In order to compete, Retailer decided to form a subsidiary corporation, e-tailer.com, to handle its e-tail operations and sales. Retailer then purposefully structured its subsidiary to compete with the pure e-tailers. In a nutshell, it only collected sales tax in Arkansas, the only state in which e-tailer.com had a physical presence. Of course, Retailer wanted to take advantage of its name recognition and goodwill, so e-tailer.com’s website provided the following services:

• Purchases from e-tailer.com could be returned to any local Retailer store;
• A store locator allowed users to find the nearest Retailer location; and
• A web page told “The Retailer Story,” a concise history of the Retailer empire.

Given these facts—and current nexus case law—e-tailer.com could be standing on quicksand. Recent case law indicates that states may be justified in ignoring the separate existence of an affiliated corporation where the facts indicate that its sole purpose is to be an alter ego of a related corporation.

Second, even if Retailer and e-tailer.com are not viewed as “one and the same” for nexus purposes, their relationship may come under the law of “principal and agent” and the wide body of case law that allows states to attribute the physical presence of an agent within a state to the out-of-state principal for nexus purposes.

If e-tailer.com’s separate existence is disregarded, e-tailer.com will have nexus everywhere Retailer does. Regardless of whether an alter ego or agency theory is employed, the net result is that e-tailer.com may find itself responsible for a lot more sales tax than it bargained for.

The Nexus Rules

The nexus rules in New York State illustrate the complexity of the challenges facing Retailer. It is well estabished that an out-of-state vendor must have some physical presence in the taxing state before it can be obligated to collect its sales tax [Quill Corp. v. North Dakota, 504 U.S. 298 (1992)]. This physical presence need not be substantial [Orvis Co., Inc. v. Tax Appeals Tribunal, 86 N.Y.2d 165 (1995); in-state solicitation by out-of-state traveling salesmen], it need only be more than the “slightest presence” [National Geographic v. California Equalization Bd., 430 U.S. 551 (1977); two unrelated business offices]. In New York, physical presence may be manifested by the presence within the state of the vendor’s property or employees or agents acting on the vendor’s behalf.

The U.S. Supreme Court has held that a remote seller whose only connection with customers in the taxing state is through a common carrier or the U.S. Postal Service is not subject to that state’s sales tax collection requirements [National Bellas Hess v. Dept. of Revenue, 386 U.S. 753 (1967); see also Quill]. This establishes a “bright-line” safe harbor for remote sellers; however, any contact with the taxing state beyond this may give rise to sufficient nexus [See, e.g., Felt and Tarrant Co. v. Gallagher, 306 U.S. 62 (1939) (two soliciting sales agents and a rental office); Standard Steel Co. v. Washington Revenue Dept., 419 U.S. 560 (1975) (one resident employee operating out of his home); Vermont Information Processing, Inc. v. Tax Appeals Tribunal, 86 N.Y.2d 165 (1995) (troubleshooting visits by personnel in support of systems)]. As the U.S. Supreme Court ruled in Scripto v. Carson [362 U.S. 207 (1960)], this is true even where the contact is through an independent contractor operating within a state on the remote seller’s behalf.

New York has thus far held that the mere solicitation of sales via the Internet is insufficient to establish nexus for sales and use tax purposes [e.g., DJ & J Software, Advisory Opinion, TSB-A-98(66)S, NYS Dept. of Taxation and Finance (Sept. 9, 1998)]. Recent amendments to the New York tax law also provide that the storage of advertisements on a server or the dissemination and display of advertisements by an Internet service provider (ISP) will not create nexus with New York for sales or corporate franchise tax purposes [N.Y. Laws, Ch. 615, L. 1998; TSB-M-97(1)C, NYS Dept. of Taxation and Finance (Jan. 24, 1997)].

Given this precedent—and assuming that e-tailer.com’s only physical contact with New York is through the Internet, post office, or common carrier—e-tailer.com will not have sufficient nexus to require the collection of New York sales tax. However, Retailer has the requisite nexus with New York, and that nexus could somehow be attributed to e-tailer.com.

Attributional Nexus

Under the theory of attributional nexus, a state may attempt to assert jurisdiction over an out-of-state corporation when that corporation itself has insufficient physical presence in the state to establish nexus under Quill. States typically apply the principles of attributional nexus when they decide that the in-state activities of an entity are attributable to an out-of-state corporation, thus giving the out-of-state corporation sufficient nexus in the state. In applying attributional nexus, the states have generally taken two approaches:

Alter ego theory. The out-of-state taxpayer is so dominated by or interrelated with the in-state affiliate that the taxpayers’ separate existence is ignored. The affiliated companies are viewed as one, with a common nexus.
Agency theory. An in-state company is deemed to be acting as the out-of-state company’s agent. The “agent’s” nexus is attributed to the other company as though it had performed the agent’s activities.

