Nexus Reviews: Uncovering State Sales or Income Tax Obligations Designing an Effective Internal Process to Identify Potential Tax Exposures

Transcription

1 Presenting a live 110 minute webinar with interactive Q&A Nexus Reviews: Uncovering State Sales or Income Tax Obligations Designing an Effective Internal Process to Identify Potential Tax Exposures THURSDAY, JANUARY 6, pm Eastern 12pm Central 11am Mountain 10am Pacific Td Today s faculty features: Mark Yopp, Sutherland Asbill & Brennan, New York Chuck Jones, Manager, State and Local Tax Group, Grant Thornton, Chicago Maryann Luongo, Baker & McKenzie, Washington, D.C. The audio portion of the conference must be accessed via the telephone. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

2 Continuing Education Credits FOR LIVE EVENT ONLY For this webinar, attendees must listen to the audio over the telephone. Attendees can still view the presentation slides online but there is no online audio for this program. Please refer to the instructions ed to the registrant for additional information. If you have any questions, please contact Customer Service at ext. 10.

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4 Nexus Reviews: Uncovering State t Sales or Income Tax Obligations Webinar Jan. 6, 2011 Mark Yopp, Sutherland Asbill & Brennan mark.yopp@sutherland.com Chuck Jones, Grant Thornton chuck.jones@us.gt.com Maryann Luongo, Baker & McKenzie maryann.luongo@bakermckenzie.com

5 Today s Program Looking For Potential Sales Tax Nexus [Mark Yopp] Slide 6 Slide 17 Looking For Potential Income Tax Nexus [Chuck Jones] Slide 18 Slide 35 Leveraging Company Resources For Nexus Oversight Slide ld 36 Slide ld 39 [Maryann Luongo]

6 Mark Yopp, Sutherland Asbill & Brennan LOOKING FOR POTENTIAL SALES TAX NEXUS

7 Overview: Nexus Theories And Standards I. Constitutional requirements 7 A. Due Process Clause nexus 1. Requires that there be some definite link and minimum connection between a state and the person, property p or transaction seeking to be taxed 2. Standards: Imposition of tax must not violate fundamental fairness or offend substantial justice, and the taxpayer must purposefully avail itself of the taxing jurisdiction. B. Commerce Clause nexus 1. One of the four prongs of the test established in Complete Auto Transit v. Brady by the U.S. Supreme Court as to whether a tax violates the Commerce Clause a. The tax is applied to an activity with SUBSTANTIAL NEXUS with the taxing state t b. The tax is FAIRLY APPORTIONED c. The tax does not DISCRIMINATE against interstate commerce, and d. The tax is FAIRLY RELATED to the services provided by the taxing state.

8 Overview Nexus Theories And Standards (Cont.) II. Sales tax nexus standards A. Physical presence: Quill Corp. v. North Dakota (1992) 1. In this case, Due Process Clause nexus was met through economic presence, by a taxpayer purposefully availing itself of a jurisdiction. 2. In this case, Commerce Clause nexus was met through h physical presence that t is not de minimis. B. Attributional nexus 1. In-state representatives of a company, even if not employees of the company, can create nexus for the company through their activities. Scripto, Inc. v. Carson (1960) 2. The activities of the in-state representatives, whether employees of the company or third parties, must make or maintain i a market for the company in order to create nexus. Tyler Pipe v. Wash. Dept. of Revenue (1987) C. Affiliate nexus A. State case law: Barnesandnoble.com LLC v. State Bd. of Equalization (2007) B. State statutes (e.g. Georgia, Wisconsin) 8

9 Overview Nexus Theories And Standards (Cont.) III. Trends A. Physical presence 1. States have taken the position, in rulings and otherwise, that the slightest physical presence creates nexus, even though the Quill corporation had software discs and catalogs in the state, and that did not create nexus. B. Legislative expansion 1. Nexus/ doing business 2. Affiliate nexus statutes 3. Click-through nexus statutes (attributional) 4. Expansion of reporting requirements C. Case law expansion 1. Expansion of types of activities considered to make or maintain a market. Dell Catalog Sales v. Tax. & Rev. Dep t. of New Mexico (2008) 9

