Nexus Considerations: Navigating the “Kill Quill” Revolt
This article is authored by Rebecca Newton-Clarke, J.D. (Senior Editor, Checkpoint Catalyst). It first appeared in Thomson Reuters Checkpoint State & Local Taxes Weekly, 1/22/18 (Volume 29, No. 4) and is the first in a special series of articles dedicated to recent nexus developments.
The staid and technical world of sales and use taxes has become unexpectedly dramatic recently, as we’ve entered the era of “kill Quill” laws that may be succeeding in their goal. In one corner of the ring is the reigning champion: the U.S. Supreme Court’s landmark nexus decision in Quill Corp. v. North Dakota (1992), 1 showing its age. In the other corner is a scrappy transplant from the income-tax context: economic nexus. We can’t predict the winner with certainty, but now that the Supreme Court has agreed to take up the case of South Dakota v. Wayfair, 2 which centers on South Dakota’s economic nexus law, we know there will be one. The implications for multistate companies are enormous.
Under Quill, the U.S. Constitution prevents states from requiring a remote seller to collect sales or use tax in a state unless the business has a strong enough connection to the state. Determining whether this connection, or nexus, exists is increasingly difficult, though, with a growing number of states in full revolt against the landmark U.S. Supreme Court nexus case. Meanwhile, remote sellers are struggling to ascertain their current liabilities and predict future ones. This article is drawn partly from a December 2017 Checkpoint Catalyst Special Report, and is intended to help bring clarity to a complex and rapidly changing subject.
The Quill case. Twenty-five years ago, the Supreme Court established the requirements for sales and use tax nexus in Quill Corp. v. North Dakota, 3 ruling that a mail-order office supply company making sales to North Dakota customers did not have substantial nexus with the state. The Court determined that the office supply company’s contacts with the state were insufficient to create jurisdiction to tax. The contacts included:
- substantial sales (“just under $1 million,” according to North Dakota’s high court);4
- many transactions (number unknown, but “3500 active North Dakota customers”); 5
- regular mailing of catalogs to customers in the state; 6 and
- a small number of floppy discs licensed to customers in the state. 7
The Quill Court clarified that the “minimum contacts” requirement of the Due Process Clause of the U.S. Constitution is separate from the “substantial nexus” requirement of the Commerce Clause. 8 While the mail-order seller at issue in the case met the minimum contacts requirement, it lacked substantial nexus with North Dakota. The Court affirmed the previous holding of the U.S. Supreme Court in National Bellas Hess v. Illinois (1967) 9 that a company must have some physical presence in a state to create substantial nexus.
The company’s physical presence could be through employees, agents, or related companies in the state, or through property or activities in the state. The case established that physical presence entailed something more than sending catalogs to potential customers in the state, making mail-order sales to customers in the state, and shipping the items sold by mail.
When the Supreme Court issued its decision in Quill, it expressed some doubt, recognizing that commerce was becoming less dependent on traditional sales at brick-and-mortar companies. Still, the Court emphasized the administrative difficulty for remote sellers of following the rules of so many different states and localities if the physical presence requirement were eliminated.
The Court suggested that Congress might be better qualified to resolve the substantial nexus issue than the Court was, but took the position that a bright-line physical presence rule was the best approach in the absence of congressional action. Many interpreted the opinion as an invitation for Congress to clarify nexus for sales and use tax purposes. Despite the introduction of myriad drafts of the “Marketplace Fairness Act” and other legislation over the years, though, Congress has not done so. 10
Early disputes. In the aftermath of Quill, and with the rise of internet commerce, companies with a physical footprint in only one or two states but making sales to customers across the country had a significant advantage over large multistate franchises. Some traditional franchises attempted to overcome their disadvantage by restructuring, separating their brick-and-mortar businesses and their online retail businesses into discrete entities. 11
These efforts involved many potential pitfalls and complexities alongside the obvious potential benefits. States engaged in aggressive litigation, seeking to stop substantial declines in sales and use tax revenue as sales of items once sold in person, such as books and music, moved online. U.S. Supreme Court cases prior to Quill established that a seller’s physical presence in a state did not have to be through an office or employee but could be through unrelated third parties acting on the seller’s behalf. In Scripto, Inc. v. Carson (1960), 12 the U.S. Supreme Court upheld Florida’s imposition of use tax collection duties on a Georgia corporation that had 10 independent contractors soliciting orders for the corporation within the state. In Tyler Pipe Industries (1987) 13 , the Court reaffirmed Scripto. Other activities that agents or employees perform in a state on behalf of a company can also create nexus. These include making repairs, delivering merchandise (except by U.S. Mail or common carrier), using a local collection agency, and regularly entering the state to place or display ads. Owning tangible personal property in the state can also be a nexus trigger.
