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State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP ________________________________________________________

Illinois Amends Click-Through Nexus Statutes to Address Internet Tax Freedom Act Violation

On August 26, Illinois Governor Pat Quinn approved legislation that amends the state’s

sales and use tax click-through nexus statutes.1 In 2013, the Illinois Supreme Court held

in Performance Marketing Association, Inc. v. Hamer that the state’s click-through nexus statutes

were void and unenforceable due to the federal prohibition against discriminatory state

taxes on electronic commerce contained in the Internet Tax Freedom Act (ITFA).2 The

legislation addresses this decision by expanding the nexus provisions to include situations

where potential customers are referred to out-of-state retailers by a promotional code or

other mechanism beyond an Internet link that allows the retailer to track purchases. Also,

the legislation adds provisions that permit the retailer to rebut the presumption of nexus.

This legislation is effective January 1, 2015.

Background

In 2011, Illinois enacted click-through nexus legislation (the “2011 Act”) that required

certain out-of-state retailers to collect and remit Illinois sale or use tax on items and

services sold for use in Illinois through in-state “affiliates.”3 The 2011 Act targeted out-

of-state retailers which entered into agreements with in-state “affiliates” that used Internet

links to draw consumers to the retailers’ sites in exchange for a fee or commission on any

subsequent sales. This affiliate relationship is known as “performance marketing.”

Typically the affiliate refers Illinois customers to the out-of-state retailer through a link on

the affiliate’s Web site. In effect, the 2011 Act only applied in the context of online sales

made by Internet vendors lacking a physical presence within the state.

In Performance Marketing Association, the Illinois Supreme Court held that the 2011 Act was

preempted under the Supremacy Clause of the U.S. Constitution because the 2011 Act

imposed a discriminatory tax on electronic commerce4 contrary to the provisions

contained in the ITFA. The ITFA defines a discriminatory tax to include an obligation to

1 P.A. 98-1089 (S.B. 352), Laws 2014, effective Jan. 1, 2015. 2 998 N.E.2d 54 (Ill. 2013). For a discussion of this case, see GT SALT Alert: Illinois Supreme Court Holds Click-Through Nexus Statute Preempted by Internet Tax Freedom Act. 3 P.A. 96-1544 (H.B. 3659), Laws 2011; 35 ILL. COMP. STAT. 105/2; 35 ILL. COMP. STAT. 110/2. 4 “Electronic commerce” means “any transaction conducted over the Internet or through Internet access, comprising the sale, lease, license, offer, or delivery of property, goods, services, or information, whether or not for consideration, and includes the provision of Internet access.” 47 U.S.C. § 151 at § 1105(3).

Release date

September 9, 2014

States

Illinois

Issue/Topic

Sales and Use Tax

Contact details

Keith Staats Chicago T 312.602.8629 E keith.staats@us.gt.com Paul Bogdanski Chicago T 312.602.8269 E paul.bogdanski@us.gt.com Jamie C. Yesnowitz Washington, DC T 202.521.1504 E jamie.yesnowitz@us.gt.com Chuck Jones

Chicago T 312.602.8517 E chuck.jones@us.gt.com Lori Stolly Cincinnati T 513.345.4540 E lori.stolly@us.gt.com www.GrantThornton.com/SALT

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collect and remit sales tax on an Internet transaction in a different manner than if the same

transaction had occurred as a traditional face-to-face purchase.5 The Court found that

because the 2011 Act was in direct conflict with the ITFA, it was expressly preempted and

was void and unenforceable. The taxpayer also argued that the 2011 Act violated the

Commerce Clause of the U.S. Constitution by imposing a tax on retailers that had no

physical presence in Illinois and by being unduly burdensome to interstate commerce.

However, the Court declined to evaluate the merits of the Commerce Clause arguments.

