E-Retailers, Congress Feel Heat From States' Digital Tax Frenzy

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By Jennifer McLoughlin

July 1 — What do Alabama, Louisiana, Oklahoma and South Dakota have in common?

They are among the early shakers in a rising state crusade to recover billions in sales tax revenue lost to purchases made on the internet.

Emboldened by congressional inaction and a pair of judicial opinions that have collectively encouraged the expansion of taxing jurisdiction over remote vendors, states are making more aggressive efforts to seize remote sale taxes.

According to Multistate Associates, 16 states have introduced 42 sales tax nexus bills in 2016. Several have led to enacted legislation in Louisiana, Oklahoma, South Dakota and Vermont.

For almost 15 years, Congress has toyed with the concept of one nexus standard governing all states, but various proposals either stalled or never materialized into a formally introduced design. However, guidance offered by the U.S. Supreme Court and the U.S. Court of Appeals for the Tenth Circuit—in separate decisions within the same case—has induced states to confront the high court's 24-year-old decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) .

Under Quill, a seller must have an in-state physical presence before the state may mandate collection of sales and use tax.

“I think a lot of our tax codes in our states are written in kind of a Sears & Roebuck catalog kind of world, while we're all living in an Amazon and iPhone kind of world,” Rep. Chad Caldwell (R), who authored Oklahoma's digital sales tax law, told Bloomberg BNA June 27. “We need to update that. The economy today is very, very different than the economy we had in 1992.”

Arsenal of Attacks

Practitioners, taxpayers and politicians seemingly agree that the digital frontier has transformed the modern marketplace forever. But a common perspective doesn't translate into a uniform strategy for how to address the impact of that shift on tax bases.

The conflict between cash-strapped states and remote retailers began with affiliate-style legislation, which imposes nexus on remote retailers based on the in-state presence of affiliate individuals or entities. The movement escalated with New York's click-through nexus regime enacted in 2008, which the U.S. Supreme Court declined to review after the state's high court upheld the law.

And what has transpired since then is a jumbled assortment of nexus models, including:

  •  different definitions of taxpayers required to collect and remit taxes;
  •  varying forms of affiliate nexus;
  •  click-through and economic nexus regimes with unique thresholds; and
  •  reporting schemes, some requiring reporting to state taxing authorities and others only compelling notice to taxpayers.

“The varying approaches states are taking are a reflection of the old adage of states as laboratories of democracy, of different political make ups, and of breaking judicial developments,” Joseph Crosby, a principal at MultiState Associates, told Bloomberg BNA in a June 17 e-mail. He views the recent state action “as an acceleration of a long term trend” spanning two decades.

Raising the Stakes

Since 2015, and into 2016, states have stepped up efforts to capture remote retailers. Some shuffle along the Quill margins, but others were designed to wage war against the physical presence threshold. The recent efforts include:

  •  Alabama, whose department of revenue passed an administrative rule, 810-6-2-.90.03, mandating sales tax collection from remote vendors with more than $250,000 of in-state annual sales.
  •  Louisiana, which enacted H.B. 30, creating affiliate and click-through nexus regimes, and H.B. 1121, mandating customer notification and annual reporting of in-state sales;
  •  South Dakota, which enacted S.B. 106, mandating sales tax from remote vendors with annual in-state sales exceeding $100,000 or 200 separate transactions;
  •  Oklahoma, which enacted H.B. 2531, offering the option of voluntary sales tax collection or customer notification; and
  •  Vermont, which enacted H.B. 873, enacting economic nexus and consumer notification requirements, with effective dates either in 2017 or in accordance with specific circumstances.

Although many regimes don't align with approaches endorsed by out-of-state sellers, a greater concern may be the absence of a federal solution to unify the overgrowth of state-specific standards.

