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Commerce Clause, Due Process and Quill Corp

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Written by Monika Miles, Miles Consulting Group, Inc. (formerly Labhart Miles)

While many of the principles in state taxation (including sales taxation) are similar from state to state, there are also many differences. Our current system stems from various state statutes and regulations, but because a great deal of state taxation occurs often during the course of interstate commerce, regulation also comes from the U.S. Congress and U.S. Supreme Court decisions in multi-jurisdictional cases.

The U.S. Constitution and Interstate Commerce:

The Constitution of the United States gives Congress the ability to regulate commerce between the states. The two main principles that are regularly discussed with respect to multistate tax issues are the Due Process Clause of the 14th Amendment to the U.S. Constitution and the Commerce Clause, Article 1, Section 8 of the U.S. Constitution.

The Due Process Clause: The Due Process Clause states that no state shall "deprive any person of life, liberty, or property, without due process of law." With respect to state taxation, the Supreme Court has interpreted this to prohibit a state from taxing a corporation unless there is a "minimal connection" between the company and the state in which it operates.

The Commerce Clause: The Commerce clause, in part, authorizes Congress to "regulate commerce with foreign nations, and among the several States." The Supreme Court has ruled that the Commerce Clause prohibits states from enacting laws that might unduly burden or inhibit the free flow of commerce between the states. In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), the Supreme Court ruled that the taxpayer must have "substantial nexus" with the taxing state in order for the state to impose its tax on the taxpayer.

Important Legal References Regarding Sales Tax:

A U.S. Supreme Court case in 1992, Quill Corp. vs. North Dakota, 504 U.S. 298 (1992), answered some of the questions about how the Due Process and Commerce Clauses shape the world of sales taxation. The case attempted to clarify the terms "minimumconnection" and "substantial nexus". Quill is still recognized as the landmark case regarding nexus, and you'll find it in any research you might do on the issue. In fact, the case has recently appeared in the mainstream media quite frequently as Congress considers passing Marketplace Fairness legislation (see "Internet Tax & SST" section) that might ultimately overturn this landmark decision and change the sales tax filing landscape significantly.

Quill Corp: Quill was a mail order office supply retailer selling its products through catalogs. It made its deliveries of products via common carrier. The company was incorporated in Delaware with locations in Illinois, Georgia, and California. It had no employees or location in North Dakota, but did make significant sales into the state. North Dakota attempted to impose upon Quill the obligation to collect and remit the state's use tax on sales to North Dakota customers. The North Dakota Supreme Court ruled that Quill had sufficient economic nexus with the state, and that the company had sufficiently availed itself of the services and benefits of the state by virtue of its business relationship with North Dakota customers. The U.S. Supreme Court reversed the lower court's ruling, indicating that while Quill had met the minimum connection standard of the Due Process clause via the economic nexus, it had NOT met the sufficient nexus standard of the Commerce clause. The Court upheld its earlier ruling in National Bellas Hess, where it affirmed that substantial nexus exists only where there is a non-trivial physical presence in the state.

Why It's Important:This Supreme Court ruling is significant because many states are passing legislation that contradicts the Quill ruling that a company must have substantial nexus before being required to file. It provides a real dilemma for taxpayers when a state's legislature passes a law that provides a bright line threshold for nexus creation. For example, several states have enacted statutes that state that if a seller has a specific dollar amount of sales into the state, then nexus has been created and the company has a sales tax collection responsibility. Such legislation is contrary to the Supreme Court ruling in Quill and is therefore unconstitutional. So, a taxpayer can disagree on principal but lose in practice until challenges against the legislation work their way through the courts where it may ultimately be deemed unconstitutional.

Scripto Inc: One common misperception that companies have regarding nexus and creation of taxable presence is that they create nexus in a state only if they have property and/or their own employees physically entering the state on a regular and systematic basis as supported by the Quill decision. Many believe that if the company operates with third party contractors in a given state, it does not create nexus. This is incorrect. In Scripto, Inc. v. Carson (362 U.S. 207, 1960), the U.S. Supreme Court addressed the issue of independent sales representatives creating nexus. The court held that with respect to nexus creation, the distinction between employees and independent contractors was "without constitutional significance" and that to make such a distinction would open the door to planning for tax avoidance. Thus, independent contractors working on behalf of a company in a state are held to the same standards as employees with regard to creation of nexus.

Why It's Important: Many companies are unaware of the events that trigger nexus and may have liabilities in the current and also prior years. It is prudent for companies to review their nexus triggering events and dates in order to assess their potential exposure. As such, they should also evaluate the states in which they are doing business to determine if they have established the minimum thresholds (either via sales volume or employee/contractor activity) to create nexus.

Don't forget to check the following Sales Tax 101 sections to learn more about sales tax:

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