BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 234 HEARING: 3/13/11
AUTHOR: Hancock FISCAL: Yes
VERSION: 2/9/11 TAX LEVY: No
CONSULTANT: Grinnell
USE TAX NEXUS
Enacts "Long-Arm" Nexus to Determine Whether Retailers Must
Collect the Use Tax.
Background and Existing Law
The United States Constitution grants the power to Congress
to "regulate Commerce with foreign nations, and among the
several states, and with the Indian Tribes;" a provision
widely known as the Commerce Clause (Article I, Section 8).
If Congress fails to regulate interstate commerce wholly
or in part, the United States Supreme Court has asserted
consistently that the Constitution still precludes states
from doing so, known as the "dormant" or "negative"
Commerce Clause. Additionally, the 14th amendment states
that no state may "deprive a person of life, liberty, or
property without due process of law."
The United States Supreme Court has issued several
decisions interpreting these parts of the Constitution to
guide states seeking to tax firms engaged in multistate
commerce. Under the foundational Complete Auto Transit v.
Brady, 430 U.S. 274, 97 S.Ct. 1076 (1977), states may tax
interstate business without violating either the Commerce
or Due Process clauses; however, the taxpayer must have
nexus, the tax must be fairly apportioned and
non-discriminatory, and a fair relationship between the tax
and the services provided must exist. The Court clearly
stated that its holding applied to income taxes, franchise
taxes, and sales and use taxes.
Initially, the Court provided that a firm did not require
physical presence to trigger nexus. A firm having
employees or independent contractors is enough to trigger
the use tax collection requirement, thereby creating the
theory of "agency nexus" in Scripto, Inc. v. Carson, 362
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U.S. 207 (1960). Seven year later, the Court clarified
that states could not compel collection of the use tax from
a firm that only shipped into a state by mail or common
carrier in National Bellas Hess v. Department of Revenue,
386 U.S. 753 (1967). The Court subsequently refined its
view of use tax nexus in Quill Corp. v. North Dakota, 504
U.S. 278 (1992), relying on National Bellas Hess, holding
that states compelling retailers without physical presence
in the state to collect and remit use taxes complied with
the Due Process Clause, but violated the Commerce Clause.
In Quill, the Court found that North Dakota's statute
compelling a vendor with no physical presence but who
advertises three times in a single year or makes three
phone calls soliciting sales in the state to collect use
taxes unduly burdens interstate commerce. Quill bars
states from forcing retailers that lack physical presence
in a state to collect the use tax, although recent efforts
are challenging this standard (see Comment 5).
State law imposes the sales tax on every retailer "engaged
in business in this state" that sells tangible personal
property to collect the appropriate tax from the purchase
and remit the amount to the Board of Equalization. Unless
the person pays the sales tax to the retailer, he or she is
liable for the use tax, which is imposed on any person
consuming tangible personal property in the state. The use
tax is the same rate as the sales tax, and must be remitted
on or before the last day of the month following the
quarterly period in which the person made the purchase.
Under Quill, when a California resident purchases tangible
personal property from a retailer that lacks physical
presence in the state online, by mail order, or on a trip
to another state, the obligation rests on the consumer to
remit the use tax due. Californians may remit the use tax
on the income tax form (SB 858, Committee on Budget, 2010),
after a similar provision sunset after the 2009 taxable
year (SB 1009, Alpert, 2003).
The Sales and Use Tax Law defines a "retailer engaged in
business in this state" as:
Any retailer maintaining, occupying, or using, an
office, place of distribution, sales or sample room,
warehouse or storage place, or other place of
business, regardless of whether the retailer utilizes
the above on a temporary or permanent basis, directly
or indirectly, or through a subsidiary or affiliate.
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Any retailer having any representative, agent,
salesperson, canvasser, independent contractor, or
solicitor operating in the state under the authority
of the retailer or its subsidiary for the purposes of
delivering, installing, assembling, or the taking of
orders for any tangible personal property
Any retailer that derives rental income from leases
within the state.
