BILL ANALYSIS Ó AB 155 Page A ASSEMBLY THIRD READING AB 155 (Charles Calderon) As Amended May 2, 2011 Majority vote REVENUE & TAXATION 5-2 APPROPRIATIONS 12-5 ----------------------------------------------------------------- |Ayes:|Perea, Beall, Charles |Ayes:|Fuentes, Blumenfield, | | |Calderon, Fuentes, Gordon | |Bradford, Charles | | | | |Calderon, Campos, Davis, | | | | |Gatto, Hall, Hill, Lara, | | | | |Mitchell, Solorio | | | | | | |-----+--------------------------+-----+--------------------------| |Nays:|Donnelly, Harkey |Nays:|Harkey, Donnelly, | | | | |Nielsen, Norby, Wagner | | | | | | ----------------------------------------------------------------- SUMMARY : Expands the statutory definition of a "retailer engaged in business in this state" to improve administration of the state's use tax. Specifically, this bill imposes a use tax collection obligation on any retailer that is a member of a commonly controlled group, as defined, and is a member of a combined reporting group, as defined, that includes another member of the retailer's commonly controlled group that performs services in this state in connection with tangible personal property (TPP) to be sold by the retailer. Qualifying services include, without limitation, the design and development of TPP sold by the retailer, or the solicitation of sales of TPP on the retailer's behalf. EXISTING FEDERAL LAW : 1)Authorizes Congress, under the commerce clause of the United States (U.S.) Constitution, to regulate commerce with foreign nations, and among the several states. The U.S. Supreme Court has held that the "negative" or "dormant" commerce clause also prohibits states from enacting laws that unduly burden or discriminate against interstate commerce. 2)Provides per federal case law that, under the dormant commerce clause, a retailer must have a "physical presence" in a state before that state can require the retailer to collect its use AB 155 Page B tax. EXISTING STATE LAW : 1)Imposes a sales tax on retailers for the privilege of selling TPP, absent a specific exemption. The tax is based upon the retailer's gross receipts from TPP sales in this state. 2)Imposes a complementary use tax on the storage, use, or other consumption in this state of TPP purchased from any retailer. The use tax is imposed on the purchaser, and unless the purchaser pays the use tax to a retailer registered to collect the California use tax, the purchaser remains liable for the tax, unless the use is exempted. The use tax is set at the same rate as the state's sales tax and must be remitted to the State Board of Equalization (BOE). 3)Specifies those retailers that are considered to be engaged in business in this state and that, as such, are required to collect use tax on sales of TPP to California consumers. FISCAL EFFECT : The BOE: 1)Estimates that this bill would result in increased state and local use tax collections of $83 million annually. Changes in corporate structure to avoid the requirements of this bill or discontinuation of use of in-state companies could lead to a decline in tax revenues from other sources. 2)As well as the bill's opponents, raise the possibility that treating separate corporate entities as divisions of the same corporate entity would create an opportunity intercompany sales between related corporate entities would no longer by subject to sales tax. Although BOE does not agree that this would occur, if it does the revenue loss would be larger than any gain from the expanded collections that could occur under this bill. 3)Would incur significant administrative costs in the low hundreds of thousands of dollars, to implement the provisions of this bill. The state would likely face significant litigation expenses owing to the legal uncertainty surrounding the bill's approach. AB 155 Page C COMMENTS : The author has provided the following statement in support of this bill: Each year, California loses over $1.145 billion in revenues as a result of unreported use taxes. A large percentage of this use tax gap is attributable to out-of-state Internet sales. More importantly, the lack of use tax collection has provided a competitive advantage to many out-of-state companies, allowing them to undercut their in-state competitors. AB 155 would help to level the playing field by imposing a use tax collection obligation on retailers that use in-state sister companies to help develop or sell their goods. By taking this important step, AB 155 will promote the fair and effective administration of California's Sales and Use Tax Law. Proponents state, "ÝAB 155] is a pragmatic and thoughtful approach that strikes the appropriate balance between the state's need to close the use tax gap while also protecting California's burgeoning high tech industry from any adverse impacts." Proponents also state, "We believe that ÝAB 155], though novel, is also fair, practicable and enforceable by focusing on the corporate family relationship of a parent and subsidiary working in concert with one another, rather than the mere contractual relationship that exists between an affiliate marketer and the company it advertises on the behalf of." Opponents state, "ÝW]e oppose AB 155 because the California courts have already rejected "control group nexus" as a basis to require out of state retailers to collect use tax. Moreover, even if AB 155 could be enforced, such a requirement would not produce additional revenue for California as related companies can easily be relocated, or the services they provide can easily be obtained elsewhere." Opponents also state, "Instead of AB 155, we encourage the Legislature to consider expanding California's existing, lawful and successful program to collect use tax from the purchasers who are responsible for payment." AB 155 Page D Assembly Revenue and Taxation Committee Staff Comments: 1)California's use tax : Since 1933, the state has imposed a sales tax on California retailers for the privilege of selling TPP, absent a specific exemption. The tax is based upon the retailer's gross receipts from TPP sales in this state. In 1935, California