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TRANSCRIPT
Drop Shipments and Sales Tax Navigating Varying State Policies on Registrations and Exemptions
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WEDNESDAY, MAY 29, 2013
Presenting a live 110-minute teleconference with interactive Q&A
Miles Hutchinson, CPA, President, Sales Tax Advisors, Greater Kansas City Area
Steven Dimengo, Partner, Buckingham Doolittle & Burroughs, Akron, Ohio
Richard Fry, Attorney, Buckingham Doolittle & Burroughs, Akron, Ohio
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Drop Shipments and Sales Tax Seminar
Burroughs
May 29, 2013
Burroughs
Miles Hutchinson, Sales Tax Advisors
Steven Dimengo, Buckingham Doolittle & Richard Fry, Buckingham Doolittle &
Today’s Program
Potential Nexus-Related Difficulties
[Steven Dimengo and Richard Fry]
Fundamental Drop Shipping Concepts
[Miles Hutchinson]
Ongoing Compliance Demands From Drop Shipping
[Miles Hutchinson, Steven Dimengo and Richard Fry]
States That Pose Particular Issues
[Steven Dimengo and Richard Fry]
Slide 8 – Slide 20
Slide 60 – Slide 68
Slide 21 – Slide 38
Slide 39 – Slide 59
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
POTENTIAL NEXUS-RELATED DIFFICULTIES
Steven Dimengo, Buckingham Doolittle & Burroughs
Richard Fry, Buckingham Doolittle & Burroughs
Background:
Drop Shipment Concepts
Supplier/wholesaler selling property to retailer but delivers property
directly to the retailer’s customer on behalf of retailer
Vendor’s sales/use tax collection requirement: Bright-line physical
presence requirement
Customer is still liable for use tax if tax is not collected by vendor.
The issue: Supplier has a physical presence in the state where the
customer is located, but the retailer does not.
9
Master Your Nexus
Quill Corp. v. North Dakota, 504 U.S. 298 (1992)
Due Process Clause requires “some definite link, some minimum
connection, between a state and the person, property or transaction
it seeks to tax.”
Commerce Clause requires that a state tax (1) be applied to an
activity with a substantial nexus with the taxing state, (2) be fairly
apportioned, (3) not discriminate against interstate commerce, and (4)
be fairly related to the services provided by the state.
De minimis exception: Activities, when taken together, establish only a
trivial connection with a state. Quill, at n. 8 (presence of “a few floppy
diskettes” did not give rise to substantial nexus). Wisc. Dept. of Rev. v.
William Wrigley, Jr., Co., 505 U.S. 214 (1992).
10
What Constitutes A Physical Presence?
Physical presence can be established directly or through an
agent/representative in the state.
Nexus created by independent contractors “conducting continuous local
solicitation in [the state] and forwarding the resulting orders …” to the
taxpayer. Scripto, Inc. v. Carson, 362 U.S. 207 (1960)
Sales representatives/independent contractors’ in-state activities of calling
on customers and soliciting orders constituted continuous physical presence
of taxpayer.Tyler Pipe Industries, Inc. v. Washington Dep’t of Rev., 483 U.S.
232 (1987)
11
Common Nexus Issues
Voluntary registration: A business’ registration to do business in a state
as a foreign entity may lead to a concession that the business is subject to
the state’s taxes. Likewise, voluntary registration to collect and remit
sales tax likely constitutes a concession that sales tax collection is
required.
Employee visits: Sporadic employee visits will likely create substantial
nexus, even though a taxpayer had no permanent place of business in the
state, especially if the employee’s presence helps create or maintain the
in-state market.
Telecommuters: Employee works from home in a state where the
taxpayer otherwise does not have a place of business.
See, e.g., Telebright Corp., Inc. v. Director, Div. of Tax., No. 011066-
2008, CCH ¶401-501 (N.J. Tax Ct., Mar. 24, 2010) (Maryland
business had nexus with New Jersey for corporate business tax by
virtue of a telecommuting employee who worked out of her home
after husband was relocated to the state).