The definition of a "retailer engaged in business in this
state" also includes retailers soliciting orders in a
substantial and recurring way, and that benefits from any
banking, financing, debt collection, telecommunication or
marketing activities in the state, or that benefit from the
location of authorized installation, servicing, or repair
facilities. However, this definition is contingent upon
Congress acting to allow the state to collect sales and use
taxes from out-of-state retailers (AB 72, Klehs, 1994). AB
72 also expressly excluded from the definition taking
orders from customers in the state from a computer
telecommunications network which is not directly or
indirectly owned by the retailer. However, this exclusion
is inoperative if Congress acts to allow the state to
collect sales and use taxes from out-of-state retailers.
Proposed Law
SB 234 provides that the definition of "retailer engaged in
business in this state" includes any retailer that has
substantial nexus in this state for purposes of the
commerce clause of the United States Constitution, and any
retailer upon whom federal law permits the state to impose
a use tax collection duty. The bill also alters the
definition to provide that the existing categories of
retailers includes, but is not limited to those in current
law. The measure repeals the inclusion of retailers
soliciting orders in a substantial and existing way, and
the exclusion from taking orders over a computer
telecommunications network that are contingent on federal
actions.
State Revenue Impact
BOE provided the following revenue estimate:
"In our updated December 2010 e-commerce and mail order
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estimate, we estimated that the annual state and local
revenue loss from unreported use tax associated with
out-of-state Internet and mail order sales amounted to
$1.145 billion per year. This measure could expand the
BOE's ability to include out-of-state Internet and mail
order retailers that are currently not considered as having
nexus under current Section 6203, and require them to
register and collect use tax from California consumers. To
the extent this bill expands nexus to some of those
out-of-state retailers not currently required to collect
the use tax, we have estimated in previous analyses of
similar bills that the amount of additional revenue could
result in between 1% and 5% ($11 million to $57 million) of
the lost state and local revenue from Internet and mail
order sales by out-of-state retailers. As an example, this
provision could include out-of-state retailers that use
independent California contractors to perform warranty and
repair work on products they sell, or those out-of-state
retailers currently unregistered that sell the same or
substantially similar line of products as the retailer
maintaining sales locations in California under the same or
substantially similar business name. However, to the extent
the BOE makes a determination that other in-state
activities conducted in connection with out-of-state
retailers are sufficient to impose a use tax collection
obligation on those out-of-state retailers, the estimated
revenues associated with this provision could substantially
increase. For example, since a New York Appellate court
ruled that the affiliate nexus provision is constitutional
on its face, we include those related revenues to this
estimate. However, some of the revenues associated with
this provision could be included with the revenues
identified in the previous paragraph. The extent of this
overlap, if any, is unknown. Our static revenue estimation
methodology for this component produces a state and local
revenue increase of $152 million in 2011-12 (a half-year
effect) and $317 million in 2012-13. These estimates are
based on the combination of (1) the amount of revenues
currently being collected in New York, adjusted for
California's larger economy, and (2) increased revenues
associated with out-of-state retailers that sell to
California consumers on eBay that could have a use tax
collection obligation under the provisions of this bill.
However, the State's likelihood of actually realizing the
revenues described in the previous paragraph depends
entirely on (1) Internet retailers' (such as Amazon and
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Overstock) willingness to continue their affiliate
programs, and (2) other retailers' willingness to continue
to sell on eBay and to fully comply with the added use tax
collection obligations imposed by this bill. We have
received direct confirmation from Amazon that it will
terminate its relationship with its 10,000 California
affiliates should this measure get enacted. We estimate
that Amazon currently comprises roughly 50 percent of the
Internet sales of large firms who currently do not have
nexus in California. Consequently, the static revenue
estimates cited in the previous paragraph, adjusted for
Amazon's response, would drop to $114 million in 2011-12
and $234 million in 2012-13. If other firms were also to
terminate their affiliate programs in response to the
enactment of this bill, the revenue gain would be further
diminished. Similarly, while we lack the data to determine
to what extent out-of-state retailers would discontinue
their use of eBay to sell to California consumers, any drop
in such eBay usage would even further lower the revenue
gain. Thus, with respect to total revenues that we could
anticipate from the bill's provisions, we estimate a
potential gain for 2012-13 of $374 million if (1) 5% of the
use tax gap is closed, (2) full compliance with no
behavioral changes by out-of-state retailers with in-state
affiliate programs occur, and (3) there is no duplication
or overlap with out-of-state retailers affected by (1) and
(2). Additionally, the termination of affiliate programs
would have an adverse impact on state employment, which in
turn would lead to lower revenues from sources such as the
personal income tax and the corporation tax. The amount of
these potential reductions is unknown."