adopted a complementary "use tax" on the storage, use, or other consumption of TPP purchased out-of-state and brought into California. The use tax was designed to protect California merchants who would otherwise be at a competitive disadvantage when out-of-state retailers sell to California customers without charging tax. Unlike the sales tax, the use tax is imposed on the purchaser and not the retailer. Unless the purchaser pays the use tax to an out-of-state retailer registered to collect California's use tax, the purchaser remains liable for the tax. The use tax is set at the same rate as the state's sales tax and must be remitted to the BOE. 2)Impediments to collection : The most practical way for a state to enforce its use tax is to have retailers collect the tax at the time of sale. However, there is considerable ambiguity surrounding the circumstances under which a state may legally compel an out-of-state retailer to collect use tax on its behalf. This ambiguity has its origins in the commerce clause of the U.S. Constitution, which charges Congress with regulating commerce among the several states. The U.S. Supreme Court has held that, by implication, the commerce clause also prohibits states from enacting laws that unduly burden interstate commerce. In Quill Corp. v. North Dakota (1992), 504 U.S. 298, the U.S. Supreme Court was asked to decide the constitutionality of a North Dakota law that imposed a use tax collection obligation on out-of-state retailers that advertised in the state three or more times in a single year. The Court invalidated the law, holding that, under the negative Commerce Clause, a retailer must have a "physical presence" in a state before that state can require the retailer to collect its use tax. The "physical presence" test affirmed in Quill has complicated California's efforts to collect its use tax. For example, when a California consumer purchases a coat from an AB 155 Page E out-of-state retailer through its catalog or online store, the consumer's use of the coat in California triggers a use tax liability. If the out-of-state retailer lacks a "physical presence" in California, however, California is constitutionally prohibited from requiring the retailer to collect the tax. If the consumer fails to remit the tax, the purchase completely escapes taxation. It is estimated that this gap in California's sales and use tax (SUT) system costs the state over $1.145 billion in revenues each year.<1> 3)What would this bill do? : This bill would establish a new and rather novel approach for reducing the use tax gap. Specifically, it would impose a use tax collection obligation on "out-of-state" retailers with in-state sister companies that provide services connected to the retailer's sales of TPP. Qualifying services would include the design and development of TPP sold by the retailer, or the solicitation of TPP sales on the retailer's behalf. 4)What impact, if any, would this bill have on California affiliates? : Unlike the more traditional "Amazon" approach, this bill would not attribute nexus to remote vendors based on the activity of in-state affiliates. Indeed, this bill makes absolutely no reference to affiliates and would instead attribute nexus based on the activities of in-state sister companies. Nevertheless, in a February 24, 2011, letter to BOE Member George Runner, Amazon stated that it will terminate its relationships with well over 10,000 affiliates if California adopts any of the use tax collection proposals currently pending in the Legislature, including AB 155 (Charles Calderon). 5)The legal landscape : Some critics have suggested that the approach taken by AB 155 is prohibited by the Court of Appeal's decision in Current, Inc. v. State Board of Equalization (1994), 24 Cal.App.4th 382. As such, a more detailed examination of this case is warranted. Current, Inc. (Current) was an out-of-state mail order company based in Colorado. In 1987, Current was acquired by Deluxe Corporation (Deluxe), which had "considerable commercial -------------------------- <1> This total represents $795 million in use taxes uncollected from California consumers and $350 million in use taxes uncollected from businesses. AB 155 Page F contacts within California." Id. at 385. Thereafter, BOE asserted that Current had an obligation to collect California's use tax under Revenue and Taxation Code Section 6203(g). Id. At the time, subdivision (g) imposed a collection duty on "Ýa]ny retailer owned or controlled by the same interests which Ýsic] own or control any retailer engaged in business in the same or similar line of business in this state." Id. On review, the Court of Appeal held that Current's physical nexus with the State of California was insufficient to justify the imposition of a use tax collection duty. Id. at 391. In reaching this conclusion, the Court noted that neither Current nor Deluxe was the alter ego or agent of the other for any purpose. Id. at 388. Neither solicited orders for the products of the other. Id. Moreover, each company had its own trade name, goodwill, marketing practices and customer lists and each marketed its products independently of the other. Id. Finally, the Court noted that both companies were organized and operated as separate and distinct corporate entities. Id. Thus, the facts presented in Current are substantially different from those contemplated by this bill. Current stands for the proposition that common corporate ownership is, by itself, an insufficient basis upon which to impose a use tax collection duty. AB 155 (Charles Calderon), however, does not disregard the distinct legal status of affiliated corporations. Instead, it asserts nexus in cases where an affiliated corporation with California presence is designing and developing TPP to be sold by the retailer, or soliciting sales of TPP on the retailer's behalf. Such affiliated companies would appear to be actively engaged in both promoting and facilitating the remote vendor's sales of TPP. Analysis Prepared by : M. David Ruff / REV. & TAX. / (916) 319-2098 FN: 0000949 AB 155 Page G