Tax Planning Versus Business Strategy: The Rise and Fall of Entity Isolation in Sales and Use Taxes
71 Pages Posted: 8 Oct 2007 Last revised: 6 Mar 2008
Abstract
The purpose of this Article is to analyze, from both a legal and a business strategy perspective, the once-popular tax planning technique known as "entity isolation." This technique is most applicable to so-called "bricks-and-clicks" companies that sell goods both remotely (online or via catalog) and at physical stores. The technique involves isolating the firm's remote sales operations in an affiliated legal entity that is separate from the legal entity which holds the firm's store operations. If the remote sales entity is actually operated separately from the store entity, the remote entity can avoid sales and use tax collection duties on sales shipped to states where the affiliated store entity has stores or other physical presence. Entity isolation was once so widespread that it was considered a major threat to the very existence of the sales tax. In recent years, however, most major bricks-and-clicks retailers have abandoned the technique and have begun to collect sales and use taxes on their online and catalog sales in states where they have stores. This abandonment did not result primarily from changes in the law; it resulted because entity isolation was diametrically opposed to the industry's optimal business strategy. While the law was demanding that the remote sales affiliate be operated separately from the store operations, optimal business strategy was dictating that remote and store sales operations be integrated and the customer be provided with consistent, seamless service across all marketing channels. While others have analyzed entity isolation from a pure tax law or policy perspective, this Article adds to the literature by analyzing the issue from a business strategy perspective. The story of the rise and fall of entity isolation highlights problems with our current state tax system, epitomizes the often dysfunctional relationship between business strategy and tax planning, and serves as a vivid - and needed - reminder to tax planners, business managers, and policymakers that tax planning should not be allowed to inhibit sound business strategy.
Keywords: state taxation, sales and use taxes, corporate groups
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