Direct Marketing Association Re-files Challenge to Colorado Notice and Reporting Law in State Court

We have been updating readers on developments regarding the court challenge brought by the Direct Marketing Association (“DMA”) to a 2010 Colorado law that purported to require Internet retailers and other remote sellers that do not collect Colorado sales tax to: (1) give certain notices to their Colorado customers regarding the purchaser’s obligation to self-report Colorado use tax; and (2) file reports with the Colorado Department of Revenue detailing the private purchasing information of their Colorado customers. The DMA won a preliminary injunction in January 2011 in federal District Court suspending the law on the grounds that it violated the Commerce Clause. The Court later made the injunction permanent when it awarded the DMA summary judgment in March 2012. The State appealed.

In August 2013, the Court of Appeals for the Tenth Circuit ruled on its own initiative that the Tax Injunction Act (“TIA”) barred federal court jurisdiction over the DMA’s claims. The Court of Appeals did not reach the merits of the DMA’s Commerce Clause claims, but rather ordered that the claims be dismissed on procedural grounds. The Court held that the DMA was required under the TIA to bring its claims in Colorado state court. The DMA requested rehearing on the jurisdictional issue, but the Tenth Circuit declined in early October to rehear the matter. The Court of Appeals then issued a mandate to the District Court on October 9, directing the lower court to dissolve the injunction and dismiss the claims. (The District Court has not yet implemented the mandate, so for now the federal injunction remains in place.)

On November 5, 2013, the DMA re-filed its challenge to the Colorado notice and reporting law in state District Court in Denver. At the same time, the DMA moved for a preliminary injunction, in order to continue the suspension of the law after the federal court injunction is lifted. Briefing on the motion for a preliminary injunction is expected to conclude in December, with a hearing on the motion likely to be scheduled for early January 2014. The DMA will request that the state court rule on the injunction request prior to January 31, the deadline under the law for retailers to send certain annual notices to customers who purchased at least $500 in goods from the retailers in the prior year.

Brann & Isaacson partners George Isaacson and Matthew Schaefer are co-counsel to the DMA in connection with the appeal.

We will keep you apprised of further developments in the state court proceeding.

MFA Update: Rep. Goodlatte’s Seven Principles and an Interview with George Isaacson

Although the Marketplace Fairness Act (S. 743) ("MFA") has not yet progressed out of a House committee since its Senate passage last spring, it continues to make headlines. In late September, the House Judiciary Committee, chaired by Rep. Bob Goodlatte (R-Va.), released seven “Principles on Internet Sales Tax.” Brann & Isaacson senior partner George Isaacson was recently profiled by State Tax Notes discussing both the MFA and Goodlatte’s Seven Principles.

The Seven Principles outlined by Representative Goodlatte provide for:

1. Tax Relief – “no new or discriminatory taxes not faced in the offline world”
2. Tech Neutrality – brick and mortar and online businesses “should all be on equal footing. The sales tax compliance burden on online Internet sellers should not be less…than that on similarly situated offline businesses”
3. No Regulation Without Representation – taxpayers “should have direct recourse to protest unfair, unwise or discriminatory rates and enforcement”
4. Simplicity – no “onerous compliance requirements,” “laws should be so simple and compliance so inexpensive and reliable as to render a small business exemption unnecessary”
5. Tax Competition – “Governments should be encouraged to compete with one another to keep tax rates low and American businesses should not be disadvantaged vis-à-vis their foreign competitors”
6. States’ Rights – “States should be sovereign” and “the federal government should not mandate that States impose any sales tax compliance burdens” and
7. Privacy Rights – “Sensitive customer data must be protected.”

As Isaacson notes, “The keystone and common thread of these principles is the need for true simplification of the existing sales and use tax system and an assurance of fair treatment of remote sellers when compared with in-state retailers.” Isaacson goes on to describe several steps that could be taken to simplify sales tax collection, including setting a single rate (combined state and local) for remote sales into a state, creating uniform tax menus or bases, and establishing uniform sourcing rules for remote sellers.

