Publishers know that selling eBooks involves converting files and grappling with DRM, among other challenges. But selling eBooks also may generate new tax exposure for publishers, in part depending on the distribution model and distributors/platforms for sale of your eBooks. And, this new exposure can potentially reach beyond the eBook transactions themselves to create broader tax exposure for other sales by the publisher.

1. STATE Tax ExposureS from eBook Sales January 11, 2011 Martin Eisenstein Brann & Isaacson P.O. Box 3070 Lewiston, Maine 04243-3070 Phone: 207-786-3566 Fax: 207-783-9325 meisenstein@brannlaw.com www.brannlaw.com Material in this webinar is for reference purposes only. This webinar is being provided with the understanding that neither the author nor the ECPA (and its representatives) are engaged in rendering legal, accounting, investment, or any other professional service directly through this webinar. Neither the ECPA (and its representatives) nor the author assume any liability for any errors or omissions, or how this webinar or its contents are used or interpreted, or for any consequences resulting directly or indirectly from the use of this webinar. For legal, financial, strategic or any other type of advice, please personally consult the appropriate professional.

2. About the Webinar Speaker Martin Eisenstein, Senior Partner, Brann & Isaacson Mr. Eisenstein counsels and advises publishers, online retailers and direct marketers regarding state and local tax issues, including advice and counsel to several publishers regarding the tax implications of sales of digital publications. Mr. Eisenstein represented the Direct Marketing Association in the seminal U.S. Supreme Court case Quill v. North Dakota, 504 U.S. 298 (1992), which establishes the nexus standard for sales and use tax, and represented companies in other litigation, including AOL v. Iowa Dept of Rev., 759 N.W.2d 2 (2008); L.L. Bean, Inc. v. Pennsylvania Dept of Rev., 101 516 A.2d 820 (1986); Random House, Inc. v. NJ Division of Taxation, 23 N.J. Tax 291 (2006); AOL v. Indiana Department of Revenue (Tax CT 12/27/10); PeoplePC, Inc. v. CA Board of Equalization, 2009 WL 2853032 (Cal. App. 4 Dist. 2009); Haas Publishing Companies, Inc. v. FL Dept of Revenue, Fl. Div. of Administrative Hearings, Case # 08-3477 (2009); Sharper Image v. Department of Treasury, 216 Mich. App. 698, 550 N.W.2d 596 (1996); and L.L. Bean. v. State Tax Assessor, 649 A.2d 331 (1994). Mr. Eisenstein has practiced state tax law for over 25 years and regularly litigates state tax cases and counsels companies on state tax issues, including nexus. State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 2

3. Overview Significant new state tax exposures to publishers as a result of sales of ebooks and the Agency Model of ebook distribution New challenges for publishers regarding sales tax collection and reporting Requires publishers to take measures to limit the exposures and address the challenges. State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 3

4. Nexus in General Nexus: When a company is subject to state tax Both statute and constitutional standard Different standards depending upon tax Entity nexus Not divided by product line, activity or division Nexus of one area, division or activity gives nexus for the entire entity for all taxes 4 State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine

5. Sales Tax Nexus Constitutional Standard Property-facility Employees Located in-state Travel to state Agents Drop ships Statutory Safe Havens Printer Trade shows State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 5

6. Sales Tax Nexus (cont’d) Publisher Sales Tax Nexus Sales representatives Storage of inventory Fulfillment Resale to Wholesalers and Retail Stores: Resale Certificates The Issue for Publishers Agency model Nexus Based on where agent is located Collection and reporting requirement State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 6

7. Gross Receipts Tax The “Sleeping Dog” for Publishers 5 states: WA, MI, OH, TX and OK and some local jurisdictions in CA Should have same standard as for sales tax, but some states use an economic presence standard. States are incorrect Nexus for Publishers Representatives/agents Inventory Fulfillment State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 7

8. Income Tax Nexus Statutory Standard: PL 86-272 Provides exemption for out-of-state company if: Employees or agents merely solicit sales; Orders are approved outside of state; Delivery of products from inventory outside of state; and Sales are of tangible personal property. The issues for publishers: Are ebooks tangible personal property? Agency model for platform providers may create nexus. State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 8