The corporate structures that proliferated following Quill often involved a holding company that licensed franchises and trademarks to both the traditional retail and online sales entities. The arrangements spawned a great deal of state court litigation over the true separateness of the businesses. The rulings tended to be deeply fact-dependent.
Nexus expansion. In recent years, companies have seen states engaging in even more aggressive attributed-nexus approaches such as “click-through” nexus and affiliate nexus. In Thomson Reuters’ Journal of Multistate Taxation and Incentives, state and local tax experts noted that these gambits are an attempt to narrow Quill. 14
Click-through nexus was pioneered by New York State. 15 New York’s law establishes a rebuttable presumption that an out-of-state seller has nexus with the state if it enters into an agreement with in-state contractors or other representatives to refer potential customers to the company’s website in exchange for compensation. The presumption applies only if cumulative gross receipts from the seller’s sales to customers in the state who are referred by in-state representatives having this type of agreement with the seller exceed $10,000 during the preceding four quarterly periods. The seller can theoretically rebut the presumption by proving that the representative with whom the seller has an agreement did not engage in any solicitation in the state on behalf of the seller that would satisfy the nexus requirement of the U.S. Constitution during the four quarterly periods in question. In practice, rebutting the presumption would be administratively difficult, if not impossible, because of the nature of the referral agreements targeted.
In 2013, New York’s high court, the Court of Appeals, upheld the law against a challenge in the Overstock 16 case. The U.S. Supreme Court declined to review.
By now nearly half the states imposing a sales and use tax have enacted similar laws, some based on model language proposed by the Multistate Tax Commission. Vermont marked the tipping-point. The state’s law took effect on October 13, 2015, after the Attorney General certified that more than 15 other states had enacted a similar provision. 17 .
Nexus expansion tactics have also included detailed affiliate statutes that assert nexus based on activities, often including use of trademarks and franchises, of related and contracting entities in the state. The laws also tend to target entities doing business under the same or a substantially similar name and frequently assert nexus against remote sellers contracting with unrelated fulfillment centers and marketplace facilitators in the state. 18
The Streamlined Sales & Use Tax Agreement, a collaborative state uniformity project with many members, keeps track of which members adopt click-through and affiliate nexus laws. Because the Supreme Court’sQuill decision rested in part on the idea that it would be administratively difficult for remote sellers to contend with many different states’ and localities’ approaches to sales and use tax, the states interpreting nexus so expansively may believe there is strength in numbers.
Pure e-commerce. Recent years have also given us the rise of software downloads, digital products, cloud computing, streaming entertainment, and remote services. These “pure e-commerce” transactions have disrupted the traditional marketplace far beyond what was accomplished by mail-order sellers at the time of Quill and by online sellers of physical goods since then.
Sales and use taxes originally arose in the context of physical products, but a number of states have amended their sales and use tax laws, or stretched interpretations of them, to encompass these kinds of pure e-commerce transactions, which can create nexus issues. Remote sellers should also be aware that rented servers and even online cookies can raise nexus questions in some states. As Walter Hellerstein observes in the Thomson Reuters treatise, State Taxation, large purchasers that are routinely audited should follow state developments carefully to avoid a significant use tax bill for purchases of taxable pure e-commerce goods and services from sellers lacking nexus in the state.
Remote seller reporting requirements. A number of states, including Colorado, Louisiana, Oklahoma, Pennsylvania, Rhode Island, South Carolina, South Dakota, Texas, Vermont, and Washington, require remote sellers making sales of taxable items into the state to comply with notice and reporting requirements even when they lack a physical presence.
The Pennsylvania, Rhode Island, and Washington schemes are the most recently-enacted and are highly detailed and cumbersome. These states target remote sellers making a certain dollar amount or number of sales into the state. They require the sellers to issue multiple notices to in-state customers concerning the taxability of their purchases, and to provide reports to the state. The states offer the remote sellers the alternative of registering, collecting, and remitting tax to the state under economic nexus provisions of the kind we’ll be considering more closely in the next section.
Historically, the constitutionality of notice and reporting laws was uncertain. 19 In 2016, however, the Court of Appeals for the Tenth Circuit held, in Direct Marketing Association v. Brohl, 20 that Colorado’s notice and reporting requirements did not violate the dormant Commerce Clause because they did not discriminate against or unduly burden interstate commerce. They were constitutional, in other words. The U.S. Supreme Court, despite ruling on an injunction in the case in 2015, declined to hear the appeal. 21 These laws represent yet another major whittling-away of Quill‘s physical presence requirement.
