of 6%. However, despite the repeal of the MBT, the new corporate income tax will retain the economic nexus standard of $350,000 in gross receipts, which we have written about previously here. Any business with a physical presence of at least one day in the state would also be required to report the corporate income tax. Unlike the MBT, however, P.L.86-272 applies to the tax and provides some protections, as we have most recently written about here. Internet sellers and direct marketers should consult their tax counsel regarding the significance of the new tax and its impact on their businesses.

In other news, this week, the Louisiana legislature threw its hat into the ring of states proposing click-through nexus laws with H.B. 641. We have written previously about nexus-expanding legislation throughout the country here and here. Although Vermont and Texas legislatures recently passed their own versions of the law, as of this writing, the governor in each state has yet to sign the bill. We will keep you posted as developments arise.

Have a safe and festive Memorial Day, all!

Another State Adopts Nexus Click Through Legislation

2011-05-13T14:22:00.000-04:00

Following the model of New York, Rhode Island, North Carolina and Arkansas laws, Connecticut recently adopted click-through nexus legislation that is effective on July 1, 2011. The new law states that any retailer that has an agreement with a Connecticut resident, under which the resident, for a commission or otherwise, refers potential customers (by a web site link or other contact) to the retailer, is presumed to have nexus with Connecticut if its sales as a result of such agreements in Connecticut exceed $2,000 for the preceding year. As is the case in the four states described above, the presumption can be rebutted by proof that the residents do not undertake in-state solicitation activities that would create nexus under the constitutional standard.

The Connecticut statute differs from the statutes enacted in New York and other states, in that the threshold for sales is a lower amount–$2,000 as opposed to $10,000 (or $5,000 in the case of Rhode Island). It also differs from the recently-enacted Illinois statute inasmuch as the Illinois statute does not permit a retailer to rebut a finding of nexus that is based upon a relationship with an affiliate located in Illinois that provides a link to a retailer’s Internet site that facilitates the sale of tangible personal property.

Colorado Federal Court to Consider Possible Final Judgment on DMA’s Constitutional Challenge to the Colorado Notice and Reporting Law in DMA v. Huber

2011-05-11T15:48:00.000-04:00

This post is to update our readers regarding the status of the Direct Marketing Association’s challenge to the constitutionality of Colorado HB 10-1193, the law enacted in 2010 that imposes discriminatory notice and reporting obligations on out-of-state retailers that do not collect Colorado sales tax. Brann & Isaacson attorneys George Isaacson and Matt Schaefer are counsel to the DMA in the case

In January 2011, the federal District Court for the District of Colorado granted the DMA’ s motion for a preliminary injunction and suspended enforcement of the law on the grounds that it likely violates the Commerce Clause of the United States Constitution on two separate, and independent grounds. In February, the Defendant appealed to the Tenth Circuit, but subsequently withdrew the appeal after the District Court approved a proposal by the parties to file cross-motions for summary judgment seeking a final ruling by the Court on the Commerce Clause issues, while staying further proceedings on all other claims in the case. The District Court agreed that, if it awards summary judgment to either party, it will certify the matter for immediate appeal to the Tenth Circuit Court of Appeals, so that the Commerce Clause issues may be finally resolved.

Each party filed a motion for summary judgment with the District Court on May 6. Responses are due May 27, and replies are due June 10. A ruling by the Court on the motions, and likely an appeal to the Tenth Circuit, will follow. We will continue to update readers with further developments.

States on the Warpath

2011-04-28T14:55:00.000-04:00

In the last few months, three states (Illinois, Arkansas and South Dakota) have enacted “nexus expanding” legislation effective on July 1, 2011. Other states are considering adopting such legislation. The legislation falls into three categories: (1) click-through nexus; (2) reporting obligations; and (3) “affiliate” or “attributional nexus.”

We have previously written about the Illinois click-through nexus law (here and here), which we believe is unconstitutional since it purports to establish nexus (with no opportunity to rebut the determination) for any retailer that contracts with a person “located in Illinois” who receives a commission from the retailer based on sales of goods facilitated by a link from the person to the retailer’s web site. We will not describe here the details as to why the statute is unconstitutional, other than to note that mere national advertising, which is what the click-through represents, has never been deemed to create nexus, as pointed out in the Quill v. North Dakota case. In addition, online retailers should carefully review the Illinois statute and its requirements before deciding whether it applies to them.

The other recently-adopted nexus click-through legislation is the Arkansas law, which, unlike the Illinois statute, creates only a presumption of nexus that can be rebutted by a showing that the person maintaining the web site that provides a link does not engage in solicitation on behalf of the retailer. The statute is modeled after the New York statute, and it is possible for a retailer to structure its program with its Arkansas affiliates so as not to be subject to Arkansas sales tax collection obligations.

I also note that there is pending legislation in several states that is similar to the Arkansas statute and not the Illinois statute. (See our recent discussion of pending legislation here.)

The South Dakota statute requires all non-collecting retailers that have annual gross sales into South Dakota of $100,000 or more to provide a “transactional notice.” The transactional notice should appear both on the retailer’s web site and in catalogs and purchase orders/receipts. Because the law applies only to non-collecting retailers, who by definition do not have a physical presence in the state and who are out-of-state retailers, it suffers from the same constitutional infirmities that caused the Colorado federal court to issue a preliminary injunction staying the enforcement of a very similar statute in Colorado.See Direct Marketing Ass’n v. Huber, 2011 WL 250556 (D. Colo. 2011).

In the final category of statutes, both Arkansas and Illinois also provide for attributional nexus for commonly-owned companies when an affiliate has a physical presence in the state. The Illinois statute provides that an out-of-state retailer has nexus with the state if it has a contract with an affiliate who both sells a similar line of products under a substantially similar name as the online retailer and receives a commission from the out-of-state retailer. The Arkansas statute provides a more expansive definition of a company required to collect sales tax and bases its requirement upon either the retailer’s use of the in-state affiliate to act on behalf of the retailer or the retailer’s use of substantially similar trademarks or tradenames as used by the in-state affiliate.

In short, much of the new legislation is constitutionally suspect. How the states choose to enforce the laws, and how the industry reacts, is a work in progress. Individual companies should carefully review their own nexus profile and circumstances to determine the applicability of this new legislation.

Commercial Privacy Bill of Rights Introduced in Congress

2011-04-26T11:32:00.004-04:00

The introduction of the so-called Commercial Privacy Bill of Rights by Senators Kerry and McCain on April 12, 2011 suggests that we may be about to enter an era of robust regulation of information gathering regarding the online browsing and shopping habits of consumers. This type of data has come to be an important tool for online marketers to improve the efficiency of online advertising buys, and to improve other marketing techniques. At a minimum, this development presents a risk that online merchants will need to build out substantial new technical infrastructure to accommodate a welter of new rules under this bill. Beyond that, it may make it difficult even for highly respected and responsible merchants to engage in marketing activities that are an important part of their tool kit in the information age.

Among other things, the bill contains the following requirements:

Collectors of information must implement security measures to protect the information they collect and maintain.

Collectors of information must provide clear notice to individuals of the collection practices and the purposes of such collection. Additionally, collectors must provide the ability for an individual to opt out of any information collection that is unauthorized by the Act and to provide affirmative consent (opt-in) for the collection of sensitive personally identifiable information. Respecting companies’ existing relationships with customers and the ability to develop a relationship with a potential customers, the bill would require "robust and clear" notice to an individual of his or her ability to opt-out of the collection of information for the purpose of transferring it to third parties for behavioral advertising. It would also require collectors to provide individuals either the ability to access and correct their information, or to request cessation of its use and distribution.

Collectors must bind third parties by contract to ensure that any individual information transferred to the third party by the collector will only be used or maintained in accordance with the bill’s requirements. The bill requires the collector to attempt to establish and maintain reasonable procedures to ensure that information is accurate.

These requirements can be expected to have significant operational impacts on direct marketers. The requirement for notice and opt-out rights for a series of practices that are quite technical in nature promises to be easier said than done. Existing privacy laws require only notice of the collection of personal information (much more narrowly defined than in this bill) and only very limited opt-out rights–essentially limited to CAN-SPAM compliance. This new bill would potentially require merchants to allow consumers to opt out of the collection of pixel tags, the placing of cookies, and the sharing of data harvested from those tools with third parties. Simply building the tools necessary to collect and implement those requirements would pose significant burdens and costs for online marketers, and may very well be beyond the abilities of many merchants.

Further, the bill stretches the definition of personal information beyond any commonly understood meaning of that term. It includes email addresses and postal addresses, and if "used, transferred or stored" in connection with any of the foregoing, birth date, and most significantly, "unique identifier information." Unique identifier information is defined as "a unique persistent identifier associated with an individual or a networked device, including a customer number held in a cookie, a user ID, a processor serial number, or a device serial number." This definition essentially means that virtually any data collected about a browsing session will be protected by this statute, with strict limits on the ability to use or transfer that data without approval.

The existence of an "established business relationship" exception to some of the requirements of the bill provides cold comfort. It applies not to the commonly understood relationship of customer and merchant, but only to the "establishment of an account." While this may be typical of some merchants' relationships with their customers, many retailers do not require the establishment of an account in order to make a purchase. It is interesting to note, however, that the 800 pound gorillas in the online space, notably Google and Facebook, would be the most likely to benefit from this exception.

The bill seeks to accomplish these objectives by requiring the FTC to promulgate regulations effectuating the statute's requirements for the most part within 60 to 180 days after enactment of the bill, depending upon the provision at issue. Accordingly, it will likely be a long time before these requirements take effect (if ever), given the Congressional legislative calendar, and the frequently protracted rule-making process that would attend any promulgation of regulations. During both the legislative process and the regulatory process, the direct marketing industry will have an opportunity to point out the technical challenges presented by this statute, as well as the potential unintended consequences, including damage to the economy, that the statute could create.

Update to eMarketers: Canada’s FISA Broader than US’s CAN-SPAM Act

2011-03-28T10:23:00.002-04:00

Last late year, Canada enacted the Fighting Internet and Wireless Spam Act (FISA). The framework established by FISA is fundamentally different from the United States’s CAN-SPAM Act. First, while CAN-SPAM applies only to commercial email, FISA applies to any form of electronic message sent for marketing purposes (referred to as a “Commercial Electronic Message,” or “CEM”), including: email; SMS; instant messaging; and social media/networking. U.S. regulations have not to this point targeted communications with customers across social media.

Second, and perhaps more significantly from the standpoint of most U.S. firms, FISA requires affirmative consent from a potential recipient of a message before marketers can send a CEM. This feature of the law stands in sharp contrast to CAN-SPAM, which permits at least “one free shot” at a recipient, provided that the message itself is CAN-SPAM compliant (ie. the message includes opt-out instructions, clearly identifies the sender, identifies itself as commercial email, etc.).

Accordingly, U.S. companies now will need to differentiate their approach to marketing to Canadian customers from their approach to marketing to U.S. customers in order to ensure compliance with both the Canadian and U.S. statutes. Commonly utilized techniques for acquiring contact information, such as list rental, if used to market to Canadian customers, now have the potential to expose marketers to a violation of FISA.

The good news is that the Canadian law contains a broad definition of “Consent.” “Consent” can either be “express” or “implied” and can also include circumstances in which (i) the sender has a business relationship with the recipient, (ii) the recipient has published its electronic address in a prominent manner, or (iii) the recipient has provided its email address directly to the sender. The conventional wisdom is that a customer who provides an email address in connection with placing an order, for example, has implicitly consented to the receipt of commercial emails.

In short, those merchants who email Canadian customers would do well to take a second look at their method of acquiring emails, and undertake to determine whether their current practices comply with this new requirement.

Illinois Governor Signs "Amazon" Affiliate Nexus Law

2011-03-11T15:12:00.003-05:00

On March 10, Illinois Governor Pat Quinn signed into law HB 3659, the affiliate nexus bill passed by the legislature in January. Quinn's signing makes Illinois the fourth state (along with New York, Rhode Island, and North Carolina) to enact such a law. The Illinois bill provides that once an out-of-state Internet retailer realizes $10,000 in receipts from sales made to customers linked to the retailer's website from the websites of its Illinois affiliates, the retailer will be deemed to be a “retailer having or maintaining a place of business in this State” and be obligated to collect and remit tax on all of its sales to Illinois consumers.

In response, Amazon.com promptly informed its Illinois affiliates that it is terminating its relationships with them. Look for further developments in the coming days.

