By Adam Thimmesch
The Supreme Court of South Dakota heard oral arguments in South Dakota v. Wayfair, Inc. earlier this week. That case involves a challenge to a South Dakota statute that requires vendors to collect the state’s use tax based solely on their economic connections with the state—a requirement that seems to directly contradict the rule embraced by the Supreme Court in Quill Corporation v. North Dakota. What was unusual about the case is that the state argued that it should lose. You don’t run into that every day.
The Origin Story: National Bellas Hess
States’ authority to compel nonresident vendors to collect their sales and use taxes has been a constitutional issue for decades. Modern discussions of the issue tend to start with Quill, but it goes back much farther. For purposes of this post, we can use 1967 as the starting point. It was in that that year that the Supreme Court reviewed and rejected an attempt by the State of Illinois to require a mail order company based in Missouri, the National Bellas Hess Company, to collect its use tax. The state statute at issue imposed the tax-collection requirement based solely on that company’s solicitation of orders within the state through the use of catalogues or other advertising.
The Supreme Court held that the state’s requirement was unconstitutional, noting that it had never before authorized the imposition of tax-collection obligations on vendors “who do no more than communicate with customers in the State by mail or common carrier as part of a general interstate business.” It “declined to obliterate” that line, and the physical-presence rule staked its claim as a guiding principle in state taxation.
Quill Corporation v. North Dakota
By the late 1980s, the state of North Dakota was sufficiently displeased with the physical-presence rule that it modified its law to impose use-tax collection obligations on retailers who simply targeted in-state customers through three or more advertisements in a 12-month period. Physical presence did not matter.
That obligation seemed to clearly conflict with National Bellas Hess, but the North Dakota Supreme Court upheld the state statute anyway. That court felt that National Bellas Hess was no longer controlling given the “wholesale changes” in the economy, technology, and law that had occurred in the intervening years.
The U.S. Supreme Court disagreed and upheld the physical-presence rule as a Dormant Commerce Clause requirement. Importantly, it did not express great enthusiasm for that rule, but it was satisfied that upholding the rule was the best course of action given the principle of stare decisis and the fact that Congress could always change course using its affirmative Commerce Clause power. Congress has not done so, of course, and the rule stands today.
Fast forward another twenty-four years, and we have South Dakota taking a swing at Quill. In 2016, that state’s legislature enacted a statute that imposed use-tax collection obligations on remote vendors based solely on their economic connections with the state. (The statute isn’t based on advertising in the state, but contains a revenue threshold of $100,000 and a transaction threshold of 200.) Of course, South Dakota didn’t do that in isolation. States have been testing the boundaries of the physical-presence rule for years, and Justice Kennedy invited this type of action in his concurring opinion in DMA v. Brohl earlier in 2016.
The South Dakota statute was enacted specifically to get the issue before the Supreme Court, and the litigation is progressing quickly. What makes the case somewhat quirky is that the state isn’t interested in winning at the state-court level. It admits that its statute is facially unconstitutional, supports the defendants’ motion for summary judgment, and has requested that the state’s high court use its opinion to prod the Court to grant cert and overturn Quill. (See again here.)
This is intriguing. Why not try to win? The Court has been fairly content to let state courts decide nexus issues and has not shown an overwhelming amount of interest in getting involved—Justice Kennedy’s concurrence notwithstanding. So, it certainly isn’t clear that the Court will review this case. That makes simply conceding the issue a big risk for the state. So why do it?
One answer is that the state may not have had any other choice. The legislature enacted this statute specifically to create a constitutional dispute, and the state may have felt that the South Dakota courts would have their hands tied by Quill. It is certainly true that state courts are bound by Supreme Court precedent.
I’m not totally convinced this rationale on this though. Just as courts are bound by precedent, they also often find reasons to distinguish that precedent from the controversy at hand. Here, the development of Internet commerce, alone, is significant and is a factor that that Court hasn’t evaluated. This could be an important point of distinction. The Quill court often referred to a physical-presence rule, but it also specifically referred to the National Bellas Hess “safe harbor” as applying to “vendors whose only connection with customers in the [taxing] state is by common carrier or the United States mail.” Internet vendors almost certainly do more than that.
In addition, there have been some broad interpretations of Quill in recent years. Some states have argued that Internet “cookies” can create a physical-presence nexus. The Iowa Supreme Court has also held that the use of intangible property can create the “functional equivalent” of a physical presence.
I don’t know if any of those arguments are ultimately persuasive, but they do offer a way for lawyers and a court to distinguish, or reason around, Quill. If the South Dakota Supreme Court felt inclined to uphold the statute, there would be paths available.
Losing as the Path to Winning
Obviously, a number of factors led to the decision to just lose. Maybe the state didn’t believe that the arguments offered above were credible, maybe it wanted to save time and money, or maybe it just wants a “clean” shot at Quill. For whatever reason, though, the state is not attempting to get its statute upheld in what is presumably a friendly forum. That necessary leaves something on the table. A favorable ruling is always nice to have in one’s back pocket, especially given that getting the Court to grant cert is far from a sure thing.
That, of course, leads to the big question—will the Court grant cert? I’ve always been pessimistic on that question. (This is likely the result of the constant admonition from my mother to hope for the best, but to expect the worst.) The Court has long recognized that Congress is better off handling these issues, and Congress could always act to undo anything that the Court does under the Dormant Commerce Clause. Further, it isn’t necessarily clear what the Court should do even if it doesn’t like Quill. Does it craft another bright-line rule? Does it give states unfettered power? Does just overturn the physical-presence rule and let state courts figure out what comes next?
I’ve seen a lot of critique of Quill. I’ve seen less discussion about how the Court should balance the competing interests involved in a post-Quill world. (I’ve discussed these issues previously here.) Ultimately, I’m not convinced that the Court will want to wade into this again, but I’d be happy to be proven wrong.
Ultimately, if the Court wants to review and overturn Quill, it has many good reasons to do so. Academics have been offering those for years, and they just keep coming (see here and here). This isn’t an issue of the Court having the right legal argument to overturn Quill. It is about whether it wants to do so. What is interesting is that it might be a decision actually upholding Quill that will get the Court to act.
Regardless, I think that I can speak for everyone who has been following this controversy for any amount of time in saying that it is time for something to be done. One way or another, we need to move on and build a rational system for handling multi-jurisdictional tax issues like this one.