Are you a remote seller looking to sell your goods or services online? If so, now’s a good time to take a quick, five-second litmus test – the answer could determine whether e-commerce may trigger significant sales tax costs to your company and you. Ready?
True or False: As a remote third-party seller, I only have to charge and collect state sales tax in those states where I am physically located regardless of where my online e-commerce partners are located.
If you answered “True” – you are wrong. If you are a remote seller who is ready to partner with a major e-commerce seller or commission-based online marketing firm, thinking that they will address remote state sales tax issues and spare you the headache of state-specific tax sales tax filing responsibilities and liabilities – you may be in for an unpleasant surprise that could cost your company as well as you personally. Why? We’ll discuss that later. In fact, these arrangements could turn into a nexus-generating nightmare.
How serious is this potential nightmare? The Multistate Tax Commission recently extended its Online Marketplace Seller Voluntary Disclosure Initiative period of August 17 – October 17, 2017 to November 1, 2017 to bring online remote sellers remedial relief.
Sure, the past decade has been a boon for online merchants – the cost efficiencies and market reach yield great returns. State tax administrators, meanwhile, have increasingly sounded alarms that their states are losing sales tax revenue directly from the shift away from in-store shopping to online purchasing by consumers. Why? The 1992 Supreme Court decision Quill Corp. v. North Dakota (“Quill”) held that a state could only collect sales tax from a retailer with a “substantial” physical presence in a state. Therefore, Quill significantly limits states from asserting sales tax jurisdiction on remote or online merchants.
Quill is now more than 25 years old. The Supreme Court could not have anticipated the explosive growth in e-commerce during this time – and it is believed that at least one member of the current Supreme Court has been eager to overturn or limit the decision.
States Go After Quill and Online Remote Sellers
Numerous states have adopted so called “click through” and “affiliate” sales tax nexus provisions that establish nexus for online and remote sellers who do not have “substantial” physical presences in their state under Quill. States that have enacted “affiliate nexus” legislation have provisions that establish nexus if an affiliate is in the state. “Click through” nexus is asserted if an unrelated entity receives a commission for directing customers to the online or remote seller. This is considered to constitute the requisite physical presence needed to collect sales tax.
In addition, several states, notably Maine and South Dakota, have enacted “economic nexus” legislation in direct challenge to the “substantial” physical presence requirement of Quill.
Massachusetts has defined “physical” presence to include the presence of cookies that remote or online sellers use to access such sellers’ websites on instate buyers’ mobile devices, laptops, or computers. This in effect expands Quill without challenging or attempting to overturn Quill’s “substantial” physical presence requirement.
Sales Tax: Your Company And You May Be Personally Liable
In most states, once a state can assert sales tax nexus over a company, causing the company to register as a sales tax vendor, the company enters into a fiduciary relationship with the state; i.e., the company is acting on behalf of the state in collecting the sales tax from its customer. The states further impose personal liability on each person in the company who is determined to be a responsible person. The definition of who may be a responsible person is state specific but generally includes owners, members, officers, and managers who may have any authority or responsibility with respect to determining the company’s sales tax compliance.
E-Commerce Joint Ventures: Online Remote Seller Nexus Minefield
Here are the two most common joint-venture scenarios that every online merchant, large and small, should be aware of, so they may plan for the myriad sales tax compliance and responsibilities that may result – or worse, address the liabilities for back taxes from states suddenly popping up out of the woodwork.
Scenario 1: Partnering With an E-Commerce Seller Fulfillment Center Provider
On the face of it, the appeal of partnering with a major e-commerce seller is obvious: Suddenly a whole new market of potential buyers opens up for your product, a reach that grows if your product is available through one- or two-day shipping options. But buyer beware: That ease of shipment is made possible by signing up with the e-commerce seller’s fulfillment program. The remote online seller agrees to ship its product in bulk to the major e-commerce seller’s warehouse, or warehouses at sites specified by the major e-commerce seller who then unilaterally decides when, and where, to move your inventory, without having to tell you until after the fact.
That’s where some interesting state sales tax implications come in. Even if you initially say you want your inventory housed in, say, just one or two states to limit your nexus footprint, the e-commerce seller could still move your product, at will, wherever it sees fit.
You, in turn, have suddenly relinquished control over how you manage your nexus – because physical presence includes inventory. Now, you suddenly have an unintended physical presence – i.e., your inventory, in any number of states, and your company and perhaps you personally are on the hook for sales tax obligations. Your company will also have state income tax responsibilities in each state where your company now has inventory.
Scenario 2: Click-Through Commission Structure
For companies seeking to avoid the potential state tax liabilities that participation in a fulfillment program presents, engaging in a click-through commission structure seems like an obvious alternative. In this scenario, a company may partner with an online advertising/marketing firm to showcase their product through personalized online ads – so, if a web user likes, say, golf, the accompanying ads will showcase ancillary products across sites he or she visits.
If a web user then clicks on one of these ads and buys your product as a result, the advertising firm may, in turn, generate a commission based on the purchase of the product. Here again, a multitude of sales tax issues may arise. To date, approximately 20 states require sales tax based on click-through nexus: So if your business contracts with another entity in such a state, which either directly or indirectly drives sales of your product through a web link, your own business is considered to maintain a physical presence in that state – regardless of where you store inventory.
Whichever Scenario You Choose, Know the True Tax Costs
Let’s break down the two scenarios to identify potential planning opportunities to minimize the sales tax nexus trap.
If a business is intent on partnering with an e-commerce seller, the first step is to assess the true cost of signing that agreement. That means a vendor should conduct a thorough state nexus analysis, assessing how many states they may get pulled into – as well as the accompanying sales and use tax, income tax, personal property tax, and gross receipt taxes that may ensue. Given that you may not know how many states your product will ultimately be stored in by the e-commerce seller, keep in mind that any analysis is a little like chasing a snowball down a ski slope. But it’s an essential exercise nonetheless.
Based on that analysis, there may be planning opportunities, such as establishing a separate legal entity that will solely focus on e-commerce in an attempt to isolate your e-commerce seller activities from your core business. But, again, be mindful that numerous states have adopted affiliate nexus provisions that will overcome separate legal entity isolation strategies.
A nexus diagnostic should vet all such scenarios, and the accompanying structural opportunities available to mitigate tax liabilities.
If, on the other hand, a vendor decides to partner with an online advertising/marketing firm, different planning is involved. Since most states’ “click through” nexus provision requires a commission fee arrangement – do not use a commission fee arrangement.
If, for business or other reasons, you must use a commission fee arrangement, the very first question that must be answered is: Where is the marketing/advertising firm located? Get it in writing, review it carefully, and require in the agreement that the online advertising/marketing firm inform your company of its locations on at least an annual basis.
If you then determine the firm is located in a state with click-through nexus provisions, you have one of two options: Assume you’ll have to file, collect, and pay state sales taxes, or change the nature of the engagement entirely.
In other words, rather than agree to a commission-based structure, you can opt for engaging the firm on retainer, thereby protecting your entity from tax liabilities in click-through nexus states.
Take the First Step
The internet is an attractive vehicle to grow your business. At the same time, any joint-venture engagement has potentially significant state and liability results.
Securing the right advice, based on consulting a tax and legal advisor, is absolutely paramount – before you ever hop onboard the e-commerce train. Otherwise, you won’t be running the locomotive; it may be running over you.