In light of the Senate passing the Marketplace Fairness Act on Monday, I have decided to blog about the legal underpinnings of a state's ability to collect and remit internet sales tax. So, here we go . . .
The Constitution as interpreted by the Supreme Court limits the ability of a state taxing authority to levy taxes on certain types of retail sales. The provisions of the Constitution that are often implicated when a state attempts to utilize its’ taxing power are the: (1) Due Process Clause, and (2) Commerce Clause. As in many areas of law, the Due Process Clause does not provide a great deal of protections. The basic idea behind Due Process is that individuals are entitled to fairness both in procedure and in practice. Retailers that believe they fall outside of a state’s taxing authority will often plead that their Due Process rights have been violated. However, the Court is reluctant to overturn a tax based on this Clause alone; that is, unless the tax is blatantly outside of a state’s taxing authority. The Court has held that a seller must only have “minimum contacts” with the taxing state for there to be sufficient nexus under the Due Process Clause.
The Commerce Clause is where states’ taxing authorities meet the greatest resistance, and where the Court has taken an inequitable turn. The Court in Quill v. North Dakota, which is the controlling precedent for cases involving the taxation of sales similar to those of online retailers, established that a retailer must have “substantial presence” within a taxing state for that state to establish sufficient taxable nexus under the Commerce Clause. Accordingly, an online retailer is required to be physically present within a taxing state for that state to impose collection responsibilities upon the retailer.
At the heart of the Commerce Clause is the idea that commerce within the United States should not be encumbered or impeded by restrictive regulation. It appears by the Court’s handling of the Commerce Clause in the context of sales and use tax cases where the retailer is located in a separate state than the purchaser that the Court is attempting to protect the right of taxation for the retailer’s state at the expense of the purchaser’s state. In addition, the Court may also be concerned with double taxation; that is, the Court does not want to grant too great of taxing power to a state so that the state can tax all sales transactions that occur generally in all states. Or for that matter, the Court does not want to have the purchaser taxed by both states – a sales tax in the retailer’s state, and a use tax in the purchaser’s own state. This however, is an unrealistic concern because in cases that two or more states have a legitimate claim of taxation, the Constitution requires that the taxes imposed by each state must be fairly apportioned between the states and must not be overly burdensome.
The Constitutional limitations explained above are derived from Supreme Court jurisprudence not specifically related to online retailers. Instead, they come from Supreme Court decisions prior to the explosion of the Internet. Therefore, the controlling law in the area of the states’ ability to tax online retailers is found in a series of cases involving out-of-state retailers. These cases are duly relevant because online retailers exist primarily in cyber space, and not in the taxing state.
The following case review will provide the foundation for these Constitutional limitations:
1. Scripto, Inc. v. Carson, 362 U.S. 207 (1960).
Scripto, Inc., a manufacturer and retailer of writing utensils with a principal place of business in Georgia, used ten (10) brokers, who were independent contractors and not actual employees of the company, to solicit and make sales within Florida. These brokers did not receive a salary from Scripto; instead, they only received commission for the sales that they made. The State of Florida sought to hold Scripto deficient for uncollected use tax on the sales that were made by the brokers that occurred within Florida’s borders. Scripto filed suit against Florida alleging that the company was exempt from collecting use tax for the State because the Due Process and Commerce Clause would be violated.
The Supreme Court ruled that neither the Commerce Clause nor the Due Process Clause were violated by Florida’s use tax statute or Florida’s attempt to hold Scripto liable. According to the Scripto Court, retailers could be physically present in a state through agents acting for the company, and basically that the Commerce Clause only requires minimal contacts between the retailer and the taxing state. The Court reasoned that the difference between actual employees and independent contractors is meaningless; that is, the Court refused to make the arbitrary distinction control the outcome of this case – also, the majority’s dicta indicates that allowing such an arbitrary distinction to win the day would open the flood gates to a rash of avoidance techniques by companies seeking to shirk their tax obligations. Additionally, the Court took great care in expressing that states have the right to tax as they deem appropriate, so long as the tax is fair. That being said, the Court recognized that there needs to be some guidelines for adjudicating the fairness of a tax.