DMA v. Huber Update: Huber Appeals to Tenth Circuit

2011-03-10T13:00:00.001-05:00

As we reported in January, the Direct Marketing Association (the "DMA") recently won a landmark preliminary injunction in its lawsuit against the State of Colorado. The preliminary injunction prohibits the Executive Director of the Colorado Department of Revenue from enforcing Colorado’s new notice and reporting law, H.B. 10-1193, which would require out-of-state direct marketers and online sellers who do not collect Colorado sales and use taxes to inform Colorado purchasers of their obligation to self-report tax and to provide Colorado customers summaries of their purchases, and also would require sellers to report specific customer purchase information to the State. As we wrote previously, the Court, in granting the preliminary injunction, found that the requirements of H.B. 10-1193 likely both violated the Commerce Clause and would cause irreparable harm to out-of-state retailers if enforced

On February 25, the Defendant filed an interlocutory appeal of the District Court’s order granting the preliminary injunction, seeking review of the injunction by the Tenth Circuit Court of Appeals. It will likely be six to nine months before the Tenth Circuit issues its ruling in the matter, but we will keep you updated as developments arise.

Additional States Introduce Affiliate-Nexus Legislation

2011-03-07T17:49:00.001-05:00

On March 2, an Internet-affiliate nexus bill was introduced in the Arkansas State Senate (SB 738). Arkansas joins Arizona, California, Connecticut, Hawaii, Illinois, Massachusetts, Minnesota, Mississippi, New Mexico, Tennessee, Texas, and Vermont, as the thirteenth state this legislative season to consider such a measure. Nearly all of the bills -- with the exception of Illinois’s HB 3659, which was passed by the Illinois legislature and is now awaiting signature or veto by Governor Quinn, and Connecticut’s SB 5545 -- are patterned directly upon the New York affiliate nexus law enacted in 2008 and challenged in court, so far unsuccessfully, by Amazon.com. In other words, 11 of the 13 proposed laws create a rebuttable presumption that an out-of-state Internet retailer is obligated to collect and remit the state’s sales and use taxes if the retailer enters into an agreement with an in-state resident (an “affiliate”) pursuant to which the affiliate places a link from the affiliate’s website to the retailer’s site, and the retailer realizes at least $10,000 in sales to customers referred to it by the affiliate’s links. The presumption can be negated by proof that the in-state affiliates did not engage in any in-state solicitation on behalf of the retailer.

In its November 2010 ruling, the Appellate Division of the New York Supreme Court found that the ability of a retailer to rebut the presumption of solicitation was an important factor in determining that the New York law is not unconstitutional on its face. The Court, however, remanded the case for further proceedings on the issue of whether the law violates the Commerce Clause and Due Process Clause as applied to specifically to Amazon. As the ongoing proceedings in the New York case make clear, the constitutionality of such “New York-style” affiliate-nexus legislation is far from resolved.

At the same time, it is worth noting that the Illinois and Connecticut bills differ from the New York law in that neither bill provides that the presumption that a retailer must collect sales and use tax as a result of having in-state Internet affiliates may be rebutted. Imposing an irrebuttable presumption of nexus is highly suspect under both the Commerce Clause and Due Process Clause. Without a rebuttable presumption in place to protect retailers, Illinois and Connecticut would subject Internet retailers to burdensome state tax collection obligations when the retailers are effectively doing nothing more than advertising. For that reason, the progress of each of these bills bears watching. Stay tuned.

D.C. Circuit Cites Quill as Instructive in Analyzing the Due Process Ramifications of a National Tax Scheme

2011-02-23T17:07:00.006-05:00

The Supreme Court’s analysis in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) has been cited favorably again, this time with regard to a Due Process challenge to a federal statute. On February 18, the United States Court of Appeals for the District of Columbia Circuit vacated the denial of a motion for a preliminary injunction brought by a plaintiff challenging the constitutionality of a federal law regulating online sales of tobacco products, and remanded the case for further proceedings. Gordon v. Holder, 2011 WL559002 (D.C. Cir. Feb. 18, 2011). Previewing the issues to be addressed by the District Court on remand, the Court of Appeals cited Quill as “instructive” in analyzing the plaintiff’s claim that the federal statute violates the Due Process Clause.

In a statement likely to send shivers up the spines of the members of the Governing Board of the Streamlined Sales and Use Tax Agreement and other advocates for federal legislation to override Quill’s “physical presence” requirement arising under the Commerce Clause, the D.C. Circuit commented that “there remains an open question whether a national authorization of disparate state levies on e-commerce renders concerns about presence and burden obsolete” as a matter of Due Process. Id. at *4 (emphasis added). While this statement, and the Court’s opinion, does not alter the analysis under Quill of the constitutionality of state tax (and tax-related) laws under the Commerce Clause, it suggests that the concerns about “presence and burden” presented in Quill are potentially also relevant to determining whether a federal law authorizing state tax levies is consistent with the Due Process Clause.

Proponents of federal legislation to allow states to impose sales and use tax collection obligations on Internet retailers and other remote sellers without regard to the sellers’ nexus have long–assumed that the “dormant” Commerce Clause is the only obstacle to such a scheme, and that this obstacle is one which could be swept away by Congress. But, the D.C. Circuit’s statement in Gordon signals that such a law may also face a meaningful challenge under the Due Process Clause, violations of which Congress cannot approve. Citing Quill and International Shoe, the D.C. Circuit notes that “Even national legislation—which can permissibly sanction burdens on interstate commerce—cannot violate the Due Process principles of “fair play and substantial justice.”

The “open question” identified by the Court may mean that genuine simplification of state sales and use tax systems will be a constitutional prerequisite to a national mandate of compliance with such systems, to ensure that basic Due Process requirements have been satisfied. The D.C. Circuit, at least, perceives “disparate” state tax obligations as potentially at odds with fundamental due process.

Arbitration Clauses, Class Actions and State Tax

2011-02-16T15:11:00.001-05:00

What a funny combination of terms. You might be asking what state tax has to do with arbitration and class action suits. Two recent court decisions illustrate the connection.

In particular, a “bad day” for a corporate executive is receiving the complaint and summons for a class action lawsuit. While there have been fewer class action lawsuits in connection with state taxes than there have been in other areas of the law, the plaintiff’s bar has looked at state tax as a development opportunity and has commenced suits for inappropriate collection of state taxes. The basis commonly used for such a suit is that the state’s unfair and deceptive trade practices statute is violated by the collection of sales tax if such tax is not due. For example, a company might be collecting tax on food in a state in which food is not taxable. A better example would be collecting tax on Internet access, which is prohibited under a federal statute, the Internet Tax Freedom Act, 47 U.S.C. § 151n (1998) (“ITFA”), as amended, unless a state is grandfathered.

AT&T found out the hard way about class action lawsuits in the state tax area. It was collecting tax on Internet access services. Under the ITFA, it was prohibited from collecting such tax in all but a few states. Thus, as I wrote in my blog post of September 17, 2010, AT&T was slammed with a class action lawsuit, and settled for payment of millions of dollars of attorneys’ fees and other costs.

AT&T also recently discovered that there is a way to preclude such class action suits, at least in Texas. In particular, AT&T provided in its agreements with customers that the exclusive basis for resolving all disputes relating to its service was arbitration. When a class action lawsuit was brought against AT&T by Texas consumers for collecting tax on Internet access charges less than $25.00 (Texas, a grandfathered state, imposes tax only on Internet access charges in excess of $25.00 per month), AT&T filed a motion to dismiss the suit based on the arbitration clause in its agreement. Construing the clause broadly, the U.S. District Court for the Southern District of Texas ruled in the case of Stephen T. Johnson v. AT&T Mobility, LLC (12/21/2010), that the clause should be read to include disputes regarding the collection of sales and use tax. Thus, the court dismissed the class action lawsuit and stated that each customer would be required to bring its own dispute in arbitration. If such decision is sustained on appeal, it will significantly limit AT&T’s exposure.

Whether an arbitration clause will in all instances require potential plaintiffs to present their claims in private arbitration rather than public litigation will depend upon a number of factors, but any company doing business with consumers should consider the use of arbitration clauses as a means to resolve disputes. This, of course, is particularly appropriate in the case of a telecom company, but it can be used for Internet retailers and other direct marketers, as well.

Maine Introduces Modified, Colorado-Style Notice and Reporting Law, Which Also Likely Violates The Commerce Clause

2011-02-14T16:51:00.003-05:00

On February 9, 2011, the Maine Legislature introduced a bill (LD 469) which would impose upon certain out-of-state retailers a set of notice and reporting obligations that closely parallel the requirements of Colorado’s 2010 law, H.B. 10-1193. Enforcement of H.B. 10-1193 was recently enjoined by a federal judge in Denver on the grounds that such requirements are likely unconstitutional and in violation of the Commerce Clause. As we have reported in prior posts, Brann & Isaacson represents the Direct Marketing Association in the federal court challenge to the now-suspended Colorado law, after which the Maine bill is patterned.

Maine’s LD 469 includes all three of the Colorado law’s notice and reporting requirements – retailers must provide the Transactional Notice, Annual Purchase Summaries to customers, and Customer Information Reports to revenue officials – and would impose penalties on affected retailers for non-compliance with the law. Notably, however, unlike the Colorado law, the Maine bill includes no $500 annual minimum purchase threshold to trigger the requirement that an affected retailer must send a customer an Annual Purchase Summary. Similar to Colorado’s law, under LD 469 such annual summaries to customers must include, if available, “[d]escriptions of items purchased,” as well as dates and amounts. Also in contrast to Colorado, the report to Maine Revenue Services must include all of the information provided to each purchaser in the annual summary – thereby requiring that at least descriptions of the items purchased by customers of an affected out-of-state retailer be turned over to Maine Revenue Services. The Maine bill thus raises even more significant privacy concerns for Maine consumers buying from affected retailers than does the privacy-invading Colorado law.

The Maine bill also appears to differ from the Colorado law in another respect: whereas the suspended Colorado law applies, by its terms, to all out-of-state retailers that do not collect Colorado sales tax, LD 469 imposes its onerous notice and reporting obligations only upon companies that are presumed to be doing business in the state because they are members of a “controlled group of corporations” that has at least one member who is already a retailer with a physical presence in the state. The Bill Summary states that “[t]his bill requires out-of-state retailers that are not required to collect sales tax and that are part of a controlled group of corporations with a connection in the State” to comply with the notice and reporting obligations. The apparent requirement that, to be subject to the law, an out-of-state retailer must have an affiliated retailer with physical presence in Maine, means that the proposed law would not apply to as broad a group of out-of-state companies as does the Colorado law.

What the sponsors of the bill apparently fail to recognize is that limiting the notice and reporting obligations to a more narrow group of out-of-state retailers who do not collect sales tax (i.e, only those who are part of a controlled group) does not change the fact that it discriminates against interstate commerce in violation of the Constitution. The Supreme Court has made it perfectly clear that a state cannot pick and choose which out-of-state companies it will discriminate against – even state laws that have imposed disparate treatment upon only a single out-of-state company that is not imposed upon in-state companies are virtually per se invalid under the Commerce Clause.

The prospects for passage of LD 469 are, at this point, entirely uncertain, so there is still time for Maine’s elected officials to avoid following in the footsteps of their Colorado counterparts. In addition to running afoul of over 180 years of established constitutional law, LD 469 is simply bad policy – invading the privacy of Maine citizens should never be viewed as a proper approach to promoting use tax reporting.

Since the new year, several other states, including Arizona, California, Connecticut, Hawaii, Illinois, New Mexico, South Dakota, Vermont, and Texas, have introduced new notice and reporting bills, or “Amazon” affiliate-nexus legislation. Stay tuned for an update on the progress of these bills.

A Reminder About The State Tax Implications of Passive Partnership Interests: U.S. Supreme Court Declines To Review State Court Ruling That Mere Partnership Interest Creates Income Tax Nexus

2011-01-31T16:34:00.002-05:00

E-commerce companies that have affiliates doing business as (or even just investment interests in) partnerships or other pass-through entities in states in which the e-commerce company has no direct presence should be aware that such partnership interests may be deemed to create income tax nexus for the company. A number of state laws and regulations provide that ownership in a pass-through entity establishes nexus for the owner. See, e.g., 34 TAC Sec. 3.586(c)(13) [Texas]; 830 CMR 63.39.1(8) [Massachusetts]. To date, state tax tribunals have agreed. See, e.g., Shell Gas Gathering Corp. #2, N.Y. Tax Appeals Tribunal, DTA Nos. 821569 and 921570 (Sept. 23, 2010).

