In a recent technical advice memorandum (TAM 2022-01), the California Franchise Tax Board (FTB) laid out its position on how certain activities conducted over the internet impact whether a business selling tangible personal property has nexus with California for income tax. The FTB’s position represents an expansion of the list of activities that will create nexus (following the recently revised guidance from the Multistate Tax Commission) and essentially narrows the nexus protections offered by federal Public Law 86-272 (PL 86-272).
Background
Businesses that have multistate sales of tangible personal property are generally protected from paying tax in states where their only activities are soliciting sales. This protection is provided by federal law in the form of PL 86-272 under Congress’s authority to regulate interstate commerce. PL 86-272 bars a state from imposing a tax based on income if that business’s only activity in the state is the “mere solicitation of sales.” The law does not provide detail as to what constitutes the mere solicitation of sales, so states and the courts have had to interpret the meaning of “solicitation”. These interpretations have produced non-exclusive lists of protected and non-protected activities – activities that fall under PL 86-272’s umbrella of “mere solicitation” and activities that exceed solicitation.
In August of 2021 the Multistate Tax Commission (MTC), an organization of state tax commissioners that provides non-binding guidance that states can use to consistently apply tax policies, released guidance that reinterpreted activities meeting the protections of PL 86-272 and activities exceeding those protections. The guidance from the MTC and the FTB references the 2018 U.S. Supreme Court decision in South Dakota vs. Wayfair, in which the court ruled that Wayfair and other defendants were obligated to collect sales tax on sales to South Dakota customers, even though they did not have any physical presence in South Dakota. While the Wayfair decision did not involve PL 86-272, which only applies to taxes based on net income, the MTC and FTB say that they are basing their guidance on the court’s analysis of internet-based commerce.
FTB’s Position
In TAM 2022-01, the FTB describes a variety of activities that are conducted electronically, and whether it considers businesses engaging in those activities in California to exceed the protections of PL 86-272.
According to the FTB, activities that do not exceed the protections of PL 86-272 include:
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- Providing post-sale assistance to California customers by posting a static list of frequently asked questions on the business’s website
- Placing on California customers’ computers or other electronic devices “cookies” that gather customer information for uses “entirely ancillary” to soliciting orders for tangible personal property (e.g., remembering items added to a customer’s shopping cart during a web session, storing personal information provided by the customer, reminding customers of items they considered on prior visits to the website)
- Offering only tangible personal property for sale on the business’s website, with the website allowing customers to search for items, read product descriptions, purchase items and select delivery options (assumes that the business does not engage in any California business activities not described in the fact pattern)
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Activities that exceed the protections of PL 86-272, according to the FTB, include:
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- Having an employee who telecommutes from California on a regular basis performing non-sales solicitation activities (e.g., business management and accounting tasks)
- Regularly providing post-sale assistance to California customers through an electronic chat or email that customers initiate by clicking on an icon on the business’s website
- Soliciting and receiving online applications for its branded credit card through the business’s website
- Placing on the business’s website an invitation for California viewers to apply for non-sales positions within the business (the website enables viewers to fill out and submit an online application and submit a resume and cover letter)
- Placing on California customers’ computers or other electronic devices “cookies” that gather customer search information for use in adjusting production schedules and inventory amounts, developing new products or identifying new items to offer for sale
- Remotely fixing or upgrading California customers’ previously purchased products by transmitting code or other electronic instructions to those products over the internet
- Offering and selling extended warranty plans through the business’s website to California customers who purchase the business’s products
- Contracting with a marketplace facilitator to facilitate the sale of the business’s products on the marketplace facilitator’s online marketplace, where the marketplace facilitator maintains inventory, including that of the business, at fulfillment centers in a state in which the business’s customers are located
- Contracting with California customers to stream videos and music to electronic devices for a charge
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Implications
Businesses that have relied upon PL 86-272 to avoid paying California income tax should re-evaluate their activities in that state to determine if they fall under the FTB’s new guidance. The guidance does not have an effective date, and it is unclear whether the FTB plans on enforcing this position on a retroactive or prospective basis; however, the references to Wayfair, both in the MTC and FTB guidance, may indicate that retroactive application of this guidance is possible.