Sales Tax Collection Obligations
Is Physical Presence Still
By Jennifer M. Boll
AUGUST 2008 - Sales
tax collection obligations can be confusing to businesses selling
products in multiple states. Today, even the smallest of sole proprietors
may sell products in two, 20, or even all 50 states. When selling
in more than just the business’s home state, it is important
to reconcile all sales activity with the laws of each state to confirm
sales tax collection obligations.
following is a review of the current status of nexus interpretations
governing the obligations of out-of-state businesses to collect
sales tax. These obligations have expanded in recent years through
court cases and administrative interpretations. Accordingly, the
most recent interpretations are not always readily available or
straightforward to apply. Mistakes, however, can be extremely
costly for businesses that fail to collect sales tax but are deemed
to have been required to do so.
In most states,
out-of-state vendors are required to collect a “use tax”
rather than a sales tax. Collection obligations and rates of use
tax are identical to those of sales tax. Generally, if sales tax
applies, use tax does not, and vice versa. To avoid confusion,
this article refers to both sales and use taxes as only “sales
tax,” although in many cases “use tax” is the
precise tax at issue.
states and the District of Columbia impose a sales tax. If a business
should have collected sales tax from its customers but did not,
the business (and, in many cases, its owners) may be required
to pay the tax on all taxable sales made in the state from the
inception of the business activity in such state, plus interest
and penalties. In most cases, no statute of limitations applies
because no returns were filed. State tax rates range from 5% to
9.35%. Penalties and interest rates vary from state to state,
but they mount quickly and generally compound.
must collect sales tax from its customers when it has a direct
or indirect physical presence in a state, known as “nexus.”
The standard for nexus is not difficult to articulate, but can
be nearly impossible to apply.
In most states,
a business (whether a sole proprietor, or organized as a partnership,
limited liability company, or corporation) has a physical presence
in a state if any employees or agents have had a physical presence
in the state or if the business owns or leases property there.
This is a direct physical presence. Many businesses assume that
if they do not have a direct physical presence in a state, they
have no sales tax collection obligations there. This is a common
misconception, and it can prove costly in the case of a sales
of indirect presence in a state, alone, will not trigger
a sales tax collection obligation. A business owner can be comfortable
that the mere selling of products over a website or by a catalog
and shipping them to a state (by the U.S. Postal Service or common
carrier) will generally not trigger a sales tax collection obligation
because such activity does not constitute a physical presence.
The U.S. Supreme Court confirmed that such activities do not create
nexus in 1992 in Quill Corp. v. North Dakota (504 U.S.
298). Any other contact with a state, however, should be carefully
reviewed because it might obligate a business to collect sales
of indirect physical presence often create nexus. Since the Quill
decision in 1992, the scope of indirect physical presence necessary
to create nexus has steadily lessened. Any individual or entity
working on behalf of a business that physically enters a state
may trigger a collection obligation, even if the individual or
entity is an independent contractor. A common example is an independent
sales agent or representative in the state; the presence of these
individuals often triggers the obligation to collect sales tax.
Similarly, contractors performing repairs, installation, or similar
work on behalf of the business, or accepting returns for the business,
may trigger a collection obligation in a state. These “agents”
could be individuals or they could be other entities. They do
not need to be employees; they do not even necessarily need to
Presence: The Cases
the business model of Scholastic Book Clubs, Inc. Scholastic sells
books to children in elementary schools. Teachers distribute the
order form, collect the money from students, and send the money
and order form to Scholastic. Scholastic then sends the books
to the teachers, who distribute them to students. A number of
states have held that teachers are the “sales agents”
of Scholastic [see Scholastic Book Clubs, Inc. v. State Board
of Equalization, 207 Cal.App.3d 734 (1989); Appeal of
Scholastic Book Clubs, Inc., 260 Kan. 528 (1996)].
teachers are deemed agents of Scholastic and they are physically
present in the state, Scholastic must collect sales tax in all
applicable states. Some state tax authorities attribute the physical
presence of the teachers in the state to Scholastic. The teachers
are not employees; they are not even paid, and yet their actions
on behalf of Scholastic trigger a sales tax collection obligation.
the concept of indirect presence by an agent, many states have
applied the concept known as “attributional nexus”
to require out-of-state businesses to collect sales tax. Typically,
this concept is applied when any individual or entity with a physical
presence in the state contributes in any manner to the out-of-state
business making sales there.
in the Borders Online case, California required Borders Online
to collect sales tax because, among other things, its customers
were permitted to make returns at the separately owned and operated
Borders bookstores located throughout California [Borders
Online, LLC v. State Board of Equalization, 129 Cal.App.4th
1179 (2005)]. Even though the Borders bookstores were not typical
sales agents and were not directly involved in the selling process,
the court held that the ability of customers to make returns at
physical locations in California assisted in the sales process.
Accordingly, the court held that Borders bookstores were Online’s
representatives for the purpose of selling goods in California.