12
Common Nexus Issues (Cont.)
Trade show presence
Many states have specific exemptions for the attendance of trade
shows, with some being qualified by the number of days attending
the trade show and whether orders are taken at the trade show.
Other states, Texas for example, have taken a more aggressive
position that nearly any presence at a trade show where products are
sold, orders are taken or promotion for future sales are made creates
nexus.
State-specific standard
13
In-State Representative Activities
General rule: Substantial nexus will be present if (1) a representative relationship
is exists (regardless of contractual designation), and (2) the representative
performs in-state activities on the taxpayer’s behalf that help create or maintain
the taxpayer’s market.
Deliveries or installations: Nexus is present if a business delivers property to
customers in the state using its own trucks. Delivery via common carrier or U.S. mail
is excluded.
Warranty repairs and service work: Generally will create nexus, even if performed by
an independent contractor or representative
Dell cases: Contractually, Dell was the agent and the warranty provider was the
principal. Dell argued that a principal’s presence cannot be attributed to its agent
to create nexus. But, a substantial presence was found due to Dell’s control over
the service provider. The customer was first obligated to contact Dell for over-
the-phone technical support. Dell determined whether an issue was covered by
the warranty, and the service provider’s presence was significantly associated
with Dell’s ability to create and maintain a market in the state. See Dell Catalog
Sales, LP v. New Mexico, 199 P.3d 863, (N.M. App., 2008); State v. Dell Int’l, Inc.,
922 So.2d 1257 (La.App., 2006); and Dell Catalog Sales, LP v. Comm’r of Rev.
Serv., 834 A.2d 812 (Conn. Sup., 2003) (failed to find substantial nexus due to lack
of evidence concerning extent and frequency of warranty provider’s presence,
despite finding that Dell receives significant benefit from provider)
14
Click-Through Nexus
11 states have click-through nexus statutes or administrative policies.
Generally, nexus is presumed to exist if:
Agreement with in-state affiliates
To refer sales, including via Web link
In exchange for a commission or other consideration, and
Sales from such referrals is more than $10,000 per year.
NY statute recently upheld amid facial constitutional challenge.
Overstock.com, Inc. v. N.Y. St. Dept. of Tax and Fin., 2013 WL 1234823
(N.Y. Ct. of Apps., Mar. 28, 2013)
Limited to compensation paid based upon completed sales;
recognized mere advertising insufficient to create nexus. N.Y. St.
Dept. of Tax and Fin. Memorandum No. TSB-M-08(3)S (May 8,
2008)
California has “Google” exception. Cal. Rev. & Tax. Code 6203(c)(5)(B)
& (C)
15
Affiliate Nexus
Deems nexus to exist if a related entity with an in-state physical presence:
Sells the same or substantially similar products under the same or a
substantially similar name
Has facilities or employees in the state which advertises, promotes or
facilitates sales for the out-of-state seller, or helps establish or
maintain an in-state marketplace (such as receiving or exchanging
returned merchandise)
Has an in-state distribution center, warehouse or similar location that
delivers products sold by the out-of-state seller
16
Drop Shipments
Physical presence?
In-state representative fulfilling orders on behalf of out-of-state seller?
Presence of in-state property (inventory)?
In 2013 BNA “Survey of State Tax Departments,” 15 states indicated that
the use of a drop shipper would create nexus when the drop shipper and
customer are in the same state.
Is nexus created even if the customer and drop shipper are not in the
same state?
No state has made such a finding (except Missouri via administrative
regulation, which is discussed later).
17
Web-Based Nexus
Owns or leases in-state server
Shared use of third party’s in-state server
Pays a Web-hosting provider with an in-state server
18
Slide Intentionally Left Blank
Trailing Nexus
In 2013 BNA “Survey of State Tax Departments,” 35 states responded
that they would find nexus to exist for the entire taxable year during
which nexus-creating activities ceased (but no longer).
