On March 3, 2015, the Supreme Court decided Direct Mktg. Ass’n. v. Brohl, No. 13-1032, holding that the Tax Injunction Act (TIA), which provides that federal district courts “shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law,” 28 U.S.C. §1341, does not bar a suit to enjoin enforcement of a Colorado law requiring retailers that do not collect Colo­rado sales or use tax to notify Colorado customers of their use tax liability and to report tax-related information to customers and the Colorado Department of Revenue.

The State of Colorado enacted legislation in 2010 requiring retailers whose gross sales in Colorado exceed $100,000 and who do not collect Colo­rado sales or use tax to notify Colorado customers of the customers’ use tax liability and to report tax-related information to customers and the Colorado Department of Revenue. Direct Marketing Association (DMA) is a trade asso­ciation of businesses and organizations that market prod­ucts directly to consumers, including consumers in Colorado. Many of DMA’s members have no physical presence in Colorado and choose not to collect Colorado sales and use taxes on Colorado purchases, and consequently are subject to Colorado’s notice and reporting requirements. In 2010, DMA brought suit in federal court in Colo­rado against the Colorado Department of Revenue, claiming that the state’s notice and reporting requirements violate provisions of the United States and Colorado Constitu­tions. The District Court granted partial summary judgment to DMA and permanently enjoined enforcement of the notice and reporting requirements. The 10th Circuit reversed and, without reaching the merits, held that the District Court lacked juris­diction over the suit because of the TIA.

The Supreme Court unanimously reversed, holding that the TIA did not bar the District Court from hearing the challenge to Colorado’s notice and reporting regime. The Court determined that, read in light of the Federal Tax Code, the terms “assessment,” “levy,” and “collection” in the TIA refer to discrete phases of the taxation process. The provision of information notices and reports is part of a phase of the taxation process that occurs before assessment. Even understood more broadly, the terms relate to actions taken after information has been reported to the taxing authority. According to the Court, “[e]nforcement of the notice and reporting requirements may improve Colorado’s ability to assess and ultimately collect its sales and use taxes from consumers, but the TIA is not keyed to all activities that may improve a State’s ability to assess and collect taxes.” Therefore, although the TIA is keyed to the acts of assessment, levy, and collections, “enforcement of the notice and reporting requirements is none of these.”

The Court further held that the Court of Appeals read the phrase “suspend or restrain” too broadly to mean “any suit that would ‘limit, restrict, or hold back’ the assessment, levy, or collection of state taxes.” Acknowledging that the term “restrain,” standing alone, can have several meanings, the Court adopted a narrower definition “consistent with the rule that ‘jurisdictional rules should be clear.’” Reading “restrain” in context with the surrounding terms, the Court held that the 10th Circuit’s broad definition would “defeat the precision of that list, as virtually any court action related to any phase of taxation might be said to ‘hold back’ ‘collection.’” The Court determined that under the narrower definition, “a suit cannot be understood to ‘restrain’ the ‘assessment, levy or collection’ of a state tax if it merely inhibits those activities.”

Justice Thomas delivered the opinion for a unanimous Court. Justice Kennedy filed a concurring opinion. Justice Ginsburg filed a concurring opinion in which Justice Breyer joined and in which Justice Sotomayor joined in part.

In his concurrence, Justice Kennedy called for a re-examination of the Court’s 1992 ruling in Quill Corp. v. North Dakota, observing:  “The Internet has caused far-reaching systemic and structural changes in the economy, and, indeed, in many other societal dimensions. . . .  Given these changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill.”

Brent Auberry and Ben Blair contributed to this post.

On March 4, 2015, the United States Supreme Court decided Alabama Department of Revenue v. CSX Transportation, Inc., No. 13-553, holding that a rail carrier can prove discrimination under the Railroad Revitalization and Regulation Reform Act (4-R Act), 49 U.S.C. § 11501(b)(4), which forbids states from imposing taxes that “discriminate against a rail carrier,” by showing that the rail carrier was subject to tax treatment different than that applied to its “similarly situated” competitors, but that such a tax disparity could be rendered nondiscriminatory if the competitors were subject to an alternative, “roughly equivalent” tax.

