On April 18, the New Mexico Court of Appeals held that an out-of-state online bookseller, Barnesandnoble.com LLC (B&N), had substantial nexus for purposes of the New Mexico gross receipts tax based on its shared trademarks with an in-state related party's activities.1 In reversing the hearing officer, the Court found that the in-state related party created goodwill for the shared trademarks, and as a result, helped B&N to create and maintain a market within the state.
Background
B&N, an Internet-based retailer of books, music, online courses, and movies with a broad multistate customer base, had no physical presence in New Mexico during the audit period giving rise to the litigation. B&N shipped all products to New Mexico customers from a point outside the state through the U.S. Postal Service or a third party common carrier. However, Barnes & Noble Booksellers, Inc. (Booksellers), related to B&N through common ownership by a corporate parent, owned and operated three retail stores in New Mexico during the audit period.
Booksellers made sales of gift cards that could be used to make purchases from either Booksellers or B&N, and the reverse side of the gift cards displayed B&N's Web site address. When Booksellers sold a gift card, it sent the proceeds of the sale to a related marketing entity after receiving a small fee payment for making the sale. When the value of the gift card was honored, the related marketing entity credited the value to the retailer that honored it.
Booksellers also sold memberships to a "Readers' Advantage" loyalty program. Customers who enrolled were entitled to discounts at Booksellers' stores and online. Membership fees went to the parent company and Booksellers or B&N received a share of the fees based on the percentage of discounts that applied to their sales.
In addition, Booksellers allowed customers who made purchases from B&N to return the items to Booksellers. For online purchases that were returned, Booksellers provided an in- store credit or gift cards that could be redeemed in stores. B&N's Web site provided information about the expansive return policy and also provided a store locater and descriptions of in-store events.
The New Mexico Taxation and Revenue Department issued an assessment for gross receipts tax and interest against B&N for sales into the state during the audit period, January 31, 1998 through July 31, 2005. B&N protested the assessment based on the position that Booksellers' activities could not be attributed to B&N and could not cause B&N to have "substantial nexus" under Quill.2 The Department's own hearing officer decided in favor of B&N3 and the Department appealed the case to the Court of Appeals.
Commerce Clause Not Violated
The sole issue before the Court of Appeals was whether the hearing officer abused her discretion in determining that there was a lack of substantial nexus, as required under the Commerce Clause of the U.S. Constitution, to support the assessment against B&N.
The U.S. Supreme Court has held that a seller must have a "physical presence" in a state in order to satisfy the substantial nexus requirement.4 However, the Court pointed out that the threshold for establishing "physical presence" is not high5 and "physical presence" can even be established where a third party performs acts in the state "on behalf" of the seller, which are significantly associated with the seller's ability to establish and maintain a market in the state.6 In Dell Catalog Sales, the Court ruled that Dell, a computer vendor without any property, stores, sales agents or employees in New Mexico, had substantial nexus with the state by virtue of its use of in-state servicemen, who acted "on behalf" of Dell to make the repairs under service contracts purchased by the majority of Dell's customers.7
Physical Activities in State
The Court considered Booksellers' various types of activities, which allegedly helped B&N to create and maintain a market in the state. First, with respect to Booksellers' store information (i.e., locations, events, return policies) provided on B&N's Web site, there was no transmission or "activity" that occurred in the state. Moreover, the store information was not being provided on behalf of B&N. Rather, it was being provided on behalf of the parent company that paid B&N to provide the information. Therefore, the online store information did not establish substantial nexus for B&N.
Additionally, since Booksellers' expansive return policy allowed individuals to return books, without a receipt, regardless of where they were originally purchased, such policy was not preferential to B&N, because the policy did not help B&N to create and maintain a market in New Mexico. Furthermore, the record did not show that customers who purchased from B&N online made in-store returns. If anything, Booksellers likely accepted returns for the convenience of its customers or for its own benefit, not for the benefit of B&N.
Similarly, the Court found that the gift card scenario also failed to create substantial nexus for B&N. Where customers purchased a gift card through B&N's Web site and used the gift card to make purchases in stores, B&N was not performing any in-state activities and the ultimate purchase from the store was not benefiting B&N. Where customers purchased a gift card from a store, Booksellers could not control where the customer will redeem the gift card and if it could control the redemption, presumably, it would prefer customers to redeem the value within its own stores. Booksellers' act of selling a gift card may have resulted in a sale for B&N, but this benefit was only incidental. Booksellers received a fee for every gift card sold.
Analogous to the gift card scenario was the "Readers' Advantage" loyalty program, which permitted members to make discounted purchases either online or in stores. Again, Booksellers would prefer that customers make discounted purchase in stores versus online. The Department hearing officer's conclusion that the loyalty program did not increase B&N's New Mexico sales was not an abuse of her discretion. Accordingly, the hearing officer's overall conclusion that Booksellers' activities did not create substantial nexus between B&N and the state was not an abuse of her discretion.
