Beware of taxable presence in on-line and catalog arenas

If you are thinking about expanding your retail discount sales business by selling on the Internet or catalogs-beware. There are significant use-tax dangers for the uninformed.

Suppose you have retail discount stores in 35 states. You want to grow, so you set up a Web page and send out catalogs. It works. In 1999, you will ship $40,000,000 in merchandise to one million customers in 39 states from your warehouses in three states. Now a tax auditor in one of the states bills your company $125,000 for unpaid use taxes in 1997. You will never recover this money from your customers, and there are more audits coming.

What turned your dream into a nightmare? Nexus, also known as taxable presence. Generally, you must collect and pay use taxes on each taxable item of tangible personal property delivered to any state in which your company has nexus.

It doesn't take much for your operation to create nexus with a state. Most state statutes say that having such things as a warehouse or other place of business or employees in the state, owning real property, regularly maintaining a stock of tangible property for sale, entering into the state regularly to provide service or repairs, or having an agent or salesman operating in the state constitutes nexus and requires the collection and payment of use taxes on items delivered to consumers in that state.

It may not be easy to recognize that you have nexus with a given state. However, long after you've started shipping product to consumers in that state, when the taxing authorities perform an audit, you may find that your company owes 4% to 8 1/2% (depending on the state tax rate) of the value of the goods sold, plus interest and penalties, for failure to collect a use tax on every taxable item delivered to residents of that state for a period of years. Many state revenue departments (particularly in densely populated states) have nexus teams whose job it is to discover companies that have nexus with the state and are not paying use taxes.

There are ways that companies can structure their operations to reduce their exposure to this unexpected, potentially devastating tax assessment, as well as ways to help companies limit their exposure when audited--but that is another subject. The new federal Internet Tax Freedom Act still requires that Internet sellers collect and pay use taxes. A few examples of ways to avoid collecting and paying use taxes are:

* Setting up your organization and confining its activities to one state;

* Creating or buying Internet or catalog subsidiaries that are kept separate from the parent store corporation;

* Contracting out with independent companies for fulfillment of Internet or catalog sales.

If you choose to operate from a state with no sales tax or use tax and limit your nexus with other states to low-population states, you will not have to collect or remit significant taxes to any state. Your prices will be lower because you will not have to charge taxes to all or most of your customers. (Consumers should file use-tax returns on items that are purchased out of state but used within state. But they almost never do.) This gives you an advantage over other companies that sell similar items, protecting past and future profits.

It is important to understand this issue, make informed decisions on where to have and not have nexus, create and maintain an organizational mentality that controls your company's presence in other states. The continued economic viability of your company and its competitive edge over other providers of discount, catalog and Internet products could be at stake.

COPYRIGHT 1999 Lebhar-Friedman, Inc.
COPYRIGHT 2000 Gale Group