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A Keystone Of Internet Commerce Is Threatened

The legal principle that is the foundation of Internet commerce in this country faces what may be a mortal threat because Justice Anthony Kennedy has concluded that e-commerce is a big deal.

He’s right, of course. The U.S. Census Bureau’s most recent report, which discusses Internet commerce through 2012, indicated that e-commerce shipments made up more than half of all manufacturing shipments that year, and totaled $3 trillion, an increase of 10.5 percent compared to 2011. Retailers reported e-commerce sales of $227 billion. No one imagines online commerce will become less important in the foreseeable future, either.

But though Internet commerce is certainly a big deal, if Kennedy gets what seems to be his way, he may create a new legal rule that restricts that big deal to big players only.

Kennedy’s epiphany emerged in a concurring opinion he wrote in Direct Marketing Association v. Brohl. This case, as many before it dealing with online retailers, rests largely on a precedent established by Quill Corp v. North Dakota. That 1992 case, about which I have written before, reinforced the principle that before any enterprise can be subject to state tax jurisdiction, it must be physically present in that state. Until now, the Supreme Court has shown little interest in re-examining the issue, so the principle has remained in place.

This has the clearly unfair result of giving online merchants an advantage over brick-and-mortar stores that sell to the same customers. Stores must collect sales tax; if the online merchant has no presence in the state, it does not. That does not mean responsibility for the tax disappears altogether, of course. Residents who purchase untaxed goods from out-of-state vendors are required to pay use tax on those items. But while businesses, which are regularly audited, tend to be reasonably compliant, consumers are much less so.

States have shown no appetite for going line by line through consumers’ credit card statements or checking accounts, however. Instead, they would prefer to shift the burden to out-of-state merchants. This would mean that anyone who offers goods for sale online would become responsible for knowing exactly which goods and services are taxable, and at what rate, in thousands of jurisdictions across the country. Merchants would also have to make sure they timely filed reports and submitted payments. Big enterprises can absorb this kind of burden; small ones can’t.

Colorado tried to sidestep Quill, which resulted in the dispute at issue in Direct Marketing Association v. Brohl. Instead of having out-of-state merchants collect its tax themselves, Colorado merely required merchants to report to each Colorado resident how much he or she purchased, and to provide a copy of the information directly to the state.

But Colorado has no right, under Quill, to impose even that burden on vendors in places like Montana, which has no general sales tax of its own. A district court enjoined the statute, under the reasoning that it was most likely unconstitutional. The appeals court disagreed, so the Direct Marketing Association took the case to the Supreme Court. The Supreme Court decided that the injunction could stand while the parties continued litigation, reversing the appeals court’s decision, but did not weigh in on whether or not the underlying statute itself was valid. That question remains to be dealt with in the lower courts, for now.

The non-decision would normally mean that this case was not especially newsworthy. And, indeed, it was not a decision that was widely remarked upon when it was handed down last week. It may, however, serve as something of a canary in the coal mine as far as online retailers are concerned. Up to this point, the Court has seemed distinctly uninterested in budging the precedent set by Quill, and thus the e-commerce status quo. Kennedy’s language suggests Quill could be in trouble.

“There is a powerful case to be made that a retailer doing extensive business within a State has a sufficiently ‘substantial nexus’ to justify imposing some minor tax-collection duty, even if that business is done through mail or the Internet,” Kennedy wrote.

Kennedy seriously misunderstands the nature of a national “tax collection duty” that might be imposed on a small business seeking to sell across state lines. Even a single state, such as New York, can have a wide variety of tax rates that apply to consumers in different cities or counties. Moreover, there is a wide variation among the states in the scope of goods and services that are subject to tax, in the exceptions and exemptions that apply to such taxes - including spur-of-the-moment tax holidays around back-to-school seasons - and in the timing and manner of tax collection and remission. State legislatures should be accountable to their own voters for these burdens, and those voters should bear the costs of administering the taxes their representatives impose.

If the court reverses the Quill doctrine, it will be up to Congress to put new constraints on the states, or to stand by as small Internet sellers are forced to limit the markets in which they can sell in order to escape the inevitable tax headache of doing business nationwide.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us,” and Chapter 4, “The Family Business.” Larry was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

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