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Remote Retailers Held Responsible for Tax Collection in Washington

If there’s a lesson to be learned from the Washington Court of Appeals’ recent holding in Orthotic Shop Inc. and S&F Corporation v. Department of Revenue, No. 39321-6-III (Jan. 23, 2024), it’s that the use of a marketplace does not eliminate a remote seller’s tax responsibilities, particularly for pre-Wayfair periods.

The dispute in Orthotic Shop involved a retailing business and occupation tax (B&O tax) and a retailing sales tax assessment against two merchants for sales they made on an online retailer’s website. The audit report asserted that the merchants were “retailers” who maintained a nexus to Washington because they maintained a stock of goods in the online retailer’s warehouses located in the state. As such, the audit report concluded that the merchants were liable for retailing B&O tax and sales tax on sales to Washington customers made via the online retailer’s website.

The merchants admitted before the Court of Appeals that they sold their goods to consumers and not to the online retailer. However, the merchants challenged the assessment and argued that the online retailer’s provision of fulfillment services necessarily rendered it a “consignee” responsible for remitting retailing B&O tax and sales tax on transactions facilitated through its website in accordance with WAC 458-20-159. The merchants also asserted that the assessment was unfair because they lacked an understanding that they could incur a tax collection liability in Washington through the storage of their merchandise in an in-state warehouse.

The Court of Appeals determined that the merchants failed to show that the online retailer was a consignee with sole responsibility for tax collection. “A consignee,” the Court of Appeals explained, “makes sales on behalf of the consignor.” By contrast, the merchants’ product pages on the marketplace’s website listed the merchants as the sellers, not the online retailer. Accordingly, the Court of Appeals concluded: “[s]ince the merchants sold to buyers, they are liable for retailing B&O tax on those sales.”

The merchants’ failure to list the online retailer as the “seller” on their respective sales pages was also fatal to their argument that they were not liable for retailing sales tax on sales made via the online retailer’s website. The Department of Revenue’s administrative rules explain that while a consignee is responsible for collecting and remitting sales tax on sales made in its own name, when the consignee is selling in the name of the consignor, the consignor may instead report and remit the retail sales tax. Here, the Court of Appeals noted that while the online retailer’s agreement with the merchants provided that it would remit the sales tax if the merchants asked it to do so, neither merchant made such a request.

The Court of Appeals also was unimpressed by the merchants’ assertions that they did not understand that they could establish physical presence nexus and incur a tax liability based on the storage of their goods at a warehouse in the state. The Court of Appeals explained that ignorance of the law, was not an acceptable defense.

CASE TAKEAWAYS

Although Orthotic Shop [...]

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Following Maryland’s Lead? We Guess Everyone Wants to Go to Court. Icy Challenges to Nebraska’s Advertising Services Tax Act Start to Emerge

Nebraska Governor Jim Pillen’s ambitious plan to provide $2 billion in property tax relief via an increase in the sales tax rate and an expansion of the sales tax base is stirring significant debate. Part of his proposal is embodied in the newly introduced Legislative Bills 1310 and 1354, known as the “Advertising Services Tax Act” (the Act), which aims to finance this tax relief by imposing a 7.5% gross revenue tax on advertising services. However, this initiative faces a wall of voter opposition. A recent Battleground Connect survey revealed that 70% of likely voters disapproved of increasing the sales tax rate to offset property taxes. It should come as no surprise that Nebraska voters would not want to follow Maryland’s lead. What is surprising is that Nebraska legislators are willing to tie the fate of their new tax to a law that is currently being challenged in court in Maryland after the state adopted a similar tax in 2021.

The heart of the controversy lies in the new advertising tax’s specifics. The tax only targets firms with US gross advertising receipts exceeding $1 billion, a threshold that effectively discriminates against out-of-state advertising service providers and implicates constitutional and federal laws governing interstate commerce.

The proposed law specifically excludes “news media entities” and targets out-of-state digital advertising platforms. “Advertising services” incorporates a range of services, including digital advertising services, related to advertisement creation and dissemination. The term also includes “online referrals, search engine marketing and lead generation optimization, web campaign planning, the acquisition of advertising space in the Internet media, and the monitoring and evaluation of website traffic for purposes of determining the effectiveness of an advertising campaign.” Advertising services does not include services provided by entities “engaged primarily in the business of news gathering, reporting, or publishing articles or commentary about news, current events, culture, or other matters of public interest.” A news media entity does not include “an entity that is primarily an aggregator or republisher of third-party content.” Taxing publishers of one type of content and not taxing others raises profound First Amendment concerns.

