State Sales Tax Litigation 2017 Outlook – Cases, Issues ... · State Sales Tax Litigation 2017...

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State Sales Tax Litigation 2017 Outlook – Cases, Issues and Policies to Watch

May 12, 2017 Marc Simonetti Partner

TEI New Jersey Chapter

Eversheds Sutherland

Agenda

─ Sales Tax Nexus

─ Commerce Clause

─ Taxable Transactions: Software vs. Information Services

─ Bad Debt Relief

─ Exemption: Sale for Resale

─ Alternative Tax Litigation: False Claims Act & Class Action Lawsuits


Sales Tax Nexus Physical Presence Defined


Overview

Sales Tax Nexus

• What we know from Quill? • “Substantial nexus” entails some level of physical presence;

i.e., more than a de minimis physical presence may result in substantial nexus.

─ What constitutes “physical presence”? • More than slightest presence:

• Employees working in the state • Employees performing activities in the state • Lease or ownership of tangible property • Lease or ownership of real property

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Physical presence defined


Attributional Nexus

─ Traditional Categories • Independent Contractors • Representatives

─ Expanded Categories • Agency Nexus • Affiliate Nexus • Intangible Nexus • Click-Through Nexus • Economic Nexus

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Sales Tax Nexus Physical presence defined


Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2015)

─ Direct Marketing Association (DMA) asked for an injunction to prevent enforcement of Colorado’s notice and reporting obligations for out-of-state retailers.

─ In 2012, the federal district court in Colorado declared the law unconstitutional and issued a permanent injunction.

─ In 2013, the 10th Circuit Court of Appeals reversed the injunction and held that the Tax Injunction Act (TIA) bars federal jurisdiction.

─ In 2015, the U.S. Supreme Court held that the notice and reporting requirements do not violate TIA.

─ In 2016, the 10th Circuit Court of Appeals held that the notice and reporting requirements did not violate the Commerce Clause.

─ On December 12, 2016, the U.S. Supreme Court denied review. ─ On February 22, 2017 the parties settled the matter.

Sales Tax Nexus Use Tax Reporting


Justice Kennedy’s Concurrence

─ In Direct Mktg. Ass’n v. Brohl, 135 S. Ct. 1124

(2015), Justice Anthony Kennedy went out of his way to invite reconsideration of Quill. • “Given these changes in technology and consumer sophistication,

it is unwise to delay any longer a reconsideration of the Court’s holding in Quill. A case questionable even when decided, Quill now harms States to a degree far greater than could have been anticipated earlier….It should be left in place only if a powerful showing can be made that its rationale is still correct.”

─ In response, states have taken legislative efforts to force remote vendors to collect sales tax.

Sales Tax Nexus Use Tax Reporting


Sales Tax Nexus

─ South Dakota’s Statutory Challenge • S.B. 106 (enacted March 22, 2016) asserts nexus against remote

sellers with $100,000 gross revenue from annual sales in the state or 200 separate transactions involving delivery into the state.

• Positioned for an expedited appeals process. • South Dakota v. Wayfair, Inc., et al., Hughes County Circuit Court

Docket No. 32CIV16-00092 • State trial court found the remote sales tax law to be unconstitutional under

Quill. • Trade associations also filed a separate constitutional challenge to

S.B. 106 in state court in Am. Catalog Mailers Ass’n v. Gerlach, No. 32CIV16-___ (6th Judicial Cir., S.D.).

─ Alabama’s Regulatory Challenge • Rule 810-6-2-.90.03 asserts nexus against remote sellers with at

least $250,000 in annual sales in the state. • Newegg Inc. v. Ala. Dep’t of Revenue, No. S 16-613 (Ala. Tax

Tribunal) • On June 8, 2016, Newegg filed suit in the Alabama Tax Tribunal challenging an

assessment based on the new regulation. • Newegg contends that the Department’s attempt to apply its regulation is

unconstitutional and violates U.S. Supreme Court precedent. Newegg also argues that the regulation conflicts with Alabama’s statutes.

• Alabama’s Answer to Newegg’s Complaint filed on Aug. 26, 2016 contends that Quill is “unworkable.”

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Economic Nexus


─ Tennessee’s Regulatory Challenge • Tenn. Comp. Regs. 1320-05-010.129 requires out-of-state sellers without a

physical presence to collect and remit sales tax if they have over $500,000 of sales into TN.

• The Department offered a prospective amnesty period for registration to collect tax.