Furthermore, on January 25, 2011, the United States Supreme Court declined a petition asking the Court to review a Kentucky Appeals Court decision that an out-of-state corporation was properly required to pay Kentucky state income tax, despite the fact that its only connection to Kentucky was its interest in a partnership that was engaged in business in the state. Asworth, LLC v. Kentucky Department of Revenue, 2009 WL 3877518 (Ky. App. Ct. Feb. 10, 2010), review denied (Ky. 2010) and cert denied, U.S. Supreme Court Dkt. 10-662 (Jan. 25, 2011). While mere passive ownership in a partnership that generates revenue from activities in a state would not, by itself, be enough to subject the partner-owner to nexus for sales and use tax purposes, the Supreme Court’s refusal to review the Kentucky decision leaves undisturbed the position taken by many states that owners of an interest in a pass-though entity can be compelled to report state income tax.

DMA Wins Landmark Injunction Against State of Colorado

2011-01-27T10:42:00.002-05:00

On behalf of the Direct Marketing Association, Brann & Isaacson partners George Isaacson and Matthew Schaefer won a landmark preliminary injunction in federal court in a lawsuit that affects thousands of direct marketers across the country. The ruling prohibits the State of Colorado from enforcing its controversial new law, H.B. 10-1193, that required direct marketers to -- among other things -- report to the state the names, addresses, and purchase amounts of their customers.

To be clear, so long as the injunction remains in place, out-of-state retailers that do not have nexus with Colorado and do not collect Colorado sales tax are no longer required to: (1) give notice to their Colorado customers, in connection with each sale, that the customer must report Colorado use tax (the “Transactional Notice”); (2) send via First Class mail by January 31, to each customer that purchased more than $500 of goods for delivery to Colorado during 2010, a summary of their purchases for the year (the “Annual Purchase Summary”); or (3) submit a report to the Colorado Department of Revenue, by March 1, 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”). See http://www.colorado.gov/cs/Satellite/Revenue/REVX/1251581938320.

The DMA argued that the law violates the Commerce Clause of the United States Constitution by (a) imposing discriminatory obligations upon out-of-state retailers that do not apply to in-state Colorado retailers, and (b) unduly burdening interstate commerce under principles set forth by the Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Court accepted these arguments in finding that the DMA had a likelihood of success on both Commerce Clause counts, and concluded that out-of-state retailers subject to the new law would suffer irreparable harm if enforcement of the statute is not barred.

The preliminary injunction entered by the Court does not end the case, but it effectively suspends the law while the litigation continues and until the Court makes a final ruling regarding the law’s constitutionality.

You can read a copy of the order here.

Read previous posts about the lawsuit here and here.

DMA’s Constitutional Challenge to Colorado’s Notice and Reporting Law Will Be Argued In Federal District Court on January 13

2011-01-06T16:36:00.000-05:00

A happy new year to our readers. Many internet and catalog retailers have been following with interest the constitutional challenge of the Direct Marketing Association (“DMA”) to Colorado’s new notice and reporting law, H.B. 10-1193, enacted in 2010. In addition to burdensome consumer notice requirements that went into effect last year, the law requires out-of-state retailers that do not collect Colorado sales and use tax to send (by January 31, 2011) annual purchase summaries to customers purchasing $500 or more of goods for shipment to Colorado and, worst of all, to file (by March 1, 2011) with the Colorado Department of Revenue a listing of all of the retailer’s customers who have purchased goods for shipment to a Colorado location, regardless of where the customer resides.

As we previously reported (see our July 2, 2010 post), the DMA contends that the Colorado law violates multiple provisions of the United States Constitution, because it 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 deprives retailers of their valuable customer list information without due process or fair compensation. The DMA has filed a motion for preliminary injunction based on the law’s violations of the Commerce Clause, asking the Court to suspend enforcement of the law’s notice and reporting requirements pending a full adjudication of the law’s constitutionality.

The federal District Court for the District of Colorado has scheduled a hearing on the DMA’s motion to be held on January 13, 2011, at 10:00 a.m. in Denver. B&I senior partner and lead counsel for the DMA, George Isaacson, will argue the motion on behalf of the DMA. We will report on further developments after the hearing.

Distribution of Promotional Materials in Indiana is Not Taxable

2011-01-04T13:35:00.000-05:00

In D.H. Holmes Company, Ltd. v. McNamara, 486 U.S. 24 (1988), the U.S. Supreme Court held that a state did not violate the Commerce Clause when it imposed a use tax on the distribution of catalogs and other promotional materials mailed from outside of the state since the company on whose behalf the catalogs were distributed had nexus with the state. Prior to that date, there were some state courts and tax commentators which had declared that a destination state’s imposition of tax on catalogs printed and mailed from outside of the state to residents of the state violated the Commerce Clause.

As a result of the D.H. Holmes decision, a large number of states have imposed a use tax on promotional materials distributed in their state on behalf of a company with nexus in the state (e.g. Arizona, Colorado, Connecticut, Florida, Georgia, and Tennessee). There have been some exceptions to this rule (See e.g., Michigan (Sharper Image Corp. v. Department of Treasury, 550 N.W.2d 596 (1996)), New York, Ohio, California, and Pennsylvania).

Recently, the Indiana Tax Court ruled in the case of AOL, LLC v. Indiana Department of State Revenue that the distribution of CD ROMs and other marketing materials on behalf of AOL by AOL’s printer and assembly house was not taxable. The basis for the decision was that AOL had supplied the components—the CD ROM discs, paper, and other components of CD ROM packages—to the assembly house and printer. Thus, the assembly house and printer were merely providing a service, and not selling tangible personal property. Under the Indiana statute, the provision of services is not taxable. It is only the sale of tangible personal property that is taxable. Nor were the components themselves taxable because only the final CD ROM package and printed materials were distributed in Indiana. The components were transformed by the assembly houses and printers into final products.

This decision is in line with prior decisions of the Indiana Tax Court, including Ameritech Publ’g, Inc. v. Ind. Dep’t of State Revenue, 916 N.E.2d 752 (Ind. Tax Ct. 2009) and Morton Bldgs., Inc. v. Ind. Dep’t of State Revenue, 819 N.E.2d 913 (Ind. Tax Ct. 2004). Thus, any direct marketer which has been distributing promotional materials in Indiana and paying use tax on those promotional materials should consider filing a claim for refund for taxes paid if the direct marketer supplied the underlying raw materials to the printer or other party assembling the promotional materials.

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

2010-12-24T10:17:00.038-05:00

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.

So, what exactly is the Commerce report, and where is it likely to lead? The Commerce report refers to itself as a “green paper,” which one might think is a nod to wholesome environmental practices. Actually, in government-speak, a green paper is merely a tentative proposal or call for comments that might lead, eventually, to a white paper, which is a more formal statement of governmental policy. As a result, both the Commerce report and the FTC initiative reflect tentative steps in the direction of statutory, regulatory, and policy changes. How far they proceed is a matter of guesswork, particularly with a new and more conservative Congress waiting in the wings.

The Commerce Report Sounds the Defense of the Status Quo In Privacy Regulation, Founded In Large Part On Self-Regulation By Industry. The Commerce report praises almost unconditionally the handling of the Internet under US law, focusing mainly on at the success of industry as voluntary self-regulators. The report also posits the Department of Commerce itself as the leadership entity within the US Government on privacy matters, and claims a power to “ensure the Internet fulfills its social and economic potential.” The FTC’s mandate of protecting consumers from commercial abuses is far narrower. Direct marketers may have found, in the Department of Commerce, a voice to stand up to the newly regulation-happy and business-unfriendly FTC, and one that is ready to take power from the FTC. This could not be clearer than in Commerce’s own recommendation that an overarching Privacy Policy Office be created under its regulatory umbrella.

FIPPs. Commerce’s approach centers on the “broad adoption” of Fair Information Privacy Practices (“FIPPs”) that are sweeping and general enough to provide “ample flexibility” and “encourage innovation,” and envisions these being reflected in “voluntary, enforceable codes of conduct.” If they are voluntary, of course, they likely would not be promulgated in the form of statutes and regulations. If they are nonetheless enforceable, it would seem as if Commerce -- at least in part -- envisions trade groups and associations to require adherence by members and to provide for their own policing. Whatever the implications, they are different from the FTC’s report requesting that Congress invest it with greater legal authority over privacy matters. The FIPPs, as envisioned by Commerce, would include “simple notices, clearly articulated purposes for data collection, commitments to limit data uses to fulfill those purposes, and the expanded use of robust audit systems to bolster accountability.”

The PPO. Commerce’s proposed Privacy Policy Office is intended to be both “the convener of diverse stakeholders” on privacy matters, but also the “center of Administration commercial data privacy expertise.” It would work with the FTC in “leading efforts to develop voluntary but enforceable codes of conduct.” In a sentence that likely made career FTC employees cringe, Commerce states that compliance with such voluntary codes would serve as a “safe harbor for companies facing certain complaints about their privacy practices.” In other words, compliance with these voluntary codes could potentially insulate a company from privacy and security related claims asserted by the FTC, the individual states, and potentially even money-hungry class action lawyers. Of course, the scope of the “safe harbor” protection is not made especially clear in the Commerce report, and past experience—as in the telemarketing area—suggests that Congress could seriously fumble on the issue preemption of state laws and limitations on bankrupting class action lawsuits.

Uniform Security Breach Notification Rules? The Commerce report takes on an issue that has plagued direct marketers in recent years, and on which Congress has been unable to anything meaningful. Specifically, it proposes replacing the patchwork of dozens of inconsistent state security breach laws with a single national law. While this would put an array of consultants out of business, it would—if done correctly—remove significant regulatory expense (and uncertainty) from the shoulders of direct marketers of all sizes.

Overall, the Commerce report, if it is taken at face value as a genuine reflection of the Department of Commerce's position on commercial privacy matters, is a breath of fresh air. Unlike the FTC's report, which treats things like personalized advertisements as horrible invasions of privacy, the Commerce report reflects an understanding that the collection and use of customer information by businesses has an important place in not only bolstering the growing internet economy, but also serving legitimate consumer and business interests. And, unlike the FTC, places the greatest governmental focus on far more important privacy issues like data security and identity theft.

We are now at the beginning stages of a great debate about Internet privacy that could result in considerable change to the regulatory landscape. In subsequent blog posts, we will be addressing in greater detail individual issues raised by both the Commerce and FTC reports, and provide insights how the debate is evolving.

We wish all of our readers a wonderful holiday season!

Income Tax Nexus in a Digital World

2010-12-20T10:46:00.000-05:00

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.

Public Law 86-272 does not define the term “tangible personal property.” Recently, the New Jersey Tax Court helped clarify that standard with regard to software. See Accuzip, Inc. v. Director, Division of Taxation, 25 N.J. Tax 158 (2009). In Accuzip, the New Jersey Tax Court determined that prewritten computer software constitutes tangible personal property based upon the sales and use tax law’s definition of tangible personal property and U.S. Treasury Regulations regarding the transfer of software.

In the digital world, resort to sales and use tax law or federal tax law may be helpful to taxpayers in determining whether the products they sell are tangible personal property. For instance, in several states digital music and digital books are deemed tangible personal property subject to the sales tax. In those states, taxpayers will argue that they are protected by the federal statute by citing the sales tax law and the New Jersey Tax Court’s decision in Accuzip.

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

2010-12-14T15:37:00.005-05:00

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.

If the FTC has its way, you will need to redesign your web sites and emails to provide real-time notice and choice to every consumer, whether or not they make any purchases. The overarching theme of the report is highly paternalistic, suggesting that consumers are incapable of making informed choices about their buying decisions and Internet browsing activities. Thus, privacy policies and full disclosure of information collection practices are viewed dimly by the FTC. Instead, it commands that “consumers should [repeatedly] be presented with choice about collection and sharing of their data at the time and in the context in which they are making decisions.” Not only would implementation of such a scheme add substantially to the programming costs of commercial web sites, it could interfere significantly with the consumer purchasing experience. It is hard to imagine Web sales not suffering.

The FTC's "Do Not Track" Initiative Creates a Presumption Against Collecting Information About Web Site Usage, Even If that Information Is Not Individually Identifiable. The item in the report receiving the largest amount of press is the “do not track” recommendation. It would obligate direct marketers to implement technology – through something “similar to a cookie,” according to the FTC – that would prevent the collection of web browsing activities by individuals or individual browser installations. This would be mandated even if retailers do not actually collect individually-identifiable personal information. Indeed, the FTC report supports doing away with the line drawn in existing law between information that is personally identifiable and that which is not, claiming that “traditional distinctions between the two categories of data are eroding.” Because "some" companies allegedly find surreptitious ways to connect non-personal information to specific individuals, the FTC is ready to recommend that all companies be prevented from collecting even aggregate usage data, which could be a significant blow to retailers who use this data to obtain helpful information for their businesses. Data collection serves important functions that parallel the physical retail environment, including the measuring of foot traffic in certain areas of a store. Denying this data to retailers in its non-personally identifiable form suggests a significant lack of government understanding of – or at least a gross lack of sensitivity to – legitimate industry needs.

