A Reminder About The State Tax Implications of Passive Partnership Interests: U.S. Supreme Court Declines To Review State Court Ruling That Mere Partnership Interest Creates Income Tax Nexus

E-commerce companies that have affiliates doing business as (or even just investment interests in) partnerships or other pass-through entities in states in which the e-commerce company has no direct presence should be aware that such partnership interests may be deemed to create income tax nexus for the company.  A number of state laws and regulations provide that ownership in a pass-through entity establishes nexus for the owner.  See, e.g., 34 TAC Sec. 3.586(c)(13) [Texas]; 830 CMR 63.39.1(8) [Massachusetts]. To date, state tax tribunals have agreed. See, e.g., Shell Gas Gathering Corp. #2, N.Y. Tax Appeals Tribunal, DTA Nos. 821569 and 921570 (Sept. 23, 2010).

Furthermore, on January 25, 2011, the United States Supreme Court declined a petition asking the Court to review a Kentucky Appeals Court decision that an out-of-state corporation was properly required to pay Kentucky state income tax, despite the fact that its only connection to Kentucky was its interest in a partnership that was engaged in business in the state.  Asworth, LLC v. Kentucky Department of Revenue, 2009 WL 3877518 (Ky. App. Ct. Feb. 10, 2010), review denied (Ky. 2010) and cert denied, U.S. Supreme Court Dkt. 10-662 (Jan. 25, 2011).  While mere passive ownership in a partnership that generates revenue from activities in a state would not, by itself, be enough to subject the partner-owner to nexus for sales and use tax purposes, the Supreme Court’s refusal to review the Kentucky decision leaves undisturbed the position taken by many states that owners of an interest in a pass-though entity can be compelled to report state income tax.

St. Thomas University Looking for Business Associations Faculty

A plug for my school. We are still looking for a new or lateral Business Associations faculty for next year. With Florida now also testing UCC Articles 3 and 9, I suspect there is more room for commercial law as well as traditional corporate subjects. Here is the ad from Fall. We've filled some slots, but are still looking in the business arena. If you are looking or would like to recommend anyone, please contact me directly at jmartin@stu.edu or hiring chair Tamara Lawson, below.

ST. THOMAS UNIVERSITY SCHOOL OF LAW in Miami, Florida, invites applications from experienced and entry-level candidates for tenure-track positions beginning in the 2011/2012 academic year. The Law School especially seeks candidates in the areas of Business Associations, Wills and Trusts, Constitutional Law, Securities Regulations, Property and Civil Procedure. Applicants must possess a distinguished academic record, a dedication to excellence in teaching, and a demonstrated commitment to scholarship. Consistent with the Law School’s tradition of diversity, members of minority groups and women are especially encouraged to apply. Applicants should send a letter of application and a resume. CONTACT: Professor Tamara Lawson, Chair of the Faculty Recruitment Committee, St. Thomas University School of Law, 16401 NW 37th Avenue, Miami Gardens, Florida 33054. E-MAIL: tlawson@stu.edu. FAX: (305) 623-2390.

— JSM

DMA Wins Landmark Injunction Against State of Colorado

On behalf of the Direct Marketing Association, Brann & Isaacson partners George Isaacson and Matthew Schaefer won a landmark preliminary injunction in federal court in a lawsuit that affects thousands of direct marketers across the country. The ruling prohibits the State of Colorado from enforcing its controversial new law, H.B. 10-1193, that required direct marketers to -- among other things -- report to the state the names, addresses, and purchase amounts of their customers.

To be clear, so long as the injunction remains in place, out-of-state retailers that do not have nexus with Colorado and do not collect Colorado sales tax are no longer required to: (1) give notice to their Colorado customers, in connection with each sale, that the customer must report Colorado use tax (the “Transactional Notice”); (2) send via First Class mail by January 31, to each customer that purchased more than $500 of goods for delivery to Colorado during 2010, a summary of their purchases for the year (the “Annual Purchase Summary”); or (3) submit a report to the Colorado Department of Revenue, by March 1, listing the name, billing and shipping addresses, and total amount of purchases of all customers who purchased goods for delivery to Colorado (the “Customer Information Report”).  See http://www.colorado.gov/cs/Satellite/Revenue/REVX/1251581938320.

