E-Commerce, Nexus, and State Policy Trends. LeAnn Luna. 7 th Annual Tax Policy Conference May 20, 2010

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1 E-Commerce, Nexus, and State Policy Trends LeAnn Luna University of Tennessee Prepared for the New Mexico Tax Research Institute epa ed o t e e e co a esea c st tute 7 th Annual Tax Policy Conference May 20, 2010

2 Quarterly Total State Tax Collections, year over year growth rcent grow wth Pe Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Source: U.S. Census Bureau. 2

3 Percent Growth in Total State Tax Revenue Collections, FY U.S. = -8.2 % Less than -10.0% -10.0% to -5.7% Greater than -5.7% 3

4 Quarterly State Tax Collections by Source,,year over year growth Percent gro owth Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q4 Corporate Income Sl Sales Individual id Income Source: U.S. Census Bureau. 4

5 Sales Tax Base as a Percent of Personal Income, Percent

6 Estimated Total E-Commerce Sales* Source: U.S. Census *Sales-taxing states only 6

7 Industry Share of E-Commerce, 2006 Retail 44% 4.4% Services 4.60% Wholesale 26.4% Manufacturing 65.6% 7

8 State and Local E-Commerce and Revenue Losses ($millions) Total B2B E-commerce 2,480,011 2,231,283 2,767,010 3,253,412 3,656,856 Total B2C E-commerce 179, , , , , Total E-Commerce 2,659,244 2,392,540 2,966,985 3,488,540 3,921,140 Estimated Taxes Due 31,113 27,992 34,713 40,815 45,877 Estimated Taxes Collected 23,386 21,041 26,093 30,679 34,484 Estimated Total State and Local Revenue Loss 7,727 6,951 8,620 10,136 11,393 8

9 Estimated E-Commerce Losses for Selected States (2012) 1,750 1,500 1,250 1,

10 State Tax Policy Trends Income Tax Combined reporting and expense disallowance Apportionment formulas Sourcing of service revenue Economic nexus Gross receipt taxes Sales Tax Other Digital products Agency, affiliate, and flash nexus Click-through nexus and the Amazon Tax Increase tobacco tax rates Decoupling from federal incentives and credits Amnesty programs 10

11 Combined Reporting Most popular reform being discussed. Meant to prevent tax planning strategies, including the PIC. But increased complexity for taxpayers. Uncertainty regarding the definition of unitary. May be viewed as business unfriendly. Effect on revenues is uncertain. There are winners and losers. Univ. of TN study (2009). 11

12 Mandatory Combined Reporting (2010) 12

13 Expense Disallowance States 13

14 Apportionment and Sales Sourcing Apportionment Traditional equal weighting of property, payroll and sales Double weighted sales California effective after 2010 Single weighted sales Michigan effective after 2007 Colorado effective after 2008 Utah effective after 2012 Sales Sourcing Move away from cost of performance rule to sourcing all sales of non-tangible personal property based on the audience or market found within the state. California effective after 2010 Special rules for industries 14

15 Sales Factor Sourcing of Services (2010) 15

16 Gross Receipts Taxes Increased attention in gross receipt taxes (GRT) as a replacement for the standard d state t corporate income tax. Prior to 2002, only Delaware and Washington imposed significant gross receipts taxes (GRTs). Since 2002, Ohio, Michigan, and Texas have levied variants of GRTs. Illinois, i Maine, and Montana have considered d a GRT. The reasons given included tax simplification, increased economic competitiveness, and creating revenue from companies that are not generating a profit. 16

17 Gross Receipts Taxes Low rate and broad base: The GRT as currently structured generally has lower rates and a broad base. Therefore, it may be considered more stable than the traditional corporate income tax. Economic Neutrality: Pyramiding is a problem for GST and creates incentives i and disincentives i i for business operations. It encourages vertical integration and discriminates against contracting work with independent suppliers. 17

18 Gross Receipts Taxes Competitiveness: The tax discourages capital investment by adding to the cost of factories, machinery, and equipment, and the disincentive increases as more of those capital goods are produced in the taxing state. Fairness: Firms with the same net income will face radically different effective tax rates on that income. Low-margin firms will be at great disadvantage relative to higher-margin g firms, regardless of their overall profitability. Many new and expanding firms are often unprofitable or have low margins, reducing the chance that these firms will survive. Administration Costs: There will be transition costs and issues of nexus, sourcing, and combined reporting remain. 18

19 General Nexus Standard A taxpayer must have nexus with the taxing jurisdiction to be subject to tax. Two standards must be met under the federal constitution. Due Process a taxpayer need only have a minimal contact with a state seeking to impose tax. May be met without physical presence (Quill Corp v. North Dakota, 504 U.S. 298 (1992). Commerce Clause requires substantial nexus. Complete Auto Transit v. Brady, 430 U.S. 274 (1977) It is applied to an activity with a substantial nexus with the taxing state. It is fairly apportioned. Does not discriminate i i against interstate commerce. Is fairly related to the services provided by the state. Physical presence is required (at least for sales and use tax). Quill Corp v. North Dakota, 504 U.S. 298 (1992). 19

20 Physical Presence Why is it such a problem? Trivial acts inside a state can establish nexus. The standards vary tremendously from state to state. Uncertainty Two primary questions: What is physical presence? How much is sufficient? 20

