More Cautionary Tales of State Tax Laws With Retroactive Effects

We have written before about retroactive tax laws, but there is reason for concern that the phenomenon of states resorting to retroactivity may be on the rise. In the most recent case to wind its way to the end of the state appeal process, the Michigan Court of Appeals upheld a statute that amended Michigan’s use tax code with an effective date 5 years prior to its enactment. General Motors Corp. v. Department of Treasury, 290 Mich. App. 355 (2010), appeal denied, 489 Mich. 991 (2011), and cert. denied, 132 S.Ct. 1143 (2012). The Michigan Supreme Court denied review in the case last year, and the U.S. Supreme Court refused to review the decision a few weeks ago, in late January 2012. The decision by the GM Court, which cited the Kentucky case discussed in our earlier blog post, Miller v. Johnson Controls, 296 S.W.3d 392 (Ky. 2009), rehearing denied (2009), and cert. denied, 130 S.Ct. 3324 (2010), suggests that the legal standard a state must satisfy to amend its tax law retroactively is, in many instances, not very exacting.

GM concerned a statute passed by the Michigan legislature to block the giant automaker (and potentially other companies) from obtaining a refund of use tax paid on “demonstration” vehicles driven temporarily by GM employees, but expressly held by GM in inventory for resale, and later sold to consumers. Over the years, GM had paid tens of millions of dollars in use tax based on the Michigan Department of Treasury’s enforcement position, asserted in audits of the company, that GM was required to self-assess and pay Michigan use tax as a result of its employees’ temporary use of the vehicles in the state.

However, in 2006, the Michigan Court of Appeals held (in a case involving auto dealerships) that such demonstration vehicles acquired and held for resale were not subject to use tax, and that interim employee use did not result in conversion of the autos’ use to a taxable use, as the Department argued. The Michigan Supreme Court affirmed the relevant portion of the Betten decision in 2007. Betten Auto Center, Inc. v. Department of Treasury, 272 Mich.App. 14, 20-22 (2006), aff’d in pertinent part, 478 Mich. 874 (2007).

GM promptly filed refund claims for prior years seeking more than $115 million in overpaid use tax. On top of that, the Michigan Department of Treasury estimated that, for all potential claimants, the total refund exposure to the state was in excess of $250 million.

To prevent the risk of a substantial loss in (erroneously) collected revenue, the Michigan Legislature also took swift action. In October 2007, the legislature enacted a law that preserved the Betten decision as to the specific taxpayers in that case (the auto dealerships), but retroactively amended the use tax to codify the Department’s “conversion to a taxable use” approach, effective as of September 30, 2002. The law made clear that the Legislature’s intent was to deny any claim for a resale exemption by another taxpayer based on the Betten decision. The Department thereafter denied GM’s refund claims, and the company sued, asserting multiple constitutional violations, including a deprivation of its due process rights.

Although GM prevailed before the lower court, the Court of Appeals rejected GM’s claims for refund. The Court agreed with GM that the change in the use tax law did not merely clarify the existing tax code, but in fact effected a substantive change. However, the Court stressed that, under applicable Supreme Court precedent, including United States v. Carlton, 512 U.S. 26 (1994), taxpayers have no vested right in the continuance of any tax law (and generally no claim for an unconstitutional taking of property under the tax code, except where laws are so arbitrary as to be confiscatory). As a result, the court found tax laws are generally subject to the relatively lenient standards of “procedural” due process (as opposed to the more stringent standards of “substantive” due process applicable to vested or fundamental rights).

Under the procedural due process standard, the law’s retroactive application must merely be “rationally related to a legitimate legislative purpose.” The Court noted that Carlton and other Supreme Court decisions establish that the goal of preventing a “significant and unexpected revenue loss” has been repeatedly upheld a legitimate purpose, to which a change in the tax code is rationally related. The Michigan Court also rejected the claim that a five year period of retroactivity was excessive, holding that there is no fixed limit on the period of retroactivity, and that such determinations must be made on a case-by-case basis.

