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BREAKING NEWS: US Supreme Court Denies Cert in Direct Marketing Association v. Brohl

This morning, the US Supreme Court announced that it denied certiorari in Direct Marketing Association v. Brohl, which was on appeal from the US Court of Appeals for the Tenth Circuit. The denied petitions were filed this fall by both the Direct Marketing Association (DMA) and Colorado, with the Colorado cross-petition explicitly asking the Court to broadly reconsider Quill. In light of this, many viewed this case a potential vehicle to judicially overturn the Quill physical presence standard.

Practice Note:  Going forward, the Tenth Circuit decision upholding the constitutionality of Colorado’s notice and reporting law stands, and is binding in the Tenth Circuit (which includes Wyoming, Utah, New Mexico, Kansas and Oklahoma as well). While this development puts an end to this particular kill-Quill movement, there are a number of other challenges in the pipeline that continue to move forward.

In particular, the Ohio Supreme Court recently decided that the Ohio Commercial Activity Tax, a gross-receipts tax, is not subject to the Quill physical presence standard. A cert petition is expected in this case, and could provide another opportunity for the US Supreme Court to speak on the remote sales tax issue. In addition, litigation is pending in South Dakota and Alabama over economic nexus laws implemented earlier this year. A motion hearing took place before the US District Court for the District of South Dakota last week on whether the Wayfair case should be remanded back to state court. If so, the litigation would be subject to the expedited appeal procedures implemented by SB 106 (2016), and would be fast tracked for US Supreme Court review. Tennessee also recently adopted a regulation implementing an economic nexus standard for sales and use tax purposes that directly conflicts with Quill that is expected to be implemented (and challenged) in 2017. While Governor Bill Haslam has praised the effort, state legislators have been outspoken against the attempt to circumvent the legislature and impose a new tax. Notably, the Joint Committee on Government Operations still needs to approve the regulation for it to take effect, with the economic nexus regulation included in the rule packet scheduled for review by the committee this Thursday, December 15, 2016.

All this action comes at a time when states are gearing up to begin their 2017 legislative sessions, with many rumored to be preparing South Dakota-style economic nexus legislation for introduction. While DMA is dead as an option, the movement to overturn Quill continues and the next few months are expected to be extremely active in this area. Stay tuned to Inside SALT for the most up-to-date developments.




Digital Tax Update – Local Edition

After the highly publicized administrative lease transaction and amusement tax expansions in Chicago last year, more cities around the country are taking steps to impose transaction taxes on the sale or rental of digital content. Unlike tax expansion efforts at the state level (such as the law recently passed in Pennsylvania), which have almost all been tackled legislatively, the local governments are addressing the issue without clear legislative authority by issuing administrative guidance and taking aggressive positions on audit. As the local tax threat facing digital providers turns from an isolated incident to a nationwide trend, we wanted to highlight some of the more significant local tax developments currently on our radar.

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Alabama Issues Remote Sellers Use Tax Assessments, Newegg Inc. Appeals

Ever since Alabama’s new economic nexus regulation went into effect, litigation over its constitutionality has been expected given that Alabama Commissioner Julie Magee and Governor Bentley said as much when announcing it (Rule 810-6-2-.90.03, effective January 1, 2016).  It appears that they finally got their wish. On June 8, 2016, Newegg Inc. (Newegg) filed a Notice of Appeal in the Alabama Tax Tribunal challenging the Alabama Department of Revenue (DOR) Notice of Final Assessment of Sellers Use Tax (Assessment) that was entered on May 12, 2016. The Assessment is for seller’s use tax, interest and penalties for the months of January and February 2016 (the Assessment Period), which represent the first two months the new regulation was in effect.

The Alabama litigation comes on the heels of the litigation in South Dakota, which also involves Newegg and other retailers. Although the critical issue in both is whether economic nexus is constitutional, given that the Alabama imposition is through a regulation and not a statute, the arguments in each state’s litigation may not be parallel.

DOR Explanation of the Assessment

The DOR asserts that under the new regulation Newegg has a “substantial economic presence” in Alabama.  According to Newegg, the DOR “has offered no basis for its determination” that the regulation’s requirements were satisfied during the Assessment Period. Specifically, Newegg notes that the DOR “conclusion appears to be based solely upon the fact that Newegg had ‘significant sales into Alabama,’ i.e., more than $250,000 of retail sales to Alabama customers.”

