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State v. Wayfair Inc.

United States District Court, D. South Dakota, Central Division

January 17, 2017




         The State of South Dakota sued Defendants Wayfair, Inc.,, Inc., and Newegg, Inc.[1] in state circuit court to enforce a new state law requiring the remittance of sales tax on internet sales to South Dakotans by sellers lacking a physical presence within South Dakota. Doc. 1-1. Defendants removed the action to this federal district court alleging federal question jurisdiction. Doc. 1. Plaintiffs filed a Motion to Remand to State Court, Doc. 21, and on the same day, Defendants filed a Motion for Summary Judgment, Doc. 25. Because there is no federal jurisdiction over this state taxation case based on Franchise Tax Board of California v. Construction Laborers Vacation Trust for Southern California, 463 U.S. 1 (1983), this Court remands the case to state court.

         I. Background

         The Supreme Court in Quill Corp. v. North Dakota. 504 U.S. 298 (1992) reaffirmed the prohibition on states levying a sales and use tax on sales by businesses that lack a physical presence within the state. Echoing its prior decision in National Bellas Hess. Inc. v. Department of Revenue of Illinois. 386 U.S. 753 (1967), the Court in Quill held that while a physical presence was not required under the Due Process Clause when seeking to impose a duty to collect a state use tax, a physical presence was required to avoid a violation of the "negative" or "dormant" Commerce Clause's substantial nexus requirements. Quill. 504 U.S. at 312. Based on stare decisis, Quill, though decided well before the internet-sales boom, acknowledged the fading distinctions between direct and indirect taxes perpetuated by formalism and drafting. Quill, 504 U.S. at 311 ("[C]ontemporary Commerce Clause jurisprudence might not dictate the same result were the issue to arise for the first time today."). Recently, in Direct Marketing Ass'n v. Brohl, 135 S.Ct. 1124 (2015), the Supreme Court decided a case touching on Bellas Hess. Quill, and the dispute at issue here. Acknowledging the precedent of Quill, the state of Colorado passed a law requiring consumers themselves to fill out a return and remit taxes to the state on items purchased online from sellers who do not collect state sales and use taxes; retailers were responsible for notifying consumers of the self-reporting and taxation requirements. Brohl, 135 S.Ct. at 1127-28. In discussing the Colorado tax law, the majority acknowledged the internet's impact on state revenues, but as it was not within the gambit of the question presented, did not discuss the idea that Quill was wrongly decided or outdated. Id. Justice Kennedy's concurrence, however, focused on the need to reevaluate Quill in light of "changes in technology and consumer sophistication." Id. at 1135 (Kennedy, J., concurring). Justice Kennedy wrote that "[t]he legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess." Id.

         Justice Kennedy's concurrence in Brohl spurred quick action from the State of South Dakota. During the 2016 Legislative Session, the South Dakota Legislature passed Senate Bill 106, "An Act to provide for the collection of sales taxes from certain remote sellers." S.B. 106, 2016 Leg., 91st Sess. (S.D. 2016). This bill requires that certain out-of-state sellers comply with South Dakota's sales tax laws "as if the seller had a physical presence in the state." S.B. 106 § 1. The law excludes sellers that did not exceed $100, 000 in gross revenue from sales within South . Dakota, or did not have more than two hundred separate transactions within the state in the prior calendar year or year to date. S.B. 106 § 1(1)-(2). The law directs the State to bring a declaratory judgment action to establish that the requirement that out-of-state sellers remit sales tax to the State is valid under state and federal law. S.B. 106 § 2. The filing of such a declaratory judgment action operates as an injunction from enforcing the remittance of sales tax under Section 1 of the Act. S.B. § 3. The Legislature included in S.B. 106 eleven specific legislative findings, targeting without name Quill, which prohibits the tax plan established in the Act. S.B. 106 § 8. These findings outline the loss of revenue South Dakota experiences from online-only sales that are not subject to state taxes, the ease with which retailers could adapt to the new taxation scheme, and Justice Kennedy's call in his concurrence to Brohl that the Quill doctrine should be reconsidered, S.B. 106 § 8 (1), (6), (7). Governor Dennis Daugaard signed S.B. 106 into law on March 22, 2016, making it effective on May 1, 2016. See S.B. 106 § 9.

         The South Dakota Department of Revenue sent individualized notices to 206 sellers it identified as meeting the statutory requirements of S.B. 106 on or about March 25, 2016. Doc. 1-1 at 16, The notice required the sellers to register for a license to collect and remit state sales tax by April 25, 2016. Doc. 1-1 at 16-17; see also Doc. 1-1 at 33-37. On April 28, 2016, [2] the State initiated a state court suit against four non-registered companies, Wayfair, Inc., Systemax, Inc.,, Inc., and Newegg, Inc., under the Act's provisions. Doc. 1-1. In its complaint, the State "recognizes that a change in federal constitutional doctrine will be necessary for the State to prevail in this case." Doc. 1-1 at 23. The State's complaint includes numerous references to Bellas Hess and Quill, and many of the Legislature's findings. Doc. 1-1 at 6-7, 18. The prayer for relief requests that "the Court declare that the requirements of section 1 of the Act are valid" and that "the Court enter an injunction requiring the defendants to register for a license to collect and remit the sales tax." Doc. 1-1 at 23-24. Upon receiving the State's complaint, Systemax, Inc. voluntarily agreed to register with the Department of Revenue to remit taxes under the Act, and was then dismissed from the lawsuit. See Doc. 1 at 2.

