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Nexus Reviews: Uncovering State Sales g

• r Income Tax Obligations

Designing an Effective Internal Process to Identify Potential Tax Exposures

T d ’ f l f

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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 Maryann Luongo, Baker & McKenzie, Washington, D.C.

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N R i U i St t S l Nexus Reviews: Uncovering State Sales

• r Income Tax Obligations Webinar
• Jan. 6, 2011

Chuck Jones, Grant Thornton chuck.jones@us.gt.com Mark Yopp, Sutherland Asbill & Brennan mark.yopp@sutherland.com Maryann Luongo, Baker & McKenzie maryann.luongo@bakermckenzie.com

Today’s Program

Looking For Potential Sales Tax Nexus

[Mark Y

• pp]

Slide 6 – Slide 17 Looking For Potential Income Tax Nexus

[Chuck Jones]

Slide 18 – Slide 35 h l d l d Leveraging Company Resources For Nexus Oversight

[Maryann Luongo]

Slide 36 – Slide 39

LOOKING FOR POTENTIAL

Mark Yopp, Sutherland Asbill & Brennan

LOOKING FOR POTENTIAL SALES TAX NEXUS

Overview: Nexus Theories And Standards

I. Constitutional requirements A. Due Process Clause nexus 1. Requires that there be some definite link and minimum connection between a state and the person, property or transaction seeking to p , p p y g be taxed 2. Standards: Imposition of tax must not violate fundamental fairness

• r 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 Complet e Aut o p g

p 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 ith th t i t t with the taxing state

b. The tax is FAIRLY APPORTIONED c. The tax does not DISCRIMINATE against interstate commerce, and and d. The tax is FAIRLY RELATED to the services provided by the taxing state.

7

Overview – Nexus Theories And Standards (Cont.)

II. Sales tax nexus standards A. Physical presence: Quill Corp. v. Nort h Dakot a (1992) 1. In this case, Due Process Clause nexus was met through economic presence, by a taxpayer purposefully availing itself of a jurisdiction. 2 I thi C Cl t th h h i l th t 2. In this case, Commerce Clause nexus was met through physical presence that is not de minimis. B. Attributional nexus 1 In-state representatives of a company even if not employees of the company 1. In state representatives of a company, even if not employees of the company, can create nexus for the company through their activities. S

cript o, Inc. v. Carson (1960)

2. The activities of the in-state representatives, whether employees of the thi d ti t k i t i k t f th i company or third parties, must make or maintain a market for the company in

• rder to create nexus. Tyler Pipe v. Wash. Dept . of Revenue (1987)

C. Affiliate nexus A State case law: Barnesandnoble com LLC v S

t at e Bd of Equalizat ion (2007)

A. State case law: Barnesandnoble.com LLC v. S

t at e Bd. of Equalizat ion (2007)

B. State statutes (e.g. Georgia, Wisconsin)

8

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 4. Expansion of reporting requirements C. Case law expansion 1. Expansion of types of activities considered to make or maintain a market Dell Cat alog S

ales v Tax & Rev Dep’t of New Mexico

• market. Dell Cat alog S

ales v. Tax. & Rev. Dep’t . of New Mexico

(2008)

9

C N T 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

• rders

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

C N T (C ) Common Nexus Traps (Cont.)

Cli k th h t t t

• Click-through nexus statutes

― 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 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

Common Nexus Traps (Cont.)

• Click-through nexus statutes (Cont.)

― New York litigation ― Amazon.com LLC v. New Y

• rk S

t at e Dep’t of Taxat ion and Finance, et al. and Overst ock.com, Inc. v. New Y

• rk S

t at e Dep’t of Taxat ion and Finance, et al., 0210 NY Slip Opinion

07823 (1st 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.

12

C N T (C ) Common Nexus Traps (Cont.)

• Other activities that may create nexus

― Third parties sending e-mails from out-of-state servers ― Third parties distributing gift cards or coupons ― Third parties sending physical mailings from an out-of- state location Inserts in packaging ― Inserts in packaging ― Using servers in a state (Texas) ― New Texas regulation New Texas regulation ― Potential Internet Tax Freedom Act issues ― Visiting vendors g

13

D f i N Q i i Drafting Nexus Questionnaires

• Employee activity – Possible questions

― Where are employees traveling? ― What activities are the employees engaged in while in another 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 Bringing property the retailer owns into the state for display, signage, etc. ― Is the employee conducting activity on behalf of a related party?