Alabama imposes a 4 percent tax on the purchase or use of property that applies to rail carriers’ purchases or use of diesel fuel.  Alabama exempts diesel fuel purchases made by trucking transport companies (motor carriers) and water transport companies (water carriers) from this tax.  Instead, motor carriers pay a 19-cent-per-gallon fuel excise tax on diesel, and water carriers pay no alternative tax.  CSX Transportation (CSX), a rail carrier, challenged this asymmetrical tax treatment as discriminatory under the 4-R Act and sought an injunction preventing Alabama from collecting sales tax on its diesel purchases.  The District Court and the Eleventh Circuit both initially rejected CSX’s claim.  In a prior decision, the Supreme Court reversed, rejecting Alabama’s argument that sales and use tax exemptions cannot “discriminate” within the meaning of the 4-R Act.  The Supreme Court also explained that a tax violates subsection (b)(4) of the 4-R Act when it “treats ‘groups [that] are similarly situated’ differently without sufficient justification for the difference in treatment.”  On remand, the District Court again denied CSX’s claim.  The Eleventh Circuit reversed, holding that a rail carrier could show discrimination within the meaning of the 4-R Act by showing that Alabama treated rail carriers differently than their competitors and rejecting Alabama’s argument that the alternative fuel excise taxes imposed on motor carriers offset the sales tax exemption.

The Supreme Court reversed.  The Court held that the Eleventh Circuit properly concluded that a state tax that treats rail carriers and their “similarly situated” competitors differently can constitute discrimination under the 4-R Act, rejecting Alabama’s argument that the only appropriate comparison class for a subsection (b)(4) claim is “all general and commercial industrial taxpayers.”  The Court explained that although the first three subsections of the 4-R Act require comparison “to commercial and industrial property in the same assessment jurisdiction,” subsection (b)(4) “contains no such limitation, leaving the comparison class to be determined as it is normally determined with respect to discrimination claims.”  Accordingly, the Court concluded that “[w]hen a railroad alleges that a tax disadvantages it compared to its competitors in the transportation industry, the railroad’s competitors in that jurisdiction are the comparison class.”  The Court also held a comparison class composed of a rail carrier’s competitors could qualify as “similarly situated,” because “discrimination in favor of that class most obviously frustrates the purpose of the 4-R Act, which was to ‘restore the financial stability of the railway system of the United States’ . . . while ‘foster[ing] competition among all carriers by railroad and other modes of transportation.’”

However, the Court overturned the Eleventh Circuit, holding that asymmetrical tax treatment of rail carriers and their similarly situated competitors could be rendered nondiscriminatory if the competitors were subject to an alternative, “roughly equivalent” tax.  The Court explained that “[i]t does not accord with ordinary English usage to say that a tax discriminates against a rail carrier if a rival who is exempt from that tax must pay another comparable tax from which the rail carrier is exempt.  If that were true, both competitors could claim to be disfavored—discriminated against—relative to each other.”  The Court also rejected CSX’s argument that, because section (b)(4) refers to a “tax” in the singular, the inquiry is only whether the challenged “tax” discriminates, explaining that a tax “does not discriminate unless it treats railroads differently from other similarly situated taxpayers without sufficient justification.”  In other words, “[t]here is simply no discrimination when there are roughly comparable taxes.”  The Supreme Court remanded for the Eleventh Circuit to consider whether “Alabama’s fuel-excise tax is the rough equivalent of Alabama’s sales tax as applied to diesel fuel, and therefore justifies the motor carrier sales-tax exemption.”  The Supreme Court also instructed the Eleventh Circuit to consider Alabama’s alternative justifications for the sales tax exemption for water carriers, which pay neither the sales tax nor the fuel excise tax on their purchases of diesel.