The DMA argued that the law violates the Commerce Clause of the United States Constitution by (a) imposing discriminatory obligations upon out-of-state retailers that do not apply to in-state Colorado retailers, and (b) unduly burdening interstate commerce under principles set forth by the Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Court accepted these arguments in finding that the DMA had a likelihood of success on both Commerce Clause counts, and concluded that out-of-state retailers subject to the new law would suffer irreparable harm if enforcement of the statute is not barred.

The preliminary injunction entered by the Court does not end the case, but it effectively suspends the law while the litigation continues and until the Court makes a final ruling regarding the law’s constitutionality.

You can read a copy of the order here.

Read previous posts about the lawsuit here and here.

Opportunity for Publishing for Commercial Law Profs

For those who didn't attend the Annual Conference in San Francisco or visit the CALI booth or simply haven't heard . . . CALI is also sponsoring fellowships in a program called ELangdell whereby professors submit proposals to CALI for law school text books and supplements and, if accepted, CALI publish the work as a digital e-book in multiple formats. CALI pays $500 per chapter to authors, but gives the books away for free to students. This is a great resource for students and professors in a time where book costs are very high and resources slim. CALI is hoping to both have a nice library of free books itself and, perhaps, to put market pressure on the main publishers regarding their pricing of e-books. Several books are in progress and the beta versions of Doug McFarland’s Civil Procedure text (6th edition) and a chapter on Ethics for Tax lawyers are already available. Other proposed texts are in process.



If you are interested in putting in a proposal for something in the Commercial Law area, contact Deb Quentel at CALI at dquentell@cali.org. The next round of proposals are due by February 2, 2011.

- JSM

Arbitration by Door Posting?

Dan Barnhizer (Michigan State) posted yesterday on the Contracts list serve this photo sent to him from a student that saw it at a Whataburger. The text reads:

"Arbitration Notice"
"By entering these premises, you hereby agree to resolve any and all disputes or claims of any kind whatsoever, which arise from the products, services or premises, by way of binding arbitration, not litigation. No suit or action may be filed in any state or federal court. Any arbitration shall be governed by the FEDERAL ARBITRATION ACT, and administered by the American Mediation Association.
"Arbitration Notice"

Naturally, this raises many questions about consent to abitration, class action arbitrations and rules that might even apply to any such disputes. And, of course, Barnhizer asked "what they do for drive-through customers?"

- JSM

AALS Section on Financial Institutions and Consumer Financial Services

The section program at the Annual Meeting of the Association of American Law Schools in San Francisco on January 7 this year focused on the "post-crisis" landscape. The Call for Papers panel featured papers by William Birdthistle, Jim Hawkins, Adam Levitin, Alan White and Sarah Woo.

One of my favorites on this panel was James Hawkins' (University of Houston) paper on Regulating the Fringe: Reexamining the Link Between Fringe Banking and Financial Distress forthcoming in the Indiana Law Review. Basically Jim argues that products like payday loans, pawn loans, and rent-to-own leases— might not cause as much financial distress to consumers because of the finality involved in these transactions and the amount. As such, perhaps we might reconsider whether regulators should lump these types of transactions with others. At the heart of this is what constitutes financial distress. While I am not a fan of the fringe banking products, Jim's argument that they might require differing treatment in terms of regulation is worth serious consideration. For my part, I part with him in some of the ideas regarding monetary valuation. I remain unconvinced that one person's financial distress is the same as another's due to relative economic means as a whole. For instance, a person of very limited means may experience serious financial distress when their $750 auto is repossessed and they cannot get to work, then loose their employment, etc. While the event of losing the car may have a finality in and of itself that does not continue to plague the consumer, even smaller dollar transactions can have great impact on the lives of many consumers. That aside, the finality of the transaction is worth further thought when considering regulation of fringe banking products, as is the differing impact of the size of these transactions.