Only IN responded that trailing nexus may extend beyond the
taxable year.
“One year seems reasonable to me as a benchmark for states without
specific guidance, but a state may have unique consideration that
dictate a different policy.” - Thomas Shimkin, director of the
Multistate Tax Commissioner’s nexus program
20
FUNDAMENTAL DROP SHIPPING CONCEPTS
Miles Hutchinson, Sales Tax Advisors
About Miles Hutchinson
22
Miles Hutchinson is a seasoned veteran of finance, accounting and tax law with over 35 years experience including roles from financial auditor at PricewaterhouseCoopers to CFO of a billion dollar real estate development company. He writes and speaks for many of the national and international seminar companies and is recognized as an expert in payroll and sales & use tax as well as financial modeling & analysis tools, business strategy and communications. Mr. Hutchinson holds a CPA accreditation and is the author of several useful accounting and tax tools available at www.soxpolicies.com and www.salestaxadvisors.com. Please visit his web sites to see how you can further benefit from his expertise.
Sales Tax Advisors, Inc.
Fundamental Drop Shipping Concepts
• The drop shipment transaction
• Problematic scenarios and issues to anticipate
• Case examples
– California
– New York
23 Sales Tax Advisors, Inc.
Interstate Vs. Intrastate
• Interstate – buyer and seller are in different states; goods are delivered across a state line.
• Sourcing rules - depends on the rules of the shipping state re:
– Title transfer
– Shipping point
– Destination
• Intrastate – goods are delivered within the same state from which they were shipped
• Sourcing rules - depends on the rules of the state re: – Title transfer
– Shipping point
– Destination
24 Sales Tax Advisors, Inc.
Nexus
nex·us (nkss) n. pl. nexus or nex·us·es
1. A means of connection; a link or tie
2. A connected series or group
3. The core or center
25 Sales Tax Advisors, Inc.
Nexus (Cont.)
• Many states require out-of-state sellers to register to collect sales and use tax if they engage in activities within the state such that nexus is created.
• Sellers should check state statutes for nexus requirements before doing business in or registering in a foreign state.
26 Sales Tax Advisors, Inc.
Determining Nexus
• Download a copy of state’s nexus questionnaire
• Review state definitions for authority to tax
• Contact Sales Tax Advisors, Inc., www.salestaxadvisors.com
27 Sales Tax Advisors, Inc.
Interstate Commerce Exemption
• U.S. Constitution
• Commerce Clause of the ICE
• States will not tax goods moving in interstate commerce – no border taxes.
• If property comes to rest, it may become subject to that state’s power to impose a tax.
28 Sales Tax Advisors, Inc.
The Drop Shipment Transaction
V2 – Manufacturer/ Distributor
V1 – Retailer
Customer
Key conditions: V1 does not have nexus in the customer’s state. V2 does have nexus in the customer’s state. V2 requires proper exemption certification to avoid charging tax in Invoice 1.
29 Sales Tax Advisors, Inc.
The Drop Shipment Transaction (Cont.)
V2 – Manufacturer/ Distributor
V1 – Retailer
Customer
Ord
er 1
Key conditions: V1 does not have nexus in the customer’s state. V2 does have nexus in the customer’s state. V2 requires proper exemption certification to avoid charging tax in Invoice 1.
30 Sales Tax Advisors, Inc.
The Drop Shipment Transaction (Cont.)
V2 – Manufacturer/ Distributor
V1 – Retailer
Customer
Ord
er 1
Exempt Order 2
Key conditions: V1 does not have nexus in the customer’s state. V2 does have nexus in the customer’s state. V2 requires proper exemption certification to avoid charging tax in Invoice 1.
31 Sales Tax Advisors, Inc.
The Drop Shipment Transaction (Cont.)
V2 – Manufacturer/ Distributor
V1 – Retailer
Customer
Ord
er 1
Exempt Order 2
Key conditions: V1 does not have nexus in the customer’s state. V2 does have nexus in the customer’s state. V2 requires proper exemption certification to avoid charging tax in Invoice 1.