Justice Scalia delivered the opinion of the Court.  Justice Thomas filed a dissenting opinion, in which Justice Ginsburg joined.

Lawsuits have been filed against retailers accused of wrongfully collecting sales tax where customers used coupons to discount the sales price.

The information in this blog is for general informational and educational purposes only, including any information provided by guest bloggers.  Postings are not solicitations or legal advice.  This information is not intended to create and receipt of it does not constitute an attorney-client relationship.  The reader should not rely or act upon any information in this site without seeking professional legal counsel or advice from his or her tax professional.

If you are a retailer or a business that accepts or issues coupons, a slew of class action lawsuits should have you double-checking your sales tax collection practices. Recent lawsuits filed by consumers have accused retailers of fraud because of the miscalculation of sales tax when coupons are used, and significant compensatory and punitive damages have been sought against retailers.

The first problem is that not all coupons are created equal. Coupons come in two broad categories: store-issued and manufacturer-issued. Generally, store-issued coupons technically function as discounts to consumers, resulting in a reduction of sales tax owed to the state where the coupon is redeemed. When a store-issued coupon is redeemed, the sales tax is based on the discounted price — the cost of the item after the coupon is applied. However, manufacturer-issued coupons, which are typically issued by manufacturers of goods, generally do not reduce the amount of sales tax owed by the consumer. When a consumer uses a manufacturer-issued coupon, sales tax is based on the total price of the item before the coupon is applied. Compliance issues arise when a retailer does not have a process in place to deal with both types of coupons.

A further challenge for retailers is that lawsuits have also been filed because of the language on the coupon (or more specifically, language missing from coupons). In Illinois, for example, a company issuing a coupon owes the corresponding use tax on the value of the coupon, which means it remits the use tax on the value of the coupon. However, Illinois law allows the tax burden to shift to the consumer if the coupon’s small print indicates the bearer — in most cases, the consumer — assumes the tax liability.

Recently, two lawsuits against national retailers have been filed in Illinois because the manufacturer-issued coupon did not include such language. (Wong v. Target Corporation, 1:15-cv-01985 (N.D. Ill. Mar. 5, 2015); Wong v. New Albertson’s Inc., d/b/a Jewel-Osco, 1:20-cv-01732 (N.D. Ill. Feb. 26, 2015)). The lawsuits claim the consumer should not have been charged the sales tax because the coupon didn’t say the consumer was liable, and the retailer ends up caught in the middle. If the courts endorse this argument, retail clerks would need to carefully read the fine print on every coupon presented, and self-service lanes may have to disallow the use of manufacturer-issued coupons. These changes would be significant burdens in an industry built on consumer convenience.

So, what should retailers do so they don’t find themselves clipped by similar lawsuits? Since state law varies on coupon-redemption sales tax liability, retailers should review their tax collection process in all states where they do business and seek counsel on how to be compliant in those states. They may also want to put into place some review and control procedures with regard to the small print on manufacturer-issued coupons.

This post was prepared by Francina Dlouhy and Ben Blair.

The authors gratefully acknowledge Emily Steeb, Faegre Baker Daniels law clerk, for her contribution to this post.

This post is for general informational and educational purposes only.  The reader should not rely or act upon any information in this post without seeking professional counsel or advice from his or her tax professional.

On May 7, 2015, Indiana Governor Mike Pence signed into law P.L. 213, which establishes a tax amnesty program that might give business taxpayers with concerns about Indiana tax reporting a great opportunity to settle any outstanding or potentially outstanding tax liabilities with the Indiana Department of Revenue (Department). This is Indiana’s first tax amnesty program in nearly 10 years. The 2005 tax amnesty program collected over $205 million from business taxpayers. The new program is expected to collect between $109 million and $159 million for the state.

