Federal Court Declares Colorado Use Tax Notice and Reporting Law Unconstitutional

Good news for Internet retailers and other direct marketers. Last Friday, March 30, 2012, Judge Robert Blackburn of the Federal District Court for the District of Colorado, entered summary judgment in favor of the Direct Marketing Association (DMA) in its suit challenging a 2010 Colorado notice and reporting law. The Court declared the law unconstitutional and permanently enjoined and restrained the State from enforcing it. (The Court had previously suspended enforcement of the law in January 2011, pending entry of a final judgment in the case. George Isaacson and Matt Schaefer of B&I represent the DMA in the case.)

The Colorado law sought to impose three principal requirements upon retailers that do not collect Colorado sales tax. First, the Act required affected out-of-state retailers to give notice to their Colorado customers, in connection with each sale, that the customer must report Colorado use tax (the “Transactional Notice”). Second, the Act required affected retailers to send annually to each customer that purchased more than $500 of goods for delivery to Colorado, a summary of the customer’s purchases for the year (the “Annual Purchase Summary”). Third, of perhaps greatest concern to retailers, the Act required remote sellers to submit a report to the Colorado Department of Revenue, by March 1 of each year, listing the name, billing and shipping addresses, and total amount of purchases of all customers who purchased goods for delivery to Colorado (the “Customer Information Report”). The Court struck down each of these requirements as unconstitutional under the Commerce Clause.

The Court’s ruling is particularly important because Judge Blackburn found in favor of the DMA on both counts of its complaint challenging the law (and its implementing regulations) under the Commerce Clause. In other words, Judge Blackburn agreed with the DMA that the statute and regulations violate the Commerce Clause because they both: (a) discriminate against out-of-state retailers who do not collect Colorado sales tax, by imposing upon them burdens that are not imposed on Colorado retailers; and (b) place undue burdens upon retailers with no physical presence in the state, consistent with the Supreme Court’s landmark decision in Quill Corp. v. North Dakota.

On the issue of whether the Colorado law discriminates against interstate commerce in violation of the Commerce Clause, the Court ruled that, by singling out retailers that do not collect Colorado sales tax for differential burdens, the law imposes its notice and reporting obligations solely upon out-of-state retailers. The Court expressly rejected the Department’s argument that the law is non-discriminatory because out-of-state retailers could “choose” to collect Colorado sales tax and thereby avoid the notice and reporting burdens imposed by the Act. The Court found that, by conditioning an out-of-state retailer’s reliance upon its constitutional rights on a requirement that the retail accept a different burden, unique to out-of-state retailers, the purported “choice” offered by the Act “does not eliminate, but instead, highlights the discrimination” against out-of-state retailers with no physical presence in the state. The Court also found that the Department had offered no evidence to show that the law's goal of increased tax compliance by Colorado purchasers could not be achieved through reasonable non-discriminatory alternatives, such as those suggested by the DMA.

The Court also agreed with the DMA that the law imposes improper and burdensome regulations upon retailers with no physical presence in the state, in violation of the Commerce Clause principles embodied in Quill. Judge Blackburn wrote:

“Looking to the practical effect of the Act and the Regulations, as Quill instructs, I conclude that the burdens imposed by the Act and Regulations are inextricably related in kind and purpose to the burdens condemned in Quill. The Act and the Regulations impose these burdens on out-of-state retailers who have no physical presence in Colorado and no connection with Colorado customers other than by common carrier, the United States mail, and the internet. Those retailers are protected from such burdens on interstate commerce by the safe-harbor established in Quill.”

The Court’s application of the Quill physical presence nexus standard to a law that does not impose use tax collection obligations upon remote sellers, but instead purports to impose related, but different regulatory burdens, is a potentially significant development with regard to the constitutional protections afforded to remote sellers against states seeking to extend their regulatory authority beyond state borders.

The State of Colorado is expected to appeal the District Court’s ruling to the Federal Court of Appeals for the Tenth Circuit.