When does an out-of-state online retailer have to collect Tennessee sales tax because it uses an in-state warehouse or distribution center?

Subject

Opinion No. 11-52, Out-of-State Dealer's Nexus with Tennessee Due to Activities of In-State Distribution Center, June 28, 2011

Plain-English summary

Senator Randy McNally and Representative Charles Sargent asked four questions tied to a then-pending amendment to Tennessee Senate Bill 529 / House Bill 136. The bill was Tennessee's response to a wave of state-by-state fights over whether internet retailers had to collect sales tax when they used in-state warehouses or distribution centers operated by affiliated entities. The factual backdrop was familiar: Amazon was building a Tennessee distribution facility in Chattanooga in 2011, and the legislature wanted to know whether sales by Amazon (or any other out-of-state retailer with a Tennessee warehouse run by a separate corporate affiliate) could be reached by Tennessee sales tax.

The AG's answers, in short, were yes across the board. Under the U.S. Supreme Court's bright-line Quill rule (since overturned in 2018 by South Dakota v. Wayfair), a state could only require an out-of-state seller to collect sales tax if the seller had a "substantial nexus" with the state, which in Quill meant physical presence. The AG explained that the physical presence necessary for nexus does not have to be the retailer's own employees or property. Under Tyler Pipe and Scripto, in-state activities by an affiliate or independent contractor can establish nexus if those activities "are significantly associated with the taxpayer's ability to establish and maintain a market in this state." Tennessee's own Court of Appeals had applied that standard in Arco Building Systems v. Chumley and found nexus where an in-state contractor handled blueprints, fabrication, shipment, payment, and post-sale service for an out-of-state dealer.

On the proposed amendment, the AG concluded it would be constitutionally defensible because it incorporated the Tyler Pipe "substantially contribute" standard rather than reaching beyond it. Once enacted, the statute would override any inconsistent administrative rule, including Tenn. Comp. R. & Regs. 1320-5-1-.96 (Rule 96). The Department of Revenue cannot issue rules that contradict the statute.

Currency note

This opinion was issued in 2011. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

The legal landscape for online sales tax shifted dramatically in 2018, when the U.S. Supreme Court overruled Quill in South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018). After Wayfair, physical presence is no longer required for substantial nexus, and states may impose sales tax collection obligations on remote sellers based on economic activity alone (typically dollar volume or transaction count thresholds). Tennessee has since enacted economic nexus and marketplace facilitator legislation. Anyone evaluating a current sales tax collection question should look to the post-Wayfair statutory framework, not this 2011 opinion's Quill-based analysis.

Background and statutory framework

The Quill rule, as it stood in 2011. Under Quill Corp. v. North Dakota, 504 U.S. 298, 301-02 (1992), an out-of-state seller could not be required to collect sales and use tax on goods purchased by in-state customers when the seller's only connection with the customers was by common carrier or mail. The Court found that the Due Process Clause permits taxation of a remote seller, but the Commerce Clause separately requires "physical presence" to establish "substantial nexus."

Attributional nexus through affiliates or contractors. Physical presence does not require that the seller itself own property or have employees in the state. Tyler Pipe Industries, Inc. v. Washington Department of Revenue, 483 U.S. 232 (1987), and Scripto, Inc. v. Carson, 362 U.S. 207 (1960), allow attributional nexus when in-state activities by another entity "are significantly associated with the taxpayer's ability to establish and maintain a market in this state." Tyler Pipe, 483 U.S. at 250. It does not matter whether the in-state actor is the seller's own employee, an affiliate, or an independent contractor.

Tennessee's application in Arco. In Arco Building Systems, Inc. v. Chumley, 209 S.W.3d 63, 74 (Tenn. Ct. App. 2006), the in-state contractor prepared price quotes, drew blueprints, fabricated products, arranged shipment, accepted final payments, and provided post-delivery service. The Tennessee Court of Appeals held those activities established substantial nexus even though the contractor did not solicit sales.

The proposed amendment to SB 529/HB 136. The legislative draft added warehouses and distribution centers operated by subsidiaries, agents, or affiliates (as defined in § 67-4-2004) to the definition of "dealer." It declared substantial nexus exists when the in-state place of business is used for "conducting activities in this state that substantially contribute to the person's ability to establish and maintain a market in this state." It also addressed liability shifting: sales by a dealer to a retailer who directs delivery to a Tennessee consumer would be subject to tax unless the retailer was a registered Tennessee dealer and presented a valid resale certificate.

