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Nexus Explosion: California Governor Signs Bill Expanding California Sales Tax Collection Requirements

With all the drama and suspense of a Hollywood movie, California Governor Jerry Brown signed AB X1 28 on June 29—more than two weeks after the bill

July 7, 2011

With all the drama and suspense of a Hollywood movie, California Governor Jerry Brown signed AB X1 28 on June 29—more than two weeks after the bill originally passed the California legislature. AB X1 28 has been controversial because it significantly expands California’s sales and use tax collection requirements by substantially incorporating all of the provisions of former AB 153 (click-through nexus), AB 155 (affiliate nexus), and SB 234 (constitutional nexus). Together, these changes combine California’s recent efforts to force remote sellers to collect California sales tax. To further complicate matters, AB X1 28 provides that these changes become effective immediately.

AB X1 28 amends California’s definition of “retailer engaged in business” for sales and use tax collection purposes, as set forth in Cal. Rev. & Tax Code § 6203, to include three new groups of “retailers” as follows.

Click-Through Nexus

First, “retailer engaged in business” is revised to include any retailer entering into agreements with a person in the state, for a commission or other consideration, where the person directly or indirectly refers potential purchasers, whether by an Internet-based link or an Internet Web site, or otherwise, to the retailer, provided that the retailer has more than $10,000 in sales from the referrals and more than $500,000 of total sales to California customers within the last 12 months. This provision has been commonly referred to as “click-through nexus” and is similar to laws enacted in several other states (e.g., New York, North Carolina, and Illinois) that attempt to assert that remote/online sellers are subject to a sales tax collection requirement by virtue of their agreements with unrelated third parties in the state. These laws are currently being challenged in New York (the first state to adopt such a provision) in Amazon.com, LLC, et al. v. New York State Dep’t of Taxation and Finance and Overstock.com, Inc. v. New York State Dep’t of Taxation and Finance, et al., 81 A.D.3d 183, 913 N.Y.S.2d 129 (Nov. 4, 2010). Unlike other states, California’s click-through nexus law also contains a provision that provides that “retailer includes an entity affiliated with a retailer within the meaning of Section 1504 of the Internal Revenue Code.” This language appears to attempt to require any affiliates of the retailer to also collect California sales and use tax.

California’s click-through nexus provision contains an exception that provides that to the extent the retailer purchases advertisements from persons in the state, to be delivered on television, radio, in print, on the Internet, or by any other medium, this relationship is not an agreement that creates a California sales and use tax collection obligation unless:

  1. The advertisement revenue paid to the person in the state consists of commissions or other consideration that is based upon sales of tangible personal property; or
  2. The person in the state also directly or indirectly solicits potential customers through use of flyers, newsletters, telephone calls, electronic mail, blogs, microblogs, social networking sites, or other means of direct or indirect solicitation specifically targeted at potential customers in California.

A retailer may also be excepted if it can be shown that person did not engage in referrals that would violate the commerce clause of the U.S. Constitution.

Affiliate Nexus

Second, AB X1 28 also includes within the term “retailer engaged in business” a retailer that is a member of a commonly controlled group and a member of a combined reporting group that includes another member of the retailer’s commonly controlled group that, pursuant to an agreement with or in cooperation with the retailer, performs services in this state in connection with tangible personal property to be sold by the retailer including, but not limited to, design and development of tangible personal property sold by the retailer, or the solicitation of sales of tangible personal property on behalf of the retailer. California law previously contained a statutory affiliate nexus provision (although different); however, the provision was successfully challenged in Current, Inc. v. State Bd. of Equalization, 24 Cal. App.4th 382 (1st Dist. 1994) and ultimately repealed.

Constitutional Nexus

Finally, AB X1 28 modifies “retailer engaged in business” to include any retailer that has substantial nexus with this state for purposes of the commerce clause of the U.S. Constitution and any retailer upon whom federal law permits this state to impose a use tax collection duty. This provision attempts to expand California sales tax collection requirements to the full extent permitted under the U.S. Constitution.

AB X1 28 carries some additional baggage that will likely make it vulnerable to legal challenge. AB X1 28 is a budget trailer bill—it was not part of the main budget bills. Proposition 25, passed last year, modified the California Constitution to reduce the threshold to enact the state budget bill and “other bills providing for appropriations related to the budget bill” from a two-thirds vote of both houses of the Legislature to a majority vote. However, Proposition 26, also passed last year, modified Article XIIIA (Proposition 13) of the California Constitution to expand the types of charges considered to be tax increases subject to a two-thirds vote of both houses of the legislature. As a result of Propositions 25 and 26, there could be ambiguity over whether a bill requires a majority or two-thirds vote. AB X1 28 only passed both houses of the legislature by a majority vote.

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