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Internet Tax Freedom Act preempts Illinois click-through nexus law

 

By Sally P. Schreiber, J.D.
October 21, 2013

On Friday, the Supreme Court of Illinois held that Illinois’s click-through nexus law is expressly preempted by the federal Internet Tax Freedom Act (ITFA), P.L. 105-277, which prohibits states from imposing discriminatory taxes on electronic commerce (Performance Marketing Ass’n v. Hamer, No. 114496 (Ill. 10/18/13)).

The Illinois law (35 Ill. Comp. Stat. 105/2) expanded the definition of retailers obligated to collect sales tax to those having a contract with a person located in Illinois who refers potential customers through a link on the Illinois person’s website (a so-called click-through connection). According to the state Supreme Court, out-of-state internet retailers are required to collect use tax if they have a contract with a person in Illinois who displays a link on his or her website connecting an internet user to that retailer’s website. This is referred to as performance marketing. 

Lower-court proceedings

In May 2012, the Circuit Court for Cook County, Ill., issued an order declaring the click-through nexus law unconstitutional because it violated the Commerce Clause’s requirement for substantial nexus and it was preempted by the ITFA (Performance Marketing Ass’n v. Hamer, No. 2011 CH 26333 (Ill. Cir. Ct. Cook Cty. 5/7/12)). Because the case involved the law’s constitutionality, the court’s ruling was directly appealable to the Illinois Supreme Court under Illinois Supreme Court Rule 302(a), which the Illinois Department of Revenue did.

Performance Marketing Association (PMA), the plaintiff, is a national trade association whose members are in the performance marketing business. (A similar organization, Direct Marketing Association, was the plaintiff in a case challenging Colorado’s Amazon law. The Tenth Circuit recently reversed a lower-court ruling that declared the law unconstitutional. See “Tenth Circuit Throws Out Decision Striking Down Colorado’s Amazon Law.”)

The Illinois Supreme Court’s opinion 

According to the court, Illinois amended its use tax law, which originally required any retailer doing business in the state to collect use tax from its customers, to also require a retailer that has a contract with a person located in Illinois who displays a link on his or her website that connects an internet user to the retailer’s website to collect use tax on those sales.

As the court noted, these types of marketing arrangements, in which advertisers are compensated based on the success of the marketing campaign, are not limited to the internet—they also exist in print and broadcast media. The court agreed with PMA that this new law imposed a tax that discriminated against electronic commerce for purposes of the ITFA because it did not impose a similar obligation on print and broadcast advertisements. Therefore, the Illinois Supreme Court affirmed the lower court’s grant of summary judgment in PMA’s favor on the grounds that the state law was preempted by the federal IFTA under the Supremacy Clause of the U.S. Constitution (under which a federal statute preempts state law in cases where there is a conflict between the two). The court did not reach the Commerce Clause issue.  

The dissent

Justice Lloyd Karmeier raised the lone dissent to the 6–1 opinion, noting that many states are wrestling with the issues raised by the rise of internet commerce: the inability to collect use tax from consumers efficiently and the competitive advantage out-of-state retailers have because many consumers purchase goods from them knowing they will not pay any sales tax and not caring or realizing they owe use tax.

Karmeier also objected strongly to the court’s failure to address the Commerce Clause issue. He noted that New York, which has a law similar to the Illinois statute, had its courts dismiss a challenge to its law based on the Commerce Clause. Considering that the lower court’s decision rested on the Commerce Clause and the parties arguments’ focused on the Commerce Clause, Karmeier found the Illinois Supreme Court’s refusal to even address the issue remarkable. The ITFA is scheduled to expire next year, and, once it does, Illinois will be free to reenact or reinstate its law, and another suit challenging it on Commerce Clause grounds will probably ensue.   

Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.

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