14

Drafting Nexus Questionnaires (Cont.)

• Third-party activities – Potential questions

― How are the third parties promoting sales by the retailer? I th thi d t di il h ti t t ― Is the third party sending e-mails, hosting content on a server, distributing gift cards or coupons, distributing samples, etc.? ― What contractual authority does the third party have to act

• n behalf of the retailer?

How is the third party compensated? ― How is the third party compensated? ― Are the third party’s services, space or Web “real estate” generally sold as advertising?

15

W T A id N T Ways To Avoid Nexus Traps

• Employee activities
• Employee activities

― Limit activities to non-nexus activities while in a state ― Limit employees from negotiating or signing agreements in Limit employees from negotiating or signing agreements in a state ― Limit employees from working remotely while on vacation th i

• r otherwise

― Look for safe harbors in states for activities at conferences

• r 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

W T A id N T (C ) Ways To Avoid Nexus Traps (Cont.)

• Third-party activities

― Review contractual language to limit the third party’s authority to act on behalf of the retailer aut o ty to act o be al o t e eta le ― Limit the third party to performing activities that fall within “traditional advertising” rather than soliciting H thi d ti f bl ti ti iti l i ― Have third parties perform problematic activities only in states with no sales tax or where the retailer is collecting ― Limit third parties from sending e-mails from non-nexus states ― Get rulings or seek guidance from the states

17

LOOKING FOR POTENTIAL

Chuck Jones, Grant Thornton

LOOKING FOR POTENTIAL INCOME TAX NEXUS

A d F Thi S i Agenda For This Section

• A. Brief review of nexus theories and trends in income tax
• B. Common nexus traps

1 E i i l d ti iti i j i di ti h

• 1. Examining sales and activities in jurisdictions where

company makes sales

• 2. Agency relationships and warranty providers

g y p y p

• 3. Factor presence
• 4. Other common nexus-creating activities
• C. How to effectively translate questions about those nexus traps

into nexus questionnaires D H h i i i i hi h

• D. How to otherwise investigate within your company on those

traps

19

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 86-272
• A. Prohibits states from imposing taxes based on or measured by

t i h tit ' l i t t ti it i t i t d net income, when an entity's only in-state activity is restricted to mere solicitation of orders of tangible personal property B. Limited to income tax and tangible personal property

20

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 I N H hi d Wi i th l

i l t

h d t d B. In New Hampshire and Wisconsin, the legislatures have adopted 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
• 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 Texas

• C. Some states are beginning to apply to income taxes

21

N T S l A d A i i i Nexus Traps: Sales And Activities

I. A company must carefully examine its sales and activities in the jurisdictions where it makes sales.

• A. Sales: For purposes of P

.L. 86-272 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 86 272 protection if it B. Activities: A company may lose P .L. 86-272 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 4. Repossesses property

22

N T A A d W i Nexus Traps: Agency And Warranties

I Agency relationships and provision of warranties may result in nexus 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 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 4. Repossesses property in Oregon 5. Provides maintenance and warranty services in Oregon 6. Closes mortgage loans 7. Services mortgage and consumer loans

23

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. 86-272 protection. 2. Courts have held that warranties go beyond the protected "solicitation of orders" [Alcoa Building Product s v. [

g 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 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 y p p y purchased.

24

N T F P 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

, p y state if any of the following thresholds is exceeded during the tax period: A $50 000 of property

• A. $50,000 of property

B. $50,000 of payroll

• C. $500,000 of sales, or
• D. 25% of total property, payroll or sales

25

N T F P (C ) Nexus Traps: Factor Presence (Cont.)

I. Ohio I. Ohio

• A. For purposes of the Ohio Commercial Activity Tax (CAT),

several different factors, including a bright-line presence, t t h ith th t t cause a taxpayer to have nexus with the state.

