DMA Wins Landmark Injunction Against State of Colorado

On behalf of the Direct Marketing Association, Brann & Isaacson partners George Isaacson and Matthew Schaefer won a landmark preliminary injunction in federal court in a lawsuit that affects thousands of direct marketers across the country. The ruling prohibits the State of Colorado from enforcing its controversial new law, H.B. 10-1193, that required direct marketers to -- among other things -- report to the state the names, addresses, and purchase amounts of their customers.

To be clear, so long as the injunction remains in place, out-of-state retailers that do not have nexus with Colorado and do not collect Colorado sales tax are no longer required to: (1) give notice to their Colorado customers, in connection with each sale, that the customer must report Colorado use tax (the “Transactional Notice”); (2) send via First Class mail by January 31, to each customer that purchased more than $500 of goods for delivery to Colorado during 2010, a summary of their purchases for the year (the “Annual Purchase Summary”); or (3) submit a report to the Colorado Department of Revenue, by March 1, 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”).  See http://www.colorado.gov/cs/Satellite/Revenue/REVX/1251581938320.

The DMA argued that the law violates the Commerce Clause of the United States Constitution by (a) imposing discriminatory obligations upon out-of-state retailers that do not apply to in-state Colorado retailers, and (b) unduly burdening interstate commerce under principles set forth by the Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Court accepted these arguments in finding that the DMA had a likelihood of success on both Commerce Clause counts, and concluded that out-of-state retailers subject to the new law would suffer irreparable harm if enforcement of the statute is not barred.

The preliminary injunction entered by the Court does not end the case, but it effectively suspends the law while the litigation continues and until the Court makes a final ruling regarding the law’s constitutionality.

You can read a copy of the order here.

Read previous posts about the lawsuit here and here.

DMA’s Constitutional Challenge to Colorado’s Notice and Reporting Law Will Be Argued In Federal District Court on January 13

A happy new year to our readers. Many internet and catalog retailers have been following with interest the constitutional challenge of the Direct Marketing Association (“DMA”) to Colorado’s new notice and reporting law, H.B. 10-1193, enacted in 2010. In addition to burdensome consumer notice requirements that went into effect last year, the law requires out-of-state retailers that do not collect Colorado sales and use tax to send (by January 31, 2011) annual purchase summaries to customers purchasing $500 or more of goods for shipment to Colorado and, worst of all, to file (by March 1, 2011) with the Colorado Department of Revenue a listing of all of the retailer’s customers who have purchased goods for shipment to a Colorado location, regardless of where the customer resides.

As we previously reported (see our July 2, 2010 post), the DMA contends that the Colorado law violates multiple provisions of the United States Constitution, because it discriminates against interstate commerce, exceeds the State’s regulatory authority over out-of-state businesses, violates the privacy rights of Colorado consumers, infringes the free speech and due process rights of retailers and consumers, and deprives retailers of their valuable customer list information without due process or fair compensation. The DMA has filed a motion for preliminary injunction based on the law’s violations of the Commerce Clause, asking the Court to suspend enforcement of the law’s notice and reporting requirements pending a full adjudication of the law’s constitutionality.

The federal District Court for the District of Colorado has scheduled a hearing on the DMA’s motion to be held on January 13, 2011, at 10:00 a.m. in Denver. B&I senior partner and lead counsel for the DMA, George Isaacson, will argue the motion on behalf of the DMA. We will report on further developments after the hearing.

Distribution of Promotional Materials in Indiana is Not Taxable

In D.H. Holmes Company, Ltd. v. McNamara, 486 U.S. 24 (1988), the U.S. Supreme Court held that a state did not violate the Commerce Clause when it imposed a use tax on the distribution of catalogs and other promotional materials mailed from outside of the state since the company on whose behalf the catalogs were distributed had nexus with the state. Prior to that date, there were some state courts and tax commentators which had declared that a destination state’s imposition of tax on catalogs printed and mailed from outside of the state to residents of the state violated the Commerce Clause.

As a result of the D.H. Holmes decision, a large number of states have imposed a use tax on promotional materials distributed in their state on behalf of a company with nexus in the state (e.g. Arizona, Colorado, Connecticut, Florida, Georgia, and Tennessee).  There have been some exceptions to this rule (See e.g., Michigan (Sharper Image Corp. v. Department of Treasury, 550 N.W.2d 596 (1996)), New York, Ohio, California, and Pennsylvania).

Recently, the Indiana Tax Court ruled in the case of AOL, LLC v. Indiana Department of State Revenue that the distribution of CD ROMs and other marketing materials on behalf of AOL by AOL’s printer and assembly house was not taxable. The basis for the decision was that AOL had supplied the components—the CD ROM discs, paper, and other components of CD ROM packages—to the assembly house and printer. Thus, the assembly house and printer were merely providing a service, and not selling tangible personal property. Under the Indiana statute, the provision of services is not taxable. It is only the sale of tangible personal property that is taxable. Nor were the components themselves taxable because only the final CD ROM package and printed materials were distributed in Indiana. The components were transformed by the assembly houses and printers into final products.

This decision is in line with prior decisions of the Indiana Tax Court, including Ameritech Publ’g, Inc. v. Ind. Dep’t of State Revenue, 916 N.E.2d 752 (Ind. Tax Ct. 2009) and Morton Bldgs., Inc. v. Ind. Dep’t of State Revenue, 819 N.E.2d 913 (Ind. Tax Ct. 2004).  Thus, any direct marketer which has been distributing promotional materials in Indiana and paying use tax on those promotional materials should consider filing a claim for refund for taxes paid if the direct marketer supplied the underlying raw materials to the printer or other party assembling the promotional materials.

