Out of state companies can sometimes be exposed to liability for failing to collect sales tax on internet and catalog sales to Illinois residents. A recent Illinois appellate decision, The People ex rel. Beeler, Schad and Diamond, P.C., v Relax the Back Corp., 2016 IL App (1st) 151580, sheds light on what type of connections with Illinois are required in order to obligate a merchant to collect sales tax in Illinois. In that case, the Court’s analysis paralleled the similar analysis that courts use for determining whether a court has personal jurisdiction over a person or an entity.
Relax the Back Corp. (“RTB”) is a California based supplier of back and neck care products that operated an internet sales site and a sales catalog. RTB’s only other connection with Illinois was five retail stores owned and operated by franchisees. Indeed, prior to 2013, RTB had no employees in Illinois. These franchisees were required to display the fact that they were independent owners, and the franchise agreement between RTB and the franchisees expressly disclaimed any agency relationship between RTB and the franchisees. Finally, RTB also required that the franchisees distribute 1,000 catalogs each year to customers.
Beeler, Schad and Diamond, P.C., filed the original action in 2003 for alleged violations of the False Claims Act (formerly the Illinois Whistleblower Reward and Protection Act), claiming that RTB had a duty to collect and remit a use tax in Illinois and that RTB knowingly avoided its duty to collect this tax. Subsequently, it became known that RTB had enlisted outside legal counsel and accountants to help determine if RTB had a duty to collect tax in Illinois. Plaintiff argued that RTB had a sufficient “nexus” with Illinois, which would establish RTB’s duty to collect taxes as a result of RTB’s franchisees and continuous, systematic internet and catalog sales to Illinois residents. However, RTB argued that the plaintiff had not met its burden to show that RTB had acted recklessly or with deliberate ignorance in failing to collect Illinois use tax, basing its argument on State ex rel. Beeler Schad & Diamond, P.C., v. Ritz Cameral Centers, Inc., 377 Ill.App.3d 990 (2007), which, according to RTB’s position, stated that there can be no recovery under the False Claims Act if a defendant acts in good faith to determine its tax liability.
After hearing all the testimony and arguments, the trial court determined that RTB had no duty to collect tax on its internet sales to Illinois residents, but that RTB had a duty to collect tax on its catalog sales to Illinois residents because the franchisees acted under the direct control of RTB to distribute 1,000 catalogs per year. According to the trial court, this established a sufficient nexus between RTB and Illinois to impose the duty to collect use tax. The trial court found RTB’s tax liability to be $5,181.00, which after factoring in treble damages and a statutory penalty, amounted to $21,043, and further awarded approximately $110,000 in attorneys’ fees to the plaintiff’s attorneys. Both parties then cross appealed.
The appellate court reduced the plaintiff’s claim to that of a “reverse False Claims Act,” where the concealment or omission of facts to the government results in the violation of the Act. In its analysis, the appellate court stated that it is “necessary to distinguish between conduct arising from ‘a deliberate concealment’ and a conduct merely resulting from flawed reasoning or a difference in interpretation of unsettled law.” The court then noted that RTB’s chief financial officer had sought the advice of outside counsel and accountants and had performed yearly audits on RTB’s financial statements. None of these activities alerted RTB that it had an obligation to collect Illinois sales tax. The CFO also relied on the Illinois Department of Revenue’s audit that found that RTB had no duty to collect Illinois use tax. Furthermore, the appellate court stated that the law that justifies the collection of use tax itself is far from clear. The Illinois Supreme Court case that provides the most guidance on this subject states that the “slightest” physical presence in a state is not sufficient to establish a substantial nexus that would require the collection of state use tax. Ultimately, the appellate court held that the trial court had errored in finding that RTB had violated the False Claims Act because RTB had not knowingly deceived the government in regards to RTB’s position that it did not have a duty to collect tax from the catalog sales. As a result, the appellate court overturned the damages and attorneys’ fees awards.
As illustrated above, analyses for both tax liabilities and legal jurisdiction can be very closely related. Such analysis requires more consideration than simply determining whether a company conducts any business in Illinois. Thorough legal analysis of both current facts and past precedent can be the key in obtaining a favorable outcome. The professionals at Rock Fusco & Connelly, LLC, have the skills and experience necessary to protect your business’s best interests.