10 Common Nexus Traps I. Third-party activities and contracts A. Contractual language can imply that third parties are acting on behalf of a company (Using partner or agent ). B. There is a wide variety of third-party activities that may create nexus ( making or maintaining a market ). 1. Accepting orders, accepting returns, customer service, approving orders C. Most states have followed Quill and consider traditional advertising to not be nexus-creating. II. Affiliate activities and contracts A. While some states have adopted statutes that say mere presence of a retailer s related party in a state creates a collection requirement, these statutes have not been regularly enforced. B. Broad inter-company agreements may impart activities to related parties that are not actually being performed. 10

11 Common Nexus Traps (Cont.) Click-through h nexus statutes t t Have been passed in New York, North Carolina and Rhode Island Proposed in many other states The statutes presume that an out-of-state retailer is doing business in the state if a resident of the state is being paid a commission for referring sales through an Internet link. Threshold of amount of sales generated through this arrangement - $10,000 for New York Many states say that their existing statutes cover this activity. 11

12 Common Nexus Traps (Cont.) Click-through nexus statutes (Cont.) 12 New York litigation Amazon.com LLC v. New York State Dep t of Taxation and Finance, et al. and Overstock.com, Inc. v. New York State Dep t of Taxation and Finance, et al., 0210 NY Slip Opinion (1 st Dept. App. 11/4/10) Appellate court held that the statute was constitutional on its face and remanded the case for a factual determination of whether the statutes are constitutional as applied. Arguments made by the retailers Statutes do not require that the in-state residents make or maintain a market in the state; presumption applies to mere presence. Contracts contained language that prohibited solicitation by the in-state Web sites.

13 Common Nexus Traps (Cont.) Other activities that may create nexus Third parties sending s from out-of-state servers Third parties distributing gift cards or coupons Third parties sending physical mailings from an out-ofstate location Inserts in packaging Using servers in a state (Texas) New Texas regulation Potential Internet Tax Freedom Act issues Visiting vendors 13

14 Drafting Nexus Questionnaires i Employee activity Possible questions Where are employees traveling? What activities are the employees engaged in while in another state? Examples of problematic activities: Negotiating or signing contracts Distributing any promotional items, cards or samples Bringing property the retailer owns into the state for display, signage, etc. Is the employee conducting activity on behalf of a related party? 14

15 Drafting Nexus Questionnaires (Cont.) Third-party activities Potential questions How are the third parties promoting sales by the retailer? Is the third party sending s, hosting content t on a server, distributing gift cards or coupons, distributing samples, etc.? What contractual authority does the third party have to act on behalf of the retailer? How is the third party compensated? Are the third party s services, space or Web real estate generally sold as advertising? 15

16 Ways To Avoid Nexus Traps Employee activities Limit activities to non-nexus activities while in a state Limit employees from negotiating or signing agreements in a state Limit employees from working remotely while on vacation or otherwise Look for safe harbors in states for activities at conferences or trade shows Scrutinize activities by sales employees more rigorously than those by management or back-office staff Get rulings or seek guidance from the state 16

17 Ways To Avoid Nexus Traps (Cont.) Third-party activities Review contractual language to limit the third party s authority ty to act on behalf of the retailer Limit the third party to performing activities that fall within traditional advertising rather than soliciting Have third parties perform problematic activities iti only in states with no sales tax or where the retailer is collecting Limit third parties from sending s from non-nexus states Get rulings or seek guidance from the states 17

18 Chuck Jones, Grant Thornton LOOKING FOR POTENTIAL INCOME TAX NEXUS

19 Agenda For This Section A. Brief review of nexus theories and trends in income tax B. Common nexus traps 1. Examining i sales and activities iti in jurisdictions where company makes sales 2. Agency relationships and warranty providers 3. Factor presence 4. Other common nexus-creating activities C. How to effectively translate questions about those nexus traps into nexus questionnaires D. How to otherwise investigate i within your company on those traps 19

20 Brief Review, Nexus The0ries And Trends I. A state's ability to impose income tax on an out-of-state retailer is limited by the Due Process Clause and the Commerce Clause. II. Due Process Clause: Must be a definite link or minimum connection between the state and the taxpayer, property or transaction that the state wants to tax III. Commerce Clause: Must be substantial nexus IV. Public Law A. Prohibits states from imposing taxes based on or measured by net income, when an entity's only in-state t activity it is restricted t to mere solicitation of orders of tangible personal property B. Limited to income tax and tangible personal property 20

