Multi-State Sales and Use Tax Attorneys
Multi-State Sales and Use Tax Attorneys
Multi-State Sales and Use Tax Attorneys
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Texas is one of many states beginning to tax software as a service. Known as SaaS, these new impositions of tax are still struggling with practical application. Software as a service typically includes a situation in which a software company develops software to be accessed via the internet. The software company then operates or hosts the website through which the software is accessed by customers online. It is important to note that customers do not possess or own the software; rather they pay for access to it online.

To understand the difference, let’s use the example of a video game. A user can purchase a game and access it remotely online. That would be considered software as a service. However, is the game allows users to download the program, that is not software as a service because the customer ultimately has possession of the software on his or her computer. The distinguishing feature of SaaS is that the user does not own or possess the software.

The type of SaaS addressed by Texas in a a recent letter ruling is one in which a customer uses a web-based dashboard application to receive and process data, translate and store messages, and create analytic reports for the customer’s use. The Taxpayer describes and markets their business as “a better, faster way to communicate with today’s customers.” By using a dashboard application, subscribing businesses communicate and interact with their customers via text and other types of mobile messaging channels. Customers are able to text questions, orders, etc. to the business directly. The Taxpayer reconfigures the incoming message from the customer and so that it can be displayed in English on the business’s dashboard application. Following that, custom or canned replies, or both, are reconfigured and sent back to the customer. Meanwhile the analytic services provided include the generation of reports on the number of requests per day, the categories of requests, and the average response times.

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Over the past several decades nexus has been at the forefront of the state and local tax world.  Since the Quill ruling in 1992, states have aggressively created ways in which a company can have a sufficient connection to their state.  Once the connection, or “nexus,” is made, a state can require a company to charge collect and remit sales tax to it.  As the economy has changed more to an online model, states continue to play catchup to get their fair share of the taxes.

Perhaps the most popular issue on a national multi-state tax level is whether a company has nexus with a state if they use the Fulfillment by Amazon (FBA) services.  In short, if Amazon houses a company’s inventory in a distribution center, does that inventory create nexus – ie – an obligation for that company to collect and remit taxes to that particular state.  That question has been affirmatively answered in most jurisdictions and companies have been blindsided by huge tax obligations often spanning many years.

For those companies that have been living in fear of large tax assessments, a Multi-State Tax Amnesty was recently released by the Multi-State Tax Commission (MTC).  Effective August 17, 2017 through October 17, 2017, several states will allowed companies who used FBA programs to come forward and comply.  Under the program, if a company complies, the state will forgive back taxes, interest and penalties in exchange for several requirements on a go forward basis.   To date, the participating states are:

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Tennessee has issued a notice stating that tours fall under the definition of “amusement” and are subject to sales and use tax. While amusements typically appear as places of amusement, such as amusement parks, concerts, and other shows, Tennessee also includes tours under that definition.

The first category of tours includes tours by vehicle. Included in this category are trolley tours, river cruises, and bus tours. Pub crawl tours on group bicycles probably fall under this category as well. Meanwhile, the second category of tours that are included under the definition of “amusement” are ghost tours, plant tours, pub crawls, etc.

This clarification is important for a state with a substantial amount of tourism. As the country music capital of the world, Nashville attracts many visitors who participate in these tours. However, the Department acknowledged that it is important to remember that exemptions exists to this rule. For example, tours conducted by a nonprofit, government agency, or for a Tennessee historic property are exempt from tax.

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As it turns out, Colorado really was just the beginning. As of January 1, 2018, Washington will begin requiring remote sellers to either remit sales and use tax or comply with reporting and notice requirements similar to those in Direct Mktg. Ass’n v. Brohl (DMA IV), 814 F.3d 1129 (10th Cir. 2016). Who is subjected to this burden in the land of Nirvana and the Space Needle? Remote sellers with gross receipts in the current or preceding year of at least $10,000 are, which makes Washington state another to skirt around Quill, the SCOTUS case that requires actual, physical presence for a state to have nexus with a taxpayer, with a reporting requirement.

But the legislative change goes further. Not only are retailers who make income from sales within the state required to follow this, but referrers who receive income from referral services within the state are subject to it as well if the total gross income from that is at least $267,000.

