On Oct. 13, 2021, a California federal court rejected an online merchant trade group’s motion for a preliminary injunction against the California Department of Tax & Fee Administration for pursuing back sales taxes from sellers with inventory located in Amazon fulfillment centers throughout the state.1 Similar to other federal courts ruling on the same issue, the Court determined that it lacked subject matter jurisdiction to hear the case under the Tax Injunction Act (TIA) because a remedy is available to the taxpayers in California state court.
The Online Merchants Guild is a group comprised of online merchants who engage in the sale of products primarily through the Fulfilled by Amazon (FBA) program. The program allows online retailers to sell their goods via Amazon’s online marketplace platform. Under the FBA arrangement, retailers convey their goods to Amazon for warehousing, but often retain title to their products as Amazon transports the goods between its distribution and/or fulfillment centers. This is done so that the products may be delivered to the customer more quickly once products are purchased from the seller.
In 2019, California adopted a sales tax collection and remittance requirement for marketplace facilitators.2 Prior to that time, California required retailers to collect sales tax from the consumer at the point of sale. In addition, the Department has recently begun an aggressive enforcement effort to require retailers to collect and remit sales tax on sales made prior to 2019, when in-state physical presence was still necessary to impose sales tax obligations, to the extent that they had inventory stored in a marketplace facilitator’s distribution or fulfillment center located in the state. The Department has taken the position that inventory located in California gave such retailers physical presence in the state, allowing the Department to assert nexus and a sales tax filing and collection obligation.
In September 2020, the Guild, which represents numerous FBA sellers targeted by the Department’s recent enforcement efforts, filed a lawsuit in the U.S. District Court for the Eastern District of California. The Guild argued that the Department had no basis to assert that remote sellers have California nexus due to inventory stored in Amazon fulfillment centers located in the state, often without the seller’s knowledge. The Guild alleged that the Department’s demand for uncollected sales tax violated the Due Process and Commerce Clauses of the U.S. Constitution, along with the federal Internet Tax Freedom Act (ITFA).3 Most recently, the Guild filed a motion for preliminary injunction, asking the Court to enjoin the Department from pursuing back sales taxes from Guild members.
In response, the Department argued that the Court lacked jurisdiction to hear the case under the TIA because the issue concerned the collection of state taxes. As such, the Department filed a motion to dismiss for failure to state a claim upon which relief can be granted.4
In a six-page order, the Court reviewed the standards for granting both a motion to dismiss and a motion for preliminary injunction. Next, the Court discussed the applicability of the federal TIA, which provides that “district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State.”5 As established under federal case law, the Court noted that the primary purpose of the TIA is to prevent federal courts from interfering with state tax assessment and collection, which is a power reserved for the states.6
Finding that the TIA applies to the present case, the Court determined that the Guild’s claims “are clearly barred here.” While not providing an in-depth analysis of the Guild’s arguments, the Court noted that the ITFA does not create an exemption to the TIA, citing federal case law.7 Finding that it lacked jurisdiction to hear the case, the Court granted the Department’s motion to dismiss with leave to amend. Finding no likelihood of success on the merits, the Court also denied the Guild’s motion for preliminary injunction for the same reasons that were provided for granting the Department’s motion to dismiss, but allowed the Guild up to 20 days to file an amended complaint.
California’s pursuit of out-of-state retailers selling products on Amazon’s online marketplace follows a recent trend by several states to assert inventory nexus for remote sellers participating in the FBA program prior to the enactment of marketplace facilitator laws in response to the U.S. Supreme Court’s decision in South Dakota v. Wayfair.8 Under the FBA program, smaller online sellers may not know where their inventory is stored or where their products are eventually sold, which may lead to sales tax assessments from states in which remote sellers have otherwise limited connections.
The Court’s decision is the latest in a pattern of federal court decisions that have rejected sales tax litigation brought by taxpayers in the instance where an alternative remedy is available at the state court level. Most recently, an Illinois federal court dismissed an Illinois online seller’s lawsuit against the Department for seizing the seller’s bank account in an effort to collect prior California sales taxes allegedly owed on the basis of inventory stored in Amazon warehouses located in California.9 Earlier this year, a Pennsylvania federal court rejected a similar challenge from the Guild to Pennsylvania’s nexus assertion on out-of-state businesses having in-state inventory through their participation in the FBA program.10 In response, the Guild re-filed the case in Pennsylvania Commonwealth Court. Unless the Guild filed an amended complaint in the present case by the Court-imposed 20-day deadline, the Guild’s only remaining option would be to file a separate lawsuit in California state court.
Online sellers have pursued lawsuits in federal court in an effort to avoid lengthy and potentially more costly litigation in different state courts that may reach different conclusions on inventory nexus. Additionally, litigants often believe that federal courts may be more sympathetic to arguments that small sellers should not be held liable for sales tax in states where their inventory is located pursuant to an FBA arrangement without their knowledge. However, the pattern of federal courts dismissing such cases is representative of the relatively high bar that exists for sales tax cases to proceed in federal court with the TIA as a barrier to taxpayer claims for relief. These cases raise the question of whether it is fair and equitable for small online sellers to pursue their claims in state court, where they often lack the resources to pursue such appeals and are often required to pay the assessed tax in advance before pursuing a refund claim.
1 Online Merchants Guild v. Maduros, U.S. District Court for the Eastern District of California, No. 2:20-cv-01952, Oct. 13, 2021.
2 CAL. REV. & TAX CODE §§ 6042, 6043.
3 The ITFA prevents states from imposing taxes on Internet access or taxes that discriminate against electronic commerce. 47 U.S.C. § 151.
4 In federal court, a motion to dismiss for failure to state a claim is a defense available under the Federal Rules of Civil Procedure. FED. R. CIV. P. 12(b)(6). While the defense does not resolve the underlying questions of law, the court must determine whether the plaintiff has stated a claim for relief that is “plausible on its face.” Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007).
5 28 U.S.C. § 341.
6 Jerron West, Inc. v. California State Board of Equalization, 129 F.3d 1334 (9th Cir. 1997).
7 Citing California v. Grace Brethren Church, 457 U.S. 393 (1982); Hyatt v. Yee, 871 F.3d 1067 (9th Cir. 2017).
8 138 S. Ct. 2080 (2018).
9 Rubinas v. Maduros, U.S. District Court for the Northern District of Illinois, Eastern Division, No. 1:21-CV-00096, Sept. 16, 2021. For a discussion of this case, see GT SALT Alert: Federal court passes on California sales tax suit.
10 Online Merchants Guild v. Hassell, U.S. District Court for the Middle District of Pennsylvania, No. 1:21-cv-00369, May 28, 2021.
Jamie C. Yesnowitz
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
Washington DC, Washington DC
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