The Politics of Economic Nexus in Tennessee

Now to tax, Tennessee tax that is.

And where do we start? Well, with the hottest tax issue in Tennessee tax right now … economic nexus, and the politics behind economic nexus.

Background

By way of background, sales tax nexus in Tennessee has long been based on physical presence dating back to before the U.S. Supreme Court’s decision in Quill, which held that an out-of-state retailer had to have a physical presence in the taxing state before it could be required to collect the state use tax. Tennessee, unlike many states, has been so firm on physical presence nexus that even the nexus standard in Tennessee for income tax purposes is based on physical presence from the J.C. Penney National Bank case from the late 1990’s. That differs from many states that have relied on economic nexus for years for income taxes.

Fast forward to 2015 when the Tennessee legislature passed the Revenue Modernization Act, which included economic nexus statutes for the Tennessee franchise and excise tax and the Tennessee business tax. Notably absent from the legislation was an economic nexus provision for the Tennessee sales and use tax.

From a legislative perspective, economic nexus for the franchise and excise taxes and the business tax was not controversial because the target of those provisions was out-of-state companies with little-to-no political capital to sway Tennessee legislators from enacting those tax provisions. Economic nexus for sales and use tax is a different animal, and Governor Haslam to his credit was savvy enough to realize that an economic nexus provision for sales tax in the RMA could have derailed the entire legislative package, so it was conveniently omitted. He knows like all legislators that horn-honking Tennesseans have no interest in paying higher taxes. 

No harm, no foul. Right? Well, it appears now that what Governor Haslam was really thinking was that there was more than one way to skin a catfish.

Regulation Effort

The balance of 2015 and 2016 saw the employment of numerous regulation projects by the Department of Revenue to implement the RMA, including regulations on market sourcing, research and development credits, and revised business tax statutes. While those regulations were still being finalized, the Department dropped another regulation notice for … that’s right – economic nexus for Tennessee sales and use tax. What the administration was afraid to do by statute, they were now trying to do with a regulation.

It might seem like a minor distinction, but by using the regulation project, what the Governor was able to do is avoid having the legislature to actually vote on whether out-of-state, online retailers should be required to collect sales and use tax from Tennessee consumers. The reason that is important is that no Tennessee legislator, and especially the Republican variety, wants to go on record as voting for what would have been, in essence, a tax increase on Tennessee consumers (aka voters). While it all looks nice and neat, there was one hiccup - well-settled Tennessee case law is clear that a regulation cannot be promulgated by the executive branch without a statute from the legislature authorizing the regulation. While Tennessee has strained to find a legislative basis for the regulation, it is hard to believe that a legislative basis for the regulation exists, especially when the Governor felt compelled to include economic nexus statutes in the RMA for Tennessee's other major taxes only two years ago.

One catch on the Governor’s plan was that the Joint Government Operations Committee was required to review the economic nexus regulation before they become law. That committee holds hearings, listens to testimony, and typically votes to approve newly promulgated rules. Those rules are later approved by the full legislature in the omnibus regulation bill.

In late 2016, the Joint Government Operations Committee heard testimony on the proposed economic nexus regulations. Many of the Republican legislators were adamently opposed to the regulations during the hearing based on their comments and questions, but when it came time tovote, there were enough abstentions and present-not-voting declarations made that the regulation proceeded out of the committee without approval but also without a negative recommendation. Those regulations are now a part of SB53/HB261, and a vote for that bill in its current form is a vote to make out-of-state retailers collect sales and use tax from Tennessee consumers. If you read the bill, you cannot tell that, but that is the beauty of the regulatory process in Tennessee. Transparency reigns supreme!

Absent an amendment removing the economic nexus regulations from the omnibus bill, the economic nexus regulations will become effective upon passage of SB53/HB261. That is not, however, the end of the story.

Administrative Challenge

Many believe that the regulation is both unconstitutional and an unauthorized promulgation of rules by the Haslam administration. Rather than pick a fight with the legislature over the passage of SB53/HB261, a taxpayer recently filed a challenge to the economic nexus regulations with a Tennessee Code section 67-1-105 petition, filed with the Commissioner of Revenue.

This is a slightly different procedural challenge than in normal tax cases in which taxpayers typically either seek refunds of tax or challenge assessments of tax made by the Department. The 67-1-105 hearing allows taxpayers to proceed with a challenge on a tax issue without first having to pay the tax and without having to accrue a liability for the failure to collect the tax. This is a narrow provision but applicable here.

Significantly, the Commissioner cannot decide the constitutional issue in the administrative 67-1-105 process. Only the regulatory action will be reviewed. Once a decision is issued from this hearing, an appeal to Chancery Court will be the next procedural step, which will put both the statutory and constitutional issues properly before the Courts on whether economic nexus becomes the law in Tennessee.

While the constitutional question is pending in other states, the regulation may meet its demise on procedural grounds and put the regulation squarely back into the legislatures hands, but that remains to be seen.

So there you are – the long and winding road to economic nexus in Tennessee. The end of this story has yet to be written, so make sure to visit again, so you can get the latest from Tennessee on economic nexus. We will be watching for the vote on SB53 and a potential appeal to Chancery Court as the next chapters in this story. Stay tuned...