The Marketplace Fairness Act of 2013 and Issues for Digital Distributors of Software in California

On Monday, May 6, 2013, the Senate approved Senate Bill 743, known as “the Marketplace Fairness Act of 2013,”[1] a bill authorizing online retailers that have gross annual receipts in total remote sales in the United States exceeding $1,000,000 to collect a sales tax from residents of states where they sell goods, even if such online retailers do not have a physical presence in these states.[2] If enacted, the Marketplace Fairness Act will substantially change the responsibilities of internet retailers and impose new burdens on large internet retailers for collecting sales taxes.

The Law Today

Unlike conventional “brick and mortar” retailers, which must collect applicable state and local sales taxes, online retailers have not had to assess sales taxes. Instead, buyers of online goods are tasked with the responsibility of self-reporting their online sales and paying a “use tax,” which is a “tax on the enjoyment of that which was purchased.”[3] Because states collect less from use taxes than they do from sales taxes, they have desired to impose sales tax requirements on out-of-state online retailers, but they have been precluded from doing so as a result of Supreme Court decisions holding that taxing out-of-state retailers violates the Due Process Clause of the Fourteenth Amendment of the Constitution[4] or the “Dormant Commerce Clause.”[5]

Two Supreme Court cases have severely constrained states from imposing sales tax requirements on out-of-state retailers. In National Bellas Hess, Inc. v. Department of Revenue of Illinois,[6] a mail order house located in Missouri was assessed sales tax by Illinois, notwithstanding the fact that it owned no tangible property in Illinois; had no sales outlets, representatives, telephone listing, or solicitors in that State; and did not advertise there by radio, television, billboards, or newspapers. The mail order house appealed a judgment from the Illinois Supreme Court requiring it to collect and pay to Illinois the tax imposed by the State upon consumers who purchased the company’s goods for use within the State. The Court determined that the “test whether a particular state exaction is such as to invade the exclusive authority of Congress to regulate trade between the States, and the test for a State’s compliance with the requirements of due process in this area are similar.”[7] With respect to due process, the court found that the Constitution requires “some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax.”[8] With respect to the Dormant Commerce Clause, the court determined that mail-order commercial transactions were interstate in character and operated within “a domain where Congress alone has the power of regulation and control.”[9] Consequently, Illinois was prohibited from imposing a duty of tax collection and payment upon the mail-order company.

While Bellas Hess seemed to preclude states from taxing out-of-state retailers lacking an in-state physical presence, in a later case, the Court seemed to signal a willingness to permit at least some forms of sales taxes levied by states upon entities without a substantial in-state physical presence. In Complete Auto Transit, Inc. v. Brady,[10] the Court ruled in favor of Mississippi, which had levied a sales tax that was specifically characterized as a “privilege [tax] for the privilege of . . . doing business within the state,”[11] upon an auto transporter that moved cars from the terminus of a railway line to dealerships. Complete Auto Transit overruled an earlier case, Spector Motor Service, Inc. v. O’Connor,[12] which held that a state tax on the “privilege of doing business” in the state was per se unconstitutional when applied to interstate commerce. In addition, Complete Auto Transit announced a new four-prong test to determine whether a state tax on interstate commerce will be upheld. Under the new rule, such a tax does not violate the Constitution if it is “applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided by the State.”[13]

In Quill Corp. v. North Dakota, the Supreme Court reaffirmed that a state cannot tax vendors that do not have a physical presence within a state.[14] In Quill Corp., a vendor of office equipment and supplies that primarily conducted its out-of-state business through mailings, advertisements in national magazines, and telephone calls, challenged a North Dakota statute that required it to collect a tax on orders placed by North Dakota residents.[15] As in Bellas Hess, the vendor in this case challenged the constitutionality of the imposition of the tax on alternate grounds. First, it alleged that the tax violated the Due Process Clause. Second, it asserted that the tax created an impermissible burden on interstate commerce in violation of the Commerce Clause.

With respect to the Due Process Clause, the Court noted that its “due process jurisprudence had evolved in the 25 years since Bell Hess”[16] and observed that the due process analysis for whether a “defendant had minimum contacts with the jurisdiction “such that the maintenance of the suit does not offend ‘traditional notions of fair play and substantial justice'””[17] had shifted from “more formalistic tests that focused on a defendant’s “presence” within a State in favor of a more flexible inquiry into whether a defendant’s contacts with the forum made it reasonable, in the context of [the] federal system of Government, to require it to defend the suit in the State.”[18] The Court ultimately found that requirements of due process were met because Quill had “purposefully directed its activities at North Dakota residents,” the “magnitudes of those contacts is more than sufficient for due process purposes,” and the “use tax is related to the benefits Quill receive[d] from access to the State.”[19] Thus, the Court determined that due process requirements could be met when a State taxed an out-of-state corporation conducting business in the State even if the corporation lacked an in-state physical presence, overruling its prior holdings to the extent that the earlier holdings “indicated that the Due Process Clause requires physical presence in a State for the imposition of a duty to collect a use tax.”[20]

