September 17, 2018
Author: Jonathan L. Grob
Organization: McGrath North Mullin & Kratz, PC LLO
Nexus and Multiple States
A. Nexus Defined
The term “nexus” is a legal term used to refer to the minimum level of contact between a state (or other jurisdiction) and a taxpayer which is needed to allow that state to impose a tax on that taxpayer or a transaction completed by the taxpayer.
Under the U.S. Constitution, states may only impose a tax on a taxpayer, or require that taxpayer to collect and remit tax to the state (e.g. sales tax collection requirement), when that taxpayer has requisite “nexus” with that state. As an example, if the author, a Nebraska resident, purchases an item from a Nebraska retailer, the State of California cannot legally impose sales or use tax on that transaction. I do not have a sufficient contact with California to allow California to impose a tax on the transaction. However, if I was a California resident, I would have sufficient contact with California for California to impose a use tax on me from the purchase.
The leading U.S. Supreme Court case on state tax nexus for sales and use tax purposes is Quill Corp. v. North Dakota, a case decided in 1992. In Quill, the State of North Dakota attempted to require an out-of-state mail order house, which had no physical outlets or sales employees in North Dakota, to collect and pay a use tax on goods purchased by and sent to Quill’s North Dakota customers.
The U.S. Supreme Court analyzed North Dakota’s position under both the Due Process and Commerce Clauses of the U.S. Constitution. The Due Process Clause generally requires some minimum connection between a state and the property, person, or transaction which the state seeks to tax. The Court held that North Dakota’s tax imposition did satisfy the Due Process Clause.
However, the U.S. Supreme Court held that the Commerce Clause of the U.S. Constitution required that there be a “substantial nexus” between the activity at issue and the taxing state. For sales and use tax purposes, this “substantial nexus” meant that a taxpayer or tax collector must have a physical presence in the state which is beyond a de minimis presence. The Court ruled that Quill Corp. did not have such physical presence in North Dakota, so North Dakota did not have jurisdiction to impose sales or use tax on Quill.
As you may be aware, the Commerce Clause of the U.S. Constitution literally states that Congress shall have power \"To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes.\" The “dormant Commerce Clause” is a legal doctrine which has been inferred from this provision. The concept behind the dormant Commerce Clause is that the clause’s grant of power to Congress also implies a restriction which prohibits a state from passing laws that improperly burden or discriminate against interstate commerce in favor of intrastate commerce. The restriction will apply even when Congress has not passed a statute governing an area of commerce.
When there is no federal statute, the Court will presume that this has meaning and that Congress does not want regulation in the area by the states.
Because the Supreme Court decided Quill under the dormant Commerce Clause, Quill leaves open the ability for the U.S. Congress to pass a law eliminating the physical presence requirement in Quill. There have recently been several bills introduced in Congress which would eliminate the physical presence requirement and allow states to require internet and mail-order sellers to collect sales tax on those sales. These proposals appear to be attracting more support, so the author expects that Congress may act to require sales and use tax collection by internet and mail-order sellers in the near future.
B. Activities Which Constitute Nexus.
Quill imposes a physical presence standard, which is certainly met by having a physical location with employees in a state. Many state taxing authorities have taken the position that the commerce clause physical presence requirement can also be met by more subtle acts of presence. Each year the Bureau of National Affairs, or BNA, a reporter of legal tax issues for practitioners, publishes an annual survey of State Tax Departments. In this survey, taxing authorities list those activities which they believe gives a company nexus, for sales tax purposes, in their state. For your reference, I have included a partial listing of activities which the Nebraska Department of Revenue considers as creating taxable nexus in Nebraska for sales and use tax purposes:
• Reimbursements of in-state salespeople for home office costs
• The company sells property to Nebraska residents and has employees visit Nebraska four or more times in a year
• The company sells property to Nebraska residents and authorizes employees or independent salespeople to solicit Nebraska sales
• The company sells property to Nebraska residents and authorizes employees or third parties to resolve customer issues or provide training to Nebraska customers
• The company sells property to Nebraska residents and delivers such property to Nebraska residents by its own fleet of vehicles
• The company sells property to Nebraska residents and ships its products to an independent distributor who labels, packages and ships such products
• The company sells property to Nebraska residents and has its employees attend a Nebraska trade show (even where no sales or orders are taken at such show)
• The company sells property to Nebraska residents and has its employees occasionally enter Nebraska to meet with suppliers
• The company sells property to Nebraska residents and hires an independent call or fulfillment center to process orders derived primarily from residents of other states
A full listing of activities is available in the study. In summary, it is clear that states view physical presence as being met in a number of subtle ways that many businesspeople would not consider. When undertaking any activity in a new state, it is best to consider the potential tax ramifications of such activity.
C. Sales To Customers In Other States
Nebraska law specifically exempts the following sales to customers in other states:
• An amount charged for the fabrication, production, installation, or application labor of property owned and furnished by an in-state or out-ofstate customer which is fabricated in Nebraska and then shipped by the Nebraska retailer performing the fabrication to a point outside Nebraska.
• Property shipped outside Nebraska pursuant to a sales contract calling for out-of-state delivery by the retailer, or delivery by the retailer to a carrier, to the post office, or to a forwarding agent for its shipment out-of-state, to be installed/used in another state.
In addition to this exemption, Nebraska’s sales tax sourcing rules may independently limit Nebraska’s ability to impose sales or use tax on sales to out-of-state customers. These sourcing rules are discussed in more detail in Section E of this outline.