At present, the FTC, itself, believes that it does not have authority to implement a tracking system without further action by Congress. But, the pressure is on for Congress to enact a potentially sweeping new set of powers for the agency. In the interim, the makers of at least one popular browser, Firefox, are exploring ways to implement a “do not track” feature that leaves it to consumers to choose whether they will be tracked. Microsoft has already implemented a similar feature in its most recent release of Internet Explorer. This approach is far less onerous for retailers, but may rob them of the very data they need to present consumers with meaningful purchasing choices through targeted advertising. The least effective and most intrusive recommendation – that the FTC appears to favor – involves a “do not track” list that may leave it to Internet companies to figure out whether a person who is visiting their web site has chosen to place themselves on a list. Because the specifics have yet to be determined, it is unclear what this list would even look like. The FTC claims that a list of machine specific identifiers (as might be embedded in an operating system or hardware) or IP addresses is not a likely option.

Prepare to Open Your Files. Some of what the FTC report recommends is positive for the industry, including “standardized” privacy-related notices (which might reduce uncertainty surrounding potential challenges by privacy rights groups, among other things), but the context – including whether federally mandated notices would preempt individual states from enacting different or more complicated disclosure requirements and whether class action lawsuits would be permitted against violators – remains a mystery, and the potential perils for eCommerce are significant. Other FTC recommendations are chilling, including the requirement that companies provide customers “reasonable access” to all the data maintained about them and that the Children’s Online Privacy Protection Act’s onerous obligations be extended to cover children between the ages of 13 and 17.

What's Next? The FTC has asked for industry comments as it pushes forward with its new privacy initiative. This is a critical moment for direct marketers to be heard in petitioning the government to create and implement a more sensible, uniform approach to privacy protection that balances a realistic assessment of the potential harm to consumers against potentially dramatic and commerce-suppressing costs.

The Perils of Responding to Nexus Questionnaires

2010-11-24T16:57:00.002-05:00

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.

The taxpayer in that case made several mistakes. First, it apparently assumed that the standard under Public Law 86-272 applies in the sales tax context, and therefore that the kind of activity that would otherwise be shielded by this federal statute from income tax liability would also be excluded from sales tax collection obligations. Second, if it had understood the true state of the law and facts, it might have considered not completing the questionnaire in the first place. Third, even if it decided to submit the questionnaire, it should have provided more precise answers without characterization of the activities as solicitation. Stating that the employees solicited sales in Michigan is a difficult admission to overcome, even though the activity that had been undertaken may well not have been solicitation. Thus, the old saw that “no good deed goes unpunished” certainly holds true in this case.

The lesson to be learned is to treat a response to a questionnaire as if it were court testimony. In a court case, lawyers prepare, advise and counsel the company. Responding to inquiries from state tax agencies should not be treated differently. Advice of counsel regarding whether to respond to the questionnaire and how to respond to the questionnaire should be sought.

I hope all have a good Thanksgiving holiday.

Amazon Wins First Amendment Challenge to North Carolina DOR Information Request

2010-10-29T10:37:00.001-04:00

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

2010-10-06T17:22:00.002-04:00

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.

In the second situation, the person or entity must own directly or indirectly at least 50% of the equity of the remote seller and a company with nexus in New York (the New York affiliate). If the New York affiliate engages in activity in New York that benefits the remote seller in its development or maintenance of a market for its goods or services in New York, to the extent that those activities are sufficient to satisfy the nexus requirement of the U.S. Constitution, then the out-of-state seller is deemed a vendor required to collect the New York sales tax. TSB-M-09(3)(s) outlines the kind of activities that relate to the development or maintenance of a market for the remote seller’s products, They include the affiliate: referring New York customers to the remote seller; accepting merchandise returns on behalf of the remote seller’s customers; distributing catalogs on behalf of the remote seller; and accepting orders on behalf of the out-of-state company.

Recently, the Assembly adopted a law, Chapter 57 of the Laws of 2010, that amended the 2009 law on affiliates, to narrow the definition of companies that are deemed sales tax vendors. Specifically, the 2010 statute provides that if the in-state New York affiliate only provides accounting or legal services or advice, or directs the activities of the remote seller insofar as making decisions about strategic planning, marketing, inventory, staffing, distribution or cash management, the remote seller will not be deemed a vendor required to collect sales and use tax. TSB-M-10(12)(S), issued on August 19, 2010, provides an informational statement about the Department of Taxation and Finance’s views on the 2010 law.

Under the 2010 clarification, therefore, if a New York-based holding company of a direct marketer with facilities located outside of New York were to provide traditional administrative and management services to the remote seller, the remote seller would not be deemed to have nexus under New York law. This, of course, is a significant, favorable clarification for New York-based enterprises that wish to own and control remote sellers located outside of New York without creating nexus in New York.

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

2010-10-05T16:53:00.006-04:00

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.

Per to the Department’s new “clarification,” which took effect on September 1, 2010 (see TSB-M-10(7)S (July 19, 2010), the Department had previously articulated its policy that “the sale of public documents by private entities” does, indeed, constitute the sale of a taxable information service. See State Farm Mutual Automobile Insurance Co., Adv. Op. Comm. T&F, TSB-A-04(29)S (December 28, 2004). However, as the Department went on to explain in its recent clarification:

“Despite the issuance of this Advisory Opinion in 2004, some taxpayers may have continued to reasonably rely on correspondence from the Tax Department predating this Advisory Opinion. That correspondence, which gave advice to the contrary, also indicated that the Tax Department would provide notification if the advice in the letter was reversed.”

Thus, the Department acknowledges that it was actively advising companies in a manner that it now admits is contrary to New York tax law and its own existing policy, and that, despite such advice, tax is due on the sale of information services derived from public documents. It is not entirely clear what prompted the Department to “clarify” its policy on the sale of information culled or compiled from public documents at this time. But, the recent TSB suggests that the Department feels the clarification serves to “better reflect controlling judicial case law and administrative decisions.”

In light of this express mea culpa from the Department, the Department has determined that it “will not assess any sales tax due that was not collected, or any related penalty and interest, for sales of public documents made during” tax periods prior to September 1, 2010. Thus, while sellers of information services must begin (or continue) to collect sales and use tax on such information services as of September 1, 2010, companies will not be exposed to liability for uncollected/unpaid tax for prior periods.

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

2010-09-17T15:09:00.001-04:00

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

2010-09-15T11:39:00.000-04:00

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

2010-09-13T15:00:00.000-04:00

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

2010-09-08T15:36:00.001-04:00

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.

The Court rejected the IRS’s arguments. As to the first document, the Court determined that work product protection extends to thoughts and opinions of a company’s attorneys developed because of the prospect of litigation, regardless of whether such work product is contained in a document prepared by the company’s accountants in connection with an audit. As to the Dow legal memoranda, the Court held that providing documents to the company’s independent auditors does not constitute a waiver of the work product protection over such documents because a company’s auditors are not inherently adverse to the company and because it was reasonable of Dow to expect that Deloitte would maintain the documents confidentiality against Dow’s adversaries (in this case, the government).

It is important for all businesses, including online sellers and other direct marketers, to understand both the principles that the Deloitte decision stands for, and those that it does not. On the one hand, it is meaningful for a federal court of appeal to uphold protections for the confidentiality of work product contained in documents provided to a company’s independent auditors. Particularly for a publicly–traded company, which may be required to provide such information to its auditors in order to secure an unbiased review of its financial condition, having a basis for maintaining the confidentiality of certain information related to actual or anticipated litigation, despite disclosure, is clearly important.

However, companies should not misunderstand the holding of Deloitte and assume it provides them carte blanche to disclose information to their accountants without fear of discovery. The work product doctrine goes only so far: it does not protect any information, including legal advice of counsel, unless such information or documents were prepared because of litigation. Tax planning strategies unrelated to anticipated litigation will not be shielded under Deloitte if disclosed to an auditor. Thus, companies should continue to take care to consult with counsel in responding to requests made by their accountants that seek the disclosure of legal advice, prior to making any such disclosures.

Update: California Senate Moves Tax Bill to Inactive File

2010-08-31T13:10:00.001-04:00

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

2010-08-30T18:13:00.004-04:00

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.

Perhaps the limiting feature for national publications is the fact that the sourcing provisions of the new law would source advertising revenues to Washington for B&O purposes only on the basis of where the purchase orders for such advertisements were issued. Sourcing is not based on traditional apportionment factors such as payroll and property costs.

Publishers who do not have a physical presence in Washington would have a potential constitutional challenge to the new statute. In particular, as discussed in the prior blog post, Quill/Bellas Hess should be read to apply to gross receipts taxes, so (we would argue) that the physical presence test of Quill/Bellas Hess should apply. Indeed, in Tyler Pipe Industries, Inc. v. Washington State Department of Revenue, 483 U.S. 232, 107 S.Ct. 2810 (1987), the U.S. Supreme Court found that the B&O Tax could be imposed on an out-of-state company because it had sales representatives operating in Washington and therefore was making a market in Washington. While the Court did not cite to Quill or its predecessor Bellas Hess, it did cite as support for its holding National Geographic Society v. California Board of Equalization, 430 U.S. 551 (1977), which in turn relied on Bellas Hess. Sales representatives under Quill and Bellas Hess create a physical presence. Thus, if a publisher does not have sales representatives who operate in Washington, it should consider a potential constitutional challenge to any imposition of B&O tax on its advertising revenues.

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

2010-07-28T18:08:00.000-04:00

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.

Furthermore, while further simplification remains elusive, there is growing evidence that states have substantially overstated the amount of revenue they “lose” through uncollected sales and use tax on Internet and other direct marketing sales by out-of-state vendors who are not required to collect such tax under Quill. The SSUTA contingent has long relied upon a study conducted by a group at the University of Tennessee (the “UT Study”), which was most recently updated in April 2009. The UT Study estimates that states will fail to collect between $45-50 billion in sales and use tax on direct marketing sales during the five year period from 2008-2012.

A more recent study, prepared by Jeffrey Eisenach and Robert Litan at Empiris LLC, entitled “Uncollected Sales Taxes on Electronic Commerce: A Reality Check” (the “Empiris Study”) and published in February 2010, presents a compelling critique of the UT Study. The Empiris Study’s Executive Summary powerfully summarizes the study's conclusions, including the fact that total potential uncollected sales tax revenues in 2008 were less than three-tenths of one percent of all state and local tax revenues. Also, it found that more than one-third of such uncollected tax revenues are associated with small businesses that would likely be excluded from use tax collection obligations under a “small business” exemption in federal legislation. Overall, the Empiris Study convincingly shows that the amount of projected uncollected state and local sales and use tax is far less than claimed by states or projected by the UT Study. Indeed, the Empiris Study concludes that “the increased collections associated with overturning Quill would be substantially lower than previously thought,” and would be approximately 33% of the amount estimated by the UT Study.

Such relatively modest amounts of additional tax revenue do not justify imposing the still-significant regulatory and compliance burdens associated with state and local sales and use tax collection that, in part, motivated the Supreme Court’s decision in Quill. The proper solution to the ongoing complexity of state and local sales and use tax systems is true simplification, which H.R. 5660, unfortunately, does not provide.

Is Amnesty Really Amnesty?

2010-07-27T14:45:00.001-04:00

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)!

2010-07-09T16:03:00.002-04:00

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.

There are significant issues regarding the proposed regulations. They go beyond the statutory authorization. First of all, there is no requirement in the statute for email confirmation if the retailer does not use invoices. Second, the detailed specifications of the notice, as set forth in the proposed rule, go well beyond the requirements of the statute and will place significant burdens on remote sellers. Third, the statute does not appear to require both notice on the retailer’s Internet website and inclusion of notice on invoices.

In addition to the fact that the proposed regulations exceed the requirements of the statute, the regulations, in combination with the statute, present significant questions of violation of the Commerce Clause of the U.S. Constitution. These are similar to those raised by the Colorado statute and regulations. See our blog post of July 2.

