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BREAKING NEWS: US Supreme Court Overrules Quill

Moments ago, the US Supreme Court issued its highly-anticipated decision in South Dakota v. Wayfair, Inc., et al., No. 17-494. The 5-4 opinion was authored by Justice Kennedy and concluded that the physical presence requirement established by the Court in its 1967 National Bellas Hess decision and reaffirmed in 1992 in Quill is “unsound and incorrect” and that “stare decisis can no longer support the Court’s prohibition of a valid exercise of the States’ sovereign power.” This opinion will have an immediate and significant impact on sales and use tax collection obligations across the country and is something every company and state must immediately and carefully evaluate within the context of existing state and local collection authority.

Summary of Opinions

The majority opinion was authored by Justice Kennedy and was joined by Justices Thomas, Ginsburg, Alito and Gorsuch. In reaching the conclusion that the physical presence rule is an incorrect interpretation of the dormant Commerce Clause, the opinion states that the Quill physical presence rule: (1) is flawed on its own terms because it is not a necessary interpretation of the Complete Auto nexus requirement, creates market distortions and imposes an arbitrary and formalistic standard as opposed to the case-by-case analysis favored by Commerce Clause precedents; (2) is artificial in its entirety and not just at its edges; and (3) is an extraordinary imposition by the Judiciary. The majority went on to conclude that stare decisis can no longer support the Court’s prohibition of a valid exercise of the States’ sovereign power, noting that “[i]t is inconsistent with this Court’s proper role to ask Congress to address a false constitutional premise of this Court’s own creation.” The majority noted that the South Dakota law “affords small merchants a reasonable degree of protection” and “other aspects of the Court’s [dormant] Commerce Clause doctrine can protect against any undue burden on interstate commerce.” The majority opinion specifically notes that “the potential for such issues to arise in some later case cannot justify an artificial, anachronistic rule that deprives States of vast revenues from major businesses.” Finally, the majority decision provides that in the absence of Quill and Bellas Hess, the first prong of Complete Auto simply asks whether the tax applies to an activity with substantial nexus with the taxing State and that here, “the nexus is clearly sufficient.” Specifically, the South Dakota law only applies to sellers that deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions, which “could not have occurred unless the seller availed itself of the substantial privilege of carrying on business in South Dakota.” With respect to other principles in the Court’s dormant Commerce Clause doctrine that may invalid the South Dakota law, the majority held that “the Court need not resolve them here.” However, the majority opinion does note that South Dakota appears to have features built into its law that are “designed to prevent discrimination against or undue burdens upon interstate commerce” including: (1) a [...]

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How Far Back Can a Back Tax Go? Petition for Certiorari in Hambleton Asks Supreme Court to Right Unjust Retroactivity

Retroactivity is an endemic problem in the state tax world.  In this year alone, we have seen retroactive repeal of the Multistate Tax Compact (MTC) in Michigan, as well as significant retroactivity issues in New York, New Jersey and Virginia.  But after decades of states changing the rules on taxpayers after-the-fact, relief may be on the way if the Supreme Court of the United States grants certiorari in a Washington estate tax case, Hambleton v. Washington, with retroactivity that makes you say “What the heck?”.

The taxpayers filed a petition for certiorari on June 5, 2015.  The Court requested a response, which is now due by September 9, 2015.  The Tax Executives Institute filed an amicus brief on July 6, 2015.

The case involves two widows’ estates.  As stated in the petition:

Helen Hambleton died in 2006, and Jessie Macbride died in 2007.  Each was the passive lifetime beneficiary of a trust established in her deceased husband’s estate, and neither possessed a power under the trust instrument to dispose of the trust assets.  Under the Washington estate tax law at the time of their deaths, the tax did not apply to the value of those trust assets.  In 2013, however, the Washington Legislature amended the estate tax statutes retroactively back to 2005, exposing their estates to nearly two million dollars of back taxes.

In 2005, Washington state enacted an estate tax that was intended to operate on a standalone basis, separate from the federal estate tax.  In interpreting the new law, the Department of Revenue issued regulations that the transfer of property from the petitioners’ husbands to the petitioners through a Qualified Terminable Interest Property (QTIP) trust was not subject to the Washington estate tax.  The Department then reversed its position and assessed tax.  Petitioners, along with other estates, challenged the Department’s position and won in Washington Supreme Court (In re Estate of Bracken, 290 P.3d 99 (Wash. 2012)).  Then in 2013, the Washington legislature amended the estate tax to retroactively adopt the Department’s position, going back to 2005.  The petitioners challenged this law up to the Washington Supreme Court, which held in favor of the Department and concluded that the retroactive change satisfied the due process clause under a rational basis standard.

The petition urges the Supreme Court to take the case to resolve the uncertainty as to “how long is too long” when it comes to retroactive taxes, citing multiple examples of past and ongoing litigation in which lower courts have taken divergent approaches to the length of retroactivity that is permissible.  Of particular interest, one of the cases cited is International Business Machines Corp. v. Michigan Department of Treasury, 852 N.W.2d 865 (Mich. 2014).  The retroactive repeal of the MTC election in Michigan is a central issue in that ongoing litigation. If the Supreme Court takes Hambleton, its decision would likely impact the Michigan MTC litigation. The recent decision by the New York Court of Appeals, allowing [...]

