Online tax lawsuit could bring unintended consequences

Friday, January 13, 2017, Vol. 41, No. 2

Cumberland Transit owner Allen Doty isn’t sure if a rule requiring major out-of-state retailers to collect Tennessee sales taxes will create more equity for his shop.

But Doty, who has been selling everything from bicycles to kayaks and camping gear for 34 years in Nashville, is definitely tired of people shopping in his store for hours, snapping a picture of shoes they like, then going home and buying them online “just to avoid sales tax.”

The landmark retailer on West End Avenue likely has staying power because “loyal customers” like its service, atmosphere and selection.

In a state that depends on sales tax for the lion’s share of its revenue, Cumberland Transit pays the Department of Revenue about $300,000 a year in sales taxes, far more than Doty says he takes home in pay.

Doty even admits people can buy anything in his store cheaper at any number of online sites.

Yet, big, out-of-state retailers too often get away without collecting and remitting the 9.25 percent sales tax to the state, a situation that’s helped put many of Doty’s friends out of business.

“I’m just asking for a fair and level playing field I can deal with,” Doty told a December joint meeting of state House and Senate Government Operations Committees in Nashville.

Gov. Bill Haslam is prepared to give Doty at least a shot at a potential solution with a rule that took effect Jan. 1 requiring out-of-state retailers with sales of more than $500,000 a year in Tennessee to register with the Department of Revenue by March 1 and begin collecting and remitting sales and use tax by July 1 or on the first day of the third month after they eclipse the half-million mark.

The measure is part of the rules omnibus bill to be considered by the General Assembly this session. It moved forward following the mid-December vote by the Government Operations Committees, both of which voted against making a negative recommendation.

But it could expire June 30 if the Legislature makes an amendment and removes the out-of-state sales tax collection rule.

Such a move would undercut a priority by the Haslam administration, which is prepared to undertake a “lengthy legal process” to cope with the changing retail economy and congressional inaction, according to a Finance and Administration spokesperson.

Haslam’s philosophy

With heavyweights, such as Finance and Administration Commissioner Larry Martin, Revenue Commissioner David Gerregano and Attorney General Herbert Slatery presenting the administration’s policy in mid-December, it’s no secret where Haslam stands.

“We all believe in the marketplace. Compete on service, compete on quality, compete on price,” Martin says. “It is not appropriate for one retailer to gain an advantage over another because of collecting or not collecting a government tax. But that is what is happening statewide and across the nation.”

Sales tax makes up 61 percent of the state’s tax revenue base of $8.2 billion, with another $2.4 billion going to local governments, according to state officials.

The debate over these tax collections is nothing new.

The Legislature passed a law in 1988 requiring out-of-state retailers to pay Tennessee sales taxes. But a large number aren’t doing it, with about three-fourths of what is due coming in. Under this rule, the Division of Audit would go after retailers not abiding by the law.

The collection rule is gaining momentum because the way people shop has changed “significantly” over the last decade, Martin says.

On the most recent Black Friday, sales at brick-and-mortar stores decreased by 10.4 percent while online sales went up by 21.6 over the previous year, he notes.

The National Retailer Federation also released a survey showing 108.5 million Americans shopped online over Thanksgiving weekend, compared to 99.1 million who went to stores, a dramatic change from last year when the numbers were even, according to Martin.

The matter is not as clear-cut as it might seem, though.

A 1967 decision by the U.S. Supreme Court in Bellas Hess v. Illinois Department of Revenue, said a company must have a physical presence in a state before collecting sales tax there.

A similar case went back to the high court in 1992, Quill v. North Dakota, and the court declined to overturn its initial decision, instead saying Congress should address the matter. The court turned back North Dakota’s effort to collect sales taxes from the Quill Corp., an office supply retailer, which had no physical presence in the state.

U.S. Sen. Lamar Alexander of Tennessee pushed the Marketplace Fairness Act through the Senate in 2013, but the House has stood pat.

In light of the House freeze, Haslam is ready to move.

Even though Alabama and South Dakota are already tied up in litigation over the matter, Martin says, “Frankly, we believe Tennessee can present the strongest case for overturning Quill.”

AG Slatery says his office is “comfortable” the revenue commissioner has authority to “promulgate the rule,” especially in accordance with existing law.

“We are prepared to defend the rule. We think that the rule can be defended on the basis that is distinguishable from Quill,” he says, pointing out that the case dealt primarily with mail order catalogues, which are much different than the internet and marketplace 25 years later.

Slatery also says he believes online sellers have a “meaningful presence” in Tennessee because of the internet, service providers and the ability to the reach customers “at a moment’s notice through a computer, tablet or cell phone.”

The con

Despite the state’s insistence, compelling testimony comes from George Gruhn, owner of Gruhn Guitars in Nashville, one of the world’s most respected guitar makers.

Not only does his 8th Avenue store compete on service, convenience and price, it’s also strong on availability, he says, noting the average guitar shop doesn’t have what he offers.