         Wayfair, Inc.,, Inc., and Newegg, Inc. filed a notice of removal in the District of South Dakota, Central Division. Doc. 1. The notice of removal alleges a question of federal law to support jurisdiction under 28 U.S.C. § 1331 by pointing to the State's declaratory judgment action seeking S.B, 106's constitutional validity, and the State's acknowledgement that a change in "federal constitutional doctrine" is required before the State can prevail. Doc. 1 at 3. The State filed a Motion to Remand to State Court, Doc. 21, and on the same day the Defendants filed a Motion for Summary Judgment, Doc. 25. The State concedes in its briefing that the Defendants' Motion for Summary Judgement should be granted, but by the state court after remand. Doc. 27 at 16. The Defendants oppose the State's Motion to Remand. Doc. 26. This Court held a hearing on the pending motions on December 8, 2016. Doc. 36.

         II. Federal Question Jurisdiction

         Subject matter jurisdiction, including upon removal, is an issue that can be raised at any time, either on motion of the parties or by the court itself, and cannot be forfeited or waived. 28 U.S.C. § 1447(c); United States v. Cotton, 535 U.S. 625, 630 (2002); Ruhrgas AG v, Marathon Oil Co.. 526 U.S. 574, 583 (1999). A case may only be removed to federal court where the federal court would have had original jurisdiction. 28 U.S.C. § 1441(a); Caterpillar Inc. v. Williams. 482 U.S. 386, 392 (1987) (identifying diversity of citizenship or federal question jurisdiction as two ways to file in federal court). The defendant removing the case from state to federal court bears the burden of proving that the removal was proper, and federal subject matter jurisdiction exists. In re Business Men's Assurance Co. of Am.. 992 F.2d 181, 183 (8th Cir. 1993) (per curiam). "A defendant generally is required to cite the proper statutory basis for removal and to allege facts from which a district court may determine whether removal jurisdiction exists." Pet Quarters, Inc. v. Depository Tr. & Clearing Corp.. 559 F.3d 772, 778 (8th Cir. 2009). However, federal courts have a "virtually unflagging" obligation to hear and decide cases within federal jurisdiction. Colo. River Water Conserv. Dist. v. United States, 424 U.S. 800, 817 f 19761: see also Sprint Commc'ns. Inc. v. Jacobs. 134 S.Ct. 584, 590-91 (2013).

         Under federal question jurisdiction, "[t]he district courts shall have original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States." 28 U.S.C. § 1331. A majority of cases brought under federal question jurisdiction involve a cause of action that is created by federal law. See Am. Well Works Co. v. Lavne & Bowler Co., 241 U.S. 257, 260 (1916) (establishing Justice Holmes' early conception of federal question jurisdiction). These cases easily satisfy the "well-pleaded complaint" rule, which requires that the federal question appear on the face of the plaintiffs complaint, rather than in an anticipated defense. See Louisville & Nashville R.R. Co.. v. Mottley, 211 U.S. 149, 152 (1908); Taylor v. Anderson, 234 U.S. 74, 75-76 (1914); Gullv v. First Nat'l Bank. 299 U.S. 109, 116 (1936); Williams v. Ragnone, 147 F.3d 700, 702 (8th Cir. 1998) ("Federal question jurisdiction exists if the 'well-pleaded complaint establishes either that federal law creates the cause of action or that the plaintiffs right to relief necessarily depends on resolution of a substantial question of federal law.'" (quoting Franchise Tax Bd.. 463 U.S. at 27-28))

         However, this case involves a "litigation-provoking problem, " Textile Workers Union v. Lincoln Mills of Ala.. 353 U.S. 448, 470 (Frankfurter, J. dissenting), where "the presence of a federal issue [is] in a state-created cause of action, " Merrell Dow Pharm. Inc. v. Thompson, 478 U.S. 804, 808 (1986). As the State itself has admitted, in order to succeed on the substance of its complaint and with enforcement of S.B. 106, the Supreme Court must overrule itself on an issue of constitutional interpretation. See Doc. 1-1 at 23. This complicates federal question jurisdiction, and illuminates how "the phrase 'arising under' masks a welter of issues regarding the interrelation of federal and state authority and the proper management of the federal judicial system." Franchise Tax Bd.. 463 U.S. at 8. The Supreme Court has recognized the "awkward results" produced by these cases, "in which neither the obligation created by state law nor the defendant's factual failure to comply are in dispute, and both parties admit that the only question for decision is raised by a federal pre-emption defense." Id. at 12. Beginning with Smith v. Kansas City Title & Trust Co.. 225 U.S. 180, 199-201 (1921), the Supreme Court's jurisprudence in defining the outer limits of federal question jurisdiction has repeatedly emphasized the "accommodation of judgment" needed to determine jurisdiction, and eschewed bright line rules. See Gully. 299 U.S. at 117; Franchise Tax Bd.. 463 U.S. at 8-9; Merrell Dow. 478 U.S. at.815; Grable & Sons Metal Prods.. Inc. v. Darue Eng'g & Mfg.. 545 U.S. 308, 314 (2005): see also Gunn v. Minton. 133 S.Ct. 1059, 1065 (2013) ("In outlining the contours of this slim category, we do not paint on a blank canvas. Unfortunately, the canvas looks like one that Jackson Pollock got to first."); but see Grable. 545 U.S. at 320-22 (Thomas, J., concurring) (suggesting the trouble of using a complex approach, rather than the straightforward rule advanced by Justice Holmes in American Well Works, 241 U.S. at 260, that federal question jurisdiction should be limited to cases where federal law creates the cause of action, may outweigh any benefits of the nuanced approach)

