On Jan. 26, a federal judge in Denver granted a preliminary injunction to prevent Colorado from enforcing an information-reporting law that requires e-tailers to report sales made to Colorado residents.
This preliminary injunction is a first step toward a formal decision by the trial court that would strike down this law as unconstitutional. However, e-tailers cannot start celebrating yet, because such a decision could be reversed on appeal.
The law, passed in 2010, requires e-tailers that do not collect Colorado sales and use tax tocomply with three separate requirements: 1) notify Colorado customers that the customer is required to pay use tax on the purchase; 2) send an annual statement to each Colorado customer, summarizing the customer’s total annual purchases from the e-tailer; and 3) file an annual information report with the Colorado Department of Revenue showing the total amount of sales made to each customer in Colorado.
Discrimination Claim May Prevail
The purpose for requiring the information report is to enable the Department of Revenue to collect the tax from the consumer. Even though the 2010 Colorado law does not require the e-tailer to collect sales tax, the customer is still required to pay “use tax” at the same rate as the sales tax. An e-tailer’s failure to comply with these information-reporting obligations is subject to substantial penalties, which in many cases would exceed the amount of tax that would be due.
Not long after this law was passed, the Direct Marketing Association brought an action in federal court in Denver to strike it down as unconstitutional, on the grounds that the law discriminates against interstate commerce. On Jan. 26, 2011, the federal court granted a preliminary injunction temporarily halting enforcement of the new reporting requirements.
The court found that the Direct Marketing Association is likely to prevail on its discrimination claim, because in-state retailers (who are required to collect sales tax) are not subject to the new Colorado reporting obligations. It also found that the Direct Marketing Association was likely to prevail in its alternative claim that Colorado’s 2010 law creates an undue burden on out-of-state e-tailers in violation of the commerce clause.
Prepare for the Worst
This is only the first step toward the ultimate outcome, since the judge must now hear the full case. However, a federal judge will only grant a preliminary injunction when the plaintiff (the Direct Marketing Association) has a substantial likelihood of prevailing in its challenge, so there is a good chance that the preliminary injunction will become permanent.
However, Colorado is almost certain to appeal the trial court’s decision to the Tenth Circuit Court of Appeals. Furthermore, the Colorado legislature might repeal this law, making this lawsuit irrelevant.
In the meantime, it might still be a good idea for e-tailers to continue to collect the datanecessary to generate the required information reports, in the event the Court of Appeals reversesthe trial judge’s ruling, which would reinstitute these reporting requirements.
Marvin Kirsner is a shareholder in the international law firmGreenberg Traurig. He can be reached at [email protected].