• Challenged by taxpayer in Am. Catalog Mailers Ass’n v. Tenn. Dep’t of Revenue, Tenn. Ch. Ct., No. 17-307-IV (complaint filed Mar. 30, 2017).

• On April 10, 2017, a Tennessee Chancery Court ordered that the Tennessee Department of Revenue is temporarily prohibited from enforcing the regulation.

• The Department of Revenue and Plaintiffs, American Catalog Mailers Association and NetChoice, jointly requested the court’s order to limit uncertainty in the marketplace while the case is pending.

• The Court’s order also provides that retailers who may be subject to the regulation may voluntarily comply with the regulation during the pendency of the litigation.

─ Wyoming’s Statutory Challenge • Gov. Matt Mead (R) signed H.B. 19 into law on March 1st. • H.B. 19 requires out-of-state businesses with no physical presence in the state

to collect and remit sales tax if they make over 200 sales per year into Wyoming or their in-state annual sales exceed $100,000.

• The Department of Revenue may seek a declaratory judgment on the law’s legality.

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Sales Tax Nexus Economic Nexus


─ North Dakota (S.B. 2298, enacted April 10, 2017) and Vermont (H 873, enacted May 25, 2016) have enacted similar legislation, except their statutes only become effective if the Supreme Court overturns Quill.

─ Several state legislatures are considering (or have considered) actions in the 2017 session. • Arkansas, Florida, Georgia, Hawaii, Indiana, Kansas, Maine,

Maryland, Massachusetts, Mississippi, Nebraska, New Mexico, North Carolina, Rhode Island, Texas, Utah and Washington.

• Economic nexus thresholds vary and many of the bills are coupled with other nexus expanding provisions and/or use tax reporting requirements.

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Sales Tax Nexus Economic Nexus


─ Certain states have declined to formally enact tax increases by expanding their sales tax collection requirements to remote sellers.

─ Instead, these states have increased enforcement efforts through: • Creating a nexus task force; • Hiring nexus auditors; and • More aggressive nexus positions.

• E.g., Directive 17-1, Mass. Dep’t of Revenue (Apr. 4, 2017) (distinguishing remote Internet vendors from mail order vendors through: (1) in-state software and “cookies” placed on customers’ computers; (2) use of content distribution networks; and (3) other representative in-state contacts.)

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Sales Tax Nexus Enforcement Efforts


─ New York’s 2015 Budget Bill proposed to create a new class of sales tax payer – a “marketplace provider.”

─ Marketplace providers would have been responsible and liable for collecting and remitting New York sales tax on sales by all marketplace sellers with which they have an agreement, irrespective of whether the marketplace seller has nexus in New York.

─ Marketplace providers would have all the duties, benefits and entitlements of a person required to collect the sales tax as if such marketplace provider were the vendor, operator or recipient with respect to such sale, occupancy or admission.

─ This proposal was ultimately removed from the final Budget Bill.

─ Other states have considered or are considering similar legislation.

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Sales Tax Nexus Ecommerce Platform Collection – Marketplaces


─ Crutchfield, Inc., v. Testa, Nos. 15-0386, 15-0483, 15-0794, 2016 WL 6775765 (Ohio S. Ct. Nov. 17, 2016) • Ohio adopted factor nexus provision for CAT purposes. • The Department claimed the CAT is not governed by Quill because it

is not a sales and use tax. • The Department also argued that the physical presence was met

because of “cookies” placed on in-state customers’ computers. • On November 17, 2016, the Ohio Supreme Court upheld the factor

nexus provision because the Quill physical presence nexus standard does not extend to business-privilege taxes such as the CAT. The court distinguishes that physical presence is a sufficient condition to impose a business-privilege tax, but not a necessary one.

• Instead of seeking U.S. Supreme Court review the taxpayers decided to settle their disputes with the state and comply with the tax.

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Sales Tax Nexus Do Sales Tax Nexus Principles Apply to Gross Receipts Taxes?


Commerce Clause


Florida Department of Revenue v. American Business USA Corp., 191 So.3d 906 (2016)

Commerce Clause

─ The Company had a business location in Florida.

─ All sales of flowers and other TPP were initiated online.

─ Sales orders were filled by local florists (outside Florida).

─ The Department assessed sales tax on sales delivered outside of Florida by local florists, consistent with the Florida statute.

─ No violation of Complete Auto or Due Process.

