On December 12, the U.S. Supreme Court denied the petition for certiorari in Direct Marketing Association v. Brohl (Direct Marketing). As a result, the Tenth Circuit’s earlier decision in Direct Marketing will stand. In Direct Marketing, 814 F.3d 1129 (10th Cir. Feb. 22, 2016), the Tenth Circuit upheld a Colorado law requiring out-of-state retailers with no physical presence in Colorado to either voluntarily collect sales tax or comply with substantial notice and reporting requirements. At least arguably, the Colorado statute at issue represents yet another attempt by a state to circumvent the physical presence requirement imposed by the U.S. Supreme Court on a state’s ability to impose its tax collection obligations on an out-of-state entity. After the U.S. Supreme Court’s refusal to hear Direct Marketing, the Tenth Circuit’s decision to uphold the law is now binding authority on all states within the Tenth Circuit. The decision to uphold the law could substantially increase retailer’s tax compliance obligations, especially if other states follow suit with Colorado.
In 2010, Colorado enacted an aggressive law with the goal of assisting the state in collecting the sales and use tax. Realizing it could not require out-of-state retailers without a physical presence in Colorado to collect sales or use tax from Colorado purchasers, the law instead imposed notice and reporting requirements on out-of-state retailers who do not voluntarily collect the sales tax. Those requirements include: (1) sending a “transactional notice” to purchasers informing them that they may be subject to Colorado’s use tax, (2) sending Colorado purchasers who buy goods from the retailer totaling more than $500 an “annual purchase summary” with the dates, categories, and amounts of purchases, reminding purchasers of their obligation to pay use taxes on those purchases, and (3) sending the Colorado Department of Revenue an annual “customer information report” listing their customers’ names, addresses, and total amounts spent.
Challenging the Colorado Law: Direct Marketing Association v. Brohl
In Direct Marketing Association v. Huber, 2012 BL 84914 (D. Colo. 2012), retailers argued the Colorado law was unconstitutional under the Commerce Clause. The district court agreed with the retailers, striking down the Colorado law on two grounds. First, the court held the law was unconstitutional under the dormant Commerce Clause because it “directly regulate[s] and discriminates against out-of-state retailers, and therefore, interstate commerce.” It said the law facially discriminated against out-of-state retailers by imposing additional notice and reporting requirements that Colorado does not impose on in-state retailers. Second, the court said the law was also unconstitutional under Quill v. North Dakota’s “substantial nexus” requirement. In Quill, the U.S. Supreme Court held that in order to impose state tax obligations on an out-of-state retailer, there must be some substantial nexus between the retailer and the taxing state. For there to be a substantial nexus between a retailer and a taxing state, the retailer must have some physical presence within the state. The Colorado law imposed tax obligations on out-of-state retailers who lacked a physical presence in Colorado. Therefore, the court said it was unconstitutional under Quill because there was no substantial nexus between Colorado and the out-of-state retailers. Thus, the district court struck down the Colorado law as unconstitutional because it both facially discriminated against out-of-state retailers and violated Quill by placing an undue burden on interstate commerce by imposing tax collection obligations on retailers who lacked a substantial nexus with Colorado.
On appeal, however, the Tenth Circuit reversed the district court's ruling on both grounds. First, the Tenth Circuit held the Colorado use tax law does not discriminate against interstate commerce, either facially or in practical effect. The Tenth Circuit said the law does not facially discriminate against out-of-state retailers because it does not make geographical distinctions between in-state and out-of-state retailers. Rather, the law distinguishes between retailers who collect the use tax and retailers who do not collect the use tax. Therefore, it is not facially discriminatory. Furthermore, the Tenth Circuit said the law does not discriminate in practical effect because the differential treatment of collecting and non-collecting retailers does not give in-state retailers a competitive advantage. Differential treatment alone is not enough for a law to unconstitutionally discriminate against interstate commerce. To be unconstitutional, the differential treatment must give in-state retailers a competitive advantage. The Tenth Circuit said the Colorado law does not give in-state retailers a competitive advantage because in-state retailers are still required to actually collect a sales tax (in-addition to complying with in-state licensing requirements), whereas out-of-state retailers are not required to collect a tax, but merely have to comply with a reporting and notice requirement. Thus, finding the law does not give in-state retailers a competitive advantage, the Tenth Circuit held the law does not discriminate against out-of-state retailers in practical effect.
After disposing of the retailer’s discrimination argument, the Tenth Circuit next addressed their undue burden argument under Quill. The Tenth Circuit distinguished the Colorado law from the law in Quill, narrowly interpreting the U.S. Supreme Court’s application of Quill. The Tenth Circuit said that the law at issue in Quill required out-of-state retailers to collect sales and use tax and remit the tax to the state. In contrast, the Colorado law does not impose a collection requirement, but rather, only imposes a notice and reporting requirement on out-of-state retailers. The Tenth Circuit said that Quill only applied to the narrow context of tax collection, and therefore refused to apply Quill to Colorado’s notice and reporting requirements. In turn, because the Tenth Circuit refused to apply Quill, it did not apply Quill’s physical presence test to the law. Unconstrained by Quill, the Tenth Circuit held that Colorado may impose its sales and use tax notice and reporting requirements on out-of-state retailers who lack a physical presence in Colorado.
Going Forward: What Effects Direct Marketing May Have on Out-of-State Retailers
After declining to hear Direct Marketing, the Supreme Court still has not addressed the issue of state tax nexus since Quill. The Supreme Court’s refusal to hear Direct Marketing could lead to problematic consequences for taxpayers. Since Quill, state legislatures have continued to enact aggressive laws aimed at circumventing Quill’s nexus requirement. Despite several opportunities to do so, the Supreme Court has declined to hear any other nexus cases since its 1992 decision in Quill. The Supreme Court seems hopeful that Congress will instead enact legislation in this area. Further inaction by the Supreme Court, in the absence of Congressional intervention, will leave decisions such as Direct Marketing in place and possibly encourage both states and courts to take similar action.
The immediate impact of the Supreme Court’s refusal to hear the case is that Colorado—along with the other five states in the Tenth Circuit—may now impose aggressive sales and use tax obligations on out-of-state retailers who lack a physical presence in the state. Going forward, however, this decision could have much larger ramifications. States outside of the Tenth Circuit could view the Supreme Court’s inaction in Direct Marketing as an implied “green light” to enact increasingly aggressive legislation that further circumvents Quill’s constitutional constraints. Accordingly, in the rapidly changing landscape of state and local taxation, retailers should stay well-informed and mindful of their state tax compliance obligations.
If you have any questions regarding this sales tax issue, please contact one of the authors of this blog post. David Colmenero and Paul Budd can be reached by phone at (214)744-3700 or by email at email@example.com and firstname.lastname@example.org.