While facially the Act applies to all advertising, its real focus is on digital and internet advertising and this targeting raises multiple legal and policy concerns:

  • Impact on Nebraska Businesses and Consumers. The tax, though imposed largely on out-of-state service providers, will be passed through directly to local businesses when they buy advertising. Much like a sales tax, service providers can and will add a line-item charge of 7.5% on each invoice to the local business placing the advertisement, driving up the cost of advertising services for Nebraska businesses. These higher costs will be reflected in the prices of goods and services sold to Nebraska consumers or the profits of local businesses.
  • Potential for Litigation. Drawing parallels with Maryland’s digital advertising tax, which faced legal challenges and has already once been ruled unconstitutional and barred by federal law, Nebraska’s legislation would also lead to costly and [...]

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Texas Taxing 130% of Marketplace Sales

Proving that everything is bigger in Texas, the state’s Comptroller is now assessing marketplace providers on 130% of their sales. It seems a sales tax on 100% was not big enough for tax officials in the Lone Star State. The additional 30% is a tax on the portion of the product sales price kept by marketplace providers. Talk about double dipping…

Like all states following the Wayfair decision, Texas adopted a marketplace law in 2019 that required marketplace providers to charge tax on 100% of the sales price for products sold over the platform by third-party sellers. Apparently unsatisfied, the Texas Comptroller has decided to assess tax on 130% of marketplace sales, with the additional 30% a double tax on the portion of the sales proceeds paid to the marketplace provider as a commission.

In most marketplaces, the provider charges a commission for allowing a third-party seller to use the platform and its services, like advertising and access to the platform’s user base. As most commissions are typically in the 30% range, Texas is demanding that marketplace providers pay tax on 130% of the sales price and charge the consumer for tax on the 100% and the seller for the 30%.

Without notifying the public, Texas is asserting, on audit, that these commissions are taxable. This position is contrary to a long-standing administrative ruling that was issued in 2012 and quietly revoked by the Texas Comptroller in 2020.

A quick example illustrates how aggressive this position is and the negative impact it will have on marketplace sellers in Texas: Take a book collector in Austin who is selling used books through a marketplace provider and sells a $100 rare Bible to a customer in Dallas. Historically, the marketplace provider would charge an 8% sales tax on the $100 Bible and send that $8 to the Texas Comptroller.[1] The marketplace provider would then take its $30 commission and send the balance of $70 to the local bookseller.

Now, the Texas Comptroller is telling the marketplace provider, on audit, that the $30 commission it received is separately subject to the sales tax. The marketplace provider in the example should have collected an additional $2.40 in sales tax on its receipt of the commission, resulting in an effective sales tax rate on the transaction of 10.4% (again, with no legislative authority or change behind this view). Instead of getting $70 in revenue, the bookseller will only receive the net after sales tax, or $67.60.[2] While this reduction may not seem like much, it will be the difference between being profitable and losing money for some Texas-based sellers. For the Texas Comptroller to make this policy change without legislative blessing—and while the state is enjoying a record budget surplus—should raise alarm bells.

How does the Texas Comptroller get there? First, it deems the commission payment a transaction separate and distinct from the underlying sale of the Bible in the above example. Second, it looks at the services the marketplace provider offered [...]

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OTA Finds CDTFA’s Audit Methodology Arbitrary

In Appeal of Colambaarchchi (OTA Case No. 21017152; 2023-OTA-302), a California-based retailer was audited by the California Department of Tax and Fee Administration (CDTFA) for years 2016 through 2019. Upon audit, CDTFA determined that taxable sales went unreported. In calculating the extent of the underreporting, CDTFA used various indirect methods for different periods in the audit years and applied a method to each period that maximized the amount of tax due. The Office of Tax Appeals (OTA) found that this methodology was utilized simply to create the largest underreporting, was inconsistent and lacked the required minimum rational and reasonable basis.

Colambaarchchi operated two perfume retail stores. During its audit, CDTFA performed various sales tests that suggested unreported sales. To compute the taxable measure, CDTFA used a combination of the federal income tax returns (FITR) method and the bank deposits method. Specifically, CDTFA used the bank deposits method for 2016, switched to the FITR method for 2017, then switched back to the bank method for 2018 and Q1 2019. In the audit work papers, CDTFA noted that the “[a]uditor used the higher of FITR or bank deposit difference to arrive at audited taxable sales.” In other words, CDTFA alternated between the two methodologies simply to maximize the tax liability.