Comments
1. Purpose of the bill . According to the Author, "SB 234
addresses an inequity in taxation by authorizing the BOE-to
the maximum reach of the U.S. Constitution-to require
vendors to be responsible for the collection and remittance
of use taxes, improving compliance rates and putting
brick-and-mortar CA businesses once again on an even
playing field."
2. Reach out and touch someone. As early as 1827, the
United States Supreme Court has frustrated the states'
efforts to tax interstate commerce, clearly stating that
Congress alone has the power to regulate or tax multistate
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firm's activities. Congress could solve the use tax
collection problem by simply allowing states to require
firms without physical presence to collect and remit the
use tax. In absence of such action, the California
Legislature and other states have increasingly tried to
compel collection as online commerce grows as a share of
the economy. The U.S. Census Bureau data shows that online
sales as a percentage of total sales grew from 1% in 2001
to 4% in the fourth quarter of 2011, and increases almost
15% each quarter.
Quill is widely seen as both settled law and a bright line
test that provides certainty for taxpayers and tax
enforcement agencies alike. Opponents consistently state
that Courts will cite the case to strike down any new state
efforts to compel use tax collection as they have in the
past, asserting that measures like SB 234 will result in
neither new revenue nor an end to the competitive advantage
non-collecting retailers enjoy. Courts invalidated
California's previous effort to trigger nexus on firms
advertising over cable television in 1998. As states
increasingly change their laws to try to "hook"
out-of-state retailers into collecting the use tax in a
variety of ways (See Comment 5), opponents state that
retailers will simply change business models or end
relationships which may trigger nexus under the new laws.
For example, Amazon.com and Overstock.com have both stated
that they will terminate California affiliates should the
Legislature enact AB 153 (Skinner), as it did after
Illinois, North Carolina, and Rhode Island enacted similar
laws, which would likely cause the California affiliates to
lose income from those sources.
3. The long arm of the (Sales and Use Tax) law. SB 234
implements so-called "long arm" nexus, an approach which
allows BOE to assert nexus whenever warranted under the
U.S. Constitution. Instead of providing bright-line tests,
SB 234 allows BOE to examine the individual facts and
circumstances of a particular firm, and impose the
collection responsibility on the retailer if merited by the
case law. This approach differs from AB 153 (Skinner), and
AB 155 (Calderon), which alter the definition of "retailer
engaged in business in this state" to include specific
activities, but similar to SB 655 (Steinberg). Taking a
more general approach allows BOE to use evolving case law
when making nexus determination, but increases uncertainty
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for taxpayers who currently enjoy the warm blanket of
protection provided by Quill. BOE will be restrained only
by its perceived probability of winning in the courts,
although it could proscribe regulations that provided
clearer standards than called for in SB 234. BOE could
rely on the 1984 Current case, which provided that an
in-state firm with presence does not trigger nexus for its
out-of-state owner unless the parent exercises control over
the subsidiary, implying that in-state firms controlled by
out-of-state retailers do trigger nexus for the parent
(Current, Inc. v. State Bd. of Equalization 24 Cal.App.4th
382). BOE could also apply Borders Online LLC v. State
Board of Equalization, 129 Cal.App 4th 1179 (2005) to
online retailers. That case held that a legally separate,
out-of-state online retailer, Borders Online, had nexus
because its consumers could return products purchases to
the Borders stores physically located in California. The
Court held that the retail stores served as the online
retailer's vendor and agent in the state. Other states
compel collection from firms that use third party
independent contractors to conduct repair or warranty
services.
