SOUTH DAKOTA V. WAYFAIR, INC. ET AL.

from the Tax Foundation

Ms. Sally Schreiber at The Journal ofAccountancy has commented regarding yesterday’s Supreme Court decision in South Dakota v. Wayfair, Inc., et al. Her article is below.

Mr. Joe Bishop-Henchman, Esq. has an article at the Tax Foundation in which he discusses the impact of the Court’s decision. I’ve pasted his commentary below Ms. Scrieber’s. The cool graphic is his, and if you go to the Tax Foundation’s page, their version is interactive.

Editorial thoughts:

My comments relate to compliance. Sales tax is levied by 45 states, the District of Columbia, Puerto Rico, and Guam. Each of these entities has separate rules and criterion for taxation, separate rules for remitting of tax, and separate reporting requirements. Many states have local county, borough, or city taxes in addition to the general sales tax.

Now that states have been green-lighted with the removal of the physical presence test, nexus will be determined through a variety of competing theories as to what constitutes contact sufficient to trigger registration as a taxpayer in these different venues. The Supreme Court somewhat airily dismisses these concerns with a nod toward the sophistication of modern software packages to assist in the massive tax compliance burden on-line retailers will be faced with. It remains to be seen how many states will interpret the spirit of  Justice Kennedy's opinion quoted by Mr. Bishop-Henchman such that a workable solution can be found for on-line retailers.

 

This would be an appropriate time for the Legislative Branch to pass a law harmonizing the disparate reporting requirements of each state such that on-line retailers truly compete on a level playing field while still allowing the state to tax transactions without regard to originating source.

Supreme Court overturns Quill’s physical presence requirement

By Sally P. Schreiber, J.D. 

June 21, 2018

The U.S. Supreme Court on Thursday held that states can assert nexus for sales and use tax purposes without requiring a seller’s physical presence in the state. The decision in South Dakota v. Wayfair, Inc., et al, No. 17-494 (U.S. 6/21/2018), overturns prior Supreme Court precedent in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967), both of which had required retailers to have a physical presence in a state beyond merely shipping goods into a state after an order from an in-state resident before a state could require the seller to collect sales taxes from in-state customers. The Court concluded that each decision was an “incorrect interpretation of the Commerce Clause” (slip op. at 10).

Background

South Dakota, like many other states, imposes a sales tax on the sale of goods in the state and a complementary use tax. Because compliance with the use tax on untaxed purchases from out-of-state vendors is low, South Dakota estimates it loses between $48 million to $58 million a year in sales-and-use-tax revenue from sales to state residents by out-of-state businesses that do not collect sales tax for the state. Because it has no income tax, its sales tax revenue makes up about 60% of the state’s funds each year, so the loss of those funds is substantial (slip op. at 2–3).

To try to counteract the loss of this revenue, in 2016, South Dakota enacted a law, S.B. 106, requiring out-of-state sellers that annually delivered more than $100,000 of goods or services into the state or engaged in 200 or more separate transactions for the delivery of goods or services into the state to collect and remit sales taxes to South Dakota (slip op. at 3). South Dakota’s new law prohibited retroactive application of this requirement and also provided that the law could be stayed until it had been determined to be constitutional.

Because South Dakota’s Legislature was aware that its new law would be unconstitutional unless Quill was overturned, it included a provision for expeditious judicial review if the law was challenged. Therefore, South Dakota filed a declaratory judgment action in state court against Wayfair Inc., Overstock.com, and Newegg Inc., all large internet merchants that have no employees or real estate in South Dakota and do not collect sales tax for the state. The state also sought an injunction requiring these companies to register for licenses to collect and remit sales taxes as required under the act. The companies moved for summary judgment in state court, arguing that the act is unconstitutional. After the law was declared unconstitutional by South Dakota courts, the Supreme Court granted certiorari.

