Bellas Hess, Quill, and online sales tax collection

April 25, 2012

As you’ve likely noticed, there has been quite a bit of news lately about online sales tax collection. In the media coverage of this issue, we’ve frequently seen glancing references to the Supreme Court cases Quill or Bellas Hess—but rarely an actual explanation of how they affect consumers, retailers, and states, let alone what exactly those rulings say.

On this occasion, the eve before the Senate Finance Committee Hearing “Tax Reform: What It Means for State and Local Tax and Fiscal Policy” (where we expect the Marketplace Fairness Act to be discussed at length) we thought it might be helpful to give a brief review of these two landmark Supreme Court cases.

This post is not a scholarly analysis of the (dormant) Commerce Clause, or due process concerns, or states sovereignty and federalism—such analyses are amply handled by greater legal/constitutional minds than ours. Rather, this post is intended as a primer for business leaders, so they can understand why these rulings are important and why the logic underlying them is so out-of-date—warranting attention and action by Congress.

Bellas Hess refers to the 1967 Supreme Court case National Bellas Hess v. Department of Revenue of Illinois. Illinois’s Department of Revenue attempted to force catalog retailer Bellas Hess, which was based in Kansas City, to collect Illinois sales tax. Bellas Hess refused, and the case went all the way to the Supreme Court.

In its ruling, the Supreme Court said that only businesses with nexus in a state have to collect sales tax for that state. Nexus is created by a physical presence, though opinions on what constitutes a physical presence vary. It can be a warehouse, office, retail location, employees, or even vehicles. Some states have argued that having business affiliates in a state creates nexus there.

In any case, the Supreme Court specified that businesses had to have nexus in a state to collect sales tax there because it would be too burdensome for a business located in one state to collect sales tax for another state (possibly every state). Specifically, Justice Potter Stewart wrote in the majority opinion:

The many variations in rates of tax, in allowable exemptions, and in administrative and record-keeping requirements could entangle National [Bellas Hess]’s interstate business in a virtual welter of complicated obligations to local jurisdictions.

(emphasis ours)

Interestingly, in the dissenting opinion, Justice Abraham Fortas wrote that “the Court’s response that these administrative and record keeping requirements could ‘entangle’ appellant’s interstate business in a welter of complicated obligations vastly underestimates the skill of contemporary man and his machines.” We couldn’t agree more—and it’s even more true now, in 2012, than in 1967. We know that technology is able to handle multistate sales tax because we’ve built a service that does so: TaxCloud.

The Bellas Hess ruling went on to say that an act of Congress was necessary to give states the ability to require out-of-state businesses to collect sales tax. Without an act of Congress, the Supreme Court ruling was the ultimate authority on what states could and could not do.

In 1992, the issue of out-of-state sales tax collection arose again. North Dakota tried to require Quill Corporation, a mail-order office supply company incorporated in Delaware, to collect tax on its sales into the state. Quill refused on the grounds that it had no physical operations or employees in North Dakota.

The Supreme Court sided with Quill, citing the previous ruling in Bellas Hess and stating that customers alone (in other words, an economic presence) weren’t enough to create nexus.

However, in the Quill ruling, the Supreme Court specifically invited Congress to exercise its authority to overrule the Supreme Court by enacting legislation:

[O]ur decision is made easier by the fact that the underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve. No matter how we evaluate the burdens that use taxes impose on interstate commerce, Congress remains free to disagree with our conclusions. See Prudential Insurance Co. v.Benjamin328 U.S. 408 (1946). Indeed, in recent years Congress has considered legislation that would “overrule” the Bellas Hess rule. Its decision not to take action in this direction may, of course, have been dictated by respect for our holding in Bellas Hess that the Due Process Clause prohibits States from imposing such taxes, but today we have put that problem to rest. Accordingly, Congress is now free to decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect use taxes.

Indeed, even if we were convinced that Bellas Hess was inconsistent with our Commerce Clause jurisprudence, “this very fact [might] giv[e us] pause and counse[l] withholding our hand, at least for now. Congress has the power to protect interstate commerce from intolerable or even undesirable burdens.” Commonwealth Edison Co. v. Montana453 U.S. 609, 637 (1981) (White, J., concurring). In this situation, it may be that “the better part of both wisdom and valor is to respect the judgment of the other branches of the Government.”Id., at 638.

(emphasis ours)

In other words, the Supreme Court left the issue up to Congress.

To sum up: The Supreme Court rulings in Bellas Hess (1967) and Quill (1992) determined that a business needs to have a physical presence in a state in order for the state to require the business to collect sales tax. What constitutes a physical presence is still a matter of debate, however.

The Supreme Court also made it clear that Congress has the power to pass legislation changing the outcome of the Supreme Court rulings. And because the Court based its decisions on the idea that collecting sales tax would be too burdensome for remote retailers, an idea that technology has rendered moot, it’s critically important that Congress do so.

We hope Congress will learn enough tomorrow to pass the Marketplace Fairness Act quickly to correct the devastating imbalance impacting retailers, consumers, and local governments across the country.

Chicago Tribune Article Gets it Right

November 10, 2010

Yesterday’s article in the Chicago Tribune by Columnist Eric Zorn covers all the issues related to sales tax collection by internet merchants.  The article starts by highlighting a local retailer who has been steadily losing business on price to internet retailers.  Mr. Zorn goes on to explain the finer points of use tax reporting and remittance (even helpfully including links to the tax forms that need to be completed for out-of-state sales), and goes on to say that use tax collection “…has a low compliance rate…[f]ewer than 5,000 taxpayers filed ST-44s in fiscal 2010, according to the revenue department, leaving an estimated $163 million in online Illinois sales taxes unpaid.”

The article wraps up with a discussion of why Internet companies have escaped sales tax collection thus far (Quill and Bellas Hess Supreme Court decisions) and why that view is outdated: “It wasn’t a particularly urgent question when the Web was young and e-tailers argued successfully that taxing Internet purchases would strangle the baby of e-commerce in its crib.  But now that e-commerce is an obstreperous adolescent, conventional small businesses are gasping for air and cash-strapped states are eyeing all this lost revenue hungrily.”

Good points, great article, thanks Mr. Zorn.