State and Local Issues in Contract Drafting. March 28, Daniel R.B. Nicholas Partner, Eversheds Sutherland (US) LLP

Transcription

1 State and Local Issues in Contract Drafting TEI s 68 th Midyear Conference March 28, 2018 Daniel R.B. Nicholas Partner, (US) LLP Jessica Eisenmenger Associate, (US) LLP

2 State and Local Issues in Contract Drafting Overview Jurisdiction and Nexus Issues Developing Standard Tax Clauses Checklist of Material Contract Terms Key Takeaways 2

3 Jurisdiction and Nexus Issues

4 Jurisdiction and Nexus Issues Types of Nexus Income Tax Nexus Sales Tax Nexus Physical Presence Economic Nexus 4

5 Jurisdiction and Nexus Issues 5

6 Jurisdiction and Nexus Issues What is Nexus? Nexus is a sufficient connection between a taxpayer and a state For income tax purposes, state statutes and state courts generally provide or have held that only an economic presence is required to create an income tax filing requirement in the state. This standard has been applied more aggressively to: Trademarks and intangibles Financial institutions In order for a state to impose a sales and use tax collection obligation on an out-of-state seller, the US Supreme Court has held that a physical presence in the state is required which is more than de minimis (Quill Corp. v. North Dakota (1992)) 6

7 Jurisdiction and Nexus Issues Quill Corp. v. North Dakota United States Supreme Court held a substantial nexus is required to establish nexus Substantial nexus entails some level of physical presence; i.e., more than a de minimis physical presence may result in substantial nexus What constitutes physical presence? Employees working in the state Employees performing activities in the state Lease or ownership of tangible property Lease or ownership of real property 7

8 Jurisdiction and Nexus Issues Affiliate Nexus The US Supreme Court held in two landmark decisions (Tyler Pipe and Scripto) that the activities of third parties must establish and maintain a market in the state for an out-of-state entity for the in-state presence to create nexus Establish and maintain a market has been interpreted to mean: Sales solicitation Promotional or marketing activities (e.g., distribution of promotional materials) Sales of services performed in-state Performing warranty repairs Accepting returns Use of the same or similar trademarks or trade names Joint discount or marketing programs 8

9 Jurisdiction and Nexus Issues Affiliate Nexus Affiliate nexus statutes generally provide that if an outof-state entity has an affiliated retailing entity in the state, the affiliated in-state entity can trigger nexus for the out-of-state affiliated entity if certain activities are conducted in the state Use of the same or similar trademarks or trade names In-state affiliate installs, delivers, assembles or provides maintenance services Same or similar lines of business Sells same or similar products Some states have pure affiliate nexus statutes Statute is triggered when an out-of-state entity has an in-state affiliated retailing entity 9

10 Nexus and Remote Sellers South Dakota v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. Sept. 13, 2017). On March 22, 2016, South Dakota enacted S.B. 106, which asserts nexus against remote sellers with $100,000 in gross revenue from annual sales in the state or 200 separate transactions involving delivery into the state, effective May 1, 2016 On September 13, 2017, the South Dakota Supreme Court upheld the lower court s holding that S.B. 106 is unconstitutional under Quill and stated that [h]owever persuasive the State s arguments on the merits of revisiting the issue, Quill has not been overruled The court saw no distinction between the collection obligations invalidated in Quill and those imposed by S.B. 106 Petition for a writ of certiorari granted by the US Supreme Court on January 12, 2018 (No ) Scheduled for oral argument on April 17,

11 Jurisdiction and Nexus Issues State-Specific Nexus Exceptions While the US Constitution sets the outer boundaries for nexus, states are also free to be more restrictive in their taxing statutes Many states have specific statutory or administrative nexus exceptions in specific areas that are designed to encourage certain in-state activities or industries For example, many states have nexus exceptions for: Trade shows Conferences Vendor visits Recruiting De minimis number of trips/days in the state Use of an in-state printer 11

12 Jurisdiction and Nexus Issues Specific Concerns Related to Nexus Creation Employees/agents Independent contractors/subcontractors Ownership of property and transfer of title Marketing and advertising activities Locations of data servers 12

