Tennessee Court Reverses AOL Nexus Decision

by Mike Godfrey, Tax-News.com, New York

05 August 2002

Two of the key propositions that govern the application of sales and use taxes to multi-state sales of computer services in the US are that states can't apply such taxes to cross-border sales, and (therefore) that a seller has to have a physical presence in a state (called nexus) before taxes can be applied to its sales to residents or businesses in that state.

Companies which use telecommunications networks and linked or related computer systems to sell services in many states thus have to be very careful not to create nexus in the states where they do business, and case law is important in defining what is, and is not permitted befcore nexus is created.

A case reported by Professor David Hardesty in ecommercetax.com, involving AOL and Tennessee, has been exciting attention, because it seemed to have extended the basis on which nexus can be created. Nexus normally requires 'physical presence' and that normally means employees or premises. In the case of AOL v Johnson, presence included equipment, software, contracts with subscribers, and relationships with Tennessee companies to provide its subscribers with local access, and the court surprisingly decided that this did constitute nexus.

Now the Tennessee Appeals Court has reversed the lower court's decision, as had been expected, and has sent the case back to the lower court for a more precise identification of AOL's facilities in the state.

The appeals court said, "We do not think that it is conclusive that AOL does not have offices or employees in the state or that it does not own or rent real property here. We know that a substantial nexus may be established by activities carried on within the state by affiliates and independent contractors.

"In this case there are a substantial number of businesses operating in this state helping make the AOL service available to Tennessee customers. The NSPs provide services, some through their own equipment, and some by using equipment leased by AOL and located here. One of the NSPs is an AOL subsidiary. While the record is not developed to a point of clarity, we do not think the record shows that the activities conducted here on AOL's behalf could be termed inconsequential or of only slight significance.

"We think that AOL's connection with this state amounts to more than the Internet, mail and common carrier connection in Quill and Bellas Hess." These are two previous cases which addressed the nexus issue. In Quill, the court said: "whether or not a state may compel a vendor to collect a sales or use tax may turn on the presence in the taxing state of a small sales force, plant, office."

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