STATE & LOCAL TAX NEXUS: WHEN HAVE YOU CROSSED THE LINE?

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1 STATE & LOCAL TAX NEXUS: WHEN HAVE YOU CROSSED THE LINE? Mary Reiser, CPA SALT Services Senior Managing Consultant Jana Gradeva, CMI SALT Services Senior Managing Consultant 1

2 TO RECEIVE CPE CREDIT Participate in entire webinar Answer polls when they are provided If you are viewing this webinar in a group Complete group attendance form with o Title & date of live webinar o Your company name o Your printed name, signature & address All group attendance sheets must be submitted to training@bkd.com within 24 hours of live webinar Answer polls when they are provided If all eligibility requirements are met, each participant will be ed their CPE certificates within 15 business days of live webinar LEARNING OBJECTIVES Identify types of activities that create sales & use tax nexus Identify types of activities that create state income & franchise tax nexus Understand nexus concerns for different industries Explain most recent legislative changes & trends in area of state & local tax nexus 2

3 SALES & USE TAX WHAT IS NEXUS? Connection a potential taxpayer has with a state that allows the state to impose its taxing powers Minimum physical presence required before a state taxing authority can subject a taxpayer to various taxes within the state Nexus rules may vary from state to state A person or business who has nexus in a state is required to register, file & pay various taxes in that state A person or business with nexus in a particular state is required to collect sales & use tax from its customers on sales of tangible personal property & taxable services 3

4 NEXUS: ONCE UPON A TIME Quill Corp. v. North Dakota Quill sold office supplies through mail order catalogues & shipped via common carrier U.S. Supreme Court held Quill had nexus under Due Process Clause but did not have nexus under Commerce Clause (substantial nexus) because it lacked actual physical presence in the state U.S. Supreme Court ruled a state cannot require an out-of-state seller to collect & remit sales & use tax if seller does not have a physical presence in the state IN THE YEARS AFTER QUILL Confined by physical presence requirement in Quill, states began to explore possibilities of indirect physical presence Internet sales & advancement in technology expanded range of nexus creating activities Pressure from in-state retailers State budget deficits after recession 4

5 EVOLUTION OF SALES TAX NEXUS Actual physical presence Agency nexus Click-through nexus Affiliate nexus/attributional nexus Remote seller notification requirements Economic nexus COMMON NEXUS CREATING ACTIVITIES Place of business, offices, warehouses Ownership of equipment, land, property, inventory or other assets Employees residing in state Performing services in state Third-party relationships (agents/independent contractors, third-party sales people) Frequent or recurring solicitation In-state affiliates 5

6 AGENCY NEXUS Nexus created through independent contractors & third-party agents US Supreme Court Case: Scripto, Inc. v. Carson U.S. Supreme Court held that, for nexus purposes, distinction between employees & independent contractors was without constitutional significance Nexus can not be avoided by outsourcing of nexus creating activities to independent contractors or third-party agents CLICK-THROUGH NEXUS/AMAZON LAWS In 2008, New York first adopted a breakthrough legislation by amending definition of vendor to include a presumption vendor is soliciting through a independent contractor or an agent if Vendor enters into an agreement with an in-state resident to directly or indirectly refer potential customers whether by a link or website In-state resident receives a commission or other consideration Sales into NY with assistance of in-state referral source exceed $10,000 First-of-its-kind sales tax nexus for remote sellers via e-commerce Amazon.com & Overstock.com unsuccessfully fought New York s legislation in court Many other states have adopted similar legislation following New York s Amazon tax law 6

7 STATES ENACTING CLICK-THROUGH NEXUS AFFILIATE/ATTRIBUTIONAL NEXUS Attributing nexus from a taxpayer s affiliated entities or other affiliates if there is an overlap of selling or other shared activities Out-of-state seller is owned by or holds a substantial interest in an in-state seller, & out-of-state seller sells same or similar products under same or similar name In-state taxpayer advertises, promotes or solicits sales In-state taxpayer performs other services assisting or on behalf of out-of state seller Activities of one company may create nexus for other related entities 7

