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Policy Resources |
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NEXUS ON THE INFORMATION
SUPERHIGHWAY
by
I. INTRODUCTION III. QUILL'S IMPACT ON THE JURISDICTIONAL ISSUE IV. WHAT IS "SUBSTANTIAL NEXUS" AFTER QUILL? A. "Temporary" In-State Presence C. Use of In-State Agents or Employees B. The Fundamental Question -- Use Tax Collection Responsibility 1. Application of Current Nexus Standards To Out-of-State On-Line Information Service Providers C. The Fundamental Question -- Imposition of Net Income Based Taxes VI. CONCLUSION
I. INTRODUCTION 1
You have often heard me say that identifying
the jurisdictions in which a corporation's activities may be sufficient
to subject it to a use tax collection responsibility or a direct
net income or franchise tax is one of the most perplexing questions
facing both corporate taxpayers and state tax administrators.
This jurisdictional issue is becoming even more complex. As
you are aware, we are in the midst of a technological revolution.
New and rapidly changing technologies are altering the manner
in which business is conducted. The information superhighway,
unknown to most of us just a few years ago, allows an ever expanding
group of out-of-state sellers of property and services to access
local markets without establishing a physical presence in the
market state. Needless to say, this will have a profound effect
on the states' efforts to impose use tax collection responsibility
or direct net income or franchise taxes on out-of-state sellers
who successfully navigate the information superhighway.
The states' taxing power is inherent. Moreover,
they are free to design new tax structures in an attempt to reach
those taxpayers who successfully utilize the information superhighway.
However, any new taxing structures adopted by the states remain
subject to two principal limitations: (i) the federal constitutional
limitations of the Due Process and Commerce Clauses and (ii) those
limitations imposed by federal law. This paper will begin by
examining the federal constitutional limitations on the states'
taxing jurisdiction. Specifically, this paper will examine the
contours of the Commerce Clause's "substantial nexus"
requirement and the difficulties the states will experience in
attempting to apply current Commerce Clause nexus standards to
out-of-state on-line information service providers and those out-of-state
merchants who utilize on-line information service providers or
the Internet to reach customers in the taxing states. Also addressed
will be the Multistate Tax Commission's most recent draft of its
Constitutional Nexus Guideline for Application of a State's Sales
and Use Tax to an Out-of-State Business with specific emphasis
on those provisions which address the information superhighway.
Finally, this paper will examine the application of the Commerce
Clause's "substantial nexus" standard as currently interpreted
by the courts to out-of-state on-line information service providers
and those out-of-state merchants who utilize these providers to
reach in-state customers.
A. The Due Process Clause 2
The judicial tests of the states' jurisdiction
to tax income accruing to nonresidents originate in two cases
decided on the same day. In Shaffer v. Carter 3, the Court
held that the imposition of tax against a nonresident taxpayer
engaged in the oil business who purchased, developed and operated
a number of oil and gas mining leases in Oklahoma and who owned
certain oilproducing land in the state was a valid exercise
of Oklahoma's taxing power.
Specifically, the Court stated:
[W]e deem it clear, upon principle as well as authority, that just as a State may impose general income taxes upon its own citizens and residents whose persons are subject to its control, it may, as a necessary consequence, levy a duty of like character, and not more onerous in its effect, upon incomes accruing to nonresidents from their property or business within the State, or their occupations carried on therein;.... 4
The due process requirements set forth in
Shaffer were satisfied by the fact that the taxpayer's
property, from which the income was derived, received the benefits
conferred and protections afforded by the laws of the taxing state.
The tax imposed was regarded by the Court as a reasonable means
of defraying governmental expenses. 5
The Shaffer Court also considered
the contention raised by the taxpayer in Travis v. Yale &
Towne Mfg. Co. 6 There, it had been contended that while a
state could tax the property of a nonresident located within its
borders, the state was without jurisdiction to tax the income
of nonresidents earned from businesses or occupations conducted
within the state's borders.
The Court, in rejecting the taxpayer's contention,
stated:
This radical contention is easily answered by reference to fundamental principles. In our system of government the States have general dominion, and, saving as restricted by particular provisions of the Federal Constitution, complete dominion over all persons, property, and business transactions within their borders; they assume and perform the duty of preserving and protecting all such persons, property, and business, and, in consequence, have the power normally pertaining to governments to resort to all reasonable forms of taxation in order to defray the governmental expenses. Certainly they are not restricted to property taxation, nor to any particular form of excises. In wellordered society, property has value chiefly for what it is capable of producing, and the activities of mankind are devoted largely to making recurrent gains from the use and development of property, from tillage, mining, manufacture, from the employment of human skill and labor, or from a combination of some of these; gains capable of being devoted to their own support, and the surplus accumulated as an increase of capital. That the State, from whose laws property and business and industry derive the protection and security without which production and gainful occupation would be impossible, is debarred from exacting a share of those gains in the form of income taxes for the support of the government, is a proposition so wholly inconsistent with fundamental principles as to be refuted by its mere statement. 7
The Court's decisions in Shaffer
and Travis established a standard of fairness in state
taxation that continues today. This standard suggests that so
long as there is a sufficient "contact" or "nexus"
between the taxing state and the nonresident taxpayer, and the
tax imposed is fairly related to the nonresident taxpayer's instate
activities, the tax will be upheld.
The Court's most frequently cited and quoted
description of this standard is found in Wisconsin v. J. C.
Penney Co. 8, a case which dealt with the power of a state to
impose a tax on a foreign corporation for the privilege of declaring
and receiving dividends out of income derived from property located
and business transacted in the state. There, Justice Frankfurter
set forth the due process standard in the following manner:
That test is whether property was taken without due process of law, or if paraphrase we must, whether the taxing power exerted by the state bears fiscal relation to protection, opportunities and benefits given by the state. The simple but controlling question is whether the state has given anything for which it can ask return.
The Court, in Mobil Oil Corp. v. Commissioner
of Taxes of Vermont 10, a case which resolved the question of
whether, under the Due Process Clause, a state could constitutionally
tax (by inclusion in apportionable income) dividends received
by a nondomiciliary corporation from payors having no contact
with the taxing state, restated the due process standard in the
following manner:
For a State to tax income generated in interstate commerce, the Due Process Clause of the Fourteenth Amendment imposes two requirements: a "minimum connection" between the interstate activities and the taxing State, and a rational relationship between the income attributed to the State and the intrastate values of the enterprise. 11
In the related context of in personam or
personal jurisdiction, the Court has held that if a foreign corporation
purposefully avails itself of the benefits of a economic market
in the forum state, it may subject itself to the in personam (personal)
jurisdiction of the state even if it has no physical presence
in the state. For example, in World-Wide Volkswagen Corp.
v. Woodson 12, the Court held that Oklahoma could not constitutionally
subject a nonresident automobile dealer to the in personam
jurisdiction of its courts when the only contact between the automobile
dealer and the state was the sale, in New York, of an automobile
to a New York resident who was subsequently involved in an accident
in Oklahoma. The Court found no "affiliating circumstances"
between Oklahoma and the New York dealer. 13
In Burger King Corp. v. Rudzewicz 14,
the Court held that a nonresident who purposefully contracts with
a corporation in a state may be subjected to the jurisdiction
of the state's courts without violating due process. In the Court's
view:
Jurisdiction in these circumstances may not be avoided merely because the defendant did not physically enter the forum State. Although territorial presence frequently will enhance a potential defendant's affiliation with a State and reinforce the reasonable foreseeability of suit there, it is an inescapable fact of modern commercial life that a substantial amount of business is transacted solely by mail and wire communications across state lines, thus obviating the need for physical presence in a State in which business is conducted. So long as a commercial actor's efforts are 'purposefully directed' toward residents of another State, we have consistently rejected the notion that an absence of physical contacts can defeat personal jurisdiction there."
In Quill Corp. v. North Dakota 15, the
Court applied these principles to state taxes, abandoning the
physical presence requirement for due process purposes:
In "modern commercial life" it matters little that such solicitation is accomplished by a deluge of catalogs rather than a deluge of drummers": the requirements of due process are met irrespective of a corporation's lack of physical presence in the taxing State. Thus, to the extent that our decisions have indicated that the Due Process Clause requires physical presence in a State for the imposition of a duty to collect a use tax, we overrule those holdings as superseded by developments in the law of due process. 16
As a result, "a corporation may have
the 'minimum contacts' with a taxing state as required by the
Due Process Clause, and yet lack the 'substantial nexus' with
the state as required by the Commerce Clause." 17
B. The Commerce Clause
18
The Commerce Clause prohibits the states
from unduly burdening interstate commerce. The corporate franchise
taxes initially adopted by the states, whether measured by net
income or capital, were imposed on the "privilege of engaging
in business." The application of these taxes to resident
taxpayers who engaged in interstate commerce was initially blocked
by the long-standing doctrine that, in the absence of congressional
direction, the Commerce Clause prohibited a state from taxing
the privilege of carrying on an exclusively interstate business.
