California Ruling Forces Borders.Com To Collect Sales Taxes

In a decision that may galvanize action in other states, the California Board of Equalization (BOE) has ruled that online bookseller Borders.com must collect state sales tax.

Under a 1992 Supreme Court decision, Quill Corp. v. North Dakota, states cannot compel out-of-state companies to collect sales taxes unless the company has a physical presence, or "nexus," in the state. This would include a warehouse, office, or retail store.

But many national chains with stores in every state do not collect sales taxes on their online sales. These retailers---including Borders Books, Barnes & Noble, Target, Tower Records, and Wal-Mart---contend that their e-commerce operations are distinct legal entities unrelated to their physical stores. Their internet stores therefore lack nexus and are not required to collect sales taxes. The legal term for his practice is "entity isolation."

A more accurate description, according to the Northern California Independent Booksellers Association (NCIBA), is tax evasion. For several years, the NCIBA has pressed state officials to enforce the sales tax law and thereby level the playing field for all retailers with nexus in the state.

In September, they scored their first victory when the BOE ordered Borders.com to collect tax on all of its California sales. The BOE, the state agency in charge of taxes and fees, ruled that Borders stores have been acting as the authorized representative of Borders.com by accepting returns of merchandise purchased online and giving customers cash back.

The Supreme Court held in Quill that nexus in a state is established either when an out-of-state company itself or its authorized representative has a substantial physical presence in the state. Borders.com had argued that the Borders bookstore chain is an independent third party that takes returns on behalf of Borders.com through a contractual arrangement.

According to advocates of sales tax fairness, clicks-and-mortar retailers are obligated in most states under existing law to collect sales tax. But, until this decision, enforcement officials nationwide have failed to take action against these companies.

Last year, the NCIBA put forward legislation designed to spur enforcement by clarifying that clicks-and-mortar retailers are in fact required to collect tax on their online sales. The bill passed the California legislature---quite a feat in the land of high tech---but was vetoed by the governor. Only one state, Arkansas, has enacted similar legislation (see story below).

The refusal of major chain retailers to collect tax on their online sales probably poses a bigger long-term thereat to state revenue than the sales tax exemption currently provided to mail order and internet-only retailers like Amazon.com.

• BOE decision
• More on the interest sales tax issue, including the California bill proposed by the NCIBA and the Quill decision