8 AFFILIATE/ATTRIBUTIONAL NEXUS Borders Online Inc. v. State Board of Equalization (California) Internet subsidiary of an in-state retailer was deemed to have nexus with CA because In-state retailer accepted returns & exchanges of books purchased through Internet company Both shared a same/similar name & same/similar business In-state entity conducted activities to establish & maintain a market for the online subsidiary REMOTE SELLER USE TAX NOTICE AND REPORTING REQUIREMENTS In 2010, Colorado passed legislation to require remote sellers without nexus in the state To send a notice to purchasers that the purchaser may be subject to Colorado sales & use tax To send an annual purchase summary to customers who purchase more than $500 To file an annual customer information report with Colorado Department of Revenue Out-of-state sellers not obligated to collect Colorado sales tax must notify Colorado customers of their obligation to self-report & pay use tax Direct Marketing Association (DMA) filed suit against state claiming this law imposes undue burden on interstate commerce & violates Commerce Clause 8

9 REMOTE SELLER USE TAX NOTICE & REPORTING REQUIREMENTS DMA case was appealed to U.S. Supreme Court U.S. Supreme Court granted certiorari & case was remanded back to Tenth Circuit Court for decision On February 22, 2016, Tenth Circuit held Colorado s law is constitutional & does not unduly burden intestate commerce Other states with similar notice & reporting requirements already passed since 2010 Oklahoma, Kentucky, South Dakota, Vermont ECONOMIC SALES TAX NEXUS First introduced in Alabama Admin. Code Effective January 1, 2016, Alabama requires remote sellers with over $250,000 of sales into state per year to collect & remit sales tax from in-state customers if seller conducts one or more listed activities Remotely soliciting orders for sales of TPP through direct mail, catalog, broadcasting or other advertising Out-of-state sellers who lack physical presence but making retail sales of TPP into state have a substantial economic presence in Alabama & are required to register for a license to collect & remit sales & use tax Physical presence no longer required Could be challenged in court & U.S. Supreme Court may have opportunity to overrule Quill 9

10 OTHER NEXUS ISSUES States various aggressive positions In Texas, Comptroller found an out-of-state company established substantial nexus by licensing software in state [Texas Comptroller's Decision, No. 106,632, 09/19/2014] o Taxpayer retained all property rights to software & software is tangible personal property physically present in Texas & generating revenue in state Trailing nexus Taxpayers who stop business activities creating nexus in a state may be required to continue to collect sales tax & file returns for a certain period of time after Risks Taxpayers deemed to have nexus in a particular state may be held liable for past uncollected sales & use tax No statute of limitations for unfiled returns, penalties & interest PL protection does not apply to sales & use tax FEDERAL LEGISLATIVE DEVELOPMENTS Marketplace Fairness Act of 2015 (S 698) Proposed legislation that would enable state governments to require tax collection by remote retailers & out-of-state sellers with no physical presence in state Small seller exemption Some level of audit protection Remote Transactions Parity Act of 2015 (HR 2775) Legislation would authorize states to require remote sellers to collect sales & use tax No small remote seller exemption but a small seller phase-in Audit protection for small remote sellers Lawsuit protection against Qui Tam & Class Action lawsuits 10

11 INCOME/FRANCHISE TAX INCOME/FRANCHISE TAX NEXUS Federal Public Law Economic nexus Factor-based nexus standards Intangible holding company nexus Affiliate nexus Industry nexus standards Financial institutions Transportation Pass-through nexus 11

12 EVOLUTION OF INCOME/FRANCHISE TAX NEXUS Actual physical presence Public Law Intangible holding company nexus Financial institution economic nexus Factor-based nexus PUBLIC LAW Public Law prohibits states from imposing a net income tax on taxpayers whose only in-state activity during taxable year is solicitation of orders by such person or a representative for sales of tangible personal property for approval & fulfillment by shipment or delivery from a point outside state Provision does not apply to any corporation which is incorporated in state or any individual who is domiciled in or a resident of state Provision does not apply to lease, rental or licensing of tangible personal property; sale, lease, rental or licensing of real property; sale, lease, rental or licensing of intangible property in a state; or sale of services 12

13 PUBLIC LAW Public Law does not apply to the following types of taxes imposed by state & local jurisdictions Capital or equity-based taxes Franchise taxes not based on net income Business activity taxes Gross receipts taxes Minimum taxes PUBLIC LAW Wisconsin Department of Revenue v. William Wrigley, Jr., Co. Examples of protected activities Soliciting of orders by an in-state resident employee or representative of the company, so long as such person does not maintain or use any office or other place of business in state other than an in-home office Furnishing & setting up display racks & advising customers on display of company's products without charge or other consideration Checking of customers' inventories without a charge therefore (for reorder, but not for other purposes such as quality control) Recruiting, training or evaluating sales personnel, including occasionally using homes, hotels or similar places for meetings with sales personnel 13

