Digital Sales Tax Case Returning to South Dakota State Court

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By Jennifer McLoughlin

A complaint seeking validation of South Dakota’s remote sales tax legislation doesn’t raise a federal question that supports jurisdiction in the federal courts, according to the U.S. District Court for the District of South Dakota.

In a Jan. 17 decision, the court granted South Dakota’s motion to remand a dispute over the state’s economic nexus regime ( S.B. 106). The statute, signed into law in March 2016, requires remote retailers with annual in-state sales exceeding $100,000 or 200 separate transactions to collect and remit sales tax ( South Dakota v. Wayfair, Inc. , D.S.D., No. 3:16-CV-03019, 1/17/17 ).

State lawmakers presented the law as a direct challenge to the U.S. Supreme Court rule from Quill Corp. v. North Dakota, 504 U.S. 298 (1992), which prohibits states from imposing sales and use tax collection obligations on sellers without an in-state physical presence.

The case originated in late April in the South Dakota Sixth Judicial Circuit, with the state seeking a declaratory judgment validating the law. The retailers named as defendants—Wayfair Inc., Overstock.com Inc. and Newegg Inc.—removed the matter to the federal district court, prompting the state’s request for remand.

Finding for the state and returning the case to the South Dakota Circuit Court, the federal judge found that South Dakota’s complaint doesn’t “‘necessarily raise a stated federal issue.’”

“Certainly, the central issue in the case is the constitutionality of S.B. 106, and S.B. 106 is designed to test whether Justice Kennedy’s concurrence in Brohl might signal that the Supreme Court is ready to overturn Quill,” according to the opinion. “The constitutionality of S.B. 106 under Quill, however is not a necessary element of the State’s complaint, is not needed for the ‘vindication of [its] right under state law,’ and the State’s complaint does not then ‘necessarily’ raise a federal issue.”

Federal Defense Doesn’t Suffice

The federal court concurrently considered the state’s remand motion with an opposing summary judgment motion from the retailers, asking the court to strike the statutory tax as contrary to the Quill constraints.

The court recognized the significance of Quill in the dispute, but didn’t find it compelled federal question jurisdiction.

“Although the Complaint—and indeed S.B. 106—contemplates and seeks to test the defense that Quill renders S.B. 106 unconstitutional, that issue nevertheless arises as a defense to the State’s claim,” according to the opinion. “Thus, the application of the well-pleaded complaint rule prohibits the removal into federal court"—referring to the doctrine that a federal question must appear on the face of a complaint, rather than in an anticipated defense.

Agreement on Unconstitutionality

Matthew P. Schaefer, a partner with Brann & Isaacson and counsel for the retailers, told Bloomberg BNA after a Dec. 8 hearing that the court recognized there is no dispute regarding the retailers’ right to summary judgment—given that both sides agree the law is invalid under Quill. He further noted that the Department of Revenue told the federal judge it would take the same position on the retailers’ right to summary judgment should the case return to state court.

In a Jan. 17 e-mail, Schaefer noted the importance of the federal proceedings for the state court’s determination.

“While the federal court did not reach the Defendants’ motion for summary judgment, because it ruled it lacked jurisdiction, the Court’s opinion reiterates that the State has acknowledged in its briefing (as well as on the record in open court) that the Defendants are entitled to summary judgment on the grounds that S.B. 106 is unconstitutional under current Commerce Clause standards as set forth in Quill Corp v. North Dakota,” he said. “Whether the matter had remained in federal court, or as it now moves forward in state court, there is no dispute that the lower courts must enter judgment invalidating the law.”

Kelsey Pritchard, communications director for South Dakota Gov. Dennis Daugaard (D), told Bloomberg BNA in an e-mail that the state is pleased with the federal court’s ruling.

To contact the reporter on this story: Jennifer McLoughlin in Washington at jmcloughlin@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

For More Information

Text of the opinion is at http://src.bna.com/ltQ.

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