Direct Marketers Win Round 1 
in Tax Collection Case

On Jan. 26, a United States District Court Judge in Denver entered a preliminary injunction against the Colorado Department of Revenue in the lawsuit that the Direct Marketing Association (DMA) brought challenging Colorado's new notice and reporting law, H.B. 10-1193. This controversial legislation — the enforcement of which is now suspended by the court's order — imposes three sets of obligations on out-of-state retailers that don't have nexus in the state and don't collect Colorado sales tax.

First, the law requires that remote sellers give notice to their Colorado customers, in connection with each separate internet or catalog transaction, that they must self-report Colorado use tax (i.e., the "Transactional Notice"). Second, retailers must send to all customers that purchased more than $500 worth of goods for delivery to Colorado during 2010 a summary of their purchases for the year via First Class mail by Jan. 31 (i.e, the "Annual Purchase Summary"). Third, out-of-state merchants must 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 (i.e., the "Customer Information Report").

The court ruling enjoins the Department of Revenue from enforcing all of the requirements of H.B. 10-1193 effective immediately, including the Transactional Notice, Annual Purchase Summary and Customer Information Report provisions, which would have required turning over individual customer purchase history information to the Department of Revenue.

As counsel for the DMA in this litigation, I argued that H.B. 10-1193 violates the Commerce Clause of the United States Constitution by imposing discriminatory obligations upon out-of-state retailers that don't apply to in-state Colorado companies, and unduly burdening interstate commerce in violation of the clear principles set forth by the Supreme Court in its famous 1992 Quill decision. The District Court accepted these arguments in finding that the DMA had a likelihood of 
succession in both of the Commerce Clause counts.

Judge Robert E. Blackburn wrote:

"I conclude that the plaintiff [the DMA] has shown a substantial likelihood that it will succeed in showing that the Act and Regulations are discriminatory because, in practical effect, they impose a burden on interstate commerce that is not imposed on in-state commerce."

He went on to state:

"I conclude that the burdens imposed by the Act and the Regulations are inextricably related in kind and purpose to the burdens condemned in Quill."

Judge Blackburn further concluded that out-of-state retailers subject to the new law would suffer "irreparable injury" if enforcement of the statute isn't barred, both because their constitutional rights are being violated and because "the compliance costs faced by retailers subject to the Act and the Regulations constitute irreparable injury."

The preliminary injunction is only the first stage in this legal battle between direct marketers and Colorado tax officials, but it effectively suspends the law while the litigation continues and until the court makes a final ruling regarding the law's constitutionality.

The DMA also asserted in its complaint that the new law violates other provisions of the Constitution, including the privacy rights of Colorado consumers. These additional grounds weren't involved in the preliminary injunction motion, however. They'll be part of further proceedings in this case.

The injunction may have positive short-term effects in addition to suspending enforcement of the new law. Oklahoma adopted a similar transactional notice law, and the constitutionality of that statute is now in serious doubt, although there's no pending lawsuit challenging that state's legislation. Other state legislatures, including California's, are considering similar laws, and the federal court ruling could have a deterrent effect on their enactment or encourage gubernatorial vetoes. Indeed, the Colorado decision added immediate support to efforts by some Colorado state legislators to repeal H.B. 10-1193. Shortly after issuance of Judge Blackburn's decision, Colorado House Majority Leader Amy Stephens issued a press release in which she stated:

"The decision by the court should be applauded. Unfortunately, this tax proposal was rushed through the legislature, causing concern for consumers and leading to the immediate loss of Colorado jobs. … This court ruling is just one step in the long process of repealing this unconstitutional tax."

The Colorado notice and reporting law is just one example of aggressive state laws intended to "end run" the constitutional restrictions on the scope of state taxing authority. Other approaches have included seizing upon online retailers' relationships with web affiliates, challenging click-and-mortar business structures, and limiting vendors' rights to sell to state agencies unless they "voluntarily" register for sales/use tax collection in connection with all their consumer sales into the state.