The interaction with Rule 96. Tenn. Comp. R. & Regs. 1320-5-1-.96 governs sales-tax treatment in some distribution-center scenarios. The AG noted that under Tidwell v. RCA Corp., 528 S.W.2d 179, 181 (Tenn. 1975), the Commissioner of Revenue can only adopt rules consistent with the underlying statute. So if the legislature enacted the proposed amendment, any contrary Rule 96 provision would be void.

Common questions

Did Amazon have to collect Tennessee sales tax under this opinion?

The opinion did not name any particular taxpayer. The AG noted as longstanding office policy that it does not opine on the tax liabilities of particular taxpayers based on individualized facts. The opinion sets out general principles. Whether any specific retailer was required to collect tax depended on the structure of its arrangement with the in-state center and on a factual showing about the activities performed.

Is this opinion still good law after Wayfair?

Not as a roadmap for current obligations. Quill was overruled in 2018. Today, an out-of-state seller can be required to collect Tennessee sales tax based on economic nexus alone, even without any in-state property or affiliate. The Tyler Pipe "substantially associated" test for attributional physical-presence nexus is no longer the controlling framework, because physical presence is no longer required. The historical analysis remains useful for understanding the law as it stood in 2011 and for reading older audits.

What factors did the AG list for evaluating attributional nexus?

Drawing on the Hellerstein treatise, the opinion identified three factors: (1) the precise nature of the relationship between the in-state actor and the out-of-state enterprise, including degree of control; (2) the particular activities performed on behalf of the out-of-state enterprise (marketing the product versus producing it versus after-market service); and (3) whether, in light of normal industry operations, the arrangement appears contrived to avoid tax liability.

What did Drugstore.com contribute?

In Drugstore.com, Inc. v. Division of Taxation, 23 N.J. Tax 624 (N.J. Tax Ct. 2008), an online retailer had set up two wholly owned subsidiaries: one nominally "the seller" with no physical presence, and one operating a New Jersey warehouse. The court disregarded the corporate structure because the nominal selling subsidiary was a paper entity with no employees or property, and the customer-facing website gave no indication that anyone other than drugstore.com was selling the merchandise. The case is a cautionary example for retailers structuring around nexus.

Did the AG say solicitation activities were required?

No. The opinion acknowledged that the U.S. Supreme Court's affiliate-nexus cases (Tyler Pipe, Scripto) all involved solicitation, leaving room for an argument that solicitation is required. The AG's office's stated position was that solicitation is not essential, citing Arco (no solicitation required), Borders Online (rejecting a solicitation-only rule), and Gear Research (same). The AG acknowledged that tenable arguments could be made for the contrary view, citing Amazon.com v. New York as a contemporaneous case still being litigated.

Citations

• Tenn. Code Ann. §§ 67-6-102(25), 67-6-201, 67-6-211, 67-4-2004
• Tenn. Comp. R. & Regs. 1320-5-1-.96 (Rule 96)
• Quill Corp. v. North Dakota, 504 U.S. 298 (1992)
• Tyler Pipe Industries, Inc. v. Washington Department of Revenue, 483 U.S. 232 (1987)
• Scripto, Inc. v. Carson, 362 U.S. 207 (1960)
• Arco Bldg. Systems, Inc. v. Chumley, 209 S.W.3d 63 (Tenn. Ct. App. 2006)
• Drugstore.com, Inc. v. Division of Taxation, 23 N.J. Tax 624 (N.J. Tax Ct. 2008)
• Borders Online, LLC v. State Bd. of Equalization, 29 Cal. Rptr. 3d 176 (Cal. Ct. App. 2005)
• Amazon.com, LLC v. Department of Taxation & Finance, 913 N.Y.S.2d 129 (N.Y. App. Div. 2010)
• Gear Research, Inc. v. Department of Treasury, No. 207207, 1999 WL 33441136 (Mich. Ct. App. June 18, 1999)
• In re Advisory Opinion, 509 So. 2d 292 (Fla. 1987)
• Tidwell v. RCA Corp., 528 S.W.2d 179 (Tenn. 1975)

