For nearly 25 years, the general standard for whether a state could compel a mail-order or online retailer to collect sales tax from customers was that retailer’s physical presence (or lack thereof) in that state. More recently, some states have tweaked their laws so that total sales — and not physical connection — is the determining factor. Online tech store Newegg is the latest retailer to challenge these new rules, taking issue with Alabama’s determination that the company owes the state more than $185,000 in sales tax.

The new Alabama sales tax rule [PDF] kicked in Jan. 1, 2016. It replaces the long-used physical presence test with one based on sales revenue. If a remote retailer sells more than $250,00 worth of products to people in Alabama in a calendar year, it is expected to collect sales tax from its customers there.

Thus, in May, the Alabama Department of Revenue determined that Newegg owed the state nearly $155,000 in sales tax for items sold in January and February, along with around $32,000 in penalties and interest.

In response, attorneys for Newegg today filed an appeal with the Alabama Tax Tribunal, questioning the legal basis for Alabama’s new tax rules.

At the core of Newegg’s argument is the 1992 Supreme Court ruling in Quill Corp. v. North Dakota, in which the state argued that mail-order office supply company Quill should have collected sales tax on purchases in the state because it provided software to customers that allowed them to place orders and check Quill’s inventory.

The Supreme Court disagreed, saying that the software didn’t create a nexus sufficient enough to allow the state to require that Quill collect taxes. Since then, physical presence has generally been considered a requirement if a state wants to compel the collection of sales tax by remote retailers.

“The lack of the required physical presence in the state by Newegg renders the Final Assessment… against Newegg unconstitutional,” reads the appeal, which contends that the new rule contradicts all the standards for taxable sales currently detailed in Alabama state law.

Newegg notes in the appeal that it has “no physical presence” Alabama, nor does it “own or lease any property in the state, permanently or temporarily, nor does it make any sales within the state.

The company argues that all of its sales are received, processed and filled outside of Alabama. Likewise, Newegg claims it “does not use independent contractors, brokers, employees, or agents in Alabama to conduct its affairs.”

Nothing in the state code, says Newegg, authorizes the Revenue Department to compel an online retailer without any physical presence in the state to collect sales taxes.

To demonstrate its level of physical and operational remove from the state, Newegg notes in the appeal that it has “no physical presence” Alabama, nor does it “own or lease any property in the state, permanently or temporarily, nor does it make any sales within the state.

The company argues that all of its sales are received, processed and filled outside of Alabama. Likewise, Newegg claims it “does not use independent contractors, brokers, employees, or agents in Alabama to conduct its affairs.”

The retailer says that Alabama’s decision to penalize Newegg for late payment and filing of these taxes is “improper” and “invalid,” and is asking the Tribunal to cancel the assessment.

This is the second challenge in only a few months to a new online sales tax rule. In May, trade groups representing mail order and online retailers sued South Dakota over a new rule that sets an an annual threshold of $100,000 or 200 transactions in the state before a company must collect sales tax.

As in that case, it seems likely here that the state will have difficulty remedying its new rules with the nexus standard set forth in Quill, but these actions are really just the first nudges in an issue that seems destined to ultimately be determined by the U.S. Supreme Court.

In fact, some on the nation’s highest court seem eager to hear arguments on the application of Quill, a pre-internet age ruling, to the modern retail landscape. Justice Anthony Kennedy recently opined that the 1992 decision, to which he concurred, was “questionable even when decided.”
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UPDATE: The Revenue Department has responded to the appeal, saying it believes that the recently enacted rule will “provide a proper case to the Supreme Court” to challenge the decades-old precedent set in Quill.

“The effects of Quill have been detrimental to the states’ revenues, have forced in-state retailers to operate at an unfair competitive disadvantage for decades, and have allowed online retailers who are clearly doing business in our state to evade collection responsibility,” said Alabama Revenue Commissioner Julie Magee. “Until Congress acts, we will continue to lead the charge to overturn Quill.”

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Newegg has yet to respond to our request for comment.

Meanwhile, the Retail Industry Leaders Association — a trade group that has pushed for online retailers to face the same tax collection obligations faced by bricks-and-mortar retailers — contends that both Newegg challenge and the South Dakota lawsuit are the inevitable result of lawmakers who have been reluctant to sort this issue out.

“Retailers have worked tirelessly for over a decade to close the online loophole and restore free market competition,” says Joe Rinzel, RILA’s senior vice president for government affairs. “We would prefer a legislative solution that guarantees small business protections and other simplifications over a legal challenge to Quill. However, given continued inaction by the House of Representatives, it’s become increasingly likely that the Supreme Court will re-examine Quill before Congress acts to address this issue.”

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