It remains to be seen how far states will push the concept of retroactivity. As a matter of enforcement practice, the New Jersey Division of Taxation announced in early 2011 that it intended to apply the principles of “economic nexus” to require payment of the New Jersey Corporation Business Tax by out-of-state service providers with customers in the state, effective for all periods after January 1, 2002 ― a retroactive look back period of 9 years. In Connecticut last year, the legislature adopted an “affiliate nexus law” with a future effective date. Then, after Amazon.com terminated its Connecticut affiliates, the legislature amended the law to give it a retroactive effective date, prior to the date Amazon sent its termination letters. (There have been no reports that the Connecticut Department of Revenue Services has sought to enforce the law retroactively, however.)

Many state legislators and tax officials likely recognize the policy concerns raised by amending tax laws retroactively, but in tough economic times, the Supreme Court’s recent refusal to review the GM case may further embolden state legislatures and revenue departments seeking retroactive enforcement of tax law changes. Remote sellers and Internet retailers should be watchful and aware of the risks of such efforts.

Tax Agencies Should Read the Language of the Statute and May Not Expand the Law’s Requirements

As some of our readers are aware, on June 28, 2011, California’s Governor Brown signed into law a bill (ABX1 28) that provides for “click-through nexus” under certain circumstances. This law is similar to “click-through nexus” legislation adopted in New York, Rhode Island, North Carolina, and Arkansas (which we have written about extensively in the past), inasmuch as it creates a rebuttal presumption of nexus if a company’s annual sales to California exceed $500,000 and if the company’s California sales exceed $10,000 from links or other referrals from companies (“affiliates”) who receive a commission from such referrals.

Unlike the Illinois and Connecticut statutes, which automatically create nexus in the event that sales from affiliates exceed the threshold, the California law provides that the retailer can rebut the determination of nexus based on affiliate relationships. Nevertheless, in a recent notice issued by the California Board of Equalization (Notice L-284, issued July 2011), the Board states that there are only two conditions to a finding that a retailer must be registered for sales and use tax collection: (1) that sales from affiliates exceeded $10,000 in the last 12 months; and (2) that the retailer’s total sales to California exceed $500,000 in the last 12 months. According to the Board, if a business meets the foregoing requirements and is not already registered with the Board, it must complete a “California Certificate of Registration—Use Tax.”

The Board is simply wrong. It misses two sections of the newly-enacted statute. Section 6203(5)(E) provides as follows: “This paragraph shall not apply if the retailer can demonstrate that the person in this state with whom the retailer has an agreement did not engage in referrals in the state on behalf of the retailer that would satisfy the requirements of the commerce clause of the United States Constitution.” This is similar (but not identical) to the clauses in the New York statute that permit the retailer to show that the affiliates do not engage in any solicitation in the state. Similarly, Section 6203(5)(C) provides that “an advertisement on a web site will not create nexus if the person entering the agreement with the retailer also directly or indirectly solicits potential customers in this state through use of flyers, newsletters, telephone calls, electronic mail, blogs, microblogs, social networking sites, or other means of direct or indirect solicitation specifically targeted at potential customers in this state.” Many affiliate relationships are based on advertisements placed on web sites.

In short, it is important to read not only the notices you may receive from a state tax agency, but also to review the underlying legislation and regulations. State tax agencies simply cannot expand a law. Legislatures and Governors adopt laws. State tax agencies are entrusted with enforcing the laws, not creating them.

California Adopts New Nexus Statute

On Tuesday, Governor Jerry Brown signed into law California’s new nexus legislation.  The law, which took effect immediately, expands the scope of activities requiring out-of-state retailers to collect and remit California sales and use tax by expanding the definition of “retailer engaged in business” in California.