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

2010-07-02T17:06:00.000-04:00

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

2010-07-01T11:10:00.001-04:00

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.

The statutory definition of retailer is also expanded to now include an out-of-state company that has a “contractual relationship with an entity to provide and perform installation or maintenance services for the retailer’s purchasers” in Oklahoma. This statutory provision is similar but not identical to that in Virginia. Va. Code § 58.1-612.

Of course, even if a retailer satisfies the standard under this new law, unless the retailer has nexus under the Quill Commerce Clause test, Oklahoma would not be justified in requiring sales tax collection from the retailer. Several of the provisions in the new law raise significant constitutional law questions. Please see, for example, the recent U.S. District Court for Louisiana decision in St. Tammany Parish Tax Collector v. Barnesandnoble.com, Civ. Act. No. 05-5695 (E.D. La., March 22, 2007).

Supreme Court Hands Down Decision in Bilski

2010-06-28T17:25:00.001-04:00

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

2010-06-24T12:03:00.000-04:00

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.

Even the notice that is required under the Oklahoma statute is different than that required under the Colorado statute. The law requires notice on the “Internet web site or retail catalog and invoices provided to consumers.” The use of the word “or” in the statute indicates that a retailer has a choice. It can provide notice on its web site or it may insert notice in its retail catalog and any invoices provided to consumers. It is unclear whether that was the intent of the legislators when adopting the statute. But that is irrelevant, given the statutory interpretation principle that resort to legislative history is permitted only when a statute is ambiguous. There is no ambiguity in the statute. It clearly gives the retailer the choice. The statute did not use the conjunctive phrase “and” between “Internet web site” and “retail catalog and invoices.”

Even if notice is not provided on the web site, a good argument can be made that notice in the catalogs alone is sufficient if the retailer does not provide invoices. We know that many online sellers do not provide invoices. Again, the language of the statute provides for notice in the catalog “and invoices provided to its customers.” So, if a retailer does not provide invoices to customers, under the literal language of the statute the retailer would not be required to provide the notice.

It should also be noted that, although the statute is effective as of July 1, 2010, the notice provisions are not effective until the Oklahoma Tax Commission has adopted a rule implementing the statute. Thus, we will need to review the rule when adopted in order to assess the kind of notice that Oklahoma Tax Commission feels is required.

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

2010-06-21T14:25:00.003-04:00

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.”

Additionally, the proposed subsections (b)(1) and (2) indicate mandatory reporting for vendors not registered to collect sales tax whose sales exceed a relatively modest threshold. The subsections require “every person that is not registered with the board” that sells TPP subject to use tax, to file quarterly reports including names, addresses, sales prices, the dates of sales, and “such other information as the board may require.” Subsection (b)(2) provides that the reporting requirement in (b)(1) does not apply to persons whose receipts are less than $100,000 in the prior year and who are reasonably expected to have receipts less than $100,000 in the current year.

It is unclear whether the Senate’s version will survive the legislative process. If the amended bill is passed by the Senate, it must go back before the Assembly for agreement on the amendments. If the Assembly does not agree with the Senate’s amendments, it will be referred to a conference committee formed of members of both houses to resolve any differences.

We will continue tracking the progress of the bill to keep you informed of any new reporting requirements that may be imposed by the State. We also reiterate our previously-stated concerns: that the proposed bill imposes even more onerous reporting obligations than the Colorado statute, and that it may encourage other states to follow suit in attempts to regulate interstate commerce.

Tennessee

We last wrote about Tennessee in April, noting that the State’s affiliate nexus bill had been recommended for passage, but that the State’s Department of Revenue had indicated that it did not believe a mere affiliate relationship would be adequate for a finding of nexus. The legislation has since died in committee, when the General Assembly adjourned on June 10. Only time will tell whether Tennessee intends to make a second run at imposing affiliate nexus rules on out-of-state vendors.

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

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

The Incredible Shrinking Jurisdiction?

2010-06-14T17:43:00.006-04:00

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.

Background. Under Ohio law, certain sellers of natural gas enjoy tax exemptions, while others do not. Mindful of the Tax Injunction Act, and its broad limitation on the federal courts entertaining suits seeking to arrest the collection of state tax (or to reduce the amount of tax so collected), the plaintiffs came up with a clever approach that convinced the United States Court of Appeals for the Sixth Circuit to reinstate the case previously dismissed by the District Court. In crafting their complaint, the plaintiffs sought not to reduce their own tax obligations or in any way arrest the collection of taxes. Rather, the relief they sought was to deny their competitors certain tax exemptions, the net result of which, if successful, would be to increase state tax revenues. Because the plaintiffs did not seek to arrest collection of tax, the Sixth Circuit agreed that they had avoided falling under the Tax Injunction Act’s restrictions.

In addition to the Tax Injunction Act, the doctrine of “comity” may also keep tax cases out of federal court. Comity is the doctrine under which a court can stay its hand in hearing a case that lies within its jurisdiction to hear, and to do so out of respect for the power of other courts--perhaps better suited--to resolve the matter. In tax cases like this one, a rationale for dismissal of a case on the basis of comity could include deference to state courts to resolve matters that impact on their governmental revenue-raising prerogatives and powers.

The plaintiffs in Levin argued, and the Sixth Circuit found, relying mainly upon a footnote from Hibbs v. Winn, 542 U.S. 88 (2004), that comity likewise did not bar the suit. In Hibbs, the Supreme Court explained in a footnote that principles of comity only preclude federal court jurisdiction “when plaintiffs have sough district-court aid in order to arrest or countermand state tax collection.” Hibbs, 542 U.S. at 107 n. 9. It made sense. After all, the plaintiffs expressly disclaimed any interest in having their own taxes reduced or inhibiting in any way the collection of taxes by the State of Ohio.

The Supreme Court Reverses. But, the Supreme Court ran away as fast as it could from the footnote in Hibbs. In its majority opinion, the Court held that the plaintiffs were not free to elect a form of relief that would sidestep the Tax Injunction Act or comity. Whether to strike down the exemptions (as the plaintiffs had requested) or to apply the exemptions to all natural gas sellers (including the plaintiffs) was the prerogative of the State of Ohio, the Court explained, and not the federal courts or the plaintiffs. The Court noted that it has, as a matter of practice, abstained from determining remedial choices, allowing states the flexibility to respond as they see fit once provided a finding that a state tax statute is constitutionally infirm. See. e.g., McKesson Corp. v. Fla. Dep’t of Business Regulation, 496 U.S. 18, 49-40 (1990).

The Court also distinguished Hibbs on the grounds that the plaintiffs in the Hibbs case were, effectively, strangers to the underlying tax controversy arising out of tax credits allowed for payments that subsidized parochial school scholarships. “It was essentially,” the majority in Levin observed, “an attack on the allocation of state resources for allegedly unconstitutional purposes” by “outsiders to the tax expenditure.” Thus, “[u]nlike the Hibbs plaintiffs, respondents do object to their own tax situation, measured by the allegedly more favorable treatment accorded [their competitors].” In Hibbs, the majority also noted, the only remedy was the invalidation of the tax credit—and, as a result, the case did not result in the intrusion of the federal courts into state remedial choices. Notably, in a concurring opinion, the more conservative Justices found that both comity and the Tax Injunction Act barred federal court adjudication of the case and supported their decision to reinstate the District Court’s dismissal.

Implications. The conservative members of the Court signaled the likely impact of the Levin case when they bemoaned the Court’s reliance on comity (a “prudential ground”) rather than the Tax Injunction Act (a "jurisdictional ground"). This is an important distinction—because the federal courts have it within their discretion to refrain from hearing a case where principles of comity, alone, are concerned. Such a discretionary decision ordinarily would be given considerable respect on appeal. In contrast, federal courts have no discretion to hear a case that is prohibited by the Tax Injunction Act. The Act reflects an absolute limitation on the courts' power to hear the matter. Justice Thomas pointedly identified the majority's holding as creating a loophole “to leave the door [of the federal courts] open to doing in future cases what it did in Hibbs, namely, retain federal court jurisdiction over constitutional claims that the Court simply does not believe Congress should have entrusted to state judges under the Act, see 542 U.S., at 113-28 (Kennedy, J., dissenting).”

Maine Voters Repeal Tax Legislation

2010-06-09T11:27:00.000-04:00

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

2010-05-27T19:07:00.007-04:00

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.

In 1996, the Kentucky legislature formally abolished the filing of unitary returns for tax years after 1994. Then, in 2000, with the pending refund claims for earlier years creating the prospect of a massive drain on the state treasury, the legislature passed a law prohibiting the filing of refund claims for any tax year before 1995, based on the submission of an amended, unitary return filed after December 22, 1994. As a result, even those taxpayers who had successfully challenged the 1988 policy in court and had pending refund claims were retroactively precluded from obtaining refunds of excess tax paid.

In response to a challenge to the retroactive effect of the 2000 statute, the Kentucky Supreme Court, citing United States v. Carlton, 512 U.S. 26 (1994), held last year that the law satisfied the requirements of due process because it was rationally related to the legitimate governmental purpose of raising and controlling revenue. The Court found that the taxpayers could have no settled expectation of obtaining the refunds, given the legislature’s action in 1996 to reverse the effect of the Court’s 1994 decision for subsequent years. The Court further held that the new, retroactive tax statute infringed no fundamental constitutional right of the taxpayers and thus resulted in no violation of equal protection.

The taxpayers asked the United States Supreme Court to review the decision, but the Court on Monday turned down the request. Johnson Controls v. Miller, U.S. Supreme Court, Dkt 09-981, petition for cert. denied (May 24, 2010). In light of the existing jurisprudence on taxpayer due process embodied by Carlton, the Kentucky case perhaps breaks no new constitutional ground, but it may expand the limits (not yet fully defined) on how far a state may go to foreclose tax relief in order to protect state coffers.

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

2010-05-24T17:21:00.001-04:00

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.

Michigan (in the Michigan Business Tax (“MBT”)), Ohio (in the Ohio Commercial Activity Tax (“CAT”), Texas (in the Texas Margin Tax), and Washington (most recently in the May 2010 amendments to its Business and Occupation Tax), however, have asserted that the Quill physical presence test does not apply to gross receipts taxes, but is limited to sales tax. Citing a footnote in the Quill decision, these states argue for a different standard; namely that the mere economic presence of a taxpayer by sales into the state should create nexus.

The states fail to recognize, however, the U.S. Supreme Court’s decision in Commonwealth Edison Company, et al. v. State of Montana, 453 U.S. 609, 101 S.Ct. 2946 (1981), which applied a physical presence test to a gross receipts tax. In that case, the Court addressed the standard to apply to a Montana severance tax on coal extracted from Montana mines, which was a gross receipts tax. Although the Court upheld the constitutionality of the tax, the Court noted the physical presence standard for determining nexus. In particular, the Court cited National Bellas Hess as the standard for finding nexus. The physical presence test of National Bellas Hess doctrine was confirmed in the Quill case in 1992.

The states’ argument also ignores the fair relation prong of the Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977) test. The fair relation prong requires that there be a fair relation between a tax and the benefits conferred upon the taxpayer by the State. Although the Court has not required a detailed accounting of the services the states provide in order to be able to tax, the taxpayer must be engaged in some activity in the state in order to be subject to tax. Thus, in Oklahoma Tax Commission v. Jefferson Lines, Inc., 514 U.S. 175 (1995), the Court defined the fair relation prong as follows “Complete Auto’s fourth criterion asks only that the measure of the tax be reasonably related to the taxpayer’s presence or activities in the state.” (Id. at 200, citing Commonwealth Edison Company v. Montana as setting forth the applicable standard). Clearly, if the taxpayer lacks any physical presence in the state, the fair relation prong of Complete Auto cannot be satisfied.

In short, Complete Auto, Commonwealth Edison Company, and Oklahoma Tax Commission provide one basis to resist a state’s gross receipts tax enforcement efforts against online companies and direct marketers that lack a physical presence in the state.

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

2010-05-21T16:12:00.001-04:00

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: Currently permits cash refunds for gift certificates with cash value less than $10. See Cal. Civ. Code § 1749.5(b)(2). California has legislation currently before its Senate that would raise the threshold amount to $20.

Maine: Requires cash refunds for gift and stored value cards with less than $5 remaining on request, except in the case of prepaid telephone cards, cards with an initial value of $5 or less, and cards that were not purchased but were provided as a promotion or as a refund where no receipt was provided. See Me. Rev. Stat. tit. 33, § 1953(1)(G).