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Matkovich v. CSX Transportation, Inc., 238 W.Va. 238 (W.V. 2016) Commerce Clause

─ The Supreme Court of Appeals of West Virginia held that a use tax credit must be granted to an interstate company for sales taxes paid to the municipalities of other states on purchases of motor fuel.

─ The court ruled that the Tax Commissioner’s interpretation that the credit was only available if the sales taxes were paid to other states, but not states’ subdivisions (e.g., cities, counties, etc.), violates the dormant Commerce Clause because it fails the fair apportionment and discrimination prongs of the Complete Auto test.

─ West Virginia filed a petition for certiorari on April 19, 2017. Response due May 19, 2017.

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Taxable Transactions: Software vs. Information Services



─ Matter of RetailData, LLC, DTA No. 825334 (NY Tax App. Trib., Mar. 3, 2016); Matter of Wegmans Food Markets, Inc., DTA No. 825347 (NY Tax App. Trib., Mar. 10, 2016)

─ “Competitive price audits” did not constitute the nontaxable furnishing of information which is personal or individual in nature and which is not substantially incorporated in reports furnished to other persons.

─ The Tribunal’s decision turned on the source of the raw data rather than the existence of a customized request from the customer.

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Information Services



─ Web-based program that tracks the execution of customers’ securities transactions does not constitute a taxable license to prewritten software. Appeal of Sungard Securities Finance, LLC, N.Y. Div. of Tax App., No. 824336 (Feb. 6, 2014). • Customers simply outsource their back office tracking functions to the

taxpayer, so the taxpayer’s activity constitutes “information services.” • Since reports furnished as a result of the services are “personal or individual

in nature,” the services constitute nontaxable information services. ─ Letter rulings

• Sales to financial institutions in Utah of the right to use certain online software services are sales of tangible personal property subject to Utah sales and use tax. Utah Private Letter Ruling No. 15-005 (Nov. 16, 2015).

• Taxpayer providing online backup and restoration services was subject to transaction privilege tax (TPT) because the services were taxable rentals of prewritten software. Ariz. Priv. Taxpayer Rul. No. LR 13-002 (Mar. 25, 2013)

• But many private letter rulings have found non-taxable “information services” rather than taxable software sales.

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Software



─ The Chicago Department of Revenue (DOR) determined that amusements that are delivered electronically (i.e., streaming services) are subject to Chicago’s Amusement Tax. Amusement Tax Ruling No. 5 (June 9, 2015). • The Amusement Tax applies to movie theaters, sporting events,

cable television and mobile television. • Chicago determined that the Amusement Tax also applies to

streaming video, streaming music, online gaming and movie rentals.

• The ruling applies only prospectively and took effect Sept. 1, 2015.

• In December 2015, taxpayers sued the city claiming that the rule exceeds the ordinance’s authority and violates the Internet Tax Freedom Act and the state and U.S. constitutions.

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Software


Bad Debt Relief


Citibank (South Dakota), N.A. v. Dep’t of Taxes, 2016 VT 69 (2016)

Bad Debt Relief

─ Neither Citibank nor Sears was eligible for bad debt relief.

─ Vermont may collect sales tax on retail purchases, the financing of which was ultimately defaulted on by the consumers.

─ The Department of Taxes operated within its discretion in imposing penalties on the retailer.

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Exemption: Sale for Resale


Exemption: Sale for Resale

─ A New York State Division of Tax Appeals administrative law judge (ALJ) determined that a telecommunications provider’s electricity purchases were not exempt from sales tax as sales for resale.

─ In so doing, the ALJ rejected the taxpayer’s assertion that it resold electricity by incorporating it into its telecommunications services, explaining that the regulation on which the taxpayer relied applies to tangible personal property purchases, which electricity is not.

─ The ALJ further held that the taxpayer was not exempt under a separate provision for resales of electricity, finding that the taxpayer was not reselling electricity upon sale of its telecommunications services and that the electronic signals powering its network were only incidental to the services for which its customers contracted.

