South Dakota: Federal court sends remote sales tax case back to state court

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In an effort to combat the loss of sales and use tax revenue on purchases made from out-of-state retailers, many of which cannot be compelled to collect and remit taxes as a matter of course, South Dakota took two steps last year: 1) increased the sales and use tax rate from 4 to 4.5 percent, effective June 1, 2016; and 2) passed a new law, SB 106, which establishes a sales tax remittance obligation on out-of-state retailers that incur either $100,000 of in-state sales, or generate 200 or more separate electronic or delivery transactions.

At the end of April, the Mount Rushmore State, seeking a judicial determination that it is entitled to require the defendants to collect and remit the state sales tax, sued four internet retailers, Newegg Inc., Inc., Systemax Inc. and Wayfair LLC. In its complaint, South Dakota acknowledged that it was seeking abrogation of the Supreme Court case Quill Corp. v. North Dakota, which prohibited requiring out-of-state retailers to collect sales taxes on behalf of a state absent some minimum connection with that state. In a later brief, South Dakota declared that “[t]he very point of Senate Bill 106 and the lawsuit filed by the State was to speedily” accept the invitation that Justice Anthony Kennedy extended in his recent concurrence in Direct Marketing Ass’n v. Brohl to “find an appropriate case for th[e] Court to reexamine Quill.”

According to the complaint, the result of the precedent set by Quill and other cases “is to effectively immunize out-of-state retailers lacking a physical presence within a state from having to remit any state sales or use taxes…the effects of that immunity on the State treasury and its general retail markets have vastly multiplied because of the meteoric rise of Internet commerce.”

Defendants removed the case to federal district court, on the grounds that it involved questions of a federal nature. In response, South Dakota filed a motion to remand back to the state, contending that “[b]ecause the State procedures [that] the legislature created are more than adequate to protect the Defendants—and federal jurisdiction could frustrate the protections South Dakota has provided for all interested parties—it would be inappropriate for a federal court to take jurisdiction over this case.”

South Dakota also argued that the federal court lacks jurisdiction in matters involving state taxation due to principles of comity and federalism and the Tax Injunction Act. Ultimately, South Dakota asserted, Justice Kennedy’s invitation “could be derailed for years” if the case were to remain in federal court, “only for [that court] to later hold that it cannot reach the merits because federal jurisdiction is lacking.”

In mid-January, the district court granted South Dakota's motion for remand, sending the case back to state court. Noting that usually, cases citing federal question jurisdiction involve a cause of action that is created by a federal law, the district court recognized that this case “involves a ‘litigation provoking problem,’ where ‘the presence of a federal issue is in a state-created cause of action.’”

Thus, even if the central question is the constitutionality of SB 106, which was designed to test Justice Kennedy’s invitation, such constitutionality “is not a necessary element of the State’s complaint, is not needed for vindication of [its] right under state law, and the State’s complaint does not then ‘necessarily’ raise a federal issue.” Moreover, “a State’s suit for a declaration of the validity of a state law …is not within the original jurisdiction of the United States district courts…” On this rationale, the case now goes back to state court.

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