On March 30, 2012, in Direct Marketing Association v. Huber, No. 10-CV-01546-REB-CBS, the U.S. District Court for the District of Colorado granted a motion for summary judgment in favor of a group of out-of-state retailers and permanently enjoined the enforcement of Colorado's use tax notice and reporting requirements. In so doing, the Court determined that Colorado's notice and reporting requirements violated the Commerce Clause of the U.S. Constitution.
In 2010, Colorado amended its tax laws to impose three new obligations on retailers making sales to Colorado customers but lacking physical presence and nexus with the state ("out-of-state retailers"). The obligations, as codified in Col. Rev. Stat. § 39-21-112(3.5), exclusively applied to retailers that do not collect Colorado sales tax and required retailers to:
- Notify Colorado purchasers both that use tax is due on certain purchases made from the retailer and that they are required to file a use tax return (Transactional Notice).
- Provide Colorado purchasers a year-end summary of information required by the Colorado Department of Revenue, including the total amount paid by the purchaser to the retailer in the previous calendar year, as well as dates, amounts and categories of purchases (Annual Purchase Summary).
- File an annual statement with the Department of Revenue for each individual purchaser by March 1, showing the total amount paid for Colorado purchases during the preceding calendar year (Customer Information Report).
Shortly after the law was enacted, the Direct Marketing Association (DMA) filed a motion for preliminary injunction to enjoin Roxy Huber, Executive Director of the Colorado Department of Revenue (Department), from enforcing the relevant statute and regulations. The preliminary injunction was granted by District Judge Robert E. Blackburn on January 26, 2011. DMA then sought a permanent injunction to enjoin enforcement, as well as a declaration that the new obligations were an unconstitutional violation of the Commerce Clause.
Summary of District Court's Ruling
The Court was guided by U.S. Supreme Court precedent which addressed the imposition of use tax upon out-of-state retailers shipping goods to in-state customers. National Bellas Hess, Inc. v. Department of Revenue of Illinois, 386 U.S. 753 (1967), held that requiring retailers to collect use tax in such circumstances violated both the Due Process Clause and the Commerce Clause of the U.S. Constitution. Twenty-five years later, Quill Corporation v. North Dakota, 504 U.S. 298 (1992), built upon National Bellas Hess and reaffirmed the bright line rule for out-of-state retailers under the Commerce Clause.
DMA presented two Commerce Clause arguments in its motion for summary judgment. Direct Marketing first argued that the new obligations impermissibly discriminate against interstate commerce. The Court applied the two-tier analysis of Brown-Forman Distillers Corp. v. New York State Liquor Authority, 476 U.S. 573 (1986), finding that, regardless of the laws' "salutary local purposes," the result was a geographic distinction between in-state and out-of-state retailers causing direct regulation and discrimination against the out-of-state retailers, and thus interstate commerce. Further, the Department was unable to show a legitimate state purpose that could not be served by a reasonable nondiscriminatory alternative.
DMA argued that the law also impermissibly imposed an undue burden upon interstate commerce. The Department defended on the basis that the law did not require out-of-state retailers to collect sales and use tax, but instead simply required the collection of information and notices to improve the collection of Colorado use tax. While the Court agreed that the burdens of notice and reporting may be distinct from the burdens of collecting sales or use tax, the Court opined that the sole purpose of the obligations is to collect use tax when sales tax cannot legally be collected. The Court reasoned that the practical effect of the obligations is to impose the very same burden on the out-of-state retailer that was condemned in the Quill case nearly 20 years ago.
The Court granted DMA's motion for summary judgment on both its discrimination and undue burden claims under the Commerce Clause. The Court also declared the law unconstitutional and granted DMA's permanent injunction to the extent that the laws obligated out-of-state retailers to provide transactional notice, annual purchase summaries and customer information reports. The Department has not yet filed a Notice of Appeal to the 10th Circuit Court of Appeals.
Direct Marketing comes in the midst of recent outcry from state revenue agencies for Congress to overturn Quill. Although Colorado took the lead in enacting use tax notice and reporting requirements, several states have enacted similar—though partial—versions of the law. In 2011, Vermont, Oklahoma and South Dakota enacted legislation requiring that remote sellers provide notice to customers of their use tax obligations. South Carolina and Tennessee have enacted tax collection agreements with Amazon that include notice requirements. Direct Marketing invalidated both the notice requirements and the reporting requirements of the Colorado law, so the Court's decision calls into question the constitutionality of the laws adopted by these states.
Even after the January 2011 preliminary injunction in Direct Marketing, the Multistate Tax Commission (MTC) continued to pursue a model statute largely based on the Colorado law at issue in Direct Marketing. The MTC's Hearing Officer Report in May 2011 continued to assert the constitutionality of the law, and the vote fell only one state short of being adopted at the MTC's annual meeting in July 2011. The Court's decision may chill the MTC's efforts to pass a model notice and reporting statute, but the MTC was aware that the Colorado law was constitutionally suspect when it continued to pursue the policy in 2011.
The Colorado statute at issue in Direct Marketing is an example of how states have tried to bypass the limitations of Quill. Although the Court's ruling highlights the potentially onerous impact of notification and reporting legislation on out-of-state retailers, the continued downturn in state tax revenues suggests that states will continue to experiment with use tax reporting regimes to test their constitutional boundaries. As this fight continues, it is essential that taxpayers work to protect their economic interests.