Newegg’s Grounds for Appeal

Newegg requests that the Tax Tribunal cancel the Assessment, citing the following grounds as the primary basis:

  1. The application of the new regulation to Newegg (and the Assessment) are unconstitutional because Newegg did not (and does not) have the necessary physical presence required to satisfy the “substantial nexus” standard for sales and use taxes under the Commerce Clause, as described by the US Supreme Court in Quill.
  2. The new regulation is invalid because retailers must “lack an Alabama physical presence” for it to apply. Therefore, it conflicts with both the Alabama sales and use tax statutes and the US Constitution, each of which requires a physical presence in the state by (or on behalf of) the retailer.
  3. The application of the new regulation to an internet retailer with no physical presence in Alabama is inconsistent with the authorizing seller’s use tax statute. Specifically, none of the provisions of the sales and use tax statutes (or any other provision in the Alabama Code) authorize the DOR to impose seller’s use tax collection obligations on internet retailers with no physical presence in the state.

The State of Nexus in Other States

The Alabama litigation represents the third prominent nexus case that involves Newegg.  Not only is the company involved in South Dakota (see our prior coverage of the South Dakota lawsuits here), but it is also one of the three taxpayers involved in the Ohio Commercial Activity Tax (CAT) litigation (
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Unclaimed Property Hunger Games: States Seek Supreme Court Review in ‘Official Check’ Dispute

Background

As detailed in our blog last month, MoneyGram Payment Systems, Inc. (MoneyGram) is stuck in between a rock and a hard place as states continue to duel with Delaware over the proper classification of (and priority rules applicable to) MoneyGram’s escheat liability for uncashed “official checks.”  The dispute hinges on whether the official checks are properly classified as third-party bank checks (as Delaware directed MoneyGram to remit them as) or are more similar to “money orders” (as alleged by Pennsylvania, Wisconsin and numerous other states participating in a recent audit of the official checks by third-party auditor TSG). If classified as third-party bank checks, the official checks would be subject to the federal common law priority rules set forth in Texas v. New Jersey, 379 U.S. 674 (1965) and escheat to MoneyGram’s state of incorporation (Delaware) since the company’s books and records do not indicate the apparent owner’s last known address under the first priority rule. However, if the official checks are classified as more akin to money orders under the federal Disposition of Abandoned Money Orders and Traveler’s Checks Act of 1974 (Act), as determined by TSG and demanded by Pennsylvania, Wisconsin and the other states, they would be subject to the special statutory priority rules enacted by Congress in response the Supreme Court of the United States’ Pennsylvania v. New York decision and escheat to the state where they were purchased. See 12 U.S.C. § 2503(1) (providing that where any sum is payable on a money order on which a business association is directly liable, the state in which the money order was purchased shall be entitled exclusively to escheat or take custody of the sum payable on such instrument).

In addition to the suit filed by the Pennsylvania Treasury Department seeking more than $10 million from Delaware covered in our prior blog, the Wisconsin Department of Revenue recently filed a similar complaint in federal district court in Wisconsin, alleging Delaware owes the state in excess of $13 million. Other states participating in the TSG audit (such as Arkansas, Colorado and Texas) also recently made demands to MoneyGram and Delaware.

It is interesting to note that in 2015, Minnesota (MoneyGram’s former state of incorporation) turned over in excess of $200,000 to Pennsylvania upon its demand for amounts previously remitted to Minnesota for MoneyGram official checks. Apparently not only do the states in which the transaction occurred disagree with but even a former state of incorporation took the majority path.   (more…)




Alabama Appellate Court Finds Photos Merely Incidental to Nontaxable Photography Services

Last Friday, the Alabama Court of Civil Appeals handed the Department of Revenue (Department) a significant loss in their continued attempt to tax non-enumerated services and tangible property provided in conjunction with those services under the sales tax.  See State Dep’t of Revenue v. Omni Studio, LLC, No. 2140889 (Ala. Civ. App. Apr. 29, 2016).  Specifically, the appellate court affirmed the taxpayer’s motion for summary judgment granted by the trial court, which set aside the Department’s assessment on the basis that photographs provided by a photography studio are merely incidental to the nontaxable photography services provided by the studio.  While the prospective effect of the holding in the photography context is unclear due to recent amendments to the photography regulation (effective January 4, 2016), the case is significant in that it strengthens the “incidental to service” (or “true object”) precedent in Alabama and should be seen as a rebuke to the Department for ignoring judicial precedent in favor of their own administrative practices and guidance.

