Out-of-state retailers without a substantial connection (nexus) to Colorado are not required to collect or remit Colorado sales tax or file returns. Yet taxable transactions are not suddenly exempt: Residents are required to remit consumer’s use tax if the retailer doesn’t collect sales tax at checkout. Unfortunately, most don’t, and it’s difficult for the state to enforce compliance.

To solve this conundrum, the Colorado Department of Revenue created a use tax notification requirement under which non-collecting out-of-state sellers must annually report their sales to Colorado residents to the Colorado Department of Revenue and to the residents themselves. Shortly after the reporting requirement was imposed in 2010, the Direct Marketing Association (DMA) challenged the law in federal district court, accusing it of violating the U.S. Constitution’s Commerce Clause and creating an undue burden on remote retailers. The court ruled in favor of DMA and placed an injunction on the reporting requirement.

That decision was reversed by the Tenth Circuit Court of Appeals, which determined the lower court lacked the jurisdiction to decide the case, and DMA appealed to the United States Supreme Court. In March 2015, the Supreme Court held that the Tax Injunction Act “does not bar the petitioner’s suit” and kicked the case back to the appeals court, which in February 2016 found the use tax notification requirements to be legal (Direct Marketing Association v. Brohl).

A challenge to Quill

One of the most interesting developments in the Colorado case arose from the concurring opinion penned by Supreme Court Justice Anthony Kennedy, in which he suggests it may be time to overturn the court’s decision in Quill Corp. v. North Dakota (1992). In Quill, SCOTUS affirmed an earlier decision (National Bellas Hess, Inc. v. Department of Revenue of Ill.) that vendors lacking a physical presence in a state lack substantial nexus and therefore cannot be compelled to collect tax. He wrote:

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 mail or the Internet. …

Because of Quill and Bellas Hess, States have been unable to collect many of the taxes due on

[e-commerce sales]. …

[I]t is unwise to delay any longer a reconsideration of the Court’s holding in Quill. A case questionable even when decided, Quill now harms States to a degree far greater than could have been anticipated earlier. … It should be left in place only if a powerful showing can be made that its rationale is still correct.”

Since that decision, states have been forming a line to overturn Quill. Several, including Alabama and South Dakota, have instituted economic nexus policies that challenge the physical presence requirement upheld in Quill. Litigation is pending over the South Dakota and Alabama policies, and if given the opportunity, both states intend to take their cases to the Supreme Court. Colorado may beat them there.

In late August 2016, the DMA asked the U.S. Supreme Court to review the Tenth Circuit Court of Appeals’ decision in Direct Marketing Association v. Brohl (Brohl II) (petition). It would like the court to consider the following three questions:

  1. Whether a state statute that imposes regulatory obligations that apply, as a matter of law, solely to out-of-state companies, but does not use “language explicitly identifying geographical distinctions” in its text, discriminates against interstate commerce?
  2. Whether the Tenth Circuit erred in adopting a “comparative burdens” test for discrimination, under which the burden of regulatory requirements imposed solely on out-of-state retailers may be offset by different obligations imposed on in-state retailers?
  3. Whether the Tenth Circuit erred in concluding that out-of-state retailers that do not collect Colorado sales tax are “not similarly situated” to their direct instate competitors who collect Colorado sales tax?

Colorado, in turn, filed its own Conditional Cross-Petition for Writ of Certiorari in October, asking simply, “Should Quill be overturned?” If the court agrees to review the case, Colorado asks that it:

  • “Reframe the questions presented in DMA’s petition”
  • “Take this opportunity to revisit Bellas Hess and Quill”

The state claims that “the doctrinal underpinnings of Quill have always been, and continue to be, dubious.” Furthermore, the holding in Quill is no longer relevant because of the “explosion of e-commerce and availability of technological solutions to ease tax collection burdens.”

How these challenges to Quill will play out is anyone’s guess, especially with an understaffed Supreme Court. If Congress intervenes and enacts one of online sales tax measures awaiting consideration, the Supreme Court may not need to take on the issue. Yet until either the Supreme Court or the federal government intervenes, states are likely to continue to enact policies that define nexus more broadly in an attempt to garner internet sales tax revenue, and those policies will undoubtedly be challenged.

Retailers relying on tax automation software to calculate, file, and remit sales tax are well positioned to respond to any eventuality. Learn more about automating sales tax compliance.

photo credit: dog97209 US Supreme Court Washington DC via photopin (license)