This article was co-authored by Paul A. Zee-Cheng.
On October 3, 2016, Tennessee issued a proposed rule making it the third state to impose a sales tax collection obligation on certain out-of-state sellers with no physical presence in a State (Rule 1320-05-01-.129). Under the new rules, out-of-state sellers who make over $500,000 in sales to consumers in Tennessee during the previous twelve-month period automatically have substantial nexus with the state, and are obligated to collect and remit Tennessee sales tax.
The new rule requires out-of-state sellers meeting the sales threshold to register with the state by March 1, 2017, and begin collecting sales tax on July 1, 2017. If a taxpayer meets the threshold after the March deadline, then they must register with the state and begin collecting sales tax on the first day of the third month after the month that they meet the threshold. Taxpayers that do not comply with the new rule will be subject to penalties.
Tennessee’s economic nexus provision for sales tax, which is similar to recently adopted rules in Alabama and South Dakota, is in direct contradiction to the nexus standard established by the U.S. Supreme Court in the 1992 case of Quill Corporation v. North Dakota. In Quill, the Court held that a retailer must have a physical presence within a state to be obligated to collect sales tax. The new economic nexus rules that states are adopting attempt to pave the way for Quill to be revisited by the Court, through a challenge to one of the new rules. Justice Kennedy recently invited such a challenge in his concurring opinion in Direct Marketing Association v. Brohl. With pending litigation in Alabama and South Dakota, the physical presence nexus standard could be revisited sooner rather than later.
The Tennessee Department of Revenue did acknowledge the conflict with Quill in its response to public comments regarding the new rules. Despite the conflict, the Department maintains that the rule does not restrict interstate commerce for three reasons. First, as the Court observed in Brohl, the economy has experienced significant structural changes in the past 24 years. The use of online shopping means that a business may now be present in a state without a traditional physical presence. Second, the burden of tax compliance on out-of-state sellers has decreased with sophisticated new tax software. Third, despite pressure from Tennessee and other states, so far Congress has come up short in creating an alternative legislative solution for sales tax collection by remote sellers.
Tennessee’s new rule is still subject to review under the state congress Government Operations Rule Review Committee. This committee could theoretically vote to request the agency repeal, amend, or withdraw the rule. Retailers potentially impacted by Tennessee’s new nexus provision should plan on registering by March of next year, as well as monitor whether any challenges to the provision result in delayed enforcement.
If you have questions about your company’s sales and use tax obligations, please contact Aronson or Michael L. Colavito, Jr. at 301.231.6200.
Effective August 1, 2016, Pennsylvania’s sales tax will be imposed on the sale of digital products. Thus, sellers of digital products should start collecting Pennsylvania sales tax on such sales to customers located in Pennsylvania. This is a significant expansion of the sales tax base in Pennsylvania, with purchases of music, smartphone “apps,” and online video streaming subscription services all falling within the scope of the legislation.
Specifically, the legislation (House Bill 1198), which was signed into law by Governor Wolf on July 13, 2016, expands the definition of taxable “tangible personal property” to include “electronically or digitally delivered, streamed or accessed”:
The legislation also includes in the definition of “tangible personal property” a catchall provision for “any otherwise taxable tangible personal property electronically or digitally delivered, streamed or access.” Under the new rules, these products will be taxable regardless of whether the product is purchased singly, by subscription, or any other arrangement. For example, not only will purchasing a movie for permanent use be taxable (e.g., purchasing and downloading a movie from an online seller), so too will monthly subscriptions to access movie libraries of a provider (e.g., Netflix).
The amendment to the law notably includes the taxability of remotely accessed canned software (i.e., software-as-a-service or SaaS). Although Pennsylvania did not previously have a regulation or statute on the books that reflected SaaS as being taxable, the Department of Revenue has taken the position that the sale of SaaS subscriptions fees are taxable since 2012 (See Penn. Sales And Use Tax Ruling, No. SUT-12-001, 05/31/2012). The legislation makes it clear that charges for maintenance, upgrades, or support of remotely accessed canned software, and any other product now included in the definition of “tangible personal property, are also subject to tax.
Pennsylvania purchasers (especially businesses) of digital goods from sellers that are not obligated to collect Pennsylvania sales tax should assess whether they need to start accruing and remitting use tax on such purchases. Pennsylvania is not the only state that taxes digital products. Other notable jurisdictions taxing digital products to some extent include Connecticut, Indiana, Kentucky, Minnesota, North Carolina, New Jersey, Texas, and Washington.
If you have any questions about the taxation of digital goods, please contact your Aronson Tax Advisor or Michael L. Colavito, Jr. at 301-231-6200.
On March 22, 2016, South Dakota enacted legislation (SB 106) that requires certain out-of-state sellers with no physical presence in the state to collect and remit the state’s sales tax on sales to South Dakota customers. Beginning on May 1, 2016, the obligation to collect the state’s sales tax for out-of-state sellers is based solely on having greater than $100,000 in sales or 200 separate sales transactions to South Dakota customers. In anticipation of a challenge to the law’s constitutionality, the legislation includes a fast-track judicial review procedure that can take place without an audit or assessment against a taxpayer. South Dakota has attempted to pave the way for the U.S. Supreme Court to finally readdress the “nexus” standard for sales and use tax, a task that Congress has argued in recent years.
