In a decision released this morning, the Illinois Supreme Court upheld the Circuit Court of Cook County’s decision invalidating the Illinois click-through nexus statute in Performance Marketing Association v. Hamer.1 The Supreme Court surprised many observers by basing its decision on federal preemption grounds.
In 2011, the Illinois Legislature enacted IL Public Act 096-1544 (the "Act"). The object of the Act was to extend the obligation to collect Illinois use taxes on online sales. The Act expanded the definition of a retailer maintaining a place of business in Illinois to include remote sellers having contracts with in-state publishers whereby the publisher would refer, directly or indirectly, customers to the remote seller’s website in exchange for a sales commission or other consideration. This expanded definition of a retailer was limited to sellers with gross receipts of more than $10,000 a year from sales resulting from such referral. However, the Act did not include any requirement that the $10,000 of sales be made to Illinois residents to subject the out-of-state retailer or serviceman to Illinois use tax obligations, and it did not include any requirement that the computer server hosting the Illinois affiliate’s website be located in Illinois. In fact, unlike other recent click-through nexus laws, the Act created no presumption of nexus as a pretext for imposing the obligation to collect use taxes. As a consequence, the Act seemed to disregard the bright-line that the U.S. Supreme Court drew in Quill Corp. v. North Dakota.2
The Performance Marketing Association (the "PMA"), a national trade association whose members are in the performance marketing business, filed a lawsuit in the Circuit Court of Cook County challenging the law. Specifically, the PMA challenged the language of the Act that expanded the definition of a retailer.
The PMA contended that absent substantial nexus with Illinois – for example a business location or other indicia of physical presence – a law requiring a remote seller to collect and remit sales tax to Illinois would violate the Commerce Clause, citing Quill. Furthermore, the PMA alleged that the Act improperly burdened interstate commerce because it used the affiliate’s location in Illinois to establish the requirement to collect sales tax, and did not limit the obligation to retailers making sales to customers located in Illinois in excess of the $10,000 threshold. It also claimed the law violated the Internet Tax Freedom Act ("ITFA") provision prohibiting multiple or discriminatory taxes on electronic commerce.3 The Circuit Court of Cook County agreed with the PMA, finding the law violated the substantial nexus requirement of the Commerce Clause, and therefore was unenforceable and could not be construed in a way to preserve its validity. The Circuit Court also found that the ITFA preempted the Illinois law by virtue of the Supremacy Clause.
Upon direct appeal to the Illinois Supreme Court, the Supreme Court agreed that the Act is invalid and affirmed the decision of the Circuit Court.4 However, the Supreme Court did not reach the constitutional grounds upon which its jurisdiction rested.
The PMA argued that the relevant provisions of the Act were expressly preempted under the ITFA, as it prohibits a state from imposing discriminatory taxes on electronic commerce. Specifically, the ITFA defines a discriminatory tax as (A) any tax imposed by a State or political subdivision thereof on electronic commerce that . . . (iii) imposes an obligation to collect or pay tax on a different person or entity than in the case of transactions involving similar property, goods, services, or information accomplished through other means.5
The Department of Revenue argued that "offline" performance marketing is already subject to use tax collection obligation in Illinois. The court noted that Illinois law does not currently require out-of-state retailers who enter into performance marketing contracts for "offline" print or broadcast advertising that is disseminated nationally, or internationally, to collect Illinois use tax. Based on the differential treatment of "online" and "offline" advertising, the court found that the Act constituted a discriminatory tax on electronic commerce within the meaning of the ITFA, and was therefore preempted.
The court disagreed with Department’s argument that the performance marketing service provided by the affiliates was not advertising, and should be categorized as an active effort to solicit sales. The parties’ joint stipulation of facts states that the affiliates did not receive or transmit customer orders, process customer payments, deliver purchased products, or provide pre-sale or post-sale customer services. Further, the parties stipulated that an affiliate displaying a link to an Internet retailer on its website does not know the identity of the user clicking on the link and, after connecting the user to the retailer’s website, has no further interaction with the user. Based on these stipulations, the court treated the performance marketing services as advertising.
It is of note that the Illinois Supreme Court did not address the Commerce Clause issue, and instead, based its decision solely on the ITFA preemption issue.
Justice Karmeier dissented, stating that the Act did not impose any new taxes or increase any existing taxes. Prior to the enactment of the Act, retailers and servicemen who used the Internet to make retail sales were required to collect and remit use tax if there was a physical location or agent or other representative operating within the state. When the onus is on the purchaser to remit use tax, Justice Karmeier stated that the sales were underreported. Furthermore, consumers turn to out-of-state Internet retailers to avoid tax liability, resulting in Illinois business being placed as a competitive disadvantage.
Justice Karmeier disagreed that the Act was rendered wholly inoperable by the federal preemption of the ITFA, stating that the ITFA did not assert general federal authority over matters of state and local taxation. The ITFA requires only that Internet transactions not be treated less favorably than would be the case with non-Internet-based transactions. Justice Karmeier stated that if an Internet marketing scheme has no true offline counterpart, it is difficult to see how requiring the retailer to remit would be deemed discriminatory. The "mere fact that it is technically possible to view an internet ad from anywhere does not make the ad ‘inherently national or international in scope and disseminated to a national or international audience.'" When an out-of-state retailer avails itself of Illinois print or broadcast media to target Illinois consumers, it is required to collect and remit use tax, so it is likewise fair to require an out-of-state retailer using Illinois Internet services to target Illinois consumers in the same way, to collect and remit use tax.
For more information on the Performance Marketing decision and its potential impact in Illinois and other states with similar "click-through" nexus laws, contact the authors of this Alert or another member of the Reed Smith State Tax Group. For more information on Reed Smith’s Illinois tax practice, visit www.reedsmith.com/iltax.
- Performance Marketing Association, Inc. v. Hamer, Supreme Ct. of Illinois Docket No. 114496 (October 18, 2013).
- 504 U.S. 298 (1992).
- 47 U.S. §151 note (Internet Tax Freedom Act) §1101(a)(2).
- Direct appeal to the Illinois Supreme Court was available because the decision of the Circuit Court declared a state statute unconstitutional.
- Internet Tax Freedom Act § 1105(2)(A)(iii).
Client Alert 2013-278