Quill Corp. v. North Dakota

Yesterday, the South Dakota Supreme Court released its much-anticipated opinion in the Wayfair litigation, affirming a March 2017 trial court decision granting the remote retailer’s motion for summary judgment on the basis that the economic nexus law enacted in 2016 (SB 106) is unconstitutional and directly violates the US Supreme Court’s dormant Commerce Clause precedent in Quill Corp. v. North Dakota.

The South Dakota litigation remains at the front of the pack of a host of state court cases challenging similar state economic nexus laws across the United States. The expedited review (and decision) by the South Dakota Supreme Court here is significant, and puts the litigation well within the range of cases that would be decided by the end of the October 2017 Term (i.e., by July 2018), assuming cert is granted—which is by no means a guarantee. The state has 90 days to file a cert petition with the US Supreme Court, which can be extended upon request. Stay tuned, as this litigation is far from over and the sitting US Supreme Court will be tasked with deciding whether they will honor Justice Kennedy’s request to bring a case before the Court in DMA v. Brohl.

The full South Dakota Supreme Court opinion is available here.

Can a seller have nexus with a state – so as to be obligated to collect and remit that state’s sales and use taxes – only in connection with certain sales that seller makes into that state?  In this article, the authors explore the concept that only certain transactions may be subject to that obligation, depending on the extent of the seller’s connection with that state.

Read the full article.

Originally published in State Tax Notes, July 3, 2017.

Just days away from the May 31 close of its regular legislative session, the Illinois General Assembly has yet to enact the comprehensive series of tax and budget reforms that were first proposed by the Illinois Senate leadership late last year. Yesterday, the Senate passed a modified version of Senate Bill (SB) 9, the tax proposal we described in a previous post, without any Republican support. SB 9 now moves to the Democratically-controlled House for consideration. Even if approved by the House, it seems likely that Illinois’ Republican Governor will veto the legislation. Continue Reading Illinois Bills to Watch

This morning, the US Supreme Court announced that it denied certiorari in Direct Marketing Association v. Brohl, which was on appeal from the US Court of Appeals for the Tenth Circuit. The denied petitions were filed this fall by both the Direct Marketing Association (DMA) and Colorado, with the Colorado cross-petition explicitly asking the Court to broadly reconsider Quill. In light of this, many viewed this case a potential vehicle to judicially overturn the Quill physical presence standard.

Practice Note:  Going forward, the Tenth Circuit decision upholding the constitutionality of Colorado’s notice and reporting law stands, and is binding in the Tenth Circuit (which includes Wyoming, Utah, New Mexico, Kansas and Oklahoma as well). While this development puts an end to this particular kill-Quill movement, there are a number of other challenges in the pipeline that continue to move forward.

In particular, the Ohio Supreme Court recently decided that the Ohio Commercial Activity Tax, a gross-receipts tax, is not subject to the Quill physical presence standard. A cert petition is expected in this case, and could provide another opportunity for the US Supreme Court to speak on the remote sales tax issue. In addition, litigation is pending in South Dakota and Alabama over economic nexus laws implemented earlier this year. A motion hearing took place before the US District Court for the District of South Dakota last week on whether the Wayfair case should be remanded back to state court. If so, the litigation would be subject to the expedited appeal procedures implemented by SB 106 (2016), and would be fast tracked for US Supreme Court review. Tennessee also recently adopted a regulation implementing an economic nexus standard for sales and use tax purposes that directly conflicts with Quill that is expected to be implemented (and challenged) in 2017. While Governor Bill Haslam has praised the effort, state legislators have been outspoken against the attempt to circumvent the legislature and impose a new tax. Notably, the Joint Committee on Government Operations still needs to approve the regulation for it to take effect, with the economic nexus regulation included in the rule packet scheduled for review by the committee this Thursday, December 15, 2016.

All this action comes at a time when states are gearing up to begin their 2017 legislative sessions, with many rumored to be preparing South Dakota-style economic nexus legislation for introduction. While DMA is dead as an option, the movement to overturn Quill continues and the next few months are expected to be extremely active in this area. Stay tuned to Inside SALT for the most up-to-date developments.