32 Sales Tax Advisors, Inc.
The Drop Shipment Transaction (Cont.)
V2 – Manufacturer/ Distributor
V1 – Retailer
Customer
Ord
er 1
Exempt Order 2
Invoice 1
Key conditions: V1 does not have nexus in the customer’s state. V2 does have nexus in the customer’s state. V2 requires proper exemption certification to avoid charging tax in Invoice 1.
33 Sales Tax Advisors, Inc.
The Drop Shipment Transaction (Cont.)
V2 – Manufacturer/ Distributor
V1 – Retailer
Customer
Ord
er 1
Invo
ice
2
Exempt Order 2
Invoice 1
Key conditions: V1 does not have nexus in the customer’s state. V2 does have nexus in the customer’s state. V2 requires proper exemption certification to avoid charging tax in Invoice 1.
34 Sales Tax Advisors, Inc.
The Drop Shipment Transaction (Cont.)
V2 – Manufacturer/ Distributor
V1 – Retailer
Customer
Ord
er 1
Invo
ice
2
Exempt Order 2
Invoice 1
Key conditions: V1 does not have nexus in the customer’s state. V2 does have nexus in the customer’s state. V2 requires proper exemption certification to avoid charging tax.
35 Sales Tax Advisors, Inc.
Slide Intentionally Left Blank
California Drop Shipments
• CA requires retailer to register in CA to protect drop shippers from sales tax liability.
• Retailer must issue CA resale exemption certificate to drop shipper with a CA STID number.
• Retailers may not use exemption certificates from other states; they will not protect CA drop shippers.
• Retailers must collect and remit sales tax.
37 Sales Tax Advisors, Inc.
New York Drop Shipments
• Retailer may issue a New York state certificate with a home state registration number.
• Drop shipper may accept this documentation to avoid tax on NY deliveries.
• Retailer is not required to collect sales tax.
38 Sales Tax Advisors, Inc.
ONGOING COMPLIANCE DEMANDS FROM DROP SHIPPING
Miles Hutchinson, Sales Tax Advisors
Steven Dimengo, Buckingham Doolittle & Burroughs
Richard Fry, Buckingham Doolittle & Burroughs
Consequences Of Non-Compliance
• If your company has drop shipper issues and does not know the rules in each state where goods are delivered, the consequences could be expensive.
– Drop shippers may begin charging you sales tax.
– Retailers see their profit margins erode.
– Penalties (and interest) for failure to:
• Register
• File tax returns
• Remit taxes
• No statute of limitations on retroactive application of penalties
40 Sales Tax Advisors, Inc.
Dealing With Non-Compliance
• Consider using a liaison to mediate correction of the problem
• Protect the company from discovery until a settlement is reached
• Determine whether amnesty is currently offered by the offended state
• Negotiate – states often consent to drop the penalties with those who volunteer to comply
• Interest is seldom negotiated.
41 Sales Tax Advisors, Inc.
Manage Your Tax Exposure
• Obtain a matrix of the state-by-state rules
• Follow each state’s requirements for documenting resale exemptions on your drop shipments
• Provide this documentation to the drop shippers to maintain your resale exemption and protect them from tax assessment during audits
• Remember, some states have time limits on their certificates – anywhere from two to 10 years
• Be sure to renew your exemption certificates before they expire
• Refer to: http://www.salestaxadvisors.com/v4.2/tax/drop/ for additional information and a matrix
• Several third-party vendors supply software (often Web-based) to help manage your exemption certificates.
42 Sales Tax Advisors, Inc.
Buying From Wholesalers
• Wholesalers may not be aware of the sales tax risks associated with drop shipping.
• Get ahead of this issue
• Inform your drop shippers of the need for proper documentation
• Provide the correct documentation whether asked or not
• Maintain a tickler file of expiration dates for certificates you have issued, and renew early
43 Sales Tax Advisors, Inc.
Streamlined Sales Tax Project
• Increase in Internet and catalog purchases
• Web-based businesses
• States are losing tax dollars.