Massachusetts: For gift certificates to which value may be added and which have been redeemed in part, the holder of the gift certificate may request the remaining balance be paid in cash once its value falls below $5. For gift certificates prohibiting the holder from adding additional value, the holder can request the balance be paid in cash once 90% of the face value has been redeemed. See Mass. Gen. Laws ch. 200A, § 5D.

Montana: Gift certificates with original values of greater than $5, with less than $5 remaining, must be redeemed for cash on request. See Mont. Code Ann. § 30-14-108(4).

Vermont: If the remaining value of a gift certificate is less than $1.00, the gift certificate is redeemable in cash for its remaining value on demand of the gift certificate’s holder. See Vt. Stat. Ann. tit. 8, § 2704.

Washington: If, after a purchase is made with a gift certificate, the remaining value is less than $5, the gift certificate must be redeemable in cash for its remaining value, on demand of the bearer. See Wash. Rev. Code § 19.240.020(3).

California Nixes Affiliate Nexus Legislation; Connecticut’s Attempts Stall

2010-05-14T11:48:00.002-04:00

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

2010-05-12T16:07:00.000-04:00

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?

2010-05-07T17:15:00.029-04:00

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.

Background. To date, the laws governing online information collection and usage have been a patchwork. While some states, like California, have enacted more general Internet-related privacy laws, the federal government has never seen fit to act globally in this arena, leaving businesses generally to self-regulate through the voluntary adoption of privacy policies. Although it may come as a surprise to some, there is no federal law mandating privacy policies as a general matter. Instead, Congress has limited such requirements to discrete categories of businesses (such as online businesses catering to children, banks and financial institutions, and health care providers, among others).

Key protections for business. Most notably—and importantly—for direct marketers, the draft bill has a clear preemption provision. In other words, it supersedes “any provision of a statute, regulation, or rule of a State that includes requirements for the collection, use, or disclosure of covered information.” This would dramatically simplify the initial task of understanding the scope of a company's legal obligations in this arena, and would prohibit overlapping regulation by the states. Just as importantly, the bill provides no private right of action in federal or state court, not even the much abused class action lawsuit. Enforcement would rest in the hands of regulators rather than plaintiffs’ lawyers—removing a profit motive for enforcement which often prevents reasonable settlements. Unlike plaintiffs' attorneys, regulators will take into account the unique facts and circumstances of each case and exercise something akin to "prosecutorial discretion" in determining which cases to bring and the appropriateness of any resulting penalty.

Who is subject to the requirements of the bill? The only companies that escape its reach are those that (1) collect “covered information” from less than 5,000 individuals in any 12-month period and (2) do not collect “sensitive information.” Unless you meet both of these criteria, you are subject to all of the bill's requirements.

What information does the bill cover? In terms of what is deemed to be private information, the bill's reach is unprecedented and ought to be very worrisome to the industry. A person's name, alone, is suddenly protected, as any individual's postal address, telephone number, or email address. To date, no state or federal law reaches this far, and, as drafted, it leads to absurd results. For example, it could mean that telephone companies have broken the law by publishing their local "white pages," since names and/or telephone numbers are deemed private. Private information also includes fax numbers, unique biometric data, any government-issued identification number, financial account numbers (including credit and debit card numbers) along with any password necessary to permit access, any “unique persistent identifier,” including an IP address, and even preference profiles. (Under the bill, a "preference profile" means “a list of information, categories of information, or preferences associated with a specific individual or a computer or device owned or used by a particular user that is maintained by or relied upon by a covered entity.”) “Sensitive information” is defined to include all medical information; race or ethnicity; religious beliefs; sexual orientation; financial information associated with a financial account; and “precise geolocation information.”

The following is a sampling of some of the substantive provisions of the bill:

The bill requires a “privacy notice” to be made available to every individual from whom “covered information” is obtained. Where information is collected via the Internet, the notice must be clearly and conspicuously posted and accessible from the home page. Given FTC guidance in this area, the clear and conspicuous requirement would mean the link should be visible without scrolling down. Where information is collected by means other than the Internet, the notice must be provided in writing before the information is collected. It appears that this requirement could be met by with a counter display or printed handout. However, such a sign or handout would be far more than a simple "heads up" notice.

There are fifteen separate content requirements for a “privacy notice." It would need to include the nature of the “covered information” collected; how such information is collected; the specific purposes to which such information is put; how (and how long) such information is stored; how such information may be combined with other information obtained about the individual from other sources; how the information is disposed of; the purposes for which such information is disclosed to third parties and the “categories” of such third parties; the choices available to consumer to limit or prohibit collection or disclosure; the means by and extent to which the individual may obtain access to such information; the process by which notice is given of changes to the policy; and the effective date of the policy. While some of these disclosures are familiar to online sellers, they—in whole—exceed customary industry practices.

Businesses must obtain the prior consent of the individual to collect and use “covered information.” Such consent must be either an “affirmative grant” or a failure “to decline consent,” either of which must follow the provision of the privacy statement to the individual. Strikingly, however, the law allows the consumer to withdraw consent to the use information at any time, even if it was previously collected after consent was obtained.

With some exceptions, express affirmative consent must be obtained in the event of any material change to the privacy notice or any new use of information which an individual would reasonably “not expect based on the covered entity’s prior privacy notice.”

As might be expected, consumer groups are already arguing that the bill fails to go far enough.

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

2010-05-04T17:41:00.004-04:00

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.

If your company is required to comply with the Red Flags Rule, you will need to adopt procedures satisfying certain prescribed elements, tailored to your particular business. In addition, you should be aware that Congress (perhaps to demonstrate the seriousness it ascribes to the growing crime of identity theft) expressly mandated in FACTA that affected businesses and institutions must ratify their Red Flags procedures through action of the company’s board of directors or a committee of the board of directors.

Determining your obligations under FACTA, if any, and adopting appropriate procedures requires careful consideration of your various business activities with the assistance of experienced counsel. The downside of failure to adopt Red Flags procedures is not limited to enforcement action by the FTC –– worse, by far, would be the consumer and public relations problems following a data breach of sensitive customer information without having a required FACTA plan in place to identify potential risks of identity theft. The good news is that the analysis of whether a plan is required, and the subsequent crafting and adoption of a plan, need not be burdensome.

Update: Status of 2010 Affiliate Nexus Legislation

2010-04-30T14:20:00.003-04:00

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

2010-04-29T12:17:00.002-04:00

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.

The next obvious question is how enticing is the carrot and, conversely, how threatening is the stick? Clearly, if a retailer does not have an affiliate program, and does not otherwise have a physical presence in North Carolina, neither the carrot nor the stick may be enough to induce the retailer to register for sales and use tax purposes. If, however, a retailer has an affiliate program involving North Carolina companies or individuals, or creating a physical presence in North Carolina, then the offer from the Department may be attractive.

A retailer, guided by its counsel, should look at the nature of its affiliate relationships and, in particular, the terms and conditions of its affiliate program, to determine how it fits within the nexus provisions of the North Carolina statute. For example, the North Carolina statute states that if a retailer uses an affiliate that is a North Carolina resident and is not able to overcome the presumption that the affiliate is engaged in traditional solicitation activities in the state, then the retailer has nexus. For retailers that may have difficulty rebutting the presumption, the Department’s offer may be attractive. If, however, a retailer believes that it can overcome the statutory presumption of nexus resulting from its affiliate relationships, then it would need to engage in a traditional cost-benefit analysis, i.e., do the costs of registering to collect tax (administrative expense, possible negative impact on sales) outweigh the benefits of registering (eliminating any risk of liability for uncollected tax, past and future).

In any event, the decision should not be a knee jerk reaction, but should be based upon a careful analysis of the facts and circumstances of the retailer, and reviewed by counsel for the retailer. I will be assisting my clients in making such reasoned business decisions, informed by the relevant legal considerations.

Cybersquatting and the UDRP

2010-04-27T16:55:00.000-04:00

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.

For example, the increasingly widespread use of privacy or proxy shields in connection with domain name ownership threatens a number of important policy interests, and complicates the ability to police those who are habitual cybersquatters. Many persons who register domain names now do so through third parties who hold the domain names essentially in trust, but have no real control over content or other substantive behavior that occurs on the website to which the domain name resolves. Not surprisingly, this makes it difficult for those who are injured by the content appearing on the website to get access to the real party in interest. In the cybersquatting area, it can also complicate the ability to prove bad faith, since one accepted method of doing so is to provide evidence of a pattern of cybersquatting behavior by the individual respondent.

Another interesting development in the UDRP decisions also relates to the concept of bad faith. In an increasing number of cases, UDRP panels are imposing upon cybersquatters an obligation to perform some due diligence in order to determine whether registration of a particular domain name infringes the rights of a third party. If this trend gets traction in the UDRP world, it has the potential to expand significantly the scope of registrations that might be subject to a bad faith argument.

Finally, in an interesting U.S. District Court case arising out of an Anticybersquatting Consumer Protection Act (15 U.S.C. § 1125(d)) case, a judge has reaffirmed the rule that so-called "gripe sites" are protected under the First Amendment guarantee of free speech, and in most circumstances will not be subject to a claim of bad faith. Although not a UDRP case, the reasoning is likely to be followed by UDRP panels, at least in the United States. In Career Agents Network v. careeragentsnetwork.biz, the court held that a site which has no commercial purpose, but merely contains commentary and criticism, is protected. The essence of the court's holding is that there needs to be some profit motive on the part of the owner of the gripe site in order for the trademark owner to prevail. This will no doubt be disappointing to brand owners, as gripe sites can be at best an annoyance, and at worst a significant threat to brand loyalty.

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

2010-04-19T18:22:00.002-04:00

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.

Another effect of the agency model is that the publisher will be deemed to have nexus in each of the states where its agent—Amazon, Apple or Sony—has nexus in connection with its agency responsibilities of selling and serving the sale of digital books by the publisher. See Scripto, Inc. v. Carson, 362 U.S. 207; 80 S. Ct. 619; 4 L. Ed. 2d 660 (1960). But, not only should the publisher review nexus acquired through its arrangements with its e-book sellers, it must also consider nexus on a company-wide basis. Under well-established U. S. Supreme Court precedent (see National Geographic Society v California Board of Equalization, 430 U.S. 551, 556; 97 S. Ct. 1386; 51 L. Ed. 2d 631 (1977), nexus is based on the activities of all divisions of a company. Thus, even if the publisher’s activities with regard to print books are unrelated to its sales of digital books, and even though such sales are conducted by separate personnel from separate offices, the publisher will be required to collect sales and use tax on retail sales of e-books in each state in which its print division has nexus.

Other state tax issues are raised by the new digital book model, as well. Questions include whether the company will have nexus for income tax purposes and gross receipts tax purposes, and whether the protections of Public Law 86-272 will continue to be available.

There are certainly ways to reduce state tax exposure for publishers. Thus, knowledgeable publishers are considering ways to mitigate state tax exposure before they launch full-scale the agency model.

California Follows Colorado Down the Rabbit Hole

2010-04-14T10:18:00.006-04:00

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.

The California rules are quite similar to Colorado’s, but the proposed California law requires quarterly, instead of annual, reports and provides an exemption based on sales volume. The bill provides that:

Any retailer making sales subject to tax, that is not required to collect use tax, “shall provide notification on its Internet Web site or retail catalogue that tax is imposed…and is required to be paid by the purchaser.” Cal. Rev. & Tax Code § 6208(2) (as proposed).

Such retailers must file on a quarterly basis “a report that sets forth the names and addresses of purchasers of tangible personal property, the sales price of the property, the date of the sale, and such other information as the board may require.” This requirement does not apply to retailers with qualified receipts of less than $100,000 in the prior year if the retailer’s qualified receipts are “reasonably expected” to be less than $100,000 in the current year, as well. Cal. Rev & Tax Code §§ 7055(7)(b)(1), (2) (as proposed).

Also similar to Colorado’s law, AB 2078 creates a rebuttable presumption that if a “controlled group of corporations has a component member that is a retailer engaged in business in [California],…[any retailer that is a part of the controlled group] shall be presumed to be a retailer engaged in business in” California. Cal. Rev. & Tax Code § 6203(1)(f) (as proposed). The bill does not provide any information about how a retailer can rebut this presumption.

Obviously, although similar in nature to Colorado’s law, the California bill potentially imposes even more onerous reporting obligations for out-of-state retailers, based on the sheer number of customers located in California and the quarterly filing requirements. Retailers also should be concerned about a legislation domino-effect. As we wrote previously, South Dakota is already informally demanding that out-of-state companies provide the State a list of in-state purchasers who may owe use tax. Which states will be next to attempt to regulate interstate commerce?

