sales and use tax

Back to the Future? Taxation of New Technologies in Tennessee - Using the Same Old Sales Tax Laws

Marty McFly and “Doc” Brown used the infamous DeLorean in the 1980s hit, Back to the Future, to go back in time to find out that while many things had changed, some things had also stayed the same. That can be true in the tax world in Tennessee as well as we see all kinds of new technologies and digital products that are emerging into the marketplace every day. Even though the technologies are new, some of the same old sales tax law still apply.

We have come across several of those situations this year as we see businesses collecting sales tax on various transactions that we have to step back a minute and analyze to understand why the tax is correctly being collected.

Peloton – The Case Study

I have this good friend Brooks who is pretty much on the cutting edge of most everything technology. Standing desk? Bam. Nissan Leaf? Boom. Four Computer Screens? Booyah. Tesla? Bazinga. And now… Peloton. In case you didn’t know, the Peloton is part of an exercise trend where bikers can train with a video-led trainer. No need to leave your house, go to an exercise club or endure the elements. All you need is the Peloton bike, a TV screen/monitor and you pay a subscription fee, and you are off.

How is this related to the @TNTaxLawyer? Well, while all of Brooks’ other transactions were clearly taxable, this one was a little different. The bike was plainly taxable, but what about the subscription fee for all the training videos that are used to train riders? Up until recently, no tax was collected or paid on the subscription fee in Tennessee. That is until Brooks received an email indicating that all future subscriptions fees would be subject to the sales tax.

In his email to me, he expressed outrage and dismay, and in fact, he blamed me. Oh, the life of a tax lawyer… Not representing Peloton and having some background in this area, I was a little confused at first and only speculated as to why the sales tax may be due or at least Peloton thought it was due. I promptly proceeded to forget about it and focus on other billable work.

But, not to be deterred, Brooks continued to remind me of this issue, so I had to dig in and figure it out. If I didn’t, Brooks wouldn’t leave me alone; he’d continue to whine about it, and I decided I had to put this to rest.

Why would it be taxable? I knew that Peloton wouldn’t be collecting the tax if they didn’t have a pretty good idea that it was taxable. There had to be a memo that some tax consultant had prepared somewhere that explained why the subscription fee was taxable. In thinking about it, I considered the following … Digital good? It could be taxable as a digital good, but was that really the true object of the transaction? Hmm. Amusement tax? The sales tax applies to recreation clubs, so it is possible that someone had concluded that the amusement tax applied, but I questioned that too because there is no “place of business,” which is generally part of the trigger for that tax. Was it a bundled transaction? Brooks had to buy the bike, so maybe they viewed it as a bundled transaction and it was all taxable. This seemed less likely since there seemed to be two separate parts of the transaction and seemed to be a stretch for bundling.

I puzzled over this awhile and then I happened to be perusing the Department’s website one day and came across … Tennessee Letter Ruling 17-18, released in December 2017. Dun Dun Duh! I remembered seeing it, but there often so many redactions in a ruling that you cannot figure out what the Department is even ruling, but this one became clear based on Brooks’ email and this ruling. I kind of felt like Frank or Joe Hardy… (Am I dating myself?)

Letter Ruling 17-18

In Letter Ruling 17-18, the Department addressed the applicability of the sales tax to a business that provided “access, via subscription, to online [REDACTED] training courses.” The courses were developed by a network of experts in [REDACTED] disciplines and primarily focused on the fields of [REDACTED]. The business created a virtual classroom that allows people to learn, teach, and connect. The businesses subscribers were able to enhance existing or obtain new [REDACTED] skills enabling them to improve their careers and productivity. The ruling goes on to provide additional details of the [REDACTED] online service. I could be wrong on this, and it doesn’t really matter if I’m correct or not, but if you replace [REDACTED] with cycling in each block, it makes sense that this ruling does or at least could apply to the subscription service offered by Peloton.

The question that the Ruling answered was whether the subscription fee for access to pre-recorded online training courses are subject to the sales and use tax, and the Department answered in the affirmative, citing to Tenn. Code Ann. §67-6-233 (the taxation of digital goods). When the digital goods tax was enacted, it was intended to extend the sales to digital goods that were previously in a taxable tangible form– books, video cassettes, DVDs, CDs, etc., so the rationale for extending the tax here to the subscription to online video courses is rooted in the idea that video cassettes/DVDs offering the same product under previous technology would also be taxable.

