Some states, including California and Kansas, are considering or have enacted legislation that would impose use tax collection obligations on remote sellers by expanding the definition of retailer under their relevant statutory schemes. These statutory provisions raise serious constitutional questions and appear to directly challenge the U.S. Supreme Court's decision in Quill.
California Senate Bill 103
Senate Bill 103, 2003-2004 Leg., Reg. Sess. (pending in Cal. Asm. Appropriations Comm. July 8, 2003) ("S.B. 103"), which is currently pending in the California Legislature, represents the Legislature's third attempt to pass an affiliate nexus bill for purposes of the sales and use tax. (A.B. 2412, 1999-2000 Leg., Reg. Sess. (Cal. 2000), which contained the identical affiliate nexus provisions of S.B. 103, was vetoed by the Governor. A.B. 81, 2001-2002 Leg., Reg. Sess. (Cal. 2001) contained similar affiliate nexus provisions that were amended out of the bill.)
The affiliate nexus provisions of S.B. 103 provide that a retailer is engaged in business in California if the retailer is "related," as specified, to a retailer maintaining sales locations in California, provided that the retailer sells similar products under a similar name as the California retailer, or uses facilities or employees of the related California retailer to advertise or promote sales by the retailer to California purchasers.
In pertinent part, S.B. 103 provides:
For purposes of this section, a retailer is engaged in business in this state, as defined in paragraphs (1) and (2) of subdivision (c), if both of the following conditions exist:S.B. 103 also provides that a retailer engaged in business in California would include any retailer having, among other things, any representative or independent contractor operating in California under the retailer's authority for the purpose of servicing or repairing tangible personal property.(A) The retailer holds a substantial ownership interest, directly or through a subsidiary, in a retailer maintaining sales locations in California or is owned in whole or in substantial part by that retailer, or by a parent or subsidiary thereof. For purposes of this subparagraph, "substantial ownership interest" in an entity means that degree of ownership of equity interest in an entity that is not less than that degree of ownership as specified by Section 78p of Title 15 of the United States Code, or any successor to that statute, with respect to a person other than a director or officer.
(B) The retailer sells the same or substantially similar line of products as the retailer maintaining sales locations in California under the same or substantially similar business name, or facilities or employees of the related retailer located in this state are used to advertise or promote sales by the retailer to California purchasers.
The bill states that it is the legislative intent that the above proposed amendments are a "clarification of existing law," which is to be applied prospectively. However, the proposed amendments significantly broaden the definition of the term "retailer engaged in business" under the current applicable law. Section 6203 of the California Revenue and Taxation Code (all subsequent section references are to the California Revenue and Taxation Code) currently defines a "retailer engaged in business" to mean: (1) any retailer maintaining, occupying, or using, permanently or temporarily, directly or indirectly, or through a subsidiary, or agent, by whatever name called, an office, place of distribution, sales or sample room or place, warehouse or storage place, or other place of business; (2) any retailer having any representative, agent, salesperson, canvasser, independent contractor, or solicitor operating in this state under the authority of the retailer or its subsidiary for the purpose of selling, delivering, installing, assembling, or the taking of orders for any tangible personal property; and, (3) with respect to a lease, any retailer deriving rentals from a lease of tangible personal property situated in this state.
As section 6203 currently exists, an out-of-state retailer is not regarded as having physical presence in California based solely on the fact that the retailer sells the same or substantially similar line of products as the retailer maintaining sales locations in California under the same or substantially similar business name. Similarly, an out-of-state retailer is not regarded as having physical presence in California based solely on the fact that the retailer uses an independent third party contractor to act under the authority of the retailer in repairing or servicing property sold by the retailer. State Board of Equalization ("SBE") Regulation 1684 specifically states a retailer is not engaged in business in California based solely on its use of a representative or independent contractor in California for purposes of performing warranty or repair services on property sold by the retailer. Cal. Code Regs. tit. 18, § 1684. Contrary to existing law, and the legislative intent language in the bill, which states the amendments are declaratory of existing law, S.B. 103 would establish that an out-of-state retailer is "engaged in business in California" under both of these situations.
Moreover, the bill also appears to conflict with Current, Inc. v. State Bd. of Equalization, 24 Cal. App. 4th 382 (1994). In that case, the California Court of Appeal addressed the constitutionality of an earlier affiliate nexus provision. The statutory provision under scrutiny in Current was subdivision (g) of section 6203, which provided that a "retailer engaged in business in this state" included "any retailer owned or controlled by the same interest which own or control any retailer engaged in business in the same or similar line of business in this state." Current, 24 Cal. App. 4th at 412. The court held this provision unconstitutional, finding that Current, which had no employees, inventories, or facilities in California, and had no other contacts with California, did not have nexus with California sufficient to justify the imposition of a use tax collection duty.
