Despite Unconstitutionality, Kentucky Enacts Consumer Use Tax Notification Requirement for Out-Of-State Retailers

On April 4, 2013, Kentucky Governor Steve Beshear signed into law HB 440. The bill includes an amendment to Kentucky’s tax code which will impose a new requirement on every retailer that makes sales into Kentucky from outside the state and that is not required to collect Kentucky use tax. The law requires that these retailers provide a notice to their customers that Kentucky purchasers are required to report and pay use tax directly to the Kentucky Department of Revenue. A similar provision enacted in Colorado in 2010 as part of a broader notification and reporting bill was declared unconstitutional by a federal judge in Direct Marketing Association v. Huber, a case now on Appeal before the 10th Circuit Court of Appeals. Brann & Isaacson is counsel to the DMA in the Colorado litigation.

While three other states—Oklahoma, South Dakota, and Vermont—have similar consumer use tax notification requirements on the books, Kentucky’s new law is more aggressive:

First, on its face, Kentucky’s law requires retailers to use “the exact required use tax notification language” set forth in the statute concerning compliance with Kentucky law, and does not include a substantial compliance provision likes other states. According to the statute, even if a seller already has a notice provision for other states, that notice provision is only adequate for purposes of Kentucky law “if the consolidated notification meets the requirements of this section.” In other words, only the “exact” language of the Kentucky law, and not something substantially similar that a retailer adopts in response to another state’s notification law, appears to be allowed.

Second, the Kentucky statute expressly applies to “online auction Web sites.” It is not clear whether the requirement is meant to apply to the auction site itself, or whether it means that retailers selling through an auction site must arrange for display of the notice with respect to their own sales. But note that there is a small seller exemption that exempts any retailer with sales of less than $100,000 to Kentucky residents from having to comply with the statute.  This may lessen the impact of the Kentucky law on Internet auction sites.

Third, while South Dakota and Vermont each provide that there can be no civil or criminal penalties for a retailer’s failure to comply with the use tax notification provision, Kentucky has no such non-enforcement clause. The Oklahoma statute is likewise silent on enforcement and, in practice, the Oklahoma notice law has not been enforced by the state’s Tax Commission. It remains to be seen whether the Kentucky Department of Revenue will bring enforcement actions, but nothing in the new law appears to prevent it.

For more details on the new Kentucky consumer use tax notification statute and how it might affect an out-of-state retailer’s website check-out screens and catalog order forms, ecommerce vendors and other remote sellers should consult their tax advisors.

Oklahoma Adopts a Gross Receipts Tax Providing for “Economic Presence” Nexus

Oklahoma has been in the news recently because of its enactment of a controversial sales tax statute, similar to the Colorado statute, that requires companies which do not collect and remit the Oklahoma sales and use tax because of their lack of physical presence to provide notification to Oklahoma purchasers of the purchasers’ obligation to remit sales and use tax.  (See our related blog posts of June 24, July 1, and July 9.) In addition, Oklahoma has recently adopted a Business Activity Tax, which is in lieu of the franchise tax, and which requires any company with sales greater than $500,000 to Oklahoma destinations, regardless of the company’s physical presence in Oklahoma, to pay a tax of 1% of its gross sales revenue to Oklahoma residents.  The Business Activity Tax legislation, like the sales tax legislation, ignores the Quill physical presence test, and bases nexus on the “economic presence” of an out-of-state company; i.e., greater than $500,000 of gross receipts from an Oklahoma source.  The Business Activity Tax, insofar as the tax on gross receipts, does not go into effect until calendar year 2013.

As we wrote in our prior blog posts with regard to other state statutes based on an economic presence, the Oklahoma statute raises significant constitutional concerns.   There is good U.S. Supreme Court precedent that stands for the proposition that the Quill/Bellas Hess physical presence standard of nexus applies to gross receipts taxes.  See Tyler Pipe Industries, Inc. v. Washington Department of Revenue, 483 U.S. 232, 107 S.Ct. 2810 (1987); Commonwealth Edison Company v. State of Montana, 453 U.S. 609, 101 S.Ct. 2946 (1981).

Oklahoma (again)!

This post is not a repeat of the successful musical. Rather, it is yet another blog post on the Oklahoma tax statute to supplement our posts of June 24 and July 1. The Oklahoma Tax Commission has recently proposed emergency regulations that purport to implement the notice requirements of the recently-adopted Oklahoma statute. As reported in our blog post of June 24, the Oklahoma statute is “Colorado-like,” inasmuch as it requires notice with each sale to an Oklahoma consumer by a direct marketer that does not have substantial nexus with Oklahoma. However, the statute provides that the notice is not effective until the Tax Commission has adopted regulations implementing the statute. Hence, the proposed regulations circulated by the Tax Commission, which become effective when approved by the governor.

