Sales and Use Tax Nexus – A Continually Moving Target
One of the most interesting (some would say frightening) developments in the sales tax world over the last several years has been the concerted efforts by several states to expand the scope of activities that would compel an organization to collect and remit tax their sales and use tax, otherwise known as “nexus”.
Until such time as the Marketplace Fairness Act or similar legislation becomes the law of the land, the standard set out in National Bellas Hess v. Department of Revenue, 386 US 753, 87 S. Ct. 1389 (1967), and the more famous Quill v. N.D., 504 US 298, 112 S Ct 1904 (1992) still holds sway. That is, in order for a vendor to be obligated to collect the sales and use tax of a particular state, that vendor must have a physical presence in that place. A simplified (perhaps too simplified) way of viewing the physical presence standard, is that an organization must have either people or property in that jurisdiction in order to be deemed to have nexus.
As early as 2005, we saw a series of court cases involving challenges to what does and does not constitute nexus, with many of those first cases involving nationally known booksellers. In those cases, the California Board of Equalization successfully argued that the .com arms of both Borders Books and Barnes and Noble had nexus with California and were required to collect and remit California sales and use tax. Although the .com organizations were separate legal entities from the brick and mortar bookstore businesses, the court held that the inter-relationship of the day to day business activities between the two caused the nexus of the brick and mortar entities to be attributed to the .com businesses.
Seeds for Substantial Change
However, the seeds were truly laid for substantial change when, in 2008, New York enacted Tax Law Sec. 1101(b)(8)(vi). This landmark legislation provides as follows:
A person making sales of [taxable] tangible personal property or services … shall be presumed to be soliciting business through an independent contractor or other representative if the seller enters into an agreement with a resident of this state under which the resident, for a commission or other consideration, directly or indirectly refers potential customers, whether by a link on an internet website or otherwise, to the seller.
This law was squarely aimed at internet based retail businesses that deployed affiliate vendors to drive traffic to their website. In a nutshell, the law provides that out-of-state vendors that enter into contractual agreements with New York businesses, whereby the New York business refers customers to the out-of-state business and receive a commission in return based on sales have nexus with New York. This law has been colloquially referred to as creating an affiliate or click through nexus standard.
This law was aggressively challenged through the New York court system, with the battle ending on December 2, 2013 ( which just happened to be Cyber Monday) when the United States Supreme Court declined to hear an appeal of the New York Court of Appeals decision upholding the law.
States with affiliate or click through nexus laws
Well before Supreme Court pronouncement in 2013, a number of states moved to enact similar legislation including the following:
When challenged, these laws have largely withstood judicial scrutiny. That is, with one major exception. In 2010, Illinois enacted legislation similar, but not identical, to New York, but on April 25, 2012 a state Circuit Court held that the legislation was violative of both the United States Commerce Clause and the Internet Tax Freedom Act. This decision was upheld by the Illinois Supreme Court in Performance Marketing Ass’n v. Hamer, 2013 IL 114496 (2013). To date, this is the only judicial decision striking down an affiliate/click through nexus standard.
In response, as part of the latest legislative session the Illinois legislature passed, and the Governor signed, SB 352 which takes a second stab at affiliate and click through nexus. The law, which was signed on August 26, includes a new provision that allows a vendor to rebut the presumption that nexus exists by submitting proof that the referrals or other activities of the affiliate entity were not sufficient to meet the nexus standards of the United States Constitution during the preceding four quarterly periods. By way of reference, the New York legislation also includes a rebuttable presumption, which the Court of Appeals did consider as significant in upholding the law.
Closely Monitoring the Situation
Most commentators contend that this new legislation does not take effect until January 1, 2015 and legal challenges are certainly anticipated. Taxware will continue to monitor the situation closely and provide information to our clients as news develops.
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