[7] While agreeing that in fact he had not paid the stamp duty, D'Emden argued that at law he was not obliged to pay the state tax, and made the same basic argument in an appeal to the Supreme Court of Tasmania.

To this, Drake responded that the inconsistency provision in section 109,[5] should be regarded as applying not only to federal statutes but to the Constitution itself, including to implied powers under it.

Drake then dealt with a number of decisions of American and Canadian courts in which McCulloch v. Maryland,[2] had been distinguished or held not to apply, and argued that they all involved questions distinct from the one in this case.

[8] With respect to the second argument, regarding inconsistency, Chief Justice Griffith questioned whether the federal legislation setting D'Emden's salary was not simply intended to have effect "with reference to the local conditions prevailing in the particular State, such as local taxation, house-rent, prices of food and clothing" and so on, to which Drake replied that the stamp duty legislation was in conflict with the federal legislation because the effect was to diminish D'Emden's salary before he received it, unlike the examples Griffith CJ mentioned of things which would affect it after he received it.

Nicholls conceded that it was a necessary consequence of a federal system of government that there were limits on the powers of the state and federal governments with respect to each other, and that the states "have no power by taxation or otherwise to retard or burden or in any other manner control the operation of the constitutional laws of the Commonwealth Parliament", but argued that such a doctrine should not be taken without limitation, and that the degree of interference should be considered.

Nicholls also conceded that if the stamp duty was levied only on agents of the federal government then it would be unconstitutional, but stressed that it was a general tax applying to all persons in Tasmania.

[7] The court expressed the principle in this way: "In considering the respective powers of the Commonwealth and of the States it is essential to bear in mind that each is, within the ambit of its authority, a sovereign State, subject only to the restrictions imposed by the Imperial connection and to the provisions of the Constitution, either expressed or necessarily implied... a right of sovereignty subject to extrinsic control is a contradiction in terms.

"[13] The court then quoted extensively and with approval from the judgment of Chief Justice John Marshall in McCulloch v Maryland,[2] specifically from a passage discussing the ideological basis of taxation, the relationship between the various American states and the Union, and the implications of the Supremacy Clause.

[7] The court rejected another argument raised by the majority of the Supreme Court: that it is necessary in every case to consider whether the attempted exercise of power by a state actually inhibited or interfered with the workings of the federal government, instead deciding that any claimed power which has the potential for such interference will be invalid, and consideration of whether there was actual interference would be irrelevant.

[7] The High Court proceeded to apply the implied immunity of instrumentalities doctrine in a range of cases, many of which also involved taxation and were similarly controversial.

[6] The Privy Council declined special leave to appeal from the decision in Baxter v Commissioners of Taxation (NSW) as the result of Commonwealth law was that the controversy could not arise again.

[6] H. B. Higgins, an opponent of the implied immunities doctrine who would be appointed to the High Court himself in 1906, wrote in response to the decisions in this and several other cases that "The man in the street is startled and puzzled.