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

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

New York Threatens to Discontinue Long-Standing Promotional Material Exemption

2010-04-13T09:30:00.000-04:00

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"?

2010-04-12T12:56:00.008-04:00

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.

The CPSIA, itself, does provide some limited guidance as to "factors" to be considered in determining if you're selling a children's product. You are asked to consider: (1) manufacturer's statements (including those on labels), if such statements are reasonable; (2) whether packaging, display, promotion, or advertising present the item as appropriate for use by children 12 years of age or under; (3) whether the product is commonly recognized as being intended for children 12 years of age or under; and (4) the CPSC's own "Age Determination Guidelines" which were last published in 2002.

The problem with these "factors" is that none focus on the question of whether the product is "primarily" designed and intended for children twelve years of age or under. Moreover, the Age Determination Guidelines document from 2002 is a densely written quasi-scientific overview of cognition, motor skills, and psychological and emotional development in certain ranges of ages which offers very little practical help in close cases -- particularly at the older range of the continuum. One thing the document does is show that determining the proper age group for a product is much easier for the younger age groups, but gets very foggy for eleven- and twelve-years-olds. Indeed, the document itself notes that, at twelve, a child's thinking is more "adult-like." The Guidelines also note, problematically for any company trying to sort out the "intended age" question, that twelve-year-olds will be drawn (like a magnet, probably) to products that appeal to older teens.

What does the new guidance offer to rectify this? The regulation first divides products into two basic categories: "general use products" and “children's products.” General use products are those "not being marketed to or advertised as being primarily intended for use by children 12 years or younger and that are used by a significant proportion of the population older than 12 years of age." 16 C.F.R. 1500.92(b) (as proposed). The second half of this definition is poorly written and makes little sense. But, I think the language is intended to mean that a significant portion of the product’s users are older than 12 years of age. Additionally, because the definition is in the conjunctive ("and"), it would appear that a product is for "general use" as long as it is not "marketed or advertised" as intended for use by children 12 years of age or younger. This would make life easy for the industry: you can control your legal obligations by controlling your marketing.

But, the proposed definition of "children's product" muddies the water. The test for a “children’s product” is whether the product is "designed and commonly recognized as intended for use by a significant proportion of children 12 year of age or younger," and includes in the term "use" all reasonably foreseeable "misuse." In other words, a product can be a "general use product" and a "children's product" simultaneously -- even if (1) the sole projected “use” by children twelve and under is a “misuse” and (2) the product is not advertised or marketed to that age group.

Under the proposed regulation, Sellers are expected to make an assessment of what "common recognitions" are for use of the product -- with the specific proviso that such a determination likely involves "[m]arket analyses, focus group testing, and other marketing studies..." In other words, small and large companies alike must now engage in vigorous market studies in order to limit the risk that a product may, after the fact, be deemed a children's product by the CPSC.

The regulation is helpful in that it provides a list of product categories and explains how those products would be treated under the new guidelines. Even though such categories are filled with their own caveats, they do give sellers some degree of comfort in the areas that are expressly discussed. The categories include:

Furniture and furnishings: These are generally not considered children's products unless they are decorated with a child's theme, have play value, or are sized for a child. "Decorative items that are intended only for display, with which children are not likely to interact, are generally not considered children's products, since they are intended to be used for adults."

Collectibles: Collectibles, even those that might otherwise qualify as children's products, can avoid this categorization if they have features that preclude use by children during play, "such as high cost, limited production, [and] display features, and [if they] are not marketed alongside children's products."

Jewelry: The test is whether the product is generally sized, themed, and marketed to children. Factors to consider include, among other things: very low cost; play value; childish themes on the jewelry; sale with other children's products (such as a children's dresses); sales with children's books, toys, or party favors; and sale in store (or catalog/web site) that mainly sells children's products.

DVDs, Video Games, and Computers: Logically, most computer products and electronic media devices are not considered children's products. However, handheld video games "with software intended for children...younger than 12 years" may qualify as such.

Art Materials: The marketing and labeling of these are given high priority.

Sporting Goods and Recreational Equipment: Regulation-sized sporting equipment and recreational equipment (like roller blades, camping gear, bicycles, and fitness equipment) are generally not considered children's items, unless they are sized for children and/or are decorated with childish themes.

This guidance indirectly underscores the broad reach of the proposed regulation -- everything from bicycles to camping gear to books to electronic equipment and more can be subject to onerous new product safety requirements.

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

2010-04-08T13:43:00.000-04:00

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.

In addressing the City’s claims, the Court rejected the City’s RICO argument on the ground that the City could not establish the direct causal connection required under RICO between the alleged “predicate act” (Hemi Group’s failure to report purchaser information to the State) and the City’s alleged harm (the loss of use tax revenues due from its citizens). The Court did not opine on other potential weaknesses in the City’s case.

However, while it confined its legal ruling to the lack of required causation, the Court also noted that it was important to remember that the case was “about the [alleged] RICO liability of a company [(i.e., Hemi Group)] for lost taxes it had no obligation to collect, remit, or pay.” (Emphasis added). Picking up on the Court’s comment, Justice Ginsberg in her concurrence expressly called out subtext of the case: the City was improperly attempting to use RICO to “end-run” the constitutional limits on the City’s ability to impose use tax obligations on an out-of-state company derived from the Commerce Clause and the Court’s decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

In the wake of the Court’s ruling in Hemi Group, last week Congress stepped in and exercised its Commerce Clause authority to strengthen the Jenkins Act to require out-of-state sellers to collect state and local use taxes on tobacco products. On March 31, 2010, the President signed the Prevent All Cigarette Trafficking Act (“PACT Act”), which, among a number of other provisions related to cigarette trafficking, amended the Jenkins Act to require that “delivery sellers” collect all state and local excise taxes due on cigarettes or smokeless tobacco. Importantly, Congress stressed that there are “unique harms” associated with online cigarette sales (including the long-term health effects of using tobacco products and terrorist involvement in trafficking illegal cigarettes) that justified Congressional action. Congress therefore emphasized that the PACT Act “is in no way meant to create a precedent regarding the collection of State sales or use taxes by, or the validity of efforts to impose other types of taxes on, out-of-State entities that do not have a physical presence within the taxing State.” (Emphasis added).

We have recently written in this blog about states’ attempts to increase use tax collection on Internet sales through “New York style” online affiliate nexus laws and “Colorado style” notice and reporting obligations imposed on remote sellers which seek to extend state regulatory authority across state lines. No matter how dire their short-term budgetary problems may appear, and no matter how disappointed they may be that their own citizens fail to report use tax due on remote sales, state and local government and tax officials would do well to remember that more than 200 years ago, the framers of the Constitution created a common market in the U.S. by limiting state regulation of interstate commerce via the Commerce Clause. Fortunately, it appears from the Court’s ruling in Hemi Group and the enactment last week of the PACT Act, all three branches of our federal government recognize that the Constitution reserves for Congress the task of regulating interstate commerce.

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

2010-04-05T17:17:00.002-04:00

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.

There is an argument that Finnigan is inconsistent with Public Law 86-272 because the State is taxing a non-taxable entity. That argument, however, was rejected in Disney Enterprises, Inc. v. Tax Appeals Tribunal of the State of New York, 888 N.E.2d 1029 (N.Y. 2008), which stated that inclusion of sales in the numerator did not tax the subsidiaries but simply was a method of calculating the tax. Given the differences between the New York law and the Maine law, however, the argument that Maine’s new approach is inconsistent with Public Law 86-272 may have some force, depending on the facts and circumstances of the taxpayer.

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

2010-03-31T14:49:00.002-04:00

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.

This is not a very big carrot, though, because for pure Internet sellers and direct marketers, nexus for sales and use tax purposes and for the Michigan SBT under the Michigan statute and regulations requires a physical presence of the company in Michigan, i.e., sales representative activity of at least two days on an annual basis, not including attendance at trade shows at which no orders were taken. (See Revenue Administrative Bulletin No. 1998-1 for a discussion of other nexus creating activities under the SBT).

Thus, the only real benefit of submitting a VDA to marketers who had no physical presence would be the waiver of penalties on the tax for 2008 and 2009 and the avoidance of future interest on taxes paid. The costs would be payment of taxes for which the company might not otherwise be liable and the costs and burden of providing for future tax collection. Of course, the decision as to whether the VDA process is beneficial for a company should be made only after carefully analyzing the facts and circumstances for that company under the guidance of the company’s advisers. But the point is that before grabbing the “opportunity” to sign up for the VDA, a company should analyze and weigh very carefully the benefits of the VDA against its costs.

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

2010-03-25T15:51:00.002-04:00

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.

Perhaps due to this complexity, states historically did not aggressively pursue audits or assessments on direct mail. But, those days are gone. In recent years, states and localities have begun focusing more and more on sales and use tax application to direct mail, in part due to attention given the issue by the Streamlined Sales and Use Tax Agreement (“SSUTA”). Although it takes no position on whether direct mail should be subject to tax, the SSUTA project raised the issue’s profile by adopting provisions addressing the sourcing of direct mail transactions. Those provisions were amended in late 2009 to separate the treatment of “advertising and promotional direct mail” from other types of direct mail, such as invoices, notices, etc. But, the provisions do nothing to minimize (and, coupled with other provisions in the SSUTA, arguably aggravate) the complexity of taxation of direct mail.

In the last two years, many of the more aggressive states, particularly non-SSUTA states, began to put pressure on large printers and letter shops to collect the use tax on their sales of direct mail pieces, even on sales to clients that lacked any presence in the state. Internet and direct marketers began to receive unwelcome notices from their printers that they would have to pay tax on large print contracts, adding 7-10% to the already high cost of doing business for direct marketers

Given budgetary problems in states throughout the nation, revenue departments will likely continue to look for ways to boost tax collections from direct mail transactions. Direct marketers need to be aware of this issue prior to entering into any negotiation over print and other direct mail contracts; direct mail firms should understand their potential tax obligations and recognize that they may be able to take steps to minimize their tax exposure and thereby offer more competitive fees to their clients.

Welcome Eyes on IP Readers

2010-03-18T09:32:00.001-04:00

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?

2010-03-17T18:14:00.004-04:00

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.

The presentation first shows that Facebook is "[o]ften cooperative with emergency requests." It is probably in the interest of most eCommerce companies to be cooperative in those situations, but it is likewise vital to ensure that your privacy policy makes clear the nature of such cooperation, and that you have some degree of internal controls in place to ensure that the emergency exception does not swallow the privacy rule. Vetting such requests with counsel can be an important protective measure to an appropriate balance of company interests.

In defending itself, Facebook explained: "We scrutinize every single law enforcement request; require a detailed description of why the request is being made; and if it is deemed appropriate, share only the minimum amount of information. We strive to respect the balance between law enforcement's need for information and the privacy rights of our users, and as a responsible company we adhere to the letter of the law." The presentation notes, in contrast, that Twitter only produces data "in response to legal process." Both approaches are sound.

The presentation also discusses the fact that supplying fake credentials (in violation of the terms of service) can result in civil and potentially criminal liability. CNET reports that at least one case has found no criminal liability from a breach of such terms of service, but the law, as CNET notes, remains unsettled. In the Drew case, the defendant allegedly created a deliberately false identity and pretended to be a sixteen-year old for the purpose of communicating with a minor, all "conscious violations" of the MySpace terms of service. In dismissing the criminal charges, the trial court concluded that the Computer Fraud and Abuse Act was unconstitutionally vague in connection with the argument that it criminalized intentional breaches of a website's terms of service. While it is helpful to know that the DOJ is mindful of the potential criminal implications of using false pretenses in connection with a social media account, the presentation also shows a degree of interest in such techniques that might be considered to be very disturbing by some.

Apart from whether fraudulent access to a community web site is a crime, the Drew case underscores the general importance of terms of service, and the additional degree of protection they can provide to users both in terms of criminal infiltration and unwarranted government intrusion. Clear terms that require accurate personal information in connection with all accounts help safeguard users from online predators and fraud, while also helping to ensure that law enforcement goes through appropriate channels (and not secretly) to obtain content from those sites. This is just another reminder to take those terms seriously and to treat them as more than simply boilerplate. As with privacy policies, periodic reviews are wise.

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

2010-03-16T10:53:00.012-04:00

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."

Ten years ago, the risk of such "re-identification" was "largely theoretical":

"In a corner of the U.S. Census Bureau, a small group of statisticians has been sweating out the agency's nightmare scenario: 're-identification.' That's the term for a technique that the bureau fears could allow marketers and other "intruders" to match anonymous census information with the names of the people who provided it. Such a concern is largely theoretical, so far. But if perfected, the technique could have great appeal to marketers of everything from french fries to financial services."