This decision is important in analyzing the taxability of mixed/bundled sales to Alabamans (i.e., where services and some degree of tangible personal property are provided as part of the same transaction).  As with any decision, taxpayers should consider potential refund claims. (more…)




Viral Marketers Beware – In Alabama, Sales Tax Nexus Created for Out-of-State Bookseller Even Though In-State Teachers Not Acting on Behalf of Seller

After a quarter of a century, the school book nexus cases continue to proliferate, delight and mystify.  The latest installment in the saga is from Alabama.  Scholastic Book Clubs, Inc. 2931 v. State Of Alabama Department Of Revenue, Ala. Tax Tribunal, Dkt. No. S. 14-374 (March 25, 2016).  Like the other cases, the question addressed is whether a vendor with no property or employees in the state nevertheless has nexus for sales tax collection purposes because of the activities of unrelated, and uncompensated, teachers in the state.  Like all of the other cases, these teachers received unsolicited catalogs from the vendor and could either discard the materials or distribute them to their students.  Like all of the other cases, if a teacher elected to distribute the materials, the teacher collected completed order forms and payments from the students and mailed the order and payments to the vendor.   Like all of the other cases, the teacher distributed the order once received to the individual students that placed orders.  Also, like all of the other cases the vendor provided bonus points to teachers based on the dollar amount ordered.  The vendor intended the bonus points be used to purchase additional classroom materials – either from the vendor directly or through gift cards to another retailer.

In reaching its decision, the Alabama Tax Tribunal (the Court) restricted its analysis to the historical Quill physical presence standard.  While noting that on the same facts courts in other states have been severely split on the issue of whether physical presence existed for such a vendor, the Court determined that the opinions finding physical presence were more persuasive.  The Court quoted at length from Scholastic Book Clubs, Inc. v. Comm’r of Revenue Servs., 38 A.3d 1183 (Conn. 2012).

As with most of the other bookseller cases in which a court found substantial nexus existed, the Alabama Tax Tribunal focused on the Scripto language negating the importance of labels such as “agent,” “independent contractor,” and “representative.”  This is a red-herring, as the correct analysis should be that regardless of the label, on whose behalf were the teachers acting.  Evidence was introduced that the teachers were acting on behalf of their students, not the vendor.  The Court, however, assumed this bedrock issue away by finding that regardless of on whose behalf the teachers were acting, because the teachers’ activities were substantially associated with Scholastic’s ability to establish and maintain a market in the state, this result was sufficient to establish physical presence for the vendor.  According to the Court, it did not matter that the teachers did not receive any type of compensation from the vendor and did not intend to benefit the vendor.  The only thing that mattered to the nexus analysis was that at the end of the day, the teachers were important to Scholastic’s maintenance of a market in the state.

But that cannot be the correct analysis.  Otherwise, any advertising campaign that relied on word-of-mouth (and similarly any viral marketing campaign) would establish nexus [...]

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Alabama Legislature Rejects (Yet Another) Attempted Digital Tax Expansion

Last month, a much-anticipated bill drafted by the Alabama Department of Revenue (Department) was introduced in the Alabama Senate that would have expanded the definition of tangible personal property to include “digital goods.”  See Senate Bill 242 (introduced February 16, 2016).  Fortunately, the Senate Finance and Taxation Education Committee (Committee) rejected the bill on March 9, 2016, after hearing testimony from Assistant Department Counsel Christy Edwards and extensively questioning her on the bill’s content and motives.  Notably, the Department continues to take aggressive positions in an effort to tax digital goods and services, without the requisite statutory or legislative approval to back it up.

Background

On February 28 2015, the Department proposed an amendment to Regulation 810-6-5-.09, which would have amended the rental tax on tangible personal property to include “digital transmissions” (broadly defined to include digital content such as streamed audio and video).  After significant opposition from industry representatives, the Joint Legislative Council (composed of leadership from both chambers) wrote a letter to Commissioner Julie Magee in April 2015 requesting that the proposed regulation be withdrawn.  It cited to the fact that the proposal was overly expansive and would in effect be the imposition of a new tax, a determination that rests with the legislature.  See our prior coverage here.  With hesitation and only after continued pushback from the Legislative Council, the Department withdrew the rental tax regulation amendment on July 7, 2015.