Is a Privacy Battle Brewing? The Department of Commerce Pushes Back On Commercial Privacy Regulation

In an unusual move, the Department of Commerce has chimed in on the question of Internet data privacy, issuing a 78-page report from its Internet Policy Task Force.  While the Chairman of the FTC has welcomed the new report, the business-oriented tone of the Commerce report suggests that a battle is brewing.  Indeed, the report offers strong support for a “voluntary, multi-stakeholder process” that includes businesses as important, cooperative partners, while the FTC treats voluntary efforts by industry -- and industry itself -- almost contemptuously.  While Commerce defers to the FTC as the primary enforcement authority, it also stages what appears to be a power grab to take a leadership role in defining how industry will or will not be regulated in the areas of privacy and information security.

Income Tax Nexus in a Digital World

We have written extensively in this blog about nexus for sales tax and gross receipts tax purposes.  All but a few states have an income tax.  In addition to the Due Process Clause and Commerce Clause standards of nexus, out-of-state companies are protected from income tax of other states by a federal statute, Public Law 86-272, which is found at 15 U.S.C. § 381.  P.L. 86-272 provides an exemption only for state income tax and sets forth a fairly clear, but somewhat limited, standard for the exemption.

The exemption applies if a company’s activities in another state include only the solicitation of sales of tangible personal property by an employee, representative, or independent contractor for delivery of inventory located outside the state to residents of the state, if orders are accepted outside the state.  The exemption also extends to maintenance by an independent contractor of an office in the state.  Thus, while solicitation activities of an out-of state company in a state would create nexus under the Commerce Clause and Due Process Clause standards, if the solicitation is limited to the sale of tangible personal property and, subject to the other limitations in the underscored portions above, the company would be exempt from the state’s income tax.

There have been a number of cases defining solicitation (See, e.g., Wisconsin Department of Revenue v. William Wrigley, Jr., 112 S.Ct. 2447 (1992)). And the MTC has issued guidelines, which many states have adopted, defining protected and unprotected activities under P.L. 86-272.  See Statement of Information Concerning Practices of Multistate Tax Commission and Signatory States under Public Law 86-272 (Multistate Tax Commission, Third Revision adopted July 27, 2001).

The cases and guidelines make it clear that if a company solicits the sale of services as well as tangible personal property, the exemption of P.L. 86-272 does not apply. See, e.g., Amway Corp., v. Director of Revenue, 794 S.W.2d 666 (Mo. 1990).  Thus, a pertinent issue under P.L. 86-272 is whether the items being sold by an out-of-state company constitute tangible personal property or services.

Do As I Say, Not As I Do: The FTC "Do Not Track" Initiative Could Cripple E-Commerce

Just as governments – including our own – are pursuing aggressive new initiatives to gather information about our individual browsing habits and electronic communications for law enforcement purposes, the FTC has decided to advise Congress on sweeping initiatives to prevent direct marketers from engaging in far less invasive practices that present none of the grave risks attendant to enhanced government surveillance.  Indeed, many of the commercial practices targeted by the FTC actually benefit consumers by assisting Internet sellers to configure their web sites, adjust their product offerings, and tailor advertising to the specific needs and interests of consumers.  While the FTC shrilly intones that consumer information about Internet browsing has been used by an unidentified "some" in "an irresponsible or even reckless manner," it fails to acknowledge forthrightly that the vast majority of direct marketers use such information solely to better serve their customers, and that new laws and FTC initiatives are unlikely to faze the tiny group of Internet pirates who misuse consumer data.

Although most headlines have focused on the FTC's proposal for a "do not track" list, the FTC report is about much more than that.  It foretells a highly aggressive new regulatory strategy that may change the landscape of Internet privacy without any concern for the cost impact on industry or a realistic assessment of the privacy interests of consumers.  It sweeps so broadly against business as to suggest that–if the FTC has its way–even entirely benign and non-intrusive information collection practices that do not track individual consumers will be sharply curtailed.  At the same time, new and intrusive requirements will be injected multiple times into virtually every consumer experience on the Web.  If you do business on the Internet, you need to know what the FTC is hoping to unleash on eCommerce.

The Perils of Responding to Nexus Questionnaires

A company should be very careful in determining whether to respond to the nexus questionnaire and how to respond to the questionnaire.   After all, any response is a statement to a government agency, which must be truthful and will be an admission on the part of the company.  A response that is inaccurate or a response that is not well thought out is worse than not responding at all.  In general, there is no obligation to respond to a nexus questionnaire, so the benefit of responding to a questionnaire may not be significant, yet the potential adverse consequences may be significant.

The problem in responding to a nexus questionnaire is highlighted by a recent case involving Barr Laboratories, in which the Michigan Court of Appeals held that the answers on a nexus questionnaire that indicated that the taxpayer’s employees visited Michigan between two and nine times during the year created a factual issue as to whether or not the company had nexus.   See Barr Laboratories, Inc. v. Department of Treasury (Mich. App. 2010).  The questionnaire indicated that the employees visited Michigan to solicit sales, but all sales were approved in New York.  Apparently that response overstated and mischaracterized Barr Laboratories’ connection to the state.  After an assessment by the Michigan Department of the Treasury of about $500,000, Barr Laboratories commenced a suit to abate the assessment.   In a summary judgment motion, Barr Laboratories submitted an affidavit of its Vice President of Taxation, which contradicted the responses in the questionnaire.  The affidavit stated that the visits to Michigan were only to gather information, and not to solicit sales, and were less frequent than stated in the questionnaire.   But the response to the questionnaire precluded Barr Laboratories from prevailing in the summary judgment motion, and the response was probably the basis for the assessment in the first place.