Developments in the history of taxing out-of-state retailers: part two

Written on Jan 24, 2017

By Rich Molina, CPA

This is the second part of a two-part story. See "Developments in the history of taxing out-of-state retailers" in the November/December 2016 issue

The Quill Corp. v. North Dakota, 504 U.S. 298 (1992) case found no due process concerns in imposing a tax collection obligation on an out-of-state retailer having no physical presence within the taxing jurisdiction. Moreover, while the commerce clause requires a physical presence before a seller could be required to collect taxes, the court made clear that Congress could change this result by enacting a law that provides a physical presence is not necessary to impose such a burden on out-of-state sellers.

Internet sales have grown significantly each year. According to a Wall Street Journal article, one study estimates that states have lost more than $23 billion of tax revenues by not being able to require out-of-state sellers to collect and remit use taxes. Accordingly, states lobbied the U.S. Congress relentlessly to enact legislation that would essentially overrule Quill’s commerce clause holding for two reasons. First, and most obvious, is to allow the states to generate an additional source of revenue, and second, to protect retailers that have a physical presence in the state. The in-state sellers are required to collect sales tax, so all things being equal, a buyer would rather order merchandise online to save the excise tax. States have argued that in-state sellers, particularly small businesses, are not being permitted to compete on a level playing field. In 2013, the Senate passed such a bill that would allow states to impose collection obligations on out-of-state sellers, but the bill went nowhere in the House because of diverse opinions on matters of tax policy held by Republicans.

Without Congressional intervention, states have become more aggressive in providing their own self-help. For example, since Quill, some states rely on a form of “attributional nexus” by imposing collection obligations on an out-of-state online retailer where a related company of that online retailer has a physical presence in the state and there are interactions between the two companies (such as an exchange policy where an online purchase may be exchanged at the physical store of the related company in the state) like in Borders Online LLC v. State Board of Equalization, 129 Cal.App.4th 1179, 29 Cal.Rptr.3d 176 (2005). Other states will impose a withholding obligation where there are interactions with residents who act on behalf of the out-of-state retailer in capacities other than as employees (such as agents), like in LLC v. New York State Department of Taxation and Finance, Supreme Court, New York County, New York, 2009, 23 Misc.3d 418, 877 N.Y.S. 2d 842. Other states count the number of in state visits by an out-of-state’s employees to determine when that out-of-state retailer will have a substantial nexus in the state like in re Appeal of Intercard, Inc., 270 Kan. 346, 14 P.3d 1111 (2000). Of course different states reach different conclusions. Direct Marketing Association v. Brohl ___F.3d ___ (10th Cir 2016) was decided by the U.S. Court of Appeals for the Tenth Circuit which upheld a Colorado law, and carved out a major exception to the Quill decision.

As in other states, residents who purchase goods for use in Colorado are required to pay a use tax on such purchases where a sales tax was not imposed. Very rarely, if ever, will a resident pay the use tax. Noting this noncompliance, and the associated revenue loss, the Colorado legislature enacted a law that imposed notice and reporting obligations on out-of-state retailers that do not collect sales tax. The law requires these retailers to inform Colorado resident purchasers that they may be subject to the use tax, to provide customers with an annual purchase summary stating the items purchased and the date of purchase, cost of product, etc. and to send an annual purchase summary to the Colorado Department of Revenue presumably for enforcement purposes. Obviously the law was intended to reach those sellers not required to collect taxes because of Quill’s physical presence test. Those retailers challenged the law as a violation of the commerce clause.

The court upheld the law by ruling there was no commerce clause violation. Key to its ruling was that the court interpreted Quill to narrowly apply to use tax collection obligations, and not to mere reporting requirements. First, the court held that the requirement did not discriminate against interstate commerce and did not favor in-state sellers over out-of-state sellers. The court found the law does not distinguish between in state and out-of-state economic interests, but rather, it just imposes different treatment based on whether the seller is obligated

to collect the Colorado excise tax. The statute did not favor in-state sellers because the reporting obligation does not give in-state sellers a competitive advantage because the Supreme Court had previously upheld different tax reporting obligations in the area of state income tax compliance (apportionment scheme for multi-jurisdictional taxpayers versus other methods for in-state taxpayers). Moreover, the court did not find in-state and out-of-state sellers to necessarily be similarly situated and consequently, they don’t have to be treated exactly the same. In-state sellers are subject to collection, licensing and reporting obligations from which out-of-state sellers are not burdened. In short, the court found the out-of-state sellers subject to burdens just as were the in-state sellers.

Second, the court found that the Colorado law did not unduly burden interstate commerce. Under Quill, interstate commerce was found to be burdened when a seller having no physical presence in a state is required to collect and remit taxes to that state. Because the court found Quill applicable only to collection obligations, a regulatory obligation to report information was not the same type of burden sufficient enough to violate the Commerce Clause as was found in Quill.

Interestingly, the U.S. Supreme Court declined to accept an appeal of this case as reported Dec. 12, 2016. Consequently, unless further actions are undertaken, the Colorado law is good law and retailers will be required to report the requested information to the taxing authorities.

It is becoming clear that states are becoming more aggressive in looking for ways to impose taxes compliance obligations because residents do not voluntarily comply with the use tax laws. If the 2016 election does not change the makeup of Congress it is doubtful a federal law will be enacted to overrule Quill. Therefore, an ultimate outcome may very well result where a case challenging a law similar to Colorado’s may wind up in front of the U.S. Supreme Court again, where the court will be asked to chip away at the foundation of its Quill Commerce Clause holding, although at least up to now, the court is not willing to review the law. In a narrow sense if the court were to undertake the law in the future or if other states were to enact statutes similar to Colorado’s, a case like DMA will be successful if the court were to interpret Quill as applying only to collection and remittance obligations. On the other hand, the court may find a reporting obligation to be just as much a burden on interstate commerce and interpret Quill broadly. Interestingly, the outcome may depend on facts (especially at lower court levels) to determine how much marginal effort is taken to comply with the reporting requirements as it would seem strange that sellers are not already accumulating and maintaining the data required to be reported to Colorado to enforce its collection efforts.

Rich Molina, CPA, is an adjunct professor at Cleveland State University.

1 “State Set up Fight over Web Sales Tax,” Wall Street Journal, February 24, 2016 p. A3

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