On Friday, the U.S. District Court of Colorado entered a permanent injunction against enforcement of an unconstitutional Internet tax measure passed through the Colorado legislature in 2010. H.B. 10-1193 would have required out-of-state, online businesses with no physical presence in the state to report their Colorado consumers to the state Department of Revenue, who could then go after residents for failing to pay their “use tax” on Internet purchases. Direct Marketing Association v. Huber follows the January 2011 granting of a preliminary injunction barring the State of Colorado from enforcing provisions of the law in question.
The law came in response to the U.S. Supreme Court’s ruling in Quill v. North Dakota, which ruled that a lack of a physical nexus in a state exempts an out-of-state retailer from having to collect and pay sales taxes, least it be a violation of the Dormant Commerce Clause. Many states continue trying to force unconstitutional sales tax collection onto online retailers. However, the Colorado law went after Colorado consumers, who owe “use tax” on Internet purchases, but by placing undue and unconstitutional regulations on retailers.
This statute would have established three new, burdensome regulations on out-of-state online retailers who sell products to customers in Colorado. First, the new regulations would have forced such retailers to notify their customers in Colorado that they do not collect a state sales tax, thus making the customer obligated to self-report their purchases and pay use tax to the Colorado Department of Revenue (DOR). The second provision of the law would have made these out-of-state retailers provide their Colorado customers with an annual report of their purchases from the past year, and send to the DOR an Annual Purchase Summary. Finally, it would have mandated that the retailers provide an annual report of each customer, along with their name, billing/shipping addresses, and purchases to the DOR.
In its decision, the Court rightly found that H.B. 10-1193 discriminates against remote sellers in violation of the Commerce Clause of the U.S. Constitution, and imposes an undue burden on these out-of-state retailers. In short, the statute was in violation of Quill.
The decision by the U.S. District Court in Colorado follows a number of other similar state rulings, including a case in North Carolina in which a District Court struck down the law because of First Amendment and privacy concerns in the reporting provisions. Apart from the privacy concerns, the constitutionality concerns, and the undue burden that it places on families and businesses, Internet tax laws pose a severe threat to the physical presence standard, which has long guarded against taxation without representation. Physical presence prevents states from taxing residents in other states and expanding the long arm of the tax collector past the appropriate boundary. It also incents tax competition between states. Data strongly suggests that individuals and families migrate from high tax states to low tax states thanks to stronger economic growth and lower unemployment. Allowing tax collectors to reach across state lines dissolves these borders, diminishing tax competition.
Direct Marketing Association v. Huber is a significant win in the fight to preserve the constitutional physical nexus standard and prevent taxing the borderless marketplace that is the Internet. It is important that more state legislatures stay away from this type of tax in order to ensure future prosperity for its businesses and families.