21 Income Tax Nexus Traps for the unwary Pick up defective goods in company trucks? Attends occasional board meetings? Attends occasional seminars sponsored by others? Own a display rack in a state? Set up product displays? Perform repair services 1 time? 5 times? Hold recruiting event? Employees work from home office? Get authorized to do business? 21

22 Sales Tax Nexus Traps for the unwary Make 11 deliveries in seller owned trucks? How about 13 deliveries? Supervise an installation? Attend trade shows? Attend meetings for 12 days? Conduct training i courses or seminars? Register to do business? Own an affiliate with nexus? 22

23 It s the Uncertainty In-state phone listing? In Indiana, Iowa, this does NOT create sales tax nexus. In Kansas, it affirmatively DOES create nexus. But in Nebraska and nine other states, it may create nexus. Providing warranty repairs? Texas creates sales tax nexus. Oklahoma and 10 other states, may create nexus. Virginia does not create nexus. 23

24 Uncertainty, continued What might create nexus for income tax may not create sales tax nexus. Own display rack. In Alabama, Arizona, and Arkansas, creates sales tax nexus but NOT income tax nexus. In S. Caroline, creates income tax nexus, but state has no position for sales tax nexus. Owning or leasing equipment In Hawaii, Arizona, Arkansas, does not create income tax nexus, but does create sales tax nexus. In Maine, N. Dakota, Iowa, Income tax nexus? Yes Sales tax nexus -??? 24

25 Agency Nexus - Sales Tax Can activities of agents or other representatives create nexus for an out-of-state tt principal? i Scripto, Inc. v. Carson, 362 U.S. 207 (1960) Connecticut Sales Tax Guide, Scholastic Book Clubs, Inc. v. Commissioner of Revenue Services, Connecticut Superior Court, (April 9, 2009). Do the in-state activities have to be sales related or can other activities of in-state representatives create nexus? Tyler Pipe Industries, Inc. v. Washington Dept. of Revenue, 483 U.S. 232 (1987). 25

26 Economic Nexus Income Tax Lanco and MBNA and after. U.S. Supreme Court denies cert in Lanco and MBNA (June 18, 2007) and Capital One and Geoffrey (June 22, 2009). Louisiana issues Geoffrey ruling. Massachusetts issues Geoffrey and Capital One rulings New Hampshire adopts significant presence test Michigan includes economic nexus in Business Tax Act Maine announces economic presence position Iowa issues KFC decision Oregon and Colorado consider economic nexus New Jersey issues taxpayer favorable decision in Praxair Wisconsin expands doing business statute California adopts factor presence nexus statute West Virginia applies substantial economic presence test Colorado, New York, Oregon, Washington propose economic nexus legislation 26

27 Attributional / Affiliate Nexus Nexus may be established through an affiliated company. e.g., brick and mortar stores with an affiliated online retailer. Sales Tax Affiliate Nexus Legislation Wisconsin (2009) New York (2009) Effective June 1, 2009, New York requires out-of-state vendors with New York affiliates to register if the New York affiliate either Uses the same trademark or trade name; or Engages in activities in New York that benefit the out-of-state vendor in developing or maintaining a market. California (Proposed April 2010) Washington Det. No , 28 WTD 9 (2008) 27

28 Click-Through Nexus & the Amazon Tax Amazon.com (N.Y. Sup. Ct. 1/12/09) In April, New York enacted legislation l i subjecting certain out-of-state, online retailers to a sales tax collection duty for sales to NY customers. Any seller of tangible personal property or taxable services is presumed to be soliciting business through an independent contractor or other representative if the seller enters into an agreement with a resident of New York 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. Amazon.com challenged New York s revised law requiring it to collect sales and use tax on sales to New York customers, claiming that NY imposes tax collection obligations on out of state entities that have no substantial nexus with New York. The state prevailed and other states have introduced d similar il legislation. l i Amazon should not be permitted to escape tax collection indirectly, through use of an incentivized New York sales force to generate revenue, when it would not be able to achieve tax avoidance directly through use of New York employees engaged in the very same activities. iii 28

29 Amazon Taxes (2010) 29

30 Digital Goods Offshoot of the Streamlined Sales Tax Project requirements Must explicitly impose sales and use tax on digital goods or electronically transferred items Must use Streamlined definitions to remain a member / associate member. Prohibition against taxing digital as tangible personal property Legislation adopted in 2009 in Kentucky, Mississippi, North Carolina, Vermont, Washington, and Wisconsin Legislation passed in 2008 in Indiana, Nebraska, South Dakota, Tennessee, Utah Legislation is being considered in Virginia and Minnesota. 30

31 Tobacco Tax Rates $1.60 $1.40 $1.20 Average Year-End State Tax (per pack) Inflation Adjusted State Tax (CPI) $1.00 $0.80 $0.60 $0.40 $0.20 $

32 Other Sales/Use Tax Measures Taxation of services Effective 1/1/2010 in Maine on various services Proposed in AZ, KS & KY Vendor compensation reductions Reduced/eliminated in 3 states in 2009 Proposed in NJ, OK & VA Taxation of junk food Proposed in AZ, CT, MS, NM, RI & VT Bag taxes Effective 1/1/2010 in District of Columbia Proposed in AK, CA, CO, CT, HI, ME, MA, MD, NJ, NV, NY, RI, TX, VT, & VA 32

33 Conclusion Tax shortfalls are challenging states abilities to manage balanced budgets, leading states to consider alternative ways to increase revenues. States are forced to become more creative in stimulating their economy while preserving revenue. Biggest challenge will be keeping current of the changes to stay in compliance. 33