The regulations require that the “required notice” be included (i) on the retailer’s website or in the retailer’s catalog; and (ii) on each invoice provided by the retailer. The regulations also prescribe that if the retailer does not provide invoices, the retailer must send a confirmatory email containing the required notice. The “required notice” must include the following disclosures:(1) the retailer is not required to collect, and does not collect, Oklahoma use tax; (2) the purchase is subject to Oklahoma use tax, unless exempt; (3) the purchase is not exempt because it is made over the Internet, by catalog or other remote means; (4) the State of Oklahoma requires Oklahoma purchasers to report, by filing a consumer use tax return or disclosing the same on the individual income tax return, all use tax due on out-of-state purchases and to pay such tax with the report or return; and (5) the forms and instructions for consumers to report and pay the Oklahoma use tax are available on the Oklahoma Tax Commission web site, www.tax.ok.gov.

There are significant issues regarding the proposed regulations. They go beyond the statutory authorization. First of all, there is no requirement in the statute for email confirmation if the retailer does not use invoices. Second, the detailed specifications of the notice, as set forth in the proposed rule, go well beyond the requirements of the statute and will place significant burdens on remote sellers. Third, the statute does not appear to require both notice on the retailer’s Internet website and inclusion of notice on invoices.

In addition to the fact that the proposed regulations exceed the requirements of the statute, the regulations, in combination with the statute, present significant questions of violation of the Commerce Clause of the U.S. Constitution. These are similar to those raised by the Colorado statute and regulations. See our blog post of July 2.

Oklahoma Seeks to Expand the Definition of Nexus for Internet and Catalog Retailers

In our blog post last week, we discussed the new Oklahoma sales tax statute, which contains a “Colorado-like” reporting requirement for those Internet and catalog sellers that do not collect and remit the Oklahoma sales and use tax. As a second part of the statute, the Oklahoma legislature also expanded the definition of those companies that are engaged in the business of selling tangible personal property for use in Oklahoma; i.e. those companies required to register to collect and remit the Oklahoma sales and use tax.  This part of the statute, like the reporting requirements section, is not the model of clarity, so there is some ambiguity in the statute.

First, the statute provides for “affiliate nexus” attribution. Thus, under the new law a retailer that otherwise does not have nexus based on its own activities (an out-of-state retailer) is deemed to have nexus if it and another retailer that has nexus with Oklahoma are commonly-owned, and if: (i) the Oklahoma-retailer sells the same or a “substantially similar” line of products under the same trade name as that of the non-nexus retailer (the so-called multi-channel retailer); (ii) the facilities or employees of the Oklahoma retailer are used to advertise, promote or facilitate sales by the out-of-state retailer; or (iii) the in-state retailer has a warehouse or similar place of business in Oklahoma that is used to deliver property to the out-of-state retailer’s customers, as in a drop ship relationship. Additionally, any retailer that is part of a controlled group (as defined under the Internal Revenue Code) faces a rebuttable presumption that it is engaged in business in Oklahoma if a component member of the controlled group is engaged in any of the activities described above. The presumption can be rebutted if the retailer shows that the component member did not do any of those activities on behalf of the retailer. The foregoing provisions are more comprehensive than those of other state statutes, which have some but not all of the provisions regarding common ownership. Colorado’s statute, for example, provides for a presumption of nexus similar to that described for members of controlled groups above and Arkansas’ statute contains a similar provision to that of the first category.

The statutory definition of retailer is also expanded to now include an out-of-state company that has a “contractual relationship with an entity to provide and perform installation or maintenance services for the retailer’s purchasers” in Oklahoma. This statutory provision is similar but not identical to that in Virginia. Va. Code § 58.1-612.

Of course, even if a retailer satisfies the standard under this new law, unless the retailer has nexus under the Quill Commerce Clause test, Oklahoma would not be justified in requiring sales tax collection from the retailer. Several of the provisions in the new law raise significant constitutional law questions. Please see, for example, the recent U.S. District Court for Louisiana decision in St. Tammany Parish Tax Collector v. Barnesandnoble.com, Civ. Act. No. 05-5695 (E.D. La., March 22, 2007).

Oklahoma’s New “Colorado-Like” Statute

As we have written in several previous posts, Colorado enacted an onerous reporting requirement for those remote sellers that do not collect and remit the Colorado sales and use tax. The Colorado statute requires such remote sellers to provide three types of notices that they do not collect the Colorado sales and use tax, even though they do not have nexus with Colorado under the Quill standard.  Brann & Isaacson, on behalf of the Direct Marketing Association, will be challenging the constitutionality of the statute in a suit to be filed shortly, because the Colorado statute applies to companies that lack nexus.

On June 9, Oklahoma enacted a “Colorado-like” statute, HB 2359, that requires that any retailer that sells tangible personal property to Oklahoma residents must “provide notification on its retail Internet web site or retail catalog and invoices provided to its customers that use tax is imposed and must be paid by the purchaser.” (emphasis added). The statute is Colorado-like in the sense that retailers without nexus are required to provide notice regarding the fact that sales and use tax is due on purchases, but it does not contain the Colorado provisions requiring retailers to provide annual notice (i) to purchasers of the volume of their purchases and that tax should be remitted to the Department of Revenue; and (ii) to the Department of Revenue of their Colorado purchasers and the volume of purchases made during the preceding year. Thus, the Oklahoma statute does not require annual notice to customers of their purchases in the preceding year or an annual report to the Oklahoma Tax Commission, the agency responsible for enforcing the sales tax law, of Oklahoma purchasers from the retailer.