Letter Ruling 17-17

Interestingly, the Department also issued Letter Ruling 17-17 at about the same time as Ruling 17-18. Ruling 17-17 concluded that online training courses are also taxable as computer software while live, instructor-led webinars are not subject to sales and use tax because the student is paying to participate in a live class.

Take Away

The Department’s positions in these rulings should be closely examined by companies offering digital, video, or other instruction, training or information for a fee. It appears that the Department will consider most of these services as taxable under some subset of the sales tax unless the service is a live feed where the true object is the live instruction and not the recorded training video. In many cases, groups will record live events and then charge participants to view the recorded training session. In that instance, the live presentation is nontaxable while the recorded presentation is taxable according to the Department.

It's another example of how newer technologies are taxed under the modern sales and use tax, but it is really the application of long-standing sales tax principles. It’s kind of like Back to the Future, except, we are not wearing life preservers, and it didn’t take a DeLorean to get us there.

Brooks’ Question … ANSWERED!

For Small Remote Sellers in Tennessee Looking for Alternatives after Wayfair, We're Saying There's a Chance

The Wayfair decision has sent shockwaves throughout the remote seller world. Big and small, phat and skinny, short and tall. You get it. Businesses are scrambling to determine how they should respond to this new normal in the sales tax collection world. While large remote sellers may have few options except to turn on the sale tax collection faucet everywhere, small retailers may consider taking a more reserved, wait-and-see approach. Follow me on this one.


As background, most state and local governments have adopted some form of sales and use tax on the sale of tangible personal property. In most states, the tax is imposed on the purchaser and collected and remitted by the seller as an agent of the state. For tax periods prior to 2018, taxpayers were generally only required to collect and remit sales and use tax based on whether the taxpayer had more than a de minimis in-state physical presence in the taxing jurisdiction. See Quill Corp. v. North Dakota, 504 U.S. 298 (1992); National Bellas Hess Inc. v. Illinois, 386 U.S. 753 (1967). Thus, the analysis of whether a business had an obligation to collect tax on a cross-border transaction was determined based on where the businesses offices, property, and personnel (including independent contractors) were located – PHYSICAL PRESENCE. In addition, the U.S. Supreme Court created a four-prong test in 1977 to determine whether a state tax on interstate activity satisfied the dormant commerce clause. See Complete Auto Transit Inc. v. Brady, 430 U.S. 274 (1977). According to Complete Auto, to withstand dormant commerce clause scrutiny, a state tax must (1) apply to an activity with a substantial nexus with the taxing state, (2) be fairly apportioned, (3) not discriminate against interstate commerce, and (4) be fairly related to the services provided by the state.

Since Quill was decided in 1992 requiring a physical presence to establish taxing nexus, there has been a substantial increase in electronic commerce and in the way goods and services are provided. In response to this, states have enacted increasingly aggressive standards designed to circumvent the physical presence standard. Despite these state statutes and regulations, physical presence remained the Constitutional standard to determine whether a state may require an out-of-state company to collect its sales and use tax until the Wayfair decision in June 2018.

Wayfair Decision

The issue in Wayfair was whether South Dakota could impose a use tax collection obligation on out-of-state companies with no in-state physical presence that sold taxable goods delivered into the state. In Wayfair, South Dakota enacted a law that required an out-of-state seller to collect and remit use tax as if the seller had an in-state physical presence if the seller annually either delivered more than $100,000 of goods or services into the state or engaged in 200 or more transactions for the delivery of goods or services into the state. South Dakota’s law was also tailored to foreclose the possibility of retroactive application and specifically provided that enforcement would be delayed until its constitutionality was established.

Wayfair Inc., Inc., and Newegg Inc., large online retailers with no physical presence in South Dakota but whose businesses satisfied the minimum sales or transactions requirements of the law, refused to collect the tax. These entities ultimately filed a lawsuit to challenge the South Dakota statute. The case proceeded through the South Dakota courts to the U.S. Supreme Court.

