NEW YORK COURT OF APPEALS RULES AGAINST VERMONT VENDOR ON USE TAX

By Alan Zheutlin, CPA

The New York Court of Appeals recently held that a Vermont vendor was required to collect New York use tax on its taxable retail sales to New York customers because it has sufficient physical presence in New York (In the Matter Orvis Company, Inc., N.Y. Ct. of Appeals, Nos. 138 and 139, June 14, 1995).

Background

Orvis Company, Inc. (Orvis) is located in Vermont and sells both retail and wholesale camping, fishing, and hunting equipment; casual and outdoor clothing; food; and various gift items. During the period under review, its retail sales were almost entirely through mail-order catalog purchases shipped from Vermont by common carrier or the U.S. Postal Service. In addition, Orvis also sold merchandise at wholesale to New York retail establishments. The New York Appellate Division (the Appellate Division) had ruled that Orvis need not collect use tax on their taxable retail sales to New York customers because Orvis lacked a substantial physical presence in New York.

Decision

The New York Court of Appeals (the Appeals Court) did not agree with the Appellate Division. Although Orvis did not 1) maintain, lease, or own any office, distribution house or any place of business in New York; 2) own any tangible property, real or personal, in New York; 3) have a telephone listing in a New York directory; 4) have New York resident agents or representatives; or, (5) approve orders in the state, the Appeals Court ruled that visits by the Orvis sales personnel to their New York retail store clients was sufficient presence to require collection of New York use taxes. Sales personnel for Orvis visited approximately 19 retail store clients (wholesale customers) an average of four times a year during the three-year audit period from 9/1/77 to 8/31/80. Approximately 15% of the $1 million to $1.5 million of Orvis sales to New York were to wholesale customers. The Appeals Court determined that these visits to wholesale customers were direct solicitation of all retail customers despite Orvis' affidavit that the visits were only to discuss shipments and displaying of products. Notably, the Appeals Court, in reaching its conclusion, relied on the U.S. Supreme Court language in National Geographic Society v. California Bd. of Equalization, 430 U.S. 551 (1977) and opined that the necessary vendor presence in the taxing state to require use-tax collection from customers located in the state need not directly relate to the taxed activity.

Observations

The Appeals Court decision in Orvis, requires Orvis to collect use tax on mail-order catalog sales to New York customers, although Orvis' limited presence in New York is related only to its wholesale sales.

The Appeals Court has interpreted the Quill Corp. v. North Dakota, 504 U.S. 298 (1992) decision to mean that the physical presence nexus standard is met when the vendor has property or conducts economic activities in the taxing state.

After Orvis it will be more difficult for mail-order companies who have any presence in New York to avoid collecting use tax on taxable sales to New York customers. In addition, other states may attempt to adopt the nexus standard endorsed by the Appeals Court in Orvis and as applied to mail-order companies. *

MORE ON NEW YORK AND TAXATION OF OUT-OF-STATE SALES

By Andre Montero, CPA

Two recent decisions by the N.Y. Court of Appeals make it more difficult for vendors to avoid collecting sales or compensating use taxes on out-of-state sales. These decisions have implications for both New York Corporations that ship out of state and for foreign corporations that ship to customers within New York.

The first case involved Orvis Corporation, a well-known Vermont-based company that sells hunting, fishing, and camping equipment. That case is discussed in detail in the previous article by Alan Zheutlin. The state argued successfully that, although the visits to retailers had no connection to Orvis's catalog sales, they gave the company sufficient presence in the state to make its catalog retail sales subject to compensating use tax.

Since the company did not charge sales or use taxes when the sales were made, it must absorb what is probably a large tax liability. Following the court's logic, the way for Orvis to avoid the tax in the future would be to either stop visits or stop selling to retailers within New York State.

The second case also involved a Vermont-based company. Vermont Information Processing sold computer software and hardware to beverage distributors in New York State. Products were delivered by either common carriers or the U.S. Mail. Its employees visited New York customers to give instructions on the use of its software and occasionally to help install the computer systems. As in the Orvis case, the court ruled that these visits constituted a sufficient presence to require the company to collect compensating use taxes. One way Vermont Information Services may have been able to avoid having a presence in the state would have been to use independent contractors to assist the customers. Of course, the contractors must be truly independent and not considered employees. It is also not certain how the court would have viewed this situation.

The states have been limited in their ability to tax foreign corporations by both the Commerce Clause and the Fourteenth Amendment to the Constitution. The U.S. Constitution states in part that, "No State shall, without the consent of the Congress, lay any imposts or duties on imports or exports."

A state may require a foreign (out-of-state) corporation to collect use tax only if that business has a nexus with the state. The definition of "nexus" has evolved over several U.S. Supreme Court decisions.

The dictionary defines nexus as "a means of connection; bond or link." The U.S. Supreme Court in several decisions has given a legal meaning to this definition. In the 1967 National Bellas Hess decision, the Court explicitly made the requirement that the vendor must have some physical presence in the taxing state. This requirement still exists. How much constitutes "some" was addressed in later cases.

In Complete Auto Transit v. Brady, (1970), the Supreme Court issued four standards that lower courts may use to judge the constitutionality of a state tax on interstate commercial activity. These four standards, subject to refinements in later court cases, still constitute the prevailing test used by the courts. First, the company's activities must have a substantial nexus with the taxing state. Second, the tax must be fairly apportioned. Third, the tax must not discriminate against interstate commerce. Fourth, the tax must be fairly related to the services provided by the state.

Two refinements were made in the National Geographic Society v. California Board of Equalization (1977) case. First, the court ruled that the required nexus with the taxing state need not necessarily be directly related to the activity being taxed. This explains why the employee visits to wholesale customers in the Orvis case made the unrelated catalog sales subject to tax. The second refinement is that the court required the physical presence in the state need not be "substantial" but simply more than the "slightest presence."

In the 1992 case Quill Corp. v. North Dakota, the court affirmed the requirement that the vendor have a physical presence in the state, although it came to this conclusion for different reasons than those given in the Bellas Hess case. The most recent decision of the Supreme Court is the 1995 case of Oklahoma Tax Commission v. Jefferson Lines Inc. Here, the court confirmed the doctrine that physical presence need not be substantial but only that it must be more than the "slightest presence." The New York Court of Appeals relied on this decision in both the Orvis and Vermont Information Processing decisions.

Mail order is estimated to be a $200 billion a year industry with much of that amount escaping either sales or use taxes. Because of the staggering amount of taxes involved, states can be expected to continue taking an aggressive approach to requiring foreign vendors to collect tax. Until the U.S. Supreme Court issues definitive rules, the only safe harbor may be to avoid any physical presence within the state. Any visits, even for unrelated business, may leave a company in court arguing over the definition of "slightest presence." The safest approach is to register and collect the tax, but in the highly competitive mail-order business, charging sales tax when your competitors do not could result in drastically reduced sales. This is especially true because mail-order customers are not accustomed to paying sales tax. On the other had, failure to collect taxes when the company is later found to have a physical presence in the state can have disastrous financial results. *

State and Local Editor:
Kenneth T. Zemsky, CPA
Ernst & Young LLP

Interstate Editor:
Marshall L. Fineman, CPA
David Berdon & Company LLP

Contributing Editors:
Henry Goldwasser, CPA
M. R. Weiser & Co LLP

Leonard DiMeglio, CPA
Coopers & Lybrand L.L.P.

Steven M. Kaplan, CPA
Konigsberg Wolf & Co., PC

DECEMBER 1995 / THE CPA JOURNAL