The Scripto case is important for several reasons. First, as oft analyzed, the Scripto opinion shows that the Court will ”care more about function than form” in cases involving taxable nexus of out-of-state retailers Basically, this means that the Court will look past technical distinctions and towards the functional reality of tax related issues, such as physical presence in the context of establishing sufficient taxable nexus. Second, this decision illustrates that the Court does not condone avoidance techniques, and therefore, structuring your business in such a way to just avoid taxation is not acceptable. Third, read broadly, the opinion seems to grant a good amount of deference to the states when establishing taxable nexus. Finally, Scripto appears to represent a liberal, flexible approach by the Court in matters of taxation.
2. National Bellas Hess, Inc, v, Department of Revenue of Illinois, 386 U.S. 753(1967).
Nation Bellas Hess, Inc., a mail order retailer with a sole place of business in Missouri, mailed retail catalogs to many states including Illinois. All orders placed by consumers in the various different states were processed in Missouri and subsequently shipped by mail or common carrier from the Nation Bellas Hess’s manufacturing center, which was also located in Missouri. The company did not have any physical structures or employees within any other state. The State of Illinois wished to require Nation Bellas Hess to collect and remit use tax from the orders that were placed from within Illinois. Illinois issued a deficiency notice, and the company filed suit alleging that the Constitution protected them from collecting use tax for a state in which their only connection was via mail or common carrier.  Basically, National Bellas Hess alleged that Illinois did not have a sufficient taxable nexus as required by the Due Process and Commerce Clauses.
In a six to three decision, the Court agreed with Bellas Hess – they held that there needs to be a greater connection between a state and an out-of-state company than mere mail interaction.   This holding is important because it requires there to be at least some form of physical presence within a state for a retailer to have a sufficient taxable nexus under the Commerce Clause. Additionally, it provides the foundation for the Quill decision, which is currently the controlling precedent. The physical presence requirement does not appropriately take into account the reality of modern business, especially e-business. Online retailers are everywhere; you turn on your computer, click on a web browser, and there you can shop for pretty much anything. The physical presence requirement is no longer useful, as technology changes so should the law.
3. Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
Complete Auto Transit, a company that specialized in the of transporting of motor vehicles from state-to-state for an automobile manufacturer, had a principal place of business in Michigan, and transported vehicles by truck to several Mississippi car dealerships. The State of Mississippi held Complete Auto Transit liable for a tax on “the privilege of engaging or continuing in business or doing business” within the state. Complete Auto paid the tax, but then filed suit alleging that the tax was in violation of the Commerce Clause.
The Court held for the State of Mississippi. In doing so, the Court seemed to depart from the bright-line rule of physical presence established by Bellas Hess. The decision speaks about the practical effect of taxation on an out-of-state seller, and as with the Scripto decision, seems displeased with any arbitrary cut-and-dry analysis of the Commerce Clause. Therefore, the Complete Auto Court established a four-prong test for ascertaining if a state tax has violated the Commerce Clause. The first prong is related to nexus; that is, the out-of-state seller needs to have a sufficient connection with the taxing state, this does not necessarily require physical presence. The second prong is that the tax must be fairly apportioned, which means the taxing state must take into account what other states and at what rate other states are taxing the same transaction. The third prong requires a state not to discriminate in any manner, including tax rates, between an in-state seller and an out-of-state seller. The final prong requires that the tax imposed by the state must be reasonably related to the services that the state provides for the out-of-state retailer – these services do not actually have to be utilized by the retailer, instead they merely need to available if the retailer requires such services.
The test enumerated in Complete Auto seems to be much more workable than the strict physical presence rule. TheComplete Auto test grants the Court a good deal of discretion in formulating equitable resolutions. That being said, several years after the Complete Auto ruling, the Court backtracked and held that physical presence is required for a state to establish the first prong of the four-prong test. By doing so, the Court has essentially stripped the Complete Auto test of all of its’ equitable powers.
4. Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
Quill is the seminal case involving the Constitutional limits on a state’s ability to impose a sales or use tax on an out-of-state or remote retailer. The factual identity of Quill is much like the prior cases covered in this paper. That is, Quill Corporation, which was headquartered in Delaware, was a mail-order company that sold office equipment and stationary with no tangible storefronts, distributing centers, manufacturing centers, employees or affiliates in North Dakota. Instead, Quill made sales in North Dakota by using catalogues and advertisements – the goods were delivery by common carrier. North Dakota sought to recover past due use tax from Quill, and Quill filed suit alleging that the taxation was in violation of both the Due Process and Commerce Clauses because the company did not have any physical presence or employees within the state.
