The Net vs. The Nexus
Who needs that 'recital of consideration'?
By Nathaniel T. Trelease and Andrew W. Swain
Sales of goods and services on the Net are taxable. Not tomorrow, but
today. Virtually all Internet buyers and sellers are surprised to
learn this. Every day, many Internet sellers properly collect and
report sales taxes on sales. But most do not, and that is a growing
problem for both Internet sellers and the states.
Most consumers have bought goods on the Internet without paying sales
tax and assume that these transactions are nontaxable. Most Internet
sellers will vaguely cite the Internet Tax Freedom Act (ITFA) as the
reason why they are not required to collect sales and use taxes
(together, sales taxes) on sales made over the Internet.
These assumptions are incorrect and can be very costly for Internet
Sales of tangible and intangible goods on the Internet (e-commerce)
are potentially subject to the sales and use taxes imposed by the
nation's approximately 7,500 state and local taxing jurisdictions (the
From the perspective of multistate tax law, there are few truly
mom-and-pop Internet sellers. Most of these sellers are as much
50-state businesses as McDonald's and Microsoft. The importance of
determining exactly when an Internet seller (a remote seller) becomes
subject to one or more taxing jurisdictions not its domiciliary
jurisdiction should not be underestimated. If an Internet seller is
itself liable for sales tax or at least responsible for collecting and
remitting the taxes to various jurisdictions and fails to do so, an
assessment for unpaid taxes on sales made over several years, plus
interest and penalties, could be devastating for even a successful
The risk of this has never been greater because, in an effort to stem
the erosion of their tax bases caused by a weakened economy, states
have become increasingly aggressive and clever in asserting their
taxing jurisdiction over remote sellers. Often enough, these efforts
contravene applicable federal constitutional restrictions on taxing
It is not possible in the compass of this article to fully cover the
issues raised by the application of multistate sales tax law, often
radically different in conception and application, to electronic
commerce. Instead, this article reviews the principal federal
restrictions on state taxation of interstate e-commerce and commonly
occurring situations in which the states are aggressive (and mostly
successful) in asserting their tax jurisdiction over remote
A business is a remote seller if it is physically located in one state
(its domicile) and has no facilities, substantial property or
personnel in another state. The business is "remote" from the other
states because it is not physically located in those states.
Historically, the issue of whether remote sellers can be taxed arose
when the residents of a state traveled across state lines to purchase
goods in another state and arose again in the context of catalog
The dramatic expansion of interstate e-commerce has brought renewed
attention to the dormant Commerce Clause of the U.S. Constitution,
which precludes a state from taxing a remote seller operating in
interstate commerce unless the state has "substantial nexus" with the
seller. Complete Auto Transit Inc. v. Brady, 430 U.S. 274
In Quill Corp. v. North Dakota, the U.S. Supreme Court
reaffirmed the long-standing rule that, for sales tax purposes, a
state has substantial nexus with a remote seller only if the seller is
"physically present" in the state. 504 U.S. 298 (1992)
(reaffirming National Bellas Hess Inc. v. Dept. of Rev. of
Illinois, 386 U.S. 753 (1967)). Though the court seemingly
established a bright-line rule that would reduce the amount of
confusion and litigation in this area of law, left unanswered was the
crucial question of what level of physical presence was
In Quill, the court held that a remote seller's delivery of
goods into a state via common carrier could not be a basis for
establishing nexus, and neither was it sufficient that it sent several
tons of direct mail catalogs and fliers into the state.
In the earlier case of National Geographic Society v. California
State Board of Equalization, however, the court held that a remote
seller's two offices and permanently located personnel were sufficient
to establish nexus with a state. 430 U.S. 551 (1977). In the same
case, the court held that the "slightest physical presence" was
insufficient to create nexus. The court did not explain what it meant
by slight physical presence.
Between these two guideposts — personnel and physical
facilities in a state create nexus, the slightest physical presence
does not — the standards for the creation of nexus, and the
application of these standards, vary widely among the states.
As a practical matter, states equate nexus with a remote seller's
doing business in the state, as the term is defined by state statute.
