California Affiliate Nexus Law Goes Into Effect

We have written frequentlyabout the California affiliate nexus statute, AB 155, which was adopted in June 2011, but was temporarily repealed in September 2011, pending Congressional action on a bill rejecting the Quill physical presence test. Since Congress has not enacted such a law, AB155 is set to go into effect tomorrow.

The California Board of Equalization (“BOE”) undertook a lengthy rulemaking process over the past year to flesh out the requirements of the law. Much of this effort is reflected in the BOE’s newly amended version of California Regulation 1684. Here are some of the key points:

• The law provides that an affiliate relationship will create nexus only if the payment to the affiliate is based upon a completed sale of tangible personal property; i.e., a commission-based arrangement. Thus, pay-per-click payment arrangements with affiliates do not create nexus. 
• The statute, and Regulation 1684 which interprets the statute, provides that if the arrangement with the affiliate is for the purchase of advertisements to be delivered on the Internet, the retailer will not be deemed to have nexus if the affiliate does not directly or indirectly solicit customers in California through the use of flyers, newsletters, telephone calls, email, blogs, social networking sites, or other means of direct or indirect solicitation specifically targeted at potential customers in California. Thus, if a retailer places content on the website of a California affiliate that provides information regarding the retailer’s products and the affiliate links to the retailer’s website, so long as the affiliate does not make any solicitations on behalf of the retailer that specifically target CA residents, the retailer should not have nexus under the California statute. 
• Regulation 1684 provides for a safe harbor if (1) the agreement between the retailer and affiliate provides for a prohibition of California solicitation activities on behalf of the retailer, such as distributing flyers or coupons or sending emails; (2) the retailer obtains certificates annually from the California-based affiliates that it has not engaged in any such prohibited solicited activities; and (3) the retailer accepts such certificates in good faith. 

Unfortunately, many of these important details were omitted from recent correspondence sent by the BOE to retailers, which included a form of nexus questionnaire. The BOE stated that a retailer is engaged in business in California and thus required to collect the California sales and use tax if it has a relationship with an affiliate operating in California that refers potential customers to the retailer. However, nowhere in the materials sent out by the BOE is there any mention of the exceptions to the finding of nexus discussed above.

Before making the decision either to discontinue affiliates or to collect California sales and use tax, ecommerce sellers should review the nature of their affiliate relationships to determine whether those relationships, as currently structured or as revised in the future, will create nexus in California under the actual provisions of the law. Moreover, a prudent e-tailer should not respond to the BOE questionnaire unless and until it has carefully reviewed its activities with competent professionals.

Committee Hearings Held on Remote Collection Bills; Coalition Forms to Demand True Simplification Of State Sales Tax Systems, Defend Quill

We have written previously about attempts by Congress to overturn the physical presence nexus standard of Quill Corp. v. North Dakota via the Main Street Fairness Act, the Marketplace Fairness Act, and the Marketplace Equity Act. The bills vary in their specifics as we discuss here and here, but most simply put, all three bills would permit states to require remote sellers to collect and remit sales and use tax despite such sellers having no physical presence in the state. While it is difficult to predict what Congress may do in an election year, it appears that so far, the Main Street Fairness Act has not made much progress through Congress since being introduced. The other two bills have seen some committee action lately, however, as discussed below.

Meanwhile, a coalition has formed to help protect remote sellers’ interests. The TrueSimplification of Taxation (“TruST”) Coalition was formed jointly by the Direct Marketing Association, the American Catalog Mailers Association, the Electronic Retailing Association, and NetChoice to represent “American businesses in the fight to keep interstate commerce and competition free from unfair tax burdens imposed by states where our businesses have no operations or representation.” Brann & Isaacson partners George Isaacsonand Martin Eisenstein assisted in forming the coalition and provide ongoing advice regarding the sales and use tax collection implications to remote sellers.

On July 24, 2012, the House Committee on the Judiciary held a hearing on The Marketplace Equity Act. At the hearing, the bill’s sponsors, and three others (the governor of Tennessee, a representative of the Streamlined Sales Tax Governing Board, and a visiting fellow at the Hudson Institute, a public policy think tank) all spoke in favor of the bill. On the other side, a representative from the Tax Foundation and Steve DelBianco, the executive director of NetChoice, one of the TruST Coalition members, defended the Quill standard as vital to the protection of online sellers – and in particular small Internet retailers -- in the absence of true simplification of state sales and use tax systems.

On Wednesday, August 1, 2012, at a hearing before the Senate’s Committee on Commerce, Science, & Transportation regarding the Marketplace Fairness Act, the committee heard a group of proponents testify, and Mr. DelBianco spoke on behalf of remote sellers and against the bill. However, one of the witnesses inadvertently helped make Mr. DelBianco’s case: the witness, a bookstore owner from Texas who voluntarily collects sales tax on remote sales, was found to be charging tax at the wrong rates on his remote sales, thus demonstrating just how complex remote collection can be. Perhaps through this testimony some Senators will begin to understand the challenges of nationwide use tax collection, but many may require additional education from their constituents who do business online.