The Supreme Court partially agreed with Quill. The crux of the case was regarding the first prong of theComplete Auto Test, nexus. The Court was tasked with interpreting what constitutes taxable nexus under theComplete Auto test. Justice Stevens delivered the opinion of the court which provided two separate analyses for Due Process and Commerce Clause challenges related to states’ ability to impose taxation on out-of-state sellers. First, the Court addressed the Due Process challenge. The Court held that Due Process does not require any form of physical presence within a state by an out-of-state retailer. The rationale behind this finding is related to purpose of the Due Process Clause. The Due Process Clause only requires that an individual or a company be treated fairly. Basically, the Court held that if a state’s imposition of a tax is beyond the realm of reason, and on its’ face unfair, then the Due Process Clause is violated. The Court did not believe that the tax imposed on Quill was in violation of the Due Process Clause.
The Court did, however, find that the Commerce Clause had been violated by North Dakota’s tax policy.  The Court followed the Bellas Hess precedent, and required some form of physical presence within a taxing state by an out-of-state retailer in order to establish a sufficient taxable nexus. Further, the Court went on to conceptualize what is meant by the term physical presence by supplying examples for what is not physical presence. It seems that the Court wanted to leave a little room for judicial discretion. For the most part, a court will find that physical presence exists if a company maintains offices, warehouses, employees, representatives, and the like within the taxing state. Therefore, “a ‘seller whose only connection with customers in the State is by common carrier or the United States mail’ lacked the requisite minimum contacts with the State.”
The Quill decision is very surprising. Prior to the Court’s holding in Quill it appeared that the Constitutional analysis related to the Commerce Clause and a state’s ability to impose taxes on out-of-state retailers was becoming more flexible; this is evidenced by Complete Auto. The emphasis had shifted towards a more case-by-case equitable analysis. However, the Quill decision seems to be a complete one-eighty. The Court shifted back to the formalistic, bright-line analysis of Bellas Hess. The reason for this marked change in ideology is unclear. Perhaps it can be attributed to the composition of the Court its’ self. The Rehnquist Court while noted by their emphasis on federalism, also was known for a more formalistic approach to jurisprudence. Another reason for this shift may be that the facts presented in Bellas Hess and Quill were so similar that the Court felt obligated to follow stare decisis because Bellas Hess had never been overruled by Congress or the Court.
Regardless of the reason for the change, the Court’s decision in Quill has far-reaching effects on a state’s ability to impose tax collection responsibilities on out-of-state retailers. The Quill decision’s practical effects are not equitable, and the seemingly arbitrary bright-line rule related to nexus and physical presence has produced absurd consequences. The Quill Court explicitly stated that if Congress was unpleased with the bright-line rule, then they were empowered to change it. It is time that Congress took the Court up on that offer.
5. Post Quill
The dicta in the Quill decision indicates that the Court had hoped to establish a bright-line rule so that its’ application would be easier than it was under Complete Auto. The Court wanted to get away from subjective adjudication and provide a rubric for the lower courts in ruling on cases related to out-of-state retailers and state taxing authorities. The practical result, however, is that many lower courts have had a great deal of trouble in using the Quill nexus standard. The major issue that the lower courts have faced is specifically related to the application of the somewhat amorpic physical presence test.
Even though the Quill Court attempted to conceptualize what is meant by physical presence, the definition is still not clear. One court may hold that a traveling salesperson that has only been present in a state for one evening satisfies the physical presence requirement, whereas another court may not. Another example of a potential inconsistent result is: Court A holds that an employee of a company that is traveling for business purposes by airplane to State C, is physically present in State A by the fact that the airplane was in State A airspace for several hours, whereas Court B may hold that the employee was not physically present within State B based on the same facts. That being said, the lower courts have reached a general agreement that a continuing presence of one or more salespeople within a state constitutes physical presence.
Keith R. Gercken, Pillsbury Tax Page, E-Commerce: United States Sales and Use Tax Considerations (Nov. 2001), http://pmstax.com/state/bull0111.shtml.
 A good example of this is articulated in the case review provided later in this paper.
 See Id.; Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
 Id. at 301; Gercken, supra note 6; National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753, 758 (1967).
 Gercken, supra note 6.
 Id.; Quill, 504 U.S. at 312.
