Introduction

 

Assume for a minute that a taxable sale occurs in a state where the seller and buyer are both physically located.  It should be clear that the seller is obligated to collect the sales tax from the buyer and remit the tax to the state and/or local taxing authority.

 

However, what happens when the seller is located in one state and the buyer is located in another state?  Does the seller have an obligation to collect and remit the sales tax of the buyer’s state to the buyer’s state and/or local taxing authority?  It all depends if the seller has Nexus with the buyer’s state.

 

Tax issues, and more specifically sales tax issues, are oftentimes not on the top of a new and expanding company’s list of major concerns.  Usually a new and expanding business is more concerned with marketing and sales growth.   However, a new and expanding business can avoid major sales tax problems if it has a clear understanding of nexus and the tax collection requirements when a business has nexus with other states.

 

What is Nexus and what are the factors that cause nexus?  Basically, nexus means that a seller has enough contacts or has a physical presence in another state that will allow another state to enforce its tax laws on the out of state seller.  Some factors that can cause nexus with another state, even if a business does not have an office or physical location in another state, are having employees, independent agents, company vehicles, etc… making routine visits to another state.

 

Nexus Case Law History

 

The most significant constitutional limitation on a state’s power to impose its tax laws on an out of state business is the Commerce Clause; Article I, §8, cl.3 of the United States Constitution authorizes Congress to regulate commerce with foreign nations and the several states.

 

For the first hundred plus years or so, the US Supreme Court interpreted the Commerce Clause to have a significant limiting effect on a state’s ability to impose its taxing laws on another state.  Initially, the Court held that no state has the right to lay a tax on interstate commerce in any form.  However, the Court retreated a bit from its initial ban on taxing interstate commerce with its ruling in Western Live Stock v. Bureau of Rev., 303 U.S. 250, (1938) that permitted state taxation on interstate commerce only if there was an “indirect” and not a “direct” burden on interstate commerce.

 

The Court has refined its earlier position some more with regards to taxing interstate commerce.  Some of the more prominent cases currently impacting interstate commerce are:  Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977),  Quill Corporation v. North Dakota, 504 U.S. 298 (1992), and National Bellas Hess, Inc. v. Department of Revenue, 386 U.S. 753 (1967)

 

Complete Auto is an important case, because the Court settled on a four-prong test to determine whether or not a state tax violates the Commerce Clause.   A business’ activities will not violate the Commerce Clause as long as it:

 

1.      Is applied to an activity with a 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 State.

 

The first test in Complete Auto is important because substantial nexus with a state must first be determined.  The next two cases, Quill and Bellas Hess, help define or explain the term “substantial nexus”.   Both of these cases involved mail order companies that did not have a “physical presence” in the state attempting to tax their sales.  The Court decided in both these cases that a physical presence is first required to establish “substantial nexus”, and without a physical presence, a state cannot impose its tax laws on the out of state company.

 

What are some of the things that can contribute to a business having a physical presence in a state?  An out of state company will usually have nexus with another state if the out of state company routinely sends sales reps or independent agents into another state.  Oftentimes nexus will be established with another state if the seller makes routine deliveries of its products to the out of state customer using its own vehicles.

 

Nexus Litigation After Quill

 

The Court’s ruling in Quill make it very clear that the Commerce Clause requires substantial nexus with a taxing state before a taxing state can enforce or impose its sales and use tax collection requirements.  Some states have put forth additional guidance in their administrative rules, statutes, letter rulings, or state cases related to the number of employee visits permitted into a state before a business has nexus with the taxing state.  Some of the states with clear guidance related to employee visits are listed below.

 

·        Arizona – Pursuant to Arizona Dep’t of Revenue v. Care Computer Sys., Inc., 2000 WL 1015102 (July 24, 2000), an employee visit over two days may trigger use tax collection obligations.

·        Illinois – Any employee presence in the state may trigger use tax collection obligations.  Brown’s Furniture, Inc. v. Wagner, 665 N.E.2d 795 (1996).

·        Kansas –  Eleven visits or less permitted without incurring use tax collection obligations.  Appeal of Intercard Inc., No. 83-802, 2000 WL 1801739, 2000 STT 242-19 (Kan. 2000).

