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Transaction Taxes

If At First You Don’t Succeed, Try, Try Again: Illinois General Assembly Sends Revised Version of Click-Through Nexus Law to the Governor for Signature

by Arthur R. Rosen and Mary Kay McCalla Martire | Jul 30, 2014 | Constitutional Issues, Illinois, Nationwide Importance, Nexus, Sales Tax, Transaction Taxes

In 2011, Illinois became one of the first states to follow New York’s lead by enacting “click-through nexus” legislation. The Illinois law created nexus for any out-of-state retailer that contracted with a person in Illinois who displayed a link on his, her or its website that had the ability to connect an Internet user to the remote retailer’s website, when those referrals generated over $10,000 per year in sales. Pub. Act 96-1544, §§5, 10 (eff. Mar. 10, 2011) (codified at 35 ILCS 105/2(1.1) and 35 ILCS 110/2(1.1) (West 2010). On October 13, 2013, the Illinois Supreme Court held that the click-through nexus law violated the Internet Tax Freedom Act (ITFA) by imposing a discriminatory tax on electronic commerce. Performance Marketing Ass’n v. Hamer, 2013 IL 114496. The court held that the statute unlawfully discriminated against Internet retailers by imposing a use tax collection obligation based only on Internet referrals but not on print or over-the-air broadcasting referrals. The court did not reach the question whether the law also violated the Commerce Clause of the United States Constitution (although the trial court had also rejected the law on this basis).

In its recently completed Spring 2014 legislative session, the Illinois General Assembly approved an amendment to the click-through law that was designed to correct the deficiencies found by the Illinois Supreme Court. SB0352 (the Bill). The Bill expands the definition of a “retailer maintaining a place of business in this State” under the Illinois Use Tax and Service Occupation Tax Acts (Acts) to include retailers who contract with Illinois persons who refer potential customers to the retailer by providing a promotional code or other mechanism that allows the retailer to track purchases referred by the person (referring activities). The referring activities can include an Internet link, a promotional code distributed through hand-delivered or mailed material or promotional codes distributed by persons through broadcast media. The Bill goes on to provide that retailers can rebut the presumption of nexus created by the use of promotional codes or other tracking mechanisms by submitting proof that the referring activities are not sufficient to meet the nexus standards of the United States Constitution. Presumably, under the principles of Scripto and Tyler, if a remote seller can demonstrate that the Illinois referrals are not “significantly associated” with its ability to “establish or maintain” the Illinois market, the presumption will be rebutted.

As amended, the Bill appears to address the ITFA concerns expressed by the Illinois Supreme Court by not singling out internet-type referrals. It also attempts to resolve any due process constitutional concerns by providing an opportunity for retailers to rebut the presumption of nexus created by their use of referring activities. The Bill was sent to the Illinois governor for signature on June 27. The Bill will take immediate effect upon becoming law.

At present, four other states (Georgia, Kansas, Maine and Missouri) have click-through nexus laws that expressly extend the presumption of nexus to non-Internet based referring activities. [...]

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State and Local Tax Supreme Court Update: June 2014

by Stephen P. Kranz | Jun 25, 2014 | Alabama, Allocation/Apportionment, Colorado, Constitutional Issues, Income Tax, Local Tax, Mississippi, Nationwide Importance, Sales Tax, Transaction Taxes

On June 10, 2014, the Supreme Court of the United States distributed three state and local tax cases for a conference to be held on June 26, 2014: Equifax, Inc. v. Mississippi Department of Revenue, Direct Marketing Association v. Brohl, and Alabama Department of Revenue v. CSX Transportation, Inc. The Supreme Court previously agreed to hear Comptroller of the Treasury v. Wynne and determine whether Maryland’s disallowance of a credit against its county income tax for taxes paid to other jurisdictions violated the Commerce Clause. We are eager to see if the Court will opt to hear the remaining three cases, clarifying answers to questions in the world of state taxation.

