2017 midyear tax update | Sales and use taxes

States keep stepping up the battle to capture a portion of the sales tax revenue generated by the internet and other remote sales channels. The closure of brick-and-mortar outlets by traditional retailers like J.C. Penney and Macy’s that formerly generated sales tax has added to the stakes. A recent study by the National Conference of State Legislatures and the International Council of Shopping Centers estimated that the uncollected sales tax in 2015 on electronic and non-electronic remote sales amounted to $25.9 billion (“Uncollected Sales & Use Tax from Remote Sales: Revised Figures,” NCSL and ICSC; March 2017). The decision by Amazon to change its sales tax compliance strategy and expand registrations nationwide has been something of a boon for states. The same study estimated Amazon’s 2015 sales tax collections at $3.6 billion. However, the economic struggles of brick-and-mortar retailers have partially offset the Amazon sales tax gains.

National developments affecting sales and use taxes

After gaining some traction but ultimately failing in the 2016 fall session of Congress, supporters of the Streamlined Sales and Use Tax Agreement (SSUTA) are once again launching their campaign to repeal Quill. The U.S. Supreme Court case, now more than 20 years old, established a physical presence test under the Commerce Clause of the U.S. Constitution in order for states to impose a sales tax collection requirement on retailers outside of their borders that make in-state sales.

Both the Marketplace Fairness Act and the Remote Transactions Parity Act were reintroduced in April 2017. Overall, the movement remains stalled. No new states joined its ranks during 2016 or to date in 2017.

Nexus and the physical presence test

The lack of headway in getting remote seller tax legislation through Congress, the apparent lack of interest by the U.S. Supreme Court in state tax questions and success in their own courts have emboldened states to take on Quill. Most have done it through indirect means such as click-through nexus and/or out-of-state seller notification requirements. For example, approximately 18 states now have some version of click-through nexus in place. These statutes do not explicitly repudiate Quill but instead attribute the physical presence of a third-party internet affiliate to an internet retailer. The out-of-state seller notification statutes have skirted the physical presence requirement by taking on the form of a regulatory mandate, i.e., providing required information to customers and state agencies on use tax liabilities, rather than a sales tax collection requirement.

Bright-line nexus

A growing number of states have launched a more direct attack on Quill by enacting bright-line, also called “factor presence,” nexus tests under which physical contact is unnecessary. As noted, such tests have been employed by states for some time with respect to income taxes on businesses not protected by P.L. 86-272 and for nonincome business entity taxes, e.g., Ohio’s Commercial Activity Tax. Alabama and South Dakota were the first two states to put bright-line nexus standards in place. They were joined by Indiana, North Dakota, Tennessee and Wyoming in 2017. Vermont’s requirement is scheduled to take effect on July 1, 2017, or the first day of the quarter in which the U.S. Supreme Court upholds a state challenge to Quill.

Alabama requires remote retailers with more than $250,000 of in-state annual sales to collect and remit sales tax. Under South Dakota’s statute, remote retailers with annual in-state sales exceeding $100,000 or 200 separate transactions must collect and remit sales tax. The in-state sales bright-line test is $500,000 in Tennessee and $100,000 in Indiana, Vermont and Wyoming.

Retailers, as expected, are disputing the bright-line standards in state and federal courts. Newegg Inc. has an action pending with the Alabama Tax Tribunal. In January, a federal district court remanded a challenge to South Dakota’s statute back to the state court system in State of South Dakota v. Wayfair, Inc. et al., No. 3:16-CV-03019, D.S.D., filed May 25, 2016.

Sales tax economic nexus proposals are being considered in at least 20 states, according to a Bloomberg BNA Daily Tax Report issued in May 2017.

Out-of-state seller notification requirements

Colorado is set to implement its out-of-state seller notification law on July 1, 2017. The statute was ruled constitutional by a federal appeals court in Direct Mktg. Ass’n v. Brohl, 10th Cir. App., No. 12-1175, Feb. 22, 2016. The decision withstood a petition to the U.S. Supreme Court which denied certiorari in December 2016. As a result, out-of-state, unregistered retailers with more than $100,000 in Colorado sales will face onerous use tax reporting requirements. They will have to advise in-state customers of their potential liability for consumer use tax and provide them with an annual statement of their purchases. In addition, the retailers must file a report of these sales with the Colorado Department of Revenue.