14 PUBLIC LAW Examples of unprotected activities Making repairs or providing maintenance or service to property sold or to be sold Collecting current or delinquent accounts, whether directly or by third parties, through assignment or otherwise Investigating credit worthiness Installation or supervision of installation at or after shipment or delivery Conducting training courses, seminars or lectures for personnel other than personnel involved only in solicitation Providing any kind of technical assistance or service including, but not limited to, engineering assistance or design service, when one of the purposes thereof is other than facilitation of solicitation of orders PUBLIC LAW De minimis activities Nontrivial additional connection o Activities are not considered in isolation o.00007% of Wisconsin sales sold through agency stock checks not de minimis when considering recurring exchanges of stale gum & stock of gum worth several thousand dollars De minimis standard recognized in Quill o Few floppy disks owned in North Dakota did not constitute substantial nexus 14

15 FACTOR-BASED NEXUS Nexus may be created by economic presence $50,000 payroll $50,000 property; or $500,000 sales; or 25% of total property, total payroll or total sales Public Law supersedes factor-based nexus for taxpayers who are afforded protection; however, it only applies for purposes of net income tax Taxpayers are still subject to such taxes as franchise taxes not based on net income, gross receipts & minimum taxes FACTOR-BASED NEXUS Recent states to adopt factor-based nexus Alabama New York Tennessee Washington Expanded factor-based standard to wholesalers for B&O tax Variations from $500,000 sales threshold Impact on sales factor throwback 15

16 INTANGIBLE HOLDING COMPANY NEXUS Geoffrey, Inc. v. South Carolina Tax Commission Trademarks, tradenames & merchandising know-how licensed to Toys R Us in South Carolina Royalty payments made to Geoffrey for 1% of net sales Physical presence is not required for nexus License of intangibles & derivation of income is substantial nexus Contrast: Griffith v. ConAgra Brands, Inc. Intellectual property licensed to affiliated & unaffiliated entities selling products in state Products were manufactured outside state Not sufficient presence or direction of activities toward West Virginia to justify nexus AFFILIATE NEXUS Gore Enterprise Holdings, Inc. v. Comptroller of the Treasury Wholly owned subsidiaries of W.L. Gore & Associates Gore Enterprise Holdings held & licensed patents Future Value, Inc. managed excess capital No property of payroll in Maryland No economic substance as separate entities from parent Legitimate business purpose not sufficient for substance ConAgra Brands, Inc. v. Comptroller 16

17 FINANCIAL INSTITUTION NEXUS STANDARDS Nexus-creating activities Loans secured by real or tangible personal property in state Deposits of a certain amount attributable to state Loans of a certain amount attributable to state Solicitation of or activities with a certain number of customers in state Receipts of a certain amount derived from customers in state FINANCIAL INSTITUTION NEXUS STANDARDS States adopting statutes with economic nexus (not all-inclusive) Indiana Kentucky Massachusetts Minnesota New York Pennsylvania 17

18 FINANCIAL INSTITUTION NEXUS STANDARDS Indiana Financial Institution Tax Engages in following activities with 20 or more customers Sells products or services received within Indiana Solicits business from Indiana customers Performs services outside Indiana that are received in Indiana Makes loans that result in receipts Assets, including loans & deposits, that equal or exceed $5,000,000 Tax Commissioner of the State of West Virginia v. MBNA America Bank TRANSPORTATION NEXUS STANDARDS Nexus-creating activities Interstate mileage Mileage greater than 25,000 miles in state Mileage greater than 3% of total mileage Intrastate mileage Certain number of trips into state Pick-ups or deliveries within state 18

19 PASS-THROUGH NEXUS S corporation or partnership doing business in the state generally creates nexus for the shareholders or members Exceptions in some states Entity-level taxation Limited partners Qualified investment partnerships Examples of states with investment partnership exceptions (not all-inclusive) California Kentucky Ohio Texas 19

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21 Mary Reiser Jana Gradeva