The Quill ‘Physical Presence’ Standard – A “Perfect Storm” Brewing

Ever since, and even before, the U.S. Supreme Court’s landmark 1992 decision in Quill Corp. v. North Dakota, in which it affirmed the Commerce Clause ‘physical presence’ standard for sales tax nexus, Congress has continually grappled with the increasing sales tax revenue shortfalls and perceived unfair advantage that online and mail-order retailers have over brick and mortar retailers.  The ‘physical presence’ standard affirmed in Quill currently bars states from imposing sales tax compliance obligations on out-of-state retailers who lack a ‘physical presence’ with the state. 

Last week, the Supreme Court unanimously determined in Direct Marketing Association v. Brohl  that the Tax Injunction Act did not bar federal court jurisdiction over a suit brought by non-taxpayers to enjoin the enforcement of Colorado’s notice-and-reporting requirements.  In his concurring opinion, Justice Kennedy wrote that the Court’s conclusion was wrong when decided, Quill now harm states to a greater degree than could have been anticipated and that “the legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess” in light of the Internet and changes in technology.  These words mark the first overture by the Supreme Court indicating that it may entertain a sales tax nexus case.  Recall that the Supreme Court recently denied in, Inc. v. New York State Department of Taxation and Finance, the last state tax appeal involving sales tax nexus that may have provided an opportunity for the U.S. Supreme Court to revisit Quill and Bellas Hess.

According to U.S. Supreme Court Justice Kennedy, “the legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess”

In the meantime, both the Senate and the House continue to pursue legislative measures to enable states to impose sales tax collection obligations on out-of-state retailers, regardless of whether they maintain a ‘physical presence’ or not.  On Tuesday, March 10, 2015, Senate Minority Whip Dick Durbin (D-Ill.) and Sens. Lamar Alexander (R-Tenn.), Mike Enzi (R-Wyo.) and Heidi Heitkamp (D-N.D.) unveiled the Marketplace Fairness Act of 2015, which would give states more power to collect sales taxes from businesses that don't have a physical location within their borders.  It’s predecessor version (The Marketplace Fairness Act of 2013, which they also sponsored) passed with ease in the Senate in May 2013, however it stalled in the House amid claims by opponents of the measure that this looked to constituents like a new tax.  The new version, which has additional co-sponsors, includes some changes to the 2013 version, including a one year delay in implementation upon passage and exemption for sales that take place from October - December in the initial year of implementation.  Also like its predecessor, the measure is voluntary regarding state participation, and relies on the Streamlined Sales Tax Project.

Senate and House supporters of these could try to tie the online sales tax measure to an extension of the Internet Tax Freedom Act (ITFA), which is set to expire at the end of September. 

In the House, Judiciary Chairman Bob Goodlatte (R-Va.) has been working on his own proposal, the Online Sales Simplification Act, which would authorize states that are part of a Tax Distribution Agreement (TDA) to levy taxes based on where the retailer (origin sourcing) – not the customer (destination) – is based. Tax authorities remit to a clearinghouse that distributes taxes to destination (customer) if destination state is part of TDA.  Otherwise, the tax defaults back to seller’s origin state.  Similar to the Mainstreet Fairness Act, only states that choose to participate would be allowed to collect sales tax on remote sales, and prohibits any state that chooses not to participate, from levying sales tax on remote sales in any other fashion.  But retail groups have already panned that proposal, noting that this imposes a tax on customers in states in which THEY have not physical presence.  In essence, this is enabling states to regulate consumers outside of their jurisdiction.

Just as the Senate support for the 2013 Marketplace Fairness Act attempted, supporters of these or other measures could try once more to tie the online sales tax measure to an extension of the Internet Tax Freedom Act (ITFA), which prohibits states form imposing taxes on online access.  The one-year extension of the ITFA is set to expire at the end of September. 

Whether Justice Kennedy’s invitation to state taxing authorities to bring a sales tax nexus case before the U.S. Supreme Court are the words of one man, are the shared sentiment of several remains to be seen.  Again, this same court had the opportunity to reexamine Quill and Bellas Hess just over a year ago and declined.  Furthermore, no other Justice joined Justice Kennedy’s concurring opinion.  It does appear, however, that between these words, the Streamlined Sales Tax Project, and efforts in both the House and Senate to enable states to impose sales tax on remote sales, we are headed for “the Perfect Storm” regarding sales tax nexus.   One way or another, and as irrational and unfair as it seems, it appears that approval for states to impose sales tax on remote sales may be coming, if not this year, then in the next few years.