MLM
and Sales Taxes
by
Jeffrey A. Babener
MLM Legal Attorney
©1996
Blame
the Pharaohs
Sales and use taxes are a source of great revenue for states and great headaches
for MLM and direct selling companies. Sales taxes are collected in the vast
majority of states and tens of thousands of local cities and counties have
similar taxes.
Commerce Clearing House, the publisher of many tax publications, reports that
in Egypt the pharaohs placed a general tax on the sale of all commodities
at the rate of 5% of sale price. The Romans obviously thought this was a good
idea and, after their conquest of Egypt, the rate rose to 10%. For the next
2,000 years, to this day, bureaucrats have found sales tax a favorite revenue
raiser.
Both MLM distributors and MLM companies are always asking: Can states legally
tax interstate sales? Who is responsible for sales tax? When should it be
collected? How should it be collected? These questions are constantly put
to MLM companies and their distributors.
They Call
It "Nexus."
The right of a state to collect sales tax on interstate sales is restricted
by the commerce clause in the United States Constitution, which prohibits
states from unreasonably interfering with interstate commerce. The U.S. Supreme
Court has held that states cannot impose sales tax on companies whose sole
business is a mail order business. MLM companies are in a different category
than mail order firms, however. Multilevel marketing does involve interstate
sales of products, but it also involves one-on-one personal contact with customers
and substantial activity within most states. MLM distributors or sales representatives
are basically independent, commissioned local sales people who: (1) sell the
product directly in the state; (2) procure sales orders for the company; (3)
promote product within the state; (4) recruit other participants in the state
to join the MLM program. Therefore, MLM companies have sufficient activity
to trigger a legal term called "nexus," i.e. "legal presence"
for sales tax purposes.
Because of this activity, say state tax officials, MLM companies, unlike mail
order companies, are probably liable for state sales and use taxes. In a famous
case decided by the Supreme Court in 1960, the court held liable a national
company for sales of independent distributors in Florida.
Companies that do not seriously address the question of sales tax, may find
themselves liable for some significant penalties. In the event the company
does not collect the tax, and the distributor does not collect and remit the
tax, the company may find itself liable for the entire amount, plus interest,
plus additional stiff penalties. Companies which ignore the sales tax issue
altogether are clearly headed for trouble. And it's not just tax on products,
but equally applicable is sales tax on sales aids.
So –
What To Do?
Prudent MLM companies follow one of two approaches when it comes to collection
of sales tax. Companies collect the sales tax based on the suggested retail
price at the time of the sale of product to distributors. Companies are likely
justified in collecting sales tax on the wholesale price on that product which
is actually personally consumed by distributors. The company then remits the
sales tax to the locality. This approach has some distinct advantages. First,
the company removes the administrative burden from its distributors who are
complying with local sales tax regulations. Second, the company probably develops
a better relationship with the state or locality because it has taken on the
responsibility of seeing that taxes are paid. For those companies that can
afford it, there are computer services which provide detailed sales tax information
on the thousands of taxing localities.
Some companies, on the other hand, are either not equipped to collect and
remit sales tax, or they do not want to be in the business of collecting and
remitting sales taxes. These companies require distributors to obtain and
furnish the company with a state sales tax I.D. number and to collect and
remit the tax themselves for resales or personal use. The companies that follow
this approach should be very careful to verify that their distributors have
obtained state sales tax I.D. numbers, and that their distributors are remitting
appropriate sales taxes.
It's Tough
Out There.
No question - this area is a big headache. Also, no question - this quagmire
is best navigated by qualified lawyers and accountants. If you are a distributor,
have patience with your company. If you are a company, have patience.
Jeffrey A. Babener, the principal attorney in the Portland, Oregon law firm of Babener & Associates, represents many of the leading direct selling companies in the United States and abroad. His firm has focus on startup and emerging MLM companies. He has been adviser to such companies as Avon, Nikken, Discover Toys, NuSkin, Excel, Fuller Brush, Cell Tech, Kaire, Sunrider, Melaleuca, etc. He is editor of the industry resource internet site www.mlmlegal.com. He is a frequent lecturer and has been interviewed on the industry, and published, in many publications. Babener & Associates, 121 SW Morrison, Suite 1020 Portland, OR 97204, www.mlmlegal.com