With respect to the Commerce Clause, the Court noted that “a corporation may have the “minimum contacts” with a taxing State as required by the Due Process Clause, and yet lack the “substantial nexus” with that State as required by the Commerce Clause.”[21] Recognizing the benefits of establishing a bright-line rule in the area of sales and use taxes and the principles of stare decisis, the Court asserted that the Bellas Hess rule that created a safe-harbor for vendors “whose only connection with customers in the [taxing] State is by common carrier of the United States mail”[22] remains good law. Furthermore, it held that “a vendor whose only contacts with the taxing State are by mail or common carrier lack[ed] the ‘substantial nexus’ required by the Commerce Clause.”[23] Importantly, by determining that the Due Process Clause did not bar States from imposing use taxes, it gave Congress the latitude “to decide whether, when, and to what extent the States may burden interstate mail-order concerns with a duty to collect use taxes.”[24]

The Marketplace Fairness Act

Under the Marketplace Fairness Act, Congress provides States the authorization to require the collection of sales and use taxes for a person that makes a sale into a State in which the seller would not legally be required to pay, collect, or remit State or local sales and use taxes but for the Marketplace Fairness Act (such a seller, a “remote seller”), so long as the remote seller does not qualify for the “Small Seller Exception” under Section 2(c) thereof.[25] Under the Small Seller Exception, a State is not authorized to require a remote seller to collect sales and use taxes under the Marketplace Fairness Act if the remote seller has gross annual receipts in total remote sales in the United States in the preceding calendar year exceeding $1,000,000.[26]

Member States of the Streamlined Sales and Use Tax Agreement

The States that are “Member States” under the Streamlined Sales and Use Tax Agreement (SSUTA),[27] which is a multi-state agreement designed to unify, simplify and coordinate various tax codes, are authorized to require all sellers not qualifying for the small seller exception to collect and remit sales and use taxes on remote sales sourced to the Member State pursuant to the provisions of SSUTA.[28] This provision of the Marketplace Fairness Act applies so long as SSUTA implements certain minimum simplification requirements, in accordance with Section 2(b)(2) of the Marketplace Fairness Act, as described below.[29]

Other States

Section 2(b) of the Marketplace Fairness Act authorizes each state that is not a Member State under SSUTA to require all sellers not qualifying for the small seller exception to collect and remit sales and use taxes on remote sales sourced to the non-Member State, so long as the State implements certain minimum simplification requirements, pursuant to Section 2(b)(2) of the Marketplace Fairness Act.

Minimum Simplification Requirements

Under Section (b)(2), each State that seeks to collect to collect and remit sales and use taxes with respect to remote sellers making remote sales sourced to that State must implement at least ten requirements (the “Minimum Simplification Requirements”).[30]

First, the State must provide a single entity in the State that will administer all State and local sales and use taxation, return processing, and audits for remote sales that are sourced to the State.[31] Second, it must provide a single audit of a remote seller for all State and local taxing jurisdictions that are located within State.[32] Third, it must provide a single sales and use tax return that remote sellers are to use when they file with whatever entity the State has granted responsibility for administering all State and local sales and use taxes.[33] Fourth, the State must provide a uniform sales and use tax base among the State and the local taxing jurisdictions within the State.[34] Fifth, the State must source all interstate sales in compliance with the definition of sourcing set forth in Section 4(7) of the Marketplace Fairness Act, which, following Section 310 of SSUTA, generally requires sourcing based on the delivery location.[35] Sixth, the State must provide certain information, including information about the taxability of products and services and any product and service exemptions from sales and use tax in the State.[36] Moreover, the State must provide a rates and boundary database.[37] Seventh, the state must provide free software to remote sellers.[38] Such software must calculate sales and use taxes due on each transaction at the time the transaction is completed, file sales and use tax returns, and be updated to reflect rate changes.[39] Eighth, the State must provide certification procedures that define the requirements that persons who seek to become certified software providers must fulfill.[40] Ninth, the State must relieve remote sellers, certified software providers, or both, from certain enumerated types of liabilities to the State or locality for the incorrect collection, remittance, or non-collection of sales and use taxes, including any penalties and interest.[41] Finally, the State seeking to meet the Minimum Simplification Requirements must provide remote sellers and certified software providers 90 days’ prior notice of a rate change by the State or any locality in the State and update the information.[42] If such notice is not given, the Marketplace Fairness Act requires the State to relieve any remote seller or certified software provider from liability for collecting sales and use taxes at the immediately preceding effective rate during the 90-day notice period.[43]

Member States

Assuming that SSUTA meets the minimum simplification requirements specified in Section 2(b)(2) of the Marketplace Fairness Act, Member States may exercise their authority under the Act 180 days following publication by the State of notice of their intent to exercise its authority under the Marketplace Fairness Act.[44] A Member State may not, however, exercise such authority earlier than the first day of the calendar quarter that is at least 180 days after the Marketplace Fairness Act is enacted.

