La Mirada’s Ortho Mattress Inc. is suing California’s tax collector along with an out-of-state competitor over what Ortho says is a failure to collect the state use tax stemming from online sales, according to court documents.
This isn’t the first time a brick-and-mortar business has sued an e-commerce operation over alleged unfair taxation practice, but this case is unusual because Ortho named the California State Board of Equalization as a nominal defendant alongside Brighton, Mich.-based Mattress USA Inc.
Ortho claims that the state agency failed to enforce the collection of use tax from Mattress USA, according to the lawsuit filed June 21 in Los Angeles Superior Court. Ortho, a privately held manufacturer and retailer of bedding products with more than 65 locations throughout Southern California, generated $70 million in revenue last year, according to the company.
The legal action raises the question of whether states can enforce tax collection on out-of-state companies, an issue that might not be settled in state court, but could find its way into federal court, said Kirk Stark, a professor of tax law and policy at UCLA.
It’s likely an uphill battle, however, he said.
“The legal question here is whether California can impose a use tax collection obligation on out-of-state vendors,” Stark said. “On the federal level, retailers only collect use tax online if the out-of-state company has a physical presence in that state, for example, a warehouse or sales office.”
The U.S. Supreme Court ruled in 1992 that companies that don’t have a physical presence in the state where a sale occurs don’t have to pay that state’s use taxes, which are levied in lieu of the in-state sales taxes. However, times have changed, Stark noted, with the advent of e-commerce, which the Supreme Court ruling didn’t address, and states implementing new measures to collect taxes from online sales.
Ortho contends in its lawsuit that US-Mattress, the online presence of Mattress USA, should have to pay California’s use tax because it has a local presence through its dealings with vendors and installers in the state. Avoiding those payments gives Mattress USA an unfair advantage selling its products at a cheaper price to California customers.
Ortho executives declined to comment last week.
Erik Andersen, an attorney at Irvine law firm Payne & Fears, which is representing Mattress USA, said the lawsuit isn’t valid because his client doesn’t have a California presence and that the case is outside the state’s jurisdiction.
“We have moved to dismiss the case in federal court because private parties can’t sue to enforce tax laws,” he said. “Our client is based out of Michigan and has no operations in California.”
The U.S. Supreme Court also said in its ruling that states cannot impose sales or use tax obligations on out-of-state corporations whose only contact with the state is fulfillment of orders through common carriers. Andersen said that Mattress USA uses common carriers such as UPS and FedEx for fulfillment.
The legal waters were muddied, however, when California enacted the Amazon Law in 2012 requiring large online retailers such as Amazon.com Inc., even those with no physical presence in the state, to collect and pay California’s use tax if they meet certain sales criteria.
The law mandated that such out-of-state retailers engaged in business here are required to register with the agency, collect the use tax from California customers and pay the tax to the Board of Equalization, which in July was disbanded and split into three governmental entities.
When they don’t, California law puts the onus on customers instead, Stark said. It isn’t clear whether Mattress USA would be subjected to the Amazon Law.
“For these types of purchases, the buyer is required to pay tax separately, and this can be done by self-reporting online purchases on your tax return or it can be collected by an online retailer,” Stark said.
But that policy isn’t realistic, he said.
“No one reports what they bought online on their state tax returns,” Stark said.