Handling the increasingly blurry sales tax nexus picture
Avoiding compliance issues and overpayments by keeping an eye on nexus
INSIGHT ARTICLE |
Sales and use tax nexus continues to increase in complexity. Not too long ago, nexus was relatively simple. Physical presence was virtually the only determining factor. If you had operations in a state, then you collected and remitted sales taxes in that state. If you did not, then you didn't.
With the emergence of the Internet and e-commerce, and with the blurring of corporate boundaries as evolving business models increasingly depend on contractors and other third parties, the question of nexus is no longer simple. States recognized they were losing increasingly significant chunks of sales tax revenue. As a result, states are changing their laws and also pursuing sales tax collections through new theories, such as attributional nexus.
This rapid evolution of both the law and the business landscape makes it extremely difficult for companies to keep up with states' changing positions on sales and use tax. Without a consistent focus on this issue, business processes can quickly become outdated, which can have very expensive consequences.
Brave new nexus worlds
Borders Inc., the now-defunct bookseller, provided an early case. To augment its well-established national bricks-and-mortar brand, Borders Books and Music, its parent company, Borders Inc., launched Borders Online, an Internet sales channel. The online channel was a separate legal entity and as such, had physical presence only in its home state and distribution locations. Yet customers were allowed to make returns to Borders Books and Music stores, which also promoted Borders Online. To customers, the e-commerce operation and brick-and-mortar stores seemed like a seamless shopping experience.
In 2005, California took Borders Online to court, claiming that the company should have collected and remitted sales taxes on transactions with customers in California. Relying on Quill v. North Dakota, the long-standing Supreme Court decision that held that states could not require remote sellers to collect and remit sales taxes unless they had a physical presence in the state, Borders Online disputed California's position. The court, however, found that Borders Books and Music was acting as Borders Online's agent in California and as such, established a physical presence within the state.
What you should do
The lesson for today's businesses? There are no bright lines, and the lines that remain are increasingly blurry. Numerous states have taken businesses to court on theories similar to those in the Borders decision, with differing results. While similar, state laws regarding sales and use tax are not identical. The decisions in these cases are largely driven by the specific facts and circumstances of the businesses and transactions involved.
What does this mean for you? It may well mean that your nexus situation is not as simple as you think it is.
- Do you have a separate online sales channel?
- Does your business model include contractors or other third parties operating in states where you don't have a physical presence?
- Do you make deliveries or service calls to states where you otherwise have no presence?
Any of these situations, and a wealth of others, might be enough to establish nexus. Or they might not. In the end, it will come down to the intersection of the laws for each state and the specific facts and circumstances of your unique operations.
Businesses with any risk factors for nexus should consider conducting an annual nexus review. Businesses that don't take a close look at their nexus situation could find themselves on the wrong end of a court decision holding that they should have been collecting those taxes, which means they will have to come up with the taxes (and potentially penalties and interest) themselves instead of collecting them from their customers.
But a nexus review can also have a bright side. You may be assuming nexus where none, in fact, exists. As a result, you could be collecting and remitting sales taxes where you are not required to, which puts you at a perceived price disadvantage compared to competitors who are not collecting those taxes. Correcting that oversight can create a price advantage or at least level the playing field. Additionally, if you are paying sales tax where none is required, your company may be able to secure a sales and use tax refund. A sales and use tax reverse audit can help identify past overpayments. Experience has shown that companies in the industries referenced in the graphic above frequently overpay sales and use tax. If you operate in one of these industries, consider both a reverse audit to correct past concerns and a regular nexus review to mitigate future risk.
A combination of technology and more flexible business models using a variety of third-party relationships is allowing businesses to expand sales rapidly into new markets—and is also raising a wealth of questions around sales and use tax nexus. Don't simply assume that the old rules apply to your new operations. Take a close look at nexus and make informed decisions.