“Kill Quill” momentum. Since 2016, states have been lining up to challenge the physical presence rule more directly, in an effort to “kill” Quill, or at least to force the Supreme Court to revisit its landmark decision. The mutiny has some high-level encouragement.
Until granting certiorari in Wayfair, the Supreme Court has consistently declined to hear a sales tax nexus case since its 1992 Quill decision, but in 2015 one sitting justice articulated support for overturning the physical presence standard. In an appeal of an injunction in Direct Marketing Association
- Justice Anthony Kennedy suggested in a concurring opinion in that the Court should revisit its “questionable” decision in Quill. 22 He called the delay in doing so unwise and suggested that extensive remote sales into a state might create “substantial nexus.”
His opinion was not joined by any other members of the Court. But, as mentioned above, the Direct Marketing case was ultimately decided by the Tenth Circuit Court of Appeals in 2016. Supreme Court Justice Neil Gorsuch sat on the Tenth Circuit at the time and heard the case. 23 In his concurring opinion, Gorsuch characterized Quill‘s physical presence rule as an “analytical oddity.” Quill“‘s very reasoning,” he contended, “seems deliberately designed” to ensure that “Bellas Hess’s precedential island would never expand but would, if anything, wash away with the tides of time.”
Economic nexus laws. Since 2015, Alabama, Indiana, Maine, Massachusetts, Mississippi, South Dakota, Tennessee, and Wyoming have enacted economic nexus laws or adopted regulations or directives asserting nexus against remote sellers based on the dollar amount or number of their sales into the state. 24 North Dakota has enacted a similar law, but it will take effect only if the U.S. Supreme Court overturns its decision in Quill or otherwise confirms that a state can constitutionally impose its sales or use tax under these circumstances. 25 Massachusetts takes a different tack, framing its economic nexus regulation as Quill-conforming, and asserting that high-volume remote sellers inherently have contacts with the state, such as apps or cookies stored on customers’ devices in Massachusetts, that constitute a presence sufficient to meet the Quill standard. 26 An Ohio law contains elements of Massachusetts’s approach, asserting nexus against sellers that meet the state’s gross receipts threshold and use in-state computer software or provide content distribution networks. 27
As discussed briefly above, Washington, Pennsylvania, and Rhode Island have essentially enacted laws asserting economic nexus and giving companies the choice between following highly detailed and cumbersome notice and reporting requirements or registering to collect and remit the tax. 28 Washington’s law came first, and Rhode Island and then Pennsylvania followed with substantially similar legislation. The notice and reporting requirements are sufficiently cumbersome for some to conclude it would be easier to register with the state to collect and remit the tax than to comply with them. Federal case law suggests that notice and reporting requirements are constitutional. 29 The states extend these requirements to facilitators and referrers, whose contacts with the state would need to be considered separately under Quill.
The brinkmanship effort by most economic nexus states has succeeded in its effort to force the U.S. Supreme Court to reconsider its previous nexus rulings. Now that the U.S. Supreme Court has granted certiorari in Wayfair, 30 states and companies alike will have some answers as to the viability of Quill‘s physical presence standard in a world increasingly centered on e-commerce. 31
Charting a way forward in an uncertain landscape. With the states in full revolt and Justices Neil Gorsuch and Anthony Kennedy both raising concerns about the Quill decision, the U.S. Supreme Court has decided that the time is right to take up the physical presence question again. The Court has granted South Dakota’s petition for certiorari inWayfair, and other economic cases are also making their way through the state courts, many with an eye toward possible review by the nation’s high court.
Although the outcome of Wayfair and any related cases remains uncertain, a very strict interpretation of Quill‘s physical presence rule seems unlikely. The Court’s previous denials of certiorari have allowed click-through and related-entity nexus laws to flourish across the states for several years. A great deal of state revenue now depends upon these laws, and large companies have been forced to familiarize themselves with these legislative approaches. The Court need not consider such practicalities in determining how to rule, of course, but in practice it might prove difficult to ignore them. In declining to hear the appeal of the 10th Circuit’sDirect Marketing Association ruling, the Court has also allowed cumbersome use tax notice and reporting requirements to proliferate.
The Court could overturn the new wave of laws asserting nexus based on economic presence, upholding Quill in full or in some form. It could determine that Quill‘s standard is obsolete and uphold the new laws. It could take a position similar to the Massachusetts Department of Revenue’s, finding that physical presence can arise through apps or cookies stored on a customer’s device in the state, for example. Even if the Court does ultimately rule that pure economic presence laws are unconstitutional, these laws could survive in states like Washington, Pennsylvania, and Rhode Island, where they function as elective alternatives to notice and reporting schemes.
