Andrew J. Haile
(Elon), Disruptive Technology: The Tax Injunction Act:
In March 2012, a federal district court in Colorado permanently enjoined the state’s attempt to improve its use tax collections on internet sales to Coloradans. Last month, the Tenth Circuit reversed that decision on grounds that (almost) no one predicted, holding that the district court did not properly hear the case to begin with on account of the Tax Injunction Act. Given the ever-expanding role of e-commerce in our economy, the ability of states to collect use tax has a significant impact on much-needed tax revenues. Moreover, the case in question (Direct Marketing Association v. Brohl) raises the important issue of when the Tax Injunction Act applies, with the Tenth Circuit giving a relatively broad answer to this question.
The legislation in dispute requires retailers with no physical presence in Colorado (and therefore no obligation to collect use tax under Quill v. North Dakota), to report certain information to their purchasers and to the Colorado Department of Revenue. Specifically, an affected retailer is required to provide: (1) notice to purchasers that use tax is due on their purchases; (2) an annual summary to purchasers of the amount of purchases made from the retailer during the previous year; and (3) an annual report to the Department of Revenue specifying the total purchase amounts made by Coloradans from the retailer for which no sales taxes were collected.
The Direct Marketing Association (DMA) filed suit in June 2010 contending that the reporting requirements violated, among other things, the Commerce Clause and the privacy rights of Colorado purchasers. As previously mentioned, in March 2012 the district court agreed with the DMA as to the Commerce Clause, and permanently enjoined the reporting requirements.
One of the fundamental issues in the case before the district court was whether the reporting requirements constitute a tax or simply a general regulation of commerce. If a tax, the proper analysis would be under Complete Auto Transit, Inc. v. Brady, which, in pertinent part, asks only whether a tax is discriminatory (i.e., it does not inquire into the purpose or potential benefits of the tax). If the reporting requirements were deemed a regulation, however, the court would apply a potentially more deferential test—one that would consider the purpose for the legislation and may even go so far as to weigh the burdens and benefits of the legislation. In effect, if the reporting requirements were treated as regulations rather than taxes, the state had a much greater chance of prevailing in the litigation. See Gaylord & Haile, Constitutional Threats in the E-Commerce Jungle, 89 N.C. L. Rev. 2011 (2011) for a discussion of the different judicial standards applied to a tax versus a regulation.
The Colorado district court agreed with the DMA and found the reporting requirements to constitute a tax. The district court recognized that the reporting requirements were “somewhat different than the burden of collecting and remitting sales and use taxes,” but also concluded that the “sole purpose” of the reporting requirements was “the ultimate collection of use taxes when sales taxes cannot be collected.” For this reason the district court assessed the constitutionality of the reporting requirements under the framework set forth in Complete Auto.
While not discussed in the district court’s opinion, the characterization of the reporting requirements as a tax had significant implications with respect to the federal Tax Injunction Act (TIA). As noted by tax profs David Gamage (UC-Berkeley) and Darien Shanske (UC-Davis) in a July 2012 State Tax Notes Article, characterizing the reporting requirements as a tax created an “injunctive Catch-22.” [The Saga of State 'Amazon' Laws: Reflections on the Colorado Decision, 65 State Tax Notes 197 (July 16, 2012).] Gamage and Shanske explained as follows:
[T]he Catch-22 is this: If the Colorado [reporting requirements] were properly analyzed under Complete Auto (and Quill) why did the district court have jurisdiction to enjoin them? If the [reporting requirements] constitute a tax, the court should not have jurisdiction until the tax is actually collected. Conversely, if the [reporting requirements] are not a tax, the district court presumably should not have analyzed them using the Quill and Complete Auto frameworks; instead . . . the district court should have used a different framework that is potentially more favorable to upholding the [reporting requirements].
Well, the duo of Gamage and Shanske might be the Nate Silver(s) of tax controversy, as the Tenth Circuit held in the Brohl case that the reporting requirements constitute a tax for TIA purposes, and therefore the district court should not have reached the question of the constitutionality of the reporting requirements under the Commerce Clause.
Neither party to the litigation contended that the Tax Injunction Act applied. The Department of Revenue, in a footnote in its appellate brief, did say that “[b]y treating the information reporting requirements of Colorado’s Law like a tax, the district court may have unnecessarily implicated the Tax Injunction Act.” But it went on in that same footnote to conclude that “[i]n any event, this Court may reverse the district court’s injunction without running afoul of the TIA or comity principles.” The DMA argued in its brief that the Tax Injunction Act did not apply because out-of-state retailers were not taxpayers and they were challenging “notice and reporting requirements, not a tax assessment.”
The Tenth Circuit concluded, however, that the injunction of Colorado’s reporting requirements violated the TIA. In coming to this conclusion, the court found that the TIA may apply in instances other than “when taxpayers seek to avoid a state tax.” According to the Tenth Circuit, the key question is “whether the plaintiff’s lawsuit seeks to prevent ‘the State from exercising its sovereign power to collect . . . revenues.’”
This result with respect to the TIA is particularly noteworthy because of the role of the analogous Anti-Injunction Act (AIA) in NFIB v. Sebelius (the Patient Protection and Affordable Care Act/ObamaCare litigation), where the Supreme Court found the individual mandate to constitute a tax for purposes of the Taxing Power but not for purposes of the AIA. The DMA in this litigation essentially argued that Colorado’s reporting requirements constitute a tax for purposes of applying Complete Auto and Quill, but not for purposes of the TIA. Unlike the ObamaCare litigation, however, the Tenth Circuit would not allow the reporting requirements to be characterized as a tax for one purpose but not for the other.
And so for now the Colorado reporting requirements are resurrected, though they are still subject to challenge either in the state courts immediately or in the federal courts after they have actually been applied. With no ultimate decision on the substantive underlying question of the constitutionality of the reporting requirements, both the Department of Revenue and the DMA may walk away from the Tenth Circuit decision unsatisfied. The only winners from this result may be Gamage and Shanske, who can claim to have seen the whole thing coming while the rest of us didn’t.