Isaacson also calls for providing access to federal courts to address violations of remote sellers’ rights. As the MFA now stands, remote sellers must protest tax assessments made in violation of federal statutory or constitutional law through appeals before state administrative agencies and state courts that may, as Isaacson points out, “tilt in favor or state revenue departments.” Providing for federal court jurisdiction “is the only meaningful way to protect those companies’ constitutional rights and enforce statutory limitations on the scope of state taxing power.” To that end, Isaacson argues for repeal or limitation of the Tax Injunction Act (“TIA”).

We will continue to keep our readers apprised of any developments regarding the Marketplace Fairness Act.

Federal Appeals Court Rules Lower Court Lacked Jurisdiction to Enjoin Colorado Notice and Reporting Law; Direct Marketing Association Will Seek Rehearing En Banc

Many of our readers have been following closely the litigation challenging the Colorado law passed in 2010, which required remote sellers to inform consumers of their obligation to self-report sales and use tax and also required direct marketers to turn over to the Colorado Department of Revenue the names of their Colorado customers along with sales transaction information. In 2012, the United States District Court in Denver declared the Colorado law unconstitutional, as a violation of the Commerce Clause. The Colorado Department of Revenue appealed the District Court decision to the Tenth Circuit Court of Appeals.

On Tuesday, August 20, 2013, the Tenth Circuit issued its decision in Direct Marketing Association v. Brohl. The three judge panel hearing the case did not reach, or address in any way, the constitutional issues in the case. Instead, the Court ruled solely on the question of whether the District Court had jurisdiction to hear the case.

Although the jurisdiction of the federal courts was not contested by the parties, the appellate court concluded that the United States District Court in Denver did not have jurisdiction because of the so-called Tax Injunction Act (28 U.S.C. sec. 1341) (“TIA”). This jurisdictional statute prevents federal courts from entering judgments that restrain the collection of state taxes, and the Tenth Circuit ruled that it applied in this case. The Court stated that the challenge to the constitutionality of the Colorado law must be filed in state court rather than federal court. Therefore, the Court of Appeals remanded the case back to the District Court and directed it to dismiss the DMA’s Commerce Clause claims and to dissolve the permanent injunction against the Department of Revenue’s enforcement of the law.

The effect of the Court of Appeals’ ruling that the case should be dismissed does not take immediate effect, despite some media reports that suggest the contrary. Rather, as in any appeal, the ruling of the Court of Appeals is not implemented until it issues a “mandate” to the District Court. The Tenth Circuit Court of Appeals has not yet issued a mandate in the DMA’s case, and will not do so until after certain deadlines have passed.

In addition, the DMA has decided that it will petition for rehearing “en banc” by the full group of active judges serving on the Tenth Circuit Court of Appeals. The filing of the petition for rehearing en banc will further extend the period during which the Court of Appeals will withhold issuance of the mandate to the District Court. If the petition is granted by the Court, the mandate would not issue until after the rehearing of the case by the full court.

For now, therefore, the injunction entered by the District Court remains in place, and remote sellers are not yet required to comply with the requirements of the Colorado notice and reporting law. We will keep readers apprised of developments in the case in connection with the DMA’s petition for rehearing.

Brann & Isaacson partners George Isaacson and Matthew Schaefer represent the DMA in the case.

The Incredible Shrinking Jurisdiction?

On June 1, 2010, the United States Supreme Court in Levin v. Commerce Energy, Inc., 560 U.S. __ (2010), issued as close as it gets these days to a unanimous decision. Though fractured into four separate opinions, all of the Justices reached the same conclusion: that the United States District Court for the Southern District of Ohio correctly dismissed a state tax-related case. But, the distinction between the majority opinion and a concurrence by the Court’s most conservative Justices reveals that the door to federal court involvement in state tax matters remains open.

For direct marketers, access to federal courts for challenges to the constitutionality of state and local taxes and related enforcement efforts by the states is especially important. Not only are federal courts often more experienced in regards to federal constitutional issues, including Commerce Clause disputes, but they offer at least the appearance of a more neutral playing field since the federal courts are not funded by state tax revenue and are often called upon to play the role of arbiter in jurisdictional battles between the states. Thus, any decision that appears to restrict access to federal courts needs to be reviewed very closely.