Kansas House Bill 2416
In another nexus development, Kansas recently enacted an extremely broad nexus statute that also appears to upset settled constitutional nexus principles. House Bill 2416, 80th Leg., 2003 Res. Sess. (Kan. 2003) ("H.B. 2416") which was signed in May 2003 by the Kansas governor, redefines "retailer doing business in the state" of Kansas for purposes of sales and use taxes. The new definition established under H.B. 2416 includes those retailers having or maintaining permanently or temporarily, directly, or indirectly through a subsidiary, agent or representative, an office, distribution house, sales house, warehouse, or other place of business. Under this definition, the mere presence of a subsidiary in Kansas triggers nexus for the parent, regardless of whether the subsidiary acts in any way to further the parent's business. The language of H.B. 2416 suggests, for example, that every corporate shareholder of IBM (or any other corporation with an office in Kansas) potentially has nexus in Kansas under the statute. The Kansas bill goes further than California's S.B. 103, and also provides new language which requires in-state businesses to collect sales tax on the selling price of items delivered to in-state customers who have ordered such items from out-of-state businesses not registered to do business with Kansas.
The proposed legislation under California's S.B. 103 and the new legislation under Kansas' H.B. 2416 appear to challenge the Supreme Court's holding in Quill and its progeny. In order for a state to constitutionally impose a sales/use tax collection obligation, the state must comply with both the Due Process Clause of the Fourteenth Amendment and the Commerce Clause. In Quill, the United States Supreme Court made it clear that the Due Process and the Commerce Clause pose distinct limits on the taxing powers of the states. While a state may have the authority to tax a particular taxpayer under the Due Process Clause, imposition of the tax may violate the Commerce Clause. Quill, 504 U.S. at 305.
It is clear from Quill, that in order for a state to lawfully impose, under the Commerce Clause, a sales/use tax collection obligation on an out-of-state retailer, that out-of-state retailer must have a "physical presence" in the taxing state. See also Nat'l Bellas Hess, Inc. v. Dep't of Revenue, 386 U.S. 753 (1967). Under this "physical presence" standard of nexus, the "slightest presence" of an out-of-state retailer within a state is insufficient to permit the state constitutionally to enforce a use tax against the out-of-state company. Dep't of Revenue v. Share Int'l, Inc., 676 So. 2d 1362, 1363 (Fla. 1996); see also Nat'l Geographic Soc'y v. Cal. Bd. of Equalization, 430 U.S. 551, 555-56 (1997). Rather, a state may only enforce a use tax collection obligation on an out-of-state retailer if that retailer's activities in the taxing state create a "substantial nexus" with the state. Share Int'l, 676 So. 2d at 1363; see also Nat'l Geographic Soc'y, 430 U.S. at 555-556; Complete Auto Transit, Inc., v. Brady, 430 U.S. 274 (1977).
Most of the out-of-state retailers that would be affected by the proposed California legislation and the new Kansas legislation arguably would have no "physical presence" in state under the Quill standard. For example, XYZ Corporation has a brick and mortar location in California. It is subject to the sales tax collection obligation because it is considered to be a "retailer engaged in business" in California under section 6203. XYZ Corporation forms a subsidiary XYZCorp.com. XYZCorp.com has no brick and mortar location in California; it has no employees or officers in California; it does not rent or own any property in California; it does not rely upon its parent for returns, warranty services, or any other services; thus, it has no physical presence in California. It sells essentially the same products as XYZ Corporation. XYZCorp.com sells its products via the Internet. Under California's S.B. 103 and Kansas' H.B. 2416, XYZCorp.com would be subject to a use tax collection obligation based solely on its relationship with XYZ Corporation regardless of XYZCorp.com's lack of physical presence in state.
In summary, as state budget deficits continue to grow, combined with the sustained and continued growth of Internet retailing, it is not surprising that states continue to seek ways to collect unpaid use taxes on remote sales. Whether these current attempts to expand state taxing jurisdiction can withstand constitutional scrutiny is yet to be determined. For now, taxpayers should monitor state legislation closely to keep track of these nexus-expanding efforts by the states and be prepared to challenge aggressive nexus states such as Kansas and potentially California.