Alter Ego Theory

As a general rule, corporations are treated as separate legal entities. The presence of a parent corporation in one state does not imply that a wholly- owned subsidiary will automatically be deemed present in that state for tax purposes, or vice versa [See Levitz Furniture Co. of the Eastern Region, Inc., Advisory Opinion, TSB-A-86(38)S, NYS Dept. of Taxation and Finance (Sept. 18, 1986)]. In order to prevent fraud or injustice, however, the corporate structure will be disregarded and the separate entity rule discarded, under certain circumstances [See Franklin Mint Corp. v. Tully, 94 A.D. 2d 877 (3rd Dept. 1983), aff’d without opinion, 61 N.Y. 2d 980 (1984)]. If the parent so dominates and controls the affairs of the subsidiary that the subsidiary is an instrumentality of the parent, the subsidiary may be considered the alter ego of the parent and ignored as a separate entity, and vice versa. In an alter ego analysis: Indicia such as common officers and directors, common offices, and telephone numbers between corporate entities are relevant but are not sufficient by themselves to show that one corporation is the alter ego of another. Consideration must also be given to factors such as the degree of overlap of personnel, the amount of business discretion displayed by the corporations, whether the entities operate independently of each other, whether the parent corporation owns all or most of the stock of the subsidiary, and whether the parent corporation causes the incorporation of the subsidiary. Also significant is whether the corporations trade under their own names and whether they hold themselves out to the public as separate and distinct businesses. [Franklin Mint. It should be noted that the alter ego doctrine applies to parent and subsidiary corporations as well as to affiliated corporations.] In any event, if e-tailer.com’s separate existence is disregarded, Retailer and e-tailer.com will be viewed as one and the same for nexus purposes, meaning that e-tailer.com will have nexus everywhere Retailer does. In addition, this issue may be scrutinized on an ad hoc, state-by-state basis.

New York Authority

New York State has addressed the issue of attributional nexus in at least three separate advisory opinions. In Bottiglieri [Advisory Opinion, TSB-A-88(20)S, NYS Dept. of Taxation and Finance (March 2, 1998)], a parent company doing business in New York sold memberships entitling members to purchase discounted merchandise. Historically, employees of the parent company periodically entered New York to service and solicit memberships. Under the New York rules, this presence alone created nexus. In response, the parent enlisted a network of out-of-state vendors to sell their merchandise to club members. “Subsidiary,” a direct marketer with no property or other presence in New York, was one such vendor. The parent company produced and mailed brochures advertising the club vendors’ merchandise to members. Subsidiary did not solicit sales in New York; it merely sold tangible personal property to individuals placing telephone orders and then shipped the goods via the post office or commercial carrier. The parent took telephone inquiries but did not accept orders, referring them to the vendor.

Under the holding of National Bellas Hess, Subsidiary was not required to collect sales tax; nevertheless, New York found sufficient nexus through the parent because Subsidiary would have had nexus had the soliciting and selling activities been conducted by it as a single entity. As the commissioner noted, “The creation of Subsidiary as a separate corporate entity may not preclude the finding of sufficient nexus unless valid reasons for corporate reorganization—other than the separation of promotion and marketing activities—can be demonstrated.” In Harfred Operating Corporation [Advisory Opinion, TSB-A-86(28)S, NYS Dept. of Taxation and Finance (July 18, 1986)], a parent corporation operated retail stores in New York and created subsidiaries to operate similar stores in New Jersey. The companies’ operations were conducted independently; each maintained separate books, records, and warehouse facilities. All sales were made on premises; no mail order sales were solicited. The companies had the same officers and directors and advertised jointly under the same business name with their locations separately listed.

The commissioner again recognized that the subsidiaries were not required to collect sales tax under National Bellas Hess but found nexus on the grounds that the subsidiaries were operating as the alter egos of their New York parent. This holding was partially based on the retailer’s ownership of the subsidiaries and “a significant degree of overlap of administration and personnel,” but there were two other deciding factors: First, the joint advertisements held the companies out to the public as one entity while claiming they were separate entities for avoiding sales taxes. Second, the proximity of the locations meant that “many of [the subsidiaries’] customers will be New York residents.” In the commissioner’s opinion, the subsidiaries were incorporated “as a means to make sales in New Jersey to New York residents in order to avoid collecting New York tax.” Since this “would clearly produce injustice and inequitable consequences,” the commissioner found sufficient nexus with New York to compel the subsidiaries to collect New York taxes.

