United States: How Can One Perform Debt Collection When it Doesn’t Collect A Debt? How Does One Have Nexus Without Presence? Inquiring Minds Want to Know, And Texas Responds

The Texas Comptroller has determined that a service provider that mails overdue letters to debtors and makes courtesy calls to debtors on behalf of and in the name of a creditor is providing taxable "debt collection services," even though it collects no funds from the debtor and all actual collection arrangements are handled solely between the creditor and the debtor.¹ In the same decision, the Comptroller rejected the taxpayer’s claim that it had no nexus in the state even though it had no physical presence in Texas because salesmen employed by a related entity (but not the taxpayer) were selling the taxpayer’s services inside the state.

The taxpayer in Hearing No. 39,829 provided two distinct services to its customers.

In the first instance, the taxpayer provided "loss recovery services" to its clients. Its services involved collection efforts when the taxpayer attempted to collect a specific check, open account, credit card or other form of debt that had already been written off by the creditor and was more than 120 days past due. In order to collect these amounts, the taxpayer contacted the debtor directly by mail and by telephone from a service location outside Texas. The debtor remitted payment to the taxpayer, who then sent its client the monies collected less the taxpayer’s fees.

In the second instance, the taxpayer provided "loss prevention services" (otherwise known as "early-out" services). In return for a standardized and set fee, the taxpayer attempted to collect debts that were 30 to 120 days delinquent by placing phone calls or mailing letters to debtors in Texas in the name of and on the letterhead of the creditor rather than themselves. The taxpayer tapped directly into its client’s database to obtain information (e.g., address and telephone number) and billed its client based on the number of calls made, or some other basis that was not generally associated with the amount of money collected from debtors. Debtors were never given any indication that they were being contacted by anyone other than the original creditor. All payments and future actions or correspondence were handled directly between the creditor and its debtor. The taxpayer never collected any funds, nor did it even know if such funds were ever collected. All of the "early-out" services were provided from outside Texas.

Although the taxpayer had no office or employees in Texas, and although it had no sales agents in Texas during the audit period, a related entity did. There was evidence presented by the Comptroller that at least in one instance a sales agent of this related entity sold a contract for the taxpayer’s services in Texas.

Curiously, the taxpayer did have a sales tax permit in Texas even though it did not believe it had nexus in the state. The permit had been obtained at the request of one of its major customers so that the customer would not have to accrue and remit taxes on its own return for the taxpayer’s services that were undisputedly taxable. The taxpayer filed returns and paid tax it collected from that one customer to Texas. Furthermore, the taxpayer was licensed by the state of Texas as a debt collector and had the required surety bond on file with the Texas Secretary of State. Finally, the taxpayer held a certificate of authority to do business in the state from the Texas Secretary of State, and had named a registered agent in the state.

The Comptroller assessed Texas sales and use taxes (including interest and penalty) against the taxpayer for taxes it did not collect on its admittedly taxable loss recovery services, as well as its loss prevention services. The taxpayer’s claim that it did not have nexus was rejected, primarily on the basis that it held a sales tax permit, had a registered agent, was licensed by the state as a debt collector, and the fact that someone appeared to be selling the taxpayer’s services in Texas, something that was discovered after the audit of the related entity. The taxpayer appealed the assessment to the Comptroller.

The Comptroller considered three challenges to the assessment: (i) whether the taxpayer had nexus in Texas, (ii) whether the "early-out" services were taxable debt collection services under Texas law, and (iii) whether the penalty and interest should be waived.

The taxpayer contended that it had no nexus in Texas because it had no physical presence, offices, employees, or property in Texas. None of its employees traveled to Texas to solicit or otherwise perform any other function on behalf of the taxpayer during the audit period.

The Tax Division argued that the taxpayer had nexus in Texas because it named Company A (a Texas company) as its registered agent, maintained a surety bond with Texas Secretary of State during the audit period, sought and obtained a sales tax permit, remitted sales tax in Texas for a portion of the audit period, and had entered into an agreement with Company B, a local debt-collection-service business in Texas, to assist the local company in collecting bad check debts.

