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BDO USA's Scott Smith and Todd Faciana contemplate a question that has been less emphasized during the rush to topple the U.S. Supreme Court's foundational standard for when states may impose sales and use taxes on remote sales: What happens for direct taxes if the Quill physical presence standard is gutted in favor of an economic presence standard? The authors say any economic presence nexus standard based on in-state sales thresholds, standing alone, should be viewed as suspect even under state court decisions finding a significant economic presence constitutes substantial nexus.
By Scott D. Smith and Todd Faciana
Scott D. Smith, J.D., LL.M., is a Managing Director and National Technical Practical Leader, State and Local Taxes, for BDO USA, LLP. He can be reached at email@example.com. Todd Faciana, J.D., LL.M., C.P.A., is a Senior Manager in the State and Local Tax Practice of BDO USA, LLP, located in the Philadelphia office. He can be reached at firstname.lastname@example.org. The views expressed in this article are solely those of the authors and do not reflect the views or opinions of BDO USA, LLP.
The decades old debate about whether Quill is limited to sales and use taxes and, if so, whether an economic presence nexus may constitute “substantial nexus” under the Commerce Clause for purposes of direct taxes (e.g., net income and gross receipts taxes) is well-documented. This article will not add any more to that discussion. Instead, this article takes a slightly different direction. What happens for purposes of direct taxes if or when the U.S. Supreme Court overturns Quill in favor of an economic presence standard? Simply overturning Quill does not address the level of economic presence that would be required to constitute substantial nexus under the Commerce Clause. Further, the sales thresholds under economic factor-presence nexus statutes are substantially less than the amount of sales some state courts have held constitute a “significant economic presence” sufficient to establish substantial nexus. And the arbitrary thresholds under economic factor-presence nexus statutes could restore the relevance of the Due Process Clause as a limitation on a state's taxing jurisdiction. After all, a taxpayer must meet the seemingly forgotten Due Process Clause “minimum contacts” standard to have nexus with a state, even if Commerce Clause nexus is satisfied.
The article will address these issues in a hypothetical post- Quill world. The article will also address the consequences of economic factor-presence nexus statutes in light of another state income tax trend—market-based sourcing apportionment. The combination of both trends could have significant state income tax consequences for taxpayers. Last, the article will discuss how economic factor-presence nexus statutes are now being extended to sales and use taxes, which, no doubt, violates the physical presence requirement under Quill and raises Due Process concerns similar to direct taxes.
To withstand scrutiny under the U.S. Supreme Court's dormant Commerce Clause limitations on state taxation, a state tax must satisfy a four-prong test: (1) the tax must not discriminate against interstate commerce; (2) it must be fairly apportioned; (3) the taxpayer must have a substantial nexus with the state; and (4) the state tax must be fairly related to services provided by the state. Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). In the United States Supreme Court's 1992 opinion in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), the Court re-affirmed that a taxpayer's physical presence in a state is necessary to satisfy the substantial nexus requirement, at least for purposes of a sales and use tax collection and remittance responsibility. Despite Quill, an increasing number of states assert that economic presence may establish nexus for purposes of direct taxes, including “bright-line” economic factor-presence nexus statutes based on a threshold amount of in-state sales. These statutes are typically tied to a state's sales factor sourcing rules.
Economic presence nexus traces its origins to Geoffrey, Inc. v. South Carolina Tax Comm'n.,437 S.E. 2d 13 (S.C. 1993). In Geoffrey, the South Carolina Supreme Court held that a taxpayer with no physical presence in South Carolina, but that received royalty income from its trademarks licensed for use in South Carolina, had substantial nexus with the state. To reach this conclusion, the court reasoned, in part, that Quill was limited to sales and use taxes, even though the U.S. Supreme Court has never reversed Quill, nor explicitly held that the decision is limited to sales and use taxes. Geoffrey has been followed by a significant number of courts in other states.
