Texas Comptroller of Public Accounts

Texas Comptroller of Public Accounts, Glenn Hegar

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Subcommittee on Nexus


The Nexus Subcommittee of the Comptroller's Internet Tax Policy Working Group began meeting in November, 1997. Since then, the committee has met at least once each month throughout 1998 (with the exception of July 1998).

The charge of the Subcommittee was to investigate the current policies of the Texas Comptroller of Public Accounts relating to the establishment of nexus via the use and exploitation of the Internet and electronic commerce. The Subcommittee was charged with making recommendations for either administrative change if the subcommittee found that the current Comptroller policies were in contravention of established law, or legislative change if the Subcommittee determined that the policies inhibited the growth of electronic commerce and the attraction and retention of high tech businesses to the state.

This report represents the findings of the Subcommittee.

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"Nexus" is a concept deeply rooted in federal constitutional law. At its most basic level, nexus refers to the minimum contacts that a remote seller/taxpayer must have with a state before that state may impose its state tax collection responsibilities upon it. Although most typically associated with sales or other transaction based taxes, the concept of nexus affects almost all forms of state taxation, including franchise/income taxes and ad valorem/property taxes.

Direct mail sales have traditionally been the battleground for nexus litigation and legislation. In 1967, the United States Supreme Court determined that a remote seller whose only contacts with the state were via catalog solicitation, (800) phone numbers, and shipment of orders via common carrier, lacked sufficient nexus with a state. Therefore, the seller could not be forced to collect use taxes on sales made into the state[17]. During this time period, court analysis grouped traditional minimum contacts principles under the Due Process Clause with the concept of precluded regulation of interstate commerce under the Commerce Clause. Thus the Supreme Court held that a physical presence of some kind was necessary before a state could impose collection responsibilities on remote sellers.

The Supreme Court bifurcated this analysis in 1992. In Quill Corp. v. North Dakota[18], the Court determined that a mail order seller that consistently and systematically solicited sales in a state through catalogs and other advertising could have sufficient economic presence in a state to meet the minimum contacts requirement of the Due Process Clause. Nevertheless, the Court ruled in the taxpayer's favor based on its reading of the Commerce Clause. Taxation is a form of regulation. Therefore, under the Commerce Clause, a state could enforce its sales tax collection responsibilities upon a remote seller only if Congress gave its blessing. Until now, Congress has declined to do so.

Direct mail sellers share a great deal in common with "remote sellers" over the Internet. In many cases, a remote seller has no physical presence in the state. Instead, it opens up virtual storefronts on Internet computer servers that may be located anywhere in the world. Buyers can view products in an online catalog and utilize e-commerce enabled web sites to make a purchase using a credit card. The product is then shipped to the buyer, usually via a common carrier. In the case of software, the seller may make the product immediately available to the buyer via download.

The issue of nexus also arises in relation to taxes based on net income, such as the earned surplus segment of the Texas franchise tax. A federal statute, Public Law 86-272, prohibits a state from imposing a net income tax on a company whose sole connection with a state is that it solicits and makes sales of tangible personal property in the state. For example, P.L. 86-272 protects a company that merely has employees or agents soliciting and making sales, even if those employees or agents are physically located in the state. However, once the activities of the employee or agent go beyond mere solicitation, the protections of P.L. 86-272 are lost, and the company is subject to the state's income tax[19].

The Internet and electronic commerce present special problems in this regard. For example, it is sometimes difficult to determine where Internet activities are taking place or where services such as online help systems are to be sourced.

Although to a lesser degree, nexus concepts also affect ad valorem/property taxation. While the nexus of a piece of real property is easy to determine, the nexus of computer software delivered through a web page located on an Internet computer server somewhere in the world is quite another issue.

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Findings & Conclusions

The subcommittee delineated nexus issues into eight types of activities. For each activity, the subcommittee attempted to determine the following: (i) the current Comptroller policy; (ii) whether the activity creates nexus for a remote seller; and (iii) whether a legislative or administrative change should be sought to change this policy.

Activity 1:  A remote (outside of Texas) seller stores its web page on a third party's Internet server located in Texas.

