Notwithstanding the different agendas of the various states, the benefit inherent in sales and use taxes seems to be one area that they are able to agree on.
Leading the charge in that regard are three large states in terms of population and sales tax revenue: California, New York and Texas. The expansion or limitations on sales tax rules in the three states has started a trend among many other states. What these three states have discovered is – one, by implementing a wider definition of who has nexus, particularly with respect to remote sellers, sales tax revenues increase without needing to raise tax rates. And second, exempting certain limited transactions leads to job creation and increased revenues from other tax types. The obligation of remote sellers to collect or not collect sales tax in these states is a sign of how other states, have started updating their sales tax laws.
In 2008, New York enacted its “Amazon law,” which requires an internet retailer to collect and remit sales taxes based on the concept that certain online vendors have sales “associates” located in the state. The idea here is that activity by an in-state website owner for the benefit of an out-of-state retailer gives the out-of-state vendor a taxable presence in New York. Think of New York-based websites providing links to Amazon.com, which links are used by retail customers to ultimately make purchases of taxable property or services.
California enacted similar click-through legislation in 2011. Under its provision, a vendor subject to state sales tax now includes any retailer who enters into an agreement with a person in California, whereby the person refers purchasers of tangible personal property, via a website link, to the out-of-state retailer in return for payments.
Texas arrived later to the click-through nexus scene, even though it first explored the idea in 2011. As a result of negotiations between Amazon and the state, a more limited click-through nexus statute was ultimately enacted than those in place in California and New York.
Texas’s click-through nexus law is more akin to California’s and New York’s affiliate nexus laws than it is to their click-through statutes. The Texas law subjects out-of-state sellers with substantial ownership (read 50% or more) in an affiliate that is physically present and doing business in Texas to the state’s sales tax rules. Nexus creating activity includes:
- Selling substantially similar products under a business name that is the similar to both the in and out-of-state seller’s;
- Using affiliate’s in-state facilities or employees to advertise or promote sales; or
- Maintaining an affiliate distribution center or warehouse in Texas from where products are sold to consumers.
California’s affiliate nexus provisions are an expansion of its click-through nexus rules. Sales tax nexus is attributed to any retailer that is a member of a commonly controlled and combined reporting group, which includes a member who performs services in California in connection with the sale of tangible personal property by the out-of-state retailer. This incorporates the design and development of tangible personal property and the solicitation of sales on behalf of the retailer.
The concept of affiliate nexus is encompassed within New York’s click-through nexus statute. New York basically presumes that a New York resident who has a contractual agreement for commissions with a remote vendor is affiliated with the out-of-state seller. This is due to the fact that the New York resident is considered soliciting on the behalf of the remote seller, thereby creating nexus through physical presence in the state.
California, the home to Silicon Valley, has maintained a hands-off approach with regard to sales tax on digital goods. Sales tax is not applicable to the sale of any downloaded materials, such as software, music, or data. Obviously, this is geared to appeal to the state’s computer software industry.
Seeing the enormous growth of digital product sales, New York and Texas have used the emergence of such sales as revenue generators. New York taxes all sales of prewritten computer software and products regardless of how the data is delivered. Therefore, sales software are taxable whether sold on a CD, memory drive, or by download, unless the digital product is designed and developed to the specifications of a specific purchaser, in which case the sale is exempt from sales tax.
Texas is even more comprehensive than New York, because the state in essence taxes sales of all digital products that can also be sold in a physical form. The state treats sales of digital products, such as custom and prewritten software, as tangible personal property, and therefore as fully taxable.
The sales tax trends reflected in the laws of California, New York, and Texas are indicative of where other states are going with their sales tax rules. Currently, some fourteen states, have enacted some type of click-through and/or affiliate nexus law. Furthermore, while many states tax digital products, a growing number of states such as Florida, Maryland, and South Carolina are following California’s lead and have begun to limit their sales tax rules in this regard. For example, these states have carved out electronically transmitted products as nontaxable so as to entice software development companies to relocate into their jurisdictions. While states may have difficulty agreeing on certain areas, they do agree that often widening and narrowing their sales tax net is advantageous to their state’s economic well-being. Targeting remote sellers is being used to raise funds for state coffers without having to resort to the burden of raising taxes. Similarly, eliminating specific sales tax levies is aiding in job growth through an increase in distribution center employment and computer software startups, which in turn raises other state revenue, such as income tax.
If you have any questions regarding anything set forth above, please contact Alan Goldenberg, Manager of State and Local Tax and Tax Controversy, at firstname.lastname@example.org or 212-897-6421, or contact your Friedman LLP tax professional