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Businesses encouraged to seek expert help with changing nexus laws

SHERRY KARABIN
Legal News Reporter

Published: January 22, 2013

Say an Ohio business owner regularly sells and ships products to customers in Pittsburgh, Atlantic City and Stamford, Connecticut. The business is physically located in Akron, and is in compliance with Ohio laws and tax obligations. However, the company may still be required to collect sales tax and pay sales tax to another state if it is deemed to have “nexus” with that state.

“Simply put, for sales tax purposes, a business has nexus in another state if it is physically present in the state, whether acting through a physical location, salesperson, independent contractor or some other event,” said Terri Brunsdon who owns the Brunsdon Law Firm in Akron.

“If a business is determined to have sales tax nexus, it must register with the state to collect and remit sales taxes in that state,” said Brunsdon, who is both a tax attorney and certified public accountant. “However, nexus for sales tax purposes does not necessarily mean there is nexus for income or activity tax purposes. Generally, nexus for income tax is measured by whether a company derives income from the state.”

As states face fiscal woes they have increased their sales tax collection efforts, and experts say one way they are doing so is by expanding the definition of physical presence for companies with no physical location in the state, including using “click-through” nexus as a means of holding businesses accountable for collecting sales tax on online purchases.

In the past courts have ruled that nexus for sales and use tax purposes did not exist when an out-of-state retailer’s contact was limited to direct mail solicitation and delivery by U.S. mail and common carrier. However, more states are enacting expansion measures using click-through nexus, where an out-of-state seller acquires physical presence through a link on an in-state website. Some states like California are asking Congress to grant authority to tax remote sales.

Laura Kulwicki, a state and local tax attorney in Vorys, Sater, Seymour and Pease’s Akron office, has been helping businesses navigate nexus issues since the early ‘90s. Kulwicki regularly speaks and writes about nexus issues for business groups and other tax professionals nationwide. At the end of November, she discussed nexus while on a panel at New York University’s 31st Institute on State and Local Taxation at the Grand Hyatt in New York City.

“There have been a lot of changes and developments to case law on the national level involving nexus,” said Kulwicki, whose firm was a platinum sponsor of this year’s conference. “Even local companies need to be aware of this national landscape.

“There are many gray areas in nexus enforcement and often companies are caught by surprise when they learn that they may have tax obligations in states where they have no offices, employees or other regular presence,” said Kulwicki. “For example, hiring third-parties or sending personnel into the state from time to time to install or repair products, meet with customers, or provide other technical assistance can often create nexus issues.”

She said other common nexus pitfalls include participating in trade shows or allowing even a single employee to telecommute from home in a state where the company has no other connections.

“Companies need to be aware that even these types of occasional, limited in-state connections can sometimes create tax obligations in other states,” said Kulwicki.

“Even the way a company uses technology or delivers its products, for example, digital products or online software, can impact the nexus analysis. There is a lot of new legislation relating to technological changes like computer cloud use, software licenses and other services provided by website hosting businesses that could impact a business.”

As a result, she said there is a lot of uncertainty surrounding these types of activities, not only on the business side, but among state tax departments as well, as states try to understand how the new technologies and ways of doing business fit in within the existing tax rules.

Kulwicki said she was asked by the University of Wisconsin-Milwaukee to coauthor a booklet specifically designed to explain nexus issues to state legislators and lawmakers. The publication, “A Lawmaker’s Guide to Sales Tax Nexus,” was distributed last year to every state governor and numerous legislators across the country.

The 1992 U.S. Supreme Court case of Quill Corp. v. North Dakota has long been a benchmark for measuring sales tax nexus. Quill distinguished that sufficient contacts under the due process clause requires actual physical presence in the state. Under the commerce clause, physical presence may exist where a company purposefully avails itself of the economic benefits of a state.

Since then, courts have said that an indirect physical presence can also create nexus for sales and use tax purposes. As a result states have begun looking closely at whether an independent agent operating on behalf of an out-of-state seller also establishes a physical presence or agency nexus.

“For example,” said Brunsdon, “if a company has an independent contractor selling a product in a state, sales tax nexus may exist through the agency relationship created by the contractor’s actions.”

Another example, she said is where an out-of-state headquartered company ships products through a distribution center located in another state.

“The distribution center satisfies the physical presence test needed for sales tax nexus. This is why you might see one company perform the selling while a separate company performs the distribution, however, states are finding these ‘affiliated’ groups also have nexus.”

Brunsdon said nexus for income or similar taxes in a state could be measured differently.

“In Ohio, we collect a Commercial Activity Tax (CAT), which is measured by a different nexus standard that includes a ‘bright-line’ presence test. This test looks at a business’s payroll, property, or gross receipts in the state,” Brunsdon said.

In 2008 New York enacted “click-through” legislation requiring an out-of-state Internet retailer to collect and remit state sales tax on tangible personal property or services sold through links on websites owned by state residents. It was coined the Amazon law since it appeared to target popular Internet retailers such as Amazon.com and Overstock.com that had not been collecting sales tax from New York customers.

Amazon sued alleging, among other challenges, that the law violated the Commerce Clause and the Due Process and Equal Protection Clauses of the 14th Amendment because it imposed tax collection obligations on out-of-state retailers that did not have a substantial nexus with New York. Despite the suit, other states quickly followed with similar laws.

It is not only states that are creating laws involving nexus. During its July 2011 annual meeting, the Multistate Tax Commission directed its sales and use tax uniformity subcommittee to begin drafting an associate nexus statute based on New York’s Amazon law. In addition, in 2011 the U.S. House Judiciary Committee held an oversight hearing on the constitutional limitations on states’ authority to collect sales tax in e-commerce. Congress is considering several remote sales tax proposals.

“It has become a very complex issue since the rules are different in every state,” said Brunsdon. “If I am an Ohio corporation doing business in another state, I have to review a state’s sales tax and income tax regulations to determine if and when the company’s activities create nexus. To complicate matters, if nexus is found to exist, I now have to keep up on that state’s legislative and rate changes.

“Imagine the burden. Just in Ohio, every county has a different sales rate with rate changes occurring at different times throughout the year. In addition, once I register for sales tax in Ohio, I have to file a report monthly even if no taxable sales occurred during the month; otherwise the state files one for the company and assigns the sales it deems to have occurred,” said Brunsdon.

“Given the ever growing complexity in this area, a business is wise to work with an attorney or a certified public accountant to advise it of changes and compliance with tax laws.”

Kulwicki said that simply being aware of and understanding the rules that the states have put in place may not be enough. “It is very important that there be good communication between the tax people within the company, on the one hand, and the marketing and operating personnel, on the other, so that they can detect any potential activities that might cause a problem.

“I can’t tell you how many times tax problems could have been avoided if there was better communication between the marketing team and the tax department. Here, knowledge is key,” Kulwicki said. “Companies should consider developing an internal list of dos and don’ts. Often, there are practical ways to reduce the nexus risks without sacrificing business goals.”

However, she said sometimes nexus exposure is unavoidable, even with good internal communication and planning.

“For example, growing companies are often unaware of the expansive and changing laws in other states, or business realities may make in-state contacts unavoidable. A company may also ‘inherit’ nexus problems if it acquires another business.”

Kulwicki said there are a number of ways to reduce exposure when a business discovers that it likely has nexus, but has not been paying tax in another state.

“If you truly have a problem, what you don’t want is for a state nexus enforcement unit to find you first,” Kulwicki said.

“If the issues can be identified early on, it will increase the chances of a favorable solution.”


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