This doctrine, known as the "privilege doctrine," looked
only to the fact that the incidence of the tax was on the "privilege
of engaging in business" in the state and reflected the philosophy
that interstate business should enjoy immunity from state taxation.
A later application of the "privilege doctrine" is
found in Spector Motor Service, Inc. v. O'Connor 19, where
the court struck down a state franchise tax measured by net income
applied to a trucking company doing business solely in interstate
commerce.
In 1977, the Court, in Complete Auto
Transit, Inc. v. Brady 20, overruled Spector and abandoned
the "privilege doctrine." In Complete Auto Transit,
the Court determined that the states were not barred from imposing
a nondiscriminatory tax upon the privilege of engaging in exclusively
interstate commerce. In place of the "privilege doctrine,"
the Court substituted a four-pronged test to which it has faithfully
adhered. Under this test, a state tax will pass constitutional
muster if it:
1. Is applied to an activity that has substantial
nexus with the taxing state;
2. Is fairly apportioned;
3. Does not discriminate against interstate
commerce; and
4. Is fairly related to the services provided
by the taxing state. By rejecting the "privilege doctrine," the Complete Auto Transit Court concluded that the Commerce Clause did not prevent a state from imposing a direct net income tax on income 21 earned in a taxing state by a nonresident taxpayer conducting an exclusively interstate business.
When viewed in light of decisions such as
Northwestern States Portland Cement Co. v. Minnesota; Williams
v. Stockham Valves and Fittings, Inc.; 22 Brown-Forman Distillers
Corp. v. Collector of Revenue 23, and International Shoe Co.
v. Fontenot 24, Complete Auto Transit suggests that the
degree of nexus necessary to satisfy the Commerce Clause no longer
requires a finding of local activities sufficient to constitute
the conduct of a local business separate and apart from the corporation's
interstate activities. The question that remained, however, was
whether, in the aftermath of these decisions, the Commerce Clause
continued to impose an independent "substantial nexus"
requirement or whether nexus had simply evolved into a Due Process
issue. 25 The Quill Court resolved this issue.
III. QUILL'S IMPACT ON THE JURISDICTIONAL
ISSUE
In Quill Corporation v. North Dakota,
supra, the U.S. Supreme Court provided its most extensive discussion
of the jurisdictional issue to date. Citing National Bellas
Hess, Inc. v. Department of Revenue of the State of Illinois 26,
the Court held that an out-of-state mail-order seller with no
physical presence in a destination state, who merely mails catalogs
into the state and fills orders by U.S. Mail or common carrier,
is protected by the Commerce Clause from the imposition of a use
tax collection responsibility by the destination state. 27
The taxpayer, Quill Corporation, was a non-domiciliary
mail-order retailer that solicited business in the state by distributing
catalogues and flyers via U.S. mail, placing advertisements in
periodicals, and making telephone contacts. Quill had no direct
physical contacts with North Dakota and did not utilize the services
of an agent located in the state. 28
Nexus has historically focused on a taxpayer's
physical presence in the taxing state and not on its "economic
presence" therein. 29 North Dakota, however, sought to expand
the physical presence requirement by imposing a use tax collection
responsibility against Quill on the basis of its "economic
contacts" with the state.
The trial court rejected the state's economically
based jurisdictional standard and ruled in Quill's favor. In
reversing the trial court, the North Dakota Supreme Court concluded
that the U.S. Supreme Court's decision in Complete Auto Transit,
along with the Supreme Court's rulings in several other Commerce
Clause cases, had signaled a retreat from the formalistic constrictions
of the physical presence standard in favor of a more flexible
approach focusing on a non-domiciliary taxpayer's overall contacts
with the taxing state, including its economic contacts. The North
Dakota Supreme Court stated:
. . . within the context of contemporary
society and commercial practice, we conclude that the concept
of nexus encompasses more than mere physical presence within the
State, and that the determination of nexus should take into consideration
all connections between the out-of-state seller and the state,
all benefits and opportunities provided by the State, and should
stress economic realities rather than artificial benchmarks.
On the basis of this conclusion, the North
Dakota Supreme Court held that the nexus standard under both the
Due Process and Commerce Clauses was identical and that a corporation's
economic exploitation of a state's consumer market was sufficient
to permit the state to impose a use tax collection responsibility
on a nonresident mail-order retailer.
The U.S. Supreme Court reversed the North
Dakota Supreme Court's decision holding that the nexus requirements
imposed by the Commerce Clause and the Due Process Clause were
not identical, despite the similarity in phrasing. 30 The Court,
noting that its Due Process jurisprudence had evolved significantly
since 1967, held that the Due Process Clause no longer required
a physical presence in the state. Rather, "if a foreign
corporation purposefully avails itself of the benefits of an economic
market" or purposefully directs its "efforts toward
the residents of another state," and the magnitude of its
activities are such that subjecting the corporation to the state's
taxing jurisdiction does not offend "traditional notions
of substantial justice," then nexus sufficient to satisfy
due process exists.
On the other hand, the Court disagreed with
the North Dakota Supreme Court over the proper test to be applied
under the Commerce Clause. In the Court's view, the two standards
were "animated by different constitutional concerns and policies."
The "substantial nexus" requirement under the Commerce
Clause required more that the "minimum contacts" necessary
to satisfy due process. At least in the context of use tax collection
responsibility, the Commerce Clause's "substantial nexus"
standard required physical presence in the taxing state. 31
Quill's
importance cannot be underestimated. Although the decision involves
the application of a use tax collection responsibility, there
does not appear to be any substantive constitutional difference
between a state's ability to impose a use tax collection responsibility
on a nonresident taxpayer and its ability to impose a direct net
income or franchise tax on the same taxpayer. Further, despite
the states' arguments to the contrary, the Court's analysis of
the Constitution's nexus standards does not appear to be limited
to a use tax collection responsibility. 32
It is clear, however, that the Due Process
Clause is no longer a barrier to the imposition of a corporate
net income or franchise tax against a taxpayer who is economically
present in the taxing state. In its Quill decision, the
Court analogized to cases involving the assertion of judicial
jurisdiction. The Court stated that if a foreign corporation
purposefully avails itself of the benefits of an economic market
in the forum state, it may subject itself to the state's judicial
jurisdiction. Applying the same standard to the Quill
case, the Court said that: "In modern commercial life, it
matters little that such solicitation is accomplished by a deluge
of catalogs rather than a phalanx of drummers; the requirements
of due process are met irrespective of a corporation's lack of
physical presence in the taxing state." 33 Accordingly, although
the Court's decision arose in a use tax collection context, it
appears as though the Court's sweeping language covers any type
of tax imposed by a state, including a net income based tax.
As a result, any type of economic contact with a state, even if
limited to the use of the U.S. mail or common carrier, may be
sufficient to satisfy the Due Process Clause's "minimum contacts"
requirement. Thus, the only remaining barrier to the imposition
of a net income based tax on a non-domiciliary corporation which
is economically, but not physically, present, in the taxing state
is the Commerce Clause's "substantial nexus" requirement. 34
The states believe that Quill provides
support for their efforts to assert income and franchise tax jurisdiction
over out-of-state businesses which avail themselves of the states'
markets through the interstate solicitation of orders. They argue
that Quill's "bright line" physical presence
test does not extend to the imposition of a net income based tax.
In support of their arguments, the states refer to the manner
in which the Court "be grudgingly" limited its Commerce
Clause holding to use tax collection responsibility in the mail-order
context and point to the following passages from the Quill
opinion:
. . . although our Commerce Clause jurisprudence now favors a more flexible balancing analysis, we have never intimated a desire to reject all established "bright-line" tests. Although we have not, in our review of other types of taxes, articulated the same physical-presence requirement that Bellas Hess established for sales and use taxes, that silence does not imply repudiation of the Bellas Hess rule.
