For nearly 15 years the law of the land has been clear on the issue of use tax. In 1992′s Quill v. North Dakota, the U.S. Supreme Court ruled that remote sellers such as catalogers cannot be required to collect use tax on sales unless they have a physical presence — a store, say, or a distribution center — within the particular tax jurisdiction.
Any merchant with ambitions to expand its retail presence outside its home state does so with a clear understanding that those stores will create nexus, or a physical presence, in a new tax jurisdiction. Therefore the merchant would be responsible for collecting local sales taxes on catalog or Web sales to customers in the state, county, and/or city in which it has opened a store. Along with charging catalog customers use tax, the company would also be required to file quarterly or annual tax returns to the state or local tax authority. Moreover, there is an ever-present possibility of audit.
For catalogers and online marketers, revenue growth can peak at a certain level at which list prospecting and direct-to-consumer advertising produce only incremental increases. When a company gets to that point, retail may be a natural extension of its brand. The merchant must then decide whether the possibilities of revenue growth offset the burdens of nexus.
“Whether to open stores in a new state and create nexus is purely a business decision,” says Mark Micali, vice president of government affairs for the Direct Marketing Association.
There are ways to avoid establishing nexus, Micali says, but they are less than ideal. “A company could create a separate dot-com subsidiary to insulate catalog and Internet sales,” he says. “That sounds fine and well, but the company must be very careful not to integrate promotions and returns. There must be totally separate accounting. It’s a somewhat arduous task, and it goes against the multichannel concept of marketing. It goes against everything a marketer wants to do.”
Damn the nexus, full speed ahead!
Good Vibrations, a San Francisco-based mailer of adult-entertainment products, has had stores in the Bay Area since its founding in 1977. It operates two shops in San Francisco and opened a store in Berkeley, CA, in 1995. This past January the company opened its first store outside California, in Brookline, MA, and it hopes to expand its retail operations further. As it looks at new locales for stores, the company will primarily consider traditional retail issues such as foot traffic, size, and demographics, according to director of merchandising Jonathan Plotzker. Nexus doesn’t factor into the consideration.
“Honestly, we do not take into account the need to collect use taxes where we have a business nexus,” Plotzker says. “We already have the ability to collect taxes in California, and setting up Massachusetts to do the same took a comparatively minimal effort, given our systems. We just collect the appropriate sales tax rates and write our checks to the state taxing authority. I don’t see why this would ever be a problem as we extend into other states” or even into Canada, he says.
Like many other multichannel merchants, Good Vibrations is attracted to retail expansion to find new customers and new opportunities to sell as well as to manage sales and revenue cycles.
“Our plan has always been to balance our retail and direct-to-consumer channels to take advantage of complementary peaks and valleys in the seasonality of sales and inventory needs,” Plotzker says. “Now that we’ve successfully opened our first store outside the Bay Area, we’ve worked through many of the kinks and overcome some hurdles and have put together a good template for future store openings. We’re poised to continue opening up stores in other areas as opportunities arise, as long as the locations in question match our criteria.” And those criteria have little if anything to do with use-tax collection.
Penzeys Spices of Brookfield, WI, takes a similar view with regard to retail and nexus. The company sells herbs and spices by catalog, the Web, and stores in 18 states. During the next year Penzeys expects to add stores in three more states — Colorado, New York, and Washington.
“Tax issues are not impacting our choices on expansion,” says Penzeys spokesperson Margie Gibbons. “Use tax is simply not in the equation.”
Use tax and the Internet tax moratorium
The question of whether to suffer the slings and arrows of use-tax collection resulting from the creation of nexus could become moot. The issue is likely to come up in the 110th Congress, which begins in January 2007. If the sympathies of Congress next year lie with the state tax collectors and not the business community, multichannel merchants could find themselves collecting use taxes regardless of whether or where they open stores.
Although the leading Congressional proponent of mandatory use tax, Sen. Dale Bumpers, retired in 1999, other senators have taken up the banner. Legislation is most likely to arise when Congress reconsiders the ongoing moratorium on taxation of Internet access, which it has approved every three years.
“Almost everyone agrees the moratorium has been good policy, and it’s likely to be extended,” the DMA’s Micali says. But a use-tax bill was sought as an amendment to the moratorium bill in 2001 and 2004 by Sen. Michael Enzi (R-WY) and Sen. Byron Dorgan (D-ND). Both times, the Senate tabled the amendment, and the issue went away.
Nevertheless, Micali expects Enzi and Dorgan to bring their amendment back next year, at which time state tax collectors will lobby hard for its adoption.
“It all comes back to Congress,” Micali says, “and there absolutely will be a real push by state tax collectors next year.”
When simplification isn’t so simple
Revenue-hungry states have not been idle while waiting and hoping for Congress to take action that will require businesses to collect use tax. Forty-two of the 45 states that impose sales and use tax, along with the District of Columbia, have adopted the Streamlined Sales Tax Agreement (SSTA), which went into effect in October 2005.
The stated goals of the SSTA, all of which require legislative or regulatory reforms by participating states, include
- uniform definitions within tax laws
- simplification of tax rates
- administration of state and local sales tax on the state level
- simplification of exemption administration — for instance, ensuring that marketers are not held liable for uncollected tax should customers claim incorrect exemptions
- uniform audit procedures.
Mark Micali, vice president of government affairs for the Direct Marketing Association, says the SSTA does not live up to its intentions in several important ways. “The DMA has been unequivocal that the SSTA does not offer genuine simplification,” Micali says. For one thing, the agreement failed to adopt uniform definitions for taxable merchandise. Athletic shoes, for instance, can be considered clothing in some states and sports gear in others, and while clothes are tax exempt in many (but not all) states, sports gear are typically nonexempt.
The SSTA acknowledges the U.S. Supreme Court’s decision in Quill v. North Dakota (1992), which stated that only Congress can require businesses to collect sales or use tax in states where they do not have physical presence, or nexus. In lieu of congressional action, the SSTA attempts to encourage merchants to voluntarily comply with state use-tax codes, though it does not explain why they should.
According to Micali, however, some companies have entered into voluntary agreements with states to waive their Quill vs. North Dakota protection and collect use taxes in exchange for amnesty and immunity from assessment of back taxes and interest. The DMA has not endorsed this course of action. “Our position is, Why should we surrrender the protection that we have under Quill?” Micali says.
Voluntary collection of use tax is “a dangerous thing,” Micali adds, “and a company should obtain legal counsel before agreeing to it.” — MP