NY Tax Decision Over Online Retailers May Embolden Other States

Any business with an interactive website should take note of a recent New York Supreme Court decision that could expand income tax obligations for out-of-state online retailers. The actual impact of the decision, however, may be narrow.

The decision in American Catalog Mailers Association, v. Department of Taxation and Finance is the first state court ruling to uphold these types of internet-directed regulations under Public Law 86-272. The plaintiff in ACMA has filed a notice of appeal with the Appellate Division, Third Department. The trial-level court decision may nevertheless embolden more states to adopt rules and regulations like those at issue in ACMA.

The Albany-based court affirmed the validity (but disallowed the retroactive application) of New York’s regulations addressing the types of activities that do and don’t qualify for protections under PL 86-272.

Internet-based activities are targeted most directly by the regulations, which also cover activities such as providing web-based chat assistance, placing cookies on viewers computers, and accepting online credit card applications that go beyond solicitation. Any business with a website that has these features would be disqualified from claiming PL 86-272 protection.

The case appears to indicate that companies with interactive websites may be outside the scope of PL 86-272 and therefore subject to higher corporate income tax burdens. On closer review, ACMA leaves open several avenues that online retailers and other companies with interactive websites may pursue to support a claim that they aren’t subject to state corporate income tax.

First, while the ACMA opinion doesn’t delineate between internet activities that create nexus and internet activities that are unprotected under PL 86-272, businesses must remember that these are two distinct inquiries. Nexus is a constitutional prerequisite to the imposition of tax, while PL 86-272 is an exception to nexus.

PL 86-272 prevents a state from imposing tax on an entity that already has nexus in the state. A company can conduct online activities that don’t establish the type of connection with a state necessary to satisfy the US Constitution. Merely offering chat functionality on a website doesn’t on its own create nexus, for example.

If a company doesn’t have nexus in a state, the state can’t tax that company, even if it’s conducting activities that go beyond solicitation for PL 86-272 purposes. Businesses shouldn’t simply assume they are foreclosed from raising a nexus argument just because they engage in the type of internet-based activities contemplated by PL 86-272 regulations.

Second, ACMA was decided on summary judgment, or purely legal principles. The court didn’t engage in a factual analysis of whether specified activities establish nexus or fit within the scope of PL 86-272 regulations. Where appropriate, businesses can and should document why their particular activities neither establish nexus nor exceed the protections of PL 86-272.

Finally, Congress has proposed an amendment to PL 86-272 that could expand the scope of protected activities by changing the definition of solicitation to something that “means any business activity that facilitates the solicitation of orders even if that activity may also serve some independently valuable business function apart from solicitation.”

This amendment would broaden the types of activities that could be considered solicitation for PL 86-272 purposes. It would further blunt the impact of ACMA, given that many activities listed in New York’s regulation arguably “facilitate” the solicitation of orders even if they have independent business functions.

Neither a wholesale restructuring of business activities nor a complete abandonment of nexus and PL 86-272 arguments by online companies appears to be warranted at this time. Still, businesses should be mindful of potential implications from the decision and take care to document why their business activities fall outside ACMA’s scope.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Nicole (Niki) Ford is a member of Baker McKenzie’s tax practice group in New York, where she focuses on state and local tax litigation and planning.

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