Introduction

 

In a case that has all major online retailers nervous, a Manhattan court upheld a new state tax law that requires many out of state retailers to collect state sales tax on buys by New York residents in Amazon.com LLC v. New York State Dept. of Taxation and Finance, ___ N.Y.S. 2d ___, 2009 WL 69336 (N.Y. Sup. 2009). Online giant Amazon.com challenged the law on constitutional grounds, but the New York Supreme Court judge found that Amazon did “not come close” to demonstrating unconstitutionality of the law.

 

Background

 

In 1992, the U.S. Supreme Court exempted out-of-state retailers from collecting sales tax in out-of-state transactions, i.e. where they sold goods to residents of a state where the retailer had no physical presence such as a store, office, or warehouse. Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Although Quill dealt with a mail order company, the ruling has since been relied upon by a growing number of remote online sellers.

 

In April 2008, New York sought to overcome the Quill choice when it approved a new tax as part of its 2008-09 state budget. New York Tax Law section 1101(b)(8)(vi)contains a “Commission-Agreement” provision  requiring out-of-state online retailers to collect New York state sales tax if the retailer uses independent contractors or other New York residents to solicit sales in excess of $10,000 from New York residents.

 

The law had an immediate impact on large online retailers like Seattle-based Amazon.com, which previously did not have to collect sales tax in New York because they did not have a physical presence in the state. But, Amazon and many other retailers have affiliate linking programs that enable other websites to maintain a link to the online retailer’s site for incentives. Under Amazon’s affiliate program, which Amazon considers a marketing arrangement, when a customer links to Amazon.com from the affiliate website, that affiliate receives a  commission on the customer’s buys. Amazon has “thousands” of these affiliates in New York, though the program reportedly accounts for less than 1.5% of Amazon’s total New York sales revenue.

 

New York tax officials contended that Amazon.com’s affiliate program makes it subject to the commission-agreement provision of the new tax law, forcing Amazon to collect sales tax on transactions with New York residents. Indeed, state officials referred to the tax as the “Amazon tax.”

 

Amazon filedsuit on April 25, 2008, alleging that the Commission-Agreement provision’s inconsistency with Quill   violates the Commerce Clause, the Equal Protection clause, and Amazon’s right to due process under the U.S. Constitution.  Judge Eileen Bransten, writing for the Supreme Court of the State of New York, dismissed the lawsuit upon defendants’ motion in Amazon.com LLC v. New York State Dept. of Taxation and Finance, ___ N.Y.S. 2d ___, 2009 WL 69336 (N.Y. Sup. 2009).

 

Amazon’s Constitutional Challenges to the Tax Fail

 

Amazon made three Constitutional challenges to the “Amazon tax.” First, Amazon contended that the new tax violated the Commerce Clause of the U.S. Constitution because it imposed a tax obligation on an out-of-state seller who lacked a “substantial nexus” with New York. States may require a retailer to collect state tax if the “tax is applied to an activity with a substantial nexus with the taxing State, is honestly apportioned, does not discriminate against interstate commerce, and is honestly related to the services provided by the State.” Complete Auto Transit Inc. v. Brady, 430 U.S. 274, 279 (1977).

 

The court pointed out that the “substantial nexus” test only requires the “slightest” physical presence, which can be imputed to the retailer through activities performed in the taxing state by the people or entities acting on the retailer’s behalf. Amazon, 2009 WL 69336, *3. Based on this standard, the court found that “(t)he Commission-Agreement Provision is carefully crafted to ensure that there is a sufficient basis for requiring collection of New York taxes and, if such a basis does not exist, it gives the seller an out… a tax-collection obligation will only be imposed based on an out-of-state seller’s conscious choice to contract with in-state residents who collectively refer more than $10,000 of New York based business.” Amazon, 2009 WL 69336, *4.

 

In making its due process claim, Amazon claimed that the tax law was unconstitutionally vague, because it could be interpreted to apply to non-Internet out-of-state retailers that buy ads in New York-based print media. But the court found otherwise, stating: “the statute’s applicability upon entry into an agreement with an in-state resident for a commission ‘or other consideration’ based on direct referral of New York customers or ‘indirect’ referrals is not so vague and standardless as to leave the public uncertain about its reach.” Amazon, 2009 WL 69336, *7.