4. Call me Ishmael. Since Quill, states have sought ways
to compel retailers that lack brick and mortar
establishments to collect use tax on tangible personal
property sold into the state. Pursuing retailers make
sense because of scale: retailers can collect and remit the
obligation from many taxpayers, whereas deploying auditors
to pursue consumers who do not send BOE the use tax is
rarely a cost-effective use of audit resources unless the
amounts purchased are considerable. The Use Tax line on
California's income tax form resulted in paltry amounts
that only once exceeded $10 million since enacted, when BOE
estimated in December, 2010 that compelling retailers
currently hiding behind Quill could result in in more than
$1 billion. Other collections efforts have also been
tried: ABx4 18 (2009) required all firms with more than
$100,000 in gross receipts to register its purchases with
BOE for use tax purposes, resulting in collective howls
from the business community despite an estimated $32
million in revenue. Additionally, ending the protections
of Quill would also end the current competitive advantage
out-of-state firms enjoy over retailers with in-state ones
that must collect and remit the sales tax, a tax law-driven
distortion with a statewide rate of 9.2%.
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Herman Melville's Captain Ahab pursued Moby Dick until his
death; states have tried to capture its white whale,
Washington-based Amazon.com, with similar fervor as it
hides behind Quill. In 2010, the firm had annual revenue
that exceeded $34 billion, net income of more than $1.1
billion and market capitalization upwards of $75 billion,
but collects and remits no sales and use taxes to
California despite its estimated billions of sales into
California, manufacture of its kindle products in
California through a subsidiary, and advertisement through
California-based third party sellers and internet
affiliates. Amazon.com is the top online retailer, and the
only one of the top ten not to collect and remit the use
tax. According to Forbes, 87% of Americans live in a state
where Amazon does not collect and remit the tax. According
to the New York Times, founder Jeff Bezos tried initially
forming the firm on an Indian Reservation in San Francisco
in an attempt to avoid taxation, and that the firm only
collects and remits taxes in five states. The firm
recently warned investors that having to collect sales and
use taxes could decrease future sales and profits.
5. Sharpening the Harpoon. The Legislature and other
states have several approaches to compel retailers that
lack physical presence in the state to collect and remit
sales and use taxes. Some of these include:
The Legislature first attempted to compel
out-of-state internet retailers to collect and remit
the use tax in 2000, when it passed AB 2412 (Migden
and Alpert). That measure responded to Borders and
Barnes and Noble business models by providing that an
online retailer with in-state stores had nexus.
Governor Davis vetoed the bill. Subsequent efforts
stalled in the Legislature. In 2008, a measure nearly
identical to SB 234, AB 1840 (Calderon), failed
passage on the Assembly Floor.
New York created a presumption that a retailer
solicits sales in the state if an in-state affiliate
is compensated for referring customers directly or
indirectly to the retailer, stating that
"attributional nexus" exists. New York Courts have
upheld the law, and other states have followed,
including Illinois two weeks ago. Amazon has ended
affiliate relationships in those states save New York.
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The Legislature approved an attributional nexus
measure in California (SBx3 17, Ducheny, 2009);
however, Governor Arnold Schwarzenegger vetoed the
measure. This year, the Assembly Revenue and Taxation
Committee sent AB 153 (Skinner) to its suspense file,
which is substantially similar to the "New York
model."
Colorado requires non-collecting retailers to
notify customers that sales and use taxes are due on
certain purchases, and that the consumer must file a
sales and use tax return. Failure to provide notice
results in a $5 penalty. Non-collecting retailers
must also send consumers an annual notice showing the
total amount of purchases made during the prior
calendar year and inform the consumer of the
obligation to file returns, sent separately by
first-class mail with the marking: "Important Tax
Document Enclosed." Non-collecting retailers must
also file these annual statements with the Department
of Revenue or incur penalties. Colorado's legislation
also compelled non-collecting retailers to collect and
remit the sales and use tax if it is part of a
controlled group of corporations with a component
member that is a retailer with physical presence in
the state. However, a trial court issued a
preliminary injunction barring enforcement of the law
earlier this year. Last year, AB 2060 (Calderon)
enacted this approach, but the measure was not taken
up on the Senate Floor. This year, the "Colorado"
approach is contained within AB 155 (Calderon), which
also provides that a retailer has nexus if it is part
of a commonly-controlled group of corporations that
includes a member in the state that solicits sales of
tangible personal property on behalf of the retailer,
or provides design and development services in
connection with tangible personal property sold by
that retailer.
Support and Opposition (3/17/11)
Support : Board of Equalization Member Betty Yee, City of
Berkeley, California Tax Reform Association
Opposition : Direct Marketing Association, California
Taxpayers' Association, Internet Alliance, TechAmerica,
Performance Marketing Association.
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