“While certain remote sellers are opposed to any sales tax laws that go beyond taxation of entities with physical presence, many large businesses are in favor of some sort of Congressional solution to the issue,” Jamie Yesnowitz, a Washington-based principal with Grant Thornton’s State and Local Tax practice, said in a June 20 e-mail. “I think the biggest fear shared by the vast majority of businesses is that different types of regimes have taken hold in the states and will continue to proliferate, so that there is a patchwork of laws throughout the United States that is difficult for businesses to navigate.”

Maneuvering Around ‘Quill.'

Reliance on sales tax revenue, budget shortfalls, political pressures and concerns over court challenges often shape a state's appetite to merely test or wholly defy the federally imposed physical presence standard under Quill. Adding to those factors in 2016 has been the impending presidential election, which often deters new congressional legislation.

But a pair of federal opinions in one case has fueled states' increasing drive to do away with Quill's taxing restraints.

In Direct Mktg. Ass’n v. Brohl (DMA), Colorado came under scrutiny for its law mandating that out-of-state sellers provide notice to customers and report to state tax authorities on in-state sales.

Concurring in a March 2015 decision on a procedural issue, Justice Anthony M. Kennedy urged the “legal system” to bring a case that triggers re-examination of the high court's earlier precedent, including Quill. His call for a challenge cautioned against further delay in reconsidering the holding because of technological advancements and consumer practices. Following remand to the Tenth Circuit, the lower appellate court ruled Feb. 22 that Colorado's reporting requirement is constitutional, finding no discrimination or undue burden on interstate commerce (35 DTR K-2, 2/23/16).

For states once hesitant to go head-to-head with Quill, the DMA body of law has boosted confidence to contest the 24-year-old rule of law with more force.

And combined with continued congressional inaction, Max Behlke, manager of state-federal relations for the National Conference of State Legislatures (NCSL), told Bloomberg BNA June 16 that more states will likely join the collective anti- Quill effort by pushing through legislation in 2017.

Bolder Measures

Squarely facing off with Supreme Court precedent is the economic nexus model, an increasingly popular tool embodying the swelling “kill Quill” sentiment. A relatively new approach that disregards the physical presence paradigm, calling for a taxation system based entirely on sales, it has become a test case in the wake of Kennedy's overture to reconsider Quill.

“The underlying motivation has always been to provide a level playing field for all retailers—and all consumers—and collect legally owed taxes,” Crosby said. “What has changed this year is that frustration with Congress has boiled over and Justice Kennedy opened the door to states adopting—for the first time—economic presence statutes for sales taxes.”

States enforcing this standard haven't been shy about their intention to invite litigation, hoping a case will wind to the Supreme Court and ultimately overturn Quill. And, thus far, retailers have granted their wish in two states.

Alabama, which took the lead by adopting its regulation months after Kennedy's concurrence, received its long-awaited lawsuit when online retailer Newegg, Inc. brought the first challenge in June ( see more information at the bottom of this report) (115 DTR H-1, 6/15/16).

South Dakota's new statute came under review in competing cases filed late April, one by the Department of Revenue and the other by associations representing e-commerce businesses and catalog mailers ( see more information at the bottom of this report) (121 DTR H-1, 6/23/16).

Joe W. Garrett Jr., deputy co-commissioner for the Alabama Department of Revenue, told Bloomberg BNA June 14 that the end goal behind the regulation was to trigger a case with “legs to reach the U.S. Supreme Court.”

“This is the beginning,” he said, describing the appeal as the first step in answering Kennedy's call. “This is not by any means the end.”

Other states have joined the chorus. The Tennessee Department of Revenue recently proposed Rule No. 1320-05-01-.129, which would impose collection obligations on remote retailers with more than $500,000 annual in-state sales. And Vermont enacted an economic nexus regime mirroring South Dakota's thresholds—but deferred the effective date until the laterof July 1, 2017, or the “first day of the first quarter after a controlling court decision or federal legislation abrogates the physical presence requirement” in Quill.

More Challenges Forming

Several out-of-state vendors have already registered to collect sales tax in South Dakota: 89 sales tax licenses have been issued under S.B. 106. Many have agreed in Alabama as well, including Amazon.