With 33 states facing revenue shortfalls in fiscal years 2017 and 2018, there is no doubt a need to increase taxes. However, states can go about this in a wide variety of legal ways. They can expand the tax base by taxing services or currently nontaxable technology. They can even increase the tax rate if they want to. Instead, Washington is imposing these reporting requirements to reach companies with whom they fail to meet the nexus standard to impose collecting and remitting requirements.  This overreaching of the states will likely be challenged. The question is: by whom?

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The United States Constitution expressly forbids ex post facto laws with respect to both the federal and state governments.[i] An ex post facto law is one that retroactively changes the legal status and consequences of a particular action. The easiest way to understand it is in the criminal realm. Today, I ate a yogurt. Two years from now, the government passes a law saying it is a third-degree felony to eat yogurt and makes the law retroactive for a 5-year period. While eating my yogurt today was not against the law, I am still, two years later, guilty of a felony and can be punished accordingly. Fortunately, the government is not too interested in yogurt. Unfortunately, the government is very interested in tax.

In 2014, Michigan passed 2014 PA 282, a retroactive tax law replacing the elective three-factor apportionment formula from the Multistate Tax Compact to which Michigan adhered with a new single-factor apportionment formula. This may have been just another disappointment to Taxpayers, who are regularly disappointed by the creative and nefarious ways in which states try to drum up revenue. But with a retroactive application to 2008, it was just plain devastating.

It is no surprise that the state supreme court upheld the state’s interest in collecting more tax. The case challenging this law was in fact 50 consolidated cases in Gillette Commercial Operations North America & Subsidiaries et al. v. Dep’t of Treasury, No. 325258 (Mich. Ct. App. Sept. 29, 2015). The question now is: will the Supreme Court hear the case? The Department of treasury argues that the Supreme Court can’t. Rather than a retroactive law, the state argues that 2014 PA 282 is simply a clarification of the preexisting law. Therefore, under the state statutory-construction law, the Michigan state court had adequate and independent state law ground to uphold 2014 PA 282 and the Supreme Court of the United States does not have the jurisdiction to overturn it.

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What is a worker classification issue?  When the Internal Revenue Service (“IRS”) believes that a taxpayer (i.e. employer or service recipient) is improperly treating workers as independent contractors instead of employees it will pursue the taxpayer by initiating an examination, more commonly known as an audit, where the taxpayer will likely receive a Letter 3850 (Rev 3-2006) in the mail providing them notice of the inquiry.  A worker classification issue will usually start with an analysis of whether the worker should have been classified as an independent contractor or an employee.  If it is determined that the workers should have been treated as employees, then a calculation must be prepared to determine how much the taxpayer (employer) owes the IRS.

Often, a taxpayer will resolve the tax liability generated from the worker classification audit through one of the IRS settlement programs (known as CSP or Classification Settlement Program) or through Section 530 of the Revenue Act of 1978.  Also, a taxpayer who fails to withhold the required tax may be entitled to relief, under §§ 3402(d), 3102(f)(3), 1463 or Regulations § 1.1474-4, but they must show that the worker reported the payments and paid the corresponding tax.  More simply stated, an independent contractor does not have any of its taxes withheld from a check it receives.  However, if the independent contractor should have been classified as an employee, then the employer would be entitled to offset some of the tax liability it owes the IRS by proving that the misclassified worker still paid his or her taxes that should have been withheld.

In a recent Tax Court case, the Mescalero Apache Tribe (“Tribe”) won on a motion to compel discovery against the IRS.  The Tribe was in the middle of a worker classification case.  In dispute, was the reclassification of hundreds of workers as employees instead of independent contractor.    The taxpayer, Tribe, has the burden of proof to show its worker paid income tax to reduce the amount it would owe the IRS.  (Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11)

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The rise of internet sales has created a tax problem for states. States are having difficulty getting revenue from these sales because the sellers lack nexus. In the legal community, that nexus is known as a connection with a state which allows for it to exercise jurisdiction over a vendor. Nexus is a growing concern for internet sellers because they are not physically present and states have begun overreaching in their extension of jurisdiction over them. Last year, Oklahoma enacted the Oklahoma Retail Protection Act of 2016. The purpose of the act was to (1) expand nexus to include a presumption of its existence in cases where a vendor has certain relationships or arrangements with people who do have a physical presence in the state, and (2) require out-of-state vendors to provide annual reports to their customers acknowledging the potential use tax liability on their purchases without disclosing which particular items were purchased.

