T +1 404 704 0133
Jamie C. Yesnowitz
T +1 202 521 1504
T +1 312 602 8517
T +1 513 345 4540
T +1 303 813 3973
The Alabama Court of Civil Appeals ruled on Sept. 7, 2018 that the business model used by a prominent classroom bookseller did not create a taxable sales and use tax nexus presence in Alabama during a lengthy audit period at issue.1
The Court noted that the Wayfair decision has changed the applicable nexus standards, implying that the Court of Appeals’ analysis in this matter may not apply on a prospective basis.
Scholastic Book Clubs, Inc. (“SBC”) sells books and classroom supplies to students and classrooms via catalogs, which are distributed by teachers. SBC does not enter into any kind of contract or agency agreement with the teachers, or the students’ parents, and the teachers and parents do not have any obligation to distribute the catalogs or take orders. SBC does not maintain any locations or warehouses, or have any employees in Alabama. When a teacher or parent places an order on behalf of his/her classroom and students, all orders are placed on one form, which is sent to SBC, fulfilled at SBC’s Missouri warehouse, and sent back to the classroom for distribution. SBC’s parent is Scholastic, Inc. (“Scholastic”), which contracted with Alabama to become the state’s math textbook provider in 2012.
Following an audit of SBC’s tax periods from April 1, 2007, to March 31, 2013, the Alabama Department of Revenue issued an assessment against SBC for over $815,000 in unpaid use tax, inclusive of interest. SBC appealed the assessment, arguing that it did not have an obligation to collect and remit use tax to the state of Alabama, because it did not have constitutional nexus in Alabama sufficient for the state to impose such an obligation. This assessment was made after SBC had rejected an offer by the Department to limit the audit period to three years, which could have substantially reduced the amount of Scholastic’s retroactive sales tax exposure.
The controversy ultimately reached the Alabama Tax Tribunal, which affirmed the Department's assessment on March 25, 2016, on the grounds that SBC was utilizing classroom teachers to solicit sales and perform other activities on behalf of SBC in Alabama.2
SBC filed a notice of appeal of the Tribunal’s decision with the Montgomery County Circuit Court. On Aug. 18, 2017, the Circuit Court entered a final judgment, vacating the Department's assessment of use tax against SBC.3
The Circuit Court based its determination primarily upon Ala. Code Sec. 40-23-68(b), stating that SBC’s:
“…contacts with Alabama are not included within any of the enumerated categories under Ala. Code § 40-23-68(b) and thus it has no obligation to collect and remit use tax on its sales to Alabama school children, teachers, and parents. Specifically…Alabama school teachers and parent educators were not acting on behalf of or under the authority of SBC and were not retained under contract by SBC. Rather, the Alabama school teachers and parent educators were acting on behalf of their students in helping them place orders.”
The Circuit Court further supported its decision on the basis that the activities of the teachers and parents did not fall statutorily under the expansive definition of a sales agent or representative, pursuant to Ala. Code Sec. 40-23-68(b)(3), or under Ala. Code Sec. 40-23-68(b)(9), a “catchall” provision. The Circuit Court stated that Alabama’s “longstanding rules of statutory construction” ignored the plain language of Ala. Code Sec. 40-23-68(b)(9), which solely applies to 'any other contact' not described anywhere else in the statute, rendering:
“…the remainder of the statute meaningless. Further, the [t]ribunal’s interpretation would nullify the 1991 amendment to Ala. Code § 40-23-68(b) to expressly require a contract for in-state representatives in order to trigger an obligation to collect the seller’s use tax."
The Department appealed the Circuit Court decision to the Alabama Court of Civil Appeals.
Court of Civil Appeals decision
Upon de novo review, the Court of Civil Appeals reviewed the arguments raised by the parties in the Circuit Court, along with a novel related-party argument under Ala. Code Sec. 40-23-190(b) raised by the Department for the first time at the Circuit Court. The Department contended that Scholastic maintained an Alabama presence through its contract with the state of Alabama as a textbook provider, and that Scholastic and SBC used a substantially similar name, tradename and trademark to develop, promote and maintain an Alabama market. SBC rebutted this argument, stating that SBC and Scholastic were entirely separate and any in-state activities attributable to Scholastic could not be applied to SBC. The Department also argued that under Ala. Code Sec. 41-4-116(a), SBC was an affiliate of Scholastic, and as a result, maintained a duty to register, collect, and remit sales, use, and lease tax to Alabama.
The Court of Civil Appeals summarily determined that it found no basis for reversing the judgment of the Circuit Court. In confirming the Circuit Court’s analysis relating to the potential applicability of Ala. Code Sec. 40-23-68(b), the Court of Civil Appeals noted that SBC did not retain employees or agents under contract in Alabama, and SBC did not receive and accept orders from Alabama residents within the state of Alabama. Therefore, SBC had no specific obligation to collect use tax based on its activities. The Court of Civil Appeals likewise rejected the Department’s argument that Ala. Code Sec. 40-23-190(b) applied because of Scholastic’s in-state activities, as the Department did not argue or explain how the assessment against SBC would be upheld based on that statute. Finally, the Court of Civil Appeals held that the Department had not demonstrated that SBC was subject to the obligation to collect and remit use tax under Ala. Code Sec. 40-23-68, and therefore, found no basis to reverse the judgment and reinstate the assessment under Ala. Code Sec. 41-4-116.
Court’s brief foray into Wayfair
During the course of the Court of Civil Appeals’ review of the record, both parties were asked to submit briefs addressing the effect, if any, of South Dakota v. Wayfair
on nexus-creating activities in Alabama, even though the audit period in question occurred well prior to the Wayfair
decision. SBC opined that the application of Wayfair
was unnecessary, as the case should be decided solely on statutory grounds, of which SBC did not meet. The Department, in its brief, put forth the contention that the decision in Wayfair
strengthened its position as Wayfair
established the test to determine what constitutes substantial nexus, and would allow Alabama to tax an entity with extensive business connections and economic presence in the state. The Court of Civil Appeals ultimately did not reach the question of the Department’s potential reach under Wayfair
, as the Department was unable to show that it could impose an obligation to collect use tax on SBC. In addition, the Court of Civil Appeals refused to express an opinion on whether, under a different result in this case, Alabama could constitutionally impose use tax obligations on SBC in light of Wayfair
Scholastic has a storied history of litigation surrounding the question of whether a jurisdiction can impose a sales and/or use tax on an out-of-state seller, with mixed results. In the pre-Wayfair
world of nexus, statutes designed to require out-of-state sellers to collect and remit sales tax have not always been successful from the state perspective. The Alabama courts’ statutory interpretation proves that distinctive fact patterns (as reflected by the SBC model) and non-uniform sales tax nexus statutes will result in inconsistent nexus findings on a multistate basis.
It is interesting that the Court of Civil Appeals asked for both parties to comment on the application of Wayfair
, so soon after the decision, even though it would have been very difficult for the Court of Civil Appeals to hold that Wayfair
could be applied retroactively to SBC. Not surprisingly, SBC wanted to stick to the parameters of its own case, and not opine on what Wayfair
could bring to bear on its business model, while the Department looked to do the opposite. While SBC was successful in arguing their position in this case, that may not be the result for periods after June 21, 2018,5
based on state adoption of economic nexus provisions en masse. Post-Wayfair
, remote sellers have entered a regime in which their physical presence connections to a state may not matter as much, to the extent that newly minted de minimis sales/transaction thresholds are met.6
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.