Colorado’s Internet tax law questioned but federal law questioned as well

Colorado’s Internet tax law

Colorado’s Internet tax law

On March 3rd, the U.S. Supreme Court dealt a potentially crippling blow to Colorado’s efforts to force out-of-state retailers to assist the state’s efforts to collect use taxes on Internet and mail order purchases. While the court unanimously sided with retailers opposing Colorado on a key jurisdictional question, at least one justice expressed concern that states have been unfairly restrained in taxing Internet purchases.

Direct Marketing Association v. Brohl

Colorado legislators adopted a law in 2010 imposing a number of reporting requirements on out-of-state retailers who do not otherwise maintain a physical presence in the state. First, these retailers had to inform all of their Colorado customers they were liable for use tax on their purchases. Second, retailers had to send a specific notice to each Colorado customer who purchased more than $500 worth of goods during the previous year about their use tax liability. Finally, retailers had to provide the state’s Department of Revenue with the names, addresses and total purchase amounts for each of their Colorado customers.

Colorado's internet tax law

Justice Kennedy’s assertion that it may be time to do something about the outdated Quill decision is highlighted if you look at the number of states that have attempted to enact their own version of Internet sales tax legislation.

The Direct Marketing Association (DMA), a trade group representing Internet and mail-order businesses, asked a federal judge for an injunction to prevent Colorado from enforcing this law. The judge granted that injunction in March 2012, holding Colorado’s Internet tax law requirements violated the Commerce Clause of the U.S. Constitution. Under the landmark 1992 U.S. Supreme Court decision in >Quill v. North Dakota, the Commerce Clause forbids a state from requiring retailers who do not maintain a “physical presence” within the state to collect its taxes. Here, the judge agreed with the DMA that the three reporting requirements “impermissibly imposed undue burdens on interstate commerce” and were therefore unconstitutional.

But in 2013, the U.S. 10th Circuit Court of Appeals reversed the trial judge’s decision. The appeals court did not address the merits of the DMA’s constitutional arguments. Rather, the three-judge panel said the federal courts lacked the jurisdiction to hear the case at all. In 1937, Congress passed a law prohibiting federal courts from issuing any injunction which interfered with a state government’s “assessment, levy or collection” of its own taxes. The 10th Circuit said that anti-injunction rule applied to Colorado’s Internet tax law reporting requirements.

The Supreme Court disagreed. In an opinion authored by Justice Clarence Thomas, the high court said the “notice and reporting requirements” in Colorado’s Internet tax law are not part of the tax “assessment” or “collection” process. In fact, Thomas said the reporting requirements precede both. For instance, the word “assessment” in the 1937 law refers to the act of recording a taxpayer’s liability; but Colorado’s law addresses efforts to gather information about the taxpayer’s liability. Thomas said the anti-injunction rule does not extend to such information gathering efforts.

Time to reconsider Quill?

In a separate opinion, Justice Anthony Kennedy wrote to express his personal belief the court should reconsider and overturn Quill v. North Dakota. Kennedy said requiring states to establish a physical presence (or “substantial nexus”) before imposing tax collection responsibilities on out-of-state retailers caused “extreme harm and unfairness to the States.” Kennedy said many states were struggling to collect use taxes on Internet and mail-order sales – Colorado alone loses about $170 million a year, he said – and given the “far-reaching and structural changes in the economy” caused by the online shopping revolution, he argued the time had come for the court to reconsider its position.

Kennedy acknowledged the DMA case was not the right time and place to address this issue, but he added, “The legal system should find an appropriate case for this court to reexamine” the Quill decision.

This may not be the last word

Although the Supreme Court said the anti-injunction law did not stand in the way of the trial court’s original decision in favor of the DMA, this case is not yet over. In a footnote to its 2013 opinion, the 10th Circuit suggested the legal principle of “comity” cautioned federal courts against interfering with Colorado’s internet tax law collection policies. Comity basically means that even if a federal court has the legal right to hear a case, it should decline to do so out of courtesy to the state’s authority. Colorado officials did not actually present a comity as a defense – and Justice Thomas said he and his colleagues took no position on the issue at this time – but the 10th Circuit may revisit the question following the Supreme Court’s decision.

S.M. Oliva is a writer living in Charlottesville, Virginia. He edits the international legal blog Bonham’s Cases.

Illinois trys again with click-through substantial nexus law

substantial nexus

substantial nexus

Illinois enact click-through nexus

Illinois is one of many states to enact a click-through nexus or “Amazon tax” law saying that merchants making sales through online marketing (grossing over $10,000 annually through clicks with affiliates in the state)  have established nexus and are liable to pay use tax even if the sales were not to Illinois residents.

Generally a state may only collect sales or use taxes if there is a “substantial nexus” between the seller and the state imposing the tax. The substantial nexus requirement arises from the United States Constitution, which gives Congress the exclusive right to regulate interstate commerce. As the U.S. Supreme Court explained in the 1992 decision, Quill v. North Dakota, before the Constitution’s adoption, “state taxes and duties hindered and suppressed interstate commerce; the Framers intended the Commerce Clause as a cure for these structural ills.”

In modern practice this means two things: first, a state cannot use its tax policies to discriminate against out-of-state commerce; second, a state cannot tax a transaction that has no real connection – i.e., a substantial nexus – to the state itself. This latter requirement is an ongoing source of tension in the age of Internet commerce, as online retailers can sell millions of dollars worth of goods in a state where the company maintains no physical or legal presence.

The “Amazon” Tax

One battlefield in this tax war is the use of affiliate or “click-through” marketing programs. Most people are familiar with these types of programs. A website contains an ad for goods available for sale at another website, such as Amazon; the user clicks the ad, purchases the product, and the affiliated website operator receives a commission from Amazon.

More and more states are contending that this advertising relationship alone creates a “substantial nexus” with an out-of-state retailer justifying the collection of sales or use tax. This past January, Illinois announced its second effort to collect such taxes. Illinois legislators made their initial attempt in 2011, asserting sales and use tax jurisdiction over any “retailer having a contract with a person located in this State under which the person, for a commission or other consideration based upon the sale of tangible personal property by the retailer, directly or indirectly refers potential customers to the retailer by a link of the person’s Internet website.”

A trade association representing affiliate marketers challenged Illinois’ action as a violation of a federal law prohibiting “discriminatory taxes on electronic commerce.” In an October 2013 decision, the Illinois Supreme Court agreed with the challengers and nullified the state law. The Illinois General Assembly responded in August 2014, passing a revised law allowing retailers to present evidence their referral activities are “not sufficient to meet the nexus standards of the United States Constitution.” The new law also applies to “promotional codes distributed through the [retailer’s] hand-delivered or mailed material,” such as catalogs. This requirement is intended to address the Illinois Supreme Court’s finding the earlier law singled out Internet-only promotions.

Under the new Illinois law, which took effect on Jan. 1, any out-of-state retailer that “made cumulative gross sales of $10,000 during the preceding four quarterly periods to customers referred by persons located in Illinois,” must register and pay state use taxes. Note the $10,000 threshold is based on the location of the affiliates, not the customers. So if an Illinois-based website’s referrals lead to $10,000 in sales for the out-of-state retailer, the retailer is liable for Illinois use tax even if only $5,000 of those sales were actually made to people living in Illinois.

click through substantial nexus

Courtesy The Tax Foundation (Graphic created circa 2009)