This voluntary compliance may encourage other states to adopt a similar model. Saying that Kennedy's concurrence “has lead to a complete rethinking regarding what is possible,” Crosby expects the trend toward economic nexus through regulation or statute will continue into 2017.

Utah is already looking ahead to a potential bill that tracks South Dakota's law, after three bills implementing affiliate nexus and reporting requirements died this session.

“The intent is to draft a bill that will enhance the prospect of overturning Quill with the courts,” Utah Sen. Curtis Bramble (R) told Bloomberg BNA June 30. “In other words, our intent will be to mount a direct challenge to Quill, which is what South Dakota did.”

The obstacle to Utah's efforts wasn't necessarily a lack of support or votes, but rather was rooted in concerns voiced by bloggers amid the threat of Amazon terminating affiliate contracts, as the company has done in other states (65 DTR H-2, 4/5/16).

But, as the national movement is accelerating, Bramble is confident that a future South Dakota-type bill will move forward in 2017.

And with increasing frustration toward Rep. Robert Goodlatte (R-Va.), who many identify as the obstruction to congressional action, Utah will likely not stand alone in launching a Quill attack next year.

“If we can't get Goodlatte to do his job, then the alternative is to have the courts do theirs,” said Bramble, who is also president of the NCSL, which plans to double its efforts encouraging more state legislatures to bring challenges.

Goodlatte hasn't yet formally introduced his Online Sales Simplification Act, though he disseminated bullet points and talking points in May. Many have accused him of withholding other proposals from the House floor, including the Remote Transactions Parity Act sponsored by Rep. Jason Chaffetz (R-Utah), which has more than 50 co-sponsors.

Resolution Through Reporting?

Utah Rep. Mike McKell (R) also noted that his state is watching the status of Colorado's reporting law, and whether it may prove effective someday.

Reporting laws have generated more attention in the wake of the Tenth Circuit's decision, although Crosby said that this is likely not the “ultimate solution” for most legislatures. Of the states that jumped on the bandwagon in 2016, many passed their reporting laws in conjunction with other nexus provisions.

Louisiana crafted a Colorado-style law, requiring both consumer notification and annual reporting to the department of revenue, so long as the remote retailer generates more than $50,000 from annual in-state sales.

Oklahoma and Vermont enacted their own vendor notification requirements, but veered away from mandating disclosure to state tax authorities. And Vermont's law doesn't take effect until the earlier of July 1, 2017, or the first day of the first quarter that Colorado implements its law challenged in DMA.

“The states are hoping that requiring nonregistered remote sellers to notify customers of their use tax obligations will encourage these customers to become more compliant, which will bring in additional revenue to the state,” Yesnowitz said. “However, notification to purchasers without a follow-up report to the state tax authorities is unlikely to achieve the goal of increased compliance.”

With use tax compliance at only 4 percent, and a tax collection deficit approximating $300 million, Oklahoma's new law offers remote retailers the choice of voluntarily collecting or providing customers with an annual sales statement (97 DTR H-1, 5/19/16).

Earlier critics cited privacy concerns as a reason to exclude the extra step of notifying the state tax commission, contemplated in the bill's original version. Caldwell described it as “one, if not the most broad, interpretation of nexus in the country.”

The enacted regime was part of an overall compromise—responding to resistance arising from a perceived “tax increase,” potential constitutional challenges and general competitiveness among online retailers—that Caldwell predicts will be effective, even if not perfect.

“If someone wasn't paying their income tax, and the state made them start paying it, we wouldn't view that as a tax increase,” he said, explaining the objective as leveling the playing field for Oklahoma-based businesses subject to the transaction tax. “We would view that as enforcing a tax law that is already on the books.”

And while the law may not produce total compliance, there is optimism for a healthy increase in use tax collections. Amazon supported the law as passed, which may forecast its intention to collect—and prompt other remote retailers to follow its lead.

“Just like today is different than yesterday, two or three years from now I'm sure there will be a lot of changes in that period of time too,” Caldwell said, anticipating the legislature will revisit the law after it plays out for a few years. “And maybe courts will give us some extra guidance on which direction we need to be going.”