As further evidence of the lack of the applicability
of a bright-line physical presence test to net income based taxes,
the states refer to what they describe as the Court's admonitionthat:
While contemporary Commerce Clause jurisprudence might not dictate the same result were the issue to arise for the first time today, Bellas Hess is not inconsistent with Complete Auto and our recent cases.
The above cited passages lead the states
to conclude that the Bellas Hess bright-line, physical
presence standard only applies in the context of use taxes and,
even in that context, only protects direct mail-order sellers
with no connection to a state other than through the U.S. Mail
or by common carrier. In the states' view, the principles of
stare decisis that preserved the Bellas Hess bright-line,
physical presence test are not applicable to corporate net income
and franchise taxes. While the states do not profess to know
what will ultimately constitute a "substantial nexus"
in the income and franchise tax area, they appear to currently
believe that Quill supports the proposition that the "economic
presence" test -- a regular, systematic or purposeful availment
of the state's market -- may be sufficient, in and of itself,
to satisfy the Commerce Clause's "substantial nexus"
requirement for net income or franchise tax purposes.
Historically, however, the Court has intimated
that the degree of presence required to subject an out-of-state
company to a direct tax liability is higher than the degree of
nexus required to impose an obligation to collect tax from others. 36
In fact, the Court, in Tyler Pipe Industries, Inc. v. Washington
State Dep't of Revenue 37, upheld the direct liability of an
out-of-state corporation under the Washington Business & Occupation
Tax based upon the in-state activities of the corporation's third
party representatives who were legally independent contractors
rather than employees. In doing so, however, the Tyler Pipe
Court merely cited its prior decision in Scripto, Inc. v. Carson 38
as controlling, and failed to draw a distinction between nexus
sufficient to support use tax collection responsibility and nexus
sufficient to support a direct tax liability. Although Quill
seemingly distinguishes between sales and use tax collection responsibility
and the imposition of direct taxes, limits the "bright-line,
physical-presence" test to sales and use taxes and favors
a more flexible balancing analysis rather than "formalistic
constrictions of a stringent physical presence test", 39 the
Court cautions against assuming that physical presence
is not required for other types of taxes":
"[A]lthough our Commerce Clause jurisprudence now favors more flexible balancing analyses, we have never intimated a desire to reject all established 'bright-line' tests. Although we have not, in our review of other types of taxes, articulated the same physical-presence requirement that Bellas Hess established for sales and use taxes, that silence does not imply repudiation of the Bellas Hess rules." 40
Indeed, the Court also notes expressly that
all of its prior decisions upholding taxes against Commerce Clause
challenges, including the modern cases on which North Dakota placed
reliance, involved taxpayers who did, in fact, have a physical
presence in the taxing state. 41
Thus, although the Court, in Quill,
did not expressly extend the "bright-line physical-presence"
requirement to other types of taxes, and left open the possibility
of a "balancing analysis" to determine if "substantial
nexus" consistent with the Commerce Clause exists in areas
other than use tax collection, the Court nevertheless made it
clear that the nexus required under the Commerce Clause is more
than the "minimum contacts/purposeful availment" of
a state's market that is sufficient to satisfy the modern Due
Process Clause. In other words, "substantial nexus"
for Commerce Clause purposes involves some degree of physical
presence within the taxing state. 42
IV. WHAT IS "SUBSTANTIAL NEXUS"
AFTER QUILL?
It is now clear that a state may not compel
an out-of-state direct mail-order seller with no connection to
the state other than through the U.S. Mail or by common carrier
to collect use tax from its in-state customers, unless the seller
has "substantial nexus" with the market state. 43 It is
also clear that "substantial nexus" for Commerce Clause
purposes must be defined in terms of a seller's physical presence
in the taxing state. Yet, precisely what "substantial nexus"
means after Quill remains unclear. Does "substantial
nexus" require a "substantial physical presence"
in the taxing state; or will "anything more than the slightest
presence" suffice? Would an "economic presence"
suffice? Do members of an affiliated enterprise share nexus?
What about the mere presence of intangibles in the taxing state?
Do occasional or sporadic ties create nexus?
In Quill, Justice White warned that
"[r]easonable minds surely can and will differ over what
showing is required to make out a `physical presence' adequate
to justify imposing responsibilities for use tax collection .
. . it is a sure bet that the vagaries of `physical presence'
will be tested to their fullest in our courts. 44 Recent state court
decisions bare this out, providing insight for future income and
franchise tax challenges based on Quill's "substantial
nexus" principles.
Since Quill, a number of state courts
and many state tax authorities have considered the Commerce Clause's
"substantial nexus" standard in the context of use tax
collection responsibility. Many state tax authorities have also
argued that the Quill bright-line physical presence standard
does not extend to net income based taxes. However, there does
not appear to be any principled distinction between the constitutional
standards for imposing use tax collection obligations and those
for the imposition of taxes based on net income. Indeed, the
Court, in Quill, cautioned against assuming that physical
presence is not required for other types of taxes:
[A]though our Commerce Clause jurisprudence now favors more flexible balancing analyses, we have never intimated a desire to reject all established `bright-line' tests. Although we have not, in our review of other types of taxes, articulated the same physical-presence requirement that Bellas Hess established for sales and use taxes, that silence does not imply repudiation of the Bellas Hess rules. 45
A. "Temporary" In-State Presence
The Supreme Court in, Quill, reaffirmed
the rule established in Bellas Hess that substantial nexus
under the Commerce Clause requires a physical presence in the
taxing state. Although the Court did not quantify the amount
of physical presence necessary to establish nexus, it did note
that it must exceed the "slightest presence." 46 Since
Quill, courts in a number of states have considered the
quantum of physical presence required before the state may constitutionally
compel out-of-state sellers to collect use taxes.
1. New York Cases: Orvis,
Vermont Information Processing, and NADA
The New York Court of Appeals, New York's
highest court, has adopted the narrowest interpretation of Quill,
holding that virtually anything more than the slightest physical
presence in the taxing state meets the Commerce Clause's substantial
nexus standard. As a result, the court appears to endorse the
economic nexus theory embodied in the Quill Court's analysis
of the Due Process "minimum connections" requirement.
a) Matter of Orvis
In the Matter of Orvis Company, Inc.
v. Tax Appeals Tribunal of the State of New York 47,
the New York Court of Appeals refused to interpret Quill's
substantial nexus standard as requiring a substantial physical
presence in the taxing state. Instead, the court ruled that anything
more than the "slightest presence" in the state is sufficient
to impose use tax collection duties on an out-of-state seller.
Orvis Co, Inc. is a Vermont company that
sells camping, fishing, and hunting equipment and clothing through
mail-order catalogs. Orvis also had a wholesale division that
made sales for resale to retailers. The wholesale division sent
employees into New York but the employees did not solicit any
business in the state and only traveled there to monitor orders
delivered to retailers. Orvis employees traveled to New York
a total of twelve times during the three-year audit period at
issue. Orvis had no property or permanent employees in New York
and it did not advertise its merchandise there other than by catalog.
The Tax Appeals Tribunal found that Orvis
was subject to New York's taxing jurisdiction and affirmed the
use tax assessment on Orvis' mail order sales to New York. Under
the Tax Tribunal's interpretation of Quill's Commerce Clause
standard, Orvis was subject to a tax collection responsibility
in New York because the company had "more than the slightest
presence" in the state.
The Appellate Division disagreed. In its
view, Quill had rejected the "slightest presence"
test in favor of the substantial nexus standard. The Appellate
Division found that the Orvis employees entered New York only
twelve times during the three year audit period and held that
such "sporadic presence" in New York did not satisfy
Quill's substantial nexus standard.
The Court of Appeals reversed on grounds
that the Appellate Division misapplied Quill's substantial
nexus requirement. Specifically, the Court of Appeals rejected
the Appellate Division's view that Quill elevated the Commerce
Clause test from "any measurable presence" to a "substantial
physical presence." In so doing, the Court of Appeals found
that although the Commerce Clause required a physical presence,
the presence need not be substantial. Rather, the court held,
a nondomiciliary seller need only have demonstrably more than
a "slightest presence" in the taxing state to satisfy
the Commerce Clause's substantial nexus requirement. Such presence,
the court ruled, may be demonstrated by the vendor's property
or the conduct of economic activities in New York performed by
the seller's employees or agents.
