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Marketing Mechanism Constitutes Tax Nexus In Tennessee

Kids still read books, but nobody uses Quill, pens the Tennessee Court of Appeals in reversing the lower court and finding that nexus exists even without agents or a physical presence.

Remember Scholastic Book Club? Those were the books you ordered in grade school and your teacher placed the order for the class. A few weeks later, a package arrived and teacher gave you the books.

Sort of like Amazon but a lot easier since you could guilt-trip your parents into buying you some cool mystery paperbacks.

Book clubs may be passe, but empty state coffers are current news.

The State of Tennessee wanted to charge Scholastic sales & use tax.

The company argued that it had no presence in Tennessee, and that teachers who took the book orders were agents of the students. The company also argued that it did not place demands on state services.

In particular, the company relied on Quill v North Dakota (1992) and said that there was no tax nexus that would be recognized under US Supreme Court jurisprudence on the matter.

On appeal, the issue was presented:

Whether the activities of in-state schools and school employees on behalf of an out-of-state seller that enable the seller to establish and maintain a market in Tennessee create sufficient nexus with Tennessee under the Commerce Clause of the United States Constitution to support an assessment of Tennessee sales and use taxes against the seller.

The court opinion is troubling for franchisors. The court held that Quill was dispositive and nevertheless managed to find tax nexus:

the issue in this case is not whether Tennessee teachers may be considered agents of SBC, but whether SBC’s connections with Tennessee’s schools and teachers establishes a “substantial nexus” such that the Commissioner’s assessment may be sustained under the Commerce Clause

The court found:

In short, SBC has created a de facto marketing and distribution mechanism within Tennessee’s schools and utilizing Tennessee teachers to sell books to school children and their parents. Contrary to SBC’s assertion that it uses no public services in Tennessee, this State’s school facilities and teachers are, in large part, funded by taxpayer dollars. We agree with the Commissioner that SBC’s connections with its customers in Tennessee do not fall with the narrow safe harbor provisions affirmed in Quill Corp

Of particular interest to franchisors is the court's statement that Quill stands for the proposition that contact may only be via "common carrier or the United States mail."

By the reasoning of the Tennessee appellate court, franchisors with sales agents and support/compliance audits within the state are outside the "narrow safe harbor" of Quill.

Unlike the schoolteachers in Scholastic, the local representatives of franchisors are not working without compensation; in fact their compensation is often tied to a percentage of what the franchisor is earning. It is true that the appellate court noted the taxpayer support of schoolteachers, but a reading of the Opinion suggests that this was not the basis for the decision and more in the nature of dicta than a necessary element of finding nexus.

The court ruling is a roadmap for SCOTUS to gut Quill without actually overturning precedent, and the Scholastic reasoning is likely to be closely read when and if Quill is challenged at the high court.

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Scholastic Book Clubs v Farr OPINION 27Jan2012.pdf113.65 KB
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