In response to the rejection of the proposed regulation, the Department went through its historic revenue rulings and revoked a number of technology rulings in January 2016, noting they will continue attempting to apply the rental tax to streaming services.  Commissioner Magee cited the revocations as a mere “clarification” that did not change the law.  In her comments to the revocations, Commissioner Magee noted that all taxpayers will be collecting and remitting tax in the future “[e]ither legislatively through a digital goods bill or through audits and assessments.”

Senate Bill 242

The digital goods bill arrived just a few weeks later, sponsored by Senator Trip Pittman.  As introduced, the bill would define “tangible personal property” to include “digital goods.”  For these purposes, digital goods include “[s]ounds, images, data, facts, or information, or any combination thereof, transferred electronically, including, but not limited to, specified digital products and any other service transferred electronically that uses one or more software applications.”  As is readily apparent, this language is extremely broad and arguably includes every service delivered over the internet.  The definition also raised concerns because it borrows from Streamlined language (“transferred electronically”; “specified digital products”), but Alabama is not a Streamlined state and does not define those terms elsewhere in the legislation or Code.  As drafted, the bill would have become effective immediately upon passage.

After cancelling a scheduled Committee hearing earlier this month, citing the need for revisions, the sponsor and Department entered the March 9 public hearing with a substitute bill.  Instead of defining “digital [...]

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Financial Statement Countdown for Remote Sellers Selling into Alabama

Remote sellers making sales into Alabama have until January 1, 2016, to begin collecting sales tax regardless of their physical presence in the state or consider whether there is any impact on financial statement issues as a result of non-collection.

This summer, the Alabama Department of Revenue issued a surprising new regulation, § 810-6-2-.90.03. This rule specifically provides that a remote seller with more than $250,000 of sales into the state that also meets the provisions of the “doing business” statute must register for a license and collect and remit sales/use tax to the state. Notably, the list of activities that are considered “doing business” includes solicitation of sales using cable television advertising; substantial solicitation of sales plus benefitting from any banking; financing; debt collection; telecommunication; or marketing activities occurring in this state; any contact with the state sufficient to allow Alabama to impose a sales and use tax collection requirement under the U.S. Constitution. Ala. Code § 40-23-68(b)(9). The rule goes into effect January 1, 2016.

If this had happened 10 years ago, the response would be simple – Alabama’s economic nexus threshold is clearly unconstitutional under Quill. However, several developments, both legal and environmental, have made the analysis more complex. First, the Alabama legislature has provided an option to remote sellers to use the “Simplified Sellers Use Tax Remittance” process. This program creates almost the simplest tax calculation and remittance process possible: one rate, no exemptions, single jurisdiction filing. Alabama is surely counting on the Supreme Court of the United States to find that this simplified process removes the burden which concerned the Court in Quill. There are, of course, numerous arguments against this scenario; many of them quite strong. Nevertheless, Alabama’s clever, parallel compliance juggernaut does mandate some respect.

Second, Justice Anthony Kennedy clearly feels it is high time for the holding in Quill to be relegated to an era when only academics knew of the internet. One justice’s comments do not mean that sculptors should begin carving Quill’s headstone, but the Court already has at least two justices that do not believe the dormant commerce clause exists at all. Today, there is clearly the highest risk ever of some type of melting of the Quill iceberg.

So what does this mean for remote sellers with Alabama customers?  First—of course such sellers could begin collecting, but, some sellers philosophically believe in the underpinnings of Quill and other sellers may find collection, even under the simplified system, financially oppressive and/or administratively difficult. For those sellers that will not or cannot comply, the immediate questions that must be answered are: (1) What are the risks of not collecting; and (2) Do those risks rise to the level of financial statement issues?  Obviously the first risk is that with every sale, the seller may be incurring tax liability that it otherwise could have passed on to its customers. How real this risk is dovetails with the second issue. In determining the risk of probable loss (or other financial statement standard), [...]

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Arizona ALJ: Remote Provider of Subscription Research Service is the Lessor of Tangible Personal Property

In a curious decision out of Arizona, an Administrative Law Judge (ALJ) found an out-of-state provider of online research services was properly assessed transaction privilege tax (TPT, Arizona’s substitute for a sales tax) based on the logic that the provider was renting tangible personal property to in-state customers.  The Office of Administrative Hearings (OAH) decision, No. 14C-201400197S-REV, available here, should be unsettling for all remote providers of subscription-based services with customers in Arizona.  This decision offers an example of the continued push by states to administratively expand the tax base to include nontaxable digital services.  Many states, like Arizona, do so by considering remote access to digital goods and services to be tangible personal property, as defined by statutes that are decades old.