Earlier today, the Tennessee Department of Revenue (DOR) submitted a new sales and use tax regulation for publication titled “Out-of-State Dealers” (Rule 1320-06-01-.129) that would administratively create an economic nexus threshold. With the submission, Tennessee becomes the most recent addition to the growing list of states seeking to directly attack the Quill physical presence standard.  As detailed in our prior blog, both Alabama and South Dakota are already litigating whether their economic nexus standards are sufficient to satisfy the dormant commerce clause substantial nexus requirement.  Additionally, at least 11 different bills in eight different states have been introduced in state legislatures so far in 2016.  With states continuing to attack Quill from all angles, remote sellers are scrambling to keep up with the increasingly volatile nexus landscape. Continue Reading Breaking News: Tennessee Submits Proposed Economic Nexus Regulation for Publication

Ever since Alabama’s new economic nexus regulation went into effect, litigation over its constitutionality has been expected given that Alabama Commissioner Julie Magee and Governor Bentley said as much when announcing it (Rule 810-6-2-.90.03, effective January 1, 2016).  It appears that they finally got their wish. On June 8, 2016, Newegg Inc. (Newegg) filed a Notice of Appeal in the Alabama Tax Tribunal challenging the Alabama Department of Revenue (DOR) Notice of Final Assessment of Sellers Use Tax (Assessment) that was entered on May 12, 2016. The Assessment is for seller’s use tax, interest and penalties for the months of January and February 2016 (the Assessment Period), which represent the first two months the new regulation was in effect.

The Alabama litigation comes on the heels of the litigation in South Dakota, which also involves Newegg and other retailers. Although the critical issue in both is whether economic nexus is constitutional, given that the Alabama imposition is through a regulation and not a statute, the arguments in each state’s litigation may not be parallel.

DOR Explanation of the Assessment

The DOR asserts that under the new regulation Newegg has a “substantial economic presence” in Alabama.  According to Newegg, the DOR “has offered no basis for its determination” that the regulation’s requirements were satisfied during the Assessment Period. Specifically, Newegg notes that the DOR “conclusion appears to be based solely upon the fact that Newegg had ‘significant sales into Alabama,’ i.e., more than $250,000 of retail sales to Alabama customers.”

Newegg’s Grounds for Appeal

Newegg requests that the Tax Tribunal cancel the Assessment, citing the following grounds as the primary basis:

  1. The application of the new regulation to Newegg (and the Assessment) are unconstitutional because Newegg did not (and does not) have the necessary physical presence required to satisfy the “substantial nexus” standard for sales and use taxes under the Commerce Clause, as described by the US Supreme Court in Quill.
  2. The new regulation is invalid because retailers must “lack an Alabama physical presence” for it to apply. Therefore, it conflicts with both the Alabama sales and use tax statutes and the US Constitution, each of which requires a physical presence in the state by (or on behalf of) the retailer.
  3. The application of the new regulation to an internet retailer with no physical presence in Alabama is inconsistent with the authorizing seller’s use tax statute. Specifically, none of the provisions of the sales and use tax statutes (or any other provision in the Alabama Code) authorize the DOR to impose seller’s use tax collection obligations on internet retailers with no physical presence in the state.

The State of Nexus in Other States

The Alabama litigation represents the third prominent nexus case that involves Newegg.  Not only is the company involved in South Dakota (see our prior coverage of the South Dakota lawsuits here), but it is also one of the three taxpayers involved in the Ohio Commercial Activity Tax (CAT) litigation (see our prior coverage of the Ohio lawsuits here). All three cases involve the imposition of nexus on a company without physical presence in the taxing state, one with respect to a gross receipts tax (the Ohio CAT), and the others with respect to sales and use taxes.

On May 25, 2016, the fast-tracked lawsuit filed by South Dakota was (at least temporarily) slowed down when defendants filed a Notice of Removal (Notice) in the US District Court for the District of South Dakota. Under the Federal Rules of Civil Procedure, the plaintiff (South Dakota here) has 30 days (i.e., until June 24, 2016) to file a motion to remand based on a defect in the removal procedure. However, a claim based on lack of subject matter jurisdiction can be raised at any time. According to the Notice and accompanying documentation, the basis for removal is federal question jurisdiction. Because the defendants notified the state court, the state court is likely deprived of jurisdiction to act unless the federal court remands the case back to state court. If South Dakota proceeds with the litigation in federal court, it will lose the benefits of the expedited state court appeal process enacted by Senate Bill 106. Only time will tell how the case proceeds.

Practice Note

As judicial challenges to the continued viability of Quill move further along (with Alabama now joining South Dakota as a state with potential Quill litigation pending), the impact on the status of federal legislation remains to be seen. Speaking before the Federation of Tax Administrators (FTA) yesterday, Commissioner Magee pointed out that 41 remote sellers have signed up for Alabama’s Simplified Sellers Use Tax Program, which allows them to avoid the application of the new economic nexus regulation. The Commissioner proudly touted revenue raised in excess of $1 million in the first calendar quarter of 2016 alone. Although we only know of the Newegg case at this point, it’s likely that there are many other assessments and suits to come in Alabama.