Online was assessed more than $150,000 in tax for prior periods
based on its relationship with Borders bookstores.
York’s Proposal: Website Links Create Nexus
State has extended the indirect physical presence standard for
nexus even further. In November 2007, the New York State Department
of Taxation and Finance issued a Sales Tax Memorandum [TSB-M-07(6)S]
purporting to interpret New York’s nexus requirements applied
to out-of-state businesses. The memorandum was withdrawn shortly
after it was issued, but the 2008 budget included legislation
amending New York’s definition of a vendor required to collect
sales tax to include a nexus standard similar to the standard
described in the memorandum.
to the memorandum, if an out-of-state business solicits sales
by paying any sort of fee to an in-state person or entity associated
with a “click-through” from the in-state person or
entity’s website, or otherwise, the in-state person is considered
a “sales agent” of the out-of-state business. The
Tax Department provided an example in the original memorandum:
(XYZ) is an Internet-based retailer of sporting goods specializing
in downhill skiing equipment. XYZ is located in Vermont, where
it has its administrative offices and its warehouse, which holds
its inventory for sale. XYZ makes sales of its merchandise throughout
the United States and has customers in New York State. The merchandise
sold by XYZ is delivered by the U.S. Postal Service or by common
carrier, such as United Parcel Service or Federal Express. As
part of its marketing plan, XYZ has entered into an agreement
with Downhill Ski Club (Ski Club), which is based in Saratoga
Springs, New York, whereby Ski Club will maintain links to various
skiing equipment listed for sale on XYZ’s retail website
on the Club’s own website. XYZ will pay a commission to
Ski Club based on the amount of sales that XYZ makes that originate
from the links on Ski Club’s website. Ski Club uses the
commissions as a fundraising activity to partially offset the
expenses for the ski trips it sponsors. To maximize its commissions,
Ski Club actively solicits its members and the local community
to purchase new skiing equipment through the Ski Club’s
website by clicking on the link to XYZ’s retail website
and making their purchases from XYZ.
have similar arrangements with other representatives in New
York, but otherwise has no other additional connection with
New York state that would cause XYZ to register as a New York
state sales tax vendor. Based on its agreement with Ski Club
… XYZ must register as a New York state sales tax vendor,
collect New York state and local sales taxes, and file the required
sales tax returns.
interpretation and the newly proposed legislation are natural
extensions of Scholastic and Borders Online.
Any assistance in the selling process by a person or entity physically
located in the state will create nexus with that state for an
out-of-state business selling goods there.
example of this business model might involve pet supply retailers
or small pet stores with online capabilities. Arrangements with
humane societies and other animal-related charities are common
and often involve click-throughs from the charity’s website
to the online pet supply retailer’s website. The retailer
will often pay a percentage of the sales price to the charity
if a customer makes a purchase. Based on the proposed legislation,
this type of business model may require the online pet supply
retailer to collect sales tax on all taxable sales to New York
residents if any of the charities are physically located in New
with this broad nexus interpretation requires a careful review
of all of a business’ compensated and uncompensated arrangements
that may assist in out-of-state sales. Given a broad scope of
indirect physical presence, merely confirming the location of
employees and property is not sufficient. To confirm whether nexus
is likely to exist, a much more detailed compliance review is
whether a business has sales tax nexus in any particular state,
a careful review of all of its business connections to that state
is necessary. A business should review the following nexus issues
in all states in which it or any related entity:
or leases offices, warehouses, stores, or equipment;
sales through independent sales representatives, authorized
agents, or distributors;
deliveries by company-owned trucks;
in trade shows;
contractors or employees to make warranty repairs;
contractors or employees to provide installation services;
payments to any person or entity located there in connection
with any sales made there;
contractors to accept returns; and
- Has officers
maintaining a residence.
list is not complete, but it does provide a starting point for
reviewing a typical business’s connections with other states.
If a review of the business connections reveals that any of the
connections described above exist in any states other than the
business’ home state, sales tax nexus might exist there.
The next step is to review, with legal counsel, the scope of the
connection in conjunction with the particular state’s laws,
regulations, administrative interpretations, and court cases to
confirm whether a collection obligation has been triggered.
If an obligation
has been triggered, there may be an amnesty program available.
Amnesty programs may reduce the tax, interest, and penalties payable
for prior periods. In many cases, amnesty is available only for
businesses that voluntarily register. Once an audit has commenced,
it is generally too late to qualify. Accordingly, a proactive
approach in reviewing sales tax collection issues before receiving
audit notices is important.
M. Boll, Esq., is a principal of the law firm of Tuczinski,
Cavalier, Gilchrist & Collura, P.C., in Albany, N.Y. She is
also a lecturer at the University at Albany (SUNY) in the MS in
taxation program, and an adjunct professor at Albany Law School.
Boll is the former director of the Harvard Legislative Research
Bureau, which published proposed congressional legislation in 1998
concerning sales tax nexus issues.