These definitions are broadly drafted, generally not founded in the
physical presence standard of Quill and frequently
over-inclusive of circumstances under which a state can validly assert
its taxing jurisdiction.
Texas, for example, defines doing business as including, among other
things, the licensing of a remote seller's trade name to a party in
the state, collecting royalties from the licensing of personal
property to Texas customers, or the use of representatives to do
canvassing and distribution functions. Tex. Admin. Code tit. 34,
§ 3.286(a)(1); see also Texas Tax Publication 94-108
(April 1999) (available at http://window.state.tx.us/taxinfo/
taxpubs/tx94_108.html) (providing guidelines to a remote seller
regarding whether or not its activities create nexus).
It is important that the sale of both custom and off-the-shelf
software in Texas is considered a sale of personal property and thus
subject to the state's sales tax. Tex. Tax Code Ann. § 151.009;
Tex. Admin. Code tit. 34, § 3.308. Therefore, a remote seller
establishes nexus with Texas if it licenses either off-the-shelf or
custom software to a Texas customer. Decision of the Texas Comptroller
of Public Accounts, Hearing No. 36,237 (July 21, 1998).
Texas's approach is not unusual. Arizona broadly defines doing
business as including all activities or acts, personal or corporate,
engaged in or caused with the object of gain, benefit or advantage,
either directly or indirectly, excluding casual sales or activities.
Ariz. Rev. Stat. § 42-5001.1. At certain points of application,
Arizona adopts an "economic presence" test for nexus (that is, the
exploitation of a local consumer market, whether or not the remote
seller is physically present, creates nexus) that was repudiated in
Similarly, so broad is Tennessee's definition of doing business that
it includes businesses that import taxable property into the state or
merely offer to sell taxable property in the state. Tenn. Code Ann.
The most common basis for states asserting jurisdiction over a remote
seller involves the visits made by the seller's personnel to the
state. States generally take the position that, when a seller's
personnel enter the state, however briefly and for whatever purpose,
the remote seller is present. The states vary, however, on how many
visits over a certain period of time are sufficient to establish
Often enough, what is sufficient to give rise to taxing jurisdiction
in one state will be insufficient in another. In New York, for
example, 12 visits over three years establishes nexus, but in Kansas,
11 visits in a single year is insufficient. See Orvis Co. Inc. v.
Tax Appeals Tribunal, 612 N.Y.S.2d 503 (App.Div.3dDept. 1994);
In re Appeal of Intercard Inc., 14 P.3d 1111 (Kan. 2000);
Cole Bros. Circus Inc. v. Huddleston, No. 01-A-01-9301-CH00004,
(Tenn. Ct. App. June 4, 1993) (29 visits over 2 1/2 years is
sufficient); Department of Revenue v. Share International Inc.,
676 So.2d 1372 (Fla. 1996) (three visits in one year is
It is of potential significance to many remote sellers that Illinois
has ruled that the presence of a remote seller's sales manager working
solely from his home is sufficient to establish nexus with the remote
seller. Illinois Department of Revenue, Letter Ruling No. ST
01-0052-GIL (March 2, 2001).
The common law distinction between employees and independent
contractors is not respected for purposes of establishing
nexus. Scripto v. Carson, 362 U.S. 207 (1960). The presence of
either in a state can be treated as establishing the presence of a
remote seller. This principle allows the states to reach remote
sellers even though the sellers may innovatively structure their
marketing programs to use independent contractors.
A classic case is the Scholastic Book Club, which recruits teachers
nationwide to sell its books to their students. Teachers distribute
catalogs, collect payments and distribute the books when they arrive
in the mail. In exchange, the teachers receive "points" that may be
redeemed for merchandise.
The teachers were not employees of the club, but the states are split
on whether they are representatives of the club. If they are
representatives under each state's law, the teachers' presence
establishes nexus with the remote seller club. See, for example,
Scholastic Book Clubs Inc. v. State Board of Equalization, 207
Ca.3d 734 (Cal.Ct.App. 1989) (teachers' presence sufficient to
establish nexus); Freedom Industries v. Roger W. Tracy, Tax
Commissioner of Ohio, Ohio Board of Tax Appeals, No. 92-C-597
(Dec. 12, 1994) (insufficient).