CDTFA subsequently issued a notice of determination, which the company timely appealed. At the prehearing conference, OTA placed the parties on notice that, in deciding the appeal, the OTA may consider “[w]hether respondent was justified in selecting the bank deposit method for 2016, 2018 and the first quarter of 2019 and gross receipts from the [FITR] for 2017.” Accordingly, bearing the initial burden of showing that its decision to switch between two methods was reasonable and rational, CDTFA argued that it “selected the FITR method for 2017 because ‘the bank deposits may not have all cash deposited into the bank’ in 2017, and that it may have selected the bank deposits method for 2016, 2018 and 1Q19 because the income tax returns ‘may not be accurate because obviously there are additional [bank] deposits in addition to what they reported on their income tax returns.’”

OTA rejected this argument because it found “no support in the record for CDTFA’s assumption that the bank deposits method is less accurate in 2017 than in the other periods such that it would be reasonable and rational for CDTFA to switch to the FITR method in 2017.” According to OTA, CDTFA “cannot assume that one indirect audit method is more accurate in one period than another just because it produces a higher result.” OTA further stated that “this arbitrary selection made solely to increase unreported taxable sales is not reasonable and rational. Where CDTFA alternates between indirect audit methods because one method produces a higher result, CDTFA is no longer attempting to estimate the correct measure of tax but instead is arbitrarily increasing the tax measure.” Consequently, OTA held that CDTFA failed to meet its burden of proof, and CDTFA was ordered to utilize the bank deposits [...]

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California Supreme Court Lets It Stand That CDTFA Can Decide Who Is and Is Not a Retailer

On April 26, 2023, the Supreme Court of California declined to review the Second District Court of Appeal’s decision in Grosz v. California Dep’t of Tax & Fee Admin. In the underlying case, Stanley Grosz, a business owner based in Fresno, California, filed suit seeking a declaration that the California Department of Tax and Fee Administration (CDTFA) has a mandatory duty to collect sales and use tax from an internet retailer for sales that were made by third-party merchants on the retailer’s website, but fulfilled by the retailer. Grosz also sought an injunction requiring the CDTFA to collect the sales and use tax.

The internet retailer’s service allows third-party merchants to outsource their order fulfillment to the retailer. As part of the service, the internet retailer stores the merchants’ products at one of its fulfillment centers. According to Grosz, the provision of these services necessarily defined the internet retailer as a “consignment retailer” responsible for remitting sales tax on transactions facilitated through its website. (18 CCR § 1569.) The CDTFA disagreed and counter-argued that the determination of who constitutes a “retailer” under California sales and use tax law is a decision that is within its sole discretion to make.

The Second District Court of Appeal, in analyzing the statutory definition of “retailer” contained in Section 6015(a) of the Revenue and Taxation Code, concluded that it was “clear” that both the internet retailer and the third-party merchants could be regarded as retailers for purposes of transactions conducted under the service. The Court then agreed that the CDTFA has broad discretion to determine who constitutes a “retailer” under California’s sales and use tax laws.

It is important to note that the facts in this case occurred before the enactment of California’s Marketplace Facilitator Act (MFA). Under current law, marketplace facilitators generally are responsible for collecting, reporting and paying the tax on retail sales made through their marketplace for delivery to California customers. Thus, the current statutory scheme has greater clarity concerning the sales tax collection and reporting requirements for marketplace facilitators and sellers. Nevertheless, this case highlights the exposure some sellers may have for sales made before the MFA went into effect if tax was not properly collected and remitted.




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Massachusetts Department of Revenue Releases Guidance on a De Minimis Exception for Use Tax on Rolling Stock

The Massachusetts Department of Revenue (DOR) recently released Directive 23-1, which outlines the conditions for a de minimis exception where the Commissioner will not require a taxpayer to pay the use tax for rolling stock used or stored within the state. This directive comes at a time when the DOR is auditing many companies that use trucks and trailers and is currently assessing use tax on rolling stock if no sales tax was collected at the time of sale.

Directive 23-1 provides that “the Commissioner will consider the in-state use [of rolling stock] to be de minimis and will neither impose, nor require the taxpayer to pay, use tax on the use or storage of the rolling stock” where the taxpayer can prove “that the rolling stock that it owns or leases for 12 months or longer was used or stored in Massachusetts for no more than six days during a 12-month period” (emphasis added).

