United States: State Court Grants Injunction Against Colorado’s Sales And Use Tax Notice And Reporting Requirements

Colorado's remote sales notification and reporting requirements have once again been suspended by a court injunction. The Denver District Court granted the preliminary injunction based on an initial determination that the Colorado sales and use tax notice and reporting requirements unlawfully discriminated against nonresident retailers.¹

Procedural Background

The Direct Marketing Association (DMA), which consists of businesses and organizations that market products directly to consumers via catalogs, print advertisements, broadcast media and the Internet, filed a lawsuit against the Colorado Department of Revenue in U.S. District Court. In its lawsuit, the DMA challenged the constitutionality of Colorado's sales and use tax notice and reporting requirements for remote retailers enacted on February 24, 2010 (the "Act"⁾² by asserting violations of the Commerce Clause.³

The District Court granted the DMA's motion for a preliminary injunction against the Department that prevented enforcement of the notice and reporting requirements on remote retailers pending a final determination in the case.⁴ Both the DMA and the Department subsequently filed cross motions for summary judgment.

On March 30, 2012, the District Court granted a motion for summary judgment in favor of the DMA and issued a permanent injunction against the Department that enjoined the enforcement of the notice and reporting requirements.⁵ The District Court concluded that Colorado's notice and reporting requirements discriminated against and placed undue burdens on interstate commerce, in violation of the Commerce Clause. The Department appealed the District Court's decision.

On August 20, 2013, the Tenth Circuit of the U.S. Court of Appeals ordered the District Court to dismiss the case.⁶ After determining that the federal Tax Injunction Act (TIA)⁷ deprived the U.S. District Court of jurisdiction to enjoin Colorado's tax collection effort, the Tenth Circuit remanded the case to the District Court to dissolve the permanent injunction and to dismiss the Commerce Clause claims raised by the remote retailers. In remanding the case, the Tenth Circuit did not consider the merit of the constitutional arguments. Upon dismissal of the federal case, the DMA commenced a similar challenge in Colorado state court.

Notice and Reporting Requirements

Under the Act and the associated regulations promulgated by the Department, remote retailers that did not collect Colorado sales and use taxes are required to notify customers that they are obligated to self-report and remit use tax on their purchases.⁸ Remote retailers that did not collect tax are also required to provide Colorado customers with an annual report by January 31 of each year, via first-class mail, detailing a customer's purchases in the previous year and notifying the customer that the retailer was required to report the customer's name and amount of purchases to the Department.⁹ Finally, remote retailers that did not collect tax are also required to report to the Department, the name, billing address, shipping address and total amount of purchases made by Colorado customers by March 1 of each year.¹⁰ Under the state's regulations, however, certain de minimis retailers, or retailers with de minimis purchasers, are not subject to these requirements.¹¹

Preliminary Injunctive Relief Granted by Denver District Court

Based on the conclusion that each of the three Colorado notice and reporting requirements are facially discriminatory against non-resident retailers, the Denver District Court granted the DMA's request for a preliminary injunction.

Standards for Preliminary Injunctive Relief

In granting the injunction, the Court considered the six established requirements in Colorado for a party to be entitled to preliminary injunctive relief. Specifically, the plaintiff must prove: (i) that there is a reasonable probability of success on the merits; (ii) a danger of real, immediate and irreparable injury which might be prevented by an injunction; (iii) there is no plain, speedy, and adequate remedy at law; (iv) the granting of the preliminary injunction will not disserve the public interest; (v) the balance of the equities favors the injunction; and (vi) the injunction will preserve the status quo pending resolution of the merits.¹²

The Denver District Court focused its analysis for purposes of the preliminary injunction on whether the DMA has a reasonable probability of succeeding on its Commerce Clause challenges. Of the six required factors listed above, the others were easily met by the DMA and noted in the decision, along with the differences between the federal preliminary injunction standards that had been previously applied in federal district court and those required by Colorado law.¹³

Commerce Clause

The DMA brought eight separate claims for declaratory relief, of which the first two related to the application of the Commerce Clause. The first claim sought relief because the Act was facially unconstitutional as it discriminated against nonresident retailers. The second claim sought relief on the grounds that the Act was an improper regulation of interstate commerce.¹⁴