The newly amended section 6203 of the California Revenue and Tax Code provides that a retailer engaged in business in the State includes any retailer that:

• has substantial nexus with the State within the meaning of the Commerce Clause;

• is a member of a commonly controlled group of corporations that includes another member which performs services for the out-of-state retailer in California (including the design and development of TPP sold by the out-of-state retailer or the solicitation of sales on behalf of the out-of-state retailer); or

• enters into an agreement under which a person in California refers potential customers to the out-of-state retailer via the internet or other means in exchange for a commission or other consideration.

Similar to other state’s so-called “click-through” laws, California excludes from the definition of retailer out-of-state retailers that do not meet certain referral and sales threshold requirements.  In California’s case, an out-of-state retailer will only be considered a retailer engaged in business in the State if all sales by the retailer from in-state referrals exceed $10,000 for the preceding 12 months and if the retailer has at least $500,000 in total sales to California customers.

However, unlike other states, California’s click-through law actually applies to affiliate referrals regardless of the channel through which the out-of-state retailer receives its referrals.  While states like Illinois only include internet referrals in their nexus statute, California’s statute covers referrals from internet, television, radio, print, and other media in making the determination as to whether an out-of-state retailer is engaged in business in the State.

Also, unlike other state statutes, California’s new law states that, in the case of click-through, web-based affiliates, the in-state affiliate will only create nexus for the out-of-state retailer if, in addition to placing a link on its website, the affiliate also directly or indirectly solicits sales on behalf of the retailer through in-person, print, or electronic solicitation specifically targeted to potential California customers.

Finally, unlike other click-through states (with the exception of Illinois and Connecticut), the California statute does not specifically refer to any presumption of nexus which may be rebutted by the out-of-state retailer.  However, the statute does make it clear that the affiliate nexus provisions will not apply if the out-of-state retailer can show that its affiliates made no referrals in the State sufficient to satisfy the Commerce Clause.

Keeping in mind the statute has already gone into effect, retailers should make sure to consult with their tax advisors soon.  With that said though, we also advise our readers to have a safe and festive July 4^th holiday!

Connecticut Amends Its Affiliate Nexus Law To Mirror Illinois

We have written frequently in recent months about affiliate nexus legislation introduced this legislative session in a number of states, and enacted recently in Illinois, Arkansas, Connecticut and, on a deferred basis (to take effect only after 15 states have adopted similar legislation) Vermont. (A similar bill has been passed in California, but has not yet been signed by Governor Brown.) Nearly every such bill has closely paralleled the affiliate nexus law adopted in New York in 2008, which provides for a presumption of nexus that can be rebutted by a retailer if the retailer can establish that its in-state affiliates have not engaged in any active solicitation in the state, but have merely posted online advertisements on behalf of the retailer that link to the retailer’s website. Illinois was the only state to adopt a law without such a rebuttable presumption.

The Connecticut legislature has now amended the affiliate nexus statute it passed in May 2011, to eliminate the rebuttable presumption and, instead, to closely mirror the Illinois law. Connecticut HB 6652, signed by Governor Malloy on June 21, repeals the affiliate nexus statute adopted in May, and instead modifies the definition of “retailer” (as well as the definition of “engaged in business in the state”) to classify as a Connecticut retailer any company that has affiliate relationships with persons in Connecticut pursuant to which the affiliates refer customers to the retailer in return for commissions or other consideration based on sales, via an online link or otherwise. The retailer must realize cumulative gross receipts of at least $2,000 on sales to Connecticut customers as a result of such referrals in order to be “engaged in business in the state.” In addition, HB 6652 makes the change in the definitions of “retailer” and “engaged in business” retroactive to May 4, 2011 – prior to the date on which the previously enacted affiliate nexus law was even adopted.

It warrants mention that the Connecticut legislature amended its affiliate nexus statute after the Performance Marketing Association filed suit in federal court in Chicago challenging the constitutionality of the Illinois law. Brann & Isaacson represents the PMA in that action.