Companies “can demonstrate the frequency with which rolling stock was used or stored in Massachusetts through sufficient records that show the dates of travel into and in Massachusetts, such as GPS logs.” Additionally, a credit against the Massachusetts use tax is allowed if the taxpayer has paid a sales tax legally due to another state and that state allows a corresponding credit for sales or use tax paid to Massachusetts.




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Pennsylvania Supreme Court Rules Coupon Amounts Are Not Subtracted from Sales Tax Base Unless Sales Receipt Adequately Describes Taxable Item and Coupon

Overturning a 6-1 en banc decision by the Pennsylvania Commonwealth Court, the Pennsylvania Supreme Court held that a coupon does not reduce the price upon which sales tax must be collected unless the coupon is adequately described and “linked” with the taxable item in accordance with Pennsylvania Department of Revenue (DOR) regulations. The case was brought by a retail customer seeking a sales tax refund on the difference between the retail price of the product and the discounted price as the result of a coupon. The decision instructs retailers on the application of coupon discounts when collecting sales tax. The decision may also provide comfort to retailers facing class action lawsuits in Pennsylvania for collecting sales tax on full invoice prices without taking discounts from coupons into account.

The case examined three transactions between a retailer and customer. In two of the transactions, the customer purchased a single taxable item and used a single coupon. In the other transaction, the customer purchased six taxable items and used five coupons of varying amounts. The receipt provided in each transaction identified each coupon as a “SCANNED COUP” and identified the discount provided with each coupon but did not further describe the coupon nor link the coupon as a discount to any specific item purchased. In all three transactions, the retailer collected sales tax on the full purchase price without taking the coupons into account. The customer sought a sales tax refund from the DOR, maintaining that sales tax should have been collected on the discounted price. The DOR denied the refund claim.

The Pennsylvania Supreme Court agreed with the DOR’s position that under Pennsylvania regulations, “sales tax is owed on the full purchase price” (disregarding any coupons) unless an invoice or receipt (1) separately states and identifies the amount of the taxable item and the coupon and (2) provides a description of both the taxable item and the coupon. Further, the Court agreed that a satisfactory description in the receipt must contain a “linking” element, meaning the coupon must be adequately described to show that it applied to a specific item. The Court explained that such a description on the receipt was necessary because, under Pennsylvania law, “there are discounts or coupons that do not establish a new [taxable] purchase price, such as a discount for shopping on a specific day, discounts from a minimum purchase amount, and sales tax absorption coupons.”

In recent years, state tax departments have been very aggressive in asserting that coupons and discounts do not reduce the sales tax base. This decision serves as a reminder to retailers that the description of coupons on invoices is critical in determining the amount of sales tax to collect. In Pennsylvania, the coupon must be separately identified and “linked” to the taxable product upon which the discount is applied.

This decision highlights the dilemma many retailers face when collecting tax on discounted products: if they collect on the full retail price, they face the potential for customer class action suits [...]

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Is California Picking the Pockets of Other States?

In Matter of Body Wise International LLC (OTA Case No. 19125567; 2022 – OTA – 340P), a California-based retailer collected amounts designated as “tax” related to jurisdictions where it was not registered to collect tax. The California Office of Tax Appeals (OTA) held that the retailer must remit those amounts to California, even though the sales were not taxable in California, because the retailer did not actually pay the “tax” amounts it collected to the other states nor did it refund those amounts to its customers.

Body Wise International, LLC sold weight loss supplements to customers across the country and shipped the products directly to customers via common carrier from its warehouse in California. During the periods at issue, Body Wise’s tax software program charged a “Tax Amount” on all sales to customers located in various states based upon the respective tax rates in those other states. In states where Body Wise had not registered to charge or collect tax, Body Wise did not remit the “tax” collected to those states.

On audit, the California Department of Tax and Fee Administration (CDTFA) determined that the “Tax Amounts” Body Wise collected in those other states constituted excess sales tax reimbursements under California Revenue & Taxation Code (R&TC) section 6901.5, which provides that a retailer who collects a sales tax reimbursement exceeding the amount of the sales tax liability imposed upon the sale must remit the excess to the customer or to the state. CDTFA concluded that those amounts collected but not paid over to the other states must either be returned to the customer or remitted to California.