With respect to the challenge brought by the DMA, the central notion of the dormant Commerce Clause command that states not regulate commerce was noted by the Court to mean that states cannot discriminate between in-state and out-of-state economic interests in a way that benefits the former and burdens the latter, referring to the result as "facial discrimination."¹⁵ The Court also distinguished the two fundamental methods of challenging state action under the Commerce Clause: "proving that it is facially discriminatory (tier one) or proving that, even though not facially discriminatory, it nevertheless excessively burdens interstate commerce compared to its local benefits (tier two)."¹⁶

As to the DMA's claim that the Colorado notice and reporting requirements are facially discriminatory, the burdens placed on non-resident retailers were found to correspondingly benefit resident retailers, thus resulting in facial discrimination. The Court considered the four-prong test to survive Commerce Clause scrutiny first established in Complete Auto Transit,¹⁷ also noting the additional bright-line test established in National Bellas Hess¹⁸ and affirmed in Quill.¹⁹ The Court rejected the argument presented by the Department that the notice and reporting requirements do not impose a different burden on non-resident retailers, but instead equalize the tax collection burden already borne by in-state retailers. According to the Department, the inequality in tax collection burden to be remedied by the reporting requirements resulted from Colorado historically requiring in-state retailers to collect sales tax, but not being constitutionally able to require out-of-state retailers to collect the corresponding use tax. The Court declined to address in detail any additional facts put forth by the Department to support its position, noting only that it is "unlikely, on this record, that Defendants will be able to meet this almost impossible burden."

Having found in favor of the DMA as to the first tier challenge under the Commerce Clause, the Court declined to address in detail the DMA's claim that the statute places an undue burden on interstate commerce. However, the Court did note its view that it is unlikely, based on the current record, that the DMA would be able to prevail on this claim, primarily because of the procedural and substantive hurdles that must be overcome. Specifically, the provision commonly included in state statutes making retailers liable themselves for the sales and use taxes they fail to remit is the essential language that typically turns a collection obligation into a taxing obligation, triggering the bright-line rule of Bellas Hess and Quill. However, in this instance, non-resident retailers who fail to comply with the notice and reporting requirements do not become liable for uncollected use tax – instead, they are penalized. Therefore, whether the regulations at issue are subject to the four-prong test for determining Commerce Clause violations of a tax code remains an open question. As long as the retailers do not become liable for the tax which remains uncollected, the notice and reporting requirements might in fact be found constitutional.

Commentary

This is a significant decision for remote retailers considering how to address the controversial and expansive notice and reporting requirements enacted in Colorado, as well as several other states. Non-collecting retailers may not have focused on Colorado rule compliance to date, as the Department had issued a notice²⁰ indicating that it would not enforce the rules pending the outcome of this decision, possibly based on expectations that another injunction would be granted. It should be noted, however, that in granting the preliminary injunction, the Denver District Court stated that the very preliminary conclusions reached in the case are not "written in stone," and may change by the time the Court addresses the merits of the case.

Although Colorado took the lead in enacting these requirements for remote retailers, several other states have followed suit. For example, Kentucky enacted legislation requiring remote retailers to provide notice to purchasers that they must report and pay tax directly to the Kentucky Department of Revenue on purchases of non-exempt personal property.²¹ Moreover, Oklahoma,²² South Dakota²³ and Vermont²⁴ have also enacted remote seller notification requirements. The requirements enacted by other states, however, are not nearly as extensive as Colorado's requirements. The other states only require that the remote seller notify the customer of its obligation to pay use tax. Unlike Colorado, they do not require an annual purchase summary and customer information report. Presumably, however, it is the hope of each of these jurisdictions that in response to these rules, remote retailers will choose to register and collect sales taxes from in-state customers rather than simply follow the notification and reporting requirements. The decision by the Denver District Court could temporarily chill additional efforts by the states to adopt notice and reporting requirements of this nature.

It is interesting that the Denver District Court, in granting the injunction, took note of the fact that the regulations at issue could be considered regulatory in nature, rather than being viewed as imposing a tax. Perhaps this is because the sales and use tax, the incidence of which falls on Colorado-based purchasers, is already due. Accordingly, what Colorado seeks is not the imposition of a new tax but rather assistance in forcing its citizens to comply with existing law. As such, the constitutional standards applied to determine the validity of the Commerce Clause challenge could ultimately diverge significantly from those typically applied to determine the constitutionality of a tax statute. As the case progresses, the final determination of whether the regulations are in fact tax statutes could become a critical point.

Footnotes

1 Direct Marketing Association v. Department of Revenue, District Court, City and County of Denver, No. 13CV34855, Feb. 18, 2014 (Order Granting Motion for Preliminary Injunction).

