Ruling Based on Lack of Substantial Nexus with the Taxing State

In American Business USA Corp. v. Department of Revenue, Case No. 4D13-1472 (4th DCA November 12, 2014), the Fourth District Court of Appeal held that an assessment of sales tax pursuant to a provision in Florida's sales tax statutes was unconstitutional because it violated the Commerce Clause of the U.S. Constitution. This ruling is important because Florida businesses that make sales in other states will need to review their sales tax obligations with respect to those sales in light of this case. This case is also a reminder of the strategy considerations that should go into litigating a tax case.

The provision at issue in this case was Fla. Stat. 212.05(1)(l), which provides: "Florists located in this state are liable for sales tax on sales to retail customers regardless of where or by whom the items sold are to be delivered." Fla. Admin. Code Rule 12A-1.047(1) further provided that "[f]lorists are engaged in the business of selling tangible personal property at retail and their sales of flowers  … and other such items of tangible personal property are taxable."

American Business was a Florida corporation that operated an online business. As a result, it made sales inside and outside of Florida. It charged sales tax on flowers and other items that were delivered in Florida, but it did not charge sales tax on flowers and other items delivered outside the state. The company apparently did not maintain any inventory, and it used local florists to fulfill the out-of-state orders. Relying on the statute and rule, the Department of Revenue sought to impose Florida sales tax on the out-of-state sales. The taxpayer challenged the assessment on constitutional grounds – namely that imposing Florida sales tax on the out-of-state transactions violated the due process and the dormant Commerce Clauses of the U.S. Constitution. 

There is well-developed law on these constitutional issues, especially in the context of sales tax.  In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977), the Supreme Court established a four part test for evaluating whether a tax comports with the Commerce Clause.  Generally, the tax must be applied to an activity 1) with a substantial nexus, with the taxing state, 2) that is fairly apportioned, 3) that does not discriminate against interstate commerce, and 4) that is fairly related to the services provided by the State. A tax that does not satisfy all of these requirements violates the dormant Commerce Clause. The Supreme Court has also decided two other important sales tax cases involving substantial nexus. Quill Corp. v. North Dakota, 504 U.S. 298, 312 (1992); National Bellas Hess, Inc., 386 U.S. 753, 754 (1967). These cases generally held that there must be some sort of physical presence in order to establish the substantial nexus.

Quill and National Bellas Hess considered a slight twist on the scenario at issue in this case.  Those cases were attempts by the states in which the products were delivered to impose sales tax, while American Business was an attempt by the state in which the taxpayer was registered to impose sales tax. Nevertheless, based on the clear analysis set forth in those cases, the Fourth District Court of Appeal concluded that "[m]erely registering in a state does not give the taxing state the right to assess sales taxes on transactions without any other facts to constitute 'substantial nexus.'" It therefore held that the assessment of sales tax on the sales of flowers and other tangible personal property "outside Florida, ordered by out-of-state customers for out-of-state delivery, violates the Commerce Clause of the U.S. Constitution."

The application of a tax also cannot violate the due process clause, but this is an easier standard for the states to meet. It is the same "traditional notions of fair play and substantial justice" that apply to due process in non-tax areas. See Int'l Shoe Co. v. Washington, 326 U.S. 310, 316 (1945). Because American Business was registered in Florida and had a mailing address in Florida, the District Court of Appeal concluded that there was no violation of the due process clause.

This case highlights that when challenging a proposed assessment or litigating a tax case, it is important not to focus solely on the substance of the statute and regulation. One must look to all available defenses. In this case it was the constitutionality of the statute as applied to the taxpayer. When the government's position is largely dependent on a favorable regulation that it wrote, taxpayers have attempted to invalidate the regulation. In a current federal case, the taxpayers are asserting a separation of powers challenge to the appointment of the Tax Court judge that decided their case. 

Constitutional and other such challenges against tax statutes are difficult to win. It is rare that these sorts of defenses would be warranted or ultimately meritorious, but they should not be overlooked. In this case, the taxpayer was seemingly not able to contest the merits of the tax under the statute and regulation, but it had the benefit of favorable and well-developed case law on the constitutional issue. Other cases may also present the right opportunity for these types of challenges.