A retailer’s sales tax collection obligations under South Dakota’s new law stem from the fact that it’s inefficient for states to audit their residents for the use taxes they have not remitted to the state – for example, on their purchases from certain online retailers. Clearly, it’s more effective to have retailers collect and remit the tax to the respective states where they make sales. Still, this can be unduly burdensome on small retailers. Collection of the sales tax is especially important in South Dakota, a state that does not impose an income tax. There is just one minor roadblock in the way of South Dakota’s law remaining intact – the Constitution. In 1992, the U.S. Supreme Court held in Quill Corporation v. North Dakota that a state cannot require a retailer to collect its sales tax unless the retailer has a physical presence in the state. The Quill decision is yet to be overturned. Thus, the physical presence nexus standard is still good law today.
For a number of years, states have passed laws that clarify their position on what constitutes a physical presence, many of which are arguably consistent with the decision in Quill. For example, many states’ sales tax laws specifically provide that having an out-of-state retailer with an in-state affiliate results in a presumption that the out-of-state affiliate has a physical presence in the state. This largely addresses businesses attempting to avoid the collection of sales tax for online sales by setting up their brick-and-mortar stores in one legal entity and their online seller in another.
However, the South Dakota law is clearly at odds with the decision in Quill, as it bases the requirement to collect state’s sales tax solely on a retailer meeting a certain threshold of sales to South Dakota customers. Thus, instead of having a “physical presence” nexus standard, the law establishes an “economic” nexus standard. In recent years, a handful of states have adopted “economic” nexus laws for income tax purposes on the basis the Quill decision does not apply to income tax, but the South Dakota law is the first of its kind applicable to sales tax. Alabama is the only other state with a similar rule, but theirs is in the form of a regulation.
The judicial review procedure established in the new law reflects South Dakota’s awareness of the significance of the requirements that it is attempting to impose on remote sellers. During a review, which can be initiated by the state itself through a request for a declaratory judgement, the state is prohibited from enforcing the collection obligations in the law until its constitutionality has been determined. Thus, despite the May 1, effective date, it could be quite some time, if ever, before the law can be enforced, especially if the U.S. Supreme Court eventually hears the case. Still, South Dakota has boldly gone where no other state has, which could finally result in the reconsideration of the “physical presence” nexus standard.
If you have questions about your company’s sales tax collection obligations, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301-231-6200.
There is a growing list of states that have adopted a more aggressive income tax nexus standard. On August 11, 2015, Alabama added itself to the group of states that impose their income tax on out-of-state businesses solely based those businesses a certain level of sales to customers in the state. The trend is a natural response to the impact that technology has had on the ability of businesses to provide their services on a national (or even global) scale without having an expansive physical presence.
The legislation enacted in Alabama (H.B. 49), which will take effect for tax years beginning after December 31, 2014, is commonly known as a “factor presence” or “bright-line” nexus test. Under Alabama’s the new nexus rule, a business organized outside the state will have an income tax filing obligation if:
In the last year, New York and Tennessee have also adopted similar nexus rules. Other states that have a factor presence nexus rule for their income tax (or other business activity tax) include California, Colorado, Connecticut, Ohio, and Washington.
For years, state tax practitioners would typically advise their clients that they did not have an income tax filing obligation in a state unless they had a physical presence in the state. Thus, the fact that a state applied a destination-based sourcing rule for sales of services was irrelevant because the business did not have the requisite nexus with the state to have a filing obligation. Under a factor presence nexus rule, sourcing is front and center. An out-of-state business will have a filing obligation in the state by merely making sales to customers in the state. Service providers should pay close attention to this trend, as states that adopt a factor presence nexus rule typically change their rules to consider a sale of a service to be an in-state sale when the customer is located in the state. Thus, the location from which the service is performed is largely irrelevant in determining if the business has a filing obligation in the state. The result is that companies with very small physical footprints could have a much larger tax compliance footprint.
While the list of states imposing a more aggressive factor presence nexus rule is still relatively small, the fact that three states have enacted such a rule in the last year suggest that more will follow suit. Service providers should know where their large customer bases are located, and monitor legislation in those states to ensure they are in compliance.
If you are interested in learning more about how states are taxing the new economy, please register for our upcoming webinar on August 25th.
Effective July 1, 2015, Tennessee will begin imposing its sales tax on remotely accessed software (i.e., software-as-a-service). The taxability of software-as-a-service, also known as SaaS, is a developing tread across the nation, as software providers continue to expand their product offerings over the cloud. Other states that impose a sales tax on remotely accessed software include Indiana, New York, Texas, Utah, and Washington.
Under Tennessee’s prior sales tax rules, accessing software remotely from Tennessee was not considered a taxable sale because the user did not actually download the application being accessed. The new rule, enacted by the Revenue Modernization Act (H.B. 0644), deems accessing software from a location in Tennessee where the software remains in the possession of a dealer to be the equivalent of a taxable sale or license of software that is electronic delivery for use in Tennessee. The legislation allows for the proration of the sales tax where a customer has users accessing the software from locations inside and outside of Tennessee. The so-called “multiple points of use” sourcing is based on the percentage of software users located in the state.
The expansion of Tennessee’s sales tax was part of a larger bill that also included significant changes to the state’s business tax and the franchise and excise tax, including:
If you have any questions regarding sales tax treatment of remotely accessed software or the upcoming changes in Tennessee, please contact your Aronson tax advisor or Michael J. Colavito, Jr. at 301.231.6298.