In a line of other cases, state courts have held that substantial nexus existed for the imposition of income tax on out-of-state banks and financial institutions having credit card or loan receivables and revenues from customers in the state, absent a physical presence. These courts introduced the concept that an out-of-state bank's significant economic presence in a state constitutes substantial nexus. See, e.g., Capital One Financial Corp. v. Hamer, No. 2012-TX-001/02 (Ill. Cir. Ct. May 11, 2015); MBNA America Bank, N.A. v. Dept. of State Revenue, 895 N.E. 2d 10 (Ind. Tax Ct. 2008); Capital One Bank v. Comm'r of Revenue, 899 N.E. 2d 76 (Mass. 2009); Tax Comm'r v. MBNA America Bank, N.A., 640 S.E. 2d 226 (W. Va. 2006) (hereinafter, the “ MBNA/Capital One cases”). For example, and most recently, in Capital One Auto Finance Co. v. Dept. of Revenue, No. T.C. 5197 (Or. Tax Ct., Dec. 23, 2016), the Oregon Tax Court held that an out-of-state financial institution that had solicited Oregon customers by mail and the Internet, and generated substantial revenue from lending and credit card activities with respect to Oregon customers, had a significant economic presence that satisfied the substantial nexus requirement of the Commerce Clause.
In 2002, the Multistate Tax Commission (MTC) adopted a proposed model statute for a factor-presence nexus standard for business activity taxes (e.g., net income and gross income taxes). Ohio was the first state to enact an economic factor-presence nexus statute in 2005 in Ohio Rev. Code §5751.01(H)(3), (i) (effective beginning on or after July 1, 2005) (Ohio sales of $500,000 or more). Eight other states have followed suit for their direct taxes: Alabama (Ala. Code §40-18-31.2 (effective for taxable years beginning on or after January 1, 2015; Alabama sales of $500,000 or more, indexed for inflation); California (Cal. Rev. & Tax. Code §23101(b) and (d) (effective for taxable years beginning on or after January 1, 2011; California's sales threshold is indexed for inflation and for 2016 is $547,711); Colorado (C.R.S. §39-22-301.1(2)(c)(iii)(E) and (F) and Colo. Reg. 39-22-301.1 (effective for taxable years beginning on or after January 1, 2010; Colorado sales of $500,000 or more); Connecticut (Conn. Gen. Stat. §12-216a(b) (effective for taxable years beginning on or after January 1, 2010; Connecticut sales of $500,000 or more); Michigan (Mich. Comp. Laws §§208.1200(1) (former Business Tax) and 206.621(1) (current corporate income tax, effective for taxable years beginning on or after January 1, 2012; Michigan sales of $350,000 or more); New York (N.Y. Tax Law §209.1(b) (effective for taxable years beginning on or after January 1, 2015; New York sales of $1 million or more); Tennessee (T.C.A. §67-4-2004(52) (effective for taxable years beginning on or after January 1, 2016; Tennessee sales of $500,000 or more); and Washington (R.C.W. §82.04.067(1)(c) (effective for taxable years beginning on or after January 1, 2010; Washington's sales threshold is indexed for inflation and for 2016 is $267,000). Alabama, California, Colorado, Connecticut, Michigan, New York, and Tennessee have enacted these statutes as part of their corporate income tax regimes. Ohio and Washington enacted factor-presence nexus statutes for purposes of their gross receipts taxes. These states also provide a factor-presence threshold based on in-state property and payroll (e.g., $50,000 each or 25 percent or the total). The use of these physical presence related factors effectively operates as de minimis physical presence standards.
Other states have also enacted economic presence nexus statutes, but without any “bright-line” factor-presence thresholds. For example, New Hampshire (N.H. Rev. Stat. Ann. §77-A:1(XII)), Oregon (Or. Rev. Stat. §318.020(2)), and Wisconsin (Wis. Stat. §71.22(1r)) have enacted such statutes.
Despite what could appear to be successes for states regarding the enactment and defense of economic presence nexus, economic factor-presence nexus statutes are susceptible to constitutional challenge on Commerce Clause and Due Process Clause grounds. And such challenges have not even begun.
The Due Process Clause is concerned about whether a taxpayer had sufficient minimum contacts with a state to satisfy notice and fairness, where the key question is whether the taxpayer had purposefully directed its activities at the state. Quill, 504 U.S. at 308. The concern of the Commerce Clause is the effect that state taxation or regulation of interstate commerce has on the national economy. Quill, 504 U.S. at 312. To that end, the purpose of the substantial nexus requirement under the Commerce Clause is to limit the reach of a state taxing authority so that interstate commerce is not unduly burdened. Quill, 504 U.S. at 313. Accordingly, the key constitutional question for purposes of the Commerce Clause's substantial nexus requirement is whether the application of economic factor-presence nexus statutes results in an undue burden on interstate commerce—a question that turns on the extent of the taxpayer's presence in a taxing state. Simply overturning Quill (or limiting the decision to sales and use taxes) does not address what amount of in-state sales constitutes substantial nexus, nor whether a taxpayer had purposefully directed its activities at the state to satisfy minimum contacts.