Taxes covered by the program are any taxes administered by the Department — the “listed taxes” — including, among others, the Indiana adjusted gross income tax, sales and use taxes, and financial institutions tax. While program details are yet to be worked out by the Department, the new law establishes certain program limitations which include, among others, the following:

• A requirement that the Department establish an eight-week program that must conclude before January 1, 2017.
• The program only applies to liabilities for tax periods ending before January 1, 2013.
• Taxpayers are not eligible to participate if they participated in the 2005 amnesty program.
• The Department will waive penalties and interest for accepted participants.
• A failure to pay all listed taxes due for a tax period invalidates any amnesty granted for that tax period.

Based on the success of the prior program, this new program could be very beneficial for a large number of business taxpayers with outstanding or potentially outstanding Indiana tax liabilities.

This post was prepared by Francina A. Dlouhy, J. Daniel Ogren, and Matthew C. Piatt

Indiana’s Tax Amnesty Program will begin in mid-September 2015.

In a recent post, we explained Indiana’s new tax amnesty program. We have now just learned that the Indiana Department of Revenue (Department) may soon be announcing that the eight-week tax amnesty program will start in mid-September 2015. The Department will be publishing emergency regulations soon to provide details on the amnesty program. The Department appears to be willing to explore settling taxes, as well as affording taxpayers the abatement of penalties and interest in connection with the amnesty program. Taxpayers with pending disputes with the Department should consider this possible opportunity.

The Department also urges that taxpayers begin discussions with the Department about settlement and amnesty well before the amnesty program start date. Depending upon the issues involved, a business wanting to explore settlement and amnesty with the Department should consider utilizing a tax professional to approach the Department first, especially if the business is a non-filer.

This post was prepared by Francina A. Dlouhy and J. Daniel Ogren.

The following post was originally published by Law360 on May 7, 2015.  Since this post’s original publication, additional lawsuits relating to sales tax collection practices, discounts, and “instant rebates” have been filed in California and elsewhere.

A slew of recent class actions have retailers and other businesses that accept or issue coupons double-checking their sales tax collection practices. These lawsuits are not cut-and-dried, but they risk upending an industry built on streamlined, efficient practices and customer convenience.

Interplay Between Taxes and Coupons

All but five states have some form of statewide sales tax and 38 states also authorize at least one form of local sales taxes. Sales taxes are usually paid by customers when they purchase goods or services subject to the tax. To simplify tax collection and administration, sales tax is usually collected by retailers on behalf of the state at the time of the sale. Collected taxes are then held in trust for the state until they are remitted by the retailer. Alternatively, in some states, including Illinois, the tax is imposed on the retailer, which collects use tax from the customer as reimbursement at the time of the sale.

Sales taxes are based on the retailer’s gross receipts from the transaction. As that name suggests, gross receipts include all consideration received by the retailer, including cash and credits, and are measured without deductions for the cost of the goods, shipping costs, interest or any other expense. In order to properly determine the sales tax base, the retailer must consider receipts from all sources attributable to that transaction.

The determination of the sales tax base can present problems for retailers when coupons and other forms of discounts are accepted.

Coupons come in two broad and self-descriptive categories: manufacturer-issued coupons and store-issued coupons. Manufacturer-issued coupons are issued by the manufacturers of retail goods. When a customer presents a manufacturer-issued coupon to a retailer, the retailer is fully or partially reimbursed by the manufacturer, and the loss in revenue is absorbed by the manufacturer. Conversely, a store-issued coupon is issued by the retailer itself, so when a customer presents a store-issued coupon to a retailer, the retailer is not reimbursed by another party and the loss in revenue is absorbed by the retailer.

Under the sales tax regulations of many states, including Illinois, store-issued coupons constitute a reduction in the retailer’s gross receipts. Accordingly, the sales tax liability is reduced. On the other hand, manufacturer-issued coupons do not generally reduce the retailer’s gross receipts, because the retailer is reimbursed by the manufacturer.

