Retailers Caught in the Middle: To Tax or Not to Tax Delivery Fees
Over the past decade we have seen a large increase in the number of third party tax enforcement claims against retailers involving transaction taxes (see Multistate Tax Commission Memorandum regarding survey of class action refund claims and false action claims, dated July 12, 2013, describing such actions). The lawsuits typically are brought either as proposed class actions, alleging an over-collection of tax, or as whistleblower claims on behalf of state governments, alleging a fraudulent under-collection of tax owed to the state or municipality. With respect to certain issues, including shipping and handling charges, retailers have been whipsawed with lawsuits alleging both under- and over-collection of tax.
On April 3, a proposed class action lawsuit was filed in Florida alleging that Papa John’s Pizza was improperly collecting tax on its delivery fees (Schojan v. Papa John’s International, Inc., No. 14-CA-003491 (Circuit Court Hillsboro County, Florida)). The lawsuit is similar to an action filed in Illinois that resulted in an Illinois Supreme Court ruling rejecting a proposed class action claim that a retailer was improperly collecting tax on its shipping charges (Kean v. Wal-Mart Stores, Inc., 919 N.E.2d 926 (Illinois 2009)).
Both Florida and Illinois impose sales tax on services that are inseparably linked to the sale of tangible personal property (see, e.g., 86 Ill. Admin. Code § 130.415(b) & Fla. Admin. Code Ann. r. 12A-1.045(2)). The regulations provide that whether a customer has separately contracted for shipping charges, or has an option to avoid shipping charges by picking up the property at the retailer’s location, can be used as a proxy to determine whether the services are separate and thus not taxable (86 Ill. Admin. Code § 130.415(d); Fla. Admin. Code Ann. r. 12A-1.045(4)(a), (b)).
In Kean, the Illinois Supreme Court held that shipping charges were a taxable part of an internet sale in which the customer had no option but to pay shipping charges. After the ruling, the Illinois Department of Revenue made no announced change to its commonly understood audit position that sales tax was not owed on separately stated shipping charges that were assessed at a retailer’s actual cost.
Seeking to capitalize on the Kean ruling, an Illinois law firm has filed upwards of 150 lawsuits under the Illinois False Claims Act against retailers that do not collect tax on the shipping and handling charges associated with their internet sales, alleging an intentional failure to collect tax and seeking treble damages, attorneys’ fees and associated penalties. The suits were filed without regard to whether the retailers had been audited and found not to owe tax on their shipping and handling charges. The State has declined to intervene in the majority of these cases, permitting the Relator to proceed with the prosecution. Because the amounts at issue are small (6.25 percent tax on shipping and handling charges), the lawsuits force many retailers to choose between paying an (entirely undeserved) settlement to resolve the litigation or bearing the expense of litigation. For reasons not entirely clear, the Illinois General Assembly has failed to act on a corrective bill that would make such lawsuits more difficult to be filed.
Fortunately, other states have not been as reticent to take action to prevent the type of abusive litigation that retailers have experienced in Illinois. Tennessee has amended its false claims act to prevent its use in tax litigation, and in Nevada, the state attorney general intervened and successfully moved to dismiss similar litigation. Most recently, in Loeffler v. Target Corp. ( No. S173972 (Cal. May 1, 2014)), the California Supreme Court held that consumers were precluded from bringing actions based on consumer fraud statutes, where consumers sought refunds of sales tax reimbursement previously paid and an injunction against future collections. The court reasoned, in part, that the state tax code provides the exclusive means by which to dispute the taxability of a retail sale, stating that “it would be inconsistent with this scheme to permit the consumer to initiate a consumer action such as plaintiffs’ requiring a court to resolve, outside the searching regulatory scheme established by the tax code, whether a sale was taxable or exempt. …”.
In addition, the Multistate Tax Commission and the American Bar Association are each working to resolve the issues faced by retailers with respect to third party enforcement tax administration. The ABA has adopted model legislation that would limit the rights of purchasers to bring over-collection of tax claims against retailers. The Commission has formed a joint state/industry work group to examine the issues involved in tax-related third party class action suits and false claims act suits. Hopefully these efforts will provide retailers with additional weapons to defend against third party tax claims.