On February 22, 2016, the US Court of Appeals for the 10th Circuit (“Tenth Circuit”) upheld the constitutionality of Colorado’s use tax notice and reporting requirements imposed on out-of-state retailers in Colo. Rev. Stat. § 39-21-112(3.5) and the regulations thereunder (collectively the “Colorado Law”). Direct Marketing Association v. Brohl, Dkt. 12-1175 (10th Cir. 2016) (“DMA I”). The Direct Marketing Association (“DMA”), an industry group of businesses and organizations that market products via catalogs, advertisements, broadcast media and the Internet, challenged the Colorado Law, claiming that the notice and reporting requirements violated the Commerce Clause by discriminating against out-of-state retailers and unduly burdening interstate commerce. The Tenth Circuit found that the Colorado Law does not violate the Commerce Clause on either ground. The court also held that the bright-line physical presence nexus standard established by the US Supreme Court in Quill v. North Dakota, 504 U.S. 298 (1992), only applies to sales and use tax collection and not to the use tax notice and reporting requirements imposed by the Colorado Law, meaning that such requirements of the Colorado Law could be imposed on retailers without a physical presence in Colorado.

Assuming an appeal of DMA I is forthcoming, if this decision was ultimately upheld, the sales and use tax landscape would be anticipated to shift dramatically, as other states would likely enact similar use tax notice and reporting laws designed to significantly increase use tax compliance. But even if that were the case, the impact to taxpayers would likely pale in comparison to the effect of actually overturning Quill and allowing states to impose sales and use taxes on companies without an in-state physical presence.

Although the substantive matter before the Tenth Circuit in DMA I does not seek to overturn Quill, an earlier review by the U.S. Supreme Court, relating to the inapplicability of the Tax Injunction Act to the federal district court review of the Colorado Law, has raised the issue as a possibility. Direct Marketing Association v. Brohl, Dkt. 13-1032 (U.S. 2015) (“DMA II”). For a further discussion, please see prior Tax News and Developments article, US Supreme Court Grants Certiorari in Direct Marketing Association (Vol. XIV, Issue 4, August 2014). Specifically, Justice Kennedy’s concurrence to DMA II advocates for a review of Quill, stating, “Given these changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill. . . . [Quill] should be left in place only if a powerful showing can be made that its rationale is still correct.”  Some states, namely Alabama and South Dakota to date, have recently taken action to challenge the physical presence standard itself and make this precise reconsideration of the physical presence nexus standard seemingly inevitable.

To further appreciate these implications, the following is a high-level summary of DMA I, and the actions taken by Alabama and South Dakota in reaction to DMA II.

The Colorado Law: Colorado’s Use Tax Notice and Reporting Requirements

The Colorado Law requires retailers that do not collect Colorado sales tax and that have at least $100,000 of gross sales in Colorado (“Remote Sellers”) to:

  • Notify their Colorado customers that Colorado sales or use tax is due on all purchases that are not exempt from sales tax;
  • Provide an annual purchase summary to each of their Colorado customers who spent more than $500 in the previous calendar year; and
  • Provide an annual customer information report to the Colorado Department of Revenue (“Department”) that details each of the retailer’s Colorado customers and the total amount of their purchases.
  • The Colorado Law also provides for the imposition of penalties on non-compliant Remote Sellers.

DMA I: The Colorado Law Does Not Discriminate Against Interstate Commerce

The Tenth Circuit held that DMA did not carry its burden of showing that the Colorado Law: (1) was discriminatory on its face against out-of-state retailers; or (2) had a discriminatory effect of favoring in-state economic interests over out-of-state interests.

The Tenth Circuit found that the Colorado Law is not facially discriminatory because it does not explicitly distinguish between in-state and out-of-state economic interests. Rather, the statute “distinguishes between those entities that collect Colorado sales tax and those that do not.” Absent statutory language that explicitly identifies geographic distinctions, the court held that a statute does not discriminate on its face.

The court further concluded that DMA failed to meet its burden of showing that the Colorado Law has a discriminatory effect on interstate commerce because the Colorado Law does not “alter the competitive balance between in-state and out-of-state firms.” DMA failed to prove that the Colorado Law benefits local actors to the detriment of out-of-state actors, as is required to successfully challenge a law on dormant Commerce Clause grounds. The court concluded that, based on the evidence put forth by DMA, “the notice and reporting requirements for non-collecting out-of-state retailers are [not] more burdensome than the regulatory requirements in-state retailers already face.”