Background. Under Ohio law, certain sellers of natural gas enjoy tax exemptions, while others do not. Mindful of the Tax Injunction Act, and its broad limitation on the federal courts entertaining suits seeking to arrest the collection of state tax (or to reduce the amount of tax so collected), the plaintiffs came up with a clever approach that convinced the United States Court of Appeals for the Sixth Circuit to reinstate the case previously dismissed by the District Court. In crafting their complaint, the plaintiffs sought not to reduce their own tax obligations or in any way arrest the collection of taxes. Rather, the relief they sought was to deny their competitors certain tax exemptions, the net result of which, if successful, would be to increase state tax revenues. Because the plaintiffs did not seek to arrest collection of tax, the Sixth Circuit agreed that they had avoided falling under the Tax Injunction Act’s restrictions.

In addition to the Tax Injunction Act, the doctrine of “comity” may also keep tax cases out of federal court.  Comity is the doctrine under which a court can stay its hand in hearing a case that lies within its jurisdiction to hear, and to do so out of respect for the power of other courts--perhaps better suited--to resolve the matter.  In tax cases like this one, a rationale for dismissal of a case on the basis of comity could include deference to state courts to resolve matters that impact on their governmental revenue-raising prerogatives and powers.

The plaintiffs in Levin argued, and the Sixth Circuit found, relying mainly upon a footnote from Hibbs v. Winn, 542 U.S. 88 (2004), that comity likewise did not bar the suit. In Hibbs, the Supreme Court explained in a footnote that principles of comity only preclude federal court jurisdiction “when plaintiffs have sough district-court aid in order to arrest or countermand state tax collection.” Hibbs, 542 U.S. at 107 n. 9. It made sense. After all, the plaintiffs expressly disclaimed any interest in having their own taxes reduced or inhibiting in any way the collection of taxes by the State of Ohio.

The Supreme Court Reverses. But, the Supreme Court ran away as fast as it could from the footnote in Hibbs. In its majority opinion, the Court held that the plaintiffs were not free to elect a form of relief that would sidestep the Tax Injunction Act or comity. Whether to strike down the exemptions (as the plaintiffs had requested) or to apply the exemptions to all natural gas sellers (including the plaintiffs) was the prerogative of the State of Ohio, the Court explained, and not the federal courts or the plaintiffs. The Court noted that it has, as a matter of practice, abstained from determining remedial choices, allowing states the flexibility to respond as they see fit once provided a finding that a state tax statute is constitutionally infirm. See. e.g., McKesson Corp. v. Fla. Dep’t of Business Regulation, 496 U.S. 18, 49-40 (1990).

The Court also distinguished Hibbs on the grounds that the plaintiffs in the Hibbs case  were, effectively, strangers to the underlying tax controversy arising out of tax credits allowed for payments that subsidized parochial school scholarships. “It was essentially,” the majority in Levin observed, “an attack on the allocation of state resources for allegedly unconstitutional purposes” by “outsiders to the tax expenditure.” Thus, “[u]nlike the Hibbs plaintiffs, respondents do object to their own tax situation, measured by the allegedly more favorable treatment accorded [their competitors].” In Hibbs, the majority also noted, the only remedy was the invalidation of the tax credit—and, as a result, the case did not result in the intrusion of the federal courts into state remedial choices. Notably, in a concurring opinion, the more conservative Justices found that both comity and the Tax Injunction Act barred federal court adjudication of the case and supported their decision to reinstate the District Court’s dismissal.

Implications. The conservative members of the Court signaled the likely impact of the Levin case when they bemoaned the Court’s reliance on comity (a “prudential ground”) rather than the Tax Injunction Act (a "jurisdictional ground"). This is an important distinction—because the federal courts have it within their discretion to refrain from hearing a case where principles of comity, alone, are concerned.  Such a discretionary decision ordinarily would be given considerable respect on appeal.  In contrast, federal courts have no discretion to hear a case that is prohibited by the Tax Injunction Act.  The Act reflects an absolute limitation on the courts' power to hear the matter.  Justice Thomas pointedly identified the majority's holding as creating a loophole “to leave the door [of the federal courts] open to doing in future cases what it did in Hibbs, namely, retain federal court jurisdiction over constitutional claims that the Court simply does not believe Congress should have entrusted to state judges under the Act, see 542 U.S., at 113-28 (Kennedy, J., dissenting).”