9. Role of Third Party Platform Provider Third Party Platform Providers include Amazon, Apple, Google and Barnes & Noble Platform Providers operate on either an agency or distributor/wholesale model Agency, a commission relationship : the principal, the bookseller, determines the price and is the seller of record. Distributor (Amazon customary) model: platform provider resells at prices it determines and is the seller of record. Platform Providers May or May Not Collect Sales Tax Apple collects and remits in every state. Amazon (where acting as an agent) has a more limited footprint and collects in only a few states. Google does not collect taxes but seller’s responsibility. State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 9

10. State Tax Implications of Agency Model Sales Tax Nexus Collection required where agent has servers and where company has nexus Are digital products taxable? 24 states tax digital products To which state are the products sourced? How is state of download determined? What about gifts? To which locality are the products sourced? Who collects? Who reports and how does the publisher report? State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 10

11. Tax Implications of Agency Model: Gross Receipts and Income Tax Gross Receipts Taxes: Exposure of entire entity’s gross receipts to tax. Income Taxes: Entire entity’s exposure to income tax liability in states where platform provider server is located. This is so even though entity on sale of printed books is protected by PL 86-272 or does not have constitutional nexus. State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 11

12. Reduction of Tax Exposure Sale for resale model Structuring of relationship and obtaining resale certificates Drop ship issues: CA and other states Nexus study of publisher Should be done under guidance of counsel Determine exposure of publisher and where platform providers have nexus Determine where ebooks are taxable Determine sourcing methodology Do you ask the state of download or do you rely on the purchaser’s address? State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 12

13. Tax Exposures: Creating a Newco Creation of ebook entity-Newco Isolate potential nexus in ebook entity Preclude spillover effect for income tax, gross receipts, and sales tax Creation of separate entity without more is not good tax planning. Will it backfire? Trademark holding companies State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 13

14. Best Practices in Creating a Newco Avoiding piercing the corporate veil Requires an analysis and study with counsel to develop a digital books entity with substance Review of the piercing the corporate veil factors How Newco holds itself out to third parties Web Site/stationery Newco’s employees Newco’s use of services and assets of parent company Newco’s business purpose Newco’s respecting corporate formalities State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 14

15. Misconceptions 1. The activities that create a physical presence in the state are unrelated to the publisher’s other sales, so there is no exposure to sales tax, gross receipts tax or income tax for online sales. 2. My company has created a separate division for digital book sales. That should protect us from income tax exposure. 3. My company is unitary. What is the point of a separate corporation? 4. My company’s only activities in a state consist of visits by representatives, but all orders are accepted outside of the state at our headquarters, so we have no nexus. State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 15

16. Misconceptions(cont’d) 5. We don’t maintain sales representatives in a state, but they do call on customers in the state. This should not be an issue, correct? 6. We need not implement a sales tax collection system because we sell print books at wholesale. 7. We rely on our agent platform provider to collect sales tax so we have no future liability. 8. We did create a separate company for ebooks, but we don’t have any employees in the company State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 16

17. Misconceptions(cont’d) 9. We created a separate company, but because we believe in presenting a single message to our customers about who we are, we refer to the company as our digital books division. 10.We participate in trade shows throughout the country. If we distribute catalogs or other promotional materials, do we create nexus? 11.We use printers in other states where we store paper we purchase from paper mills. Does this create nexus? State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 17

18. Conclusions The state tax exposures are real as a result of the sale of digital books: They result from both the nature of the product sold and the use of platform providers to sell the product. Publishers should review their nexus footprint in light of the digital sales and implement sales tax collection systems to address. Publishers should consider the appropriateness of establishing a separate company to sell digital products and, if they do so, should reduce the risk that a state claims that the company is a sham and therefore, can pierce the corporate veil. State Tax Exposures From eBook Sales Martin I. Eisenstein, Brann & Isaacson, Lewiston, Maine 18