Circling Back to Affiliate

Although not a direct assault on Quill, and perhaps lacking the buzz surrounding the economic nexus and reporting regimes, affiliate and click-through laws also still serve as a solution for some states. Louisiana enacted an affiliate and click-through law this year.

A challenge to Alabama’s remote seller tax rule could face review in four separate courts before getting a chance at a U.S. Supreme Court hearing—the Alabama Department of Revenue’s ultimate goal.

Online retailer Newegg appealed a sales tax assessment to the Alabama Tax Tribunal June 8, contesting the state’s new rule that sizeable out-of-state retailers must collect and pay sales tax on shipments into the state.

The odds of Alabama officials ultimately succeeding at rewriting federal tax law via the courts aren’t good, according to Will Sellers, a state and local tax attorney with Balch & Bingham.

“I’m not sure how Las Vegas would handicap this, but I’d say the state has a pretty big hill to climb,” he told Bloomberg BNA.

Whichever side loses the challenge at the Alabama Tax Tribunal level will have the option of appealing to the Montgomery County (Ala.) Circuit Court, Bruce Ely, tax partner with Bradley Arant Boult Cummings LLP, told Bloomberg BNA.

From there, appeals could go directly to the Alabama Supreme Court or make an intermediary stop at the Alabama Court of Civil Appeals first. Only after an Alabama Supreme Court ruling would Newegg or the Alabama DOR be ready to seek certiorari at the U.S. Supreme Court.

“This could take a while,” Ely said, predicting that tax tribunal Chief Judge Bill Thompson will carefully study the case before making a decision. Then he expects the losing party to appeal to circuit court, which offers a trial de novo.

As an executive branch judge, Thompson lacks the ability to declare a statute unconstitutional on its face, although he could rule the state’s pre- Quill economic nexus statute or the DOR’s regulation unconstitutional as applied to Newegg, Ely said.

“I’m not sure he can grant the taxpayer all the relief they’re requesting, even if he agrees with them,” he said.

Thompson could void the Alabama DOR’s remote seller rule on the basis that it isn't authorized by Alabama’s sales and use tax statutes, without even addressing the constitutional question, Sellers said.

Ely predicted that many will watch to see what happens with the Newegg case, rather than launch their own fight against the remote seller rule. Other out-of-state retailers facing assessments could opt to appeal them to the tax tribunal and ask to have their cases stayed pending the outcome of the Newegg challenge.

“I don’t expect to see a flurry of other cases filed in Alabama unless the Department of Revenue issues a flurry of assessments,” Ely said.

By Chris Marr in Atlanta. Contact him at cmarr@bna.com

Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.

July 1 — The battle over South Dakota's online sales tax is proceeding down two separate paths that are potentially leading to the U.S. Supreme Court.

In late April, two complaints were filed one day apart in the South Dakota Sixth Judicial Circuit, seeking competing judgments over the constitutionality of S.B. 106. Procedural tactics have split the cases into two jurisdictions, with one pending in South Dakota state court and the other pending in federal district court. Both have the potential to lead to the high bench.

An appeal from any final ruling in the circuit court would proceed directly to the South Dakota Supreme Court, as there is no intermediate appellate level in the state. From there, a final ruling would allow a party to file a petition for a writ of certiorari with the U.S. Supreme Court.

All retailers named as defendants in the Department of Revenue's case—Wayfair Inc., Overstock.com, Inc. and Newegg Inc.—removed the matter May 25 from state court to the U.S. District Court for the District of South Dakota. The federal court approved a briefing schedule June 29, setting parallel deadlines for two opposing submissions—the retailers' motion for summary judgment and the DOR's motion to remand the case to state court. Briefing will conclude by Aug. 26.

Should the federal district court retain jurisdiction, and rule on the merits, an appeal would be available before the Eighth Circuit Court of Appeals. The losing party could then seek certiorari with the high court.