Many states also establish nexus on the basis of a remote seller's
licensing or leasing property to residents. The general theory is that
even if the property is shipped into the state for a short period of
time by common carrier and returned to the seller on the expiration of
the license or lease, the seller still retains a substantial
reversionary interest in the property — all rights, title and
interest in the property less the term of the license or lease
— and that this interest somehow constitutes a physical
presence in the state.
Here too, though, the states vary as to how long the property must be
in the state on a lease or license for the contact to be sufficient to
establish nexus. In Alabama, the in-state presence for 48 hours of a
licensed film was sufficient to establish nexus with the remote
seller. Boswell v. Paramount Television Sales Inc., 282 So.2d
892 (Ala. 1973). However, in Connecticut, the in-state presence of a
licensed film for three days was held insufficient to establish nexus.
Cally Curtis Co. v. Groppo, 572 A.2d 302 (Conn. 1990). As noted
above, Texas takes the position that the licensing of software to the
state's residents is sufficient to establish nexus.
Because of the growing difficulty of breaking through online
marketing "noise" to reach potential customers, Internet sellers have
started using traditional forms of offline advertising —
television and radio ads, mail drops and billboards.
Whether advertising alone constitutes a sufficient basis for
establishing nexus is somewhat unclear. In Quill, the Supreme
Court effectively established a "safe harbor" for direct mail drops of
catalogs and fliers. In at least one state, Tennessee, courts have
invalidated the portion of the doing-business statute that established
nexus through in-state advertising. Bloomingdale's By Mail Ltd. v.
Huddleston, 848 S.W.2d 52, 57 (Tenn. 1992).
Other courts have used advertising as a basis for upholding the
assertion of nexus, but most of these cases have also involved the
in-state presence of personnel or some form of property. See, for
example, National Geographic Society v. California Board of
Equalization, 430 U.S. 551 (1977); Cole Bros. Circus
Inc. v. Huddleston, No. 01-A-01-9301-CH00004, (Tenn. Ct. App. June
4, 1993). Whether the in-state presence of billboards — in
which the remote seller has some form of property interest for a
lengthy period of time — is sufficient to establish nexus has
not been addressed.
Whatever bases they use to establish nexus, several states expressly
deem certain Net-related activities insufficient to establish nexus
with the state. California, for example, has established that nexus is
not established by a remote seller maintaining a Web site on a
computer server located in the state, having purchase orders taken by
an in-state Internet Service Provider, having limited attendance at
in-state trade-shows, or having contracts with in-state, unrelated
third-party contractors to handle repair and warranty services. Cal.
Code Regs. tit. 18, § 1684(a).
Other major states have similar computer server exemptions. See,
for example, Texas Comptroller of Public Accounts, Letter Ruling
No. 9802118L (Feb.10, 1998); New York State Department of Taxation and
Finance, Memorandum TSB-M-97(1)C ((Jan. 24, 1997); TSB-M-97(1)9S (Jan.
States use a variety of "attributional nexus" theories to create
nexus. In "affiliate nexus" cases, states try to attribute the
physical presence of an affiliate to a remote seller. In the context
of e-commerce, taxing jurisdictions attempt to attribute a retail
store's physical presence in the jurisdiction to the formally separate
out-of-state online unit.
In most instances, these assertions of nexus are defeated in court,
because, without reason to "pierce the corporate veil," the
attribution violates the axiomatic principle of corporate law that the
existences of separate entities will be respected. See, for
example, SFA Folio Collections Inc. v. Bannon, 585 A.2d 666
In "agency nexus" cases, states try to attribute the activities of
independent contractors or business partners to a remote seller. One
of the more interesting and troubling applications of this theory came
in a recent decision of the California Board of Equalization (CBOE).
Borders Online Inc., SC OHA 97-638364 56270 (Sept. 26, 2001).