In Spencer Gifts [Advisory Opinion, TSB-A-86(37)S, NYS Dept. of Taxation and Finance (Sept. 18, 1986)], the parent company (Parent) established a subsidiary (Mail Order) in New Jersey to solicit sales through the mail. Mail Order’s only contact with New York was the shipping of merchandise via the post office or commercial carrier. Customer complaints and refunds were handled by mail or telephone by personnel located outside of New York. A sister company (Retail Stores) operated stores in 46 states, including New York. Retail Stores did not act as an agent of or otherwise facilitate Mail Order sales. Mail Order promotional materials were not available at Retail Stores. Retail Stores neither accepted customer orders for Mail Order merchandise nor handled complaints or refunds. Each company maintained its own merchandising and marketing departments, as well as separate warehouses, inventories, and bank accounts. There was no joint purchasing, and less than 5% of items sold were common to both. Transactions between Mail Order and Retail Stores were at arm’s-length prices. Parent maintained executive offices in New York and performed certain advisory, tax, and financial planning services for Mail Order and Retail Stores. It also performed periodic reviews of each company’s operations. Some employees of Mail Order and Retail Stores were covered by Parent’s stock benefit and medical plans.

On the facts presented, the commissioner held that Mail Order was operating as the alter ego of neither Retail Stores nor Parent, and, therefore, no nexus existed to compel the collection of New York sales tax. The commissioner cautioned, however, that “additional facts which demonstrate that Mail Order is the alter ego of its New York affiliates would warrant a conclusion that there would be sufficient nexus to compel Mail Order to collect New York tax. In that instance, it would be unjust and inequitable to allow Mail Order to avoid tax collection responsibilities.”

The issue of attributional nexus was also addressed by New York State’s Division of Tax Appeals in NADA Services Corp. [NYS Division of Tax Appeals, Administrative Law Judge Unit (Feb. 1, 1996); administrative law judge decisions in the Division of Tax Appeals are not considered precedential]. Here, the National Automotive Dealers Association (Parent), a trade association with New York nexus, provided consulting and training services to auto dealerships. NADA Service Corporation (Subsidiary), a Delaware corporation with a principal place of business in Virginia, published and distributed three automotive publications through the U.S. mail: Automobile Executive, NADA Official Used Car Guide, and Trade-in Guide. Subsidiary’s only connection to New York was through the mail. Parent members received complimentary subscriptions to Automobile Executive and NADA Official Used Car Guide, which accounted for 80% and 12%, respectively, of total subscribers to each publication. Parent purchased the subscriptions from Subsidiary at fair market value.

Parent’s primary market was automobile dealers; Subsidiary’s market was much broader. Parent and Subsidiary shared offices in a building owned by Subsidiary, which leased the premises to Parent at fair rental value. The companies and their respective departments were divided by partitions, dividers, or walls. The companies shared a receptionist, listed as a Subsidiary employee, whose salary was allocated to both companies. The companies also shared a general telephone number and an 800 number; calls were routed by the receptionist or an automated answering system.

Subsidiary’s accounting, payroll, and data processing departments serviced Parent, whereas Parent’s human resources and legal departments serviced Subsidiary. Each recipient paid the provider fair market value for such services. Subsidiary’s 11-member board consisted of individuals serving on Parent’s board or executive committee. The companies maintained separate minute books and board meetings, although such meetings were held on the same day. The companies maintained separate bank accounts. They maintained separate but identical payroll systems and health care plans and separate and different retirement plans. Subsidiary paid a fee to Parent for the use of its name, logo, and the phrase “the official publication of Parent” under a licensing agreement identical to another by an unrelated third party.

Even though Subsidiary derived a benefit from Parent’s name recognition (for which it paid a licensing fee) and from certain cost-sharing efficiencies, it observed the formalities of a separate existence. In refusing to apply the alter ego theory, the Division of Tax Appeals found:

In sum, the two entities had separate though overlapping markets, separate main business functions, purposes, and goals, and went about executing those purposes on separate operational planes.… Petitioner here was not merely a “device”—it was a viable business enterprise conducting its own activities, carrying out its own purposes, and paying its expenses to unrelated creditors as well as its carefully determined portion of administrative expenses for services shared with its parent.

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