The taxpayer in Quill licensed a “few floppy diskettes” to its customers in North Dakota. Quill, 504 U.S. at 315, note 8. When the U.S. Supreme Court stated in footnote 8 that the taxpayer's licensing of a “few floppy diskettes” was only a “slightest presence,” but not substantial nexus, the Court acknowledged that a taxable presence under a Constitutional (or statutory) standard has a de minimis exception, even if the taxpayer has a physical presence in the state (i.e., the taxpayer in Quill had a physical presence from the diskettes, albeit a de minimis or “slightest presence”). Economic presence should not be exempted from the same “slightest presence” limitation. However, does a $500,000 or less sales threshold satisfy that “slightest presence” limitation?
The in-state sales amounts in the MBNA/Capital One cases that the courts held constituted a significant economic presence (and, thus, substantial nexus) were far in excess of the sales thresholds under any of the economic factor-presence nexus statutes. For instance, in Capital One Bank v. Comm'r of Revenue, 899 N.E. 2d 76 (Mass. 2009), receipts from Massachusetts customers consisted of $4.2 million to $6.8 million of intercharge fees annually for the two audit years, plus tens of millions in receipts from credit card receivables. In Tax Comm'r v. MBNA America Bank, N.A., 640 S.E. 2d 226 (W. Va. 2006), receipts from West Virginia customers were $8 million to $9 million for the audit period. In both cases, the financial institutions engaged in tens and hundreds of thousands of mail order and Internet solicitations of customers in Massachusetts and West Virginia. Under these facts, the state courts held that the taxpayers had a significant economic presence and, thus, a substantial nexus with the state.
Perhaps the particular facts in the MBNA/Capital One cases support a holding of significant economic presence, but they do not necessarily support the sales thresholds adopted in any of the economic factor-presence nexus statutes. Admittedly, the sales receipts in the MBNA/Capital One cases were not held by those state courts to constitute the minimum level of sales receipts that constitute a significant economic presence. Still, it is relevant to the substantial nexus analysis that the amount of in-state sales in the MBNA/Capital One cases were substantially greater than the sales thresholds in the economic factor-presence nexus statutes.
It could be argued that the sales thresholds in the economic factor-presence nexus statutes are not “significant,” based on the MBNA/Capital One cases. That is, if the U.S. Supreme Court ultimately holds that a significant economic presence or similar economic connection constitutes substantial nexus with a taxing state, the sales thresholds may not satisfy such a significant economic presence requirement. What sales threshold is significant enough? That answer is unclear. Yet, even if an adequate or “significant” sales threshold could be found, other facts or considerations should also contribute to determining if an out-of-state company has substantial nexus with a taxing state beyond the company's sales volume in that state. And here is where the Due Process Clause may take on a more significant role as a limitation on a state exercising its tax jurisdiction.
In Crutchfield Corp. v. Testa, No. 2016-Ohio-7760 (Ohio Supreme Ct., Nov. 17, 2016), the Ohio Supreme Court held that the sales threshold in Ohio's economic factor-presence nexus statute satisfied the substantial nexus requirement of the Commerce Clause. Two companion cases were decided with Crutchfield on the same day. Newegg, Inc. v. Testa, No. 2016-Ohio-7762 and Mason Companies, Inc. v. Testa, No. 2016-Ohio-7768. In these cases, the court reasoned that Quill did not impose a physical presence nexus standard for direct taxes, such as Ohio's commercial activity tax (or CAT), and as long as a state's nexus standard is based on an adequate quantitative standard, the substantial nexus requirement is satisfied. Crutchfield Corp. v. Testa, No. 2016-Ohio-7760, slip op., at 17. The court then noted that, relying on the U.S. Supreme Court's decision in Pike v. Bruce Church, 397 U.S. 137 (1970), and its “balancing test,” when applying the substantial nexus standard without the Quill physical presence requirement, a state statute “will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits.” Pike v. Bruce Church, 397 U.S. at 145-146. As such, according to the court, the CAT burden on an out-of-state seller having $500,000 or more of gross receipts from Ohio customers was not “clearly excessive” in relation to Ohio's interest in taxing the gross receipts of in-state and out-of-state sellers evenhandedly. Crutchfield Corp. v. Testa, No. 2016-Ohio-7760, slip op., at 24.
