Sales Tax Checklist for Technology Companies
- Do you make internet sales? (On all internet sales, sales tax is due … assuming the product / service is taxable. The issue is whether the seller has a duty to collect and remit or whether the buyer is required to self report.)
- Do you have affiliate relationships (for generating sales) with out-of-state companies?
- Do you have sales representatives travel outside of your home state?
- Do you engage in trade shows outside of your home state?
- Do you have employees or agents that perform services on your behalf outside of your home state?
If you answered "yes" to one or more of these questions, you could be creating a sales tax liability outside your home state. Also, remember income tax nexus is not equal to sales tax nexus. The rules apply differently.
Nexus is a "connection" or "link". Sales and use tax nexus refers to the connection between a person or entity and a taxing jurisdiction sufficient for that jurisdiction to require the person or entity to comply with its sales and use tax laws.
The current basis for determining when sales and use tax nexus exists is found in two Supreme Court cases; Quill Corp. vs. North Dakota [May 26, 1992], and National Bellas Hess, Inc. vs.Department of Revenue of the State of Illinois [May 8, 1967]. In both Quill Corp. and National Bellas Hess, Inc., the Supreme Court ruled in favor of the taxpayer, limiting the states' ability to impose its taxing authority over interstate commerce. The guidance derived from these two cases can be employed in today's markets to manage sales and use tax compliance responsibilities.
While most States continue to reference these cases when defining sales tax nexus thresholds, the States continue to pursue expansion of their sales and use tax authority. With nexus being the foundational element that requires a company to collect and remit sales tax, it's important to note some of the difficulties in determining whether a company has sales tax nexus or not.
As with most sales and use tax related matters, determining whether or not sales tax nexus exists requires some level of interpretation of a state's statute as it applies to the activities of the entity. With that backdrop, here are the most common issues that technology companies struggle with from a sales tax nexus perspective. Also, it should be noted that sellers do not actually "charge" sales tax. Rather, seller's "collect and remit" sales tax. This can be important. For example, as in the case of internet sales, sales tax is always "due". This issue becomes whether the seller has the obligation to collect and remit the tax or if the buyer is obligated to self report.
# 1. Affiliate Nexus, "Amazon Laws", and Click-Through Nexus
The internet has resulted in a shift in our buying patterns and a decline in sales tax revenues. With our current tax system and the nexus rules as outlined above, an out-of-state retailer (translation – a retailer without nexus in the state) selling goods to a consumer or business over the internet is not required to collect sales tax. It is the buyer's responsibility to self-assess the tax and voluntarily remit use tax to the state. Most businesses are aware of this nuance but many consumers are not.
States ensure compliance with these laws through business audits; however, the states don't have the bandwidth, nor is it practical, to audit every consumer. So instead of going after the consumer, states are looking to implement taxing rules that require the out-of state business to collect the tax.
This is why "affiliate nexus", and the "Amazon Law" or "click through nexus" have evolved. These are ways in which states have tried to use the existing nexus standards to require out-of state retailers to collect the tax that otherwise would not have been collected. The typical scenario occurs when an out-of-state business forms a relationship with an in-state business (often referred to as an affiliate) for the sole purpose of customer referrals via a connection to the out-of-state business's website. For this referral, the in-state business receives some type of commission or other consideration. The relationship established through the affiliate programs creates nexus for the out-of-state business, creating an obligation to collect and remit local sales tax. Multiple states including Illinois and California have introduced recent affiliated nexus legislation mainly targeting large internet retailers such as Amazon, hence the title "Amazon Law". In reaction to this legislation, Amazon has dropped their affiliate programs in most of these states. By dropping the affiliate programs, the company intends to terminate its nexus with the state and avoid prospective sales tax collection responsibility. However, this can be problematic as most states deem nexus to exist for a period of at least twelve months subsequent to the activity that created nexus.
