There have been several recent developments in the continuing efforts by states to make out-of-state Internet retailers collect and remit sales taxes.
Brick-and-mortar retailers are required to collect sales taxes. However, where an out-of-state Internet seller ships goods into the state but has no other in-state contacts, the transaction is not subject to sales tax. The recipient of the goods is supposed to pay a use tax in the same amount. Commercial enterprises are subject to state sales and use tax audits and generally comply, but individual purchasers seldom do. Brick-and-mortar retailers believe that this gives Internet retailers an unfair advantage. Many cash-strapped states would like to require the Internet sellers to collect and remit the use tax, rather than relying on their own residents to comply.
The problem for states stems from Quill Corp. v. North Dakota, 504 U.S. 298 (1992), in which the U.S. Supreme Court held that a state could not require an out-of-state mail order company to collect use tax unless the company had “substantial nexus,” generally interpreted to require a physical presence, in the state. The Court made it clear that Congress could limit or abolish this restriction at will, but Congress has not done so, despite agreement by many states to apply uniform and simplified rules to make the collection process easier.
States have therefore looked for ways to work around Quill, such as finding nexus through in-state affiliates of the Internet retailer. For example, there are thousands of “affiliate” Web sites that link to Amazon.com. New York passed a law that said that any of those sites located in New York would be presumed to be soliciting, not just advertising, for Amazon unless shown to the contrary. If any one such site engaged in solicitation by actively encouraging its readers to use Amazon, rather than passively including an Amazon advertisement, that could provide a basis to tax Amazon on its New York sales under the U.S. Supreme Court’s decision in Scripto, Inc. v. Carson, 362 U.S. 207 (1960) (solicitation by independent contractors in state provides sufficient nexus). In November 2010, an intermediate New York court delivered an opinion in Amazon.com, LLC v. New York State Department of Taxation and Finance, upholding the law against Amazon’s facial challenges but remanding to the trial court to develop the record as to whether it was unconstitutional as applied to Amazon. Some other states have enacted similar laws. The latest state legislature to pass such a law was Illinois earlier this month; as of this writing, the bill is awaiting action by the governor.
Many states have read the Quill restrictions as limited to sales and use taxes, not income taxes. In December, the Iowa Supreme Court held that there was sufficient nexus to impose a state income tax by reason of use of the taxpayer’s intellectual property by franchisees in the state. KFC Corp. v. Iowa Dep’t of Revenue, 2010 Iowa Sup. LEXIS 149. As one basis for its decision, the court stated that “we conclude that the Supreme Court would likely find intangibles owned by KFC, but utilized in a fast-food business by its franchisees that are firmly anchored within the state, would be regarded as having a sufficient connection to Iowa to amount to the functional equivalent of ‘physical presence’ under Quill.” Arguably, this same basis of decision could be put forward in a sales or use tax case.
The U.S. Supreme Court has steadfastly refused to revisit the area since Quill, but it is possible that an Amazon-type case or one adopting an aggressive version of KFC would be granted certiorari. Outright reversal of Quill, however, is unlikely. The three justices who heard Quill and are still on the Court (Scalia, Kennedy, and Thomas) all emphasized the substantial reliance that had grown up around the physical presence requirement and believed that stare decisis was determinative. Assuming that they have the same view today, it would be necessary, to overturn Quill, to pick up 5 of the 6 remaining votes. However, possibly the outer limits of Quill could be clarified.
Content for this post was provided by Howard Weinman, a tax partner in the Washington, DC office of Crowell & Moring.
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