The Borders bookstore chain maintained formally separate entities for
its chain of stores (retail unit) and its online bookstore (online
unit). The online unit represented on its Web site that the retail
unit was an authorized representative for merchandise returns. In
practice, the retail unit accepted returns of merchandise from
customers of the online unit in exchange for cash refunds. The retail
unit also accepted returns from competitors' customers in exchange for
On the basis of this disparity in its return policy, the retail unit's
activities were attributed to the online unit because, the CBOE held,
the process of accepting returns is integral to the selling process
and thereby encompassed within the term "selling" as used in Cal. Rev.
and Tax Code § 6203(c)(2).
The CBOE's interpretation of selling is arguably too broad because the
statute leaves out other specific activities — for example,
order taking and product installation — that are arguably more
integral to the sales process than accepting returned merchandise. The
decision is on appeal, but it shows the potentially broad and
troubling application of some form of agency theory that can be used
to pierce the corporate veil without satisfying the traditional
requirements of that extraordinary remedy.
Furthermore, the decision could have application to third-party,
joint-marketing partners. For example, if an online bicycle shop
entered into a joint marketing agreement with a national chain of
sports stores where the stores distributed the Internet seller's
coupons in its customers' merchandise bags, could the activities (and
thus the physical presence) of the stores' employees be attributed to
the Internet seller? Perhaps. If so, the Internet seller would have
nexus in all of the states where the national retail chain had stores
Because of the increasing importance of these questions, Internet
sellers and their clients are encouraged to take three practical steps
to begin identifying what continuing tax collection obligations and
historic tax liability the sellers may have:
first step is to begin collecting geographic-based information on the
seller's operations, including all the states into which it sends its
products, how those products are distributed, and what type of
commercial relationships it has with co-marketers, salesmen,
distributors, manufacturers and suppliers in those jurisdictions. The
information should be collected for both current and historical
second step is for the seller's legal advisers to identify potential
liability in at least the major jurisdictions in which the seller
operates. For instance, if the seller makes sales of $1 million in
three states, with nominal sales in all the rest, it makes eminent
sense for the seller's legal advisers to ascertain the state of sales
tax law in each of those three states. Counsel should focus on
determining whether tax liability is imposed on the seller or the
consumer, whether there is an arguable claim by the state that the
seller has nexus in the state, how aggressive the state department of
revenue is in pursuing current and historic assessments against
Internet sellers, and the likelihood of audit.
If tax liability is imposed in the first instance on the consumer, but
the consumer (as is very likely) does not self-assess and remit those
taxes, the seller may find itself liable for those taxes, even though
it could have avoided liability had it collected the taxes from the
third step is for the seller to factor in the findings of its legal
advisers into its competitive analysis. For instance, if one or
several states where the seller completes substantial sales will have
an arguable claim of nexus, it may make sense for the seller to
implement a tax-collection system for online sales. Or, if the claim
of nexus is founded on activities in the state or relationships with
partners in the state that are unnecessary or can be restructured, the
seller may want to consider reorganizing its operations.
If a seller has nexus in a state, it should also explore with its
legal advisers whether it can effectively "withdraw" from nexus and
re-enter the state through means that will not make it amenable to
Florida Dept. of Rev., Tech. Asst. Advisement No.
00A-020 (April 25, 2000) (vendor that terminated its physical presence
but then solicited in-state orders through Web site did not have
The ultimate question for Internet sellers is whether effective
exemption from sales tax liability is central to their respective
business plans. If so, restructuring its operations to avoid nexus in
as many states as possible may make sense. For other sellers, however,
expanding and deepening commercial relationships with offline
marketing partners will make sense.
In either case, the time when Internet sellers and their customers
could confidently assume that the Internet was a tax-free zone is
gone. The long arm of multistate tax law reaches deep into cyberspace
and Internet sellers have every incentive to clarify and discharge
their tax-collection obligations.
Trelease is a tax lawyer in Denver. His e-mail is
is also a tax lawyer in Denver. His e-mail is