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Division of Tax Appeals Rules Patent License Fees not Taxable in New York

A New York State Division of Tax Appeals administrative law judge (ALJ) recently ruled in favor of a medical device and technology company represented by McDermott Will & Emery on the question of whether patent license fees that the company charged to its customers were subject to New York sales tax. In Matter of AMO USA, Inc., DTA No. 824550 (N.Y. Div. Tax App. June 19, 2014), the ALJ determined that the patent license fees were not taxable because they were received in exchange for the right to use the company’s patents, which was a valuable intangible right that could be sold separately from any tangible personal property.

AMO USA, Inc., (AMO) was engaged in the development, manufacture and distribution of surgical procedures and technologies involved in laser assisted corrective eye surgery, and obtained patents covering many of the methods and apparatuses used to perform the surgery.  Under United States patent law, the patents issued to AMO created an enforceable right against the unauthorized use of the patented methods and apparatuses for a limited period of time.  When AMO sold a laser directly to a physician or hospital that would operate the laser in surgical procedures, AMO also granted its consent to perform the surgical procedures covered by its patents by entering into written patent license agreements with the purchasers.  The fee that the customer paid for the right to perform AMO’s patented surgical procedures was separately stated from the charge for the equipment on the customer’s invoice; while AMO collected sales tax on the latter, it claimed that the separate fee for the patent license was exempt from sales tax.

New York imposes its sales tax on retail sales of tangible personal property but not (as a general rule) on transfers of intangible property.   Further, under New York law, the primary purpose of the transaction controls the taxability of the entire transaction, even if some parts of the transaction would be taxable and other parts would not be if they were purchased separately.  If a person makes a taxable sale of tangible personal property, the entire amount of the receipt, including any expenses incurred by the seller that are passed on to the purchaser, is subject to sales tax.

The Division of Taxation (Division) asserted that the patent license fees were not independent of the charges for tangible personal property and thus the entire transaction should have been subject to sales tax.  AMO, however, explained that the patents themselves were valuable intangible rights that could be sold separately from any tangible personal property.  The ALJ agreed with AMO, remarking that the “essential and considerable value of a patent is the intangible right vested in its owner to have exclusive authority and control over the procedure, process or apparatus for a term of years[.]”

In reaching his decision, the ALJ distinguished AMO’s case from an Advisory Opinion, TSB-A-11(32)S (Dec. 7, 2011) in which the Division had ruled that certain patent license fees paid in connection with laser eye procedures were [...]

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Retailers Caught in the Middle: To Tax or Not to Tax Delivery Fees

Over the past decade we have seen a large increase in the number of third party tax enforcement claims against retailers involving transaction taxes (see Multistate Tax Commission Memorandum regarding survey of class action refund claims and false action claims, dated July 12, 2013, describing such actions).  The lawsuits typically are brought either as proposed class actions, alleging an over-collection of tax, or as whistleblower claims on behalf of state governments, alleging a fraudulent under-collection of tax owed to the state or municipality.  With respect to certain issues, including shipping and handling charges, retailers have been whipsawed with lawsuits alleging both under- and over-collection of tax.

On April 3, a proposed class action lawsuit was filed in Florida alleging that Papa John’s Pizza was improperly collecting tax on its delivery fees (Schojan v. Papa John’s International, Inc., No. 14-CA-003491 (Circuit Court Hillsboro County, Florida)).  The lawsuit is similar to an action filed in Illinois that resulted in an Illinois Supreme Court ruling rejecting a proposed class action claim that a retailer was improperly collecting tax on its shipping charges (Kean v. Wal-Mart Stores, Inc., 919 N.E.2d 926 (Illinois 2009)).

Both Florida and Illinois impose sales tax on services that are inseparably linked to the sale of tangible personal property (see, e.g., 86 Ill. Admin. Code § 130.415(b) & Fla. Admin. Code Ann. r. 12A-1.045(2)).  The regulations provide that whether a customer has separately contracted for shipping charges, or has an option to avoid shipping charges by picking up the property at the retailer’s location, can be used as a proxy to determine whether the services are separate and thus not taxable (86 Ill. Admin. Code § 130.415(d); Fla. Admin. Code Ann. r. 12A-1.045(4)(a), (b)).

In Kean, the Illinois Supreme Court held that shipping charges were a taxable part of an internet sale in which the customer had no option but to pay shipping charges.  After the ruling, the Illinois Department of Revenue made no announced change to its commonly understood audit position that sales tax was not owed on separately stated shipping charges that were assessed at a retailer’s actual cost.

Seeking to capitalize on the Kean ruling, an Illinois law firm has filed upwards of 150 lawsuits under the Illinois False Claims Act against retailers that do not collect tax on the shipping and handling charges associated with their internet sales, alleging an intentional failure to collect tax and seeking treble damages, attorneys’ fees and associated penalties.  The suits were filed without regard to whether the retailers had been audited and found not to owe tax on their shipping and handling charges.  The State has declined to intervene in the majority of these cases, permitting the Relator to proceed with the prosecution.  Because the amounts at issue are small (6.25 percent tax on shipping and handling charges), the lawsuits force many retailers to choose between paying an (entirely undeserved) settlement to resolve the litigation or bearing the expense of litigation.  For reasons not entirely clear, the Illinois General Assembly [...]

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