Last month, we discussed states’ efforts underway to attack Quill Corp. v. North Dakota, which provides a bright-line safe-harbor from sales and use tax collection for taxpayers without physical presence in a state. We discussed Alabama’s regulation requiring out-of-state sellers with sufficient sales to collect sales tax regardless of physical presence, as well as draft legislation circulated to the states by the National Conference of State Legislatures (NCSL).
Since then, a federal appellate court decision has given the states new ammunition. On February 22, the U.S. Court of Appeals for the Tenth Circuit issued an opinion in Direct Marketing Association v. Brohl (DMA II). The case addresses the constitutionality of a Colorado law requiring sellers without physical presence in the state to issue notices to Colorado customers regarding their tax obligations and to report to the state regarding their sales to Colorado customers, so that Colorado can then collect use tax from the customers. The challengers to the law argued, among other things, that the notice and reporting requirements violate Quill. The case had already been up to the U.S. Supreme Court to decide whether the federal courts have jurisdiction to hear the case in light of the federal Tax Injunction Act (DMA I). It was the Supreme Court’s decision on that issue that prompted Justice Kennedy’s call for the judicial system to produce a proper case to revisit Quill.
On remand, the Tenth Circuit addressed the merits of the taxpayer’s challenge. The court found the state’s notice and reporting requirements to be constitutional: mandating use tax reporting for out-of-state sellers does not burden interstate commerce. Importantly though, in coming to its decision, the Tenth Circuit refused to recognize that the holding of Quill extends beyond sales and use tax collection and liability. According to the Tenth Circuit, Quill prevents a state from requiring a seller without physical presence to collect sales and use tax, but it says nothing about a remote seller’s obligation to report the sales and use tax obligations of its purchasers.
(For a deeper discussion of the case, see Alston & Bird’s recent advisory on DMA II)
A concurring opinion by Judge Gorsuch took the critique of Quill even further. He wrote that the Supreme Court decided Quill as it did only to preserve earlier precedent (i.e., National Bellas Hess v. Illinois) and to protect taxpayers who had come to rely on it. In other words, the Supreme Court didn’t really uphold the physical-presence rule in Quill on its merits. Judge Gorsuch suggested that the ongoing efforts to diminish Quill are, ironically, part of the decision’s design:
“Quill might be said to have attached a sort of expiration date on mail order and internet vendors’ reliance interests on Bellas Hess’s rule by perpetuating its rule for the time being while also encouraging states over time to find ways of achieving comparable results through different means.”
Since the decision in DMA II, more states have made efforts to implement these “different means.” For example, the Utah Legislature has introduced legislation that would impose affiliate nexus and use tax collection on certain remote sellers. Oklahoma is considering legislation to require out-of-state sellers to collect tax under particular conditions. South Dakota has passed a measure with similarities to the NCSL’s model legislation, which, among other things, provides that a challenge to Quill will take a fast track to the state supreme court.
But is Judge Gorsuch right? Does Quill’s physical-presence rule have any practical justification? Or does the rule exist only because Supreme Court says it does? We’d like to suggest that there are very good reasons why—even today—Quill makes good sense. Quill’s opponents argue that it’s outdated. Collecting sales tax in jurisdictions across the country, the argument goes, may have been a burden for mail-order retailers fifty years ago, but with modern technology and business practices, collecting in every state is not much more difficult than collecting in one or two states.
Perhaps this is the case for some large retailers of consumer goods, but it’s not the case for many taxpayers. We continue to see clients for whom multistate sales tax collection impedes operations or acquisition transactions. Sellers of cloud computing and digital products are a good example. The sales tax rules for these products are poorly defined and vary dramatically among the states. Moreover, sellers of digital products and goods transact business across state lines routinely without expanding their physical presence to more than a few states. This leads to a situation where small and emerging technology companies can potentially rack up huge unknown and unexpected sales tax liabilities. For them, the rule of Quill dramatically reduces this risk and relieves what is a significant, and very real, burden on interstate commerce.
The courts and the states have asked Congress to act to set clear rules on multistate sales tax collection. So far, Congress has been unwilling to do so. So states have acted alone. Nonetheless, Quill is still good law—for now. But stay tuned for updates in this quickly shifting arena.