The taxpayer in Equifax filed a petition for a writ of certiorari on February 19, 2014, appealing a decision by the Mississippi Supreme Court. The state court upheld the Mississippi Department of Revenue’s application of market-based sourcing as an alternative apportionment formula instead of the statutory cost-of-performance sourcing for apportioning the income of Equifax, a credit reporting company. In making this determination, the court required the Mississippi chancery courts to use a highly deferential standard of review. The Institute for Professionals in Taxation, the Georgia Chamber of Commerce and the Council On State Taxation filed amicus curiae briefs.

The Direct Marketing Association filed a petition for a writ of certiorari on February 25, 2014. The Direct Marketing Association seeks review of a decision by the U.S. Court of Appeals for the Tenth Circuit that held that the Tax Injunction Act barred federal court jurisdiction over the Direct Marketing Association’s challenge to a Colorado sales and use tax reporting law. The law requires remote sellers that do not collect Colorado sales or use tax and have total annual gross sales in Colorado of $100,000 or more to inform the customer at the time of sale of the customer’s use tax obligation, to send annual notices to customers who purchased $500 or more in goods from the seller and to file a report with the state regarding a customer’s total purchases. An amicus curiae brief was filed by the Council On State Taxation. If the Supreme Court were to hear Direct Marketing Association v. Brohl, it would likely clarify the holding of Hibbs v. Winn to better clarify the scope of the TIA’s protection.

On October 30, 2013, the Alabama Department of Revenue filed a petition for a writ of certiorari in CSX Transportation. The Alabama Department of Revenue is challenging the U.S. Court of Appeals for the Eleventh Circuit’s decision that Alabama’s sales tax on diesel fuel discriminates against rail carriers in violation of the Railroad Revitalization and Regulatory Reform Act of 1976 (4-R Act) because motor carriers and interstate water carriers are not required to pay the 4 percent sales tax. The Supreme Court had previously issued a 2011 opinion stating that the taxpayer could challenge sales and use taxes under the 4-R Act, but the Supreme Court remanded the case to determine whether the tax was discriminatory. Amicus [...]

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Retailers Caught in the Middle: To Tax or Not to Tax Delivery Fees

by Mary Kay McCalla Martire | Jun 12, 2014 | California, False Claims Act, Florida, Illinois, Nationwide Importance, Nevada, Sales Tax, Tennessee, Transaction Taxes
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 [...]

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Illinois Legislative Tax Policy Subcommittees Issue Joint Report on Findings

by Mary Kay McCalla Martire | May 29, 2014 | Illinois, Incentives, Income Tax, Sales Tax, Transaction Taxes
On May 28, 2014, the Tax Policy Subcommittees of the Illinois General Assembly’s Joint Revenue and Finance and State Government Administration Committees (Subcommittees) issued their long-awaited Report on Findings regarding the State of Illinois (Report). The Report was generated after months of hearings and solicitation of written comments from interested parties with respect to Illinois tax rates, tax incentives and tax policy issues.

The Report is chock full of facts and figures. Unfortunately, it fails to offer much clear direction for the state, as the members of the Subcommittees were unable to agree on the majority of the issues considered. For example, the Report provides that the state should “continue to explore” the question of whether Illinois should apply the sales tax to services, as do many surrounding states. Similarly, the Report concludes that while most members of the Subcommittees believe that the corporate income tax rate should be reduced, they could not agree on the amount of the reduction, what corresponding cuts in state spending would offset such a reduction, or even whether the Illinois personal property replacement tax should be considered as part of the corporate income tax rate when comparing Illinois’ income tax rates to those of other states. The Report also concludes that the Subcommittees are “strongly interested” in providing sales tax exemptions to customers who provide data centers in Illinois, but has not come to a consensus about how to move forward with that process. The Subcommittees also failed to reach a consensus regarding any changes needed to the Economic Development for a Growing Economy credit, instead offering only the platitude that “it is imperative to ensure that Illinois remains competitive in today’s economy.”

