Washington Rules on Out-of-State Tax Nexus

The Washington Department of Revenue (WDOR) recently published a ruling in a case that addresses the establishment of a substantial nexus for sales and use tax purposes by an out-of-state company. 

The WDOR ruling highlights the pivotal shift that has occurred in recent years, underscoring that, in some instances, even without a direct physical office or employees in the state, an out-of-state company's activities and business arrangements may result in the establishment of a substantial nexus, bringing considerable tax implications.

Facts of the Case and the WDOR's Decision

Following the tax audit, the WDOR determined that an out-of-state company, which assists insurance companies in responding to claims by their insureds for water mitigation services, such as properly cleaning, sanitizing, drying, repairing, and restoring a property to its pre-water damage condition, owes significant taxes on its retail services, which are taxable.

The company provided its services by hiring Washington-based providers to perform water mitigation services for insurance claims. It arranged these services after claims were filed, billed insurance companies directly, and paid the providers.

In opposition to WDOR's claims, the company argued that it did not provide taxable retail services, but administrative services, which are not taxable. Moreover, the company claimed that it does not have a physical presence in the state and that, even if the services provided were taxable, only its markup should be taxable, not the entire amount.

However, the WDOR concluded that under Washington legislation and constitutional standards, a physical nexus was established because the in-state activities of the contractors were closely linked to the company's ability to maintain its market in the state. More precisely, the company's referral network and oversight of local providers were essential to fulfilling contracts and maintaining its business presence. Additionally, by assuming warranty responsibilities, the company acted as the seller rather than merely a coordinator.

Conclusion

The WDOR's ruling underlines that using third-party contractors in a state can create sufficient physical presence to trigger tax obligations for out-of-state businesses. Therefore, taxable persons that do not have headquarters in Washington, but are engaged in activities such as managing claims, dispatching technicians, or coordinating repairs through local networks, are liable for tax purposes. 

As a direct consequence of the ruling, taxable persons should carefully evaluate their relationships with third parties in the state to determine if their activities establish a physical nexus.

Source: Washington Department of Revenue