Consider how this practice becomes complicated in situations where the sales tax is borne by the retailer and reimbursed by the customer, as in Illinois. In the case of manufacturer-issued coupons, the tax owed by the retailer is on the higher, undiscounted price (because the retailer receives gross receipts from both the customer and the manufacturer). But the customer would ordinarily only owe use tax on the amount expended by the customer (i.e., the discounted amount). To address this issue, an Illinois regulation provides that, while “technically, the coupon issuer … owes the corresponding use tax on the value of the coupon,” in many cases “the coupon issuer incorporates language into the coupon that requires the bearer … to assume this use tax liability.” In other words, the fine print on the coupon can allow the tax burden to shift onto the customer.

Plaintiffs’ Theories and their Consequences

Several class actions have recently been filed against national retailers in Illinois and elsewhere capitalizing on the confusion surrounding sales taxes and coupons. In each case, the customer allegedly presented a manufacturer-issued coupon that did not have language shifting the tax burden to the customer. The retailers collected tax on the full, undiscounted price of the goods as they would do with any other manufacturer-issued coupon.

In the complaints, the plaintiffs argue the retailers violated the Illinois Consumer Fraud Act by collecting tax on the coupon amount and were unjustly enriched as a result. The plaintiffs seek compensatory damages, punitive damages of at least 1 percent of annual revenues from each retailer’s Illinois stores during the years in issue, and fees and costs.

In another recent lawsuit, a Florida plaintiff filed a class action against a wholesale club retailer, alleging the retailer collected sales tax on the full price of merchandise when the goods were discounted as a result of the store-issued discounts, rather than manufacturer-issued discounts. The complaint alleges violations of Florida’s Deceptive and Unfair Trade Practices Act, fraud, and unjust enrichment, among other things.

Whatever the merits of these lawsuits, they present problems for retailers beyond the potential damages in any individual case. The lawsuits put retailers between a tax-collecting rock and a litigious hard place. On one hand, retailers can err on the side of undercollecting sales tax, but in doing so, they risk being audited by taxing authorities; those audits can result in the payment of penalties and interest, and potentially risk the loss of the retailer’s license. On the other hand, retailers can err toward overcollecting sales tax, but in doing so they expose themselves to class actions and their associated expenses and negative publicity.

Further, if the courts endorse the arguments of the class action litigants, retail clerks would need to carefully read — and understand the implications of — the fine print on every coupon presented, and self-service lanes may have to disallow the use of manufacturer-issued coupons. These changes would be significant burdens in an industry built on customer convenience.

Best Practices to Cut Exposure

Sales tax compliance is already complicated enough for retailers doing business in multiple jurisdictions. Even the best point-of-sale systems can have problems determining whether to collect tax under the thousands of fact patterns that arise daily. Each state and locality has its own tax rate, tax base and exemptions from that base. A bag of coffee, for example, may or may not be taxable in a particular jurisdiction; the presentation of a coupon for that coffee only muddies the water further.

While there is no practical way to fully eliminate exposure to these types of lawsuits, retailers should consider several best practices that can reduce that exposure while also managing audit risk.

First, retailers should regularly review their tax collection process in all jurisdictions where they do business and ensure they are diligently complying with each jurisdiction’s unique sales tax rules. In-house attorneys and accountants should regularly compare the retailer’s practices with the requirements of the jurisdiction and engage outside counsel familiar with the nuances of the jurisdiction when questions arise.

When a retailer is uncertain how a particular discount should be classified for tax purposes, particularly in jurisdictions without specific rules relating to such discounts, retailers should also consider seeking regulatory guidance from the taxing authorities. Assuming retailers comply with the guidance, administrative rulings can provide retailers with a level of protection against damages in lawsuits while simultaneously reducing exposure to audits. It would be impractical to seek a ruling for every fact pattern in every jurisdiction, however, so retailers should be selective in which rulings to pursue.

