Articles Posted in Sales and Use Tax

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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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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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Tennessee is the latest of states to jump on the economic nexus bandwagon.  In an effort to sidestep the physical presence the proposed rule would require out-of-state dealers that engage in the regular or systematic solicitation of consumers in Tennessee through any means and make sales exceeding $500,000 to Tennessee consumers during the calendar year would be considered to have substantial nexus with the state. One substantial nexus is established, the dealers would be required to register with the state and collect and remit sales and use tax.

Similar to recent rulemaking in Alabama, Tennessee does not believe its position offends the Commerce Clause. The proposed rule, may go into effect on or about November 8, 2016. It is worthy to note the rule is subject to committee review in both house of the Tennessee legislature and legislative approval is needed before a rule can become permanent.

Tennessee is not the only state attempting to combat Quill. Similarly, Alabama and South Dakota are litigating whether their economic nexus standards are sufficient to satisfy the Commerce Clause substantial nexus requirement. Earlier this year, South Dakota adopted the economic nexus for sales and use tax purposes. South Dakota is currently a plaintiff and defendant in two separate cases addressing the constitutionality of the substantial nexus law.

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If states could impose tax on every company that makes a sale within its borders, they would. Luckily, the Commerce Clause of the Constitution requires something known as “nexus,” or a connection, between a company and state in order for that company to be subject to state and local taxes. The standards for nexus can be ambiguous, particularly in recent years as a result of the radical changes to traditional business models that have occurred with the internet.

While nexus may seem easy to determine using the physical presence test, the definition of physical presence has in fact been something that courts across the country have struggled with since the beginning. That struggle has only become increasingly complicated with the internet and virtual marketplaces that no longer require a company to open a brick and mortar shop everywhere it wants to sell its products.

Recently, Washington state has found nexus with a company that made wholesale sales through infomercials. This particular company sent employees to Washington to participate in trade shows and other promotional events. However, they did not have a physical business location within the state.

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Hawaii was the most recent in a line of states to take a stance in the long tax battle between online travel companies, such as Priceline, Expedia and Orbitz, and states over what is commonly referred to as “tourist development taxes,” or “bed taxes.”  Over the last couple of years, states have fallen on both sides of the issue of whether hotel rooms are taxable at the price a hotel receives for a room or the price that an online travel company sells a room.  The Hawaii case, Travelocity.com, L.P. v. Hawaii Director of Taxation, involves two taxes, the first of which is called a “GET” or “general excise tax,” and the second of which is called a “TAT” or “transient accommodations tax.”

The 2015 court decision has been clarified this month in an announcement by the state that online travel companies were in fact liable for the “GET,” along with any penalties for late payment, on their portion of the sale price for hotel rooms located in Hawaii. However, online travel companies are not liable for the “TAT.” This is similar to states like Florida, in which the amount the online travel company receives for the rental of a room within Florida is not subject to local tourist taxes.

The state reasoned that the portion of the sale that online travel companies receive is in fact for “occupancy rights” that are used in their entirety within the state of Hawaii when the sale is for a room within the state. Under that reasoning, the state determined that the revenue made by the online travel companies is subject to Hawaii state tax.

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Florida’s hotel reservation industry recently received an important victory relating to Tourist Development Tax (“TDT”).  TDT is a tax imposed on the privilege of renting, leasing or letting “for consideration any living quarters or accommodations in any hotel . . ., or condominium for a term of six months or less.”  § 125.0104(3)(a)1., Fla. Stat.  Notably, the TDT is due on the consideration paid for occupancy in the county. § 125.0104(3)(a)1., Fla. Stat.

In 2015, the Florida Supreme Court held that the “consideration paid for occupancy” is limited to the actual rental amount paid for occupancy of the room and not to mark-up charges and service charges associated with the reservations.  See Alachua County v. Expedia, Inc., 175 So. 3d 370 (Fla. 2015).

The issue in Sarasota Surf & Racquet Club Condominium Assn., Inc. v. Sarasota County, et al., Case No. 2015 CA 002612 NC (Fla. 12th Cir, July 11, 2016) was whether reservation and cleaning fees charged by a condominium association to guests during the reservation process were subject to TDT.  The County argued that the fees were part of the total consideration paid for occupancy and therefore subject to TDT.  The association argued that, pursuant to Expedia, only the rental amount was subject to TDT, not the reservation and cleaning fees charged in connection with the reservation.

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On December 14, 2015, the Supreme Court of the State of Utah issued its ruling in the case of DIRECTV and DISH Network v. Utah State Tax Commission. At issue in this case was a tax scheme that provided a sales tax credit for “an amount equal to 50%” of the franchise fees paid by pay-TV providers to local municipalities for use of their public rights-of-way.

The franchise fees were imposed for the running of cable and the construction of hubs on public property. Therefore, it is exclusively cable providers who pay franchise fees and qualify for the credit. Meanwhile, satellite providers such as DIRECTV are not subject to franchise fees and do not qualify for the tax credit.

DIRECTV argued that the tax credit was a violation of the dormant commerce clause of the Constitution. The dormant commerce clause is a legal term that means that states cannot either discriminate against interstate commerce or unduly burden interstate commerce because the power to do is in the hands of Congress. From a practical perspective, allowing 50 states to regulate interstate commerce differently would cause complete chaos, so the federal government wants to reserve that power for itself. Furthermore, states’ motivation to help their own local businesses would weaken the national economy as a whole.
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Since Quill in 1992, states only have the power to impose taxes on businesses if they have a “physical presence” in the State. For example, in order for a state to be allowed to require a company to charge sales tax, the company must have a place of business in the State, employees in the State or have a representative in the State. However, as the economy has shifted, more and more States are enacting an “economic nexus” to impose a tax on businesses.

But, what is economic nexus?
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Our firm has been extremely involved with Florida’s wholesale tobacco tax for the past several years. Since Micjo in 2012, the Florida wholesale tobacco tax area has been fraught with seemingly endless litigation. In addition to the Micjo litigation, which focused on whether Florida tax applied to Federal Excise Tax (“FET”), there was another parallel of litigation which centered on a product called a blunt wrap or a cigar wrapper. Florida’s 1stDCA spoke loud and clear on April 6, 2016, by determining that the Wrap product is not subject to Florida tax, which appears to be a giant step towards putting an end towards at least 1 important issue for the industry.
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