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America Online, Inc. v. Ruth Johnson, Commissioner of Revenue

No. M2001-00927-COA-R3-CV (Tenn. Crt. App., July 30, 2002)

Reversing the decision of the court below, the Tennessee Court of Appeals holds that issues of fact preclude it from determining if America Online Inc. ("AOL") has sufficient nexus with the State of Tennessee to make it subject to Tennessee state taxes.  While AOL does not own or lease any real property in Tennessee, and does not have any "regular employees" in the state, there were issues of fact as to whether AOL could be held to have a sufficient nexus with the state as a result, inter alia, of the presence in Tennessee of (a) equipment AOL leased, which equipment was used by an AOL subsidiary to assist AOL customers in connecting to AOL's network, (b) unpaid persons working from their homes who were trained by AOL to, and did, moderate real time conferences on AOL's network and were called by AOL "remote staff," and (c) a substantial number of discs containing software used to assist users in connecting to AOL's network.  The Court of Appeals accordingly denied AOL's motion for summary judgment, and remanded the case to the Chancery Court for further proceedings.

In dicta, the court also stated that a nexus sufficient to permit the assertion of taxing authority does not exist "where the only contact with the state is by the Internet, mail and common carriers."

Under the Supreme Court's holding in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, rehg. denied, 430 U.S. 976 (1977) States are permitted to tax out-of state sellers provided the tax "(1) is applied to an activity with a substantial nexus with the taxing state, (2) is fairly apportioned, (3) does not discriminate against interstate commerce and (4) is fairly related to the services provided by the state."

Tennessee sought to impose state taxes on AOL as a result of is alleged activity in Tennessee.  AOL argued that it did not have the requisite "substantial nexus" with Tennessee to subject it to such taxes, a conclusion with which the Chancery Court agreed.  On appeal, the Tennessee Court of Appeals reversed, holding that issues of fact precluded it from determining the question on AOL's summary judgment motion.

Importantly, the court held that "a substantial nexus does not exist … where the only contact with the state is by the Internet, mail and common carriers."

The court held that a substantial nexus could be established, however, even if a corporation had neither employees nor offices in the jurisdiction.  "[A] substantial nexus [can be] based on in-state activities carried on by affiliates or independent contractors on the tax payer's behalf."  A substantial nexus will be found to exist where "activities are 'being conducted in the taxing state that substantially contribute to the taxpayer's ability to maintain operations in the taxing state.'" 

On the record before it, issues of fact precluded the court from resolving the question at this time.  AOL provides various Internet services to its clientele, including electronic mail and Internet access.  Its principal offices are located in Virginia, where its main computers may be found.  AOL has neither offices nor "regular employees" in Tennessee, but it does sell services, including Internet access and e-mail services, to Tennessee residents.  Tennessee residents who wish to access AOL's network dial telephone numbers provided by network service providers ("NSPs"), who in turn route the call over their networks to AOL.  Starting in 1994, AOL began using AOLnet, which had its own NSPs to handle these calls.  One of these NSPs was ANSCO+RE Systems, Inc. ("ANS"), a subsidiary of AOL.  The NSPs who were part of AOLnet connected AOL's customers to AOL's network using dedicated equipment leased by AOL and located in Tennessee.

AOL also had located in Tennessee various unpaid users of its service who were trained by AOL to, and did moderate real time conferences held on AOL's network.  AOL called these members "remote staff."

In addition, AOL sent a significant number of discs containing software necessary to access its system to Tennessee both via direct mail and as magazine inserts.

Based on this record, the court concluded that "we think the question of whether AOL's nexus with this state satisfies the Complete Auto Transit test is still open" and accordingly denied AOL's motion for summary judgment.

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