In addition, the Court of Appeals noted
the United State Supreme Court's 1995 decision in Oklahoma
Tax Comm'n. v. Jefferson Lines, Inc. 48 In the Court's view,
if the Supreme Court had wished to raise the threshold for Commerce
Clause nexus to "substantial physical presence," it
would have done so in its 1995 ruling. Applying the lower, "more
than the slightest presence" threshold to Orvis, the court
found that Orvis had a substantial wholesale business in New York
that was achieved by means of its sales personnel's direct solicitation
of retailers in the state. The court also found that the "systematic
visitation" by Orvis to its wholesale customers on the average
of four times a year "demonstrably exceeded" the "slightest
presence," in satisfaction of the Commerce Clause nexus requirements.
b) Vermont Information Processing
In the Matter of Vermont Information
Processing, Inc. v. Tax Appeals Tribunal of the State of New York 49,
a companion case to Orvis, the Court of Appeals again moved
towards an economic nexus standard when it refused to equate Quill's
substantial nexus standard with a substantial physical presence
requirement.
Vermont Information Processing, Inc. ("VIP")
is a Vermont company that sells computer software and hardware
to beverage distributors nationwide. VIP did not maintain a place
of business in New York. Nor did it have any employees in the
state or any sales force which regularly traveled there to solicit
sales. All deliveries from VIP to New York customers were made
via common carrier and all information requests were handled by
telephone or through the mail.
VIP employees traveled to New York only
when it was necessary to install or maintain computer programs.
Most computer program modifications were resolved via modem or
by an employee in Vermont. VIP occasionally conducted training
sessions in New York, but most customers received training at
VIP's Vermont headquarters.
The Tax Appeals Tribunal affirmed the Department's
use tax assessment. The Tribunal found that VIP's New York activities
amounted to more than a "slightest presence" because
VIP employees periodically entered the state to install or to
provide maintenance for its customized software.
The Court of Appeals upheld the Tax Appeals
Tribunal's ruling. The court found that VIP's sales agreements
obligated it to send a VIP computer installer to handle post-installation
problems without charge. In addition, the court found that VIP
invoices showed charges for more than forty trips to VIP's New
York customers' locations during the three-year audit period and
that VIP conducted more than fifty taxable transactions in New
York during that same period. The court found that VIP's promise
to make trouble-shooting visits, and the visits themselves, allowed
VIP to establish and maintain its New York computer market. Accordingly,
the court held that VIP's contacts with New York were more significant
that a "slightest presence."
c) NADA Services Corp.
In contrast to the result in Orvis
and VIP, an administrative law judge, in In the Matter
of the Petition of NADA Services Corp., 50 held that 20 trips
into New York State by a taxpayer, in addition to "sporadic
visits" by the taxpayer's independent contractor, were not
sufficient to exceed the "slightest physical presence"
needed to compel the taxpayer to collect sales tax. NADA Services Corp. is in the business of
publishing and distributing publications to people in the automotive
industry. NADA generated subscriptions to its publications through
its relationship with its corporate parent, the National Automobile
Dealers Association, and by including mail-back cards in the publications.
NADA also engaged several independent contractors to sell advertising
in several states. One of these contractors had its office in
New Jersey and made sporadic visits into New York. Relying on the Tax Appeals Tribunal's 1994 ruling in Orvis, the Audit Division argued that NADA's contacts with New York established an in-state presence sufficient to allow the imposition of a use tax collection responsibility. In addition, the division sought to equate to NADA, the in-state contacts of its corporate parent.
NADA argued that based on the Supreme Court's
Commerce Clause analysis in Quill, its contacts with New
York were so minimal that they were insufficient to create a substantial
nexus with the state. The administrative law judge agreed. Specifically,
the administrative law judge noted that although NADA made 20
trips into New York, the visits should be disregarded as inconsequential
in effect and/or unrelated to NADA's primary activities. The
administrative law judge additionally considered whether sporadic
visits by independent contractors selling (exempt) advertising
is enough to exceed the "slightest physical presence."
The administrative law judge found that while economic activity
was performed on NADA's behalf in New York, the nature of that
activity and the totality of NADA's in-state contacts simply failed
to constitute something "demonstrably more" than the
"slightest physical presence" in New York.
2. Share International, Inc.
v. Florida Dep't. of Revenue
In Share International, Inc. v. Florida
Dep't. of Revenue, 51 the Florida District Court of Appeals interpreted
the Quill substantial nexus standard as demanding an ongoing
or continuous physical presence in the state. Specifically, the
court found that a taxpayer's annual attendance at a three-day
convention did not establish substantial nexus with Florida for
use tax collection purposes.
Share International, Inc. ("Share")
is a Texas mail order business that manufactured and sold business
forms and supplies to chiropractors. Share's sole shareholder
and employee, Dr. James Parker, and his son each owned a one-half
interest in Parker Chiropractic Resource Foundation ("Parker")
which was also a Texas corporation. Parker was in the business
of providing educational and support seminars for chiropractors
worldwide. Every year, Parker held a three-day convention in
Florida to promote Share's products and provide educational seminars
for chiropractors. Dr. Parker's only physical presence in Florida
was his annual attendance at the Parker conventions.
At the Parker conventions, Share products
were displayed and were available for sale. The products were
sold by Parker employees, who operated cash registers and charged
and collected Florida sales tax. Less than 5% of Share's annual
sales were generated at Parker's Florida conventions. Florida
issued an assessment against Share based on its finding of nexus
arising from Share's attendance at the conventions.
The trial court applied Quill and
concluded that Share's presence at the three-day conventions did
not create substantial nexus with Florida. The court found that
under Quill, a foreign taxpayer's in-state presence "must
be real, and cannot be slight or based on insubstantial activity."
Further, the court held that a sporadic physical presence was
insufficient. The court concluded that absent a continuing physical
presence in Florida, the assessment of a tax against Share was
unjustified and violated the Commerce Clause.
The Appellate Court agreed, rejecting the
state's argument that virtually any in-state presence will subject
an out-of-state seller to Florida use tax collection duties.
In so doing, the appeals court treated the Quill bright-line
physical presence standard as one element of a two-part test.
The court stated:
"If the bright line is crossed, and the out-of-state vendor no longer falls within the safe harbor, it must then be determined whether the vendor's activities within the state establish a substantial nexus within the taxing state such that imputing the duty to collect and remit tax on sales to residents of the taxing state does not violate the Commerce Clause."
Applying that test, the court concluded
that Parker's presence in Florida for three days each year is
not sufficient to establish substantial nexus.
3. Care
Computer Systems, Inc. v. Arizona Dep't. of Revenue
In Care Computer Systems, Inc. v. Arizona
Dep't. of Revenue, 52 the Arizona Board of Tax Appeals ruled
that annual visits by a sales representative, three week-long
visits by training personnel, and the in-state presence of two
leased personal computers did not create substantial nexus with
Arizona.
Care Computer is a Washington corporation
engaged in the business of selling and leasing computer hardware,
licensing computer software and providing computer training tonursing homes nationwide. During the audit period in question,
Care Computer's contacts with Arizona consisted of a sales representative's
annual visit, approximately 21 days of customer training per year
by nonresident personnel and approximately 180 sales transactions
generating around $385,000 of Arizona income. All but two of
the transactions were conducted via mail or common carrier. Care
Computer also had two personal computers in the state for seven
months. These computers were subject to lease purchase agreements.
In reaching its decision, the Board began
by reviewing Complete Auto Transit's four-prong test.
It then noted that the Quill Court found that a large number
of sales to North Dakota residents through catalog and mail solicitations
for nearly $1,000,000 in sales revenue was not sufficient to allow
the imposition of use tax collection responsibility, despite the
in-state presence of computer diskettes. The Board, citing City
of Phoenix v. West Publishing Co., 53 (out-of-state book seller
with a full-time salesperson living and conducting business in
Phoenix) and State Tax Comm'n of the State of Arizona v. Murray
Comp. of Texas, Inc., 54 (manufacturer of equipment and steel
buildings that occasionally provided supervisory construction
help on-site), found that Arizona courts have likewise held that
limited contacts with the state did not create substantial nexus.
The Board then stated that "[t]o have
a substantial nexus, . . ., a business must have more than just
a large number of sales and occasional visits of personnel"
and concluded that the taxpayer's contacts with the state did
not satisfy Complete Auto Transit's "substantial nexus"
standard. In so doing, the Board noted that the presence of two
personal computers in the state for seven months, which were subject
to lease purchase agreements was not sufficient to establish a
business presence in the state.
