The evolution of sales tax nexus expansion laws.

• Author: Jensen, Jennifer West

Over the past three years, driven largely by the need to raise additional revenue, states have increased their sales tax collection efforts. One way they have done so is to expand the activities that create sales tax nexus for out-of-state retailers without a physical presence in the state. This article describes and compares those expansion efforts and, in several instances, the legal challenges to them.

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Physical Presence Requirement

For decades, states have worked to develop ways to require out-of-state retailers to collect and remit taxes on sales to in-state customers, although historically, courts have required states to show that sellers have a physical presence or other substantial nexus within a state. In Quill Corp. v North Dakota, (1) the U.S. Supreme Court ruled that a state cannot require an out-of-state retailer to collect and remit use tax if it does not have a physical presence in, or substantial nexus with, the state. Quill was (and is) a direct marketer of office and business supplies. The company's only contact with North Dakota was through solicitation materials and shipment of goods into the state by U.S. mail or common carrier. After distinguishing between the nexus standards imposed by the Due Process Clause of the 14th Amendment and those of the U.S. Constitution's Commerce Clause, the Court reaffirmed that the physical presence requirement it had upheld in National Bellas Hess v. Department of Revenue (2) for use tax purposes was still required to establish Commerce Clause substantial nexus.

Agency Nexus

With the establishment of the physical presence requirement, states began to look for any connection an out-of-state retailer might have that could be construed as a physical presence. Courts have held that, in addition to a seller's direct physical presence, indirect physical presence also may create nexus for sales and use tax purposes. As a result, the states switched tactics and began to look more closely at whether an independent agent's operating on behalf of an out-of-state seller establishes a physical presence, or agency nexus.

Further, with the explosion of internet sales, the recent recession, and increased pressure from in-state retailers, a trend is developing among the states to expand the range of activities creating sales tax nexus, specifically through expanded forms of agency nexus.

"Amazon" Laws and "Click-Through" Nexus

In 2008, New York enacted legislation requiring out-of-state internet retailers to collect and remit state sales tax on tangible personal property or services sold through links on websites owned by state residents. (3) The legislation appeared to target popular internet retailers, including Amazon.com and Overstock.com, that previously did not collect New York sales tax from their New York customers. This was the first "Amazon law."

The law requires out-of-state sellers operating "affiliate programs" in the state to register to collect and remit sales tax. It provides that a "vendor" includes a person making sales of tangible personal property or services to New York customers through an agreement with a New York resident for a commission or other consideration, by which the resident directly or indirectly refers potential customers, by a link on an internet website, to the seller, if the cumulative gross receipts from such sales exceed $10,000 per year. In other words, potential customers reach the out-of-state retailer's website by clicking on a link on the in-state affiliate's website (thereby creating "click-through" nexus). The presumption of nexus may be rebutted by proof that the resident with whom the seller has an agreement did not engage in any solicitation in the state on behalf of the seller that would satisfy the nexus requirement of the U.S. Constitution.

Two days after the Amazon law was signed, Amazon.com filed suit in New York state court alleging, among other challenges, that the law violates the Commerce Clause and the Due Process and Equal Protection Clauses of the 14th Amendment, both on its face and as applied to Amazon.com, because it imposes tax collection obligations on out-of-state retailers who have no substantial nexus with New York. (4)

The trial court ruled against Amazon, com, holding that the statute did not violate the Commerce or Due Process Clauses, both on their face and as applied, and did not violate the Equal Protection Clause as applied. Amazon.com appealed the trial court's decision. In November 2010, the appellate court found the statute constitutional on its face. (5) The court remanded the case for further fact-finding to determine whether the statute was unconstitutionally applied to Amazon.com under the Commerce and Due Process Clauses. (6)

Despite the legal challenge in New York, two more states--Rhode Island and North Carolina--followed New York's lead and adopted substantially similar vendor presumption language in 2009. In Rhode Island, a retailer that enters into an internet link referral agreement with a Rhode Island resident is presumed to be soliciting business in the state if the cumulative gross receipts from sales to customers referred to the retailer by all residents with this type of agreement exceed $5,000 per year. (7) In North Carolina, the threshold is $10,000 per year. (8) Both states provide that the presumption may be rebutted by proof that the resident with whom the seller has an agreement did not engage in any solicitation in the state on behalf of the seller that would satisfy the nexus requirements of the U.S. Constitution.

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