On June 3, the New Mexico Supreme Court held that an out-of-state online bookseller, Barnesandnoble.com LLC (B&N), had substantial nexus for purposes of the New Mexico gross receipts tax based on the in-state activities of its related entity.1 In affirming the Court of Appeals, the Supreme Court determined that the related entity's activities in New Mexico were significantly associated with B&N's ability to establish and maintain a market in the state. The Court of Appeals' holding primarily relied on the use of common trademarks, but the Supreme Court explained that there were additional reasons that B&N had substantial nexus with New Mexico. The finding of substantial nexus was further supported by the related entity's following activities: (i) the promotion of B&N through the sale of gift cards; (ii) the sharing of customers' email addresses with B&N; and (iii) the implicit endorsement of B&N through the companies' shared loyalty programs and the product return policy.
Background
B&N, an Internet-based retailer of books, music, online courses, and movies with a broad multistate customer base, had no physical presence in New Mexico during the audit period giving rise to the litigation. B&N shipped all products to New Mexico customers from a point outside the state through the U.S. Postal Service or a third-party common carrier. However, Barnes & Noble Booksellers, Inc. (Booksellers), related to B&N through common ownership by a corporate parent, owned and operated three retail stores in New Mexico.2
During the audit period, Booksellers sold gift cards displaying B&N's Web address that could be used either at Booksellers or B&N. In addition, Booksellers sold memberships in a loyalty program that also gave customers a discount at B&N. Booksellers shared customer's email addresses with B&N. Further, Booksellers and B&N shared common trademarks.
Booksellers accepted the return of items that customers purchased from B&N. For online purchases that were returned, Booksellers provided an in-store credit or gift cards that could be redeemed in stores. B&N's Web site provided information about the return policy and also provided a store locator and descriptions of in-store events.
The New Mexico Taxation and Revenue Department issued an assessment for gross receipts tax and interest against B&N for sales into the state during the audit period, January 31, 1998 through July 31, 2005. B&N protested the assessment based on the position that Booksellers' activities could not be attributed to B&N and could not cause B&N to have "substantial nexus" under Quill.3 After the Department's own hearing officer decided in favor of B&N,4 the Department appealed the case to the Court of Appeals.
The Court of Appeals held that B&N had substantial nexus based on its shared trademarks and cross-marketing activities with Booksellers.5 In reversing the hearing officer, the Court found that Booksellers created goodwill for the shared trademarks, and as a result, helped B&N to create and maintain a market within the state. B&N appealed the Court of Appeals' decision.
Commerce Clause Not Violated
The sole issue before the New Mexico Supreme Court was whether the imposition of tax against B&N violated the Commerce Clause of the U.S. Constitution. Specifically, the Court needed to determine whether Booksellers performed activities on behalf of B&N that were significantly associated with B&N's ability to establish and maintain a market for its sales in New Mexico.
The U.S. Supreme Court has held that the Commerce Clause allows a state to tax an actor in interstate commerce "when the tax is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State."6 Of these four requirements, the only one at issue in this case was substantial nexus. If B&N's actual sales had substantial nexus with the state, New Mexico could constitutionally tax those sales.
According to the U.S. Supreme Court, a seller must have a "physical presence" in a state in order to satisfy the substantial nexus requirement.7 However, the Court has taken a "functional approach" and found substantial nexus to exist in cases where the business did not have property or regular employees in the taxing state. In Scripto, Inc. v. Carson,8 the Court held that a taxpayer with no full-time employees in the state had substantial nexus because it had independent contractors in the state to solicit orders. In Tyler Pipe Industries, Inc. v. Washington State Department of Revenue,9 the Court held that even though the taxpayer formally had no property or employees within the state, its sales representatives' in-state activities created sufficient nexus. The Court explained in Tyler Pipe that "the crucial factor governing nexus is whether the activities performed in this state on behalf of the taxpayer are significantly associated with the taxpayer's ability to establish and maintain a market in this state for the sales."10
In determining that B&N had substantial nexus with the state, the New Mexico Supreme Court considered the activities that Booksellers performed on B&N's behalf for B&N's benefit. Booksellers displayed B&N's Web address on gift cards (used at either Booksellers or B&N) that they sold in stores, providing B&N with advertising. In addition, Booksellers shared customers' email addresses and sold memberships in a loyalty program that also gave customers a discount at B&N. Because Booksellers and B&N both used the same trademarks, the Court inferred that consumers would consider the two corporations to be one company. B&N benefitted from the brand loyalty established by local branches of Booksellers. Based on these factors, the Court held that Booksellers' instate activities assisted B&N's efforts to establish and maintain a market in New Mexico.
