In conjunction with the growing popularity of news connected with the affiliate nexus tax bills and laws passed in various states, a number of merchants have approached me asking a question that may be summarized as follows:
Can the use of web hosting servers in another state be considered grounds for tax nexus in that state?
They’re wondering about a “tax nexus”. So a quick definition first:
A nexus in general means a connection. The term nexus is used in tax law to describe a situation in which a business has a “nexus” or presence in a state and is thus subject to state income taxes and to sales taxes for sales within that state. Nexus describes the amount and degree of business activity that must be present before a state can tax an entity’s income. [source]
Now back to the original question: If you’re hosting your ecommerce website in a state other than yours, can that constitute a nexus, making you liable to pay a state income tax and/or a sales tax in that state in addition to what you’re already paying in yours?
The short answer is: it depends and differs from state to state (in some cases it may, while in others it may not).
Back in 2001 Pillsbury Winthrop Shaw Pittman LLP, a law firm specializing on tax matters, noted that “some states have begun to apply these [physical presence of an out-of-state seller’s employees/agents in another state] general rules in certain specific e-commerce contexts” [source]. On the same page they quote several interesting precedents and different rulings.
Yesterday night, as I was pondering about this topic, I got in touch with Rebecca Madigan, the Executive Director of the Performance Marketing Association, to see what she knows about the current situation. She couldn’t speak for every state, but shared some interesting thoughts on Texas and California. She wrote to me:
Currently, TX and CA have exempted servers from establishing nexus. But this year there are bills being introduced that remove that exemption, and at the same time just happen to include affiliate nexus tax schemes. It signifies an attempt to establish nexus for out-of-state retailers via the Internet. This is nothing new for states. They’ve tried unsuccessfully in the past to say catalogs establish nexus, or use of 800 numbers, infomercials on cable TV, credit cards. They are aggressively trying to find outside sources of revenue. So far the Supreme Court continues to say that sending something or advertising into a state isn’t nexus, a retailer needs an actual physical presence.
Obviously, it’s a question each e-tailer must carefully monitor in the state where their web servers are located.
American Bar Association (Section of Business Law) runs a greatly useful project devoted solely to Cyberspace Law. On its website they write:
Some states have found that a maintenance of local web server can constitute a physical presence within a state for certain e-commerce retailers because (1) a web-hosting service is acting as the agent of the remote seller, (2) the online seller is making use of the phone lines and infrastructure of the state, or (3) web servers constitute a physical presence on behalf of the online seller. Even more potentially troubling, a substantial nexus with the taxing state could exist based on a point of presence (POP) site in a taxing state maintained by an internet service provider (ISP) or internet access provider (IAP). …If so, then a state could find a substantial nexus with online retailers based on a theory that their IAPs and/or ISPs are acting as their agents. This would mean that an Internet-based retailer could be required to collect and remit taxes to every state in which its internet service or access provider was located and/or maintained a POP site. Due to these possibilities, the parties’ respective tax liability should be addressed in their web site hosting and ISP agreements. [source]
So, if you aren’t yet monitoring the legislation applicable to your case, now is a good time to start.
Disclaimer: The above should not be read as any sort of legal and/or financial advice. Talk to your accountant and/or finance attorney for a concrete advice regarding your concrete situation.