4. Brown's Furniture, Inc. v.
Raymond Wagner
The Illinois Supreme Court recently clarified
the test for determining whether an out-of-state vendor's activity
in Illinois is sufficient to subject it to Illinois use tax collection
responsibility. In Brown's Furniture, Inc. v. Raymond Wagner, 55
Illinois' high court ruled that an out-of-state vendor's physical
presence in Illinois need not be substantial to subject it to
use tax collection responsibilities from Illinois buyers. Rather,
so long as the nondomiciliary vendor displays anything more than
"the slightest presence" in Illinois, it will be subject
to such obligations.
Brown's Furniture
represents the Illinois Supreme Court's first effort to articulate
state taxing authority within the framework laid down by the U.S.
Supreme Court in Complete Auto Transit, Inc. v. Brady. 56
More specifically, the case addresses the Illinois standard for
applying the substantial nexus prong of the test.
Brown's Furniture is engaged in selling
and delivering furniture. As a Missouri business located 15 miles
from the Illinois border, Illinois residents comprise a good portion
of the vendor's clientele. In fact, Illinois residents' purchases
account for approximately 30% of the store's sales. While Brown's
Furniture owns no property in Illinois, has no offices or plants
in Illinois, and employs no permanent or part-time sales force
in Illinois, it does advertise extensively in Illinois. During
the ten month period at issue in this case, from January 1, 1989
to October 31, 1989, Browns's Furniture had 2,800 individual advertisements
in Illinois media outlets. As it did with all its customers,
Brown's Furniture regularly delivered merchandise to its Illinois
customers in its own trucks. Brown's Furniture averaged between
15 and 18 delivery trips into Illinois each month with each of
these trips typically involving five or six delivery stops. In
all, the vendor made 942 deliveries to Illinois during the period,
valued at more than $675,000, yet never collected or remitted
Illinois use tax.
The Illinois Department of Revenue audited
Brown's Furniture and determined that its contacts with Illinois
were sufficient to warrant the imposition of a use tax collection
responsibility. Brown's Furniture paid the assessment under protest
and filed a complaint for injunctive relief in the Sangamon County
circuit court. The circuit court granted Brown's request on grounds
that it lacked sufficient nexus with Illinois. The Department
of Revenue appealed the circuit court's decision to the Illinois
Supreme Court, which determined that sufficient nexus existed
to warrant the imposition of a use tax collection responsibility.
In determining that Brown's Furniture's
business activity in Illinois constituted substantial nexus, the
court undertook a detailed analysis of both Quill and Orvis.
In Quill, the U.S. Supreme Court held that, in terms of
a Commerce Clause analysis, "substantial nexus" must
be defined in terms of the seller's "physical presence"
within the taxing state. 57 Although the Court did not quantify the
amount of physical presence necessary to establish nexus, it did
note that it must exceed the "slightest presence." 58
As has been noted, New York's Court of Appeals, in Orvis,
offered the most narrow interpretation of Quill:
"While a physical presence of the vendor is required, it need not be substantial. Rather, it must be demonstrably more than a "slightest presence." And it may be manifested by the presence in the taxing State of the vendor's property or the conduct of economic activities in the taxing State performed by the vendor's personnel or on its behalf." 59
In defining the "nexus" required
for Brown's Furniture to be considered "present" in
Illinois, the Illinois Supreme Court adopted the aforementioned
Orvis standard verbatim.
After considering the type of delivery activity
conducted in Illinois, whether such deliveries were "occasional
or sporadic," and whether advertising in Illinois was "extensive
or incidental," the Illinois Supreme Court held that the
vendor maintained the required physical presence for constitutional
taxation. The above-mentioned activity of Brown's Furniture in
Illinois established "demonstrably more than a slightest
physical presence" required by Illinois courts to meet the
substantial nexus component of the Complete Auto Transit
test. Moreover, the court noted, this level of activity is well
beyond Quill's "safe harbor" for vendors whose
only connection with customers in the taxing State is by common
carrier or through U.S. mail.
Brown's Furniture
is important not only because it defined the level of activity
necessary to fulfill the "substantial nexus" prong of
the Complete Auto Transit test with respect to Illinois
use taxes, but also because it significantly limited the influence
and scope of Miller Bros. Co. v. Maryland. 60 In Miller
Bros., the U.S. Supreme Court concluded, solely on Due Process
grounds, that the State of Maryland could not impose an obligation
on a Delaware furniture store to collect its use tax on the store's
sales to Maryland customers because it wasn't physically present
within the taxing state. The Illinois Supreme Court attacked
Miller Bros. on two fronts. First, the court questioned
the authority of Miller Bros. in light of Quill's
conclusion that contemporary Due Process no longer requires a
company to be "physically present within a state before use
tax collection duties can be imposed." Second, to the extent
that Miller Bros. remained relevant precedent, the court
limited the scope of its holding to that case's specific facts.
As a result, the Miller Bros. decision was irrelevant
to the case at hand because of its distinguishable facts. Unlike
Brown's Furniture, Miller Brothers did not employ agents to solicit
sales in the taxing state nor did they advertise there directly.
Moreover, because all of Miller's sales were finalized in their
Delaware store, deliveries to the taxing state occurred only occasionally. 61
5. Koch Fuels, Inc. v. R. Gary
Clark
In Koch Fuels, Inc. v. R. Gary Clark, 62
the Supreme Court of Rhode Island, in an innovative interpretation
of substantial nexus, held that the "practical effect"
of physical presence, rather than actual physical activity by
the taxpayer in the taxing state, is sufficient to meet the substantial
nexus prong of the Complete Auto Transit test.
Koch Fuels, Inc. ("Koch"), a Delaware
corporation with headquarters in Wichita, Kansas, is engaged in
sale and distribution of fuel-oil. On six occasions between the
years 1982 and 1984, Koch sold fuel-oil to New England Power to
be used for the generation of electricity at its subsidiary's
generating plant in Providence, Rhode Island. All shipments were
delivered via common carriers using barges or vessels pursuant
to sales contracts negotiated and agreed upon via telecommunications
between Koch's representatives in Texas or in New Jersey and New
England Power's representatives in Westborough, Massachusetts.
Although the buyer received invoices for and paid the purchase
price of the fuel-oil outside Rhode Island, the terms of the sales
contracts were f.o.b. Providence, indicating that title, possession
and risk of loss surrounding the fuel-oil shipments passed from
Koch to the buyer at the point where the vessel's oil outflow
pipe interlocks the oil terminal's inflow pipe in Rhode Island.
These transactions were the only instances in which Koch had
any business contact with any entity in Rhode Island. Moreover,
at all times relevant to the sales made to New England Power,
Koch did not have employees in Rhode Island and did not rent,
lease, or own real property within Rhode Island.
Still, however, the Rhode Island Division
of Taxation issued Koch a notice of deficiency determination under
Rhode Island's Gross-Earnings Tax Act, 63 and the tax administrator
affirmed the assessment, regarding five of the six fuel oil deliveries
made by Koch to New England Power's subsidiary in Providence.
Koch paid the tax division the full assessment and filed a complaint
with the Rhode Island District Court in its Sixth Division. Holding
that the tax did not violate either the Due Process or Commerce
clauses, the District Court upheld the tax assessment. In its
appeal to the Rhode Island Supreme Court, Koch challenged the
District Court's analysis of the Commerce Clause.
The Rhode Island Supreme Court was presented
with two significantly relevant issues. 64 First, the court had
to determine whether physical presence in the taxing state is
required in order for a "gross earnings tax" to be constitutionally
valid, as is necessary under Quill and its progeny for
sales or use taxes, or whether a different standard is applicable
for those taxes, like a "gross earnings tax," that are
distinguishable from a sales or use tax. As a result of its holding
that the statute at issue imposed a tax only upon specific sales
transactions in Rhode Island, and thereby created the "practical
effect of a sales or use tax," the court failed to address
this question. Accordingly, the court noted, because the tax
at issue was a "sales or use tax," 65 the substantial nexus
prong of the Complete Auto Transit test could only be satisfied
if the taxpayer maintained a physical presence in the taxing state. 66
The Rhode Island Supreme Court also considered
whether Koch's activity within Rhode Island was sufficient to
constitute the physical presence required for substantial nexus
to exist between Koch and Rhode Island. In answering this question
in the affirmative, the court again undertook a substance over
form analysis. The court essentially dismissed the fact that
neither Koch, nor any of its agents, was ever actually present
within Rhode Island's borders. In fact, the court's analysis
gave only slight credence to the fact that the six transactions
were the only instances in which Koch had any business contact
with any entity in Rhode Island, that Koch utilized common carriers
to handle delivery in all of the transactions, 67 and that, at all
times relevant to the sales made to New England Power, Koch did
not have employees in Rhode Island and did not rent, lease or
own real property within Rhode Island. Instead, the court was
influenced by the practical effect of Koch's "total control"
over the shipments, the exclusive nature of the common carrier's
contract, the unique nature of the cargo, and the fact that the
sales were consummated upon delivery in Rhode Island. Indeed,
Koch not only retained title, possession, and risk of loss over
the oil up until the point it reached the flange in Providence,
but was also in continuous contact and control with both the common
carrier and the buyer, and was in a position to cancel the delivery
if contract performance was not met by the buyer. Moreover, although
common carrier's were used, Koch's fuel-oil represented the entire
and exclusive cargo on the vessels at issue. Together, this evidence
pushed the court to one of the more innovative holdings to date
in the "substantial nexus" arena; that the "practical
effect" of physical presence, rather than actual physical
activity by the taxpayer in the taxing state, is sufficient to
meet the substantial nexus prong of the Complete Auto Transit
test.