The Comptroller determined that the taxpayer had a physical presence in Texas, thus had nexus in Texas. First, the Comptroller recognized that, for sales and use tax purposes, the term "substantial nexus" requires a physical presence in the taxing state.² The Comptroller also confirmed that "mere possession of a certificate of authority does not satisfy the requirement that the tax be applied to an activity with a substantial nexus to Texas."³ However, the Comptroller found that the taxpayer did not merely hold a Certificate of Authority or a sales and use tax permit — it had at least six contract salesmen in Texas who were soliciting business for the taxpayer. The fact that these individuals were not employees or under contract with the taxpayer was not addressed. Based on these findings, however, the Comptroller found that the taxpayer had a physical nexus in Texas "via its contract salesmen or independent contractors."⁴ Furthermore, the Comptroller noted that the taxpayer, under the agreement with a related company, agreed to provide internal staff for coordination and implementation of all clientrelated activities, "which also resulted in the taxpayer having a physical presence in Texas."⁵

Interestingly, the Comptroller also denied the taxpayer’s argument that its "early-out" services were not taxable. The taxpayer took the position that its "early-out" program was not a debt collection service, because debtors did not send payment to the taxpayer, and the letters and phone calls placed were all made in the name of its client or on the letterhead of its client. The taxpayer in this regard was no different than a mailing service that had been asked to send out the same letters, as all actual "collection" activities were handled between the creditor of the debtor, not the taxpayer. However, the Comptroller determined that this fact was not controlling in determining whether the services were taxable debt collection services. Under Texas law, "it was not a statutory requirement for the debt collector to actually collect any monies from the debtor."⁶ All it took, according to the Comptroller, was a finding that such services were related in some way to the actual debt collection activities.

The taxpayer also contended that interest should be waived because the Tax Division issued a Position Letter about 23 months after the taxpayer filed its Petition for Redetermination. The Tax Division took the position that interest should not be waived because the taxpayer failed to provide records that related to the issue of nexus.

The Comptroller concluded that, where there is evidence of undue delay caused by Comptroller personnel, interest should be waived. Accordingly, interest is waived for the period that the hearing was on hold for 14 months.

The Texas Comptroller’s nexus determinations in this case are in line with its general "groundhog nexus" reputation. Just about any activity that casts a shadow in Texas will be considered sufficient to give a taxpayer nexus in Texas. The interesting twist in this case, and the caution to be obtained from it, is that the sales agent shadow was not cast by the taxpayer in this case, or any direct sales agent under contract to the taxpayer. Instead, it was the ancillary activities of a related entity that were sufficient to give the taxpayer nexus under the Comptroller’s view if those activities accrued to the benefit of the taxpayer. One can easily envision a situation where a related company sends a salesman to a trade show in Texas, speaks to a potential customer, and mentions that another company in the corporate family also happens to provide a service the trade show attendee might be interested in. Under this ruling, this type of incidental and ancillary remark could be read to accrue to the benefit of the related company, and, through none of its own contact, give the related entity nexus in the state.

The Comptroller’s ruling on the early-out services is even more troubling, and demonstrates a tendency by the Texas Comptroller to hang labels on activities without looking to the substance of what service is actually being performed. There is no doubt that if the creditors in this instance had simply gone to a mailing service or a call center and purchased the exact same services (mailing of letters to designated recipients or phone calls to designated debtors in the name of the creditor), the services would not have been considered taxable. The only logical conclusion that can be reached is that these services were considered taxable because they were performed by a company that otherwise specialized in debt collection. This is not the law, and it is perhaps unfortunate that this hearing’s decision was not appealed to the courts.

1. Tex. Comptroller of Public Accounts, Hearing No. 39,829 (Apr. 29, 2004).

2. Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

3. Tex. Comptroller of Public Accounts, Hearing No. 39,829 (Apr. 29, 2004) (citing Rylander v. Bandag Licensing, 18 S.W.3d 296 (Tex. App. -Austin, 2000)).

4. Id.

5. Id

6. Id.

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