In addressing whether the physical presence standard applied and prevented South Dakota from requiring the remote sellers to collect the state’s use tax, the Court determined that economic changes had occurred since Quill and stated that the physical presence rule, both as first formulated and as applied today, was an “unsound and incorrect” interpretation of the commerce clause. The majority concluded that Quill and Bellas Hess were now overruled. For purposes of this analysis, it is unnecessary to explain the Court’s reasoning on its physical presence holding. However, it is important that the Court in Wayfair was not content to merely overrule Quill and Bellas Hess. It created a new sufficiency test to determine whether substantial nexus exists under the commerce clause and, in so doing, it changed the entire landscape of state and local taxation in the United States.

Substantial Nexus

According to the majority, substantial nexus is established “when the taxpayer [or collector] ‘avails itself of the substantial privilege of carrying on business’ in that jurisdiction.” This new sufficiency standard was satisfied in Wayfair “based on both the economic and virtual contacts” the remote sellers had with South Dakota. The Court’s reasoning was that the remote sellers at issue were “large, national companies that undoubtedly maintain an extensive virtual presence.” The justices concluded that “the substantial nexus requirement of Complete Auto [was] satisfied in this case.”

Post-Wayfair, the new substantial nexus test turns on whether a taxpayer has availed itself of the substantial privilege of carrying on business in the taxing jurisdiction at issue through economic and virtual contacts. The Court left the minimum threshold of this sufficiency test undefined and for lower courts to determine. Because the substantial nexus analysis is fact-specific, the only existing guidance for determining the sufficiency of the economic and virtual contacts that satisfy this test are the particular South Dakota contacts of the remote sellers involved in the Wayfair litigation.

The Court did not analyze those businesses’ contacts with the state; rather, it merely concluded that each business, by being a large national company, “undoubtedly maintain[ed] an extensive virtual presence.” As a result, the only conclusion that can be drawn with certainty is that a business with an “extensive virtual presence” has availed itself of the substantial privilege of carrying on business in a taxing jurisdiction. The Court left open the question of whether something less than an extensive virtual presence is also sufficient to establish substantial nexus.

Undue Burden on Interstate Commerce

In addition to the substantial nexus issue addressed above, the Court’s opinion also addressed other commerce clause authority that must be satisfied for a state taxing statute to withstand constitutional scrutiny - “[s]tate regulations may not discriminate against interstate commerce and [s]tates may not impose undue burdens on interstate commerce.” Wayfair, slip op. at 7. These issues were not argued to the Court in the parties’ briefs, so the Court remanded the Wayfair case to the South Dakota Supreme Court to determine whether the law violated “some other principle of the Court’s commerce clause doctrine.”

The Court’s holding as it relates to the “undue burden” analysis directed the lower court to review South Dakota’s law to determine whether it either discriminates against interstate commerce and is per se invalid or imposes a burden on interstate commerce that is clearly excessive in relation to the putative local benefits. See e.g. Granholm v. Herald, 544 U.S. 460, 476 (2005); Pike v. Bruce Church Inc., 397 U.S. 137, 142 (1970) (a state law that regulates evenhandedly to effectuate a legitimate local interest will be upheld unless the burden imposed on interstate commerce is clearly excessive in relation to the putative local benefits). This question addresses the third prong of the Complete Auto commerce clause analysis and is an alternative way to challenge the constitutionality of tax collection regime. In the analysis section of the opinion, the Court describes two distinct burdens that must be considered: (a) the burdens imposed by the South Dakota tax collection regime; and (b) the burdens imposed on the respondents by the tax collection regime.

Regarding the burdens imposed by the tax collection regime, the Court noted that certain features of the South Dakota regime “appear designed to prevent discrimination against or undue burdens upon interstate commerce” - (1) the act applies a safe harbor to those who transact only limited business in South Dakota; (2) the act ensures that no obligation to remit the sales tax may be applied retroactively; and (3) South Dakota is one of more than 20 states that have adopted the Streamlined Sales and Use Tax Agreement (meaning South Dakota provides free software, and adopts uniform definitions of products and services). The Court was careful to note that these are features, rather than a test, but the takeaway from this analysis was that state statutes that satisfy these three requirements would ostensibly be constitutional.