Until late 1997, the Texas Comptroller of Public Accounts had issued various rulings indicating that storage of a web page on a Texas server created Texas nexus for the remote seller. Subsequently, the Comptroller has reversed this position.

The issue of whether this activity is sufficient to create nexus is complicated by the fact that computer software is treated as tangible personal property for sales tax purposes. Therefore, the argument could be made that the storage of a web page, designed in a myriad of Internet-oriented computer programming languages such as hypertext markup language (HTML), could be considered "tangible" personal property stored within the state.

The Subcommittee unanimously agreed that storage of a web page should not establish nexus for a remote seller. Few if any states find nexus in this circumstance, and if Texas were to enforce such a policy, companies would likely abandon Texas Internet Presence Providers (companies whose primary function is to host web sites) in favor of IPP's in states with no such requirement. This would mean Texas would not develop the infrastructure needed for efficient Internet access.

All members, including those from the State, therefore agree that the Comptroller's current policy should be continued.

Activity 2:  A remote seller stores its web page on a third party's Internet server located in Texas, in addition to soliciting Texas customers via telephone, print advertising, and direct mail.

This scenario raises the issue of whether a web page located on a server in Texas would provide sufficient physical presence in the State so as to overcome the United States Supreme Court decision in Quill. Once again, the Subcommittee agreed that these activities do not provide sufficient basis for establishing nexus. The Subcommittee recommends that this current Comptroller policy should be continued based upon the analysis in Activity 1.

Activity 3:  A remote seller or Internet Service Provider leases telecommunications switches and/or telephone lines from a third-party telecommunications service provider, allowing its Texas customers to call a local telephone number to access the seller or its services located outside of Texas.

This scenario generated considerable discussion within the Subcommittee.

On the one hand, the State was (and is) concerned that the lease of the switch or line constitutes the lease and use of tangible or real property located in the state. Most views of nexus would consider this a sufficient physical presence within the state to establish nexus.

Telecommunications industry representatives argue, however, that access to a leased line or telecommunications switch is not a "lease" at all. They argue that a leased line or switch is really the provision of a telecommunications service.

The issue is further complicated by the fact that such services are often used in conjunction with other transactions. For example, an out of state Internet service provider may lease a switch or phone line to allow Texas customers to access its Internet server located outside the state. In some cases, the provider may maintain a bank of computer modems within the state to answer incoming calls before they are routed to the out of state server. The modems may establish nexus independently of the leased line or switch.

Even if the transaction is determined to be the provision of a service, a seller may face difficult and confusing issues. Based on the concept of "agency nexus," some courts have determined that activities or services performed by a third-party that are necessary to maintain a remote seller's market in the state may establish nexus on behalf of that remote seller.

Based upon the explanation of the transaction by telecommunications industry representatives, the subcommittee determined that leased lines and switches constituted, in and of themselves, the provision of a telecommunications service and hence did not amount to the lease and use of tangible or real property within the state. State representatives conditionally agreed with this determination, pending their own investigation as to the nature of the telecommunications service contracts, process and equipment.

The issue of agency nexus was unsettled as being highly fact specific. For example, if companies such as America Online provide leased lines and switches to give their customers a local access number, isn't the telephone company providing a telecommunications service that is essential to AOL's continued market in the state?

Activity 4:  Remote seller sells computer software over the Internet, "storing" its inventory on an Internet server located in Texas.

The Subcommittee discussed this issue at some length and came to the conclusion that under current law computer software held for sale and stored on a Texas server was tangible inventory stored within the state, and hence, gave the remote seller nexus in Texas for sales and use tax purposes.

Having reached this conclusion, however, the subcommittee considered the impact such a ruling would have. Unlike inventory stored in physical warehouses, computer software stored on a server can be moved to another server in seconds. Therefore, it is extremely easy for a remote seller to change from a Texas Internet service provider to a state with more favorable rulings. The seller would not even have to change the Internet address of its web storefront, as such Internet domain names are just as mobile.

The Subcommittee therefore recommended that a legislative change be implemented to prevent the migration of business web services from Texas to out-of-state ISPs.

