February 2013: An Eventful Month In The Debate Regarding Use Tax Collection By Internet Retailers

If it seems like there has been a lull in the debate regarding whether ecommerce vendors should be required to collect sales and use tax, this month has seen a series of developments that demonstrate the conflict continues apace.

On February 6, 2013, New York’s highest court heard oral arguments by attorneys for Amazon.com, Overstock.com, and the state Department of Taxation and Finance in the Internet retailers’ respective constitutional challenges to the New York affiliate nexus law enacted in 2008. (The cases are captioned Amazon.com v. New York State Department of Taxation and Finance, Court of Appeals Case No.APL-2012-00045, and Overstock.com v. New York State Department of Taxation and Finance, Court of Appeals Case No. APL-2012-0001.)  Recall that, under the New York law, an out-of-state retailer is presumed to be soliciting sales through representatives in the state if it enters into a contract with a New York resident for the placement of a link on the resident’s website that refers internet users to the out-of-state retailer’s website, pays the New York resident compensation based on sales to customers completed through the link, and makes a minimum $10,000 in such sales to New York customers.  See N.Y.Tax Law § 1101(b)(8)(vi).  A retailer with an in-state representative that solicits sales is required under New York law to collect and remit use tax on sales to New York customers.  The state prevailed before the trial court and intermediate appellate court finding that the law was not unconstitutional on its face.  According to reports, the Justices on the Court of Appeals appeared somewhat receptive to Amazon’s arguments that (1) the law violates the Due Process Clause because the presumption cannot be effectively rebutted and (2) the law violates the Quill “physical presence” standard of nexus.  That said, the state has the advantage of having prevailed below.  Decisions by a state high court are usually issued several months after argument, and we will continue to monitor the case.

More Cautionary Tales of State Tax Laws With Retroactive Effects

We have written before about retroactive tax laws, but there is reason for concern that the phenomenon of states resorting to retroactivity may be on the rise. In the most recent case to wind its way to the end of the state appeal process, the Michigan Court of Appeals upheld a statute that amended Michigan’s use tax code with an effective date 5 years prior to its enactment. General Motors Corp. v. Department of Treasury, 290 Mich. App. 355 (2010), appeal denied, 489 Mich. 991 (2011), and cert. denied, 132 S.Ct. 1143 (2012). The Michigan Supreme Court denied review in the case last year, and the U.S. Supreme Court refused to review the decision a few weeks ago, in late January 2012. The decision by the GM Court, which cited the Kentucky case discussed in our earlier blog post, Miller v. Johnson Controls, 296 S.W.3d 392 (Ky. 2009), rehearing denied (2009), and cert. denied, 130 S.Ct. 3324 (2010), suggests that the legal standard a state must satisfy to amend its tax law retroactively is, in many instances, not very exacting.

GM concerned a statute passed by the Michigan legislature to block the giant automaker (and potentially other companies) from obtaining a refund of use tax paid on “demonstration” vehicles driven temporarily by GM employees, but expressly held by GM in inventory for resale, and later sold to consumers. Over the years, GM had paid tens of millions of dollars in use tax based on the Michigan Department of Treasury’s enforcement position, asserted in audits of the company, that GM was required to self-assess and pay Michigan use tax as a result of its employees’ temporary use of the vehicles in the state.

However, in 2006, the Michigan Court of Appeals held (in a case involving auto dealerships) that such demonstration vehicles acquired and held for resale were not subject to use tax, and that interim employee use did not result in conversion of the autos’ use to a taxable use, as the Department argued. The Michigan Supreme Court affirmed the relevant portion of the Betten decision in 2007. Betten Auto Center, Inc. v. Department of Treasury, 272 Mich.App. 14, 20-22 (2006), aff’d in pertinent part, 478 Mich. 874 (2007).

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

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!

Distribution of Promotional Materials in Indiana is Not Taxable

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.

The Perils of Responding to Nexus Questionnaires

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.

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.

New York Threatens to Discontinue Long-Standing Promotional Material Exemption

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.

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

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.