2 H.B. 10-1193, Laws 2010, which is now codified at COLO. REV. STAT. § 39-21-112(3.5).

3 U.S. CONST. art. I, § 8.

4 Direct Marketing Association v. Huber, U.S. District Court, D. Colorado, No. 10-cv-01546-REB-CBS, Jan. 26, 2011 (Order Granting Motion for Preliminary Injunction).

5 Direct Marketing Association v. Huber, U.S. District Court, D. Colorado, No. 10-cv-01546-REB-CBS, March 30, 2012.

6 Direct Marketing Association v. Brohl, U.S. Court of Appeals, 10th Circuit, No. 12-1175, Aug. 20, 2013. Note that the defendant in this litigation originally was Roxy Huber, the Executive Director of the Colorado Department of Revenue when this litigation commenced. The current Executive Director, Barbara Brohl, was substituted as the defendant.

7 28 U.S.C. § 1341.

8 COLO. REV. STAT. § 39-21-112(3.5)(c); 1 COLO. CODE REGS. § 39-21-112.3.5(2)(b). The Denver District Court referred to this as the "transactional notice."

9 COLO. REV. STAT. § 39-21-112(3.5)(d)(I)(A), (B). The Denver District Court referred to this as the "annual purchase summary."

10 COLO. REV. STAT. § 39-21-112(3.5)(d)(II). The Denver District Court referred to this as the

"customer information report."

11 According to the state's emergency regulations, a retailer is presumed to be de minimis if it made less than $100,000 in total gross sales in Colorado in the prior calendar year and reasonably expects total gross sales in Colorado in the current year to be less than this amount. 1 COLO. CODE REGS. § 39-21-112.3.5(1)(a). Moreover, the summary of annual purchases is required to be delivered only to customers who spend over $500 in the calendar year with a particular retailer. 1 COLO. CODE REGS. § 39-21-112.3.5(3)(c).

12 Rathke v. MacFarlane, 648 P. 2d 648 (Colo. 1982).

13 The differences between the preliminary injunction standards applied when this case was presented to the federal district court and those required by Colorado law under Rathke were noted as follows: (i) the federal standard required a "substantial likelihood" of success, while the state standard requires a "reasonable probability;" (ii) the federal standard lacks two elements required by the state standard: the plain, speedy, and adequate remedy at law and preservation of the status quo; and (iii) the state standard requires that the plaintiff ultimately prove a statute is unconstitutional beyond a reasonable doubt. In utilizing the state law preliminary injunction standards, the Denver District Court noted that the terms "substantial likelihood" and "reasonable probability" were used interchangeably by courts without acknowledging any difference.

14 The Denver District Court characterized the first claim as the discrimination claim and the second claim as the undue burden claim. The six other claims related to federal and state constitutional violations of Colorado customers' privacy interests and free speech rights, as well as a violation of due process and an unconstitutional taking.

15 Citing Oregon Waste Sys, Inc. v. Department of Environ. Qual., 511 U.S. 92 (1994); Wyoming v. Oklahoma, 502 U.S. 437 (1992); and Chemical Waste Mgmt., Inc. v. Hunt, 504 U.S. 334 (1992).

16 Citing Brown-Forman Distillers Corp. v. New York State Liquor Auth., 476 U.S. 573, 578-79 (1986).

17 Complete Auto Transit v. Brady, supra, 430 U.S. at 279, establishing that a state tax will survive Commerce Clause scrutiny if it satisfies each of four inquiries: (1) the activity taxed has a substantial nexus with the taxing state; (2) the tax is fairly apportioned; (3) the tax does not discriminate against interstate commerce; and (4) the tax is fairly related to the services provided by the state.

18 National Bellas Hess, Inc. v. Department of Revenue, 386 U.S. 753 (1967), wherein the Court determined that a mail order retailer with no store, sales force, or other physical presence in a state did not have a "substantial nexus" to the taxing state.

19 Quill Corp. v. North Dakota, supra, 504 U.S. 298.

20 Notice, Colorado Department of Revenue, Dec. 19, 2013.

21 Ch. 119 (H.B. 440), Laws 2013, amending KY. REV. STAT. ANN. § 139.450.

22 OKLA. STAT. tit. 68, § 1406.1.

23 S.B. 146, Laws 2011.

24 VT. STAT. ANN. tit. 32, § 9783.

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