Source

• Landing page: https://www.tn.gov/attorneygeneral/opinions.html
• Original PDF: https://www.tn.gov/content/dam/tn/attorneygeneral/documents/ops/2011/op11-052.pdf

Original opinion text

June 28, 2011
Opinion No. 11-52
Out-of-State Dealer's Nexus with Tennessee Due to Activities of In-State Distribution Center

QUESTIONS

1. Under what circumstances would an out-of-state dealer's use of an in-state distribution center to ship goods sold by the out-of-state dealer serve as sufficient nexus under the Commerce Clause of the United States Constitution to require the out-of-state dealer to collect Tennessee sales tax on its retail sales to Tennessee consumers?

2. If enacted, would the attached amendment to Senate Bill 529/House Bill 136 of the 107th General Assembly be constitutionally defensible under the Due Process and Commerce Clauses of the United States Constitution?

3. If enacted, would the proposed amendment serve as sufficient underlying statutory authority to preclude, or otherwise invalidate, any future amendments to the sales and use tax rules that would exempt from Tennessee sales tax out-of-state dealers operating in-state through an in-state affiliated separate entity distribution network?

4. If enacted, would the proposed amendment serve as sufficient underlying statutory authority to preclude, or otherwise invalidate, any future amendments to Rule 96 that would exempt these in-state affiliated separate entity distribution networks from collecting Tennessee sales tax from these out-of-state dealers?

OPINIONS

1. An out-of-state dealer's use of an in-state distribution center will support a finding of nexus if the in-state distribution center's activities are significantly associated with the out-of-state dealer's ability to establish and maintain a market in this state for the sales.

2. Yes, the proposed amendment would be constitutionally defensible.

3. Yes, the proposed amendment, if enacted, would preclude any sales and use tax rules inconsistent with the statutory amendment.

4. Yes, the proposed amendment, if enacted, would preclude any future amendments to Rule 96 inconsistent with the statutory amendment.

ANALYSIS

1. Your request addresses Tennessee's constitutional and statutory authority to tax sales made to Tennessee residents by an out-of-state dealer that uses an in-state warehouse or distribution center to store and deliver goods sold by the out-of-state dealer. Under certain circumstances, the distribution center's physical presence in Tennessee would create sufficient nexus under the Due Process and Commerce Clauses to support Tennessee's imposition of sales taxes on the out-of-state dealer's sales to in-state customers. This opinion is intended to provide a discussion of attributional nexus factors in general terms only. It is the longstanding policy of this Office not to opine about the tax liabilities of particular taxpayers premised on detailed and individualized facts.

In 1992, the U.S. Supreme Court reaffirmed its bright-line rule that an out-of-state seller cannot be required to collect sales and use tax on goods purchased by in-state customers when the seller's only connection with the customers is by common carrier or mail. See Quill Corp. v. North Dakota, 504 U.S. 298, 301-02 (1992). While the Court found that the Due Process Clause would allow a state to require a mail-order business with no in-state physical presence to collect sales and use tax, the Court held that physical presence is required under the Commerce Clause to establish a "substantial nexus" sufficient to tax such a mail-order business.

If an out-of-state seller owns an in-state warehouse or distribution center or has employees in the state, that would constitute a physical presence by the out-of-state seller sufficient to establish nexus. Ownership of property or presence of employees, however, is not the only means of establishing the physical presence necessary for nexus. Physical presence by an out-of-state seller can also arise from the actions of other parties. For example, nexus may be established by activities conducted within the taxing state by a taxpayer's affiliates or independent contractors. In Tyler Pipe Industries, Inc. v. Washington Department of Revenue, 483 U.S. 232, 107 S. Ct. 2810 (1987), and Scripto, Inc. v. Carson, 362 U.S. 207, 80 S. Ct. 619 (1960), the United States Supreme Court "expressly upheld the imposition of state sales and use tax obligations based on an out-of-state seller's use of non-employee representatives who are not regular agents to conduct business activities in the taxing state." Arco Bldg. Systems, Inc. v. Chumley, 209 S.W.3d 63, 74 (Tenn. Ct. App. 2006). These authorities reveal that such in-state activities will support a finding of nexus if they "are significantly associated with the taxpayer's ability to establish and maintain a market in this state for the sales." Tyler Pipe, 483 U.S. at 250, 107 S. Ct. at 2821. For purposes of this analysis, it is immaterial that the activities are performed by third-party contractors or affiliates rather than the taxpayer's own employees. See id.; Scripto, 362 U.S. at 211, 80 S. Ct. at 621. The determinative issue is whether the in-state distribution center carries on substantial business activities in Tennessee on behalf of the out-of-state dealer. See Arco Bldg. Systems, 209 S.W.3d at 74.