The U.S. Supreme Court's Pike balancing test “is reserved for laws ‘directed to legitimate local concerns, with effects upon interstate commerce that are only incidental.’” Philadelphia v. New Jersey, 437 U.S. 617, 624 (1978). According to the court, taxing in-state and out-of-state sellers “evenhandedly” was the local concern. Thus, at least according to the court, the CAT burden on out-of-state taxpayers with no Ohio physical presence, but with at least $500,000 of Ohio sales, is not clearly excessive in relation to Ohio's interest in not discriminating against in-state sellers (i.e., by taxing their gross receipts but not the gross receipts of remote out-of-state sellers).
Although the Ohio Supreme Court cited the MBNA/Capital One cases for support, the court did not compare the facts in these cases (and amount of in-state sales) to those in Crutchfield. Instead, the court found the quantitative standard to be adequate seemingly without justification and relied on the Pike balancing test.
It remains to be seen how much weight Crutchfield will carry in other states. The Ohio Supreme Court's use of a Pike balancing test to uphold the constitutionality of a state taxing statute is unique. The Pike balancing test appears to be confined to assessing the validity of nondiscriminatory state regulatory measures intended to promote local consumer or environmental protection, health or safety, and similar state and local regulatory measures. Although the Complete Auto four-prong test, of which substantial nexus is a prong, bears some resemblance to Pike, it is distinct from the Pike balancing test. Further, the Pike balancing test is meant for nondiscriminatory state laws that have only “incidental” effects on interstate commerce, and it is difficult to see how the assertion of a state's taxing jurisdiction statute has only an incidental effect on such commerce.
As mentioned, the Due Process Clause in the context of the exercise of a state's taxing jurisdiction is concerned about matters of notice and fairness. The Due Process Clause requires that a taxpayer have a “minimum connection” or sufficient “minimum contacts” with a state before it may impose a tax. Miller Brothers Co. v. Maryland, 347 U.S. 340 (1954). Rather than a physical presence, the Court in Quill held that due process minimum contacts is satisfied, even in the absence of a taxpayer's physical presence, as long as the taxpayer has purposefully directed its activities at a state's residents. Quill, 504 U.S. at 308. In Quill, the Court applied its Due Process Clause minimum contacts jurisprudence that it had developed to govern the exercise of jurisdiction over an out-of-state defendant to state taxes. Under Due Process Clause minimum contacts jurisprudence, the exercise of personal jurisdiction over an-out-of-state defendant in the absence of any physical connection with a state may be upheld as long as the defendant had purposefully directed activity towards the state. See Burger King Corp. v. Rudzewicz, 471 U.S. 462 (1985) (contract having a “substantial connection” with a state based on the parties prior negotiations, future actions, and actual course of dealing supported the exercise of personal jurisdiction over a defendant despite the absence of any physical connection.) When a taxpayer has purposefully directed economic activity at a state's residents, the taxpayer has the requisite notice or fair warning that its activity may be subject to tax.
Since Quill effectively made the Commerce Clause substantial nexus standard more stringent than the Due Process Clause minimum contacts standard, the Due Process Clause has declined in importance as a limit on a state's taxing jurisdiction. However, the economic factor-presence nexus statutes could revive the standing of the Due Process Clause in the context of state tax jurisdiction. This is because the arbitrary thresholds under the economic factor-presence nexus statutes may result in the assertion of taxing jurisdiction without consideration of or requiring other connections or activity in a state. This was not an issue in the referenced economic nexus cases because, for example, the taxpayers in the MBNA/Capital One cases engaged in substantial solicitation of business in the taxing states and had, undoubtedly, purposefully directed their activities toward the state. However, there will be situations where an out-of-state company may have the requisite level of sales required by the state's statute, but may not have purposefully directed any economic activity at a state's residents. For example, consider a typical drop shipment scenario:
State A asserts jurisdiction to impose its gross receipts tax when an out-of-state company has $500,000 or more of sales of goods or services to in-state residents.