Tax authorities in some states have attempted
to impose use tax collection requirements on out-of-state sellers
under an "affiliate nexus" theory. Under this theory,
corporate members of an enterprise of affiliated companies share
the nexus of other members. Thus far, state courts have been
unwilling to adopt arguments based on this theory. As a result,
courts have refused to find that an out-of-state seller, lacking
independent nexus in the taxing state, is nevertheless subject
to taxation there because of the undisputed nexus of a corporate
affiliate.
1. SFA Folio Collections, Inc.
v. Tracy
In SFA Folio Collections, Inc. v. Tracy, 68
the Ohio Supreme Court held that the state may not attribute nexus
to a corporation with no physical presence in Ohio because of
an affiliate corporation's in-state presence.
SFA Folio Collections, Inc., ("Folio")
a New York company, is a wholly-owned subsidiary of Saks &
Company ("Saks"), also a New York company. Folio sells
clothes and accessories by direct mail to Ohio customers. Folio
mails its catalogs to customers, and the customers place orders
with Folio by telephone, mail or facsimile.
Folio customers pay for merchandise by check
or credit card, including Sak's company credit cards. If payment
is made by check, Folio sends the merchandise after the check
has cleared the bank. If payment is made by credit card, the
credit card companies, and not Folio, guarantee payment. Consequently,
Folio does not enter Ohio to collect payments. Folio ships the
merchandise to customers via mail or common carrier. Folio maintains
no facilities in Ohio and directs dissatisfied customers to return
merchandise to New York.
Saks also owns another subsidiary, Saks
Fifth Avenue of Ohio ("Saks-Ohio"), which has stores
throughout Ohio. Saks-Ohio sells merchandise at retail and is
a separate profit center from Folio. If a customer cannot find
an item at Saks-Ohio, the store might refer the customer to the
Folio catalog, but Saks-Ohio does not place orders for its customers
or assist customers in doing so.
The Saks-Ohio stores accepted returns of
merchandise purchased from Folio. Saks-Ohio stores charged the
returns to its inventory and attempted to sell the merchandise
itself; it did not contact Folio about such transactions. Returns
of Folio merchandise constituted a minimal part of Saks-Ohio's
total returns.
The Board of Tax Appeals affirmed the Tax
Commissioner's assessment of use tax on Folio's sales to Ohio
residents. The Board reasoned that under Ohio's affiliate nexus
statute, Folio had substantial nexus with Ohio because Folio was
a member of the affiliated group including Saks-Ohio.
The Ohio Supreme Court reversed. Applying
Quill, the court noted that the Commerce Clause requires
that an interstate seller have a physical presence in a state
before the state may compel the seller to collect use tax. The
court reasoned that because Folio maintained no physical presence
in Ohio, and hence did not itself have substantial nexus with
the state, the Commerce Clause barred the imposition of use tax
collection responsibilities.
In addition, the court refused to ignore
the legal distinction between the parent and subsidiary corporations.
Because the companies were distinct legal entities, and not agents
or alter egos, there is no basis for attributing nexus among them.
Thus, the court held, to impute nexus to Folio because a sister
corporation has physical presence in Ohio contravenes both the
U.S. Constitution and state corporation law.
Finally, the court found that Folio had
no employees or agents in Ohio, maintained no bank accounts there,
and performed no credit investigations or collection in the state.
The court concluded that the infrequent return of Folio merchandise
to Saks-Ohio is industry custom, and Saks-Ohio accepted such returned
items to enhance its own goodwill, and not to benefit Folio.
2. Current, Inc. v. State Board
of Equalization
In Current, Inc. v. State Bd. of Equalization, 69
the California Court of Appeals ruled that the state's affiliate
nexus provisions violated the Commerce Clause of the U.S. Constitution.
Current, Inc. is a mail order seller engaged
in business in California. Current solicits orders for gift wrapping
paper, greetings cards, and novelty checks via catalogs, flyers,
and print ads sent into California. Current has no employees,
inventories or facilities in California. During the audit period
in question, Current was acquired by Deluxe Corporation, a Minnesotamanufacturer with facilities located throughout California.
In assessing use tax against Current, the
California State Board of Equalization relied on the state's affiliate
nexus statute. 70 The statute provided that sellers obligated to
collect California use tax include: "Any retailer owned
or controlled by the same interests which own or control any retailer
engaged in the same or similar line of business in this state."
On the basis of the foregoing provision, the state concluded
that Current had substantial nexus with California because of
the in-state presence of its corporate-parent Deluxe.
The California Appellate Court rejected
the state's argument and affirmed a lower court ruling that applying
the affiliate nexus statute to establish nexus between Current
and California violated the Commerce Clause. The court noted
pre-Quill state court decisions that considered the affiliate
nexus concept. Those cases, the court observed, required either
an agency relationship or corporate piercing as a basis for attributing
nexus among corporate affiliates. Because neither factor was
present, the court held that California's affiliate nexus statute
was unconstitutional as applied to Current. As a result, unless
a seller itself has an in-state presence, or unless a seller employs
an in-state affiliate as an agent, there is no basis for finding
nexus by affiliation. 71
C. Use of In-State Agents or Employees
Since Quill, a number of state courts
and other tax authorities have also considered the question of
whether a mail-order seller has a physical presence in a taxing
state as a result of the use of in-state agents or employees to
conduct its business or to receive and process its orders.
1. Carpace, Inc. v. Limbach
In Carpace, Inc. v. Limbach, 72 the
Ohio Board of Tax Appeals ruled that the employment of an in-state
manufacturer's representative may subject a nonresident
mail-order seller to use tax collection requirements.
Carpace was engaged in the business of manufacturing
and selling orthopedic devices to both dealers and consumers in
Ohio. Carpace employed a manufacturer's representative to provide
support and assistance to dealers. The representative's duties
included providing samples, developing product promotions, hiring
additional dealers, and conducting training and sales seminars.
Carpace asserted that its representative
was not present in Ohio for the purpose of conducting the business
of the seller (as required under the Ohio statute) because the
representative did not solicit orders or call upon prospective
customers. The Board rejected Carpace's assertion and found that
the employment of the in-state representative met the Quill
physical presence requirement. The Board found that although
the representative did not directly procure sales, the representative's
function was clearly to support sales activities of the dealer
who in fact made sales. Accordingly, the Board ruled that Carpace
itself was deemed to be physically present in Ohio as a result
of the representative's activities.
2. Troll Book Clubs, Inc. v.
Pledger
In Troll Book Clubs, Inc. v. Pledger, 73
the Arkansas Supreme Court held that an interstate mail-order
seller lacked nexus with Arkansas because the seller's in-state
representatives were not the seller's agents under Arkansas law.
Troll Book Clubs is a New Jersey corporation
engaged in the business of marketing and selling children's books.
Troll markets and sells its merchandise by mailing catalogs to
teachers who have either previously purchased books or who have
requested the catalogs. The catalogs instruct teachers on how
to collect student orders. Troll fills the orders and sends the
books to the teachers in the mail or by common carrier. Teachers
receive cash or merchandise bonuses depending on the size of the
order.