·        Massachusetts – Any presence in state beyond use of Massachusetts’ roads for twelve days a year result in use tax collection obligations.  Aloha Freightways v. Commissioner of Revenue, 701 N.E.2d 961 (Mass. 1998)

·        Michigan – Employees may visit with government employees, suppliers, attend trade shows or job fairs for ten or fewer days per year without incurring use tax collection obligations.  See  Michigan Revenue Administrative Bulletin 1999-1, May 12, 1999.

·        New Mexico – One visit per year is allowed without incurring a use tax collection obligation.  See  Taxation & Revenue Dep’t Ruling 401-98-11.

 

Also, many other states do not have any clear guidance as to the number of employee visits permitted before the taxing state will impose its sales and use tax collection obligations.  So, it is important to be proactive and contact the Nexus Secti0n (most states have a nexus section) of the state taxing authority on an anonymous basis if there is any question regarding nexus.   If the state comes back with an answer stating that your company does indeed have nexus, many states will permit the business to voluntarily determine the sales/use tax obligation for a reduced look-back period, usually three to four years, and will also abate or waive non-filing penalties.   Be proactive!

 

Why is important to know if you have Nexus with another State?

 

It is important to know if your business has nexus with another state, because there can be significant administrative costs involved and other responsibilities as well.  Some of these additional costs and responsibilities are:

 

1.      Fiduciary responsibility – You will be acting as an agent for the state when collecting sales and use tax and remitting the tax to the taxing authority.

2.     Cost of collecting tax and filing returns – There will be no cost or expense for the sales and use tax, because the tax is collected from the customer.  However, there can be significant administrative costs related to the routine tax compliance required by states.  Many large companies that conduct business in all states have one or more professionals whose sole responsibility is to ensure that accurate sales and use tax returns are prepared and that the sales tax collected is remitted in a timely manner.

3.      Audit exposure and cost – States conduct routine sales and use tax compliance audits to ensure that the correct amount of tax is paid to the state.  These audits usually cover a three to four year period and can be very time consuming depending on the volume of sales and the amount of tax and accounting records associated with the audit period.  Compliance audits can sometimes take over a year to resolve especially when a taxpayer does not agree with the audit findings and decides to protest or appeal the audit.  Additional costs will also incur if outside tax consultants and attorneys are hired to assist with the audit appeal.

4.     Statute of limitations for unregistered businesses – Probably the most important reason to determine if you have nexus with other states is to eliminate the risk of being audited by a state when/if the taxing state determines that you have nexus and are not registered with the state taxing authority.   Many states do not have a statute of limitations for audit purposes when there are non-filed returns or there is an unregistered business operating in the taxing state.   Most states will go back three or four years to conduct an audit of a properly registered taxpayer, but may go back seven or ten years if a company has nexus with a state, but has never filed sales and use tax returns or even bothered to register for sale and use tax.

 

The Internet and Affiliate Nexus

 

More and more sales activity is now conducted over the Internet.  Many brick and mortar companies are setting up online businesses as separate legal entities in an attempt to avoid the physical presence requirement necessary to establish substantial nexus as per Quill.   This is obviously keeping sales and use tax from flowing into the state coffers where the online customers are located – and the states don’t like this! 

 

With the recent and increasing erosion of sales and use tax dollars due to Internet sales, some states are aggressively going after these online retailers using something called “Affiliate Nexus”.  For example, New York State’s so-called “Amazon tax” is New York’s way of claiming nexus because Amazon uses a web server located in the state that provides a link to business outside of the state.    California and Idaho are also considering affiliate nexus laws similar to New York’s.  And, in Texas, a distribution center that is a different legal entity, but is affiliated with an out of state online retailer, provides enough contact with Texas where the online retailer has nexus with Texas.

 

With the rapid increase in online sales, you can bet that states will continue to aggressively establish affiliate nexus rules to avoid a further erosion of sales tax dollars.

 

You should immediately contact you accountant or tax consultant if you have any nexus questions.  Or, contact Silver Oak Advisors, LLC for a free no obligation consultation.  For information contact Mike Martin.

 

Source of information – Institute for Professionals in Taxation’s sales and use tax reference book, Sales and Use Taxation, 2004.

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