When a multi-level marketing company sells vouchers to its distributors that are redeemed for printed goods like trading cards, who owes sales tax on the sales to the final customer?

Subject

Direct Sales Organization/Multi-Level Marketing Company — Sale Of Vouchers Redeemed For Printed TPP (Trading Cards, Calendars, Greeting Cards) By Purchaser

Plain-English summary

This letter is the Comptroller's response to a taxpayer's request to reconsider an earlier position that "ABC PHOTOGRAPHIX" (a redacted stand-in name used in the letter) is a direct sales organization for sales tax purposes. ABC sells its products -- printed items like trading cards, calendars, and greeting cards -- through independent distributors, using a multi-level marketing style structure. Customers buy vouchers from distributors, and those vouchers are later redeemed for a set number of printed cards or other items.

The taxpayer argued that ABC shouldn't be treated as a direct sales organization because: the sales to distributors were final (ABC didn't control resale); ABC didn't direct or compensate the distributors; and ABC had no way of knowing what price the vouchers were ultimately resold for. The taxpayer also argued the vouchers were really the sale of an intangible right (like a department-store gift certificate), not a sale of tangible personal property.

The Comptroller rejected both arguments and reaffirmed that ABC is a direct sales organization:

• The vouchers are not intangible property. The Comptroller compared the voucher to a receipt for prepaid goods -- like a receipt you get when you pay for lumber at a lumber yard, which you later exchange for the physical plywood. ABC has effectively already sold the cards; the voucher is just the receipt for that purchase. Even if the vouchers were treated as intangible, distributors that only sold vouchers still couldn't avoid the result, since intangibles of that type are not separately taxed anyway -- ABC is selling tangible personal property.
• ABC operates as a direct sales organization. ABC (through a marketing firm) recruits and trains distributors, requires them to sign an agreement to follow ABC's distributor manual (which includes a limited return policy), and supplies the vouchers the distributors sell. Distributors who need more items than a voucher covers place orders directly with ABC, which fills them either through the distributor or by shipping straight to the customer.
• The statute doesn't require proving "control" over distributors at all. The Comptroller noted it isn't even necessary to resolve whether ABC controls its distributors, because the law provides an alternative basis for holding the supplier (ABC) responsible whenever the distributor obtains tangible property from that supplier -- which happened here, since the distributors bought the cards from ABC and hold receipts (the vouchers) for that purchase.

The Comptroller's conclusion: ABC is a direct sales organization and is responsible for tax on the full selling price of the vouchers and other items sold by its distributors to the ultimate customer, plus any transportation and handling charges. The letter states it is necessary for efficient administration of the sales tax that ABC, rather than each individual distributor, be required to report and remit that tax.

What this means for you

Direct-sales and multi-level marketing companies

If your company distributes tangible products (in any form -- including vouchers redeemable for printed or other tangible items) through a network of independent distributors, you may be treated as a "direct sales organization" responsible for collecting and remitting sales tax on the full retail selling price charged to the end customer, not just on your wholesale sales to distributors. Arguing that the sale to the distributor was "final" or that you don't control resale pricing did not change the outcome here.

Companies that sell vouchers, certificates, or prepaid tokens for goods

This letter draws a line between a true intangible (like some gift certificates) and a voucher that is really a receipt for prepaid tangible goods. If a voucher entitles the holder to a specific, defined quantity of a tangible product, the Comptroller is likely to treat it as evidence of a completed sale of tangible personal property rather than as the sale of an intangible right -- meaning sales tax applies to it as tangible property.

Accountants and tax professionals

Note the letter's key legal move: it avoids having to decide the fact-intensive question of whether the supplier "controls" its distributors, because it relies on an alternative statutory basis for supplier responsibility that applies whenever the distributor obtains tangible property directly from the supplier. When advising a direct-sales client, focus first on whether product (or a voucher functioning as a receipt for product) passes from the company to the distributor, since that alone can trigger the company's reporting obligation regardless of the control-based arguments.

Common questions

Q: Is a company that sells through independent distributors automatically a "direct sales organization" responsible for sales tax?
A: Under this letter's reasoning, yes if the distributors obtain tangible personal property (including vouchers that function as receipts for tangible property) from the company. The Comptroller found it unnecessary to decide whether the company also "controls" the distributors, because supplying tangible property to them is itself an alternative basis for responsibility.