Upon appeal, the OTA agreed with CDTFA. OTA first observed, “it is not necessary for a sale, purchase, or any other type of transfer for consideration to be subject to California’s sales tax in order for the excess tax reimbursement provisions of R&TC section 6901.5 to apply.” Rather, OTA then stated, the requirement to remit or refund excess sales tax reimbursement to CDTFA applied to Body Wise even where the underlying transaction was nontaxable or exempt in California. Based upon this, OTA concluded that Body Wise must remit those amounts collected to California. OTA supported its conclusion by observing that Body Wise was not registered to collect sales tax in some or all of the other states.

However, logically, the excess tax reimbursement covered by the statute must be excess California tax reimbursement in the first instance. Indeed, the statute by its own terms expressly applies to “taxes due under this part [the California Sales and Use Tax Law].” (Cal. Rev. & Tax. Code § 6901.5.) Because these were not taxes due to California but ostensibly to the other states, California’s attempt to abscond with revenues belonging to another state would appear to be unconstitutional as violating the sovereignty of that other state.

The OTA’s conclusion would seem to be at odds with the important maxim of statutory construction to avoid an interpretation of the statute that would render it [...]

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More than Tax Compliance: California Legislation Requires Marketplace Facilitators to Track “High-Volume” Seller Information

The responsibilities of marketplace facilitators operating in California are expanding under legislation recently signed by Governor Gavin Newsom. Starting on July 1, 2023, an “online marketplace” will be required to collect and maintain specified contact and financial information related to its “high-volume third-party sellers.” The legislation is intended to “provide greater tools for law enforcement to identify stolen items” being resold through online marketplaces.

Under the legislation, a “high-volume third-party seller” is defined as any seller who, in any continuous 12‑month period during the previous 24 months, has entered into 200 or more transactions through an online marketplace for the sale of consumer products to buyers located in California, resulting in a total of $5,000 or more in gross revenues. While the legislation includes its own definition of an “online marketplace,” the definition will likely reach most (if not all) businesses classified as “marketplace facilitators” for California sales tax purposes.

An online marketplace will be required to collect information about any high-volume third-party seller on its platform, including the seller’s name, tax ID number and bank account number (presuming the seller has a bank account), along with certain government-issued records or tax documents if the seller is not an individual. For those sellers making at least 200 sales totaling at least $20,000 in gross revenues to buyers in California, an online marketplace must collect additional information, disclose certain contact information to consumers and provide a means to allow users “to have direct and unhindered communication with the seller.”

Information collected about sellers must be verified within 10 days and be maintained for at least two years, and the online marketplace must suspend sales activities of a high-volume third-party seller out of compliance with the requirements of the legislation. An online marketplace not in compliance with the legislation will be subject to a penalty of up to $10,000 for each violation.

Businesses impacted by this legislative development or with questions about marketplace facilitators are encouraged to contact the authors of this article.




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New Mexico Proposes Regulations Addressing Gross Receipts Tax Treatment of Digital Advertising Services

On August 9, 2022, the New Mexico Taxation and Revenue Department published proposed regulations addressing the gross receipts tax (New Mexico’s version of a sales tax) treatment of digital advertising services. The Department states the proposed regulations do not reflect a change in policy but instead ensure the rules are consistent for all advertising platforms.

While the proposed regulations provide some clarity regarding the taxation of digital advertising services under preexisting rules, they introduce several inconsistencies and other gaps, particularly with respect to the finer details of the sourcing provisions. For example, we believe the proposed regulations leave ambiguity regarding whether gross receipts from the provision of digital advertising services should be sourced to:

  1. The purchaser’s address
  2. The server’s location
  3. The viewer’s location

Separately, the proposed regulations would allow a deduction for gross receipts from national or regional advertising. However, the deduction is not allowed if the purchaser is incorporated in or has its principal place of business in New Mexico. While this significantly narrows the base for the tax, it injects complexity by requiring that the seller know the state in which its purchaser is incorporated or has its principal place of business, information not likely available in the context of internet-based advertising platforms.

Collectively, these inconsistencies and lack of clarity could lead to future compliance issues, which we hope will be mitigated as part of the Department’s regulatory approval process.

The Department scheduled a public hearing on the proposed rules for September 8, 2022, at 10:00 am MDT, which also is the due date for submission of written comments. The proposed regulations would be effective upon publication in the New Mexico Register, which could happen as soon as October 11, 2022 (or thereabout).

Please contact the McDermott Will & Emery State & Local Tax team if you have any questions about the potential impact of these proposed regulations on your company. In the meantime, we will be monitoring the regulation approval process and participating in next month’s public hearing.




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