Internet taxes on trial: new strategies for litigating remote-seller sales and use tax cases.

• Author: Hogan, Steven M.

In 2013, two novel legal theories emerged out of litigation in Illinois and Colorado over whether the states could collect taxes on sales made by remote sellers over the Internet. In Performance Marketing Association, Inc. v. Hamer, -- N.E.2d --, 2013 IL 114496 (Ill. 2013), the Illinois Supreme Court held that the state's "click-through" nexus law was preempted by the federal Internet Tax Freedom Act. (1) In Colorado, the U.S. Court of Appeals for the 10th Circuit held in Direct Marketing Ass'n v. Brohl, -- F.3d --, 2013 WL 4419324 (10th Cir. 2013), that the federal Tax Injunction Act precluded federal jurisdiction over a challenge to a Colorado law requiring online retailers to report purchaser information to the state. (2) These cases represent new ways to litigate cases involving states' attempts to tax Internet sales. Taxation of these sales has proven difficult, if not impossible, for the states since the U.S. Supreme Court issued its landmark decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

This article examines the significance of Performance Marketing and Direct Marketing to litigators challenging or defending attempts by states to collect tax on sales by remote sellers. The novelty of these opinions lies in the willingness of the courts to base their holdings on federal statutes rather than Quill. These cases represent a new vein of argumentation that may allow courts to decide multi-state taxation cases without reaching the merits under Quill.

Quill and its Consequences

The Quill case involved an office equipment and supply company, Quill Corp., that solicited business through catalogs, flyers, advertisements in national periodicals, and telephone calls. (3) One of the states in which it solicited business was North Dakota, a state where Quill Corp. had at least 3,000 customers. (4) None of Quill Corp.'s employees or facilities were located in North Dakota. (5) All of its merchandise was delivered to North Dakota customers via mail or common carrier from locations outside of the state. (6)

Quill Corp. took the position that North Dakota did not have the power to compel it to collect a use tax on goods that it sold to its North Dakota customers. (7) The tax commissioner of North Dakota filed suit in state court to compel Quill Corp. to collect use taxes on its North Dakota sales. The Supreme Court of North Dakota departed from prior U.S. Supreme Court precedent to hold that Quill Corp. was obligated to collect and remit use tax to the state. (8) The U.S. Supreme Court reversed, holding that Quill Corp. lacked sufficient "nexus," or connection, with the state to allow North Dakota to compel collection of use taxes on Quill Corp.'s sales to North Dakota residents. (9)

The Quill decision created two distinct "nexus" tests based on the U.S. Constitution's Due Process Clause and Commerce Clause, respectively. These tests were intended to help courts decide whether a state has a close enough connection to a remote seller to allow it to impose taxes on its sales. A state must "pass" both nexus tests under Quill in order to constitutionally impose tax on transactions between state residents and remote sellers. (10)

The due process nexus test is a "flexible" standard that is not dependent on a seller's physical presence within a state. (11) Instead, a remote seller can meet the due process nexus requirement through "purposeful direction" of its efforts toward a state to solicit business. (12) The flexibility of this standard reflects the purpose of the Due Process Clause, which is primarily about "the fundamental fairness of government activity." (13) The relevant question is, therefore, whether the remote seller has purposefully availed itself of the economic market in the forum state. (14) Under Quill, a remote seller is unlikely to win a challenge to a state statute based on the due process nexus requirement; a remote seller that avails itself of a state's economic market to any significant degree will invariably satisfy the due process nexus requirement.

The Commerce Clause nexus test created under Quill is a bright-line test that requires a seller to have a physical presence in a state before the state can impose a duty to collect use taxes. (15) Though Quill itself addressed a company engaged in mail-order sales, its holding should substantially apply to Internet retailers as well: Unless a vendor has a physical presence in a given state, that state cannot require the vendor to collect sales or use taxes on a sale to a resident of that state. (16)

The Court in Quill may have anticipated the effect its ruling would have on state tax revenues due to the growth of remote sale industry. The Court recognized that the mail-order industry had realized "dramatic growth" in the years preceding its decision, partly as a result of the bright-line exemption from the duty to collect use taxes under National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967), the Court's prior statement on the issue. (17) The Court deferred to Congress as the proper venue for establishing a nationwide framework for taxing remote sales that would apply to all 50 states. (18) The Court noted that its decision was "made easier" by recognizing that Congress could step in to overrule its decision at any time...