Are You Minding The Store? Executives Held Personally Liable For Unreported Sales Tax

Two recent decisions provide an important reminder for executives and tax managers of Internet retailers and remote sellers: Make sure that you: (1) understand your company’s sales and use tax obligations; (2) have a defensible position on state tax issues; and (3) pay attention to notices from state revenue departments, including those that come from outside your home state ― or you could find yourself subject to personal liability for unreported sales and use tax.

Most states’ tax laws deem sales/use taxes collected by a company to be held in trust for the state, and allow the state to impose personal liability upon responsible corporate officers for the failure to report and remit such “trust fund” taxes. Some state statutes go farther and impose liability on corporate officers for unreported tax.

In a New York State Tax Tribunal Decision (DTA No. 822971) issued on February 23, 2012, the CEO of a publicly-traded, online vendor of wireless phone devices and accessories was determined to be personally liable for unpaid sales tax, largely with respect to shipping and handling fees charged by his company on sales to consumers. The CEO argued that he could not be held personally liable because, among other things: (1) the company had a tax department that handled such matters, on which he relied, and that reported to the company’s CFO; (2) the company further relied upon outside accountants and auditors to ensure tax compliance; (3) the size of the company and number of transactions involved made monitoring them impossible for the company’s chief executive; and (4) the CEO did not sign the company’s sale tax returns. The Tax Tribunal rejected all of the CEO’s arguments, holding that he was a responsible officer with the power to exercise oversight over all functions related to sales tax compliance, and could not avoid liability by arguing that he relied upon others – even a full tax department and outside tax professionals – to ensure the company’s compliance.

In Eberhardt v. Michigan Department of Treasury, Michigan Court of Appeals No. 299532 (March 8, 2012), the Court upheld the imposition of personal liability against the sole shareholder and responsible corporate officer of an Indiana retailer of spas and related supplies, for unreported tax on sales to Michigan residents. The Department had previously issued an assessment for unpaid sales/use tax to company, which failed to respond. The Department subsequently assessed the shareholder for the amounts not paid by the company on the theory that he was personally liable as a responsible corporate officer. The appellant responded by arguing that the State of Michigan lacked jurisdiction to issue the earlier assessment to the company. The Michigan Tax Tribunal upheld the assessment, and the Court of Appeals affirmed. The Court found that the corporate officer was barred by the company’s failure to respond to the original sales tax assessment to raise the issue of lack of jurisdiction over the company as a defense. The Court therefore affirmed the imposition of liability of over $225,000 against the appellant.

These recent decisions should be a wake-up call for all corporate officers and tax managers – whether they work in a sole proprietorship, small private company, or even in a large, publicly traded company – to be certain that the they are confident the company’s state sales/use tax affairs are being handled appropriately, and tax counsel consulted where they have meaningful doubt or uncertainty regarding the company’s compliance. Failure to exercise proper oversight responsibility could mean the company’s tax liabilities become their own.

Obama Administration Releases Consumer Privacy Bill of Rights

In April 2011, Senators Kerry and McCain introduced a bill entitled the “Commercial Privacy Bill of Rights." As discussed in this space, the bill would have required online collectors of information to permit individuals to opt out of the collection of information about browsing and shopping activities and required affirmative consent (opt-in) for the collection of sensitive personally identifiable information, including email addresses. The bill’s introduction was met with significant hand-wringing by the online business community about the impact that it might have on the business practices of even the most reputable electronic merchants. The bill was referred to committee, and little has been heard about it since.

But the issue has not gone away. Apple, Google, Facebook, Path, UPromise, and others have all suffered embarrassing public relations setbacks as a result of the exposure of certain of their practices relating to the collection and use of user information.

In the meantime, the Obama Administration has shifted its focus to a (mostly) non-legislative solution to the perceived need for more robust protection of consumers’ online privacy. On February 23, 2012, the Obama administration published A Consumer Privacy Bill of Rights The Consumer Privacy Bill of Rights provides for industry self-regulation coupled with the prospect of government enforcement in the event that industry fails to do the things that it claims it will do. It would apply to “personal data,” broadly defined as any data that can be linked back to an individual.

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).

Pennsylvania DOR Puts Constitutionally-Suspect Affiliate Nexus Interpretation on Hold

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.

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

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.

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

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.

Nexus of Subsidiary Not Automatically Attributable to Parent Company

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.