• Main Street Fairness Act
• Standardization of definitions
• Amnesty
• Member and associate states
• http://www.streamlinedsalestax.org/
44 Sales Tax Advisors, Inc.
Streamlined States
45 Sales Tax Advisors, Inc.
Sales And Use Tax Resources
State Web sites – www.cpaclassifieds.com- free CPA tools – IRS toolbar – state sites list
Professional associations
www.streamlinedsalestax.org
www.mtc.gov
www.Zip2Tax.com
R.I.A. CheckPoint online research
Sales Tax Advisors, Inc.
www.salestaxadvisors.com
46 Sales Tax Advisors, Inc.
Audit Issues From
Different Perspectives
Drop shipper/wholesaler: Were exemption certificates maintained properly?
If collection is required, upon what price must tax be collected?
Seller/retailer: What is in-state presence? Does presence through drop
shipper – inventory and/or in-state representative fulfilling orders –
create nexus?
Information collection: Seller may have been flagged due to
relationship with drop shipper.
Customer: Was tax charged on taxable purchases? Avoid double-taxation
(e.g., if drop shipper charged tax, and customer self-accrued tax)
47
Preparing For An Audit
Document retention - resale/exemption certificates
Does the state accept a resale/exemption certificate without an in-
state registration number?
Will acceptance of an out-of-state certificate relieve the drop shipper
of its collection obligation?
Does the state accept multi-jurisdictional certificates?
48
Preserving Exemption Certificates
Easiest to store electronically in central location
Periodically examine certificates for:
Completeness
Validity
Timeliness
49
Invoices
Retailer (not drop shipper) should invoice the customer.
It is best if retailer’s invoice does not indicate from where goods were
shipped. Otherwise, it appears as though the retailer had inventory
present in the state.
50
Audits
Majority allows manufacturer/wholesaler to accept multi-jurisdiction or
home state resale certificate.
SSUTA requires member states to accept a resale certificate or other
evidence, even if the seller is not registered to collect sales or use tax in
the state where the sale occurs.
24 full member states
Approximately 36 states follow these procedures.
51
Electronic Storage
Exemption certificates may be stored in paper or electronic form.
If one is accepted in electronic form, no signature is required.
52
Slide Intentionally Left Blank
Timing Of Acceptance
If accepted at the time of sale or within 90 days thereafter, the seller is
relieved of collection obligation.
120-day rule:
If an exemption certificate is not so obtained, the seller may obtain a
fully completed exemption certificate within 120 days of the state
taxing authority’s request for substantiation of exempt sales.
54
Good Faith Acceptance
Means that the claimed exemption is:
Statutorily available on the date of the transaction in the jurisdiction
where the transaction is sourced,
Applicable to the item being purchased, and
Reasonable for the purchaser’s type of business.
Good faith standard does not apply when accepted within 90 days of the
sale.
However, a state need not accept a fraudulently obtained certificate.
55
Other Evidence
Other evidence of an actual exempt use/purpose may be presented.
Seller will have burden of proof to establish exemption.
E.g., statement or letter of usage from customer
56
Non-SSUTA Members
Non-member states may have more onerous requirements to establish
exemption.
Some states only allow an exemption if the purchaser is issued a state-
specific registration or certificate.
For example, Florida requires a purchaser to obtain an annual resale
certificate to claim exemption.
Majority allows an exemption to be substantiated by other evidence of
exempt use/purpose, such as a customer statement.
But, the seller will likely have the burden of proof.
57
Additional Considerations To Support
Non-Taxability Of Sale
Supplier delivered property from outside the taxing state.
Customer has a direct pay permit.
Customer paid the tax.
Customer is entitled to an exemption as supported by obtaining a timely
exemption certificate.
Resale exemption
Status exemption (e.g., government entity or non-profit organization)
Use exemption (e.g., manufacturing equipment)
Preserve all exemption certificates indefinitely, since potentially no
statute of limitations due to failure to file sales tax returns
58
Dealing With Auditors
You may need to educate the auditor, as states with recent law changes
may not have taken the time to retrain their auditors.