Our readers should note, as well, that the July 31 deadline set by the California legislature for adoption of federal legislation overturning Quill has passed. This means that, barring any additional state legislation, California’s affiliate nexus provisions are back in play beginning September 15, 2012. We will continue to monitor each bill’s progress and keep our readers posted of developments in this area.

Nexus of Subsidiary Not Automatically Attributable to Parent Company

Recently, a number of states have adopted statutes providing that an out-of state retailer is presumed to have nexus in the state by virtue of ownership of a subsidiary that does business in the state. See California (ABX 1, but note its implementation was delayed by AB 155); Colorado (Colo. Rev. Stat. § 39-26-102(3)(b)(II)); and Arkansas (Ark. Code Ann. 26-52-117(b)). While each of these state statutes provides that mere ownership creates only a presumption of nexus, which a retailer can rebut, some commentators have interpreted these laws as attributing the nexus of in-state affiliates to related out-of-state companies.

But an out-of-state retailer’s mere ownership of a company without the company acting as an agent or representative of the retailer will not create nexus for the retailer under the constitutional standard. Quill and a number of cases decided both before and after Quill stand for the proposition that mere ownership of another company that has an in-state presence does not create nexus for the parent, absent the in-state subsidiary engaging in activities on behalf of the parent to create a market in the state for the parent. We wrote an article back in 1996 that discusses the case law. See Defending Against Affiliate Nexus in Sales and Use Tax Collection Liability Cases, State Tax Notes (March/April 1996). In other words, the subsidiary must be acting as an agent or representative of the parent company in the state for the nexus of the subsidiary to be attributed to the parent.

The constitutional standard has not changed since we wrote the article in 1996. In fact, recent position statements issued by the Tennessee Attorney General and the staff of the California Board of Equalization agree that ownership of an in-state company alone does not create nexus for the out-of-state company. The Tennessee statute (Tenn. Code Ann. § 67-6-102(25)(G)), which has been on the books for a number of years, provides that an out-of-state retailer that “maintains, or has within this state, directly or by a subsidiary, sales room or house, warehouse, or other place of business distributing facility or warehouse,” has nexus with Tennessee. Cal. Rev. & Tax Code § 6203(c)(1) similarly provides that “[a]ny 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 other place of business” is required to collect and remit the California use tax.

In Opinion No. 11-71 (dated October 3, 2011), the Tennessee Attorney General opined in a response to a request from the Legislature to interpret the statute that the mere ownership by Amazon.com of a subsidiary that operated a distribution center in Tennessee would not establish nexus for Amazon.com in connection with its sales of products. Something more needs to be established. According to the Attorney General, “nexus is established only if the subsidiary’s in-state activities are significantly associated with the retailer’s ability to establish and maintain a market in Tennessee for sales.” The Attorney General’s opinion cites Tyler Pipe Industries, Inc. v. Washington Department of Revenue, 483 U.S. 232 (1987). In Tyler Pipe, the out-of-state company contracted with sales representatives that conducted in-state solicitation activities on its behalf. These activities, according to the Supreme Court, created nexus because they helped “to establish and maintain a market” in the state. The Tennessee Attorney General’s opinion notes that “the current Supreme Court jurisprudence in this area does not firmly establish whether a subsidiary’s ownership or maintenance of an in-state distributing center or warehouse would be sufficient to create nexus where the subsidiary is not engaged in actual solicitation activities.” See Attorney General’s Opinion No. 11-71 at p. 2.

Similarly, in an October 14, 2011 discussion paper regarding proposed revisions to Sales and Use Tax Regulation 1684, Board of Equalization staff commented on the state of common ownership nexus. The staff agrees with the Tennessee Attorney General that mere ownership does not establish nexus, citing Current, Inc. v. State Board of Equalization, 24 Cal.App.4^th 382 (1994) (a case that we commented on in our 1996 article), and the more recent case of Borders Online, LLC v. State Board of Equalization, 129 Cal. App.4^th 1179 (2005), in which the Court of Appeals held that the activities conducted on behalf of the retailer must “enhance the retailer’s sales to California customers and significantly contribute to the retailer’s ability to establish and maintain a market in California.” See Discussion paper at 5. (We disagree with staff’s conclusion that the standard of performing “services in this state in connection with tangible personal property to be sold by the retailer” satisfies Quill.)

In short, as we wrote long ago, the ownership of a subsidiary alone will not create nexus. The in-state subsidiary must be engaged in activities on behalf of the out-of-state company (parent) in order to create the necessary nexus for the out-of-state company. The law has not changed since we wrote the article. The recent wave of legislation does not alter the test in Quill.

