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Commerce Clause

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The recent Harley-Davidson opinion from the Superior Court of California, County of San Diego is an alarming example of why it is important to apply the appropriate constitutional standard in state tax cases.  In a Commerce Clause challenge, where the taxpayer argued a California statute discriminated against interstate commerce, both the California Appellate Court and the trial court applied Equal Protection standards in their Commerce Clause analyses.  In doing so, the courts upheld an otherwise discriminatory tax scheme on the grounds that it furthered the state’s legitimate interests in generating revenue and ensuring income is fairly apportioned among the several states.  Such a holding effectively guts the protections offered under the dormant Commerce Clause and highlights the analytical differences between discrimination under the Commerce Clause and discrimination under the Equal Protection Clause. 

The bright-line physical presence nexus standard established by the US Supreme Court in Quill v. North Dakota, 504 U.S. 298 (1992) for sales and use tax purposes is under attack. Under this standard, a company must have a physical presence within a state in order for such state to constitutionally impose its sales or use tax upon that company. If such in-state physical presence does not exist, the imposition of tax is unconstitutional because it fails the “substantial nexus” requirement of the Commerce Clause. This has been the rule for the past 24 years, but now, in response to Justice Kennedy’s concurring opinion in Direct Marketing Association v. Brohl, Dkt. 13-1032 (U.S. 2015) advocating for a reconsideration of Quill, South Dakota and Alabama have enacted controversial sales and use tax nexus laws designed to directly conflict with the US Supreme Court’s holding in Quill. Both states have found companies willing to challenge them, including Newegg, Inc., a company that has been targeted by both states in their attempts to overturn Quill. For additional background on the events leading up to each state’s change, please refer to the prior Tax News and Developments article States on the Verge of a Nexus Showdown (Vol. 16, Issue 2, April 2016).

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.