Q: Are vouchers redeemable for goods treated as intangible property (and therefore untaxed) or as tangible property?
A: In this letter, the Comptroller treated the vouchers as more like a receipt for prepaid tangible goods -- similar to a receipt you get for goods you've already paid for -- rather than as intangible property. As a result, they were treated as sales of tangible personal property, subject to sales tax.

Q: What if the company argues it doesn't control how distributors price or resell the vouchers?
A: That argument did not change the result here. The Comptroller noted that almost all direct sales organizations can make similar arguments, since few pay their distributors directly or control resale prices, but that doesn't remove the company's responsibility for the tax.

Q: Who has to report and remit the tax -- the distributor or the company?
A: According to this letter, the company (ABC) is responsible for reporting tax on the selling price of the vouchers and other items sold by its distributors to the ultimate customer, including transportation and handling charges, because it is more efficient to require the supplier to report than each individual distributor.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9609L1427G03

Original ruling text

September 5, 1996

Dear ***:

On August 30, 1996, you wrote asking that I reconsider
our office's position that ABC PHOTOGRAPHIX ("ABC") is a direct sales
organization. Your basic position was that the independent distributors did not
operate under the direction of ABC because the sales made to the
representatives were final; ABC did not control how the representatives did
business or compensate them in any way; and ABC could not know what the
vouchers were sold for. On page four, you essentially treat the vouchers as the
sale of an intangible and compare it to a gift certificate sold by a
department store.

Upon discussing this case with John Fitzgibbons, he
pointed out some additional facts. ABC employs XYZ COMMUNICATIONS to do sales
promotions to attract distributors for its products. In addition, it provides
training materials to the distributors. The distributors are required to sign
an agreement to adhere to the guidelines in ABC's distributor's manual (which
also provides a limited return policy). Finally, the vouchers entitle the
purchaser to a set number of cards. If a customer wants to buy quantities in
excess of the number represented on the vouchers or other items, the
distributor takes an order, places it with ABC and either receives the items
which are then given to the customer by the distributor or are sent directly to
the customer by ABC.

The first question that must be addressed is whether
the vouchers are intangible property. While it can be argued that the vouchers
are not tangible property but only represent a right to receive tangible
property and are therefore intangible property, it is my opinion that they are
more in the nature of a receipt for prepaid goods. For instance, if I go to my
local lumber yard and buy a sheet of plywood in the store, I am given a receipt
showing that I have paid for the plywood. I then take the receipt to the yard.
The person working in the yard asks for my receipt and gives me the plywood
when I produce it. Essentially, ABC has sold the cards and given a receipt for
their purchase. Therefore, ABC is selling tangible property to its distributors
rather than intangible property. If it was determined that the vouchers were
intangible property, we still could not permit the distributors that only sold
vouchers because there is no sales tax on the sale of intangibles of this
type.

In your letter you have raised a number of issues
concerning your obligations to the distributors and your control over them.
Almost all direct sales organizations can make the same arguments as very few
pay their distributors or control the sales of their products.

While I do believe the distributors operate under ABC
because the company solicits their participation, provides training materials,
and supplies the vouchers, it is not necessary to answer the question of
whether they operate under ABC because the statute provides an alternative to
holding the supplier responsible when the distributor obtains tangible property
from it. In this case, the distributors have purchased the cards and have a
receipt representing their purchase. Furthermore, larger orders and selling
aids are purchased directly from ABC by the distributors.

In conclusion, I am of the opinion that ABC is a direct
sales organization and is responsible for taxes based on the selling price of
the vouchers and other items from the distributor to the ultimate customer as
well as all transportation and handling charges. Furthermore, I am of the
opinion that it is necessary for the efficient administration of the sales tax
that ABC be required to report tax on the sales of its distributors.

Should you have any further questions, please write me
at 111 E. 17th Street, Austin, Texas 78774, or call me at 1-800-531-5441,
extension 3-4004.

Sincerely,

Wade Anderson
Director, Tax Policy