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Annette Nellen
Annette Nellen

Back to school: Sales tax nexus lessons

Teachers, classrooms, bright-line tests: Let's go back to school and learn the "vagaries of physical presence."

August 23, 2012
by Annette Nellen, Esq., CPA

Recent rulings in Connecticut and Tennessee held that Scholastic Books Inc. has sales tax nexus in those states. These rulings are a reminder that the physical presence test of Quill does not always bring certainty to sellers or taxing authorities.

The questions facing Scholastic are not new. State litigation on this issue predates the 1992 Supreme Court decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and has been inconsistent among the states. Even these recent rulings both reversed lower court decisions. This article reviews the string of Scholastic and Troll Book cases dating back to 1989 and the challenges of applying the Quill physical presence standard.

Bookseller decisions

The chart below provides a brief summary of the Scholastic and Troll Book decisions, presented in chronological order from 1989 through August 2012.

State

Case

Sales Tax Nexus?

Details

California

Scholastic Book Clubs, Inc. v. State Board of Equalization, 207 Cal. App. 3d 734 (1989)

Yes

The court found the case to be similar to Scripto Inc. v. Carson, 362 U.S. 207 (1960), in that teachers generate sales for an out-of-state seller, although without “written agency agreements.” Teachers collect payments and distribute goods beyond what Scripto sellers did. The court found an implied contract because Scholastic gave teachers “bonus points for merchandise.” The “more sales the teachers make, the more bonus points they earn.” Scholastic was found to be “exploiting or enjoying the benefit of California’s schools and employees to obtain sales.” Also see 1999 Board of Equalization Memorandum Opinion (pdf) and footnotes 6 and 8 of the 2009 Connecticut ruling (pdf).

Arkansas

Pledger v. Troll Book Clubs, Inc., 871 S.W.2d 389 (Ark. 1994)

No

“In Arkansas, the agency relationship must be shown to exist by proof of both authorization and control or else the doctrine of ratification is inapplicable.”

A dissenting opinion noted that a contract of agency exists once teachers send in the orders.

Ohio

Troll Book Clubs, Inc. v. Tracy, No. 92-Z-590 (Ohio Bd. Tax App. 8/19/94)

No

The issue was partially framed as whether teachers were Troll’s agents or merely Troll’s customers. The court held that the teachers were customers. The court said, “The question ultimately boils down to whether a substantial nexus can be found with proof of something less than agency. Under the facts of this case, we must answer that question no. Troll’s contact with Ohio teachers is not of such a degree to establish a physical presence.”

Kansas

In re Scholastic Book Clubs, Inc., 920 P.2d 947 (Kan. 1996)

Yes

The court held that teachers act under Scholastic’s authority when they take action to sell books to students. Scholastic’s order acceptance and use of teachers to distribute books makes the teachers implied agents of Scholastic.

“Scholastic clearly has more of a connection with Kansas than catalog sales through the mail or by common carrier. Applying the test stated in Nat. Bellas Hess [386 U.S. 753 (1967)] and Quill, Scholastic’s use of the Kansas teachers to sell their product to Kansas students provides a substantial nexus with the state of Kansas.”

Michigan

Scholastic Book Clubs, Inc. v. Dept. of Treasury, 567 N.W.2d 692 (Mich. Ct. App. 1997)

No

The court stressed that the teachers were not Scholastic’s employees or agents. The teachers were found to be more analogous to parents ordering from a catalog. Also, the teachers were not obligated to sell books.

Connecticut

Scholastic Book Clubs, Inc. v. Commissioner of Rev. Servs., 38 A.3d 1183 (Conn. 2012), rev’g Scholastic Book Clubs, No. CV 07 4013027 S (Conn. Super. Ct. 4/9/09)

Yes

The lower court found that the teachers were not obligated to sell for Scholastic and received no compensation (bonus points went to the classroom). Per the court: “[T]he teachers are not in-state ‘order-takers’ seeking to produce ‘revenue’ for themselves or SBC” and are not “representatives” under state law. The court held that the teachers act similarly to parents in helping students place orders.

The Connecticut Supreme Court reversed. The court held that the teachers were not really customers acting in the role of parents helping children place an order. Typically, the forms were sent home so parents could help students complete the order form.

The court found that the teachers “provide the substantial nexus” required for Commerce Clause purposes per the “bright-line rule established in Bellas Hess and Quill.” It is not relevant that there is no oral or written agreement between Scholastic and the teachers. Scholastic’s system places teachers in a position equivalent to salespersons. Teachers make students aware of the products, provide order forms, and handle order distribution. Teachers also earn bonus points for additional purchases.

Tennessee

Scholastic Book Clubs, Inc. v. Farr, M2011-01443-COA-R3-CV (Tenn. Ct. App. 1/27/12), rev’g No. 09-587-II (Tenn. Ch. Ct. 2012)

Yes

The Tennessee Court of Appeals reversed the trial court to find that Scholastic had nexus in the state. The court held that the nexus issue did not depend on whether teachers were Scholastic’s agents because it was enough that it had connections in the state by its use of schools and teachers to facilitate sales in the state. The court said that Scholastic “created a de facto marketing and distribution mechanism within Tennessee’s schools.”

Bright line?

The Quill decision provides that for Commerce Clause purposes, a seller must have a physical presence before a state may impose sales tax collection obligations. While the Supreme Court described this as a “bright-line test,” the bookseller cases illustrate a murky test. Arguably, the view expressed by Justice Byron White in his partial dissent in Quill describes the current state of affairs:

[T]he question of Quill’s actual physical presence is sufficiently close to cast doubt on the majority’s confidence that it is propounding a truly “bright-line” rule. Reasonable minds surely can, and will, differ over what showing is required to make out a “physical presence” adequate to justify imposing responsibilities for use tax collection. . . . it is a sure bet that the vagaries of “physical presence” will be tested to their fullest in our courts. [Quill at 330-331]

Quill also describes the Commerce Clause standard as not satisfied if a seller’s “only connection with customers in the State is by common carrier or the United States mail.” Some bookseller cases, such as the Tennessee ruling, used this approach. That court held that Scholastic used Tennessee schools and teachers to facilitate sales, also noting that this was a use of public services in the state. According to the court, Scholastic’s “connections with its customers in Tennessee do not fall (within) the narrow safe harbor provisions affirmed in Quill.”

Related questions

Store employees stock their shelves by placing orders with suppliers. That alone does not cause the supplier to have sales tax nexus in the state. Why aren’t the teachers like the store employees? Neither is obligated to buy from the supplier. Is it enough that the teacher becomes the go-between of the students/parents and the supplier?

Paper order forms are becoming things of the past. If a teacher gives the Scholastic website URL to students who then place orders that are shipped to the school, would the “yes” rulings above finding nexus reach a different result? What if the orders are shipped to the students’ homes?

Looking forward

Scholastic has asked the U.S. Supreme Court to hear the Connecticut case. That request is likely to be denied. In 1992, in the Quill decision, the Court noted that with physical presence no longer needed for Due Process Clause purposes, Congress could exercise its Commerce Clause authority to provide a nexus standard. Twenty years later, it is still a Commerce Clause issue within Congress’s authority.

States and Congress need to do more to define physical presence and the elements of a seller’s relationship with in-state persons that will create sales tax obligations. For example, must the in-state person be paid? Must they handle the goods or funds? More guidance is needed. How much longer must sellers and their tax advisers wait for a true bright-line test?

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Annette Nellen, Esq., CPA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She chairs the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax policy and reform and a blog.