21 Brief Review, Nexus The0ries And Trends (Cont.) I. Economic nexus A. Many state courts have held that physical presence is not required to impose an income tax. B. In New Hampshire and Wisconsin, i the legislatures l have adopted d economic nexus. C. In 2008, the Oregon Revenue Department adopted an administrative rule that implements economic nexus. II. Factor presence nexus A. States have been adopting a "bright-line" nexus standard that is based on minimum levels of payroll, property or sales B. Standard is used for gross receipts taxes in Michigan, Ohio and Texas C. Some states are beginning to apply to income taxes 21

22 Nexus Traps: Sales And Activities i i I. A company must carefully examine its sales and activities in the jurisdictions where it makes sales. A. Sales: For purposes of P.L protection, are the company's sales limited to tangible personal property? 1. For example, a company may lose protection if it provides a service contract for the equipment that it sells. B. Activities: A company may lose P.L protection if it engages in the following activities in a state: 1. Installs equipment 2. Replaces damaged property 3. Conducts training programs for maintenance personnel 4. Repossesses property 22

23 Nexus Traps: Agency And Warranties I. Agency relationships and provision of warranties may result in nexus with a state. A. Agency: For example, the Oregon Revenue Department provides that a company will have nexus if a third party or agent conducts these services on the company's behalf: 1. Fills orders from inventory 2. Collects on accounts 3. Checks credit history of new Oregon customers 4. Repossesses property in Oregon 5. Provides maintenance and warranty services in Oregon 6. Closes mortgage loans 7. Services mortgage and consumer loans 23

24 Nexus Traps: Agency And Warranties (Cont.) A. Warranties 1. The provision of warranty services by a company or a third party may result in the company losing P.L protection. 2. Courts have held that warranties go beyond the protected "solicitation of orders" [Alcoa Building Products v. Commissioner of Revenue, 797 N.E.2d 357 (Mass. 2003)]. 3. In an example, the Oregon Revenue Department provides that nexus exists when in-state repair and warranty services provided by an independent contractor on behalf of a direct marketing computer company are advertised as part of its standard warranty or as an option that can be separately purchased. 24

25 Nexus Traps: Factor Presence I. Under a factor presence (bright-line) nexus standard, an out-of-state entity has nexus with a state if it meets minimum dollar thresholds for property, payroll or sales in the state. II. In 2002, the Multistate Tax Commission (MTC) approved a model statute Factor Presence Nexus Standard for Business Activity Taxes. III. Under the model statute, a taxpayer has substantial nexus with a state if any of the following thresholds is exceeded during the tax period: A. $50, of property B. $50,000 of payroll C. $500,000 of sales, or D. 25% of total property, payroll or sales 25

26 Nexus Traps: Factor Presence (Cont.) I. Ohio A. For purposes of the Ohio Commercial Activity Tax (CAT), several different factors, including a bright-line presence, cause a taxpayer to have nexus with the state. t B. The definition of "bright-line" presence includes the four threshold factors from the MTC model statute. C. In 2010, the Ohio tax commissioner held in a final determination that an out-of-state retailer (L.L. Bean) had substantial nexus because its gross receipts in the state satisfied the bright-line presence test. 1. Physical presence requirement does not apply to the Ohio CAT. 26

27 Nexus Traps: Factor Presence (Cont.) I. Michigan II. 27 A. The Michigan business tax (MBT) uses a factor presence nexus standard B. Taxpayer has substantial nexus if: California 1. Physical presence in state for more than one day during tax year, or 2. Actively solicits in state and has gross receipts of at least $350,000 sourced to Michigan A. In 2009, California enacted a factor presence nexus standard for its corporation franchise tax that is effective for tax years beginning g after B. Definition of "doing business" adopts nexus thresholds similar to those found in the MTC's model statute.

28 Nexus Traps: Factor Presence (Cont.) I. States adopting standard in 2010 A. Colorado 1. Effective April 30, 2010, Revenue Department amended corporate income tax regulation that defines "doing business in Colorado," to adopt factor presence nexus standard. 2. Same thresholds as used in MTC's model statute B. Connecticut 1. On Sept. 23, 2010, Revenue Services Department implemented a bright-line nexus standard for corporate income tax. 2. Nexus if at least $500,000 attributable to Connecticut sources during the tax year 28

29 Nexus Traps: Factor Presence (Cont.) I. States adopting standard in 2010 (Cont.) A. Oklahoma In 2010, Oklahoma adopted a new business activity tax (BAT) that is effective for the 2010 through 2012 tax years. 2. Same thresholds as used by MTC's model statute 3. Differs from nexus standard applied for purposes of Oklahoma income tax B. Washington 1. Effective June 1, 2010, Washington adopted a factor presence nexus standard for purposes of the business and occupation (B&O) tax. 2. Applies four criteria from MTC's model statute to service and royalty income 3. Physical presence standard d continues to apply to retailing, wholesaling and any other classification of business not subject to single-factor apportionment formula.

