States on the Warpath

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.

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

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

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

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.