D. Mail Order Sales
A company must collect sales tax on a mail order sale into a state if a state imposes such a collection requirement on that sale, because the sale is sourced to that state and no exemption applies to the sale, and if the seller has taxable “nexus” in the state (as discussed above). If one of the above requirements is not met, the seller generally need not collect sales tax (although the seller can voluntarily collect tax if the seller does not have taxable nexus in the state). So, for sales tax purposes, the relevance of having “nexus” is largely the collection requirements placed on the seller. Companies with a physical presence in the state certainly have taxable nexus in the state. The collection requirement generally applies to such sellers. For example, Wal-Mart collects Nebraska sales tax on orders made over their website which are shipped to Nebraska customers by mail. Wal-Mart, by virtue of its physical locations in Nebraska, certainly has taxable nexus here and thus has a collection requirement. On the flip side, Amazon generally does not collect Nebraska sales tax on orders made over its website which are shipped to Nebraska customers. Amazon has taken the position that it does not have Nebraska taxable nexus and thus does not have to collect Nebraska tax.
In Nebraska, sellers who are required to collect Nebraska sales tax should ensure that they are collecting the correct amount based on the address where the sale is sourced. Many areas outside a city pay only the state 5.5% tax rate; cities collect between .5% and 2% local tax, which makes the total rate anywhere between 5.5% and 7.5%. The total rate for a particular location can be confirmed via an address verification program on the Department of Revenue’s website.
E. Sourcing Rules
Nebraska has adopted the sales tax sourcing rules of the Streamlined Sales Tax Agreement. The determination of whether a sale or use of property or the provision of services is in this state shall be governed by the following sourcing rules (except as noted by a more specific rule below):
1. When the property or service is received by the purchaser at a business location of the retailer, the sale is sourced to that business location.
2. When the property or service is not received by the purchaser at a business location of the retailer, the sale is sourced to the location where receipt by the purchaser or the purchaser's donee, designated as such by the purchaser, occurs, including the location indicated by instructions for delivery to the purchaser or donee, known to the retailer.
3. When the above rules do not apply, the sale is sourced to the location indicated by an address or other information for the purchaser that is available from the business records of the retailer that are maintained in the ordinary course of the retailer's business when use of this address does not constitute bad faith.
4. When the above rules do not apply, the sale is sourced to the location indicated by an address for the purchaser obtained during the consummation of the sale, including the address of a purchaser's payment instrument, if no other address is available, when use of this address does not constitute bad faith.
5. When the above rules do not apply, including the circumstance in which the retailer is without sufficient information to apply the above rules, then the location will be determined by the address from which property was shipped, from which the digital good was first available for transmission by the retailer, or from which the service was provided disregarding for these purposes any location that merely provided the digital transfer of the product sold.
For the lease or rental of tangible personal property, other than property identified in a specific rule below, the following sourcing rules apply:
1. For a lease or rental that requires recurring periodic payments, the first periodic payment is sourced the same as a retail sale in accordance with the rules for the outright sale of property.
2. Periodic payments made subsequent to the first payment are sourced to the primary property location for each period covered by the payment. The primary property location shall be as indicated by an address for the property provided by the lessee that is available to the lessor from its records maintained in the ordinary course of business when use of this address does not constitute bad faith. The property location shall not be altered by intermittent use at different locations, such as use of business property that accompanies employees on business trips and service calls.
3. For a lease or rental that does not require recurring periodic payments, the payment is sourced the same as a retail sale in accordance with the rules for the outright sale of property.
The lease rules are not intended for leases or rentals based on a lump-sum or accelerated basis or on the acquisition of property for lease.
The lease or rental of motor vehicles, trailers, semitrailers, or aircraft that do not constitute specialized transportation equipment, as noted in more detail below, shall be sourced as follows:
1. For a lease or rental that requires recurring periodic payments, each periodic payment is sourced to the primary property location. The primary property location shall be as indicated by an address for the property provided by the lessee that is available to the lessor from its records maintained in the ordinary course of business when use of this address does not constitute bad faith. This location shall not be altered by intermittent use at different locations; and
2. For a lease or rental that does not require recurring periodic payments, the payment is sourced the same as a retail sale in accordance with the rules for the outright sale of property. Again, these lease rules are not intended for leases or rentals based on a lump-sum or accelerated basis or on the acquisition of property for lease.
The retail sale, including lease or rental, of specialized transportation equipment shall be sourced the same as a retail sale in accordance with the rules for the outright sale of property. Specialized transportation equipment for which these rules apply means any of the following:
(a) Locomotives and railcars that are utilized for the carriage of persons or property in interstate commerce;
(b) Trucks and truck-tractors with a gross vehicle weight rating of ten thousand one pounds or greater, trailers, semitrailers, or passenger buses that are (i) registered through the International Registration Plan and (ii) operated under authority of a carrier authorized and certificated by the United States Department of Transportation or another federal authority to engage in the carriage of persons or property in interstate commerce; (c) Aircraft operated by air carriers authorized and certificated by the United States Department of Transportation or another federal authority or a foreign authority to engage in the carriage of persons or property in interstate or foreign commerce; and (d) Containers designed for use on and component parts attached or secured on the items set forth in items (a) through (c) above.
If a sale is not sourced to Nebraska under the above rules, it should not be subject to Nebraska sales or use tax.
STATEMENT REGARDING THESE MATERIALS
This publication should not be considered as legal, tax, business or financial advice. This publication is designed to provide information about the subject matter covered. It is provided with the understanding that while the author is a practicing attorney, neither he nor McGrath North has been engaged by the reader to render legal or other professional service (unless a specific engagement agreement has been executed). If legal advice or other expert assistance is required by the reader, the services of a competent professional should be sought.