“The defendant retailers believe that the federal court is clearly the proper forum to hear the case and that the statute is, as acknowledged by the State, plainly at odds with existing Commerce Clause jurisdiction,” Matthew Schaefer, partner with Brann & Isaacson, told Bloomberg BNA in a June 29 e-mail. Brann & Isaacson are counsel for the remote retailers, as well as American Catalog Mailers Association (ACMA) and NetChoice in the sister case.

In the pending state court case, the DOR secretary filed an answer June 24 responding to the complaint filed by the ACMA and NetChoice.

Schaefer explained that the DOR Secretary “has raised a number of issues in the state Circuit Court that would need to be resolved before the matter would be ripe for an appeal.”

The secretary disputes the court's jurisdiction as well as ACMA's and NetChoice's standing to bring suit. However, Schaefer said that ACMA and NetChoice “are confident that the suit was properly brought against the Secretary and that the Circuit Court has jurisdiction.”

By Jennifer McLoughlin in Washington. Contact her at jmcloughlin@bna.com

Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.

From information gathered by Bloomberg BNA, most states have a form of affiliate or attributional nexus, blurring the bright-line boundaries of Quill by targeting companies of common ownership, related parties engaged in a similar line of business and arrangements where a remote vendor benefits from an in-state affiliate's services—among other approaches. And 20 states have click-through nexus laws, although some, such as Pennsylvania and New Mexico, enforce click-through nexus through administrative policy.

“Affiliate, click-through and other attributional nexus approaches are crafted to arguably fit within existing Supreme Court jurisprudence,” Crosby said. “Some state legislatures are more comfortable with this approach than directly challenging existing precedent.”

More commonplace than the economic nexus and reporting regimes, they also haven't incited the same controversies.

Case law “combined with changing e-commerce strategies that involved greater presence in states by affiliates (e.g., distribution centers) led to a conclusion on the part of taxpayers that entity isolation was not going to be a winning strategy in the longer term,” Crosby said. “ ‘Click through' nexus was a novel concept, and thus litigation was expected, but in the wake of the NY court decisions several years ago, this issue too has waned.”

However, Behlke explained that the popularity of affiliate and click-through regimes may be fading, given that many states haven't realized the expected tax collections. States are searching for more aggressive measures to “get that little bigger piece of the pie,” and as they must exercise political capital, are aspiring to an effective, one-time legislative solution.

No National Solution

As states continue to take action, Behlke expects that economic nexus, reporting and marketplace platform bills will attract the most attention. A twist on the typical affiliate standard that may become more commonplace is imposing collection obligations on marketplace providers, such as Amazon or eBay. A 2015 New York proposal to enact marketplace legislation failed, but several states are starting to consider similar legislation.

However, a trend may not develop in the coming years should Congress or the Supreme Court take long-awaited action in resolving the Quill battle directly.

“I've been engaged on this issue for nearly two decades, and many others in the field have been at it for twice that long, so I respect the fact it has thus far eluded a clean solution,” Crosby said. “It appears to me, though, that the tide now has turned, and that states and main street retailers are closing in on the goal of full collection.”

The solution may have to come from the high court because there is little expectation that Congress will impose a national, uniform standard. States' patience has run thin with Goodlatte, in particular.

“People are saying he's making progress,” Behlke said. “No, he's moving, I'll give you that. But going backwards isn't my definition of progress.”

Bramble has long been vocal about Goodlatte's refusal to disclose the Online Sales Simplification Act in full. He recalled a meeting with the Virginia representative, also attended by Utah Gov. Gary Herbert, during which Goodlatte “said, point blank, you need to support it before I'm willing to release it.”

Expecting that Quill will ultimately fall, Bramble cautioned that continued stalling tactics may hurt the opportunity for a uniform federal resolution. Should the U.S. Supreme Court abrogate the physical presence rule, with a void of federal legislation governing the issue, states may push back on future congressional proposals, viewing them as an infringement on their independence.

“If Quill falls before there is a national solution, it will be very, very difficult to get a national solution,” Bramble said.

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

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

Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.

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