13 Jurisdiction and Nexus Issues Marketing and Advertising The nature of these contracts are high risk because marketing and promotional activities often create nexus Marketing and promotional campaigns must be distinguished from traditional advertising mediums In Quill, the US Supreme Court concluded that traditional forms of advertising do not constitute substantial nexus: Advertising in trade journals or periodicals Advertising in newspapers Advertising in magazines Television advertising Sending catalogs or other materials from outside the state 13

14 Developing Standard Tax Clauses

15 Tax Clauses Benefits of Tax Clauses Limits the types of taxes a counterparty can pass through Manages state transaction tax costs Allows for the collection of sales and use taxes and other taxes from counterparties Prevents incorrect and delayed sales and use tax bills from counterparties Provides documentation to support an exemption from specific transaction taxes Accounts for withholding taxes 15

16 Tax Clauses No one-size fits all May have multiple standard tax clauses for different types of contracts Guard against unexpected consequences resulting from changes to state laws 16

17 Tax Clauses Withholding Tax: California Many states have withholding tax rules that apply to specific types of payments (e.g., employers/employees, partnerships to partners) California has broad withholding tax rules that require withholding in certain situations Payments of California source income Payments for services performed in CA Income from intangible property where the property has acquired a business situs in CA Royalty payments where the property is located in or has acquired a business situs in CA Greater than $1,500, and To non-california business entities Business entities not incorporated in CA Business entities not registered with CA SOS 17

18 Checklist of Material Contract Terms

19 Material Contract Terms Assignment of contract by counterparty Choice of contracting entity Transfer of title regarding shipping, delivery and returns Payment terms Location where services will be performed Joint and several liability Relationship of the parties Governing law and venue 19

20 Material Contract Terms Assignment Language Counterparty assignment to an entity in another state could change nexus analysis Can be used to preserve contracting entity s ability to assign in certain situations (e.g., to an affiliate, in the case of a merger or acquisition) 20

21 Material Contract Terms Choice of Entity Entity should be appropriate from a tax perspective The entity that benefits from a contract should generally execute the agreement Avoid creating nexus by choosing an entity that already has nexus with the relevant states The scope or nature of services or activities could impact who is the appropriate party to the agreement 21

22 Material Contract Terms Transfer of Title/Shipping and Delivery Language These provisions may affect whether an entity is considered to own property in a specific jurisdiction, and may result in tax obligations with respect to such jurisdiction 22

23 Material Contract Terms Payment Terms Payment terms, such as upfront fees, contingent payments and payments that will be shared by multiple parties, have tax implications that must be taken into account 23

24 Material Contract Terms Location of Services The location where services are performed, property is owned or used, or servers are located can impact whether the parties to the contract are subject to transaction and income taxes in the relevant jurisdictions If counterparty subcontracts services, location where subcontractors operate can also have tax implications 24

25 Material Contract Terms Joint and Several Liability If more than one client entity executes the agreement, each entity should be responsible for its own obligations under the agreement to avoid deemed intercompany transactions that may be subject to income or withholding tax 25

26 Material Contract Terms Relationship of the Parties Accidental creation of a partnership can have significant tax implications and costs Clearly defining the parties as independent contractors sets expectations Note that even if the counterparty is an independent contractor, its presence can still create nexus (Scripto), so location is still important 26

27 Material Contract Terms Governing Law and Venue If governing law is not in the jurisdiction in which one or more of the parties is organized or operating, there is a risk that it could lead to a conclusion that the contracting parties have a taxable presence in such jurisdiction 27

28 Key Takeaways

29 Key Takeaways Tax clauses should clearly allocate risk between the parties Consider other clauses that are important for tax as well Identify potential tax costs relating to a transaction and ensure that they are taken into account during negotiations Avoid surprises Convey importance of tax consequences to business Factor tax costs into business decisions 29

30 Daniel R.B. Nicholas Partner (US) LLP Jessica A. Eisenmenger Associate (US) LLP