E-Commerce, Nexus, and State Policy Trends

LeAnn LunaUniversity of TennesseeUniversity of Tennessee

Prepared for the New Mexico Tax Research Instituteepa ed o t e e e co a esea c st tute7th Annual Tax Policy ConferenceMay 20, 2010

Quarterly Total State Tax Collections, year over year growthy y g

15

20

5

10

15

wth

5

0

5

rcen

t gr

ow

15

-10

-5

Pe

-20

-15

2001 Q2

2001 Q4

2002 Q2

2002 Q4

2003 Q2

2003 Q4

2004 Q2

2004 Q4

2005 Q2

2005 Q4

2006 Q2

2006 Q4

2007 Q2

2007 Q4

2008 Q2

2008 Q4

2009 Q2

2009 Q4Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4

Source: U.S. Census Bureau.

2

Percent Growth in Total State Tax Revenue Collections, FY2008-2009Collections, FY2008 2009

U.S. = -8.2 %

Less than -10.0% -10.0% to -5.7% Greater than -5.7%

3

Quarterly State Tax Collections by Source, year over year growth, y y g

60

80

40

60

owth

0

20

Perc

ent

gro

-20

P

-402001 Q2

2001 Q4

2002 Q2

2002 Q4

2003 Q2

2003 Q4

2004 Q2

2004 Q4

2005 Q2

2005 Q4

2006 Q2

2006 Q4

2007 Q2

2007 Q4

2008 Q2

2008 Q4

2009 Q2

2009 Q4

C I S l I di id l ICorporate Income Sales Individual IncomeSource: U.S. Census Bureau.

4

Sales Tax Base as a Percent of Personal Income, 1979-2008Income, 1979 2008

55

50

40

45

Per

cen

t

35

30

79 80 81 82 83 84 84 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

5

Estimated Total E-Commerce Sales*Estimated Total E Commerce Sales

Source: U.S. Census

6

*Sales-taxing states only

Industry Share of E-Commerce, 2006Industry Share of E Commerce, 2006

Retail4 4%

Services4.60%4.4%

Wholesale26.4%

Manufacturing65.6%

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State and Local E-Commerce and Revenue Losses ($millions)Revenue Losses ($millions)

2008 2009 2010 2011 2012

Total B2B E-commerce 2,480,011 2,231,283 2,767,010 3,253,412 3,656,856

Total B2C E commerce 179 233 161 257 199 975 235 128 264 285Total B2C E-commerce 179,233 161,257 199,975 235,128 264,285

Total E-Commerce 2,659,244 2,392,540 2,966,985 3,488,540 3,921,140

Estimated Taxes Due 31,113 27,992 34,713 40,815 45,877

Estimated Taxes Collected 23,386 21,041 26,093 30,679 34,484

Estimated Total State and Local

7,727 6,951 8,620 10,136 11,393Revenue Loss

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Estimated E-Commerce Losses for Selected States (2012)States (2012)

1,2501,5001,750

500750

1,000

0250500

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State Tax Policy TrendsyIncome Tax

Combined reporting and expense disallowanceA f lApportionment formulasSourcing of service revenueEconomic nexusG i Gross receipt taxes

Sales TaxDigital productsA ff f Agency, affiliate, and flash nexusClick-through nexus and the Amazon TaxIncrease tobacco tax rates

O hOtherDecoupling from federal incentives and creditsAmnesty programs

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Combined Reportingp gMost popular reform being discussed.Meant to prevent tax planning strategies including the Meant to prevent tax planning strategies, including the PIC.

But increased complexity for taxpayers.p y p yUncertainty regarding the definition of unitary.May be viewed as business unfriendly.

Effect on revenues is uncertain.There are winners and losers.Univ of TN study (2009)Univ. of TN study (2009).

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Mandatory Combined Reporting (2010)Mandatory Combined Reporting (2010)

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Expense Disallowance StatesExpense Disallowance States

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Apportionment and Sales Sourcingpp gApportionment

Traditional – equal weighting of property, payroll and salesDouble weighted sales

California – effective after 2010Single weighted salesg g

Michigan – effective after 2007Colorado – effective after 2008Utah – effective after 2012

Sales SourcingMove away from cost of performance rule to sourcing all sales of non-tangible personal property based on the audience or market non tangible personal property based on the audience or market found within the state.

California – effective after 2010Special rules for industriesp

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Sales Factor – Sourcing of Services (2010)Sales Factor Sourcing of Services (2010)

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Gross Receipts Taxesp

Increased attention in gross receipt taxes (GRT) as a l t f th t d d t t t i t replacement for the standard state corporate income tax.

