Is DILWORTH Still Good Law Or Just A Bump In The Road In The Development Of The Commerce Clause; The CARE COMPUTER Case

[Prepared for 10th Annual ABA/IPT "Advanced Sales/Use Tax & Advanced Property Tax" Seminars March 20-23, 2001]

THE CARE COMPUTER CASE.

Arizona Department of Revenue v. Care Computer Systems, Inc., 4 P.3d 469 Ariz. 197 414 P.3d 469 (App. 2000), review denied (February 15, 2001).

The Issue. The issue present by the Care Computer case is whether Arizona may impose its transaction privilege (sales) tax [not the use tax] on Care Computer's interstate mail-order sales. Or, stated another way, did Care Computer have sufficient nexus with Arizona for the imposition of the state's transaction privilege tax.

1. FACTUAL BACKGROUND.

   The Arizona Department of Revenue audited Care Computer Systems and imposed Arizona's transaction privilege tax on Care Computer's gross receipts from its interstate mail-order sales to Arizona customers. Care is a mail-order company located in Bellevue, Washington, that licenses and sells computer software to nursing homes throughout the United States. Care has never had any physical location or facility of any kind in Arizona. It has no Arizona sales or service office, warehouse, storage, product inventory, advertising or other business address. It has no employees, independent contractors, sales representatives or other agents based or residing in Arizona. In short, it had no regular presence of any kind in Arizona.

   Care's Sales Take Place in Washington, Not In Arizona. Care's Arizona customers would send their orders to Care's Washington headquarters by fax or mail. Before the goods were shipped, all contracts had to be approved by a corporate officer at Care's Washington headquarters. Goods were shipped from Care's Bellevue headquarters to Arizona customers by mail or common carrier. Under Care's standard sales contract, the goods were shipped F.O.B. Washington (i.e., title passed when the goods were delivered to the carrier or post office in Washington).

   While Care's Arizona transactions were conducted solely by mail order and fax, Care employed a salesman who lived in Irvine, California and worked out of Care's Brea, California office. Care's salesman, Gary Trabant, had as his primary territory southern California and also Arizona. His sales efforts were primarily limited to southern California because of the state's large population base and the number of nursing homes. Mr. Trabant traveled to Arizona irregularly and only on seven occasions, averaging once per year, through the audit period of January 1985 through November 1991. He made his trips by airplane, returning home the same day in most cases and never staying longer than overnight. Mr. Trabant did not have authority to accept or approve any orders and the few that he did receive he forwarded to Care's Washington headquarters for approval and acceptance.

   Occasionally other Care personnel visited Arizona nursing home customers to conduct software training sessions, which lasted one or two days. The training reps were sent from Care's headquarters or another service office outside Arizona and returned immediately after the training was completed. Care had training representatives in Arizona averaging 21 days per year. Care engaged in some 180 transactions with Arizona nursing homes during the 5-year audit period, with 65% of those transactions being with a single customer. Of those 180 transactions, 178 involved sales of software with the other two transactions being short-term, trial-basis leases of a personal computer and software programs.

   Arizona Regulations Dealing With Out-of-State Vendors. As additional background, Arizona regulations provide guidance as to when a transaction is subject to the sales tax and when a transaction is subject to the use tax. A.A.C. R15-5-2307 captioned "When a Transaction is Subject to the Sales Tax" provides that "sales made by vendors maintaining a place of business within Arizona are subject to the sales tax." In turn, A.A.C. R15-5-2308, captioned "When a Transaction is Subject to the Use Tax" lays out the corollary rule that "purchases made from vendors not maintaining a place of business in this state to Arizona customers are subject to the Use Tax." It was undisputed that Care Computer did not maintain a place of business within Arizona: it had no office, inventory, resident sales person, etc.

   Assessment and Appeal. The Arizona Department of Revenue imposed the state's transaction privilege tax on Care with respect to all of its mail-order sales to Arizona customers. The Department did not impose the state's use tax collection obligation. Care filed a protest and the Arizona State Board of Tax Appeals agreed with Care that the state lacked the required nexus to impose its transaction privilege tax on those mail-order sales. The Department appealed to the Arizona Tax Court, which upheld the Board's decision. The Department then appealed to the Court of Appeals, which held that Care's interstate, mail-order sales were subject to Arizona's transaction privilege tax. The Arizona Supreme Court denied review on February 15, 2001.

2. DEPARTMENT OF REVENUE'S APPELLATE ARGUMENTS.

   The Department of Revenue made the following arguments in the Court of Appeals case.

   1. Care's Business Activities in Arizona Provided Sufficient Nexus for the Imposition of Arizona's Transaction Privilege Tax. The Department of Revenue argued that the something more than "slightest physical presence" test of Quill applied to the Care/Arizona transaction privilege tax situation. In other words, the Department argued that as long as Care had physical presence in Arizona, but something more than "slightest" physical presence, the constitutional substantial nexus standard was met. The Department further relied on, among other cases, Orvis Co., Inc. v. Tax Appeals Tribunal, 654 N.E.2d 954 (N.Y. 1995), cert. denied 516 U.S. 989 (1995), and Brown's Furniture, Inc. v. Wagner, 665 N.E.2d 795 (Ill. 1996), cert. denied 117 S. Ct. 175 (1996), as to the number of transactions or visits in a state which meet the more than slightest physical presence standard [it should be noted that the Orvis and Brown's Furniture cases are use tax collection cases and do not involve a transaction privilege or gross receipts tax.]

      The Department noted that Quill did not say just how much fiscal presence would satisfy the substantial nexus test but left that decision for the state courts to decide on a case by case basis. The Department argued that in the Orvis case, which involved Orvis Co. and Vermont Information Processing (VIP), addressed the question of what number of contacts with taxing states would be sufficient to satisfy the nexus requirement. Orvis employees visited up to 19 New York wholesale customers on the average of four times a year (76 times per year). VIP marketed computed software and hardware to beverage distributors in New York and its employees visited its New York customers' locations on 41 occasions over the three year audit period. The New York Court of Appeals held that Orvis' and VIP's contacts were sufficient to satisfy the "substantial nexus" requirement of Quill and upheld New York's imposition of its use tax collection function on Orvis and VIP.

      The Department of Revenue also relied on Brown's Furniture, where Brown's Furniture during a ten month period in 1989 made 942 deliveries of its merchandise into Illinois (from its furniture business located in Missouri). The Illinois Department of Revenue assessed use tax on Brown's sales to Illinois residents and the Illinois Supreme Court upheld the assessment on the grounds that the 942 deliveries constituted substantial nexus with Illinois.

      The Arizona Department of Revenue argued that Care's contacts with Arizona (one annual visit by the traveling salesman and 21 days in-state by training personnel) constituted substantial nexus under the Orvis and Brown's Furniture cases.

   2. The Tyler Pipe Standard Was Met. The Department also argued that the Tyler Pipe standard for substantial nexus was met because Care's in-state activities "are significantly associated with the taxpayer's ability to establish and maintain a market in this state for...