Determinations as to nexus requirements are necessarily "fact specific and ultimately can only be adequately adjudicated as applied to specific situations and taxpayers." In re Advisory Opinion, 509 So. 2d 292, 312 (Fla. 1987); see also 2 Jerome R. Hellerstein & Walter Hellerstein, State Taxation ¶ 19.02[2][c] (3rd ed. 2009). According to one commentator, the factors significant to this analysis include (1) the precise nature of the relationship between the in-state actor and the out-of-state enterprise (e.g., the degree of control of the former by the latter); (2) the particular activities that the in-state actor is performing "on behalf" of the out-of-state enterprise (e.g., marketing the out-of-state enterprise's product as distinguished from contributing to the production of the product or providing some after-market service with respect to the product); and (3) whether, in light of the normal operations of the industry in question, the particular arrangement between the out-of-state enterprise and the in-state actor appears to be contrived to avoid tax liability. Hellerstein, State Taxation § 19.02[2][c].

A couple of notable decisions illustrate how courts apply these factors. In Arco Building Systems, Inc. v. Chumley, 209 S.W.3d 63, 74 (Tenn. Ct. App. 2006), the out-of-state dealer's in-state contractor prepared price quotes, drew up blueprints, fabricated products, arranged shipment to in-state customers, accepted final payments from in-state customers, and provided post-delivery consulting services and parts replacement. The Court of Appeals held that the in-state contractor's activities were sufficient to establish a substantial nexus despite the fact that the in-state contractor did not actually solicit sales from Tennessee residents.

While not truly a nexus case, the decision in Drugstore.com, Inc. v. Division of Taxation, 23 N.J. Tax 624, 625-26 (N.J. Tax Ct. 2008), does deal with a distribution center. There, the plaintiff, a business headquartered in Washington State, created two wholly-owned subsidiaries, referred to as DSNP Sales and DS Distribution, to, respectively, sell and distribute merchandise available on the plaintiff's website to customers in New Jersey and elsewhere. Drugstore.com conceded that it had nexus with New Jersey because it had employees and property located at the New Jersey warehouse operated by DS Distribution. Nevertheless, drugstore.com contended that DSNP Sales was the actual seller of the merchandise, that DSNP Sales had no nexus with New Jersey, and, thus, that none of its sales of merchandise were subject to tax in the state. The evidence showed, however, that DSNP Sales was merely the nominal vendor of the merchandise because it had no physical presence anywhere, had no employees anywhere, and contracted all of its administrative and purchasing functions to drugstore.com. Drugstore.com's website appeared "seamless" to the customer and "gave no indication that an entity other than 'drugstore.com' was the seller of the merchandise." Id. at 632. Based on these facts, the court disregarded the corporate structure set up by drugstore.com, finding that the reason for the formation of DSNP Sales was to bolster the claim that drugstore.com, which admittedly had nexus, was not involved in the sale of merchandise.

The United States Supreme Court cases dealing with this issue have involved actual solicitation activities by the in-state affiliate or contractor, thus leaving room for the argument that actual solicitation is required to establish attributional nexus. This Office has argued that solicitation activities are not essential to a finding of nexus. See, e.g., Arco Building Systems, 209 S.W.3d at 74 (wherein in-state contractor's activities on behalf of out-of-state dealer did not include solicitation); see also Borders Online, LLC v. State Bd. of Equalization, 29 Cal. Rptr. 3d 176, 189 (Cal. Ct. App. 2005); Gear Research, Inc. v. Department of Treasury, No. 207207, 1999 WL 33441136, at *5 (Mich. Ct. App. June 18, 1999). We also recognize that tenable arguments can be made that actual solicitation activities are necessary to support a finding of nexus. See Amazon.com, LLC v. Department of Taxation & Finance, 913 N.Y.S.2d 129, 143 (N.Y. App. Div. 2010). Any more specific guidance as to the nexus required to apply Tennessee's sales and use tax statute is difficult to discern; as the U.S. Supreme Court has noted, "our law in this area is something of a 'quagmire' and the 'application of constitutional principles to specific state statutes leaves much room for controversy and confusion and little in the way of precise guides to the States in the exercise of their indispensible power of taxation.'" Quill Corp., 504 U.S. at 315-16.