Prior to 2002, only Delaware and Washington imposed significant gross receipts taxes (GRTs).g g p ( )Since 2002, Ohio, Michigan, and Texas have levied variants of GRTs. Illi i M i d M h id d GRT Illinois, Maine, and Montana have considered a GRT.

The reasons given included tax simplification, increased economic competitiveness and creating revenue from economic competitiveness, and creating revenue from companies that are not generating a profit.

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Gross Receipts Taxesp

Low rate and broad base: The GRT as currently Low rate and broad base: The GRT as currently structured generally has lower rates and a broad base. Therefore, it may be considered more stable than the traditional corporate income tax.Economic Neutrality: Pyramiding is a problem for GST d i i d di i i f GST and creates incentives and disincentives for business operations. It encourages vertical integration and discriminates against contracting work with and discriminates against contracting work with independent suppliers.

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Gross Receipts Taxesp

Competitiveness: The tax discourages capital investment by adding to the cost of factories machinery and equipment and adding to the cost of factories, machinery, and equipment, and the disincentive increases as more of those capital goods are produced in the taxing state. Fairness: Firms with the same net income will face radically different effective tax rates on that income. Low-margin firms will be at great disadvantage relative to higher-margin firms, g g g g ,regardless of their overall profitability. Many new and expanding firms are often unprofitable or have low margins, reducing the chance that these firms will survive reducing the chance that these firms will survive. Administration Costs: There will be transition costs and issues of nexus, sourcing, and combined reporting remain.g p g

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General Nexus StandardA taxpayer must have nexus with the taxing jurisdiction to be subject to tax. Two standards must be met under the federal constitution.

Due Process – a taxpayer need only have a “minimal contact” with a state seeking to impose tax.g p

May be met without physical presence (Quill Corp v. North Dakota, 504 U.S. 298 (1992).

Commerce Clause – requires “substantial nexus.”Complete Auto Transit v. Brady, 430 U.S. 274 (1977)

It is applied to an activity with a substantial nexus with the taxing state.It is fairly apportioned.D di i i i i Does not discriminate against interstate commerce.Is fairly related to the services provided by the state.

Physical presence is required (at least for sales and use tax). Quill Corp v. North Dakota, 504 U.S. 298 (1992). North Dakota, 504 U.S. 298 (1992).

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Physical PresenceyWhy is it such a problem?

Trivial acts inside a state can establish nexusTrivial acts inside a state can establish nexus.The standards vary tremendously from state to state.Uncertainty

Two primary questions:What is physical presence?How much is sufficient?

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Income Tax NexusTraps for the unwary

Pick up defective goods in company trucks?Pick up defective goods in company trucks?Attends occasional board meetings?Attends occasional seminars sponsored by others?Own a display rack in a state?Set up product displays?P f i i 1 i ? 5 i ? Perform repair services 1 time? 5 times? Hold recruiting event?Employees work from home office? Employees work from home office? Get authorized to do business?

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Sales Tax NexusTraps for the unwary

Make 11 deliveries in seller owned trucks?Make 11 deliveries in seller owned trucks?How about 13 deliveries?Supervise an installation?Attend trade shows? Attend meetings for 12 days? C d i i i ?Conduct training courses or seminars?Register to do business?Own an affiliate with nexus?Own an affiliate with nexus?

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It’s the UncertaintyyIn-state phone listing?

In Indiana Iowa this does NOT create sales tax nexusIn Indiana, Iowa, this does NOT create sales tax nexus.In Kansas, it affirmatively DOES create nexus.But in Nebraska and nine other states, it may create nexus.

Providing warranty repairs?Texas – creates sales tax nexus.Oklahoma and 10 other states, may create nexus.Virginia – does not create nexus.

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Uncertainty, continuedy,What might create nexus for income tax may not create sales tax nexus. sales tax nexus.

Own display rack. In Alabama, Arizona, and Arkansas, creates sales tax nexus but NOT i income tax nexus.In S. Caroline, creates income tax nexus, but state has no position for sales tax nexus.

Owning or leasing equipmentIn Hawaii, Arizona, Arkansas, does not create income tax nexus, but does create sales tax nexus.In Maine, N. Dakota, Iowa,

Income tax nexus? Yes Sales tax nexus - ???

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Agency Nexus - Sales Taxg y

Can activities of agents or other representatives create f t f t t i i l?nexus for an out-of-state principal?

Scripto, Inc. v. Carson, 362 U.S. 207 (1960)Connecticut Sales Tax Guide, Scholastic Book Clubs, Inc. v. Connecticut Sales Tax Guide, Scholastic Book Clubs, Inc. v. Commissioner of Revenue Services, Connecticut Superior Court, (April 9, 2009).

D h h b l l d Do the in-state activities have to be sales related or can other activities of in-state representatives create nexus?