The Lone Star State Follows a Different Path Regarding Nexus

Bucking the trend of other states, Texas’ Governor recently vetoed proposed legislation to expand the scope of the Texas sales and use tax law regarding collection of sales and use tax. The proposed legislation—HB 2403—was approved by both houses of the Texas legislature, but vetoed by Governor Perry on May 31. This legislation was not as aggressive as that in other states that have recently adopted nexus legislation. (Illinois, Connecticut, Arkansas and Vermont are examples). It merely provided that a retailer has nexus with Texas if it has an affiliated company that operates a distribution center in Texas or if an affiliated company located in Texas performs services on behalf of the retailer or sells under the same brand name as the retailer. This was in part directed at the Amazon situation in which an affiliate of Amazon.com operated a distribution center in the state of Texas (that reportedly led to a $269 million assessment of sales tax by the Texas Comptroller of Public Accounts).

A piece of good news for sellers of digital goods does result from the legislature’s work on the bill. The legislation, as introduced, also provided that use by a remote seller of a website on a server in Texas from which digital goods are sold or delivered creates nexus. However, the House Committee that first reviewed the bill removed the language before submitting the bill to the full House for a vote. This may signify that such activity does not create nexus in Texas. But, before embarking on any such activity in Texas, a seller of digital products should examine carefully the Texas law and applicable constitutional cases in light of the proposed sales activity.

It is also noteworthy that Texas is not yet done. The legislature has before it in committee a Bill—HB 1317—that would be similar to the recently-enacted Arkansas and Connecticut laws that provide for a presumption of nexus for any retailer that pays a commission or other consideration to a company located in Texas which provides a link to the retailer’s website. While the legislature adjourned on May 31, it was back in session last week and this week to consider various budget-related issues, and may reconvene yet again. It may be that this click-through legislation would be deemed legislation that the legislature will be permitted to consider under its authorization for reconvening.

Stay tuned to developments in Texas.

UPDATE: SB1, currently under review by the legislature, has been amended to include the nexus legislation vetoed by the Governor on May 31, as discussed above.  We will track the progress of the Bill and keep you posted concerning any further developments.

Another State Adopts Nexus Click Through Legislation

Following the model of New York, Rhode Island, North Carolina and Arkansas laws, Connecticut recently adopted click-through nexus legislation that is effective on July 1, 2011. The new law states that any retailer that has an agreement with a Connecticut resident, under which the resident, for a commission or otherwise, refers potential customers (by a web site link or other contact) to the retailer, is presumed to have nexus with Connecticut if its sales as a result of such agreements in Connecticut exceed $2,000 for the preceding year. As is the case in the four states described above, the presumption can be rebutted by proof that the residents do not undertake in-state solicitation activities that would create nexus under the constitutional standard.

The Connecticut statute differs from the statutes enacted in New York and other states, in that the threshold for sales is a lower amount–$2,000 as opposed to $10,000 (or $5,000 in the case of Rhode Island). It also differs from the recently-enacted Illinois statute inasmuch as the Illinois statute does not permit a retailer to rebut a finding of nexus that is based upon a relationship with an affiliate located in Illinois that provides a link to a retailer’s Internet site that facilitates the sale of tangible personal property.

Additional States Introduce Affiliate-Nexus Legislation

On March 2, an Internet-affiliate nexus bill was introduced in the Arkansas State Senate (SB 738). Arkansas joins Arizona, California, Connecticut, Hawaii, Illinois, Massachusetts, Minnesota, Mississippi, New Mexico, Tennessee, Texas, and Vermont, as the thirteenth state this legislative season to consider such a measure. Nearly all of the bills -- with the exception of Illinois’s HB 3659, which was passed by the Illinois legislature and is now awaiting signature or veto by Governor Quinn, and Connecticut’s SB 5545 -- are patterned directly upon the New York affiliate nexus law enacted in 2008 and challenged in court, so far unsuccessfully, by Amazon.com. In other words, 11 of the 13 proposed laws create a rebuttable presumption that an out-of-state Internet retailer is obligated to collect and remit the state’s sales and use taxes if the retailer enters into an agreement with an in-state resident (an “affiliate”) pursuant to which the affiliate places a link from the affiliate’s website to the retailer’s site, and the retailer realizes at least $10,000 in sales to customers referred to it by the affiliate’s links. The presumption can be negated by proof that the in-state affiliates did not engage in any in-state solicitation on behalf of the retailer.