Going further, however, the Court suggested that the burdens on the individual company must also be considered, separate and apart from the burdens imposed by the sales and use tax collection regime more generally. The Court suggested that the burdens may be different depending on a business’s size and sophistication. As the Court describes it, the respondents in Wayfair were “large, national companies that undoubtedly maintain an extensive virtual presence,” adding that one respondent was a “leading online retailer,” while another was a “top online retailer.” The respondents were contrasted with “small businesses, startups, or others who engage in commerce across state lines.” The Court noted that “some small businesses with only de minimis contacts” may “seek relief from collection systems thought to be a burden” under “other theories.” Without saying it explicitly, the Court laid the groundwork for a state of affairs in which large online retailers that ship goods into states and compete with brick-and-mortar retailers may find it difficult to challenge tax collection regimes, whereas it may be comparatively easier for smaller online sellers, or sellers with other business models, to bring such a challenge.

The Way Forward

Based on the Supreme Court’s decision in Wayfair, the Court left open various alternatives for small remote sellers to evaluate in determining whether they have a constitutional obligation to collect sales and use tax on transactions in states in which those companies have no physical presence. Specifically, a remote seller must evaluate (1) whether it is availing itself of the privileges of the jurisdiction or whether it lacks substantial economic and virtual contacts with the jurisdiction under the first prong of Complete Auto and (2) whether the tax collection regime substantially burdens interstate commerce generally and as applied to its specific facts. The Court’s opinion suggests that large internet sellers that ship goods into a state and compete with brick-and-mortar retailers will generally face difficulty in making these arguments, but it appears that these arguments are much more feasible for small sellers.

Based on this analysis, small remote sellers in Tennessee would seem well-suited or should at least consider taking a position that they do not have substantial nexus in any state other than Tennessee. (Ignoring physical presence in another state.)  The Court did little to establish a framework to consider this issue, but it was quick to note that substantial nexus was easily established when there are large national companies involved. While many small remote sellers are very successful, they often do no rise to the level of activity of a large national company as was the case in Wayfair, and there are obvious distinctions that can be made between small remote sellers and the Wayfairs of the world. Thus, the position would be that the small seller’s economic and virtual connection with states other than Tennessee is not sufficiently “substantial” to allow the state to require it to collect and remit use tax.

Setting aside “substantial nexus,” the Court also concluded that a state’s authority to impose its use tax collection obligations on a company could impose an undue burden on that company. With respect to the specific South Dakota requirements as applied to Wayfair (and the other large online retailers), the Court noted that the South Dakota statute appeared to be designed to “prevent discrimination against or undue burdens upon interstate commerce.” The particular factors that the Court pointed to were that (1) the act applies a safe harbor to those who transact only limited business in South Dakota; (2) the act ensures that no obligation to remit the sales tax may be applied retroactively; and (3) South Dakota is one of more than 20 states that have adopted the Streamlined Sales and Use Tax Agreement (meaning South Dakota provides software, and adopts uniform definitions of products and services).  Based on this analysis, states must arguably fall within these criteria to have a chance to withstand a constitutional challenge.

The Court further stated that the burdens on the individual company must also be considered, separate and apart from the burdens imposed by the sales and use tax collection regime. Thus, the fact that the burden on a small remote seller would be more significant than the burden on a large national retailer would be relevant to determining whether there is an undue burden. Specifically, the Court contrasted Wayfair with “small businesses, startups, or others who engage in commerce across state lines.” The Court noted that “some small businesses with only de minimis contacts” may “seek relief from collection systems thought to be a burden” under “other theories.”

This plainly indicates the Court’s belief that small companies have a more compelling commerce clause position than large companies. Thus, that opens the door for small remote sellers to take the position that the burdens imposed by other states’ sales and use tax collection regimes (including the cost associated with these obligations) are more significant than the burdens placed on a large national company and would result in a commerce clause violation as applied to their business. This position would be in addition to the “substantial nexus” position described above.

Small remote sellers may still choose to be conservative and collect in states where they exceed the economic nexus thresholds. Collecting and remitting the tax is a completely reasonable position, but if you are looking for alternatives, we’re saying there’s a chance.