Tyler Pipe Industries Inc v Washington Dept of Revenue 483 Tyler Pipe Industries, Inc. v. Washington Dept. of Revenue, 483 U.S. 232 (1987).

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Economic Nexus – Income TaxLanco and MBNA and after.

U.S. Supreme Court denies cert in Lanco and MBNA (June 18, 2007) and Capital One and Geoffrey (June 22 2009)and Capital One and Geoffrey (June 22, 2009).Louisiana issues Geoffrey ruling.Massachusetts issues Geoffrey and Capital One rulingsNew Hampshire adopts significant presence test New Hampshire adopts significant presence test Michigan includes economic nexus in Business Tax ActMaine announces economic presence positionIowa issues KFC decisionOregon and Colorado consider economic nexusNew Jersey issues taxpayer favorable decision in PraxairWisconsin expands doing business statuteCalifornia adopts factor presence nexus statuteWest Virginia applies substantial economic presence testColorado, New York, Oregon, Washington propose economic nexus legislationlegislation

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Attributional / Affiliate Nexus/Nexus may be established through an affiliated company.

e g brick and mortar stores with an affiliated online retailere.g., brick and mortar stores with an affiliated online retailer.

Sales Tax Affiliate Nexus LegislationWisconsin (2009)( )New York (2009)

Effective June 1, 2009, New York requires out-of-state vendors with New York affiliates to register if the New York affiliate either New York affiliates to register if the New York affiliate either

Uses the same trademark or trade name; orEngages in activities in New York that benefit the out-of-state vendor in developing or maintaining a market.developing or maintaining a market.

California (Proposed April 2010)Washington – Det. No 08-0128, 28 WTD 9 (2008)

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Click-Through Nexus & the Amazon TaxClick Through Nexus & the Amazon Tax

Amazon.com (N.Y. Sup. Ct. 1/12/09) I A il N Y k d l i l i bj i i f In April, New York enacted legislation subjecting certain out-of-state , online retailers to a sales tax collection duty for sales to NY customers.

Any seller of tangible personal property or taxable services is “presumed to be soliciting business through an independent contractor or other representative if the seller enters into an agreement with a resident of New York under which the resident, for a commission or other consideration, directly or indirectly refers potential customers, whether by a link on an Internet website or otherwise, to the seller.”

Amazon.com challenged New York’s revised law requiring it to collect g q gsales and use tax on sales to New York customers, claiming that NY imposes tax collection obligations on out of state entities that have no substantial nexus with New York.Th il d d h h i d d i il l i l iThe state prevailed and other states have introduced similar legislation.

“Amazon should not be permitted to escape tax collection indirectly, through use of an incentivized New York sales force to generate revenue, when it would not be able to achieve tax avoidance directly through use of New York employees engaged in the very

i i i ” same activities.”

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Amazon Taxes (2010)

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Digital GoodsgOffshoot of the Streamlined Sales Tax Project requirementsrequirements

Must explicitly impose sales and use tax on digital goods or electronically transferred itemsMust use Streamlined definitions to remain a member / Must use Streamlined definitions to remain a member / associate member.Prohibition against taxing digital as tangible personal property

Legislation adopted in 2009 in Kentucky, Mississippi, North Carolina, Vermont, Washington, and WisconsinL i l ti d i 2008 i I di N b k S th Legislation passed in 2008 in Indiana, Nebraska, South Dakota, Tennessee, UtahLegislation is being considered in Virginia and Minnesota Legislation is being considered in Virginia and Minnesota.

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Tobacco Tax Rates

$1 40

$1.60

Average Year-End State Tax (per pack)

$1.00

$1.20

$1.40 g (p p )

Inflation Adjusted State Tax (CPI)

$0.60

$0.80

$1.00

$0.20

$0.40

$

$0.00

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

31

Other Sales/Use Tax Measures/

Taxation of servicesEffective 1/1/2010 in Maine on various servicesProposed in AZ, KS & KY

Vendor compensation reductionspReduced/eliminated in 3 states in 2009Proposed in NJ, OK & VA

Taxation of “junk” foodProposed in AZ, CT, MS, NM, RI & VT

Bag taxesEffective 1/1/2010 in District of ColumbiaProposed in AK, CA, CO, CT, HI, ME, MA, MD, NJ, NV, NY, RI, TX, VT, & VA p , , , , , , , , J, , , , , ,

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ConclusionTax shortfalls are challenging states’ abilities to manage balanced budgets, leading states to consider alternative balanced budgets, leading states to consider alternative ways to increase revenues.States are forced to become more creative in stimulating their economy while preserving revenue.Biggest challenge will be keeping current of the changes

i lito stay in compliance.

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