Louisiana has followed Colorado’s lead in enacting a remote seller notification statute. Bloomberg BNA reported in a recent Daily Tax Report that according to the National Conference of State Legislatures, similar legislation has been introduced in 10 states.

Seeking to generate additional pressure on remote sellers, the Multistate Tax Commission drafted a model notice and reporting sales tax law comparable to Colorado’s.

The obvious hope by the MTC and enacting states is to impose information reporting costs of such magnitude that out-of-state businesses register for sales tax regardless of whether nexus exists. In addition, the data states obtain by the notification laws will boost enforcement action against in-state residents that fail to self-assess tax on the reported purchases.

Marketplace legislation

Another trend related to economic nexus sales tax standards and remote seller notification requirements is the notion that nexus is established through arrangements with marketplace providers. Taking this a step further is the idea that the marketplace provider can be held responsible for state sales tax compliance. State proposals of this nature recognize the fact that many remote retailers are relying on third-party online platforms like those provided by Amazon and eBay to handle the promotion and distribution of their products. In addition, these marketplace providers may take care of invoicing and other administrative matters related to the sale.

Minnesota recently enacted the first marketplace provider sales tax liability statute in the U.S. (H.F. 1). The statute defines doing business in the state to include using a third-party online platform to facilitate sales. Similar to click-through nexus, a remote vendor participating in Amazon’s marketplace program will be deemed to have nexus unless its Minnesota sales are less than $10,000 per year. H.F. 1 contains provisions imposing collection responsibilities on marketplace providers as well as on the retailers deemed to have nexus.

Other states where marketplace provider legislation has been introduced include New York, Rhode Island, Texas and Washington.

Cloud computing

The sales and use tax treatment of cloud computing continues to evolve. The number of states issuing rulings or enacting laws is growing. These pronouncements add clarity in some instances, but only muddy the waters in others. This is not surprising given that cloud computing is an ever-changing mix of IT services, the remote use of hardware and/or software, and customer access points, e.g., mobile phones, tablets, desktop computers.

In TSB-A-17-(2)S, issued Feb. 27, 2017, the New York Department of Taxation and Finance ruled that online and on-premise file-sharing computer applications were subject to sales tax because they provided access to software. New York’s general position on remote access software, including software as a service (SaaS), is that it is taxable.

To the contrary, the Rhode Island Division of Taxation held that the following were nontaxable services:

  • Remote storage of customer content, data, applications and software
  • Infrastructure as a service (IaaS)
  • Data transfer fees

See Ruling Request No. 2017-02, “Request for Ruling Regarding the Taxability of Cloud Computing Services and Data Transfer Fees.”

Interestingly, the Utah State Tax Commission also found IaaS to be nontaxable in Private Letter Ruling, Opinion No. 16-004, Aug. 22, 2016. However, the commission’s logic was somewhat different than Rhode Island’s. Rather than determining the IaaS was not a taxable service, the commission held that it is essentially the use of computer hardware which was not present in Utah under the facts presented for the ruling request. So the issue boiled down to the situs of the equipment and not to whether the charges were for something contained within the state’s list of taxable services.

Clearly, cloud computing vendors face a confusing thicket of differing rules and rationales across the various states as do their customers. Careful analysis is required of contracts for SaaS, IaaS and other cloud computing applications to avoid a sales or use tax minefield.

State and local tax planning for sales and use taxes

Sales as well as consumer use taxes have become a focal point of state and local revenue-raising efforts. Their stepped-up discovery and audit activities place businesses increasingly at risk for large sales and/or use tax assessments.

It pays to be proactive and implement measures to prepare for and defend against such assessments. For example, consider a sales and use tax compliance review. Such a review can lay out who in the organization is responsible for key decisions in areas like nexus, the accrual of use tax, the retention of records and the issuance of exemption certificates. The goal is to make certain the company has in written form and sufficient detail policies to ensure that its compliance is accurate and consistent. Adopting best practices for sales and use tax can reduce costs in the long run and remove unwanted financial risk.

It may no longer be optional for multistate retailers to undertake a nexus study to map out the company’s sales footprint. Identifying potential exposure and remediating it through tax amnesty and voluntary disclosure programs is an effective way of safeguarding the value of the business. If you are buying or selling the business, an exposure study can be critical to making the correct pricing decision.

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