During yesterday’s FTA panel presentation on the topic (by Commissioner Magee, South Dakota Secretary Andy Gerlach, COST’s Fred Nicely and Steve Kranz) and conversations that followed, tax administrators in a number of states expressed a willingness to accept prospective voluntary disclosure agreements (VDA’s) from remote retailers. See our prior article explaining why taxpayers should say no to standard VDA lookback periods. In states where a risk of retroactive application exists (or where the taxpayer is going to begin filing anyway) it makes sense to explore the possibility of a prospective arrangement and ensure the state does not seek backward-looking compliance with their new law or position. It should be noted that, unlike South Dakota, the Alabama regulation does not contain any provisions regarding retroactivity.  The regulation took effect as of January 1, 2016, and, ostensibly, liability for retailers not collecting and remitting is accumulating. Retailers should review their positions regarding Alabama and determine the potential liability.  Retroactivity was a significant issue in the Quill case and, unlike South Dakota, there is no statute limiting the effect of a judicial decision to a prospective basis. How this will affect the litigation remains to be seen.

The New York State Department of Taxation and Finance (Department) has just revised its Guide to Sales Tax in New York State, Publication 750.

The Guide will be particularly useful for companies that are just starting to do business in New York State. It provides a well-organized and easy-to-read outline of the steps that should be taken to register as a vendor selling products that are subject to the sales tax and to collecting and remitting taxes. Small businesses and their advisors will find the Guide particularly useful.

The Guide confirms the State’s required adherence to the United States Supreme Court decision in Quill Corp. v. North Dakota (a case in which the taxpayer was represented by McDermott Will & Emery) to the effect that an out-of-state company must have a physical presence in New York to be required to collect use tax on sales to New York customers. It confirms that a company need not collect use tax on sales to New York buyers if its only contact with the State is the delivery of its products into the State by the U.S. Postal Service or a common carrier. It cautions, however, that use tax must be collected if the company has employees, sales persons, independent agents or service representatives located in, or who enter, New York. Although the law has been clear for many years that a sales representative can create nexus for an out-of-state company even though he or she is an independent contractor and not an employee, some companies still seem to be under the mistaken impression that this is not the case. Moreover, although there is no New York authority directly in point, cases in other states have established the principle that nexus can be created by the presence in the state of a single telecommuting employee, even if the employee’s work is not focused on the state.

The Guide contains a cryptic reference to New York’s click-through nexus rule under which an out-of-state company can be compelled to collect use tax on sales to New York purchasers if people in the state refer customers to the company and are compensated for doing so. Such persons are presumed to be soliciting sales for the company and, although the presumption can be rebutted, that will prove to be impossible in the vast majority of cases. The Guide contains cross-references to Department rulings that explain the presumption and the manner in which it can be rebutted, but it would have been helpful if the Guide could have provided more detail about these rules.

One attractive feature of the Guide is that people accessing it online can use links in the Guide to get to relevant rulings.

In addition to the state-wide sales and use tax, special sales taxes that are imposed only within New York City are discussed. These include taxes on credit rating services and certain localized personal services such as those provided by beauty salons, barber shops, tattoo parlors and tanning salons. Interestingly, the Guide does not address the Department’s position that services provided by credit rating agencies in rating debt and preferred stock offerings are taxable. This represents a reversal of a position that the Department had taken in audits for some 40 years. McDermott Will & Emery represented the industry in negotiating the terms of the change of position with the Department. Under the Department’s new position, offerings after September 1, 2015, are subject to the New York City tax if the invoice address of the issuer or representative is in the city.

The Guide discusses the treatment of taxable business purchases. Although one can argue that all purchases by a business that sells products that are subject to the sales tax should be exempt from tax, the law has never so provided and, while there are exemptions for property purchased for resale and for property directly used in manufacturing goods that are sold, the purchases of many items that contribute to the production of taxable items (e.g., computers, furniture, supplies) are subject to the tax, even though their cost is effectively included in the price of the taxable products that the company sells to its customers.

The discussion of the resale exclusion indicates that the exclusion does not apply if “you later use the property or services rather than reselling them.” This does not address the common situation in which property that was purchased and is being held for resale is incidentally used for other purposes. Companies often pledge their inventory as collateral for loans and the Department has never contended that this use defeats the resale exclusion. It would be helpful if the Department issued guidance on the incidental situation.

Companies and their advisors should be aware that the resale exclusion is just that: an exclusion and not an exemption. It is part of the definition of what constitutes a taxable retail sale. This can be important in audits and litigation, because the law is clear that the Department has the burden of persuasion if the issue involves the interpretation of a statute imposing a tax whereas the taxpayer bears this burden in a case involving the application of an exemption. Since the resale exclusion is part of the definition of a taxable retail sale, the burden with respect to its application is on the Department.

