When It Comes To Third-Party Nexus, Three Is A Crowd
Nexus is the minimum link required between a state and the business it is attempting to tax. Where a third party is involved, nexus can also be determined on the nature and extent of the in-state activities they participate in, rather than the formal legal label given to the relationship.
There are a variety of third-party relationships that fall under possible nexus scenarios. We know that having employees stationed in a state creates nexus, but what about an independent contractor hired to drum up some business? Or maybe, contracting out customer service? Maybe the item was requested from the manufacturer and will be delivered directly by their company? Very rarely do companies handle all channels on their own these days. Most companies concentrate on a specialty and contract out everything else.
States have been aggressively seeking to tax companies based on these scenarios. The rules surrounding the use of a drop shipper are the most difficult to interpret. There are also many ways in which the expanded definitions of nexus (third-party, affiliate, and click-through) overlap. This is because they are so closely intertwined, some states blend the types together, and because no one has really figured out which kind will stand up to judicial examination.
But what about the rest of the third-party relationships mentioned?
As it stands now, the U.S. Supreme Court has declined to get involved in any nexus related cases for more than 20 years; it falls upon the seller to know if third-party transactions have been taxed within the state they are conducting business in. Some states determine third-party nexus on whether if performs any activity on behalf of the seller, others only when they have been authorized to solicit sales on behalf of the seller.
The authorized use of non-employee third parties such as independent contractors, sales representatives, and manufacturing representatives to solicit sales or perform other significant sales-related activities on behalf of an out-of-state retailer is generally considered sufficient to create nexus. This is often referred to as “agency” nexus. This type of relationship is very common with large companies, such as Amazon and has led to a new body of law called “click-through” nexus.
There is one case that represents the predominant mindset when it comes to third-party nexus. In Scripto, the Supreme Court found that physical presence existed because the out-of-state seller contracted ten independent contractors to solicit sales on its behalf in the state. The Court held that these contractors created nexus because they acted on behalf of Scripto by “conducting continuous local solicitation in [the state] and forwarding the resulting orders”. Scripto, however, argued that nexus did not exist because it used independent contractors, rather than its own employees or designated legal agents, to conduct the local sales activities. These independent contractors did not work exclusively for Scripto. The Court focused on the nature of the relationship itself between the two parties. The Court focused on substance over form, instead of legal titles. In the Court’s view, these facts clearly established nexus.
Notably, the Supreme Court itself has described Scripto as “the furthest constitutional reach to date of a State’s power to deputize an out-of-state retailer as its collection agent for a use tax.” The decision in Scripto plainly indicates that an unrelated third party under certain conditions can establish nexus and is heavily relied on in most states. What remains unclear, however, is the nature and extent to which such activities performed on the seller’s behalf will subject an out-of-state company to tax obligations.
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