Activity 5:  Remote seller sells tangible personal property over the Internet and contracts with designated third-party warranty service providers in Texas to perform repairs under seller's warranty.

For many years, Texas has determined that sellers who provide local warranty service through third-party repairmen located in the state have nexus because these repairmen help to maintain the seller's market in the state.

The majority of the Subcommittee agreed that this policy should not be changed. The Subcommittee felt that an Internet remote seller should fare no better than the mail order seller.

Activity 6:  Remote seller sells tangible personal property over the Internet and does not have a contract with warranty service providers but will reimburse customers for approved repairs performed by designated third-party warranty service providers in Texas.

The Comptroller policy is that these activities do not create nexus. The Subcommittee agreed that no change is necessary.

Activity 7:  Remote seller of computer services "takes over" and services a Texas customer's computer via modem or Internet connection.

Many computer sellers and computer consultants now provide a method whereby a technician employed by the seller can "autopilot" a customer's terminal from its remote location to examine program configuration files, examine installed hardware, and otherwise troubleshoot problems with the system.

The Subcommittee was concerned that such a service could be considered the equivalent of performing services within the state, giving that remote seller or service provider nexus in the state.

The Subcommittee agreed that unless the technician physically entered the state to service the computer, the company would not have sufficient contacts with the state to establish nexus.

Activity 8:  Seller pays an e-commerce Internet service provider with nexus in Texas for some combination of storing Seller's web page, taking orders from its customers through an Internet e-commerce program, payment processing by checking credit card information, and directing shipment of product upon approval.

This scenario garnered perhaps the most discussion among committee members. Electronic commerce is generating the largest percentage of growth in the Internet in terms of real dollars exchanged, and a variety of service providers are tapping this market. Some service providers actually operate centralized e-commerce web sites designed to sell a variety of products (e.g., the Internet Mall). Some service providers operate e-commerce web sites for more traditional brick and mortal retailers or wholesalers. The costs of either service are usually calculated as a combination of an up front fee and a percentage of revenues coming through the Internet storefront.

While the mere storage of the web page (or a link to a web page) was not considered sufficient to establish nexus on behalf of the mall seller, the other services provided, such as order and credit processing, were more problematic.

The Subcommittee agreed that the best analogy for such services was the provision of fulfillment services and (800) number phone banks. For example, many remote sellers may hire a Texas company to answer an (800) number advertised during a TV ad. The company answers the phone, takes the order, does an initial credit card check, and directs shipping instructions to the remote seller.

The Texas Comptroller has determined that such fulfillments centers act as agents for the remote seller, and give the remote seller nexus in Texas.

The Subcommittee agreed that applying such a ruling to e-commerce service providers could be devastating to the development of electronic commerce in Texas. Portability is once again the issue. E-commerce providers can move their web operations out-of-state just as easily as any other business. With them will likely go jobs and the considerable startup capital needed to create and operate these e-commerce web sites.

The committee agreed that legislative action was needed to prevent this from happening.

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Suggested Courses of Action

The Nexus Subcommittee was part of the unanimous Working Group proposal that the Legislature repeal the sales and use taxes on data processing services and information services. It also recommends specific nexus-related legislation as outlined in parts IV(C)(4) and (8) above, so that storage of computer software inventory and e-commerce service provision would not create nexus.

  1. See National Bellas Hess v. Department of Revenue of the State of Illinois, 386 U.S. 753 (1967).
  2. 504 U.S. 298 (1992).
  3. One of the best known examples of this was a case involving the Wrigley chewing gum company. Salesmen would check chewing gum displays in stores and replace stale stock. These were determined to be activities beyond mere solicitation, and hence, subjected Wrigley to state income tax. See Wrigley Chewing Gum Co. v. Wisconsin Dept. of Revenue, 505 U.S. 214 (1992).
Required Plug-ins

In 2015, the Texas Legislature passed House Bill 855, which requires state agencies to publish a list of the three most commonly used Web browsers on their websites. The Texas Comptroller’s most commonly used Web browsers are Microsoft Internet Explorer, Google Chrome and Apple Safari.