Texas Rules That Online Clothing Retailer Has Physical Presence Nexus

October 30, 2018

Even after Wayfair, physical presence can still create nexus, and taxpayers that own property that is temporarily located in a state can establish sales tax nexus, as explained in this Texas private letter ruling.

By Tina M. Chunn, SALT senior manager

Every day, entrepreneurs are finding new ways to provide goods and services to the market and to reach new customers, often through the use of technology.  Even the most traditional industries, such as clothing retailers, have found unique ways to serve customers.  However, as these alternative approaches enter the marketplace, it is often the case that sales tax nexus is not considered by the business or its advisors.  It is important to recognize that, even considering the Wayfair case, taxpayers can still create nexus through physical presence if (i) the state has not adopted an economic nexus rule or (ii) the state has adopted an economic nexus rule and the taxpayer does not meet the requisite sales revenue or transaction thresholds.  In other words, physical presence still creates nexus even after Wayfair; all Wayfair stands for is that physical presence is not required to create nexus.  Therefore, whether or not a taxpayer has created physical presence in a state is still a necessary consideration for any nexus analysis.

Texas has not currently adopted economic nexus[1] and recently issued a Private Letter Ruling[2] to address physical presence nexus for an online clothing retailer.

The taxpayer is an online clothing retailer that allows the customers to receive clothing each month through a subscription service (there is no membership fee).  The taxpayer does not have any employees, warehouses, offices or capital assets in Texas.  Further, there are no independent contractors soliciting sales or marketing for the taxpayer in Texas.

Each month, the taxpayer sends a preview email to each of its customers showing the clothing selected for such customer by taxpayer’s fashion experts.  The customer has 48 hours to reject the shipment.  If not rejected, the taxpayer ships the clothes, but does not charge the customer for the clothing upon shipment.  Instead, the taxpayers charges the customer a “styling fee” to cover the cost of the fashion expert selecting the clothes, free shipping and returns, and the convenience of a 7-day try-on period (as explained below).

The customer is given seven days to examine the clothes (try-on period) beginning the date the common carrier marks the package as delivered.  Once the 7-day try-on period has expired or the customer has informed the taxpayer of the clothes that he or she wants to keep (if prior to the 7th day), the taxpayer charges the customer for the clothing kept (less the “styling fee”) and recognizes the revenue from the sales transaction.  The customer ships back any items not kept using a prepaid return slip provided by the taxpayer.

The ruling addresses whether the taxpayer has established nexus and is required to collect and remit sales tax.  The ruling notes that during the try-on period when the clothes are in the state, the taxpayer retains the rights to the clothes and only allows customers use of the clothes on the condition that they will either return the clothes within the 7-day period or pay for them once this period expires (or they have informed the taxpayer that they will keep the clothes).  Although the terms and conditions state that the taxpayer passes risk of loss and title to the property to the customer upon delivery of the clothes to the common carrier, the state is not bound by the terms of that contract since it is not a party to it.  Further, under the state’s sales tax statute, a sale is defined as a transfer of title or possession for consideration.[3]  The customer does not pay for the clothes, and the taxpayer does not recognize revenue, until after the clothing is in the state.  Therefore, the sale has not taken place until after the clothes are in the state.

Based on these facts, Texas ruled the taxpayer has nexus based on its ownership of the clothing in the state.  Accordingly, the taxpayer is required to collect and remit sales tax on its sales to Texas customers.

Whenever a business creates a new method of delivering goods/services or modifies it current method, it is important to re-examine how that new or revised method impacts state tax nexus.  If that analysis is not undertaken (perhaps as was the situation here), the business may quickly find itself with significant state tax exposure.  Aprio’s SALT team has experience with analyzing these types of transactions and assisting your business with nexus issues so that you remain in compliance and do not create unexpected state tax liabilities.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn at [email protected] or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at [email protected] for more information.

This article was featured in the October 2018 SALT Newsletter.

[1] Texas has issued informal guidance on its website that economic nexus is likely to be implemented in 2019 when the Texas Legislature reconvenes.  Rule amendments will likely be adopted in early 2019 with collection requirements beginning later in 2019.

[2] Texas Private Letter Ruling No. 2017010116, August 14, 2018.

[3] Texas Tax Code § 151.005(1).

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.

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About the Author

Tina Chunn

Tina is a senior manager with Aprio’s State & Local Tax group. She has over 24 years of experience assisting companies and their owners to minimize their tax liability and maximize their profitability. Some of the industries Tina serves include professional services, manufacturing, warehousing and distribution, telecommunications, real estate, retailers and wholesalers. Tina has extensive experience dealing with corporate tax issues, including state and local tax returns; state and federal tax credits; state and local sales; and use, income, escheat, business licenses and property tax issues.

(770) 353-5334