California Governor Signs (Possibly Temporary) Affiliate Nexus Law Repeal

As we wrote recently, on September 9, the California legislature passed AB 155, which repeals (for at least the next year) the affiliate nexus provisions of the affiliate nexus law (ABX 1-28) enacted in June. The repeal may be only temporary, because the new law provides that if federal legislation overturning Quill Corp. v. North Dakota is not adopted by July 31, 2012, or if such legislation is adopted, but California does not implement the federal law’s requirements by September 14, 2012, then the affiliate nexus provisions of the repealed law, with some modifications described in our prior post, will kick back in on January 1, 2013, under the terms of AB 155.

Although Governor Brown reportedly had some misgivings regarding AB 155, he signed the bill into law earlier today. The law is effective immediately, so for now, California no longer has an affiliate nexus law. Whether federal legislation will be enacted and whether California will implement any such law’s requirements remains to be seen…

California Affiliate Nexus Law Repealed (At Least Temporarily) In Deal With Amazon

As we have previously reported, on June 28, California enacted an affiliate nexus law (ABX 1-28). Under the California law, an out-of-state retailer that has contracts with California affiliates to publish online advertisements linking consumers to the retailer’s website would have been required to collect California sales tax (or use tax) on all of its sales to California purchasers, if: (1) the in-state publishers also engaged in solicitation of customers in the state on behalf of the retailer through other means (such as by flyers, telephone calls, or e-mails) targeting California consumers; (2) the publishers of the advertisements were compensated based on sales made by the retailer; (3) over a 12 month period, the retailer realized at least $10,000 in cumulative sales to consumers accessing its site through such online ads; and (4) the retailer had California sales of at least $500,000 during such 12 month period.

Amazon.com responded to ABX 1-28 by supporting a campaign to repeal the new affiliate nexus law by citizens’ referendum, which was reportedly well on the way to gathering the necessary signatures to get the repeal measure on the ballot next year.

Now, political maneuvering between Amazon and the California General Assembly has resulted in a compromise. On Friday, September 9, the General Assembly enacted AB 155, which will become law immediately if Governor Brown signs the bill (as he is expected to do, despite some reported misgivings). AB 155 repeals, at least for a year (on the conditions described below), the California affiliate nexus law (i.e., ABX 1-28 described in the first paragraph), and also provides that the law will not be enforced for the period between June 28 and the effective date of AB 155. The bill also repeals (on the same conditions) the “controlled group” of corporations provisions of ABX 1-28. Those provisions purported to require use tax collection by any out-of-state retailer that is part of a group of corporations that includes a member that performs services in California in connection with tangible personal property to be sold by the retailer.

The repeal of the California affiliate nexus law is contingent upon the enactment by Congress of federal legislation to overturn the “physical presence” nexus requirement of Quill Corp. v. North Dakota, which prohibits a state from imposing a sales/use tax collection obligation on a remote seller or Internet retailer without a physical presence in a state. Amazon has reportedly agreed to lobby for such federal legislation and, in a press statement, said: “This [California] legislation will allow us to continue to work with Congress and the states to obtain a federal resolution to the sales tax issue as soon as possible.”

Here’s how the repeal works (if signed by Governor Brown):

• The California affiliate nexus provisions of ABX 1-28 enacted on June 28 are repealed and no longer of any effect, and also will not be enforced with respect to the period from June 28 through the effective date of AB 155 (i.e., the date Governor Brown signs the bill);

• If no federal legislation is adopted over-ruling Quill before July 31, 2012, then the California affiliate nexus provisions (as re-stated in AB 155, with one important change, noted below) will become law on September 15, 2012;

• If federal legislation overturning Quill is adopted by July 31, 2012, and California does not implement the requirements of such a federal law by September 14, 2012, then the California affiliate nexus provisions (again, as restated in AB 155, with the change noted below) take effect January 1, 2013; 

• If federal legislation over-turning Quill is adopted by July 31, 2012, and California implements the requirements of such a federal law by September 14, 2012, then the affiliate nexus provisions of AB 155 will NOT take effect.

Note that the affiliate nexus provisions of AB 155 that may later take effect ― in the event that Congress either does not enact federal legislation overturning Quill or California does not act to implement such federal legislation ― have been modified under AB 155 to increase the minimum sales threshold, so that they now will apply only to retailers that have in excess of $1,000,000 in cumulative sales to California residents in a 12 month period (although only $10,000 of those sales need to come from sales referred by in-state web affiliates).

This is a lot to take in, and remote sellers making sales to California residents should consult their legal advisors with any questions. At a high level, as a result of AB 155, e-commerce businesses and direct marketers that engage in online advertising through California affiliates get a temporary reprieve of at least 12 months from the effects of the California affiliate nexus law, and can continue to use California publishers of online advertisements during that period. But, they will likely need to scrutinize their California web affiliate relationships again before September 2012 and keep track of federal and California legal developments until at least January 2013.

The larger issue confronting each remote seller, however, may be whether the compromise struck in California is consistent with their own company’s goals and interests, and with the continued development of e-commerce more generally. Affected online retailers and publishers should stay informed and engaged regarding developments affecting the authority of all states to impose use tax collection obligations on out-of-state businesses. The time for sitting on the sidelines and watching the contest play-out between retail behemoths and the states has passed.