Nexus Standard Amended

The statutes continue to provide that retailers are present in Illinois and therefore, must

collect and remit tax if they contract with a person located in the state who, for a

commission or other consideration based upon the sale of tangible personal property or

services, refers potential customers to the retailer.6 Prior to amendment, the referrals were

limited to the use of a link on the person’s Internet Web site. As amended, the statutes

now include referrals by providing to the potential customers a promotional code or other

mechanism that allows the retailer to track purchases referred by such persons. Examples

of this type of mechanism include but are not limited to the use of a link on the person’s

Internet Web site, promotional codes distributed through the person’s hand-delivered or

mailed material, and promotional codes distributed by the person through radio or other

broadcast media. As before, this provision only applies if the cumulative gross receipts

from sales to customers in Illinois who are referred to retailers under these contracts

exceed $10,000 during the preceding four quarterly periods.

Under a new provision, a retailer that meets these requirements is presumed to be

maintaining a place of business in Illinois but may rebut this presumption by submitting

proof that the referrals or other activities pursued within the state were not sufficient to

meet the nexus standards of the U.S. Constitution during the preceding four quarterly

periods.7

Commentary

The Performance Marketing Association case was significant because this was the first (and to

date, the only) instance that a state’s high court has struck down a click-through nexus

statute for violating the ITFA. The newly enacted Illinois legislation is an effort to amend

the Illinois click-through nexus provisions so that they no longer violate the federal

prohibition against discriminatory state taxes on electronic commerce contained in the

ITFA. The provisions are expanded to include potential customer referrals through

promotional codes that do not constitute electronic commerce. Thus, this arguably will no

longer be a discriminatory tax that violates ITFA because electronic commerce

transactions are not treated differently than transactions that are not conducted

electronically. Although the Illinois Supreme Court did not address the statutes’ lack of a

rebuttable presumption, the legislation further strengthens the statutes by adding a

rebuttable presumption that frequently is a feature of the click-through nexus legislation

5 A discriminatory tax “imposes an obligation to collect or pay the tax on a different person or entity than in the case of transactions involving similar property, goods, services, or information accomplished through other means.” 47 U.S.C. § 151 at § 1105(2)(A)(iii). 6 35 ILL. COMP. STAT. 105/2; 35 ILL. COMP. STAT. 110/2. 7 Id.

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enacted by other states.8 Under this provision, retailers can offer proof that they do not

have sufficient nexus with the state under the U.S. Constitution and should not be subject

to its tax.

This amendment may have cured the ITFA violation, but it remains to be seen whether

the new statute is constitutionally flawed in other respects. For example, the specific

addition of language to include promotional codes distributed by mail or broadcast media

may create a Commerce Clause violation that is not present in other states’ click-through

nexus statutes. Additionally, as noted above, the plaintiff in the Performance Marketing

Association case raised a Commerce Clause challenge to the state’s original click-through

nexus statute, which the Illinois Supreme Court did not address in its opinion. Thus, it

appears likely that the amended statute may be subject additional scrutiny in the future.

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8 For example, the click-through nexus legislation enacted by the following states provides retailers with an opportunity to rebut the nexus presumption: Arkansas (ARK. CODE ANN. § 26-52-117(e)); California (CAL. REV. & TAX. CODE § 6203(c)(5)(E)); Georgia (GA. CODE ANN. § 48-8-2(8)(M)); Kansas (KAN. STAT. ANN. § 79-3702(h)(2)(C)); Maine (ME. REV. STAT. ANN., tit. 36, § 1754-B(1-A)(C)); Minnesota (MINN. STAT. § 297A.66(4a)); Missouri (MO. REV. STAT. § 144.605(2)(e), (f)); New Jersey (N.J. REV. STAT. § 54:32B-2(i)(1)(C)); New York (N.Y. TAX LAW § 1101(b)(8)(vi)); North Carolina (N.C. GEN. STAT. § 105-164.8(b)(3)); and Rhode Island (R.I. GEN. LAWS § 44-18-15(a)(2)).