Yesterday, the application period opened for the limited-time MTC Marketplace Seller Voluntary Disclosure Initiative opened and it will close October 17, 2017. Since our last blog post on the topic detailing the initiatives terms, benefits and application procedure, six additional states (listed below) have signed on to participate in varying capacities. The lookback period being offered by each of the six states that joined this week is described below.

  1. District of Columbia: will consider granting shorter or no lookback period for applications received under this initiative on a case by case basis. DC’s standard lookback period is 3 years for sales/use and income/franchise tax.
  2. Massachusetts: requires compliance with its standard 3-year lookback period. This lookback period in a particular case may be less than 3 years, depending on when vendor nexus was created.
  3. Minnesota: will abide by customary lookback periods of 3 years for sales/use tax and 4 years (3 look-back years and 1 current year) for income/franchise tax. Minnesota will grant shorter lookback periods to the time when the marketplace seller created nexus.
  4. Missouri: prospective-only for sales/use and income/franchise tax.
  5. North Carolina: prospective-only for sales/use and income/franchise tax. North Carolina will consider applications even if the entity had prior contact concerning tax liability or potential tax liability.
  6. Tennessee: prospective-only for sales/use tax, business tax and franchise and excise tax.

Practice Note

The MTC marketplace seller initiative is now up to 24 participating states. It is targeting online marketplace sellers that use a marketplace provider (such as the Amazon FBA program or similar platform or program providing fulfillment services) to facilitate retail sales into the state. In order to qualify, marketplace sellers must not have any nexus-creating contacts in the state, other than: (1) inventory stored in a third-party warehouse or fulfillment center located in the state or (2) other nexus-creating activities performed by the marketplace provider on behalf of the online marketplace seller.

While Missouri, North Carolina and Tennessee have signed on to the attractive baseline terms (no lookback for sales/use and income/franchise tax), Minnesota and Massachusetts are requiring their standard lookback periods (i.e., 3+ years). Thus, these two states (similar to Wisconsin) are not likely to attract many marketplace sellers. The District of Columbia’s noncommittal case-by-case offer leaves a lot to be determined, and their ultimate offer at the end of the process could range from no lookback to the standard three years.

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.

Earlier today, the Tennessee Department of Revenue (DOR) submitted a new sales and use tax regulation for publication titled “Out-of-State Dealers” (Rule 1320-06-01-.129) that would administratively create an economic nexus threshold. With the submission, Tennessee becomes the most recent addition to the growing list of states seeking to directly attack the Quill physical presence standard.  As detailed in our prior blog, both Alabama and South Dakota are already litigating whether their economic nexus standards are sufficient to satisfy the dormant commerce clause substantial nexus requirement.  Additionally, at least 11 different bills in eight different states have been introduced in state legislatures so far in 2016.  With states continuing to attack Quill from all angles, remote sellers are scrambling to keep up with the increasingly volatile nexus landscape. Continue Reading Breaking News: Tennessee Submits Proposed Economic Nexus Regulation for Publication

The Tennessee Department of Revenue recently released Letter Ruling No. 14-05, in which it considered whether certain cloud collaboration services are subject to the state’s sales tax.  At a high level, the provider’s services are provided in a typical Software as a Service (SaaS) form:  (1) the provider owns the hardware and software used to provide the services; (2) the software is installed on the provider’s servers; (3) the provider’s employees monitor and maintain the hardware and software; (4) the provider charges a customer a monthly user fee; and (5) customers remotely access the software (i.e., no software is ever downloaded by a customer).  Of additional note, the provider does not license any of its software to the customers.

As the Tennessee Department has done in the past, it correctly determined that the SaaS arrangement does not constitute a retail sale of computer software because the provider “does not transfer title, possession, or control of any tangible personal property or software to a customer.”  Instead, the provider “ultimately uses and consumes both hardware and software as a means of providing its services.”

However, the Tennessee Department found that the cloud collaboration services are subject to the state’s sales tax as telecommunications services or ancillary services to telecommunications.  The cloud collaboration services instruct a customer’s telecommunications equipment as to how to process and route calls, “augment[ing] a customer’s voice, video, messaging, presence, audio/web conferencing, and mobile capabilities.”  As such, Letter Ruling No. 14-05 highlights a major concern for SaaS providers:  that their services will be considered taxable telecommunications or ancillary services.  While the cloud collaboration services are perhaps more clearly telecommunications or ancillary services than others, many SaaS offerings include an element of telecommunications by the very nature of remotely accessed software.

