As the nature of services moves from physical to digital, there's likely to be more litigation over whether digital services are subject to sales and use tax, according to panelists.

During an October 24 panel at the Paul J. Hartman State and Local Tax Forum in Nashville, Tennessee, speakers discussed the top developments in state and local sales taxation, including recent litigation over state taxation of out-of-state entities through nexus and the possible unequal application of taxes on digital goods and services in violation of the Internet Tax Freedom Act.

Nexus

On recent developments regarding litigation concerning nexus, the panel focused on U.S. Auto Parts Network Inc. v. Commissioner and Quad Graphics Inc. v. North Carolina Department of Revenue.

In U.S. Auto Parts, the Massachusetts Supreme Court found that cookies and other electrons do not constitute a sufficient physical presence to create a taxable nexus, and that South Dakota v. Wayfair Inc. cannot be retroactively applied. Panelist Stephen Kranz of McDermott Will & Emery said U.S. Auto Parts will become more important as more local taxing jurisdictions follow states in taxing taxpayers through nexus.

In Quad Graphics, the North Carolina Supreme Court reversed a trial court's ruling that the state’s imposition of sales tax on transactions involving goods shipped from a Wisconsin printer to North Carolina customers is unconstitutional because the sales lacked sufficient nexus with the state. The decision implicitly overruled the U.S. Supreme Court’s 1944 holding in McLeod v. J.E. Dilworth Co. by finding that sales tax applied to an out-of-state sale. The forum panel noted that many observers found the Quad Graphics decision to be in violation of Rodriguez de Quijas v. Shearson/American Express, in which the U.S. Supreme Court held that only the Court can overrule its own precedents.

The taxpayer in Quad Graphics filed a cert petition asking the Court to rule on whether the state supreme court "was correct that state courts and taxing authorities no longer must follow Dilworth because this Court has implicitly overruled it," and whether the Supreme Court "should overrule or retain the holding of Dilworth that a state may not tax sales that occur outside its borders."

The Court denied the cert petition on June 20.

John Fletcher of Jones Walker LLP said he's disappointed that the Court did not take up Quad Graphics to weigh in on whether a state court can implicitly overrule Supreme Court precedent. He said an answer to this question might lie in Mallory v. Norfolk Southern Railway Co., in which the Court held in June that “if a precedent of this Court has direct application in a case,” a lower court “should follow the case which directly controls, leaving to [the Court] the prerogative of overruling its own decisions.”'

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