Tiptoeing through the Nexus Minefield

Article excerpt

IN BRIEF

Trying to Have Their Coke and Eat It Too

Traditional businesses have long envied the taxfree advantages enjoyed by dot-com retailers. Though consumers may believe that the Internet is a tax-free zone, e-tailers are only spared the burden of state sales tax collection where they have no nexus that would subject them to the consumer's state tax jurisdiction. The nexus rules, however, are not quite cut and dry.

Although many brick-and-mortar retailer have formed e-tailer subsidiaries to reap the benefits of e-commerce, the authors point out that many companies have ignored alter ego and agency considerations, creating the possibility that the nexus of the parent will be attributed to the subsidiaries. Avoiding attributional nexus requires the companies to be distinct entities: They should avoid common officers and personnel, eschew joint promotion and advertising, and sell different products. It is also essential to keep customer service activities separate and maintain arm's-length pricing for any licensing agreements. If a careful division is maintained, the companies can enjoy the benefits of click-and-mortar operations while avoiding the dangers of the nexus minefield.

The bane of Main Street businesses, "e-tailers" enjoy the luxury of being able to sell to customers across the country (and the world) without the burden of collecting sales tax in every jurisdiction. By limiting their physical presence to one or two states, they effectively limit their sales tax collection responsibility to those states, giving them a competitive edge over traditional "brick-and-mortar" retailers. After years of howling over this inequity, many traditional retailers have decided that they'd rather switch than fight: Wal-Mart, Kmart, and Borders have all recently unveiled e-tailing operations.

But the megaretailers have a problem that pure e-tailers do not: Their brick-and-mortar operations give them nexus in most states and they are required to collect sales tax on their Internet sales in those states. The retailers' dilemma is compounded by the fact that consumers have come to expect all Internet sales to be tax-free (ignoring or forgetting that they are responsible for any applicable use taxes on such transactions).

Consumer expectations and increased competition have led many of the new "click-and-mortar" retailers to try to structure their way around collecting sales taxes. Many have broken their new e-tailing units out into separate subsidiaries or affiliates with a limited physical presence. The traditional retailer naturally wants to capitalize on its goodwill and name recognition, and therein lies the problem: If the retailer/e-tailer relationship is too seamless, there is a very real danger that states will treat the two entities as one for nexus purposes.

The new breed of click-and-mortar retailers must consider how much integration will be acceptable to taxing authorities. But where to draw the line? The authors' review of various websites indicates that many retailers may not understand the significance of this decision. Although the names have been changed, the problems presented in the following case study are real. Retailers should be warned that it was not difficult to find the incriminating evidence, and more likely than not the state tax auditors are not far behind. The stakes are high and the rules are anything but clear.

Cage Study

Retailer Inc. maintains retail outlets throughout the continental United States and has been an industry giant in the computer hardware business for the last decade. Retailer thought it especially important to establish a website, which it used to market, support, and sell its products. After the initial fanfare, however, sales from Retailer's website began to decline. Many of its customers complained about having to pay sales tax, believing that Internet sales were tax-free. Other customers didn't complain; they simply took their business to Retailer's biggest competitor, a pure e-tailer that only collected tax in the two states where it had a physical presence. …