California FTB issues memorandum updating guidance related to P.L. 86-272 and business activities conducted over the internet

Adopted by Congress in 1959, P.L. 86-272 generally prohibits a state from imposing a net income tax on the income derived from interstate commerce if the only business activities conducted within the state consist of the solicitation of orders for sales of tangible personal property that are sent outside of the state for acceptance or rejection which, once accepted, must be filled by shipment or delivery from a point outside the state.  For the in-state activity to be protected activity under P.L. 86-272, it must be limited solely to solicitation.  Solicitation means (1) speech or conduct that explicitly or implicitly invites an order; and, (2) activities that neither explicitly nor implicitly invite an order, but are entirely ancillary to requests for an order.  Ancillary activities are those activities that serve no independent business function for the seller apart from their connection to the solicitation of orders. Activities that a seller would engage in apart from soliciting orders shall not be considered as ancillary to the solicitation of orders.

In TAM 2022-01, the FTB noted that in the 60+ years since P.L. 86-272 was enacted, there have been significant changes to the way in which interstate business is conducted. The FTB’s new positions on protected and non-protected activities largely mirror the Multistate Tax Commission’s (“MTC”) Revisions to the Statement on P.L. 86-272 adopted for recommendation to the states by the MTC at its annual meeting on August 4, 2021.

The TAM discusses the Supreme Court’s 2018 Wayfair decision, which found that an internet seller “may be present in a state in a meaningful way without that presence being physical in the traditional sense of the term.” The TAM notes that even though the Court’s decision in Wayfair focused on sales tax nexus, California considers the Court’s analysis with respect to virtual contacts to be applicable to the question of whether a seller is engaged in business activities in states where its customers are located for the purposes of P.L. 86-272.

In the TAM, the FTB has presented multiple fact patterns in which the business at issue makes sales to California customers, is commercially domiciled outside of California, and has no other activities in California other than those mentioned in the specific fact pattern. The issue in each fact pattern is whether the business has exceeded the protections of P.L. 86-272, due to its online activities

The FTB’s guidance

• Telecommuting employee

An employee telecommuting on a regular basis from within California performing business management and accounting tasks would cause a business to lose the protection of P.L. 86-272 immunity. These are considered business activities in California which do not constitute sales activities and are not considered ancillary to the solicitation of orders for sales of tangible personal property.

• Post-sale assistance

A business regularly providing post-sale assistance to California customers, via electronic chat or email, that customers initiate by clicking on an icon on the business's website, would not qualify for P.L. 86-272 immunity. The company is considered to be conducting business in California that goes beyond solicitation or is not ancillary to solicitation because it takes place after the sale.

• Credit card applications

A business that solicits and receives on-line applications for its branded credit card via its website from California customers does not qualify for P.L. 86-272 immunity. Offering to provide credit to customers is an activity that exceeds solicitation and is outside of the solicitation of orders for sales of tangible personal property in California.

• Job applications

A business that invites people in California to apply for non-sales jobs via its website does not qualify for P.L. 86-272 immunity. The business activity in California consisting of providing access to job applications and allowing upload of applications, cover letters, and resumes through computers or other electronic devices located in California exceeds solicitation as it involves human resource outreach to fill jobs that are not limited to sales.

• Internet cookies

Placing Internet cookies onto the computers or other electronic devices of California customers to collect customer search information that will be used to adjust production schedules and inventory amounts, develop new products, or identify new items to offer for sale, will not qualify for P.L. 86-272 immunity. This activity exceeds the solicitation of orders for sales of tangible personal property.

In contrast, placing Internet cookies onto the computers or other electronic devices of California customers to collect customer data that is only used for a purpose which is ancillary to the solicitation of orders for tangible personal property, will qualify for protection under P.L. 86-272. This includes such purposes as (1) recalling which items customers placed in their shopping cart during a web session; (2) storing personal data so that customers will not need to re-input the data when they return to the seller's website; and (3) reminding customers what products they have previously considered purchasing.

• Remote repairs or upgrades

A business that transmits code or other electronic instructions to remotely fix or upgrade computers or other electronic devices previously purchased by California customers will not qualify for P.L. 86-272 immunity. Providing repairs or upgrades to previously sold products are “post-sales activities” and not considered related to sales of tangible personal property.

• Extended warranties

Selling, or offering to sell, extended warranty plans via a business's website to California customers is considered a business activity in California. Since it involves the sale of intangible property, it is not ancillary to the sale of tangible personal property and does not fall under the protection of P.L. 86-272.

• Marketplace facilitator contracts

If a business contracts with a marketplace facilitator that supports the sale of the business's products on the facilitator's on-line marketplace, and the facilitator maintains some of the business's inventory in California, this activity will not qualify for P.L. 86-272 protection. This activity is considered the consignment of stock of goods to another entity (including an independent contractor) for the purpose of making a sale and would exceed solicitation of orders for sales of tangible personal property.

• Streaming services

Contracting with California customers to stream videos and music to electronic devices for a charge is not a protected activity under P.L. 86-272. The sale of digital video and music streaming are considered the sale of services, not sales of tangible personal property and, therefore, are not activities under the protection of P.L. 86-272.

• Frequently asked questions

California has specified that providing post-sale support to California customers by posting a list of static Frequently Asked Questions (FAQs) with answers on a business's website does qualify for P.L. 86-272 immunity, since it is not considered a business activity within California. Viewing of static FAQs on a company’s website does not provide the necessary interaction between the California customer and the business.

• Tangible personal property

Only offering items of tangible personal property for sale on a business's website will not disqualify the business from P.L. 86-272 immunity, because the business engages exclusively in in-state activities that either constitute solicitation of orders for sales of tangible personal property or are entirely ancillary to such solicitation. The business activity is in California due to the interaction between the website and customers' computers or other electronic devices located in California. Because this business activity does not exceed solicitation of orders for tangible personal property, the business remains protected by P.L. 86-272.

Mazars’ insight

Companies based outside of California should evaluate their business activities and consider whether these new guidelines impact previously protected P.L. 86-272 activities. It is not yet clear whether the FTB will apply TAM 2022-01 prospectively or to prior tax years as the TAM does not provide an effective date and does not address the applicability of the TAM to the provisions of FTB Publication 1050 (Application and Interpretation of P.L. 86-272).

Should California choose to impose the TAM retroactively, the applicable statute of limitations will not have started for non-filers. Therefore, taxpayers who have not previously filed returns may want to consider voluntary disclosures to limit prior tax period liabilities and mitigate penalties.

Lastly, the TAM makes the point that P.L. 86-272 not only impacts the determination of whether a state where tangible personal property is delivered (the “destination state”) may tax the income of the seller, but also impacts the determination of whether the state from which tangible personal property is shipped (the “origin state”) may subject the related receipts to that state’s throwback rule. As such, taxpayers may want to consider potential refund opportunities with respect to receipts that were “thrown back” to California but should have been taxable in other states based on the guidelines in the TAM.  

The actions of the FTB may be just the first of what is expected to be multiple states that seek to upend the protections of P.L. 86-272.

Please contact your Mazars professional for additional information.

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.