The Tennessee Court of Appeals ruled on January 27, 2012 that
Scholastic Book Clubs' ("Scholastic") use of schools
and teachers to facilitate book sales and deliveries in Tennessee
establishes a sufficient presence in Tennessee requiring Scholastic
to collect sales and use tax on its sales. Scholastic Book
Clubs, Inc. v. Farr, Dkt. No. M2011-01443-COA-R3-CV, slip op.
at 9 (Jan. 27, 2012).
Scholastic markets and sells books and other publications and
products to teachers and students at nursery, primary, and
secondary schools across the United States. During the period under
audit by the Tennessee Department of Revenue, over 8,000 Tennessee
schools participated in Scholastic's program, generating sales
in excess of $34 million. Scholastic did not collect or remit
Tennessee sales and use tax on the book sales and, following audit,
the Department of Revenue issued a $6 million sales tax
The activities of Scholastic in Tennessee were undisputed on the
parties' cross-motions for summary judgment at the trial court.
Specifically, the parties agreed that Scholastic maintained no
property, employees, agents, bank accounts, data, or telephone
listings in the state. The trial court concluded that Scholastic
"lacked a 'substantial nexus' in the State of
Tennessee" and was not required to collect Tennessee sales and
The issue on appeal was whether the activities of Tennessee
schools performed by school employees on behalf of Scholastic
created a sufficient presence in Tennessee under the Commerce
Clause to support an assessment of Tennessee sales and use tax.
Scholastic argued that its only connection to customers in
Tennessee is through mail order catalogs. The teachers distribute
the catalogs to their students and, in some instances, assist
students with the purchase of books. Book orders are submitted to
the teachers, together with payment, and the teachers forward the
orders and payment to Scholastic at its Missouri headquarters. The
orders are filled and sent via common carrier to the teachers to be
distributed to the students in Tennessee. Based on these facts,
Scholastic maintained that it did not have a physical presence in
Tennessee and that the teachers were not agents of Scholastic.
The Court of Appeals reasoned that the issue was not whether the
teachers were "agents" of Scholastic but whether
Scholastic's connections with Tennessee schools and teachers
established a "substantial nexus" to sustain the
assessment on Commerce Clause grounds. This issue has a long
history of being litigated across the country, and the Court
acknowledged a split in other jurisdictions such as California,
Kansas, Michigan, and most recently in Connecticut.
The Tennessee Court of Appeals relied on its most recent nexus
decision, Arco Building Systems, Inc. v. Chumley, 209
S.W.3d 63 (Tenn. Ct. App. 2006), to conclude that Scholastic had
created "a de facto marketing and distribution
mechanism within Tennessee's schools ... utilizing Tennessee
teachers to sell books to school children and their parents."
Accordingly, the Court held that Scholastic's connections with
customers in Tennessee did not fall within the "safe
harbor" of the Commerce Clause established by Quill Corp.
v. North Dakota, 504 U.S. 298 (Tenn. Ct. App. 1992). Moreover,
the Court rejected Scholastic's assertion that it used no
public services in Tennessee, because "this State's school
facilities and teachers are, in large part, funded by taxpayer
The Court of Appeals has remanded the case to the trial court
for further proceedings consistent with the ruling. In addition to
raising a Commerce Clause challenge, Scholastic also raised Due
Process and Tennessee Constitutional challenges that were not
decided on the parties' cross-motions for summary judgment.
Scholastic has sixty (60) days within which to file an application
with the Tennessee Supreme Court for discretionary review.
Practice Pointer: This decision
continues a troubling trend in Tennessee for multistate businesses
that have typically focused on compensated employees and
contractors when determining what states in which they must collect
and remit use tax. In Arco, the activity that satisfied the nexus
standard was the use if an in-state manufacturer. Here, the Court
of Appeals ignores the fact that the teachers were uncompensated
for their participation in the Scholastic program, focusing instead
on the fact that the teachers' activities are performed on
behalf of Scholastic regardless of monetary compensation. The
broader standard that has evolved will require out-of-state
companies to reconsider current filing positions in Tennessee based
on activities performed on their behalf by various third
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The Internal Revenue Service has recently published an IRS Large Business & International Directive, which updates an earlier directive to field agents addressing the examination of capitalization and repair costs issues.