Non-Member States

States that are not Member States (“Non-Member States”) have the authority to require collection of sales and use taxes beginning no earlier than the first day of the calendar quarter that is at least 6 months after the date that the State enacts legislation to exercise the authority granted by the Marketplace Fairness Act[45] that (a) specifies the tax or taxes to which such authority and the Minimum Simplification Requirements will apply;[46] (b) specifies the products and services to which the authority of the Marketplace Fairness Act will not apply;[47] and (c) implements all of the Minimum Simplification Requirements.[48]

Issues for Software Distributors in California

It is anticipated that the Marketplace Fairness Act, in its House counterpart, H.R. 684, may meet significant resistance in the House.[49] Given that states are eager to collect revenue, however, the Marketplace Fairness Act may pass the Republican-controlled House because it has received at least some bipartisan support; Representative Steve Womack, Republican of Arkansas, has collected 55 co-sponsors from both parties for H.R. 684, which he introduced.[50] Many brick-and-mortar retailers, including Sears, the Gap, and Barnes and Noble, are supporting the Marketplace Fairness Act because online competitors have benefitted from a significant pricing advantage, as they are not currently required to collect a sales tax. [51] Moreover, many major on-line retailers, including Amazon, have dropped their opposition to the Marketplace Fairness Act because they have built physical distribution facilities, which clearly create a tax nexus, in many states.[52] Such retailers have lobbied for or have withheld opposition to the Marketplace Fairness Act because its enactment would nullify the pricing advantages that other online retailers lacking such distribution centers presently enjoy. Assuming that H.R. 684 passes the House, President Obama has pledged to sign the bill.[53]

Digital distributors of software may be required to collect sales taxes on all sales shipped to the 22 states that are Member States as early as January 1, 2014. Such distributors will likely need to update some of their legal documents, including their terms of service and end-user license agreements, to reflect how the distributors will collect sales taxes. Given the possibility that the Marketplace Fairness Act may pass without significant amendment, digital distributors of software should consider evaluating SSUTA certified service providers, which include Accurate Tax, Avalara, CCH, Exactor, FedTax, and TaxWare, to assess what changes they will need to make to their order systems to integrate with such software.

Digital distributors of software should note that the present system of taxation of software licensing in California may create at least a temporary tax advantage for certain types of licensing arrangements. California has exempted taxes on the transfer of software or information by electronic means.[54] As of today, “the sale or lease of a prewritten program is not a taxable transaction if the program is transferred by remote telecommunications from the seller’s place of business, to or through the purchaser’s computer and the purchaser does not obtain possession of any tangible personal property, such as storage media, in the transaction. Likewise, the sale of a prewritten program is not a taxable transaction if the program is installed by the seller on the customer’s computer except when the seller transfers title to or possession of storage media or the installation of the program is a part of the sale of the computer.”[55] California has announced proposed amendments to this Regulation, however. The State Board of Equalization is scheduled to discuss the amendments in the Board’s August 13, 2013 Business Taxes Committee.