In its November 2010 ruling, the Appellate Division of the New York Supreme Court found that the ability of a retailer to rebut the presumption of solicitation was an important factor in determining that the New York law is not unconstitutional on its face. The Court, however, remanded the case for further proceedings on the issue of whether the law violates the Commerce Clause and Due Process Clause as applied to specifically to Amazon. As the ongoing proceedings in the New York case make clear, the constitutionality of such “New York-style” affiliate-nexus legislation is far from resolved.

At the same time, it is worth noting that the Illinois and Connecticut bills differ from the New York law in that neither bill provides that the presumption that a retailer must collect sales and use tax as a result of having in-state Internet affiliates may be rebutted. Imposing an irrebuttable presumption of nexus is highly suspect under both the Commerce Clause and Due Process Clause. Without a rebuttable presumption in place to protect retailers, Illinois and Connecticut would subject Internet retailers to burdensome state tax collection obligations when the retailers are effectively doing nothing more than advertising. For that reason, the progress of each of these bills bears watching. Stay tuned.

Maine Introduces Modified, Colorado-Style Notice and Reporting Law, Which Also Likely Violates The Commerce Clause

On February 9, 2011, the Maine Legislature introduced a bill (LD 469) which would impose upon certain out-of-state retailers a set of notice and reporting obligations that closely parallel the requirements of Colorado’s 2010 law, H.B. 10-1193. Enforcement of H.B. 10-1193 was recently enjoined by a federal judge in Denver on the grounds that such requirements are likely unconstitutional and in violation of the Commerce Clause. As we have reported in prior posts, Brann & Isaacson represents the Direct Marketing Association in the federal court challenge to the now-suspended Colorado law, after which the Maine bill is patterned.

Maine’s LD 469 includes all three of the Colorado law’s notice and reporting requirements – retailers must provide the Transactional Notice, Annual Purchase Summaries to customers, and Customer Information Reports to revenue officials – and would impose penalties on affected retailers for non-compliance with the law.  Notably, however, unlike the Colorado law, the Maine bill includes no $500 annual minimum purchase threshold to trigger the requirement that an affected retailer must send a customer an Annual Purchase Summary. Similar to Colorado’s law, under LD 469 such annual summaries to customers must include, if available, “[d]escriptions of items purchased,” as well as dates and amounts.  Also in contrast to Colorado, the report to Maine Revenue Services must include all of the information provided to each purchaser in the annual summary – thereby requiring that at least descriptions of the items purchased by customers of an affected out-of-state retailer be turned over to Maine Revenue Services. The Maine bill thus raises even more significant privacy concerns for Maine consumers buying from affected retailers than does the privacy-invading Colorado law.

The Maine bill also appears to differ from the Colorado law in another respect: whereas the suspended Colorado law applies, by its terms, to all out-of-state retailers that do not collect Colorado sales tax, LD 469 imposes its onerous notice and reporting obligations only upon companies that are presumed to be doing business in the state because they are members of a “controlled group of corporations” that has at least one member who is already a retailer with a physical presence in the state.  The Bill Summary states that “[t]his bill requires out-of-state retailers that are not required to collect sales tax and that are part of a controlled group of corporations with a connection in the State” to comply with the notice and reporting obligations. The apparent requirement that, to be subject to the law, an out-of-state retailer must have an affiliated retailer with physical presence in Maine, means that the proposed law would not apply to as broad a group of out-of-state companies as does the Colorado law.