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Matter of XO Communications Services, LLC, DTA Nos. 826686 & 827014 (N.Y. Div. Tax App. Mar. 9, 2017)


Alternative Tax Litigation: False Claims Act & Class Action Lawsuits


False Claims Act

─ Under-collection

─ Approximately 30 jurisdictions currently have False Claims Acts • Some states have expanded False Claims Act “whistleblower”

actions to include tax

─ Extremely high stakes: • Generally treble damages plus substantial penalties for each

return filed • Extended Statute of Limitations period • Public relations issue: tried in the public domain, often labeled

tax fraud

─ Illinois and New York have seen the most aggressive False Claims Act litigation

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• Winetasting Network, d/b/a Winetasting.com and TSG, LLC (Ill. App. Ct. 2017) − Relator failed to plead a violation of the False Claims Act because the relator did

not allege that the plaintiff made a false statement or record.

• National Business Furniture (Ill. App. Ct. 2016) – Taxpayer reasonably relied on the results of an audit to determine that it was not required to collect use tax on shipping and handling charges − Even outside of the audit, no knowing violation of reckless disregard where the

area of law is unclear, and failure to collect tax was mere negligence

• Relax the Back (Ill. App. Ct. 2016) – No False Claims Act violation based on not collecting use tax on internet or catalog sales because defendant made good faith inquiry into collection obligation: − Relied on prior NYS audit result related to its constitutional nexus position − Annual financial audits examined position

• Lush (Ill. Cir. Ct. May 10, 2016; on appeal) – No False Claims Act violation by defendant internet retailer because: − no attributional nexus based on in-state affiliate with brick-and-mortar retail

stores; and − no scienter violation where company relied on expert advice in an area that is “far

from clear.”

False Claims Act

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Recent Illinois Litigation


• People ex rel. Schneiderman v. Sprint Nextel Corp., 26 N.Y.3d 98, 42 N.E.3d 655 (2015) − Addresses $130 million in “bundled” wireless interstate communication charges.

NY Court of Appeals denied Sprint’s motion to dismiss and held that an “objectively reasonable” interpretation of a tax statute does not bar an FCA claim.

− On May 4, 2016, NY Supreme Court explained that waivers tolling the limitations period did not prohibit the State from asserting unpaid tax in a civil complaint.

• New York Attorney General investigating art dealings. − The Attorney General asserts that NY sales tax must be paid by the purchaser, or

collected and remitted by a dealer with nexus, if the purchaser takes possession of the item in NY

− FCA action against Gagosian art gallery settled for over $4 million in tax, penalties, and fees.

• My Pillow Leveraged into New York Settlement − Plaintiff/Relator prevailed in Illinois FCA action by proving that My Pillow failed to

collect and remit use tax on internet and telephone sales − Same plaintiff subsequently filed a New York FCA suit against My Pillow on the

same issue for New York use tax − Plaintiff leveraged the Illinois win to negotiate a $1.1 million settlement

False Claims Act

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Recent New York Litigation


Consumer Class Action Lawsuits

─ Over-collection

─ Targeting large retailers

─ Targeted transactions • Delivery fees • Coupons • Rebates • Returns


Standing for refund claims Consumer Class Action Lawsuits

Matter of New Cingular Wireless PCS LLC, DTA No. 825318, 2016 WL 796626 (NYS Tax App. Trib., Feb. 16, 2016) ─ Actual payment to a customer must occur before the Department may issue a refund

to the vendor. ─ The Tribunal did not address whether the funding of an escrow account would be

sufficient to satisfy the repayment requirement. AT&T Mobility II, LLC v. Ala. Dep’t of Revenue, Nos. 13-414, 13-415, 2015 WL 10990376 (Ala. Tax Trib. May 6, 2015) ─ In 2014, Alabama’s Tax Tribunal held that AT&T and class members filed proper

refund claims with the DOR. ─ DOR now argued that it may hold refunds to offset any future potential liability of

AT&T’s customers. ─ Tax Tribunal rejected this argument – such an order would allow DOR to hold viable

refund claims indefinitely; ordered nearly $10M refund to customers.

New Cingular Wireless PCS, LLC v. Director, Div. of Taxation, No. 000003-2012, 2014 WL 714769 (N.J. Tax Ct. Feb. 21, 2014) ─ The New Jersey Tax Court held that a mobile telecommunications service provider

was not required to reimburse its customers before seeking a $32 million refund of erroneously collected sales tax because New Jersey law requires only that a provider reimburse its customers before any refund is paid. • See also Sipple v. City of Hayward, No. B242893, 225 Cal. App.4th 349 (Cal. App.

2014) (ISP has standing to file suit for refund on behalf of its customers).

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Marc Simonetti Partner Eversheds Sutherland (US) LLP 212.389.5015 Marc [email protected] stateandlocaltax.com

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