 

Finally, Amazon claimed that the law violated the Equal Protection Clauses of both the U.S. and New York constitutions because the statute was enacted specifically to collect taxes from Amazon. But, the court noted that Amazon’s complaint contained no assertion that the State has really treated it differently from other similarly situated retailers. Amazon, 2009 WL 69336, *7.

 

The Impact of the Amazon Tax

 

It is expected that Amazon will appeal this choice. In the meantime, online retailers have only two choices regarding New York sales tax – either they register with the state and collect the tax , which Amazon has chosen to do, or they cut off all ties with New York affiliates in order to avoid collecting the tax . The latter course, which Overstock.com has pursued, arguably puts a damper on e-commerce, as many of the affiliates are web start-ups that rely in part on the financial boost from these programs.

 

More importantly, this may place the online retail industry on a burdensome slippery slope. In reaching its choice in Quill Corp. v. North Dakota, the Supreme Court discussed the crushing burden that it would place on interstate commerce if remote sellers had to comply with the separate sales and use tax provisions in every location in which it conducted transactions. There are more than 6200 separate sales tax jurisdictions and more than 4400 separate use tax jurisdictions. If a significant number of those implemented a statute similar to New York’s, and if that statute were upheld on similar grounds, it would completely undermine the rationale of the Quill choice. The burden of trying to comply with each of those various jurisdictions may be more than a reasonable online retailer can handle.

 

 

 

 

 

Often it is believed that simply purchasing an aircraft outside of California eliminates the sales and use tax liability.   There is a half truth here; properly purchasing an aircraft outside of California does eliminate the sales tax obligation, but, it does not eliminate the use tax.   Many people do not know how, or where to start when going through the California sales and use tax exemption process.   The simple answer is that you must take delivery of the aircraft outside of California.   But, there is more detail behind the simple answer.   For example, the contract of sale (buy agreement) must specifically reference the location where the aircraft will be delivered to the purchaser outside the state.    As standard practice, we advise that the delivery occur in Oregon.   Oregon is the closest, non-sales tax state in proximity to California that will not have a jurisdictional claim for sales or use taxes simply because the sale occurs there.   Therefore, Oregon is often times the most convenient location.   But, it may not be convenient in every situation.   There are a total of five non-sales tax states:  Oregon, Alaska, Montana, New Hampshire, and Delaware.   Many other states have guidelines for non-resident purchasers taking delivery within their state without fearing tax repercussions.   Be sure you know the rules. To properly evidence the delivery outside of California, you must maintain a clear separation between the seller and the buyer.   To accomplish this, the seller will be solely responsible for transporting the aircraft to the out of state delivery location, and the buyer will be solely responsible for getting to the delivery location independent of the aircraft they are purchasing.   It is recommended that the buyer travel via commercial airlines to generate and obtain confirmation of the travel to the out of state delivery location.   In addition, the buyer must not exercise any right or control over the property until after it is delivered (test flights are ok, but insuring the property prior to delivery could pose a problem).   Once the seller and buyer have converged upon the delivery location, it is now time to do the paperwork.   They will do the FAA Bill of Sale, FAA Registration, any delivery receipts prepared by the seller and a proper delivery document for California sales and use tax purposes.   This is referred to by many in the industry as a “6247 statement. ”  Beware, some tax representatives will charge you for this form.   This form when properly and completely executed and notarized will evidence the out of state delivery.  The insurance on the property can become effective as of this day. Upon completion of the delivery, it is recommended that you immediately buy fuel for the aircraft, using a credit card.   Doing so will generate a receipt that will contain the date, location, tail number, and the buyers signature.  Keep copies of all your documentation; you will need it to support your exemption. The out of state delivery is only a small part of the exemption process.  There are many factors which come into play when the Board of Equalization is determining where the “place of sale” was.   They will look at the contract of sale, insurance binder, evidence of delivery, evidence how the parties converged upon the delivery location, FAA Bill of Sale, FAA Registration, and other pertinent information to develop their conclusion as to where the delivery occurred.   If there are conflicting dates, locations, or details, they may conclude that the delivery occurred somewhere other than where you intended, and classify your delivery as “ceremonial. ”  This means your delivery may jeopardize the availability of the sales and use tax exemption from the onset.