 Quill, at 312.
 See generally Exploring Constitutional Conflicts, Commerce Clause Limitations on State Regulation, http://law2 .umkc.edu/faculty/projects/ftrials/conlaw/statecommerce.htm
 This is an unrealistic concern because in cases that two or more states have a legitimate claim for taxation, the Court requires that the taxes imposed by each state must be fairly apportioned and cannot be overly burdensome.
 See Complete Auto Transit v. Brady, 430 U.S. 274 (1977).
 See generally Walter J. Baudier, Internet Sales Taxes from Borders to Amazon: How Long before All of Your Purchases are Taxed?, 2006 Duke L. & Tech. Rev. 5, 6 (2006).
 Scripto, Inc. v. Carson, 362 U.S. 207, 208 (1960); See Accord Chris Atkins, Important Tax Cases: Scripto v. Carson and the Agency Theory of Nexus (Aug. 26, 2008), http://taxfoundation.org/blog/important-tax-cases-scripto-v-carson-and-agency-theory-nexus..
 Id. at 209.
 Id. at 208.
 Id. at 209.
 Id. at 212-213.
 Id. at 210-212.
 Id. at 211.
 Id. at 212.
 See Id. at 212-213.
 Chris Atkins, Important Tax Cases: Scripto v. Carson and the Agency Theory of Nexus (Aug. 26, 2008), http://taxfoundation.org/blog/important-tax-cases-scripto-v-carson-and-agency-theory-nexus.
 National Bellas Hess, Inc. v. Dep’t of Revenue of Illinois, 386 U.S. 753, 754 (1967).
 Id. at 755.
 Id. at 753.
 Id. at 756.
 Id. at 757-758.
 But see, Commissioner of Revenue v. J.C. Penney Co., 730 N.E.2d 266 (Mass. 2000) (holding the assessment of a use tax on catalogs and other publications providing promotional material that a Massachusetts merchant sends to residence of the Commonwealth by interstate mail is consistent with the plain language of the Massachusetts use tax statute).
 See Bellas Hess, at 759.
 Complete Auto Transit v. Brady, 430 U.S. 274. 276-279 (1977)
 Id. at 274.
 Id. at 277.
 Id. at 289.
 See generally Id. at 284-285.
 See generally Id.; See also Chris Atkins, The Tax Foundation, Important Tax Cases: Complete Auto Transit v. Brady and the Constitutional Limits on States Tax Authority (May 19, 2005), http://taxfoundation.org/blog/important-tax-cases-complete-auto-transit-v-brady-and-constitutional-limits-state-tax-authority.
 Quill, 504 U.S. at 302.
 Id. at 303-304.
 Id. at 305-309.
 Id. at 311.
 Id. at 312.
 Id. at 308.
 See Id. at 312.
 Id. 306-307.
 Id. at 315-318.
 See Id. at 317.
 Id. at 311.
 See Chris Atkins, The Tax Foundation, Important Tax Cases: Quill Corp. v. North Dakota and the Physical Presence Rule for Sales Tax Collection (July 19, 2005), http://taxfoundation.org/blog/important-tax-cases-quill-corp-v-north-dakota-and-physical-presence-rule-sales-tax-collection
 Id. at 311 citing Bellas Hess, at 758.
 See generally David G. Savage, Opinions on Rehnquist: Views on the Chief Justice's Impact are Still Mixed, 82A.B.A.J. 42 (1996).
 See Quill at 318
 See Id. at 317-318.
 See generally See Walter J. Baudier, Internet Sales Taxes from Borders to Amazon: How Long before All of Your Purchases are Taxed?, 2006 Duke L. & Tech. Rev. 5, 9 (2006).
 Accord Protest of Barnesandnoble.com LLC v.Barnesandnoble.com LLC, 2012 N.M. App. LEXIS 32 (N.M. Ct. App. 2012); Musser’s Inc. v. United States, 2011 U.S. Dist. LEXIS 109629 (E.D.Pa. 2011).
 E.g., Scholastic Book Clubs, Inc. v. State, 567 N.W.2d 692, 694 (Mich. Ct. App. 1997) (“[I]t is also well established that the presence of salespersons who are employed by an out-of-state vendor to solicit business in the taxing state, regardless of whether they are residents of the taxing state, constitutes a sufficient nexus with that state)