Recently, the Arizona Court of Appeals (Court) determined the Wisconsin headquartered online auto parts retailer RockAuto, LLC (RockAuto) had established substantial nexus in Arizona through its network of distributors, vacating and remanding the tax court’s decision. With a twist of fate regarding the tax court’s decision favoring RockAuto, the online retailer now faces a liability in excess of $8 million of tax, penalties and interest assessed by the Arizona Department of Revenue (Department).
“... an activity need not produce business in order to create a nexus.”
background
As part of its operations, the nationwide auto parts retailer forwarded orders received through its website to distributors, six of whom were located in Arizona. These distributors handled inventory, shipping and returns with approximately 11% of orders placed with Arizona-based distributors shipped to customers also located in Arizona. RockAuto did not maintain its own inventory or fulfill customer orders.
In a perplexing start to the ensuing audit, a customer brought a RockAuto package into the Town of Gilbert’s tax department and “complain[ed] that they were not charged tax.” A transaction privilege tax audit was conducted and RockAuto received a proposed assessment in an amount over $8M including tax, penalties and interest.
RockAuto timely protested the assessment in Arizona’s tax court and arguing its business activities did not establish substantial nexus in Arizona. The tax court agreed with RockAuto granting its motion for summary judgment, which the Department then appealed.
Analysis
The crux of the dispute was whether RockAuto’s business activities through its Arizona distributors established a physical presence in Arizona. Highlighting RockAuto’s contracts with its customers, the Court noted that except for order acceptance, the contracts were largely executed in Arizona through its distributors. Unlike previous cases where businesses lacked in-state contractors, RockAuto’s Arizona distributors actively participated in shipping orders, processing returns and promoting the business.
Ultimately, the Court found that the distributor's activities significantly contributed to the RockAuto’s market presence in Arizona. Such activities included packaging RockAuto’s orders using the company’s branded tape and enclosing promotional materials and shipping the orders directly to customers via common carrier. If orders were returned, RockAuto supplied return labels with its name and the distributor’s address. RockAuto also made business trips to Arizona to meet with distributors, which the Court considered as a factor in its effort to “establish a market” in Arizona.
Takeaway
The Court's decision in this case highlights the abundance of activities that can potentially establish substantial nexus in another state. In the post-Wayfair world, it is crucial for businesses to understand that presence in another state can be established in ways beyond having a brick-and-mortar store. As your business continues to expand its online presence, remember that sales tax and similar transaction-type tax compliance does not have to be complicated with Libertas on your side.