-Glenn R. Simpson, "The 2000 Count: Bureau Blurs Data To Keep Names Confidential," The Wall Street Journal, February 14, 2001.

The risk is theoretical no more, and online sellers and direct marketers that fail to pay attention to the issue do so at their own peril.

The Netflix Case. Netflix just announced that it is canceling its Netflix Prize after being sued in federal court on a class action basis for invasion of privacy and violation of the Video Privacy Protection Act ("VPPA") based upon the alleged re-identification of individuals whose movie rating information was made public in a database that had been scrubbed of personal information.

Netflix sponsored a contest to see if entrants could provide "collaborative filtering algorithms" that could better predict viewers' movie ratings than Netflix's existing Cinematch recommendation engine. In connection with the contest, entrants were given an "anonymized" training data set that contained 100 million subscriber movie ratings covering 480,000 subscribers and 18,000 movies. Each of the rating entries included a unique numeric identifier representing the subscriber, but contained no personally identifiable information.
It didn't take long, however, for two researchers at the University of Texas to identify two of the anonymous subscribers in the training data set. They did so by using public reviews available on the Internet Movie Database and re-identification algorithms. The researchers found that one of the people they identified "had strong-ostensibly private-opinions about liberal and gay-themed films and had ratings for some religious films." (The complete study is available here.) The researchers were apparently able to identify individual subscribers despite the "perturbation techniques" employed by Netflix to protect individual identities. (Perturbation adds "noise" to a database to protect individual record confidentiality. The UT researchers had developed a technique that was "robust to perturbation in the data.")

In at least one respect, the Netflix case presented a good opportunity for class action plaintiffs because the federal VPPA specifically makes video rental information private. (As is often the case with privacy laws, the VPPA was passed in reaction to a highly publicized event - in this case, the release of Judge Robert Bork's video rental records during Senate hearings on his nomination to the United States Supreme Court.) But, the Netflix suit went far beyond alleged VPPA violations, and included sweeping counts under California statutes (including for alleged unfair trade practices and false advertising), as well as common law privacy claims. Not only was Netflix sued, the Federal Trade Commission jumped on the bandwagon. Eventually, after "productive discussions" with the FTC, the suit was settled and the Netflix Prize was no more.

Takeaway. The Netflix case raises very serious questions for online sellers and direct marketers with regard to supposedly anonymous aggregated databases that reflect customer information, including purchasing histories and demographic information. In the future, we may well see privacy and security laws evolve to cover databases that are susceptible to re-identification. Each company should actively examine the intersection between its business objectives and the privacy concerns of its customers with regard to the collection, storage, and use of customer data. Clear and accurate privacy policy disclosures are essential to ensure that consumers understand a company's information collection and disclosure practices. The claims against Netflix included assertions that standard privacy policy provisions were materially misleading given the availability of re-identification.

Gift Cards: The Sleeping Dog

2010-03-16T10:43:00.002-04:00

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.

Moreover, most of these laws are enforceable against online retailers, even if the online retailer doesn’t have nexus or a physical presence in the state. Constitutional “Due Process” standards permit suits against a company that might nevertheless be insulated from tax obligation under the Commerce Clause. As long as the online retailer sells to a customer in the state, the online retailer will be subject to the provisions of the state’s gift card statute.

Finally, there are several states that require the “escheat,” or payment over to the state, of the value gift certificates and gift cards that have not been redeemed within a prescribed period of time set by statute. These so-called “unclaimed property” statutes are designed to preclude a retailer from obtaining an advantage through such “breakage” and require the payment of all or a portion of the face value of the gift cards to the state.

The point is not to throw your hands up in defeat and either ignore the applicable statutes or take measures that do not make sense from a business standpoint. Rather, a prudent online retailer should review its gift card program in light of the various state statutes. This will be particularly important prior to the effective date of the CARD Act on August 22, 2010, so that the retailer can understand its obligations with respect to gift cards issued before and after the new requirements of the CARD Act take effect.

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

2010-03-12T16:43:00.000-05:00

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.

Imagine if you will the following scenario: Acme Direct Marketing is an online seller of skin cream. Acme enters into an agreement with a third party to create a revenue-sharing affiliate network for the purpose of generating traffic to Acme's website. Affiliates enroll through the third party--perhaps Google. Many affiliates, if not all, are anonymous as far as Acme is concerned. They are paid each month based upon the traffic that they drive to Acme's website. Traffic is measured by the third party, who bills Acme for traffic generated each month. I am guessing that this scenario sounds quite familiar to many online merchants--in fact almost all online merchants engage in some variation of this business practice.

Now assume that one such affiliate (or maybe several) includes content on its website for the purpose of attracting attention and referring traffic to the merchants for whom it is an affiliate. The material that it posts on its website is often not entirely accurate--after all, these folks know nothing about the cosmetics business, and even less about truth-in-advertising. Perhaps the affiliate takes some liberties with the supposed benefits of Acme's product.

Under new FTC guidelines, Acme is responsible for false or misleading statements made by its affiliates. Moreover, the affiliate is obligated to disclose that it receives remuneration in exchange for sending traffic to Acme's website.

In many instances, the system for managing far flung affiliate networks is simply not designed to permit monitoring of these affiliate sites. In addition, early indications in the marketplace show that third party affiliate programs are not eager to assume any of the legal risks associated with these new guidelines.

Under the circumstances, responsible merchants need to be thinking about techniques for monitoring affiliate networks, and for securing contractual assurances that the affiliates will comply with the new rules.

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

2010-03-11T17:53:00.005-05:00

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.

These new obligations are backed by substantial penalties for retailers that do not comply. Amazon.com reacted to the passage of the bill by terminating all of its Colorado online affiliate relationships, angering Colorado lawmakers who had worked with Amazon and its local affiliates in removing “New York style” affiliate nexus provisions from earlier drafts of the bill.

But the tiff between Amazon and Colorado is really a side-show that masks the genuine problems with the law, including both potential constitutional violations and invasions of consumer privacy. Colorado lawmakers and revenue officials made no secret during debate on the bill that the new law was expressly intended to force out-of-state online and direct marketers to begin collecting Colorado use tax on their sales to Colorado residents, despite constitutional prohibitions against the imposition of such tax obligations under the Commerce Clause, as reaffirmed by the Supreme Court in Quill Corp. v. North Dakota.

The burdens imposed by the new law are real and discriminatory; no Colorado retailer is required to comply with them, but out-of-state online and direct marketers’ compliance is mandatory. Also, given the propensity for “copy cat” nexus legislation among the states in recent years, such laws are likely to proliferate in other state legislation soon, unless online and direct marketers (and voting consumers) trumpet the problems with such laws. Already, the South Dakota Department of Revenue & Regulation is following Colorado’s lead by informally demanding that out-of-state companies provide it a list of in-state purchasers who may owe use tax.

Consumers should take note because the new Colorado law suggests that some state lawmakers feel that the answer to encouraging increased use tax compliance by online shoppers is the systematic invasion of their privacy, on a massive scale. Under the Colorado law, every online and mail-order purchaser in Colorado will have the source and amount of his or her purchases from out-of-state sellers fully documented in Colorado Department of Revenue databases, down to the last penny. Such files are presumptively public records, and thus potentially subject to disclosure under Colorado’s Open Records Law. Furthermore, even if the Department resists the formal requests for access to such records that will inevitably come, public agencies such as the Department are typically not subject to data security laws (for example, Colorado’s data breach statute applies only to individuals and commercial entities), and thus unlike private businesses are not compelled to have meaningful data security measures in place. Little wonder the great majority of all data breaches have occurred through public agencies, including other Colorado agencies.

Voters in other states beware.

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

2010-03-11T17:39:00.005-05:00

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.

Following harmonization, the Ontario HST will be 13% (comprised of a 5% federal component and an 8% provincial component), and the British Columbia HST will be 12% (5% federal/7% provincial). Both provincial component rates will be locked in for the first two years of the HST. American and other non-Canadian vendors should take note that under the new HST, imports into Canada of non-commercial goods by or for a consumer who is a resident of an HST province, regardless of the port of import, are subject to both the federal and provincial components of the HST.

In general, the new HST will have the same tax base as the current federal GST, but vendors should be sure to confirm the taxability of their goods and services. The Ontario Ministry of Revenue estimates that there will be no change in tax status for over 80% of goods and services sold to consumers. Certain items currently exempt under the PST, including children’s clothing and footwear, will continue to be exempt from the provincial component of the HST. These exemptions will take the form of a “point of sale” rebate. Basic groceries, prescription drugs, and many other goods and services already exempt under the PST will be exempt from both components of the HST. Ontario has provided comprehensive transitional rules to help businesses properly tax transactions that straddle the implementation date.

Vendors should take a close look at their current tax practices and make sure they are ready to comply with the HST before it goes into effect.

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

2010-03-11T08:52:00.010-05:00

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:

• “Only authorized employees of LifeLock will have access to the data that you provide to us, and that access is granted only on a ‘need to know’ basis.”

• “All stored personal data is electronically encrypted.”

• “LifeLock uses highly secure physical, electronic, and managerial procedures to safeguard the confidentiality and security of the data you provide to us.”

The FTC charged that "LifeLock’s data was not encrypted, and sensitive consumer information was not shared only on a 'need to know' basis." The agency also charged that the company’s data system was vulnerable and could have been exploited by those seeking access to customer information." Read more here.

Takeaway: Many companies make promises about data security, particularly in connection with online transactions. If your company is going to publish those kinds of assurances, make sure you live up to them. While this is not the first time the FTC has penalized a company for allegedly false claims about data security, the fine is one of the largest.

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

2010-03-11T08:19:00.007-05:00

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.

Takeaway: Irrespective of Massachusetts's new regulation, it is in the interest of every company that possesses confidential personal information to have a written security policy to protect confidential information from inadvertent disclosure and from disclosure by intentional interception or theft. The Massachusetts regulation provides a useful set of guidelines as to what should be in that policy.

Here are some reasons to pay attention:

First, companies can face substantial liability for data disclosures, including by consumer class actions and enforcement actions by regulators. A written WISP that is implemented and followed can be important as a defense against such claims, including claims under theories of negligence.

Second, many companies make information security promises on their web pages, and failure to back up those promises with written protocols and standards can lead to FTC complaints and penalties, among other unpleasant consequences.

Third, a written policy is probably the only practical way to effectively control the use and dissemination of confidential information within an organization of any size and to avoid, to the fullest extent possible, the legal and public relations nightmare of a data breach.

Finally, the measures set out in the WISP ought to provide a company with early warnings so that it can promptly notify regulatory agencies, law enforcement, and consumers whose information may have been compromised.

At least for now, Massachusetts has indicated that it will only audit a company for compliance with the regulation if the company notifies the state of a security breach (as it is required to do), or if a security breach as to which the State was not notified hits the press. While a potential data security breach presents inherent public relations and legal risks for a company, having a solid WISP and a good faith effort to implement it is the first and best line of defense.

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

2010-03-09T12:46:00.006-05:00

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.

But, the use of an affiliate in a state with an affiliate nexus statute does not automatically create nexus. Rather, under each of the statutes already enacted and under those proposed in other states, use of an in-state affiliate creates a presumption of nexus that can be rebutted by a showing that the affiliates do not engage in traditional solicitation activities in the state. While each state provides a general description of the type of showing an online retailer needs to make in order to avoid a finding of nexus, it is only New York that provides an actual road map to rebut the finding of nexus. New York TSB-M-08(3.1)S provides a “safe harbor” method of rebutting the presumption of nexus when an out-of-state retailer uses New York affiliates. Thus, one alternative for a retailer to consider is what I call a “New York style” approach. Namely, the online retailer would provide in each agreement with its affiliates (the “Terms and Conditions”) that the affiliate agrees (covenants) not to engage in any traditional solicitation activities in the state that result in referring potential customers to the retailer. In addition, the agreement with the retailer should provide that the affiliate will provide to the retailer on an annual basis a certificate attesting to its satisfaction of the “no solicitation” clause and agreeing that the failure to submit such a certificate terminates the affiliate relationship and the payment of commissions or other compensation to the affiliate. While the implementation of an agreement along the foregoing lines will not automatically overcome the presumption in states other than New York, it is a proactive approach to rebutting the presumption they create and is worthy of serious consideration by an online marketer, depending upon its particular circumstances and in consultation with its counsel.