The Guide contains a useful section on procedures for filing sales and use tax returns. Although it mentions that a vendor is “a trustee for the state” in connection with the remittance of sales tax that it collects, it does not mention that the responsible persons at a company can be personally liable for sales taxes that are not remitted. This often comes up in audits and it is common for the Department to ask a company’s officers to agree to extend the statute of limitations on collections of delinquent taxes from them personally. We hope that future editions of the Guide will mention this point.

Unfortunately, the Guide does not discuss the many controversial issues involving cloud computing and internet transactions.

The United States Supreme Court released a unanimous decision today holding that the Tax Injunction Act (TIA), 28 U.S.C. § 1391, does not bar suit in federal court to enjoin the enforcement of Colorado notice and reporting requirements imposed on noncollecting out-of-state retailers. See Direct Marketing Ass’n v. Brohl, No. 13-1032, 575 U.S. ___ (March 3, 2015), available here. These requirements, enacted in 2010, require retailers to (1) notify Colorado purchasers that tax is due on their purchases; (2) send annual notices to Colorado customers who purchased more than $500 in goods in the preceding year, “reminding” these purchasers of their obligation to pay sales tax to the state; and (3) report information on Colorado purchasers to the state’s tax authorities. See Colo. Rev. Stat. § 39-21-112(3.5). The TIA provides that federal district courts “shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law.”

The Court’s Opinion

The Court held that although the notice and reporting requirements are part of Colorado’s overall assessment and collection process, none of the requirements constitute an “assessment,” “levy,” or “collection” within the meaning of the TIA. Specifically, the Court looked to the Internal Revenue Code (IRC) to determine that the terms are “discrete phrases of the taxation process that do not include informational notice or private reports of information relevant to tax liability.” See Slip Op. at 5-8 (noting that no “assessment” or “collection” within the meaning of the IRC occurs until there is a recording of the amount the taxpayer owes the Government, which the notice and reporting requirements precede).  Justice Thomas, who authored the opinion, concluded that “[t]he TIA is keyed to the acts of assessment, levy, and collection themselves, and enforcement of the notice and reporting requirements is none of these.” Id. at 9.

The Court rejected the Tenth Circuit’s reliance on (and expansive interpretation of) the term “restrain” in the TIA.  Justice Thomas explained that such a broad reading of the statute would “defeat the precision” of the specifically enumerated terms and allow courts to expand the TIA beyond its statutory meaning to “virtually any court action related to any phase of taxation.” Id. at 11.  Instead, he assigned the same meaning to “restrain” that it has in equity for TIA purposes, which is consistent with its roots and the Anti-Injunction Act (the TIA’s federal counterpart).  Therefore, the Court concluded that “a suit cannot be understood to ‘restrain’ the ‘assessment, levy or collection’ of a state tax if it merely inhibits those activities.” Id. at 12.

The Court’s decision took “no position on whether a suit such as this one might nevertheless be barred under the ‘comity doctrine,’” under which federal courts – as a matter of discretion, not jurisdiction – refrain from “interfering with the fiscal operations of the state governments in all cases where the Federal rights of persons could otherwise be preserved unimpaired.” Id. at 13. The Court left it to the Tenth Circuit on remand to determine whether the comity argument remained available to Colorado.  Id.

Justice Kennedy’s Concurrence

Justice Kennedy joined the Court’s opinion, but wrote separately to take the opportunity to point out his views on the physical presence standard for sales and use tax purposes established by the Court in Quill Corp. v. North Dakota more than 20 years ago. 504 U.S. 298 (1992). Citing to the far-reaching systematic and structural changes in the economy caused by Internet commerce, Justice Kennedy expressed his view that “it is unwise to delay any longer a reconsideration of the Court’s holding in Quill . . . [because it] now harms States to a degree far greater than could have been anticipated earlier.” Brohl (Kennedy, J., concurring at 3). He went on to state that Quill “should be left in place only if a powerful showing can be made that its rationale is still correct.” Id. at 3-4. While Justice Kennedy noted that Brohl was not the proper case to resolve this issue, he requested litigants to bring “an appropriate case for this Court to reexamine Quill.” Id. at 4.

Practice Note:  While the Court’s opinion can certainly be viewed as a taxpayer victory, it is overshadowed by Justice Kennedy’s concurrence calling for the reconsideration of Quill. In terms of the main issue resolved by Justice Thomas, the door to the federal courts is now open—at least insofar as the TIA is concerned—to state tax cases that do not directly involve the assessment, levy or collection of tax. Because a federal court is generally a more favorable forum for taxpayers to litigate, we expect additional attempts to resolve more tangential state tax issues in the federal court system.