In arriving at its conclusion, the court disagreed with the Department’s position that “out-of-state retailers having the option to collect and remit sales tax makes the Colorado Law nondiscriminatory” due to the fact that out-of-state retailers are protected from this option under Quill’s physical presence nexus standard. Notwithstanding this acknowledgement, the court further noted that “[w]hether the Colorado Law works a discriminatory effect on interstate commerce turns on the reach of Quill” and reiterated its position that Quill “applies only to the collection of sales and use taxes” and not the notice and reporting obligations of the Colorado Law. Because the Colorado Law is not a tax, the court disregarded the sales tax nexus protections of Quill in determining whether discrimination occurred.

DMA I: The Colorado Law is Not an Undue Burden on Interstate Commerce

The Tenth Circuit also held that the notice and reporting requirements of Colorado Law did not pose an undue burden on interstate commerce. Based on the US Supreme Court’s distinction in DMA II between tax “assessment, levy or collection” and “information gathering” for purposes of its Tax Injunction Act analysis, the Tenth Circuit determined that Quill’s physical presence standard is limited in its application to sales and use tax collection. Because the Colorado Law only encompasses informational notices or reports, the Tenth Circuit reasoned that Quill is not controlling and the bright-line physical presence standard did not apply to the Colorado Law. Since DMA relied solely on Quill for its undue burden claim, the Tenth Circuit did not further entertain the undue burden inquiry.

Fallout From DMA II

In the wake of DMA II, Alabama and South Dakota have accepted Justice Kennedy’s invitation to challenge Quill’s bright-line physical presence nexus standard. Specifically, those states have enacted controversial sales and use tax nexus laws designed to directly conflict with the US Supreme Court’s holding in Quill.


Alabama’s challenge to Quill is in the form of a regulation that went into effect on January 1, 2016. See Ala. Admin. Code 810-6-2.90.03. Pursuant to this regulation, out-of-state sellers without an Alabama physical presence are deemed to “have a substantial economic presence in Alabama for sales and use tax purposes and are required to register for a license with the Department and to collect and remit tax” when (1) such seller’s retail sales of tangible personal property to Alabama customers exceed $250,000 per year based on the previous year’s sales and (2) the seller conducts one of the activities enumerated in Ala. Code § 40-23-68. The enumerated activities include, among other items, soliciting orders of tangible personal property in Alabama by means of catalogs, commercials on cable television, or a telecommunication or television shopping system.  Ala Code § 40-23-68(b)(7)-(10). These activities do not require the retailer to have an in-state physical presence, and, under the terms of the regulation, out-of-state retailers that engage in these activities and exceed the sales threshold are required to collect and remit Alabama sales tax. The enumerated activities also contain a catch-all for maintaining “any other contact with this state that would allow this state to require the seller to collect and remit the tax due under the provisions of the Constitution and laws of the United States.”

South Dakota

On March 22, 2016, South Dakota Governor Dennis Daugaard signed S.B. 106 into law, which is effective May 1, 2016. Under S.B. 106, any out-of-state seller selling tangible personal property, products transferred electronically, or services for delivery in South Dakota has nexus with the state for sales tax purposes, if South Dakota gross revenues from the aforementioned sales exceed $100,000 or if the seller made 200 or more separate transactions for delivery in South Dakota.

S.B. 106 also permits the state to bring a declaratory judgment in circuit court against any person the state believes to have met those thresholds, regardless of “whether or not the state initiates an audit or other tax collection procedure.” The filing of such declaratory judgment would operate as an injunction, prohibiting the state from enforcing this rule while the case was being determined. Further, any appeal of the declaratory judgment action must be made to the South Dakota Supreme Court with the mandate that “[t]he appeal shall be heard as expeditiously as possible.”  As noted in the legislature’s findings enumerated in S.B. 106, these provisions were designed to expedite the US Supreme Court’s ability to reconsider Quill’s physical presence nexus standard.

The sales and use tax nexus landscape is always being challenged and tested, but the developments listed here could fundamentally change the compliance burden for out-of-state retailers, potentially as a result of a bright-line gross receipts/transactional threshold replacing the physical presence standard for sales tax purposes or as a result of onerous information reporting requirements for use tax purposes. If either outcome is ultimately held to be permissible, it is reasonable to assume that the trend would be for states to adopt similar laws shortly thereafter. Quill’s bright-line physical presence nexus standard has endured for 24 years. How much longer will it last?

Contact the author: Michael Tedesco

This article originally was originally published in the April 2016 edition of Tax News and Developments (Volume XIV, Issue 2) and is available under insights at www.bakermckenize.com.