Even the notice that is required under the Oklahoma statute is different than that required under the Colorado statute. The law requires notice on the “Internet web site or retail catalog and invoices provided to consumers.” The use of the word “or” in the statute indicates that a retailer has a choice. It can provide notice on its web site or it may insert notice in its retail catalog and any invoices provided to consumers. It is unclear whether that was the intent of the legislators when adopting the statute. But that is irrelevant, given the statutory interpretation principle that resort to legislative history is permitted only when a statute is ambiguous. There is no ambiguity in the statute. It clearly gives the retailer the choice. The statute did not use the conjunctive phrase “and” between “Internet web site” and “retail catalog and invoices.”

Even if notice is not provided on the web site, a good argument can be made that notice in the catalogs alone is sufficient if the retailer does not provide invoices. We know that many online sellers do not provide invoices. Again, the language of the statute provides for notice in the catalog “and invoices provided to its customers.” So, if a retailer does not provide invoices to customers, under the literal language of the statute the retailer would not be required to provide the notice.

It should also be noted that, although the statute is effective as of July 1, 2010, the notice provisions are not effective until the Oklahoma Tax Commission has adopted a rule implementing the statute. Thus, we will need to review the rule when adopted in order to assess the kind of notice that Oklahoma Tax Commission feels is required.

NEXUS: Quill Physical Presence Test Should Apply to Gross Receipts Taxes

Since National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967), was decided in 1967, states have attempted to avoid the physical presence test of nexus that the National Bellas Hess case established.  Thus, in the 1980’s, the Pennsylvania Department of Revenue argued that that our client, L. L. Bean, Inc., was required to collect Pennsylvania sales and use tax on all of its sales into the state because the mail order industry had changed since National Bellas Hess was decided.  The Pennsylvania Commonwealth Court squarely rejected this challenge to National Bellas Hess.  L. L. Bean, Inc. v. Department of Revenue, 516 A.2d 820 (Pa. Cmwlth. 1986).

Similarly, the State of California threatened assessment of 300 direct marketers on the ground that they had nexus with California because of their use of 1-800 numbers and acceptance of credit cards.  On behalf of the Direct Marketing Association, Brann & Isaacson sued in federal court, and the Ninth Circuit issued a judgment in favor of the DMA, on behalf of its members, declaring that in the absence of a physical presence in a state, a company is not liable for sales and use tax in that state.  DMA v. Bennett, 916 F.2d 1451 (9th Cir. 1990), cert. denied, 500 U.S. 905 (1991).

The states’ next test case, Quill v. North Dakota, 504 U.S. 298 (1992) (Brann & Isaacson filed an amicus curiae brief on behalf of the DMA in Quill), was yet another unsuccessful effort by the states to overrule and/or limit the physical presence test.

The states’ latest efforts to limit the nexus test under the Commerce Clause by adoption of an economic presence test to measure nexus for gross receipts tax should also be rejected.

Michigan (in the Michigan Business Tax (“MBT”)), Ohio (in the Ohio Commercial Activity Tax (“CAT”), Texas (in the Texas Margin Tax), and Washington (most recently in the May 2010 amendments to its Business and Occupation Tax), however, have asserted that the Quill physical presence test does not apply to gross receipts taxes, but is limited to sales tax.  Citing a footnote in the Quill decision, these states argue for a different standard; namely that the mere economic presence of a taxpayer by sales into the state should create nexus.

The states fail to recognize, however, the U.S. Supreme Court’s decision in Commonwealth Edison Company, et al. v. State of Montana, 453 U.S. 609, 101 S.Ct. 2946 (1981), which applied a physical presence test to a gross receipts tax.  In that case, the Court addressed the standard to apply to a Montana severance tax on coal extracted from Montana mines, which was a gross receipts tax.  Although the Court upheld the constitutionality of the tax, the Court noted the physical presence standard for determining  nexus.  In particular, the Court cited National Bellas Hess as the standard for finding nexus.  The physical presence test of National Bellas Hess doctrine was confirmed in the Quill case in 1992.

The states’ argument also ignores the fair relation prong of the Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977) test.  The fair relation prong requires that there be a fair relation between a tax and the benefits conferred upon the taxpayer by the State.  Although the Court has not required a detailed accounting of the services the states provide in order to be able to tax, the taxpayer must be engaged in some activity in the state in order to be subject to tax.  Thus, in Oklahoma Tax Commission v. Jefferson Lines, Inc., 514 U.S. 175 (1995), the Court defined the fair relation prong as follows “Complete Auto’s fourth criterion asks only that the measure of the tax be reasonably related to the taxpayer’s presence or activities in the state.” (Id. at 200, citing Commonwealth Edison Company v. Montana as setting forth the applicable standard).  Clearly, if the taxpayer lacks any physical presence in the state, the fair relation prong of Complete Auto cannot be satisfied.

In short, Complete Auto, Commonwealth Edison Company, and Oklahoma Tax Commission provide one basis to resist a state’s gross receipts tax enforcement efforts against online companies and direct marketers that lack a physical presence in the state.