Ohio Explains How Mobile Phone Apps May Create Sales Tax Nexus

Ohio recently introduced two new nexus standards, known as “in-state software nexus” and “network nexus,” that will take effect on Jan. 1, 2018.

A major trend in sales and use taxation has been the enactment of laws that seek to subject more out-of-state businesses to sales tax collection and reporting requirements (i.e., sales tax nexus). This summer, Ohio enacted H.B. 49, which established two new legal standards for when an out-of-state business has seller’s use tax nexus. [1] These new nexus standards are referred to as “in-state software nexus” and “network nexus,” and they go into effect on Jan. 1, 2018. [2] Ohio recently published a Tax Information Release (“TIR”) that better explains how they will apply to out-of-state sellers. [3]

“In-state software nexus” applies to businesses using software that is actually present in the state to make sales of taxable property or services to Ohio customers. This provision will largely impact retailers who have developed phone apps that customers use to make purchases of their products. Ohio has reasoned that the presence of this software on customers’ phones or computers within the state is significantly associated with the seller’s ability to establish and maintain the market for its products in the state and thus creates nexus.

The TIR provides the following example: A large out-of-state seller (Seller A) that retails clothing to individual consumers through a website also provides for the sale of the clothing through a catalog application which is downloaded onto the customer’s computer or cell phone. The catalog application is software, as is the HTML and JavaScript coding used in displaying the seller’s website on the customer’s computer or cell phone. It is the presence of this software owned by Seller A in Ohio that is significantly associated with Seller A’s ability to establish and maintain its market.

In 2017, Seller A had $2 million of gross receipts related to the sale of clothing to consumers in Ohio. Beginning Jan. 1, 2018, it is presumed that Seller A has substantial nexus with Ohio and should register and begin collecting and remitting tax on purchases by Ohio consumers in 2018. Seller A’s first return would be due on Feb. 23, 2018 for the Jan. 1, 2018 to Jan. 31, 2018 tax period.

“Network nexus” applies to businesses that contract with another party to provide a content delivery network (“CDN”) in the state, which is a system of distributed servers and data centers that deliver websites or other content to a user based on the location of the user. [4] The purpose of such systems are to accelerate or enhance the delivery of the web content. This provision will largely impact web retailers who contract with CDN providers to better deliver their content to Ohio users. Therefore, any business that uses its website to solicit business or obtain sales and also uses the services of a CDN in Ohio could be affected by this rule.

For both of these new nexus standards to apply, the out-of-state seller’s Ohio gross receipts must exceed $500,000 in the current or preceding calendar year. Further, these rules only establish a presumption that nexus exists; out-of-state sellers may rebut this presumption by showing that these activities are not significantly associated with the company’s ability to establish or maintain a market in Ohio for such sales.

These new rules are just another example of how states are expanding the types of activities that may create sales tax nexus, and with it an obligation to collect and remit sales tax and file sales tax returns. Given the numerous changes in nexus rules each year, it is important for a business to regularly monitor and address its nexus profile.

Aprio’s SALT team has extensive experience addressing nexus issues and performing nexus studies so that businesses remain in compliance with ever-changing sales tax rules and don’t receive unexpected assessments. We constantly monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the November/December 2017 SALT Newsletter.

[1] Seller’s use tax is essentially the same as sales tax, but is imposed on out-of-state vendors who are registered to collect tax in the state. In Ohio, sales tax is only imposed on taxpayers who have business locations within the state.

[2] See Ohio Rev. Code Ann. §§5741.01(l)(2)(h) and 5741.01 (l)(2)(i).

[3] Ohio Tax Information Release ST 2017-02, Sales and Use Tax: Software Nexus and Network Nexus, October 2017.

[4] Ohio Rev. Code Ann. §5741.01(l)(2)(i) specifies that this rule applies when a person contracts with another to provide a content distribution network in the state. Note that if the company were to lease or use its own servers in the state for the same purpose, it would have nexus due to the physical presence of those servers in the state.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.