The state issued a sales and use tax assessment
against Troll on grounds that the teachers were the agents of
Troll and that Troll had nexus with Arkansas because of their
physical presence in the state. The trial court found that under
Arkansas law there was no agency relationship between Troll and
the teachers and rejected the state's argument. The court found
that the teachers had no authority to bind Troll and that the
catalogs were for display and convenience and did not constitute
an implied contract to control the teacher's actions. In addition,
the court found that bonus points earned by some teachers were
not the equivalent of compensation. As a result, the court concluded
that there was no agency relationship and hence no nexus between
Troll and Arkansas.
The Arkansas Supreme Court affirmed. As
an preliminary matter, the court acknowledged that unless the
Department of Revenue could establish an agency relationship between
the teachers and Troll, the court must conclude that Troll did
not have substantial nexus with Arkansas. The court then found
that Troll's brochures did not establish authorization and control
over the teachers, the elements required to show an agency relationship.
Absent an agency relationship between the teachers and Troll,
the court refused to find that Troll had substantial nexus with
Arkansas. 74
3. Troll Book Clubs, Inc. v.
Tracy
On facts substantially similar to those
in the Arkansas case, the Ohio Board of Tax Appeals reached the
same result in Troll Book Clubs, Inc. v. Roger W. Tracy. 75
On essentially the same grounds discussed above, the Board found
that there was no agency relationship between the teachers and
Troll and therefore concluded that Troll had no physical
presence in Ohio. For this reason, the Board ruled that Troll
lacked substantial nexus with the state. The Board also considered
the Tax Commissioner's argument that the teachers were "representatives"
of Troll and, as such, established "any other contact"
with Ohio, as required by the state's nexus statute. The Board
responded to that argument by stating that substantial nexus cannot
be found with proof of something less than agency.
The Multistate Tax Commission recently released
for comment a revision to its Constitutional Nexus Guideline for
Application of a State's Sales and Use Tax to an Out-of-State
Business draft. The guideline describes the circumstances under
which a nonresident vendor is constitutionally present in a taxing
state for purposes of the imposition of a use tax collection responsibility
and is, by its own terms, applicable only to sales and use taxes.
Under the revised draft guideline, the "minimum
contacts" requirement of the Due Process Clause would be
satisfied when one or more of the following activities is found
to be more than de minimis:
a. the out-of-state business is present in the taxing state; or
Under the guideline, an out-of-state business
is physically present in the taxing state when the business engages
in one or more of the following activities exceeding a de minimis
level:
a. has (i) an employee who is present on a regular or systematic basis or (ii) an employee who is temporarily present but whose presence is nonetheless tied to the establishment or maintenance of the market in the taxing state and reflects the conscious choice of the direct marketer to submit to the jurisdiction of the taxing state, as is the case where the direct marketer is pursing an established company policy on a continuing basis or has made an affirmative management decision. 79
The guideline also sets forth the MTC's concept of de minimis. In the MTC's view, an out-of-state business presence in a taxing state is de minimis when the presence is trivial. Presence is not trivial when the presence exceeds a slightest presence and enables the out-of-state business to enjoy the benefits, privileges and services of the taxing state or when the presence is not inadvertent, but represents a conscious choice of the out-of-state business to submit itself to the jurisdiction of the taxing state. 87
On December 20, 1995, the Multistate Tax
Commission, together with 26 states, issued Nexus Bulletin 95-1. 88
The issue addressed by the bulletin is whether an independent
contractor providing repair services to customers of an out-of-state,
direct-seller computer vendor under the vendor's warranty will
result in nexus for the vendor. The bulletin concludes that the
"industry practice of providing in-state warranty repair
services through third party service providers . . . creates constitutional
nexus for the imposition of use tax collection responsibility
for all sales made to customers in that State and for income,
franchise, or comparable tax liability . . . in the taxing State
where the warranty services are performed." In the MTC's
view, the bulletin's purpose is to (i) achieve uniform enforcement
of the tax laws among the states and to (ii) provide businesses
with assistance in determining applicable nexus standards and
filing responsibilities. 89
In support of its conclusion, the MTC correctly
notes that "[t]he limits of the States' taxing authority
under the Due Process and Commerce Clauses for the imposition
of use tax collection responsibility are set forth in Quill
Corp. v. North Dakota, 90 and in National Bellas Hess Inc.
v. Dep't of Revenue of the State of Illinois." 91 92 In its
"substantial nexus" analysis, however, the bulletin
relies on Scripto, Inc. v. Carson, Inc., 93 General Trading
Co. v. State Tax Commission of the State of Iowa, 94 Felt
& Tarrant Mfg. Co. v. Gallagher, 95 Tyler Pipe Industries
v. Washington 96 and Standard Pressed Steel Co. v. Dep't of
Revenue of Washington, 97 for the proposition that the "U.S.
Supreme Court has uniformly found that the in-state presence of
a representative of an out-of-state seller who conducts regular
or systematic activities in furtherance of the seller's business
such as solicitation of sales or provision of services, creates
nexus." 98 The bulletin then concludes that the presence of
representatives of a direct marketing computer company providing
warranty repair services in the customer's state will generate
constitutional nexus.
Some critics of Nexus Bulletin 95-1 dismiss
the bulletin's reliance on Scripto, General Trading,
Felt & Tarrant, Tyler Pipe and Standard Pressed
Steel. 99 In their view, not one of the cited cases support
a finding that "substantial nexus" can be based solely
the activity of a third party who provides repair services for
products sold by an out-of-state direct seller. For example,
they argue the Standard Pressed Steel is irrelevant because
the corporation's "physical presence" in that case resulted
from the presence of an employee rather than an independent third
party operating pursuant to a contract. 100 Other critics of the
bulletin read Scripto as applying only to independent contractors
who solicit customers. 101
V. APPLICATION OF CURRENT CONSTITUTIONAL
NEXUS STANDARDS TO OUT-OF-STATE INFORMATION SERVICE PROVIDERS
AND SELLERS UTILIZING THE INFORMATION SUPERHIGHWAY
In the typical transaction, an in-state
customer located in State A accesses a commercial on-line information
service provider such as America Online or CompuServe 102 or the Internet 103
directly through a telecommunications network with software provided
by the on-line information service provider, or in the case of
the Internet, when accessed directly, with software provided by
a commercial software company. 104 Access to the on-line information
service provider is generally gained by the in-state customer
via his/her personal computer through a local node leased from
a telecommunications company such as MCI which, more likely than
not, is located in the in-state customer's state. 105 The local node,
in turn, forwards the customer's transmission on to the commercial
on-line information service provider's server (computer) which
may be located in State B. In some instances, an on-line information
service provider may contract with a telecommunications service
provider who provides access to the local node for in-state customers.
Once access to the network is gained, a
variety of information services or "locations" are available
to the customer, including news, sports, weather, travel and entertainment.
Goods are also available to the customer through cybermalls which
can be accessed through the on-line information service provider. 106
Through the on-line service provider's network, a customer can
also gain access to the Internet which, in turn, provides the
customer with access to third party information service providers
who, for a fee, provide books, stock reports, software and other
information based products. The third party information service
server may be located in yet another state.
B. The Fundamental Question -- Use Tax
Collection Responsibility
The fundamental question to be addressed
when analyzing the application of the Commerce Clause's "substantial
nexus" standard to out-of-state information service providers
and merchants utilizing the service providers and the Internet
to reach in-state customers is whether either the out-of-state
information service provider and/or the out-of-state merchant
utilizing the out-of-state information service provider or the
Internet to reach in-state customers can acquire a substantial
nexus in the taxing state and, as a result, become subject to
a sales tax or use tax collection responsibility without being
physically present there. More specifically,
(i) is the on-line information service provider present in each state from which in-state customers access its network; and
1. Application of Current Nexus Standards
To Out-of-State On-Line Information Service Providers
The question here is how and when an out-of-state
on-line information service provider becomes subject to the taxing
jurisdiction of the state in which the customer who has accessed
the on-line information service provider's network is located.
Under Quill's bright-line, physical
presence standard, an on-line information service provider will
certainly be subject to the taxing jurisdiction of any state in
which it owns or leases property or equipment, maintains an office,
or has employees, agents or other personal representatives. Other
states, however, will have to develop and apply alternative nexus
theories to impose a use tax collection responsibility on the
out-of-state on-line information service provider who do not maintain
property or personal representatives in the taxing state.