30 Nexus Traps: Factor Presence (Cont.) I. Constitutionality of this approach may be challenged II. Adoption of objective standards to determine whether substantial nexus exists in a state may conflict with judicial concept A. Courts intended that substantial nexus test be based on a case-by-case analysis of whether a taxpayer had sufficient presence in a state. B. Companies can argue that a nexus determination should not be based simply on their property, payroll or sales in the state. 30

31 Other Common Nexus Creating Activities I. Bundled transactions that may exceed P.L protection A. For example, a seller of computer printers might lose its protection if it also services the printers or provides maintenance. II. Re-licensing of software or intellectual property III. Consigned inventory IV. Company-owned vehicle V. Company-owned gift cards sold by third parties 31

32 Nexus Questionnaires i I. How to effectively translate questions about those nexus traps into nexus questionnaries A. Educate CFO and operational personnel on the issue 1. Explain the issues and financial i ramifications i 2. Create an information flow that does not create tax department "unknowns" B. Questionnaire should include questions concerning salespersons who enter the state 1. Authority to accept orders 2. Engage in collection activity 3. Handle customer complaints 4. Pick up or replace damaged or returned propertyp 5. Provided with a company car 32

33 Nexus Questionnaires i (Cont.) A. Questionnaire should include questions concerning installation and repair or maintenance services. 1. Install or supervise installation of products 2. Offer technical assistance after the product is sold or installed 3. Provide on-site technical assistance 4. Repair or provide maintenance of the products 5. Offer warranty contracts B. Other activities to consider 1. License intangible rights (patents, trademarks, etc.) for use 2. License software for use 3. Hire, train or supervise personnel 33

34 Investigations Within Company For Nexus I. For companies that want P.L protection from income tax nexus, try to confirm that MTC provisions interpreting P.L are not violated. 34 A. Consider Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States Under Public Law ,, MTC, Third Revision, adopted July 27, B. For example, according to the MTC, the following in-state activities will cause a company to lose protection under P.L : 1. Making repairs or providing maintenance or service to the property sold 2. Installation or supervision of installation at or after shipment or delivery 3. Approving or accepting orders 4. Picking up or replacing damaged or returned propertyp 5. Maintaining an office or any place of business that does not qualify as an "in-home" office

35 Investigations Within Company For Nexus (Cont.) I. Conduct due diligence interviews with company personnel to determine whether their activities come within or violate P.L A. Important to document this for FIN 48 purposes II. Look at company Web sites III. Consider job descriptions of customer representatives IV. Examine contracts with service providers performing work on the company's behalf 35

36 Maryann Luongo, Baker & McKenzie LEVERAGING COMPANY RESOURCES FOR NEXUS OVERSIGHT

37 Working Within A Company On Nexus Oversight What are the realities of implementing a nexus-containment strategy? With aggressive state positions on nexus, is it still possible to contain nexus? Nexus can be created where you least expect it. States are issuing rulings, amendments to laws and regulations on a daily basis that REDUCE NEXUS THRESHOLDS. Instances in which companies can manage nexus are now rare. 37

38 Working Within A Company On Nexus Oversight (Cont.) How can a corporate tax staff set up ongoing g vigilance on nexus activities, in a practical fashion? Nexus study Identify activities and rank by risk of creation of nexus Review of nexus is a facts-and-circumstances review. One activity on its own may not create nexus; however, when that same activity is reviewed as part of a group of activities, it may result in nexus. Process for identifying and addressing new activities Buy-in from business groups Buy in from business groups Provide list of do s and do nots Obtain support at highest level in company, to ensure mandates will be followed Consequences for engaging in activities identified as do nots Monitoring of employee activities 38

39 Working Within A Company On Nexus Oversight (Cont.) What do companies do if they discover that t employees have engaged in nexus-creating activities? Chances are, if you dig deep enough, you will find that an employee has engaged in a nexus-creating activity. Identify the breadth and scope of activity (i.e., number of occurrences and when) Identify where such activity occurred Possible responses Discontinue activity in state; prohibit activity by company employees Register WITH STATE and FILE/PAY/collect on a prospective basis VDA/amnesty to address past liability 39