Resident of State A orders a $1 million piece of equipment from out-of-state Retailer. Retailer engages in substantial solicitation of business in State A by Internet and visits by Retailer sales personnel. Retailer purchases the equipment from out-of-state Supplier and directs Supplier to ship the equipment to Resident in State A. Supplier (drop) ships the equipment from its warehouse located in State B to Resident in State A using a common carrier. Title to the equipment transfers to Retailer at Supplier's “dock” outside of State A. Assume Supplier has never solicited business from customers in State A and has no other activities directed to State A.
If Supplier's sale (to Retailer) is sourced for purposes of State A's gross receipts tax to State A, because it is the ultimate destination state for Supplier's sale of equipment to Retailer, then Supplier could have satisfied State A's economic factor-presence nexus statute even though Supplier may not have purposefully directed any economic activity towards State A residents. Although Supplier's equipment is delivered to State A (which results in Supplier's receipts from the sale sourced to State A for sales factor purposes), that connection to State A is the common carrier's, and arguably not Supplier's. Accordingly, Supplier's contract with Retailer may have no connection to State A sufficient to satisfy Due Process Clause minimum contacts nexus.
While Supplier, like the taxpayer in Quill, is purposefully shipping its products via common carrier to Retailer's customer in State A which proximately results from Supplier's contract with Retailer, Supplier could argue that the shipment of the equipment into State A was the result of the “unilateral activity of another party or third person” (i.e., Retailer). Burger King Corp., 471 U.S. at 475-76.
When state market-based sourcing rules related to sales of services and licenses of intangibles are considered, the Due Process ramifications of the enforcement of economic factor-presence nexus statutes are heightened. For instance, most states that have enacted economic factor-presence nexus statutes refer a taxpayer to the state's sales factor sourcing rules to determine whether the requisite threshold level of sales has been met. Consider this example:
State C asserts jurisdiction to impose its corporate income tax when an out-of-state company has $500,000 or more of sales of goods or services to in-state residents.
Call Center located in State A enters into a contract with Retailer located in State B to provide call center and customer services to Retailer. Retailer's customers from throughout the United States place calls to Call Center in State A. Some of the Retailer customers placing calls to Call Center are located in State C, which uses market-based sourcing for sourcing gross receipts from sales of services to the State C sales factor. State C's market-based sourcing rules require a taxpayer to apply a “look-through” rule that operates to source Call Center's services performed for Retailer to the location of the “customer of the customer” (i.e., the State C residents who placed calls to Call Center). Alternatively, a population ratio could be used as a “method of reasonable approximation” to source Call Center's gross receipts.
This example is from an example in the MTC's model market-based sourcing regulation (MTC Reg. IV.17.(d)(3)(B)3.d., Example (iv) (approved Feb. 24, 2017)) and Tennessee's market-based sourcing rule (Tenn. Admin. Rule 1320-06-01-.42(1)(b)(4)(c)2.(iii)(IV), Example 2).
As with the drop shipment supplier in the first illustration, the Call Center in this illustration has not purposefully directed any economic activity towards the customers of Retailer who are located in State C. Rather, Call Center has purposefully directed its activity towards Retailer in State B. Nonetheless, the market-based sourcing regulation used by State C results in some of Call Center's gross receipts received from Retailer for services provided to Retailer, on behalf of Retailer's customers, being sourced to State C. If the amount of Call Center's gross receipts sourced to State C exceed State C's economic factor-presence nexus sales threshold, then Call Center would be subject to State C's corporate income tax, despite having never purposefully directed any economic activity towards State C's residents. While it is foreseeable that Retailer could have customers throughout the United States and that Call Center would receive calls from customers in State C, mere foreseeability that Call Center could receive calls from (or that the benefit of its services is received in) any state, is not sufficient for minimum contacts under the Due Process Clause. World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286, 296-297 (1980); Asahi Metal Indus. v. Superior Court, 480 U.S. 102, 109 (1987).
A number of state market-based sourcing regulations include examples sourcing receipts to a state under “look-through” rules such as those in the above call center example, even though the service provider may have directed no purposeful economic activity into that state. And the operation of these rules, as demonstrated, could trigger that state's economic factor-presence nexus statute, even in the absence of any economic activity purposefully directed at a state's residents.