Fortunately, there are strong arguments in many states for most SaaS offerings to be excluded from the definition of telecommunications or ancillary services.  Streamlined Sales and Use Tax Agreement (SSUTA) member states (Tennessee is an associate member) are required to exclude “data processing and information services that allow data to be generated, acquired, stored, processed, or retrieved and delivered by an electronic transmission to a purchaser where such purchaser’s primary purpose for the underlying transaction is the processed data or information” from the definition of “telecommunications services.”  Therefore, where a provider can demonstrate that the true object of its offering is data processing or information services—and that any telecommunications services are merely incidental to those services—the offering should not constitute taxable telecommunications services.  In fact, demonstrating that the telecommunications component of any SaaS offering is merely incidental to the true object of the service should be effective in almost all states, SSUTA members or not.  Therefore, to adequately defend against the concern that a SaaS offering will be considered taxable telecommunications or ancillary services, providers should ensure that the true object of their offering is apparent and that it is clear that any telecommunications component is provided solely to facilitate that true object.

It is difficult, but not impossible (and quite satisfactory), to find a silver lining for taxpayers in the alternative apportionment opinion Vodafone Americas Holdings Inc. v. Roberts, M2013-00947-COA-R3CV, 2014 WL 2895900 (Tenn. Ct. App. June 23, 2014).  In this much discussed case, the Tennessee Court of Appeals affirmed a variance from the statutory cost of performance sourcing method for the apportionment formula on the basis that this method failed to meet the higher goal of fairly representing the business Vodafone derives from Tennessee. As part of the rationale for the variance, the Commissioner and Court of Appeals relied on the need to avoid “nowhere income.”  As long as each state has independent sovereign authority to adopt the apportionment methodology of its choice, using the risk of nowhere income as a reason to support application of discretionary authority to vary from a statutory formula is contrary to the law and policy supporting alternative apportionment authority as well as basic concepts of our federal system.  However, until this case is overturned, looking to how other states tax income is relevant in Tennessee in determining whether Tennessee’s statutory formula should be applied.  The horse has left the hen house and taxpayers should take advantage of this.  Specifically, if a taxpayer finds that, based on the existing statutory formulas, its receipts are included in the numerator of both Tennessee and another state, the taxpayer should seek relief to remove these receipts from the Tennessee numerator.  This avoids the double taxation burden that is the flip side of Tennessee’s nowhere income fears.

It is useful to look specifically at what the court said.  In Vodafone, the court noted that:

“Because [the Commissioner’s authority to issue a variance] applies when the statutory formula does not ‘fairly represent the extent of the taxpayer’s business activities in this  state,’ the variance can apply where the state is entitled to receive more taxes as well as a situation where the taxpayer is entitled to pay less taxes. The fact that other states do not tax the Tennessee receipts indicates that it is not unfair for Tennessee to do so.” Id. at 23.

In the accompanying footnote, the Court of Appeals notes that the goal of UDITPA (the model statute which Tennessee’s variance statute is based) is to ensure that no more than 100 percent of a businesses’ corporate income is subject to tax in all jurisdictions and positing that “[t]axing otherwise untaxed income does not run afoul of this goal.” Id. at fn. 20.

Thus, in the same paragraph, the court both acknowledges that the variance should equally be used to reduce Tennessee taxes when appropriate and uses a reference to whether other states tax the Tennessee receipts as a relevant benchmark.

As of the drafting of this post, Vodafone is in the process of seeking review of the decision by the Tennessee Supreme Court. Assuming the decision of the Court of Appeals is precedential going forward, taxpayers in Tennessee should consider holding the Commissioner to his own argument in Vodafone.  If nowhere income creates a presumption of fairness, then somewhere income should create a presumption of unfairness and taxpayers should be entitled to a variance.

Practice Note: The authors unquestionably prefer that the Supreme Court reverse this fatally flawed ruling.  However, if the court of appeals’ reasoning stands, taxpayers should take every opportunity available to demonstrate why Tennessee’s results oriented approach could bite the State on its bum.