The Report does, however, contain the following findings:

In its most definitive finding, the Report recommends the elimination of the Illinois franchise tax. No specific plan or timetable is put forward for the elimination of this tax.

The Report concludes that Illinois’ eligibility criteria for the research and development (R&D) tax credit should be changed to match the federal requirements. For instance, the federal alternative simplified R&D credit would require that R&D spending exceed 50 percent (instead of 100 percent) of the previous three year average.

The Report concludes that initial filing fees for LLCs should be reduced. No consensus was reached regarding the amount of the reduction.

The Report recommends that the state streamline current processes by designating a point person to help businesses seeking the state’s help with respect to job creation, retention and relocation in Illinois.

In what appears to be an effort to boost the state’s image in the business community, the Report also references a number of favorable statements about Illinois’ business climate that the Report attributes to various business publications. The Report touts that Illinois ranks third in corporate expansions, according to Site Selection Magazine, that Illinois was identified as among the top five states for “technology and innovation” and “infrastructure” according to CNBC Top States for Business 2013 [...]

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Revise Your Tax Matrix: Remote Access of Software Exempt in Michigan and Idaho

by Stephen P. Kranz | May 6, 2014 | Idaho, Michigan, Nationwide Importance, Sales Tax, Tax Base, Transaction Taxes
A trend is developing in response to aggressive Department of Revenue/Treasury policymaking regarding cloud computing. The courts and legislatures are addressing the issue and concluding that the remote access to software should not be taxed. Here are two recent developments that illustrate the trend:

Michigan – Auto-Owners Insurance Company v. Department of Treasury

On March 20, 2014, the Michigan Court of Claims held in Auto-Owners Insurance Company v. Department of Treasury that certain cloud transactions were not subject to use tax because the transactions were nontaxable services. The State has appealed this decision.

Auto-Owners engaged in transactions with numerous vendors to provide services and products that Auto-Owners used to conduct its business. The court grouped Auto-Owners’ transactions into transactions with six categories of providers: (1) Insurance industry providers; (2) Marketing and advertising providers; (3) Technology and communications providers; (4) Information providers; (5) Payment remittance and processing support providers; and (6) Technology providers. The transactions all involved, on some level, Auto-Owners accessing software through the Internet. No software was downloaded by Auto-Owners.

The Michigan use tax is imposed on the privilege of using tangible personal property in the state. Tangible personal property includes prewritten, non-custom, software that is “delivered by any means.” Mich. Comp. Laws § 205.92b(o). The court held that the transactions were not subject to use tax under the plain language of Michigan’s statute.

First, the court held that use tax did not apply because the court interpreted the “delivered by any means” language from Michigan’s statute to apply to the electronic and physical delivery of software, not the remote access of a third-party provider’s technology infrastructure. Second, the court held that the software was not “used” by Auto-Owners. Auto-Owners did not have control over the software as it only had the “ability to control outcomes by inputting certain data to be analyzed.” Third, the court held that even if prewritten computer software was delivered and used, the use was “merely incidental to the services rendered by the third-party providers and would not subject the overall transactions to use tax.” Michigan case law provides that if a transaction includes the transfer of tangible personal property and non-taxable services, the transaction is not taxable if the transfer of property is incidental to the services.

Practice Note: This decision is encouraging in that the court said that the Department was ignoring the plain meaning of the statute and overreaching, and determined that the legislature must provide specific language extending the sales and use tax for such transactions to be taxable. It is important to note that the Michigan statute uses the phrase “delivered by any means,” and the court focused on the definition of deliver in reaching its decision. This decision will likely have implications for other streamlined sales tax (SST) member states. Auto-Owners Ins. Co. v. Dep’t of Treas., No. 12-000082-MT (Mich. Ct. Cl. Mar. 20, 2014).

Idaho – H.B. 598

On April 4, 2014, Governor Butch Otter signed into law Idaho [...]

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