- JSM

DMA’s Constitutional Challenge to Colorado’s Notice and Reporting Law Will Be Argued In Federal District Court on January 13

A happy new year to our readers. Many internet and catalog retailers have been following with interest the constitutional challenge of the Direct Marketing Association (“DMA”) to Colorado’s new notice and reporting law, H.B. 10-1193, enacted in 2010. In addition to burdensome consumer notice requirements that went into effect last year, the law requires out-of-state retailers that do not collect Colorado sales and use tax to send (by January 31, 2011) annual purchase summaries to customers purchasing $500 or more of goods for shipment to Colorado and, worst of all, to file (by March 1, 2011) with the Colorado Department of Revenue a listing of all of the retailer’s customers who have purchased goods for shipment to a Colorado location, regardless of where the customer resides.

As we previously reported (see our July 2, 2010 post), the DMA contends that the Colorado law violates multiple provisions of the United States Constitution, because it discriminates against interstate commerce, exceeds the State’s regulatory authority over out-of-state businesses, violates the privacy rights of Colorado consumers, infringes the free speech and due process rights of retailers and consumers, and deprives retailers of their valuable customer list information without due process or fair compensation. The DMA has filed a motion for preliminary injunction based on the law’s violations of the Commerce Clause, asking the Court to suspend enforcement of the law’s notice and reporting requirements pending a full adjudication of the law’s constitutionality.

The federal District Court for the District of Colorado has scheduled a hearing on the DMA’s motion to be held on January 13, 2011, at 10:00 a.m. in Denver. B&I senior partner and lead counsel for the DMA, George Isaacson, will argue the motion on behalf of the DMA. We will report on further developments after the hearing.

Distribution of Promotional Materials in Indiana is Not Taxable

In D.H. Holmes Company, Ltd. v. McNamara, 486 U.S. 24 (1988), the U.S. Supreme Court held that a state did not violate the Commerce Clause when it imposed a use tax on the distribution of catalogs and other promotional materials mailed from outside of the state since the company on whose behalf the catalogs were distributed had nexus with the state. Prior to that date, there were some state courts and tax commentators which had declared that a destination state’s imposition of tax on catalogs printed and mailed from outside of the state to residents of the state violated the Commerce Clause.

As a result of the D.H. Holmes decision, a large number of states have imposed a use tax on promotional materials distributed in their state on behalf of a company with nexus in the state (e.g. Arizona, Colorado, Connecticut, Florida, Georgia, and Tennessee).  There have been some exceptions to this rule (See e.g., Michigan (Sharper Image Corp. v. Department of Treasury, 550 N.W.2d 596 (1996)), New York, Ohio, California, and Pennsylvania).

Recently, the Indiana Tax Court ruled in the case of AOL, LLC v. Indiana Department of State Revenue that the distribution of CD ROMs and other marketing materials on behalf of AOL by AOL’s printer and assembly house was not taxable. The basis for the decision was that AOL had supplied the components—the CD ROM discs, paper, and other components of CD ROM packages—to the assembly house and printer. Thus, the assembly house and printer were merely providing a service, and not selling tangible personal property. Under the Indiana statute, the provision of services is not taxable. It is only the sale of tangible personal property that is taxable. Nor were the components themselves taxable because only the final CD ROM package and printed materials were distributed in Indiana. The components were transformed by the assembly houses and printers into final products.

This decision is in line with prior decisions of the Indiana Tax Court, including Ameritech Publ’g, Inc. v. Ind. Dep’t of State Revenue, 916 N.E.2d 752 (Ind. Tax Ct. 2009) and Morton Bldgs., Inc. v. Ind. Dep’t of State Revenue, 819 N.E.2d 913 (Ind. Tax Ct. 2004).  Thus, any direct marketer which has been distributing promotional materials in Indiana and paying use tax on those promotional materials should consider filing a claim for refund for taxes paid if the direct marketer supplied the underlying raw materials to the printer or other party assembling the promotional materials.