The Year In Review

As the year draws to a close, it’s worth looking back over a range of important legal developments in the world of electronic commerce, a number of which set the stage for fireworks in the months and years ahead.  Wishing all of our readers a wonderful holiday season, and the best and brightest New Year, we hope you enjoy our “top five” list.

Coming in at number five ...

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

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

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

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

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

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

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

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

Colorado Jumps On The Economic Nexus Bandwagon

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

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

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