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Back to School on Nexus: Debating the Definition of Physical Presence

author photo of Annette Nellen

The "bright line" test of the 1992 Quill decision is too often just a murky test. We have seen this often, but rulings in two states in the past year show the challenges taxpayers, practitioners and tax agencies face in determining if a business has sales tax nexus in a state. The cases involved Scholastic Book Clubs in Connecticut and Tennessee.  The lower court rulings found that Scholastic did not have sales tax nexus, but on appeal, it was found that they did have nexus. In June 2012, Scholastic asked the U.S. Supreme Court to hear the Connecticut case.

The Tennessee Court of Appeals attempted to find and apply the Quill bright line test by noting that Scholastic's connection with in-state customers was beyond only via common carrier or the U.S. mail. The teachers helping students place orders and receive their books and use of the schools provided the physical presence for sales tax nexus under the Commerce Clause.

The lower court in Connecticut and a few other states have found the teachers to be equivalent to parents helping students place their orders. The teachers are not agents of Scholastic (although some judges have viewed the teachers' acts of returning order forms as entering a relationship - it does seem to obligate the teachers to then distribute the books to the students). The teachers are unlikely to describe themselves as sellers of Scholastic books (while, in contrast, the contractors in Scripto likely would describe themselves as sellers of Scripto products).

Is anything beyond use of a common carrier or U.S. mail (or phone or email or a website as some states also provide) mean a seller has a physical presence? Or to be a seller with sales tax obligations, must there be tangible property or a company or individual the seller has contracted with? Of course, the answer also depends on the specifics of a state's law as some states have specified certain activities or relationships that do or do not create nexus.

How can certainty be provided to sellers given the discrepancies among the Scholastic cases?  For more on this topic, including a list of the Scholastic cases dating back to 1989 (pre-Quill) and their holdings, see a short article of mine - Back to School: Sales Tax Nexus Lessons in the AICPA Corporate Taxation Insider (8/23/12).

What do you think about the Scholastic fact pattern?  Do the teachers and use of the schools create sales tax nexus for Scholastic?

Other recent “Sales Tax Policy - Tales & Trends” posts by Annette Nellen, CPA, ESQ:

NOTE: All blog content, comments, and participation subject to disclaimer at bottom of page.


4 Responses to Back to School on Nexus: Debating the Definition of Physical Presence

  • Posted by Author photo of Annette NellenAnnette Nellen on September 10, 2012 11:52am:

    But the teachers are certainly more involved than affiliate website owners. The teachers make sure the books actually get ordered. They have to collect the forms and checks from the students. When the books are delivered, they have to get them to the right students. I have also read somewhere that the teachers handle any returns. If you asked the students or their parents, they probably think the teachers are working for Scholastic.
    I agree that if it were just handing out an order form for students to take home and process on their own, that would be different. That would be similar to the teacher telling them of a URL. But that is not the case in Scholastic.
    What does the bright line test need to be to resolve the differences among the courts on the Scholastic fact pattern?

  • Posted by BJ on September 10, 2012 9:17am:

    I think the real question is: Who do you think you are doing business with - scholastic or the teachers? The teachers provide the order forms just like a sales person but have no authority to approve the sale. The bright physical presence is not met by simply supplying an order form.
    Thank You!
    B.J. Pritchett, CMI

  • Posted by AnnetteNellen on September 8, 2012 3:42am:

    In many states, it seems that "agent" is not relevant because the statues, such as in CT, include use of a representative in the state. Here are some relevant excerpts from the CT Supreme Court decision in Scholastic:
    "we conclude that a substantial nexus exists between the plaintiff and the state because the teachers are the plaintiff’s representatives. The difference in terminology does not affect our analysis. ... Thus, because the teachers who participate in the program serve as the only means through which the plaintiff communicates with Connecticut schoolchildren, they provide the substantial nexus required to permit imposition of sales and use taxes under the bright-line physical presence rule established in Bellas Hess and Quill."
    "our legislature has determined that persons acting as ‘‘representative[s]’’ of out-of-state retailers may provide the presence necessary to justify imposition of sales and use taxes. General Statutes §12-407 (a) (15) (A) (iv). We therefore need not consider whether the teachers and the plaintiff in this case had an express or implied agency relationship."
    "The nature of the program necessarily places the teachers in a position in which they are functioning in much the same way as salesmen, in that they are bringing the plaintiff’s products to the attention of the students and are providing them with the means to order, pay for and receive delivery of those products. Moreover, the teachers derive benefits from the program because they earn bonus points that enable them to purchase other items of value from the plaintiff’s catalog. Accordingly, under the bright-line rule established in Bellas Hess and Quill and the ‘‘practical analysis’’ required by United States Supreme Court precedent, we conclude that the activities of the Connecticut schoolteachers who participate in the plaintiff’s program provide the requisite nexus under the commerce clause to justify imposition of the taxes at issue in this case."
    In TN, the court applied the "bright line" test of Bellas Hess and Quill to focus whether the vendor had any connection with the state beyond sending product by US mail or common carrier. The court found that the activities and role of the teachers indicated substantial nexus. Per the court: "The undisputed facts of this case demonstrate that SBC is not a vendor whose only connection with customers in Tennessee in by common carrier or by mail. SBC utilizes Tennessee schools and teachers to facilitate sales to school children in Tennessee."
    The court also noted that because the schools are funded by the state, Scholastic used public services in TN.
    I wonder why the courts did not spend more time on the 4-part test of Complete Auto. The TN court implied use of the 4th factor (services provided by the state). There was also no explicit discussion of whether the teachers were more in an advertising role than a selling role. Clearly, the teachers are doing more than telling students that Scholastic is one place for buying books, they are playing a role (along with the school facilities where the books are shipped) in sales occurring.
    They do more than an auction website, like eBay, or an affiliate link (which without specific soliciting statements, I view as advertising regardless of the payment mechanism).
    What do you think about the Scholastic cases?

  • Posted by Chuck on September 4, 2012 6:43am:

    I understand that Scholastic wants to declare that the teachers are not agents, but I have some familiarity with Scholastic Book Sales since my wife was a middle school librarian in Texas for many years. (In Texas sales tax was required to be collected but that is because nexus (physical warehouses in several cities in the state) was established.
    However, while not paid directly by Scholastic, school libraries earn books and other merchandise based on the amount of sales. In other words, Scholastic is compensating these "non-agents" which may add to the state's argument that there is a agent relationship.

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