Nexus: A Four-Point Refresher
Tax-savvy multichannel marketers know “nexus” isn’t a new hair product or a high-priced automobile. The term “nexus” (derived from a Latin word meaning “to connect”) refers to the amount of contact an out-of-state retailer must have with a state before that seller is legally obligated to collect sales tax from customers.
The Supreme Court’s landmark Quill v. North Dakota decision in 1992 made clear that, under the Commerce Clause of the Constitution, the nexus standard requires an in-state physical presence on the part of the retailer. In other words, mail order sales alone will not subject a remote seller to sales or use-tax collection obligations.
Nearly 16 years later, plenty of catalogers still struggle to find ways to avoid being subject to tax collection on sales to customers in various states. Here are four things to keep in mind in your efforts to avoid nexus.
1. Beware the Nexus Witch Hunt
Don’t overestimate the scope of the Quill decision. Many mistakenly believe the only way a catalog company can establish nexus is if it operates a facility in the state, such as a retail store, or if its employees enter the state to solicit sales or provide customer services. In reality, the comfort zone for direct marketers is quite tight, and there are numerous ways in which you inadvertently can fall into a nexus trap.
State revenue departments regularly conduct audits of unregistered retailers. Auditors closely scrutinize sellers’ business operations and marketing relationships to discover some basis — however remote — for asserting a nexus claim. In connection with these nexus witch hunts, state tax administrators often rely upon novel theories of tax liability, including so-called “agency nexus” and “affiliate nexus.”
2. Agency Nexus
The Supreme Court ruled back in 1960 that if an out-of-state retailer uses an in-state agent to perform services on its behalf, the agent’s physical presence will cause the remote seller to have nexus in the state. This is referred to as “attributional nexus.”
Some types of agency relationships are quite obvious. A sales rep will create nexus, even if the rep is an independent contractor who is compensated on a commission basis and who makes sales on behalf of multiple companies (i.e., not an exclusive sales rep).
Promotional activities can create nexus, even if the agent-promoter isn’t authorized to take customer orders. An agency relationship also can result from contracting with an in-state company to provide after-sale services to consumers.
For example, some direct marketers of computers and electronic equipment offer their customers on-site installation and repair services, which actually are performed by local contractors. Unless the relationship is structured carefully, the in-state service provider will be treated as the retailer’s agent for nexus purposes. Another illustration of an agency relationship is when a remote seller authorizes an in-state company to accept product returns and issue customer refunds on its behalf.
The good news is that careful planning can enable a company to achieve its business objectives while avoiding agency relationships. One way of doing this is to restructure a business transaction. For example, for installation and repair services, the marketer should have customers contract directly with a local service provider. Here, the marketer facilitates the referral and possibly receives a referral fee, but does not itself enter into a contract with an in-state company for the provision of services to its customers.
Always be extremely cautious here. Once a retailer establishes nexus, its sales/use-tax collection obligation extends to all of its sales in the state, not just to those sales resulting from the agent’s activity. Moreover, in many states there’s no statute of limitations in regard to those years for which no tax returns were filed.
3. Affiliate Nexus
Another common misperception is that you can avoid tax liability by setting up a separate corporation for any nexus-producing activities, such as a sales division that employs a field-sales force or a retail-store affiliate. This has led some clicks-and-mortar retailers to book their catalog sales to what’s little more than a paper corporation in the false belief that such a legal nicety is sufficient to provide nexus protection.
Tax auditors may inquire as to whether affiliated companies:
● overlap directors and officers;
● share employees;
● intermingle their finances;
● sell out of a common inventory;
● lack arms-length intercompany transfer pricing for products and services; and
● integrate most management, administrative tasks.
The auditor tries to prove that the affiliated companies are managed, financed and operated as a single entity and thus should be treated as one company for tax purposes.
4. In-State Ownership of Tangible Personal Property
Even though a cataloger may have no facilities or personnel in a state, merely holding legal title to tangible personal property may create nexus. For example, you may own inventory in the warehouse of a company that provides fulfillment services, or a retailer that owns raw materials being processed at an in-state factory (e.g., textiles to be cut and sewn into apparel).
Even ownership of rolls of paper at an in-state printer could con-
stitute a sufficient “physical presence” to create nexus. (A number of states, however, have enacted safe-harbor provisions to exclude the ownership of paper and printed products located at a printer’s premises.) There may be relatively easy alternatives to holding title to personal property, while still enabling you, the direct marketer, to retain unfettered access and control over materials.
George S. Isaacson is a senior partner with the Lewiston, Maine-based law firm Brann & Isaacson. He represents multichannel merchants on tax matters, and is tax counsel to the Direct Marketing Association (DMA). Reach him at firstname.lastname@example.org.