The State of New York has passed legislation, called the "commission-agreement provision," that creates a rebuttable presumption that a person (seller) making sales of tangible personal property or services is soliciting business through an independent contractor or other representative if the seller enters into an agreement with a New York resident under which the resident, for a commission or other consideration, directly or indirectly refers potential customers, whether by a link on an internet website or otherwise, to the seller (click through nexus). The presumption applies if the cumulative gross receipts from sales by the seller to customers in the state who are referred to the seller by all residents with this type of agreement with the seller is in excess of $ 10,000 during the preceding four quarterly periods ending on the last day of February, May, August and November. The presumption may be rebutted by proof that the resident with whom the seller has an agreement did not engage in any solicitation in New York on behalf of the seller that satisfies the nexus requirement of the US Constitution during the four preceding quarterly periods. NY Tax Law 1101 (b) (8) (vi).
Technology companies should review their affiliate programs and understand which states, specifically, have "Amazon Laws", "affiliate nexus" rules, or "Click-Through Nexus" rules. This is a constantly changing area that requires close monitoring. At the time of publication, California passed a 1-year repeal of their "Amazon Law".
# 2. Traveling Sales Representatives
The idea of a sales representative sitting in a home office in a state other than where corporate headquarters is located is a clear example of an activity which establishes sales tax nexus in the state where the sales representative is based. However, what happens when that sales representative travels into other states to meet with prospects or customers? This type of activity frequently occurs with technology businesses as the sales representative meets with the prospect to demonstrate their product. Whether or not this type of activity creates sales tax nexus will depend on the state and the frequency of the activity. Each state's rules are slightly different in terms of the threshold that needs to be met to create nexus. However, for some states, a sales representative traveling into the state for a single day will create sales tax nexus. While other states have more lenient thresholds, a general rule-of-thumb is that three days of activity of this type will create nexus for sales and use tax purposes.
Texas prescribes that out-of-state sellers engaged in selling, leasing, or renting taxable items for storage, use, or other consumption in Texas must collect use tax from the purchaser. "Retailer engaged in business in this state" can include, in addition to other activities, any retailer: Having any representative, agent, salesman, canvasser or solicitor operating in Texas under the authority of the retailer or its subsidiary to sell, deliver or take orders for any taxable items. Texas Tax Code Ann. 151.107 (a) (2); Texas Tax Publication 94-108, Engaged in Business (Sales and Use Tax), 11/01/2006.
Nexus Strategy: Instead of face to face customer presentations, technology businesses may consider conducting product demonstrations via the Internet through Webex, GoToMeeting, or another similar application.
# 3. Trade shows
Technology companies are frequent participants in trade shows. Typically, companies attend trade shows to promote their products and services. A company may promote its products and services via representative employees or agents and / or display its wares via a kiosk or booth. In either of these scenarios, the company is performing a type of solicitation.
It is the solicitation activity that determines whether or not nexus has been created. However, a number of states have established specific thresholds (number of days in attendance at a trade show) in order to establish when a company attending a trade show has created nexus in the state. For example, California has set a standard of more than fifteen (15) days – ie if you attend trade shows in California for fifteen days or less, you have not created nexus in the state of California (assuming this is your only activity within the state). Cal. Rev. & Tax. Cd. 6203 (d); Cal. Code Regs. 18 1684 (b).
Nexus with Michigan is not created if the only contacts a person has with Michigan consists of: (1) attending a trade show at which no orders for goods are taken and no sales are made or (2) participating in a trade show at which no orders for goods are taken and no sales are made for less than 10 days cumulatively on an annual basis. However, this rule does not apply if a person also conducts the following activities: soliciting sales; making repairs or providing maintenance or service to property sold or to be sold; collecting current or delinquent accounts, through assignment or otherwise, related to sales of tangible personal property or services; delivering property sold to customers; installing or supervising installation at or after shipment or delivery; conducting training for employees, agents, representatives, independent contractors, brokers or others acting on the out-of-state seller's behalf, or for customers or potential customers; providing customers any kind of technical assistance or service including, but not limited to, engineering assistance, design service, quality control, product inspections, or similar services; investigating, handling, or otherwise assisting in resolving customer complaints; providing consulting services; or soliciting, negotiating, or entering into franchising, licensing, or similar agreements. Michigan Revenue Administrative Bulletin 1999-1, 05/12/1999.