The full slip opinion is available here.

Over the past decade we have seen a large increase in the number of third party tax enforcement claims against retailers involving transaction taxes (see Multistate Tax Commission Memorandum regarding survey of class action refund claims and false action claims, dated July 12, 2013, describing such actions).  The lawsuits typically are brought either as proposed class actions, alleging an over-collection of tax, or as whistleblower claims on behalf of state governments, alleging a fraudulent under-collection of tax owed to the state or municipality.  With respect to certain issues, including shipping and handling charges, retailers have been whipsawed with lawsuits alleging both under- and over-collection of tax.

On April 3, a proposed class action lawsuit was filed in Florida alleging that Papa John’s Pizza was improperly collecting tax on its delivery fees (Schojan v. Papa John’s International, Inc., No. 14-CA-003491 (Circuit Court Hillsboro County, Florida)).  The lawsuit is similar to an action filed in Illinois that resulted in an Illinois Supreme Court ruling rejecting a proposed class action claim that a retailer was improperly collecting tax on its shipping charges (Kean v. Wal-Mart Stores, Inc., 919 N.E.2d 926 (Illinois 2009)).

Both Florida and Illinois impose sales tax on services that are inseparably linked to the sale of tangible personal property (see, e.g., 86 Ill. Admin. Code § 130.415(b) & Fla. Admin. Code Ann. r. 12A-1.045(2)).  The regulations provide that whether a customer has separately contracted for shipping charges, or has an option to avoid shipping charges by picking up the property at the retailer’s location, can be used as a proxy to determine whether the services are separate and thus not taxable (86 Ill. Admin. Code § 130.415(d); Fla. Admin. Code Ann. r. 12A-1.045(4)(a), (b)).

In Kean, the Illinois Supreme Court held that shipping charges were a taxable part of an internet sale in which the customer had no option but to pay shipping charges.  After the ruling, the Illinois Department of Revenue made no announced change to its commonly understood audit position that sales tax was not owed on separately stated shipping charges that were assessed at a retailer’s actual cost.

Seeking to capitalize on the Kean ruling, an Illinois law firm has filed upwards of 150 lawsuits under the Illinois False Claims Act against retailers that do not collect tax on the shipping and handling charges associated with their internet sales, alleging an intentional failure to collect tax and seeking treble damages, attorneys’ fees and associated penalties.  The suits were filed without regard to whether the retailers had been audited and found not to owe tax on their shipping and handling charges.  The State has declined to intervene in the majority of these cases, permitting the Relator to proceed with the prosecution.  Because the amounts at issue are small (6.25 percent tax on shipping and handling charges), the lawsuits force many retailers to choose between paying an (entirely undeserved) settlement to resolve the litigation or bearing the expense of litigation.  For reasons not entirely clear, the Illinois General Assembly has failed to act on a corrective bill that would make such lawsuits more difficult to be filed.

Fortunately, other states have not been as reticent to take action to prevent the type of abusive litigation that retailers have experienced in Illinois.  Tennessee has amended its false claims act to prevent its use in tax litigation, and in Nevada, the state attorney general intervened and successfully moved to dismiss similar litigation.  Most recently, in Loeffler v. Target Corp. ( No. S173972 (Cal. May 1, 2014)), the California Supreme Court held that consumers were precluded from bringing actions based on consumer fraud statutes, where consumers sought refunds of sales tax reimbursement previously paid and an injunction against future collections.  The court reasoned, in part, that the state tax code provides the exclusive means by which to dispute the taxability of a retail sale, stating that “it would be inconsistent with this scheme to permit the consumer to initiate a consumer action such as plaintiffs’ requiring a court to resolve, outside the searching regulatory scheme established by the tax code, whether a sale was taxable or exempt. …”.

In addition, the Multistate Tax Commission and the American Bar Association are each working to resolve the issues faced by retailers with respect to third party enforcement tax administration.  The ABA has adopted model legislation that would limit the rights of purchasers to bring over-collection of tax claims against retailers.  The Commission has formed a joint state/industry work group to examine the issues involved in tax-related third party class action suits and false claims act suits.  Hopefully these efforts will provide retailers with additional weapons to defend against third party tax claims.