This first part, which expands the jurisdiction of Oklahoma to cover more out-of-state vendors than it did previously, ultimately only applies a presumption to vendors who fall into a particular category. That presumption can be overcome with proof that the person with physical presence who has a relationship with the vendor does not establish or maintain the sales market in Oklahoma for that vendor. But is even a presumption of nexus in those cases crossing a line? In Quill Corp. v. North Dakota, the United States Supreme Court made it very clear that physical presence must be required by a vendor for it to have nexus within a state. To extend that to “physical presence of anyone associated with the business” is, at the very least, stretching the holding in Quill.

Meanwhile, the second requirement of the Oklahoma Retail Protection Act of 2016 requires out-of-state vendors that are not required to collect tax to send records to their customers to whom sales have been made within the state. These records need to identify the total sales made by the vendor to its in-state customer without revealing the particular items purchased. As this requirement appears to be on vendors who have no physical presence whatsoever, even by a third party, it is questionable whether Oklahoma has the authority to enforce such a burden on companies who are located entirely outside of their state.[1]

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Earlier in 2017, Premier Netcomm Solutions LLC (“Premier”) lost on reconsideration in New Jersey tax court.  The case dealt with the taxability of software as a service (“SaaS”) dating back to an audit from 2004 through 2005.  After initially beating for state, the court overturned a prior decision on reconsideration, which ultimately upheld New Jersey’s tax assessment.

Premier seems to be a classic IT provider in that it provides services such as network supports, internet access, consulting and design of IT and telephone projects, trouble shooting, remote training, data back-up, and network monitoring for businesses.  In the original decision, the court sided with Premier that its sales were not subject to sales tax.  The court concluded that prior to 2005, sales of services related to prewritten software were not taxable. In so doing the court invalidated New Jerseys tax assessment against Premier.

Unhappy with the decision, New Jersey’s Division of Taxation sought reconsideration, which is very difficult to prevail on.  The Court seemed to grant reconsideration because the original case erred fundamentally on its analysis.  Primarily, the court originally believed the law did not tax such services until its 2005 amendment.  However, the amendment was really based on New Jersey’s membership into the Streamline Sales and Use Tax Agreement (“SSUTA”) in 2005, which required it to adopt a uniform definition.  Therefore, based on a 2004 Bulletin, the court reconsidered the case and ruled that the services were and have been subject to tax since 2004.

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Over the past several years software as a service (“SaaS”) has been a booming industry.  Pioneers in the cloud computing industry, like Salesforce, have developed web based applications that offer a wide range of services to the user.  Driven by competitors such as Microsoft, Adobe, Sap, ADP, Oracle, IBM, Intuit and Google, the SaaS industry has become a $204 billion industry and grown by more than 16% last year.

Traditionally, from a sales tax perspective, states tax the sale of tangible personal property but not services.  While many states adhere to that mantra, several states have moved towards taxing software despite being intangible in nature.  Still, it can be difficult to determine whether SaaS is more like a software, which may be taxable, or if it feels more like a service provided, which is not taxable in many states.

States have been consistently inconsistent across the country in determining whether to tax SaaS.  States often have similar statutes and reach completely different conclusions in their quest to analyze SaaS.  Further, many situations occur in which a state can treat two seemingly similar SaaS companies differently within their own state.  In an attempt to comply, companies often struggle with charging the appropriate sales tax in the correct state and/or their state income tax obligations, with respect to SaaS.

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Effective August 1, 2016, Pennsylvania has joined the ranks of states attempting to expand their sales and use tax jurisdiction over digital downloads. With out-of-state internet sales taking away sales tax revenue from the states in conjunction with the sharp decline in “hard copy” sales of various media, states are scrambling to expand their tax base and capture categories of items that escaped their grasp when they evolved with the internet and technology.

ACT 84 of 2016 specifically extends to items delivered to “a customer electronically or digitally or by streaming unless the transfer is otherwise exempt. This includes music or any other audio, video such as movies and streaming services, e-books and any otherwise taxable printed matter, apps and in-app purchases, ringtones, online games, and canned software, as well as any updates, maintenance or support of these items.” While e-books and videos otherwise would be printed or “hard copy” materials subject to tax, apps and certain in-app purchases have never been available through a tangible medium.

Ultimately, the Act regains a lost tax base while also adding new items to it. The question remains that if a Pennsylvania resident makes a purchase while on vacation in Florida and listens to, for example, a one-time podcast while still in Florida, then does Act 84 of 2016 extend to that purchase? In other words, if the sale and entire use occurs within Florida but the purchaser is a resident of Pennsylvania, is the sale subject to Pennsylvania tax?