• 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 s bstantial ne s beca se its gross receipts in the state substantial nexus because its gross receipts in the state satisfied the bright-line presence test.

• 1. Physical presence requirement does not apply to the

y p q pp y Ohio CAT .

26

N T F P (C ) Nexus Traps: Factor Presence (Cont.)

I. Michigan

• A. The Michigan business tax (MBT) uses a factor presence nexus

standard B Taxpayer has substantial nexus if: B. Taxpayer has substantial nexus if: 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 II. California

• A. In 2009, California enacted a factor presence nexus standard for

its corporation franchise tax that is effective for tax years beginning after 2010. beg g a te 0 0. B. Definition of "doing business" adopts nexus thresholds similar to those found in the MTC's model statute.

27

N T F P (C ) Nexus Traps: Factor Presence (Cont.)

I. States adopting standard in 2010

• A. Colorado

1 Effective April 30 2010 Revenue Department amended 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 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

N T F P (C ) Nexus Traps: Factor Presence (Cont.)

I. States adopting standard in 2010 (Cont.) A. Oklahoma 1. In 2010, Oklahoma adopted a new business activity tax (BAT) that is effective for the 2010 through 2012 tax years. g y 2. Same thresholds as used by MTC's model statute 3. Differs from nexus standard applied for purposes of Oklahoma income tax 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 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 Ph i l t d d ti t l t t ili g 3. Physical presence standard continues to apply to retailing, wholesaling and any other classification of business not subject to single-factor apportionment formula.

29

N T F P (C ) 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 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
• B. Companies can argue that a nexus determination should

not be based simply on their property, payroll or sales in the state.

30

Other Common Nexus‐Creating Activities

I. Bundled transactions that may exceed P .L. 86-272 protection

• A. For example, a seller of computer printers might lose its

protection if it also services the printers or provides 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

N Q i i Nexus Questionnaires

I How to effectively translate questions about those nexus traps into nexus I. How to effectively translate questions about those nexus traps into nexus questionnaries A. Educate CFO and operational personnel on the issue 1 E l i h i d fi i l ifi i 1. Explain the issues and financial ramifications 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 property p p g p p y 5. Provided with a company car

32

N Q i i (C ) Nexus Questionnaires (Cont.)

A Questionnaire should include questions concerning installation and repair A. Questionnaire should include questions concerning installation and repair

• r maintenance services.

1. Install or supervise installation of products 2 Off h i l i f h d i ld i ll d 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 1. License intangible rights (patents, trademarks, etc.) for use 2. License software for use 3. Hire, train or supervise personnel

33

Investigations Within Company For Nexus

I For companies that want P L 86-272 protection from income tax nexus try to I. For companies that want P .L. 86 272 protection from income tax nexus, try to confirm that MTC provisions interpreting P .L. 86-272 are not violated. A. Consider S

t at ement of Informat ion Concerning Pract ices of Mult ist at e Tax Commission and S ignat ory S t at es Under Public Law 86-272, MTC, g y

, , Third Revision, adopted July 27, 2001. B. For example, according to the MTC, the following in-state activities will cause a company to lose protection under P .L. 86-272: 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 property g p p g g p p y 5. Maintaining an office or any place of business that does not qualify as an "in-home" office

34

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. 86-272

• 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 the company s behalf

35

LEVERAGING COMPANY

Maryann Luongo, Baker & McKenzie

RESOURCES FOR NEXUS OVERSIGHT OVERSIGHT

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 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 – 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

Working Within A Company On Nexus Oversight (Cont.)

How can a corporate tax staff set up ongoing vigilance on nexus p p g g g 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 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

Working Within A Company On Nexus Oversight (Cont.)

Wh t d i d if th di th t l h What do companies do if they discover that 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 has engaged in a nexus-creating activity. – Identify the breadth and scope of activity (i.e., number of

• ccurrences and when)

Identify where such activity occurred – Identify where such activity occurred – Possible responses – Discontinue activity in state; prohibit activity by company employees employees – Register WITH STATE and FILE/PAY/collect on a prospective basis – VDA/amnesty to address past liability – VDA/amnesty to address past liability

39