         The State seeks a remand to state court, arguing that federal question jurisdiction is improper in this case both because the well-pleaded complaint rule is not satisfied and because the Supreme Court's holding in Franchise Tax Board is controlling. See Docs. 21, 22, 30. The Defendants oppose the motion for remand, arguing that the unique circumstances of this suit-in which the only disputed issue involves federal law, the success of the State's complaint depends on an abrogation of federal law, and the Supreme Court's decision after Franchise Tax Board in Grable specifies a different test for federal jurisdiction-support federal question jurisdiction. See Doc. 26. The parties' arguments about federal question jurisdiction in this case also implicate the Tax Injunction Act, 28 U.S.C. § 1341; the Eleventh Amendment; and comity concerns surrounding a suit involving a state law specifically designed to be challenged and result in an overruling of clear Supreme Court precedent.

         Franchise Tax Board is the case most closely analogous to this one. In Franchise Tax Board, the Supreme Court addressed a case raising the issue whether the Employee Retirement Income Security Act of 1974 (ERISA) "permits state tax authorities to collect unpaid state income taxes by levying on funds held in trust for the taxpayers under an ERISA-covered vacation benefit plan." 463 U.S.. at 3-4. However, the particular question addressed in Franchise Tax Board was whether the district court properly had federal question jurisdiction over the complaint, which consisted of one claim under the California tax code, and another claim under the California Declaratory Judgment Act. Id. at 13. In Franchise Tax Board, the trustees of the targeted ERISA-covered vacation benefit plan argued that the extensive regulations covering ERISA were intended to preempt state tax laws, and they "lack[ed] the power to honor the levies made upon them by the State of California." Id. at 6. The Supreme Court swiftly rejected federal jurisdiction over the California tax code claim, because "California law establishes a set of conditions, without reference to federal law, under which a tax levy may be enforced, " and "federal law becomes relevant only by way of a defense to an obligation created entirely by state law, " the precise situation for which the well-pleaded complaint rule was created. Id. at 13-14. The Supreme Court affirmed that the well-pleaded complaint rule still applied, "even if the [federal] defense is anticipated in the plaintiffs complaint, and even if both parties admit that the defense is the only question truly at issue in the case." Id. at 14.

         The Supreme Court took more time in analyzing possible federal jurisdiction on the remaining claim under California's Declaratory Judgment Act, because the federal preemption question was a "necessary element" of the cause of action. Id at 14. The Act required an "actual controversy relating to the legal rights and duties" of the parties, and the "only questions in dispute" involved ERISA interpretation. Id. at 14. The Supreme Court drew from Skelly Oil Co. v. Phillips Petroleum Co.. 339 U.S. 667 (1950), where it interpreted the federal Declaratory Judgment Act, 28 U.S.C. § 2201, to mean that "if, but for the availability of the declaratory judgment procedure, the federal claim would arise only as a defense to a state created action, jurisdiction is lacking." Franchise Tax Bd., 463 U.S. at 16 (quotation omitted). The Supreme Court then considered whether to apply the same principle to state-created declaratory judgment acts. Id. at 15-19, In an effort to avoid making the rule of Skelly Oil "a dead letter, " the Supreme Court held that "federal courts do not have original jurisdiction, nor do they acquire jurisdiction on removal, when a federal question is presented by a complaint for a state declaratory judgment, but Skellv Oil would bar jurisdiction if the plaintiff had sought a federal declaratory judgment." Id at 18-19. The Supreme Court observed that "[t]here are good reasons why the federal courts should not entertain suits by the States to declare the validity of their regulations despite possibly conflicting federal law." Id at 21. The Supreme Court ultimately summarized its holding:

Under our interpretations, Congress has given the lower federal courts jurisdiction to hear, originally or by removal from a state court, only those cases in which a well-pleaded complaint establishes either that federal law creates the cause of action or that the plaintiffs right to relief necessarily depends on resolution of a substantial question of federal law. We hold that a suit by state tax authorities both to enforce its levies against funds held in trust pursuant to an ERISA-covered employee benefit plan, and to declare the validity of the levies notwithstanding ERISA, is ...

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