  • S. 743, 113th Cong. (2013), available at (hereinafter Marketplace Fairness Act). This bill was originally introduced on February 14, 2013 as S. 226. H.R. 684, a corresponding bill, was introduced in the House on that date.
  • Id.
  • McLeod v. J.E. Dilworth Co., 322 US 327, 330 (1944).
  • U.S. Const. amend. XIV, § 1.
  • Under the Fourteenth Amendment of the Constitution, no state shall “deprive any person of life, liberty, or property, without due process of law . . . .” Id. The “Dormant Commerce Clause” is an implied basis for judicial preemption of state laws that hinder interstate commerce to the extent that such regulations impair Congress’ ability to regulate commerce, a right expressly granted to Congress under the Commerce Clause of the Constitution. See U.S. Const. Art. I, sec. 8, cl. 3.
  • Nat’l Bellas Hess v. Dep’t of Revenue, 386 U.S. 753 (1967).
  • Id. at 756 (citing Central R. Co. v. Pennsylvania,370 U. S. 607, 370 U. S. 621-622 (concurring opinion)).
  • d. (quoting Miller Bros. Co. v. Maryland, 347 U. S. 340, 347 U. S. 313-45 (internal citations omitted)).
  • Nat’l Bellas Hess, 386 U.S. at 760.
  • Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).
  • Miss. Code Ann. § 27-65-13 (1972).
  • Spector Motor Serv., Inc. v. O’Connor, 340 U.S. 602 (1951).
  • Complete Auto Transit, Inc. v. Brady, 430 U.S. at 279.
  • Quill Corp. v. North Dakota, 504 U.S. 298, 310 (1992).
  • Id. at 303.
  • Id. at 307.
  • Id. (quoting International Shoe Co. v. Washington, 326 U.S. 310, 316 (1945)).
  • Quill Corp. v. North Dakota, 504 U.S. at 307.
  • Id. at 308.
  • Id.
  • Id. at 313.
  • Id. at 315. In a footnote, n. 8, the Court rejected North Dakota’s argument that by licensing software to some of its common carrier contacts within the State met the “substantial nexus” requirement of the Commerce Clause.
  • Id. at 311.
  • Id. at 318.
  • Marketplace Fairness Act, supra note 1, § 2(a).
  • Id. § 2(c).
  • See Streamlined Sales Tax Governing Bd., Inc., Streamlined Sales and Use Tax Agreement (May. 24, 2012), available at [hereinafter SSUTA].
  • As of October 1, 2012, there are twenty-two states that are full members of SSUTA and two associate member states, which are states that comply with the Streamlined Sales and Use Tax Agreement except that their laws, rules regulations and policies to bring the states into compliance are not in effect but are scheduled to take effect no later than 12 months after becoming an associate member.
  • Member States of SSUTA must follow the provisions of SSUTA, but only if the changes to SSUTA made after the Marketplace Fairness Act is enacted do not conflict with the Minimum Simplification Requirements. Marketplace Fairness Act, supra note 1, § 2(a).
  • Id. § 2(b)(2)(A)(i).
  • Id. § 2(b)(2)(A)(ii).
  • Id. § 2(b)(2)(A)(iii). Under the Marketplace Fairness Act, neither States nor local jurisdictions are authorized to require remote sellers to file its sales and use tax returns more frequently than local sellers. Id. § 2(b)(2)(A) (flush language).
  • Id. § 2(b)(2)(B).
  • Id. § 2(b)(2)(C). As clarified in the definition of “Sourced” set forth in Section 4(7), the State must comply with the sourcing rate that is based on the rate where the item sold is received by the purchaser, or, if the delivery location is not specified, to the address obtained by the seller during processing the sale, including the address of the purchaser’s payment instrument, e.g., the purchaser’s credit card, if no alternative address is available. This rate is the sum of the State rate and any applicable local rates. Member States must comply with the sourcing provisions of SSUTA. Marketplace Fairness Act, supra note 1, § 4(7).
  • Marketplace Fairness Act, supra note 1, § 2(b)(2)(D)(i).
  • Id.
  • Id. § 2(b)(2)(D)(i)(ii).
  • Id. § 2(b)(2)(D)(i)(iii). The software that such certified software providers provide must have the ability to calculate and file sales and use taxes in all States that qualify under the Marketplace Fairness Act. Id.
  • Id. § 2(b)(2)(E). Such liabilities include liabilities for remote sellers for incorrect collection, remittance or non-collection of sales or use taxes that results (a) from an error or omission made by a certified software providers and (b) incorrect information or software that the State provided, as well as liabilities for certified software providers for incorrect collection, remittance or non-collection of sales or use taxes that results from (x) misleading or inaccurate information provided by the remote seller and (y) incorrect information or software that the State provided. Id. §§ 2(b)(2)(E)-(G).
  • Id. § 2(b)(2)(H).
  • Id.
  • Id. § 2(a)
  • Id. § 2(b)(1).
  • Id. § 2(b)(1)(A).
  • Id. § 2(b)(1)(B).
  • Id. § 2(b)(2).
  • J.D. Harrison, After Easy Passage in the Senate, Online Sales Tax Bill Faces Much Tougher Road in the House, Wash. Post (May 8, 2013),
  • Jonathan Weisman, Internet Sales Tax Bill Gains Ground in the Senate, N.Y. Times (Apr. 22, 2013), h [hereinafter Weisman].
  • Matt Brownell, The Marketplace Fairness Act: Why Amazon Wants to be Taxed, Daily Finance (Mar. 25, 2013),
  • Id. See also Matthew Yglesias, Internet Sales Taxes Are Inevitable: Even Amazon Now Supports Taxes for E-Commerce, Slate (Apr. 23, 2013),
  • Weisman, note 50.
  • Cal. Code Regs. tit. 18, § 1502(f)(1)(D) (2012).
  • Id

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