Trademark
Following this determination, the Court pointed out that the hearing officer's ruling may nonetheless be reversed on the basis that it was not "in accordance with the law." This brought the Court to the Department's second contention that B&N's use of shared marketing, trademarks and logos created and established a market in New Mexico.
In Kmart Properties, the Court noted that the tangible use of trademarks at stores in New Mexico was the "functional equivalent of physical presence."8 In that case, an out-of-state holding company granted Kmart, an in-state entity, the right to use its trademarks throughout the United States. The Court concluded that the use of the trademarks by the in-state stores created goodwill and increased the value of the trademarks for the holding company. The licensor and licensee were "inextricably bound to each other" and few customers were actually aware that the trademarks were owned by the holding company, and not Kmart. Although the Court of Appeals' decision in Kmart Properties was ultimately reversed by the New Mexico Supreme Court for reasons unrelated to the constitutional question at issue,9 the Court, in the instant case, stated that it could rely on its rationale in Kmart as persuasive constitutional authority.
The Court's task was to decide whether the in-state activities of Booksellers, a licensee of the shared trademarks, could be imputed to B&N, another licensee of the Barnes & Noble trademarks that used the trademarks to make Internet sales to New Mexico customers. Analogizing the situation to Kmart Properties, the Court held that Booksellers' operation of its in-state retail stores strengthened the goodwill behind the trademarks, which in turn, benefited B&N. Customers "saw only one entity: Barnes & Noble." According to the Court, it was impossible to separate the goodwill generated by Booksellers' New Mexico stores into physical and Internet components.
In addition, specific store conduct also increased goodwill for B&N's Web site. For example, the gift card program and the loyalty program, standing alone, did not create sufficient nexus. However, they constituted probative evidence of cross-marketing activities that created and enhanced goodwill for the trademarks as well as B&N's Web site. The store activities increased customer awareness of B&N and, as such, helped B&N to establish and maintain a market in New Mexico. As a result, New Mexico's assessment of gross receipts tax on B&N was supported by substantial nexus.
Due Process and State Rules Act
The Court rejected B&N's assertion of a violation of due process and the State Rules Act. The due process argument was rejected because, based on the record, B&N conceded that the gross receipts tax would apply in the event that substantial nexus could be established. The State Rules Act argument that an agency seeking "to expand the reach of a statute to situations that are not reasonably apparent from its terms ... must engage in rulemaking" was rejected because B&N failed to provide or cite any authority.
Commentary
The Court reversed the hearing officer's ruling and found that there was substantial nexus in the case based on its determination that the in-state Booksellers' activities created goodwill for a shared trademark with B&N and thus, for B&N. It did not reverse the ruling based on Booksellers' activities alone. The trademarks and the increased value based on Booksellers' conduct and the overall enhancement of the brand was deemed crucial to the conclusion. If the two entities did not share a trademark and did not brand themselves to be one in the same to New Mexico customers, the result may have been different.
Interestingly, while other states have taken the same position that shared trademarks could create nexus for out-of-state businesses, they have predominantly done so through legislative action and not through the courts. With this decision, New Mexico's judicial system has interpreted constitutional law to establish this rule without the enactment of explicit legislation. Given the substantial nature of the issues involved and the taxpayer's willingness to litigate this issue in several jurisdictions, the case may be appealed to the New Mexico Supreme Court.
Footnotes
1 In re Barnesandnoble.com LLC, New Mexico Court of Appeals, No. 31,231, April 18, 2012.
2 Quill v. North Dakota, 504 U.S. 298 (1992). Note that the New Mexico gross receipts tax is imposed on any person "engaging in business" in New Mexico. The term "engaging in business" is the carrying on or causing to be carried on any activity with the purpose of direct or indirect benefit. N.M. STAT. ANN. § 7-9-3.
3 In re Barnesandnoble.com LLC, New Mexico Taxation and Revenue Department, No. 11-10, April 11, 2011.
4 Quill Corp. v. North Dakota, 504 U.S. 298 (1992); National Bellas Hess, Inc. v. Dept. of Revenue, 386 U.S. 753 (1967). This physical presence requirement applies to sales and use tax, but many state courts have held that this requirement does not apply to income tax.
5 The Court pointed out that even a single employee could establish "physical presence." See Standard Pressed Steel Co. v. Wash. Dept. of Revenue, 419 U.S. 560 (1975).
6 Dell Catalog Sales L.P. v. Taxation and Revenue Dept., 199 P.3d 863 (N.M. Ct. App. 2008).
7 Id.
8 The Court cited Kmart Properties, Inc. v. Taxation and Revenue Dept., 131 P.3d 27 (N.M. Ct. App. 2001).
9 Kmart Corp. v. Taxation and Revenue Dept., 131 P.3d 22 (N.M. 2005). The New Mexico Supreme Court held that the gross receipts tax statute did not apply to the licensing transaction at issue in the case. Due to the statutory basis for its decision, the Court did not find it necessary to reach the constitutional question.
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