Technology businesses should carefully plan where they will attend trade shows and understand the sales tax nexus thresholds associated with each state for this type of activity.
# 4. Employees or Agents Performing Services
Technology businesses that send employees into a state to provide implementation, installation or repair services are creating nexus for sales and use tax purposes. The fact that this is a non-selling or non-solicitation activity does not mean this activity does not create sales tax nexus. On the contrary, these activities are more likely to create nexus for sales and use tax purposes.
The Washington State Supreme Court, in a recent ruling, asserted that a manufacturer whose employees traveled into the State with the sole purpose of meeting with customers simply to manage the relationship was sufficient to create nexus. This activity was seen as a mechanism that created a market in the State and as a result created nexus for the manufacturer. RWR MANAGEMENT, INC., Appellant, vs. STATE OF WASHINGTON DEPARTMENT OF REVENUE, Respondent, 10-332, 06/27/2011.
Using non-employees to support clients can have a similar effect. For example, a technology hardware business that uses a local resource to repair or perform other maintenance for its customer is providing the service via an affiliate and is deemed to have created nexus for sales and use tax purposes. Whether the person providing the service to the customer is an employee of the business or not is immaterial to the states. The fact that the person is present in their state and performing a service on behalf of the out-of-state business is sufficient to create nexus for the out-of-state business.
Technology businesses should evaluate non-selling related activities they perform in each state including installation and maintenance / support services as well as services provided via a third-party representative when assessing their sales and use tax nexus foot print.
# 5. Income tax nexus does not equal sales tax nexus
There's often an assumption that where a company has income tax nexus, they also have sales tax nexus. End of story. This is true, but only partially true. The second half is that a company can have sales tax nexus without having income tax nexus. The threshold for sales tax is much lower than that of income tax. For example, the solicitation of sales is generally considered a sales tax nexus creating activity whereas this same activity will not, by itself, create income tax nexus (See PL 86-272). The most well-intentioned CPA firms are prone to assuming that because nexus has not been created for income tax purposes, sales and use tax nexus doesn't exist. This is certainly not intended but is the result of limited knowledge of sales and use tax laws.
In Pennsylvania, out-of-state vendors / sellers who maintain a place of business in Pennsylvania and sell or lease taxable tangible personal property or taxable services must register and collect Pennsylvania sales and use taxes. Pa. Stat. Ann. 72 7202; Pa.Stat. Ann. 72 7237 (b); Pa. Code 61 56.1 (a) "Maintaining a place of business" in Pennsylvania includes, in addition to other activities: Regularly or substantially soliciting orders within Pennsylvania through a solicitor, salesman, agent or representative regardless of whether the orders are accepted in Pennsylvania; Pa. Stat. Ann. 72 7201 (b); Pa. Code 61 56.1 (b).
Technology companies should be aware of the specific expertise their CPA firms have in providing sales tax advice. Sales tax is a unique discipline with differing rules from state to state.
Establishing sales tax nexus is often the culmination of multiple nexus creating activities. For example, a technology business may spend three days in a state, soliciting orders, two days at a trade show, and a day or two implementing their products. Each of these activities can create sales tax nexus by itself but should also be viewed in relation to other nexus creating activities.
An important note is that once sales tax nexus has been created, the need to collect and remit sales tax is triggered (assuming what you are selling is taxable in the particular state). Sales tax nexus is associated with the legal entity and spans all sales channels. For example, if you have a direct sales channel and an internet sales channel, once nexus is established in a state both channels are subject to the sales and use tax laws of that state.