It appears that the states have grown discouraged by what the Streamlined Sales Tax Agreement could accomplish and the protracted (and still pending) Congressional legislation to overturn Quill and enact a federal statute authorizing states to require the collection of sales or use taxes by remote sellers. The Marketplace Fairness Act of 2015 (destination-based sourcing of remote sale) sits with the Senate Finance Committee, the Remote Transactions Parity Act of 2015 (destination-based sourcing of remote sales) has only been introduced in the House of Representatives, and the Online Sales Simplification Act of 2016 (origin-based sourcing of remote sale) has only been circulated but never introduced.
As a result, these states have sought a direct confrontation with the Quill decision in hopes of seeing it reversed .
Alabama (Ala. Admin. Code r. 810-6-2-.90.03(1)), South Dakota (S.D. Laws §10-64-2), Tennessee (Tenn. Comp. R. & Regs. 1320-5-01-.129(2)), and Vermont (Vt. Stat. tit. 32, §9701(9)(F)) have enacted economic factor-presence nexus statutes or promulgated such regulations for purposes of asserting sales and use tax nexus over remote sellers. Alabama's regulation is effective for sales occurring on or after January 1, 2016, and Tennessee's rule became effective January 1, 2017. South Dakota's statute had a May 1, 2016, effective date, unless the state filed a declaratory judgment action against a remote seller it believes had economic nexus with South Dakota. On April 28, 2016, South Dakota filed a declaratory judgment action against multiple remote sellers in state court to declare the statute valid and enforcement of the law is stayed pending the outcome. The defendant remote sellers file a notice of removal to federal district court. State v. Wayfair, Inc., et al., No. #:16-CV-03019 (D.S.D., filed May 25, 2016). On Jan. 17, 2017, the federal district court granted the state's motion to remand the case back to state court. Vermont's statute becomes effective on the later of July 1, 2017, or the first day of the first quarter after that a U.S. Supreme Court decision overturns Quill. Alabama's regulation is being challenged in the Alabama Tax Tribunal. Newegg Inc. v. Dept. of Revenue, No. S. 16-613 (Ala. Tax Trib., filed June 8, 2016). It has also been reported that Tennessee's rule is now being challenged.
These state statutes or regulations employ different sales thresholds, both compared to each other and their direct taxes counterparts: Alabama, $250,000 South Dakota, $100,000; Tennessee, $500,000; and Vermont, $100,000.
At least seven additional states, plus Tennessee, are reported to be considering economic factor-presence nexus legislation for sales and use taxes (Arkansas, Nebraska, New Mexico, Mississippi, Utah, and Wyoming). See Bloomberg BNA Daily Tax Report, “At Least Six States Mull Bills on Remote Sales Tax Collection,” 11 DTR H-4 (Jan. 18, 2017). Tennessee's rule is included in the Omnibus Rules Bill (“ORB”) that is filed each year with the Tennessee Legislature approving all rules that were adopted by the Department of Revenue in the prior year. There is the possibility that an amendment to the ORB could be proposed to disapprove the factor-presence nexus rule that, if passed, would effectively delete the rule, but other legislators (and Governor Haslam) support the rule. The Mississippi Department of Revenue has issued a proposed rule using a $250,000 sales threshold for “substantial economic presence” (that is proposed to apply retroactively if a remote seller with a “substantial economic presence” does not voluntarily register for Mississippi sales tax by July 1, 2017.) Arkansas S.B. 100 recently passed the Arkansas Senate and is pending in the House of Representatives. It would establish a $100,000 sales threshold.
One rationale for the physical presence standard upheld in Quill was the burdensome task of complying with thousands of state and local taxing jurisdictions imposing sales and use taxes. This begs the question of whether the sales thresholds for sales and use tax economic nexus purposes should be established at a substantially higher level. Further, while the U.S. Supreme Court in Quill removed a physical presence requirement for minimum contacts nexus under the Due Process Clause and the Court held the taxpayer had such minimum contacts nexus, the taxpayer in Quill had “almost $1 million” of sales to 3,000 North Dakota customers for the sole tax period at issue in the case. Quill, 504 U.S. at 302.
