Two recent, related developments should serve to remind state and local government and tax officials that under our Constitution’s Commerce Clause, it is Congress ― not states and localities ― that has the power “to regulate Commerce...among the several States.” Art. I, Sec. 8, Cl. 3.
On January 25, 2010, the Supreme Court issued its decision in Hemi Group, LLC v. City of New York, 130 S.Ct. 983 (2010), rejecting an attempt by the City of New York to use the Racketeer Influenced and Corrupt Organizations Act (“RICO”) to punish a New Mexico-based online seller of cigarettes for allegedly costing the City millions of dollars in lost sales and use tax revenue on cigarettes purchased by New Yorkers. The City did not claim that Hemi Group was obligated to collect and remit the $1.50 per pack New York City use tax on cigarettes. Rather, the City claimed that the Hemi Group failed to comply with its legal obligations under the federal Jenkins Act (15 U.S.C. §§ 375-378), which requires out-of-state cigarette sellers to register and file a report with state tobacco tax administrators listing the name, address and quantity of cigarettes purchased by New York state residents. The State of New York had an agreement to share such information with the City of New York. Hemi Group’s failure to comply, the City argued, meant that it received no information from the State about cigarette purchases by City residents from Hemi Group, and therefore could not bill them for any use tax that the residents failed to self-report and pay. According to the City, Hemi Group’s violation of the Jenkins Act also constituted a RICO violation that harmed the City through the loss of use tax revenues.
In addressing the City’s claims, the Court rejected the City’s RICO argument on the ground that the City could not establish the direct causal connection required under RICO between the alleged “predicate act” (Hemi Group’s failure to report purchaser information to the State) and the City’s alleged harm (the loss of use tax revenues due from its citizens). The Court did not opine on other potential weaknesses in the City’s case.
However, while it confined its legal ruling to the lack of required causation, the Court also noted that it was important to remember that the case was “about the [alleged] RICO liability of a company [(i.e., Hemi Group)] for lost taxes it had no obligation to collect, remit, or pay.” (Emphasis added). Picking up on the Court’s comment, Justice Ginsberg in her concurrence expressly called out subtext of the case: the City was improperly attempting to use RICO to “end-run” the constitutional limits on the City’s ability to impose use tax obligations on an out-of-state company derived from the Commerce Clause and the Court’s decision in Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
In the wake of the Court’s ruling in Hemi Group, last week Congress stepped in and exercised its Commerce Clause authority to strengthen the Jenkins Act to require out-of-state sellers to collect state and local use taxes on tobacco products. On March 31, 2010, the President signed the Prevent All Cigarette Trafficking Act (“PACT Act”), which, among a number of other provisions related to cigarette trafficking, amended the Jenkins Act to require that “delivery sellers” collect all state and local excise taxes due on cigarettes or smokeless tobacco. Importantly, Congress stressed that there are “unique harms” associated with online cigarette sales (including the long-term health effects of using tobacco products and terrorist involvement in trafficking illegal cigarettes) that justified Congressional action. Congress therefore emphasized that the PACT Act “is in no way meant to create a precedent regarding the collection of State sales or use taxes by, or the validity of efforts to impose other types of taxes on, out-of-State entities that do not have a physical presence within the taxing State.” (Emphasis added).
We have recently written in this blog about states’ attempts to increase use tax collection on Internet sales through “New York style” online affiliate nexus laws and “Colorado style” notice and reporting obligations imposed on remote sellers which seek to extend state regulatory authority across state lines. No matter how dire their short-term budgetary problems may appear, and no matter how disappointed they may be that their own citizens fail to report use tax due on remote sales, state and local government and tax officials would do well to remember that more than 200 years ago, the framers of the Constitution created a common market in the U.S. by limiting state regulation of interstate commerce via the Commerce Clause. Fortunately, it appears from the Court’s ruling in Hemi Group and the enactment last week of the PACT Act, all three branches of our federal government recognize that the Constitution reserves for Congress the task of regulating interstate commerce.