Calling the situation a “bloodbath of competition,” Gruhn points out many people are mistaken about the ability of small businesses to compete.

“It is a very diversified market, but almost every music store I know has online as well as brick and mortar,” he adds.

Gruhn also sends a warning about the rule’s impact.

“If this ruling goes into effect, other states will retaliate. There’s no question about it,” he says.

In other words, it could turn into a statewide tax increase.

Steve Roth, general counsel for Jewelry Television, which employs 1,400 people in Knoxville, also says enforcing the rule would be a mistake.

“I think this measure creates an illusion that we’re solving a problem through passage of it,” he says.

Retailers won’t “line up” to pay the tax simply because the state sends them a letter telling them to collect it, he adds, noting Jewelry Television rejected a similar effort by South Dakota.

Roth says it’s also wrong to believe a lawsuit involving Tennessee would take a “speedy path” to the Supreme Court, with Alabama and South Dakota already in line.

“There’s not any reason to spend money from the taxpayers of Tennessee to pursue a fight that somebody else is already waging,” he says, noting Tennessee can file a court brief if it wants to participate.

Instead, the state should join efforts to pass legislation in Congress so the nation will have uniform rules, Roth says. Momentum could be gathering behind a bill being put together by Rep. Bob Goodlatte, a Virginia Republican.

Taking the same view, Carl Szabo, an attorney for NetChoice, argues the internet is already being taxed, with 19 of the top 20 e-retailers collecting for the state of Tennessee. He points out Amazon accounted for 42 percent of the first-quarter sales in Tennessee in 2016.

Yet, discussion also showed Amazon didn’t collect state taxes for several years when it first put warehouses in Tennessee. The online retail giant started paying after it worked an agreement with Haslam.

Just as Amazon started paying at its own leisure, online shopping allows customers to operate as they please.

“A lot of us end up going and shopping online because perhaps we don’t want to stand in line on Black Friday trying to elbow our way to the front of the cash register when, in fact, we can go online to the same store and make the purchase,” Szabo explains.

Furthermore, he contends such a move by the state will make “winners” out of tax collectors and “losers” out of online sellers. And, he calls the rule an effort to make an “end run” around the Legislature.

Legislative debate

Bipartisan opposition to the administration’s rule surfaced in the Government Operations Committee, led by Democratic state Rep. Mike Stewart, of Nashville, who called for a negative recommendation from the Government Operations Committees.

Stewart expresses skepticism, saying the Legislature passed statutes in 2015 to get rid of the physical presence requirement for franchise, excise and business taxes.

Despite administrative responses pointing out the Legislature enacted law on the matter nearly 30 years ago, Stewart notes the Supreme Court “was invited” to overturn Quill recently and chose not to.

“I worry this regulation would make us kind of the odd person out. The vast majority still recognize physical presence,” he says.

State Sen. Kerry Roberts, a Springfield Republican who used to own a bicycle shop and competed with Cumberland Transit, seems to side with the administration, himself a victim of the online sales trend and other forces such as Walmart.

Main Street retailers are operating on profit margins of less than 5 percent, and if they match the prices of big retailers they wind up losing profitability at the same time they battle Internet retailers, he points out.

“I’m no longer in business today, and one of the key reasons is the advent of the internet,” Roberts says. “It needs to be dealt with. There were almost 50 people that lost jobs when we went out of business.”

Other legislators such as Democratic Rep. John Ray Clemmons, of Nashville, fear the Haslam administration is simply looking for a legal fight on the matter and has a bigger but hidden motive for the internet sales argument.

“They pitched it as a fairness issue, but there’s something else going on there,” Clemmons says.

Amid the rambling debate, Sen. Janice Bowling, a Tullahoma Republican, may make the best point in raising concern about the rule.

When she asks how much revenue the state would raise from out-of-state sales tax collections, officials respond: $160 million in state revenue and $59 million in local revenue.

“That would seem low … and not even worth the angst we’re going through to discuss it,” Bowling says.

In fact, it’s barely a rounding number on a $33 billion budget.

The analysis

While fairness and equity are the administration’s biggest arguments and small businesses can’t be blamed for complaining, many people point out online buyers wind up paying shipping costs, which, depending on the weight of the object, could be higher than sales taxes.

Thus, home-shopping convenience, which might not be enjoyed by those in rural areas without internet access (that’s another question completely), is the key.

But for those who buy a pair of shoes online, only to find out they hurt their feet, convenience is gone with the wind. It must be noted, too, that Sears, once the king of catalogue sales, is struggling to survive as it prepares to close 150 stores nationwide.

Just like any other store, Sears offers online ordering and service.

And, let’s face it: Many people just like to shop so much they buy clothes just so they’ll have something to wear to the mall.

So many factors are involved in this debate, from quality manufacturing to pricing to delivery to service, that only the marketplace – and maybe Congress – will be able to work it out. And don’t bet the house on Congress.

For the 110th General Assembly, the main question for Tennessee is whether it wants to take on a long and expensive legal battle.

Sam Stockard can be reached at sstockard44@gmail.com.