Due to their size and scale of operations, national retailers often have significant influence with their vendors. Because many of the issues in the recent lawsuits revolve around manufacturer-issued coupons, and specifically their lack of language shifting the tax burden to the customer, retailers may want to work with vendors to ensure that the appropriate tax-shifting language is on every coupon. Manufacturers should be open to this language, as the burden of the use tax on the coupon amount otherwise may fall to the manufacturer.

Finally, and more fundamentally, retailers should ensure that the entire amount of sales tax they collect is remitted to the proper taxing authority. While this is a fairly rudimentary best practice, some class action defenses, such as the voluntary payment doctrine which states that voluntarily paid taxes cannot be recovered even if such payment was erroneous, may only be available when the tax is collected and remitted. Further, if the retailer does not retain the tax that is allegedly collected erroneously, the case for unjust enrichment is made arguably weaker. Of course, overcollecting sales tax and failing to remit it exposes the retailer to fire from both sides.

No system can practically and perfectly consider every possible variation relating to the taxability of products sold by local and national retailers, but those retailers not already in the crosshairs of class action litigants should take every opportunity to reduce their exposure, before they find themselves the next target.

This post was prepared by Francina A. Dlouhy and Benjamin A. Blair.

Electricity used by Qdoba Mexican Restaurants to keep food warm before final preparation and sale was found exempt from sales tax by the Indiana Tax Court.  On June 23, 2015, the Indiana Tax Court in Aztec Partners, LLC v. Indiana Department of State Revenue granted the refund claims filed by Aztec Partners, LLC, which operates nineteen of the restaurants in the State. The restaurants use food warmers, hot food cabinets, and other equipment to hold and to preserve the temperature of food items such as salsa, chicken, lettuce and rice until they are combined into entrées sold to customers.  After first concluding that it had jurisdiction to hear the refund claims, the Court analyzed whether the electricity used to power the equipment was exempt from sales tax under the consumption exemption, which exempts electricity acquired “for direct consumption as a material to be consumed in the direct production of other tangible personal property.”  To qualify for the exemption, the Court explained, Aztec had to show that (1) it is engaged in production, (2) it has an integrated production process, and (3) the electricity is essential and integral to its integrated production process.

Preparing entrées was production.  Noting the “iron-clad rule” that “without production there can be no exemption,” the Court observed that “production” is defined broadly. In deciding whether production occurs, the focus is on whether a marketable good is created. Aztec engaged in production, because its preparation and combination of food items into entrées substantially changed the individual food items into new, marketable products – entrées – that have a character and form different from the food items originally acquired.

Combining food created a marketable product.  Aztec’s marketable finished products were the entrées, not the individual food items.  (No evidence showed that food items were individually sold.) Entrées were not ready for sale until this final step was completed.  According to Aztec, combining food items was the last of several steps within its integrated production process.  The electricity was consumed in this process.

Electricity essential to creating entrées. Without the electricity, the individual food items could not have been properly preserved for combination into marketable products. Aztec did not need to show the electricity had a transformational effect on the food items to prove it was essential and integral to producing the entrées.  Aztec’s purchases of the electricity were exempt.

Department takes one more bite.  The Department filed a petition for rehearing in which it claimed, in part, that Aztec’s refund claims were ambiguous, so it never filed adequate claims and thereafter never invoked the Court’s jurisdiction.  In a July 30th order, the Court ruled that Aztec’s refund claims were proper, as they were filed on the Department’s designated form and described the basis for the claims.  Furthermore, the Department had sufficient information to process the claims, denying them in part and granting them in part.  The refund claims, therefore, were not ambiguous.

The Department of Revenue often seeks to narrow the scope of what is considered production and to restrict the availability of the consumption exemption.  However, as this decision shows, electricity used to create a final, marketable product – whether tacos, tanks, or turbines – is likely exempt.

This post is for general informational and educational purposes only.  The reader should not rely or act upon any information in this post without seeking professional legal counsel or advice from a tax professional.