Undoubtedly, many states and other opponents of the Quill decision were encouraged by Associate Justice Kennedy's concurring opinion in Direct Marketing Ass'n, v. Brohl, 575 U.S. , 135 S.Ct. 1124 (2015) (“Brohl II”). In his concurring opinion, Justice Kennedy intimated that it could be time to overturn Quill:
There is a powerful case to be made that a retailer doing extensive business within a State has a sufficiently ‘substantial nexus' to justify imposing some minor tax-collection duty, even if that business is done through the mail or the Internet… This argument has grown stronger and the cause more urgent with time. 135 S.Ct. at 1135 (Kennedy, J., concurring) (emphasis added).
Justice Kennedy did not elaborate on the factors or measure for determining when business in a state is sufficiently “extensive” to constitute substantial nexus.
Given Justice Kennedy's concurring opinion in Brohl II, some states and commentators hoped that a possible return of Direct Marketing Ass'n v. Brohl, No. 12-1175 (10th Cir., Feb. 22, 2016) (“Brohl III”), to the U.S. Supreme Court would open the door for the Court to reconsider Quill. However, on December 12, 2016, the Court declined to issue a writ of certiorari to either party and will not consider the case. The Court denied the petition seeking review of Colorado's use tax notice and reporting law, Direct Marketing Ass'n v. Brohl, No. 16-267, and also denied Colorado's petition seeking review to overturn Quill, Brohl v. Direct Marketing Ass'n, No. 16-458.
However, similar to direct taxes, overturning the physical presence requirement of Quill is only one part. Again, should the U.S. Supreme Court in a future case overturn the physical presence requirement, the states and their current sales thresholds may not be significant or extensive enough to constitute substantial nexus. Although the MBNA/Capital One cases dealt with income tax, the significant economic presence found in those cases substantially exceeded the $100,000, $250,000, and $500,000 sales thresholds being imposed by the economic nexus states for sales and use tax purposes. It will take more than overturning a physical presence test. The economic presence test that replaces it must still constitute a substantial nexus, and the sales and use tax sales thresholds, like their income tax counterparts, may be too low and do not require any other economic connections or activity with or directed to a state beyond a certain threshold of sales. Further, the Due Process ramifications will be heightened.
In another twist, Justice Kennedy's concurring opinion in Brohl II can be contrasted with Circuit Judge Gorsuch's concurring opinion in Brohl III. On January 31, 2017, President Trump nominated Judge Gorsuch to fill the vacant seat on the U.S. Supreme Court caused by the death of Associate Justice Scalia in February 2016. While Justice Kennedy appears ready to overturn Quill, Judge Gorsuch's concurring opinion in Brohl III suggests he could retain the precedent of Quill or limit the decision to sales and use taxes as have the states.
Given all this, respect for Quill's reasoning surely means we must respect the Bellas Hess rule it retained. But just as surely it means we are under no obligation to extend that rule to comparable tax and regulatory obligations.” Brohl III, slip op., at 5 (Gorsuch, C.J., concurring).
In his Brohl III concurring opinion, Judge Gorsuch viewed the holding in Quill as not based on the physical presence test protections for out-of-state companies from the tax burdens of thousands of taxing jurisdictions, but on “the doctrine of stare decisis and the respect due a still earlier decision.” Brohl III, slip op., at 4 (Gorsuch, C.J., concurring). However, caution should be exercised in taking Judge Gorsuch's view of the precedential respect due Quill too far. As a federal circuit court of appeals, Judge Gorsuch felt the court of appeals was circumscribed from overturning precedent of the U.S. Supreme Court, and he suggested that “… Quill's very reasoning – its ratio decidendi – seems deliberately designed to ensure that Bellas Hess’s precedential island would never expand but would, if anything, wash away with the tides of time.” Brohl III, slip op., at 9 (Gorsuch, C.J., concurring).
Perhaps Crutchfield, or some other future state court decision, will get to the U.S. Supreme Court, testing the viability of Quill in a more modern economy. Nonetheless, as discussed, it should take more than just overturning a physical presence requirement. Any economic presence nexus standard must be sufficient enough to constitute substantial nexus, and the taxpayer's contacts with the state must also satisfy the Due Process Clause. Accordingly, the sales thresholds of the states' economic factor-presence nexus statutes, standing alone, should be viewed as suspect even under the state court decisions finding a significant economic presence constitutes substantial nexus.
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