One such theory is the "agency/representative
theory." The states will undoubtedly attempt to argue that
an out-of-state on-line information service provider acquires
a substantial nexus with the taxing state in which its customer
is located through its local node and/or the telecommunications
service provider who provides in-state customers with access to
its network through the local node. In support of this argument,
the states would most likely cite the Court's decisions in Scripto
v. Carson 107 (nexus existed where a Georgia-based company
had ten salesmen conducting continuous local solicitation in the
taxing jurisdiction); Standard Press Steel v. Department of
Revenue of Washington 108 (out-of-state seller maintained an agent
in the state in the form of a single employee); Felt &
Tarrant Manufacturing Co. v. Gallagher 109 (out-of-state seller
using exclusive distributorship agreements with persons who maintained
an in-state place of business could be required to collect use
tax); General Trading Co. v. State Tax Commission of the State
of Iowa 110 (use of traveling salesmen to conduct business in
a state creates a sufficient nexus in the taxing state for use
tax collection purposes); and Tyler Pipe Industries v. Washington 111
(presence of a single sales representative in the taxing state,
without regard to whether he/she is an agent or independent contractor,
adequately supports jurisdiction to tax wholesale sales to in-state
customers). The states currently believe that these cases illustrate
the manner in which an out-of-state seller may acquire nexus in
the taxing state through an agency/representative relationship.
In their view, an out-of-state on-line information service provider
who contracts with a telecommunications service provider to provide
access to a local node for an in-state customer of the out-of-state
on-line information service provider acts as the in-state representative
or distributor for the out-of-state on-line information service
provider thereby establishing the physical presence necessary
to subject the out-of-state service provider to the state's taxing
jurisdiction. This assumes, of course, that the states are successful
in establishing that the telecommunications service provider is
acting as the agent of the out-of-state on-line information service
provider. If the states cannot, or if the telecommunications
service provider can be characterized as a "common carrier,"
the states' argument will fail. 112
2. Imputation of Nexus of the Out-of-State
Information Service Provider to Out-of-State Merchants Utilizing
the Service Provider's Network to Reach In-State Customers
Under their agency/representative argument,
the states will undoubtedly also attempt to reach third party
merchants who use on-line information service providers or the
Internet to reach in-state customers. The states believe that
the third party merchant's relationship with the on-line information
service provider is "directly associated with the taxpayer's
ability to establish and maintain a market in the state for the
sales." In their view, the on-line information service provider's
"physical presence" whether directly, or through its
relationship with a telecommunications service provider, in the
taxing state establishes the requisite nexus because the on-line
service provider serves as an essential link between the third
party merchant and the in-state customer. 113
C. The Fundamental Question -- Imposition
of Net Income Based Taxes
If an out-of-state information service provider
purposefully directs its service toward the residents of a taxing
state it may also become subject to the taxing jurisdiction of
the taxing state for net income tax purposes even though it has
not established a physical presence there. We now know that the
Due Process Clause is no longer a barrier to the imposition of
a net income based tax against a taxpayer who is economically
present in the taxing state. Quill tells us that at least
for Due Process Clause purposes, a physical presence is no longer
required. What we do not know is whether for Commerce Clause
purposes, Quill's bright-line physical presence test extends
to net income based taxes.
The states currently believe that Quill's
bright-line physical presence standard does not extend to the
imposition of net income based taxes. As a result, the states
appear to be of the opinion that Quill supports the proposition
that the "economic presence" test -- a regular, systematic
or purposeful availment of the state's market -- may be sufficient,
in and of itself, to satisfy the Commerce Clause's "substantial
nexus" requirement for net income tax purposes. If the states
are, in fact, correct, an out-of-state on-line information service
provider may be subject to the taxing jurisdiction of the states
in which its subscribers are located even though the out-of-state
on-line information service provider has no physical presence
in the taxing state. 114
The result may differ, however, for the
out-of-state merchant who utilizes the services of the out-of-state
information service provider. This assumes, of course that the
out-of-state merchant is engaged in the sale of tangible personal
property. If it is, the protections afforded by P.L. 86-272 are
available. The fact that an in-state customer places an order
through electronic means via telephone lines rather than through
the mail or by telephone should not, in and of itself, void the
protections of P.L. 86-272. However, if the on-line information
service provider performs additional services for the out-of-state
merchant and these services are not ancillary to requests for
purchases, the services provided may constitute tainted activities
and subject the out-of-state merchant to the taxing jurisdiction
of the states in which these services are performed. 115
Whether Quill's bright-line physical
presence standard extends to net income based taxes is a question
for which there is currently no definitive answer. In Geoffrey,
Inc. v. South Carolina Tax Commission. 116 The South Carolina
Supreme court concluded that the physical presence requirement
established by the Court in Bellas Hess, and reaffirmed
in Quill, was limited to sales and use tax collection responsibility.
However, Cerro Copper Products, Inc. v. State of Alabama Department
of Revenue, 117 Chief Administrative Law Judge Thompson held that,
for franchise tax purposes, the mere presence of an account receivable
in Alabama arising from an in-state sale does not establish substantial
nexus with the state. The significance of Judge Thompson's ruling
is twofold: First, it recognizes that Geoffrey is the
law of the land only in South Carolina. And second, it represents
a willingness to extend Quill's "substantial nexus"
standard to the franchise tax context.
Cerro Copper Products, Inc., a Delaware
company located in Sauget, Illinois, is engaged in the business
of manufacturing and selling copper tubing and other copper products.
Cerro had no employees in Alabama, owned no property there, and
had no manufacturing facilities in the state during the audit
period in question. During the years at issue, Cerro's Alabama
sales accounted for approximately 3% of its sales nationwide.
Cerro solicited sales in Alabama by direct
mail, telephone, and telecopier from outside the state. All orders
from Alabama customers were subject to approval at Cerro's Illinois
offices. Cerro billed all its customers by invoice issued from
Illinois. All credit decisions were made and all accounts receivable
records were maintained in Illinois. All goods were delivered
to Alabama customers by third-party commercial carriers.
Cerro filed petitions for franchise tax
refunds on grounds that it did not have substantial nexus with
Alabama. The Department of Revenue refused to grant the refund
petitions and Cerro appealed to the Department's Administrative
Law Division.
As a preliminary matter, Chief Administrative
Law Judge Thompson expressed his disagreement with the view [of
many state tax officials] that Quill affirmatively limits
the Commerce Clause physical presence test only to sales and use
taxes. Rather, he notes, the Supreme Court left open the issue
by stating that "silence does not imply repudiation of the
Bellas Hess (physical presence) test" for other taxes.
Further, Judge Thompson stated, "As a practical matter,
the same benefits of a bright-line, physical presence test cited
in Quill, at page 1915, for sales and use tax purposes
would also apply equally to other types of taxes." Judge
Thompson's view on this issue flatly contradicts that of many
state tax officials, whose interest in limiting the application
of Quill to the sales and use tax context is obvious.
Judge Thompson next considered the state's
"Geoffrey" argument -- the mere in-state presence
of accounts receivable arising from sales to Alabama customers
creates substantial nexus for Alabama franchise tax purposes.
First, Judge Thompson distinguished Geoffrey on factual
grounds. There, Geoffrey licensed the trademark for use
in South Carolina; whereas here, Judge Thompson noted, Cerro did
not use the account receivable in Alabama. Accordingly,
he concluded, the account receivable did not have a "business
situs" in the state and hence were not located there.
In addition, even if the receivables were
"located" in Alabama, Judge Thompson found that there
is "no authority, other than Geoffrey" holding that
the mere presence of an intangible in a state, without some physical
presence, is sufficient to establish substantial nexus under the
Commerce Clause. As a result, the Judge held that Cerro was entitled
to a refund of franchise taxes paid for the years at issue.
The Supreme Court, in Quill, ruled
that under the Commerce Clause, a state may not compel an out-of-state
seller to collect use tax from in-state buyers, unless the seller
has "substantial nexus" with the market state. According
to the Quill Court, the "substantial nexus" standard
requires at a minimum that a seller have a physical presence in
the taxing jurisdiction. Beyond that, the Court left open such
important questions as: How much physical presence in a state
is enough; is "anything more than the slightest presence"
sufficient? What about an economic presence? The mere
presence of intangibles? Do affiliated companies share nexus?
Does Quill's physical presence standard even apply to
franchise or income taxes? In the context of electronic commerce,
is the physical presence standard even workable? In the absence of Supreme Court guidance in answering these questions, many state courts and other state tax officials have applied the Quill "substantial nexus" principles in a variety of cases and under various theories, arriving at conflicting results. Although the bright-line physical presence rule in Quill is clear, the precise contours of the Commerce Clause "substantial nexus" standard as it applies to the information superhighway remain open for interpretation.
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