Battle California! Sales Tax Nexus Gets Even More Interesting

In the past, we have reported on so-called affiliate nexus or "Amazon" statutes and the challenges brought by Amazon.com against New York's nexus law.1 Those statutes generally impose a sales and use tax collection responsibility on out-of-state retailers that have agreements with in-state entities, when the in-state entities refer customers to the retailer, either by Internet Web site or otherwise.2 The in-state entities are often known as Internet affiliate marketers.

In addition to asserting nexus based on Internet affiliate marketing relationships, many states, including New York, have also passed statutes that impose nexus on an out-of-state retailer based on the in-state activities performed by a member of the retailer's corporate family (common ownership nexus).

In this article, we bring you an update on the latest nexus law passed in California, which includes components relating to both Internet affiliate marketers and commonly owned entities. We also summarize a few significant developments in the battles over sales tax nexus around the country, including the ways in which large retailers are coping with the changing landscape. Finally, we provide a few benchmarks regarding the ways in which we believe the affiliate nexus laws should be interpreted to assist retailers in managing their relationships with Internet affiliate marketers and commonly owned entities in light of the sales tax nexus risks.

California: The Latest Sales Tax Nexus Statute

On June 28, Gov. Jerry Brown (D) signed into law California's budget for fiscal 2011‑2012.3 The budget includes a bill that creates nexus for out-of-state retailers based on the in-state presence of Internet marketing affiliates and the in-state presence of commonly owned entities, under certain circumstances.

Internet Affiliate Marketing Nexus

The Amazon law portion of the bill imposes a sales tax collection responsibility on out-of-state retailers that have certain Internet affiliate marketing relationships with persons in the state.4 Specifically, the bill modifies the definition of "retailer engaged in business in this state" to include "[a]ny retailer entering into an agreement . . . under which a person . . . in this state, for a commission or other consideration, directly or indirectly refer[s] potential purchasers . . . by an Internet-based link or an Internet Web site, or otherwise," as long as some de minimus sales thresholds are met.5 The rule does not apply "if the retailer can demonstrate that the person in [California] with whom the retailer has an agreement did not engage in referrals in the state on behalf of the retailer that would satisfy the requirements of the commerce clause of the United States Constitution.6

California's statute provides some additional detail, which is not present in other states' statutes, on the application of the new nexus standard to advertising. In particular, California's law states that agreements to provide advertising (whether on television, radio, in print, or on the Internet) do not trigger nexus, unless (1) the fee for the advertisement is a commission or otherwise based on sales and (2) (at least for advertising on an Internet Web site) the in-state person also "directly or indirectly solicits potential customers in [California] through use of flyers, newsletters, telephone calls, electronic mail, blogs, microblogs, social networking sites . . . .7 Thus, in contrast to many other affiliate nexus statutes, California's statute makes clear that an Internet affiliate that merely advertises for an out-of-state retailer does not create nexus, even if the payment for the advertising service is commission-based.8

Common Ownership Nexus

In addition to the Internet affiliate marketing nexus provisions, California's new law also includes a provision that imposes a sales tax collection obligation on an out-of-state retailer based on that retailer's relationship with other members of a commonly controlled group that are also members of a combined reporting group.9 Nexus based on common control is triggered when the member of the group "performs services in [California] in connection with tangible personal property to be sold by the retailer, including, but not limited to, design and development of tangible personal property sold by the retailer, or the solicitation of sales of tangible personal property on behalf of the retailer.10

This law seems to trigger nexus based on in-state activities that are plainly beyond the scope of the activities identified in Tyler Pipe as the types of in-state activities on which nexus for an out-of-state retailer can permissibly be based. The standard articulated in Tyler Pipe was, of course, that an in-state entity's activities on behalf of an out-of-state retailer could create nexus for the retailer when the activities help the retailer "establish and maintain a market in th[e] state for the sales."11

California's law seems to reach beyond that category of activities to impose nexus based on a potentially broad array of services provided by the in-state entity, some of which have little or nothing to do with selling or creating a market for the tangible personal property in the state, including, for instance, the design and development of property sold by the retailer. According to...