Ownership Considerations
The New Mexico Supreme Court determined that common ownership of the corporations was not solely dispositive of whether substantial nexus existed. In Borders Online, LLC v. State Board of Equalization,11 the California Court of Appeals held that California could tax sales by Borders Online because of its affiliation with brick-and-mortar Borders stores in the state. The New Mexico Supreme Court acknowledged that Borders and Borders Online were wholly-owned subsidiaries of the same parent, but Booksellers and B&N shared only partial ownership during much of the audit period. However, the Court explained that the case law does not require the in-state entity to have any particular ownership relationship to the out-of-state taxpayer, as long as the in-state entity engages in activities on the taxpayer's behalf.
Return Policies
According to the New Mexico Supreme Court, Booksellers' return policies benefitted B&N even though they were less favorable than the return policies in Borders Online. The New Mexico Court of Appeals had distinguished Borders Online because, unlike Booksellers, Borders' store policies treated Borders Online customers preferentially. Borders stores gave refunds for purchases from Borders stores or Borders Online, but gave only store credits for returns from competitors. In contrast, Booksellers only issued refunds for items purchased from its stores. Booksellers issued store credits for items purchased on B&N or from competitors. However, the B&N Web site promoted the ability to return purchases to Booksellers and even provided a link to Booksellers' store locator. Despite the differences in the return policies, the Supreme Court concluded that B&N still received a benefit from Bookseller's return policy similar to the benefit Borders Online received from Borders' return policy. New Mexico customers who lived near a Booksellers location and preferred to return items in person would have rather purchased their items from B&N than a different online retailer.
Other Cases Distinguished
The New Mexico Supreme Court recognized that courts in several other states have held that the presence of affiliated brick-and-mortar stores in a state does not create nexus that would allow the state to tax catalog or online sales.12 However, these cases did not cite Tyler Pipe or attempt to apply its rule. The Court also acknowledged that in St. Tammany Parish Tax Collector v. Barnesandnoble.com,13 a federal district court considered an almost identical case involving the same taxpayer and found no substantial nexus. According to the New Mexico Supreme Court, the federal court appeared to have imposed a higher standard than required by Tyler Pipe by considering whether Booksellers solicited orders on B&N's behalf or produced revenue for B&N. Tyler Pipe does not require Booksellers to act as a sales agent for B&N. Instead, Tyler Pipe requires only that activities performed on B&N's behalf be significantly associated with B&N's ability to establish and maintain a market in New Mexico.
Commentary
The New Mexico Supreme Court thoroughly examined the activities that Booksellers performed for B&N in the state. The New Mexico Court of Appeals relied primarily on the shared trademarks in reaching its holding last year, but the Supreme Court specifically listed additional items such as the gift cards, the sharing of customers' email addresses, the sharing of a loyalty program and the beneficial return policy to support its nexus determination. Compared to the Court of Appeals, the Supreme Court reached a stronger conclusion that B&N had substantial nexus with the state, focusing on the "single face" of Booksellers and B&N.
Interestingly, while other states have taken the same position that shared trademarks and activities performed by in-state affiliates create nexus for out-of-state businesses, they have predominantly done so through legislative action and not through the courts. With this decision, New Mexico's judicial system has interpreted constitutional law to establish this rule without the enactment of explicit legislation. Given the constitutional implications of this decision, it would not be surprising if B&N decided to appeal the result to the U.S. Supreme Court for their consideration.
Footnotes
1 New Mexico Taxation and Revenue Department v. Barnesandnoble.com LLC, New Mexico Supreme Court, No. 33,627, June 3, 2013.
2 During the audit period, the parent company owned 100 percent of Booksellers and between 40 percent and 100 percent of B&N.
3 Quill v. North Dakota, 504 U.S. 298 (1992). Note that the New Mexico gross receipts tax is imposed on any person "engaging in business" in New Mexico. The term "engaging in business" is the carrying on or causing to be carried on any activity with the purpose of direct or indirect benefit. N.M. STAT. ANN. § 7-9-3.
4 In re Barnesandnoble.com LLC, New Mexico Taxation and Revenue Department, No. 11-10, April 11, 2011.
5 In re Barnesandnoble.com LLC, New Mexico Court of Appeals, No. 31,231, April 18, 2012.
6 Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).
7 Quill Corp. v. North Dakota, 504 U.S. 298 (1992). This physical presence requirement applies to sales and use tax, but many state courts have held that this requirement does not apply to income tax.
8 362 U.S. 207 (1960).
9 483 U.S. 232 (1987).
10 Id.
11 29 Cal. Rptr.3d 176 (Cal. Ct. App. 2005).
12 SFA Folio Collections, Inc. v. Bannon, 585 A.2d 666 (Conn. 1991); SFA Folio Collections, Inc. v. Tracy, 652 N.E.2d 693 (Ohio 1995); Bloomingdale's by Mail, Ltd. v. Pennsylvania, 567 A.2d 773 (Pa. Commw. Ct. 1989).
13 481 F. Supp. 2d 575 (E.D. La. 2007).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.