Companies adversely affected by economic nexus laws and regulations may wish to continue pursuing avenues for challenging these laws. They will also need to begin to prepare for the possibility of a post-Quill world, though, by adopting recordkeeping and other best practices to ease the burden of compliance if the physical presence standard is overturned or continues, more slowly, to fade away.
Checkpoint Catalyst. For a detailed analysis of individual states’ approaches and more, download the full Checkpoint Catalyst Special Report, Navigating the “Kill Quill” Revolt: Considerations For Remote Sellers here. Checkpoint Catalyst subscribers can find an in-depth discussion of each state’s approach in Checkpoint Catalyst, Topic #1050, Sales and Use Tax: Nexus (See ¶ 1050:000 ).
1 Quill Corp. v. North Dakota, U.S. S. Ct., 504 U.S. 298 (1992).
2 South Dakota v. Wayfair, Inc. et al., S.D. S. Ct., 2017 S.D. 56 (2017), cert. granted, U.S. S. Ct., Dkt. No. 17-494, 01/12/2018.
3 Quill Corp. v. North Dakota, U.S. S. Ct., 504 U.S. 298 (1992).
8 Quill Corp. v. North Dakota, U.S. S. Ct., 504 U.S. 298 (1992).
9 Nat’l Bellas Hess v. Illinois, U.S. S. Ct.,386 U.S. 753 (1967).
10 See generally Hellerstein & Hellerstein: State Taxation ¶ 19A.10 , “Proposed Federal Legislation,” and accompanying footnotes.
11 See generally Hellerstein & Hellerstein: State Taxation ¶ 19.02 , “Constitutional Restrictions on States’ Power to Impose, and Require Vendor Collection of, Sales and Use Taxes on Goods Sold in Interstate Commerce).”
12 Scripto v. Carson, U.S. S. Ct., 362 U.S. 207 (1960).
13 Tyler Pipe Industries v. Washington State Dept. of Rev., U.S. S. Ct., 483 U.S. 232 (1987).
16 Overstock.com, Inc. v. New York State Dept. of Tax and Finance, N.Y. Ct. App., 20 NY3d 586 (2013), cert. denied, U.S. S. Ct., Dkt. Nos. 13-259; 13-252, 12/02/2013.
19 See e.g., Hecht, Helen, “Information Reporting for Out-of-State Vendors Just as Unconstitutional as Tax Collection Responsibility,” Journal of Multistate Taxation and Incentives (WG&L), Vol. 22, No. 5, August 2012 .
20 Direct Marketing Ass’n v. Brohl, U.S. S. Ct., (10th Cir.),814 F.3d 1129 (2016), petition for cert. denied, U.S. S. Ct., Dkt. Nos. 16-267; 16-458, 12/12/2016.
21 Direct Marketing Ass’n v. Brohl, U.S. S. Ct. (10th Cir.),814 F.3d 1129 (2016), petition for cert. denied, U.S. S. Ct., Dkt. Nos. 16-267; 16-458, 12/12/2016.
22 Direct Marketing Association v. Brohl, 575 U.S. ___ (2015).
23 Direct Marketing Ass’n v. Brohl, U.S. S. Ct. (10th ),814 F.3d 1129 (2016), petition for cert. denied, U.S. S. Ct., Dkt. Nos. 16-267; 16-458, 12/12/2016.
25 N.D. Cent. Code 2298 § 1; N.D. Cent. Code 2298 § 2
27 Ohio Rev. Code Ann. § 5741.01(I)(6)(d) ; Ohio Rev. Code Ann. § 5741.01(I)(2)(h) ; Ohio Rev. Code Ann. § 5741.01(I)(2)(i) ; Ohio Rev. Code Ann. § 5741.01(I)(6)(e) ; Ohio Tax Information Release No. ST 2017-02, 10/01/2017 .
28 R.I. Gen. Laws § 44-18.2-3(A) ; R.I. Gen. Laws § 44-18.2-1 ; Notice: To All Non-Collecting Retailers, Rhode Island Division of Taxation, Notice 2017-09, 08/04/2017 ; Washington, L. 2017, Chapter 28 §§ 201-205.
29 Direct Marketing Ass’n v. Brohl, U.S. S. Ct. (10th Cir.),814 F.3d 1129 (2016), petition for cert. denied, U.S. S. Ct., Dkt. Nos. 16-267; 16-458, 12/12/2016; Quill Corp. v. North Dakota, U.S. S. Ct., 504 U.S. 298 (1992).
30 South Dakota v. Wayfair, Inc. et al., S.D. S. Ct., 2017 S.D. 56 (2017), cert. granted, U.S. S. Ct., Dkt. No. 17-494, 01/12/2018.
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