2. For purposes of imposing sales and use tax liability, section 1 of the proposed amendment to Senate Bill 529/House Bill 136 defines a "dealer" as, inter alia, every person who "[m]aintains, uses, owns or operates within this state, directly or by a subsidiary, agent or affiliate as defined in § 67-4-2004, any facility, office, distributing house, sales room or house, warehouse, or other place of business." Section 2 of the amendment declares it to be the legislative intent that every person, whether or not he has a place of business in Tennessee, is exercising a taxable privilege if the person uses any agent, facility, office, distributing house, sales room or house, warehouse, or other place of business in this state for delivering or shipping tangible personal property or providing related services to a consumer in this state if the delivery, shipment or related services are provided pursuant to a retail sale by the person to the consumer, whether or not the place of business is owned, operated or maintained by the person's subsidiary, agent or affiliate as defined in § 67-4-2004.

Relative to the issue of nexus, section 3 of the proposed amendment provides that substantial nexus to any such person who does not have a place of business in this state is established through the person's maintenance, use, ownership, or operation of any place of business, directly or by a subsidiary, agent or affiliate as defined in § 67-4-2004, having a presence in this state for the purpose of conducting activities in this state that substantially contribute to the person's ability to establish and maintain a market in this state.

Section 4 of the proposed amendment shifts the liability for the sales tax from the out-of-state dealer to the in-state distribution center under certain circumstances. That section provides that [s]ales of tangible personal property by a dealer to a retailer who directs that the dealer deliver or ship tangible personal property or provide related services to the retailer's customer in this state, who is a user or consumer, shall be subject to the tax imposed by this chapter, unless the retailer is registered as a Tennessee dealer and the retailer has presented a valid Tennessee certificate of resale to the dealer.

If enacted, the proposed amendment to Senate Bill 529/House Bill 136 would be constitutionally defensible under the Due Process and Commerce Clauses of the United States Constitution. As currently drafted, the amendment incorporates the constitutional standard set forth by the United States Supreme Court in Tyler Pipe. By its language, section 3 of the amendment recognizes the establishment of a substantial nexus only in those situations where the in-state affiliate or agent conducts "activities in this state that substantially contribute to the person's ability to establish and maintain a market in this state." The amendment is designed to reach out-of-state dealers within the constitutional limits set forth in Tyler Pipe and, thus, is constitutionally defensible.

3, 4. Moreover, if enacted, the proposed amendment would preclude the amendment or promulgation of any applicable sales and use tax rules, including Rule 96, to exempt sales to Tennessee residents by out-of-state dealers that use in-state distribution centers to ship their products, where such activities fall within the "substantially contribute" standard set forth in Tyler Pipe. "The Commissioner of Revenue only has the power to make and publish rules and regulations for the enforcement of the sales tax provisions which are consistent with the statute." Tidwell v. RCA Corp., 528 S.W.2d 179, 181 (Tenn. 1975). Any administrative rule that conflicts with the controlling statute is void. See id. As drafted, the amendment imposes sales tax liability against out-of-state dealers that use in-state distribution centers to ship their products to Tennessee customers, where such activities fall within the "substantially contribute" standard set forth in Tyler Pipe. Also, as Rule 96 currently does, the amendment imposes sales tax liability against the in-state distribution centers under certain circumstances. Thus, any attempt to amend or promulgate sales and use tax rules in a manner inconsistent with the proposed amendment, once properly enacted, would be ineffective to prevail over the statute's express language.

ROBERT E. COOPER, JR.
Attorney General and Reporter

JOSEPH F. WHALEN
Associate Solicitor General

MARY ELLEN KNACK
Senior Counsel

Requested by:
The Honorable Randy McNally
State Senator
307 War Memorial Building
Nashville, Tennessee 37243-0205

The Honorable Charles M. Sargent, Jr.
State Representative
206 War Memorial Building
Nashville, Tennessee 37243-0194