What the sponsors of the bill apparently fail to recognize is that limiting the notice and reporting obligations to a more narrow group of out-of-state retailers who do not collect sales tax (i.e, only those who are part of a controlled group) does not change the fact that it discriminates against interstate commerce in violation of the Constitution. The Supreme Court has made it perfectly clear that a state cannot pick and choose which out-of-state companies it will discriminate against – even state laws that have imposed disparate treatment upon only a single out-of-state company that is not imposed upon in-state companies are virtually per se invalid under the Commerce Clause.

The prospects for passage of LD 469 are, at this point, entirely uncertain, so there is still time for Maine’s elected officials to avoid following in the footsteps of their Colorado counterparts.  In addition to running afoul of over 180 years of established constitutional law, LD 469 is simply bad policy – invading the privacy of Maine citizens should never be viewed as a proper approach to promoting use tax reporting.

Since the new year, several other states, including Arizona, California, Connecticut, Hawaii, Illinois, New Mexico, South Dakota, Vermont, and Texas, have introduced new notice and reporting bills, or “Amazon” affiliate-nexus legislation.  Stay tuned for an update on the progress of these bills.

California Nixes Affiliate Nexus Legislation; Connecticut’s Attempts Stall

Since our last update on the status of various legislative attempts to introduce Amazon-style affiliate nexus across the country, there have been a few important developments:

California

In the most current iteration of its bill, passed by the State Assembly on May 6, California scrapped proposed affiliate nexus and Colorado-style notice requirements (discussed here by us last month), and instead merely requires out-of-state retailers to provide notice on their websites and in their catalogues that California customers are required to remit use tax.  In the bill analysis provided by the Assembly’s Revenue and Taxation Committee, the Committee rightly noted that under Quill, California is constitutionally prohibited from collecting sales tax from out-of-state retailers with no physical presence in the State.  The Committee also noted that the bill provides no repercussions for non-compliant retailers.  The bill is now before the State Senate.

Connecticut

In Connecticut, the last action taken on H.B. No. 5481, the proposed affiliate nexus legislation, was on April 13.  The 2010 regular session of the State’s legislature adjourned on May 5 without holding any vote on the bill, and it appears that no affiliate nexus legislation will be enacted in the near future.


UPDATE, Aug. 31, 2010:  Please see our most recent post concerning the status of this California Bill here.

UPDATE, Jul. 5, 2011: California has enacted a new nexus law.

Update: Status of 2010 Affiliate Nexus Legislation

As we reported on March 9, New York-style “Amazon” affiliate nexus legislation was introduced in the 2010 legislative sessions of multiple states.  Even as the North Carolina Department of Revenue has introduced a program intended to entice retailers to register for sales and use tax purposes under its existing affiliate nexus statute (see our recent post for further discussion of the issue), other states are moving closer to adopting similar laws.  At the same time, affiliate nexus legislation has died, for this legislative season at least, in several states.  Here’s an update with regard to such legislation in a number of states:

Moving Forward:

• Connecticut: Bill favorably reported out of committee with recommendation that it “ought to pass”
• Minnesota: Committee hearing on bill scheduled for April 20
• Tennessee: Bill recommended for passage by Tax Subcommittee of Ways & Means, but Tennessee Department of Revenue has indicated that it does not believe mere affiliate relationship would be adequate for nexus

In Committee:

• California: Last action (re-referral to Committee on Appropriations) was April 28, 2010
• Illinois: Last action (referral) was March 19, 2010

Dead (it appears) for 2010:

• Iowa: General Assembly adjourned without acting on the bill
• Maryland: General Assembly adjourned without the bill getting out of committee
• Mississippi: Bill died in committee
• New Mexico: Bill tabled
• Vermont: Ways and Means Committee voted not to include affiliate nexus measure in tax legislation
• Virginia: Affiliate nexus legislation tabled in committee

UPDATE, Aug. 31, 2008:  Please see our most recent post concerning the status of the California Bill here.