The article written last month titled “Proper Delivery Outside of California Starts the “Use Tax” Exemption Process” clarified the importance of, and how to, properly take delivery of an aircraft outside the state, which is the first step in the California sales and use tax exemption process.   If you didn’t get a chance to read that article you can contact Aero-tax Compliance Experts, LLC (ACE) for a copy or visit www. aero-tax. com. Many aircraft owners and potential owners have contacted us for an explanation on California’s “first functional use” requirement.   We have learned that there is a lot of mis-information and confusion on this issue.   Our attempt is to clarify some of the confusion that exists and eliminate the mis-information with the “first functional use” requirement for the California use tax exemption process. “First functional use” is a critical component of the California use tax exemption process.   California Sales and Use Tax Regulation 1620 defines first functional use as “use for which the property was designed. ”  An aircraft is defined in Law section 6274 as “any contrivance designed for powered navigation in the air except a rocket or missile. ”  Logically, one would conclude that first functional use of an aircraft is flight because aircraft are designed to glide; right?  Not necessarily.   In my experience with the sales and use tax law, one can not rely upon logic.   The California State Board of Equalization (BOE) has effectively confused the term “for which the property was designed” with “how huge it is,” or “how is it configured. ”  I’ll clarify; in May of 2002 a staff member of the BOE’s tax counsel (writer) drafted a memorandum to another staff member explaining to them the writer’s interpretation of first functional use.   Somehow, the writer deduced a formula, or justification, to distinguish between aircraft designed for personal purposes and aircraft designed for commercial purposes.   Simply place, the writer concluded in the memorandum that an aircraft with 6 or fewer seats was an aircraft designed for personal purposes, and an aircraft with 7 or more seats was designed for commercial purposes.   To confuse the issue even further, the writer chose that all jet aircraft were designed for commercial purposes, and “personal” aircraft could be “configured” for commercial purposes.   Additionally, the writer added that it was possible for someone to justify a large jet as a personal use aircraft. Now that the writer made a distinction between personal and commercial aircraft, the writer defined the “first functional use” for each.   Aircraft that are designed for personal purposes were first functionally used when flown, and aircraft designed for commercial purposes were first functionally used when flown with a passenger or cargo onboard. We have researched and reviewed several thousand legal opinions and rulings from the BOE on this issue.   The BOE had interpreted first functional use as flight, up until this memorandum was drafted and distributed throughout the agency.   After the distribution its effect was immediate, and in some cases a retroactive application of the new formula.   During our research, we developed the industries most successful approach to complete the first functional use requirements pursuant to the current standards, and have projected other items that may be required in the future.   As a standard practice, Aero-tax advises that the purchaser bring someone, to the out of state delivery location, to act as a right passenger (not a pilot, co-pilot, flight crew, CFI, etc. ) onboard a flight (or two) outside of California before proceeding with their specific exemption.   In addition, this flight must start in one state, country, territory, etc. (not California), and end in a separate state, country, territory, etc. (not California).   For example, this flight may depart from the out of state delivery location (Oregon), to another state (not within California or Oregon).   Depending on the “design/size” of the aircraft and for those who are claiming the commercial interstate or foreign commerce exemption, they must conduct business at the location they travel to.   In addition, documentation must be obtained to support the business purpose (i. e. , meeting notes, invoices, proposals, etc. ) of the flight. After the first functional use flight has been made, and prior to departing that location, fuel must be bought, ideally using a credit card.   This will generate a fuel receipt that will contain documentary evidence that the aircraft was at this location on a specific date.   Additionally, a statement will be needed from the passenger onboard the aircraft during the “first functional use” flight.   Depending upon the type of exemption you are claiming the aircraft may or may not be allowed into California.     If the foregoing process and documentation are properly completed and collected, the “first functional use” requirement should be adequately fulfilled.  The smallest variation could mean disaster for the tax exemption. The “first functional use” is only one of the small, yet critical, parts of the California use tax exemption process.   There are many aspects which must be completed successfully and documented in order to secure the exemption.   ACE will guide the purchaser through the process and ensure the success by monitoring each aspect of the exemption requirements. Unless otherwise expressly indicated, any advice contained herein was not written and is not intended to be used, and cannot be used, for the purpose of avoiding any sales or use tax, interest or penalty that may be imposed.   To be certain the exemption requirements are accurate for your specific situation, call one of our tax experts to discuss. Other articles will be coming out periodically to clarify other aspects of the California sales and use tax laws, regulations, legal decisions, exemptions, or other related matters.   If you have a specific sales and use tax topic that you would like discussed or clarified please send us an email to joe@aero-tax. com.