Explain compliance procedures to help establish reasonable cause, if
delinquency exists to avoid penalties
Only provide information that is requested
59
STATES THAT POSE PARTICULAR ISSUES
Steven Dimengo, Buckingham Doolittle & Burroughs
Richard Fry, Buckingham Doolittle & Burroughs
SSUTA Drop Shipment Treatment
SSUTA requires each member state to “allow a third party vendor (e.g.,
drop shipper) to claim a resale exemption based on an exemption certificate
provided by its customer/re-seller or any other acceptable information
available to the third party vendor evidencing qualification for a resale
exemption, regardless of whether the customer/re-seller is registered to
collect sales and use tax in the state where the sale is sourced.” Sect.
317(A)(8)
61
Problematic Treatment
Certain states place the sales tax collection burden on a drop shipper
with nexus.
Assuming retailer does not have nexus and is not registered to collect
sales tax
Avoids dispute over nexus
Collection may be based upon: (1) wholesale price, or (2) retail price or
wholesale price plus mark-up.
Drop shipper is unlikely to know the retail price.
62
Florida
If a drop shipper fulfills an order from Florida and ships to a Florida
address, the drop shipper must collect tax.
“If a Florida manufacturer sells taxable merchandise to an
unregistered out-of-state dealer, who, being unregistered dealer, but
delivers it to the out-of-state dealer’s customer in Florida, he shall
collect tax from the out-of-state dealer, who, being unregistered, is
unable to furnish a resale certificate.” Fla. Admin. Code § 12A-
1.091(10)
If a drop shipper ships from outside Florida and uses a common carrier,
drop shipper may accept a multi-jurisdictional or home state exemption
certificate.
63
Missouri
Deems retailer to have nexus based upon temporary ownership of in-
state property
Takes the position that title passes from the drop shipper to the
retailer just prior to delivery to the consumer
Is presence de minimis?
Drop shipper does not have an obligation to collect tax, because the
retailer has nexus.
12 Mo. Code of State Regulations §10-114.100(4)(F)
64
Tennessee
Drop shipper must collect tax on behalf of retailer.
“[Sales of tangible personal property or taxable services made by a
dealer to an out-of-state vendor who directs the dealer act as his (the
out-of-state vendor) agent to deliver or ship tangible personal
property or taxable services to his (the out-of-state vendor) customer,
who is a user or consumer, are subject to Sales or Use Tax. The
dealer so acting as agent for the out-of-state vendor must collect the
tax involved on the transaction …” Tenn. Comp. R. & Regs. 1320-5-
1-.96
Drop shipper cannot rely upon a consumer’s exempt status to claim
exemption.
“[T]he taxable event occurs at the time an item is sold by the [drop
shipper to the retailer]; subsequent transactions will have no effect on
the taxability of the [drop shipper]’s sale.” Tenn. Dep’t of Rev. Letter
Ruling 11-64 (Nov. 21, 2011)
Is this consistent with the above-quoted regulation?
65
Slide Intentionally Left Blank
Trending
More states are moving toward the majority of allowing a drop shipper
to accept a multi-jurisdiction or home state resale certificate, or other
evidence of actual exempt use, even if not registered with the state where
property is delivered.
Thanks to SSUTA and MTC
Nevada, Wisconsin and West Virginia recently changed position on
drop shipments.
Does this mean more pressure will be placed on retailer?
67
Summary Thoughts
Supplier/drop shipper
Always obtain properly completed resale exemption certificate from
retailer (even if not registered in destination state)
Problem/minority states, either:
Obtain customer exemption certificate (through retailer),
or
Collect tax from retailer
If audited – evidence customer paid tax (or direct pay permit)
Retailer
Don’t use drop shipper in customer state (unless prepared to
incorporate tax as part of doing business and/or increase price of
goods to cover such cost)
68