Facts

The taxpayer was an out-of-state IT research firm offering internally-produced proprietary research and data compilation content remotely.  The taxpayer’s headquarters, offices, servers and platform were all located outside Arizona.  Customers accessed the research material via usernames and passwords received as part of a subscription.  The Arizona Department of Revenue (the Department) determined that the subscription income was subject to the TPT because it was income from the leasing of tangible personal property.  The taxpayer filed a protest with the Department, arguing that the online research services provided make it a service provider—not a lessor of tangible personal property.  The taxpayer noted “at most, [they are] providing clients with a simultaneous license to use.”

Department’s Argument

The Department argued that the taxpayer was leasing tangible personal property (research and data content) through the subscriptions they provide to customers.  Because they had exclusive access and use to the digital content (via username and password), the customers were able to perceive tangible personal property through their sense of sight. Therefore, the taxpayer’s receipts from subscriptions to its research and data content are taxable rental activities subject to the personal property rental classification.

Holding

The ALJ held the taxpayer did not meet its burden of proof of showing the Department misapplied the tax laws.  The decision dismissed all of the taxpayer’s arguments that it is not engaged in leasing tangible personal property.  At the outset, the ALJ found that the inability to control or modify the digital content was not enough to consider the customers to be lacking “exclusive control.”  This is important because the Arizona Supreme Court has made it clear that the scope and application of the personal property rental classification (and its predecessor) hinges on the degree of control over the property in question that is ceded to its putative “lessee” or “renter.” In sum, because the access and use of the proprietary research and data content was offered for a periodic subscription (consideration), such activity is the leasing of tangible personal property, and the assessment by the Department was appropriate.

Analysis

As a threshold matter, it is unclear whether the Department has authority to consider remote access to digital content to be tangible property merely because the content may be viewed on [...]

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A Very Scary Time of the Year: MTC Joint Audit Selection

With both Halloween and the Multistate Tax Commission (MTC) Income Tax Audit selection nearing, taxpayers should prepare themselves for the possibility of being spooked in the near future.  On Thursday, October 30, from 2-4 pm EST, the MTC Audit Committee—including representatives from the 22 states participating in the upcoming round of joint income tax audits—will be holding a teleconference that will begin with a public comment period.  Because of the inevitable disclosure of confidential taxpayer information, the bulk of this meeting—including selecting the various companies to audit—will take place during the second half of the agenda and be closed to the general public.  Just because a company has completed an audit in the past does not mean this season will be all treats.  The authors have noticed that companies previously audited by the MTC can remain on the list of targets and are often repeat selections.

Unique Complexities

The MTC audit process is not without its share of traps for the unwary.  First and foremost is the effort a taxpayer must expend in managing a multistate audit.  Issues such as differing statute of limitations, the effects of federal Revenue Agent’s Reports (RAR) and net operating loss (NOL) differences on limitations periods, timing of protests, and tax confidentiality become of heightened importance when one auditor is reviewing a taxpayer for multiple states.  Audited taxpayers should also keep in mind that the MTC does not issue the actual deficiency notices – these must come from the states.  As a result there may be certain areas such as credits or refunds that the MTC does not review and must be raised directly with a participating state.

On the substantive side, a primary area of inquiry of an MTC audit has been and is likely to continue to be inter-company transactions.  Historically MTC audits have taken a variety of approaches to disallow a taxpayer’s intercompany structure, including collapsing separate affiliates, applying the sham transaction doctrine, or using aggressive addback concepts.      Another similar concern for taxpayers audited by the MTC is the increased likelihood of transfer pricing issues being raised.  This comes in the wake of the creation of the MTC Arm’s-Length Adjustment Service (ALAS) this summer, led by former Montana Department of Revenue Director Dan Bucks.  The group recently held a transfer pricing summit at which it designed the MTC services to include third-party economic consultants at every stage.  The MTC transfer pricing services are expected to be implemented in mid-2015—just in time for companies selected for an MTC Income Tax Audit to be the test subjects.  Notably, of the nine states committing seed money to the development of a multistate transfer pricing audit service, five (Alabama, Hawaii, Kentucky, New Jersey and the District of Columbia) are participating in the MTC Income Tax Joint Audit Program.  It is not clear whether the two MTC-sponsored audit programs will be intertwined; however, the option was proposed this past summer and remains a possibility as we approach the upcoming audit selections.

Finally, it remains to [...]

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