Supreme Court decision

The Supreme Court’s decision was written by Justice Anthony Kennedy, who in Direct Marketing Ass’n v. Brohl, 135 S. Ct. 1124 (2015), had suggested that it was time to reconsider the Quill decision given economic and technological changes since it was decided in 1992. He was joined by Justices Clarence Thomas, Ruth Bader Ginsburg, Samuel Alito, and Neil Gorsuch. Thomas and Gorsuch filed concurring opinions. Chief Justice John Roberts wrote a dissenting opinion, joined by Justices Stephen Breyer, Sonia Sotomayor, and Elena Kagan.

In deciding to overrule Quill and Bellas Hess, the Supreme Court found that the rule in Quill banning sales tax collection when businesses lack “physical presence” in a state was an incorrect interpretation of the Commerce Clause. The Court criticized the Quill decision on several grounds. First, the physical presence rule is not a necessary interpretation of the “closely related” nexus requirement from Complete Auto Transit v. Brady, 430 U.S. 274 (1977). Second, the Court found that Quill creates, rather than resolves market distortions, calling it a “judicially created tax shelter for businesses that decide to limit their physical presence and still sell their goods and services” to a state’s residents (slip op. at 13). Third, the Court found that Quill imposes “arbitrary, formalistic” distinctions that run counter to the Court’s modern precedents under the Commerce Clause (slip op. at 10). For example, a business that holds a few items of inventory in a state would be required to collect sales tax in the state under Quill, while an online retailer with pervasive sales in the state would not, a distinction that the Court said, “simply makes no sense” (slip op. at 14).

With regards to stare decisis, the doctrine that court precedent generally must be followed, the Court found that the doctrine does not justify the prohibition of a valid exercise of the states’ sovereign power, and, if a prior decision did so, the Court must be vigilant to correct its error, and that the Court should not ask Congress to fix an error of the Court’s making.

The Court noted that the Quill rule actually discouraged interstate commerce by creating incentives to avoid economic activities in many states. The Court continued: “When the day-to-day functions of marketing and distribution in the modern economy are considered, it is all the more evident that the physical presence rule is artificial in its entirety” (slip op. at 14).

The Court also rejected arguments that the physical presence test aids interstate commerce by preventing states from imposing burdensome taxes or tax collection obligations on small or startup businesses. The Court concluded that South Dakota’s tax collection plan was designed to avoid burdening small businesses and that there would be other means of protecting these businesses than upholding Quill (slip op. at 22).

Finally, the Court stated that in the absence of Quill and Bellas Hess, the first prong of the Complete Auto test simply asks whether the tax applies to an activity with a substantial nexus with the taxing state, and in South Dakota’s case, the nexus is clearly sufficient, because the South Dakota sales tax act applies only to sellers who engage in a significant quantity of business in the state, and Wayfair, Overstock.com, and Newegg are large, national companies that undoubtedly maintain an extensive virtual presence.

Therefore, the judgment of the South Dakota Supreme Court invalidating South Dakota’s out-of-state sales tax collection requirement was vacated and remanded for “further proceedings not inconsistent with this opinion,” i.e., it allows South Dakota’s law to be put into effect by lifting the state’s injunction (slip op. at 24).

In his dissenting opinion, Roberts argued that, although he agreed that Bellas Hess was wrongly decided and that the enormous growth in internet commerce in the interim years has changed the economy greatly, Congress was the correct branch of government to establish tax rules for this new economy. He also took issue with the majority’s conclusion that the burden on small businesses would be minimal.

Looking forward

Congress may now decide to move ahead with legislation on this issue to provide a national standard for online sales and use tax collection, such as the Remote Transactions Parity Act or Marketplace Fairness Act, or a proposal by Rep. Bob Goodlatte, R-Va., that would make the sales tax a business obligation rather than a consumer obligation. Under that proposal, sales tax would be collected based on the tax rate where the company is located but would be remitted to the jurisdiction where the customer is located. The AICPA has submitted comments on the Marketplace Fairness Act, noting some concerns and suggested improvements if Congress decides to proceed with such a bill.

Last week, the AICPA testified and submitted written comments opposing the Multistate Tax Commission’s model sales-and-use-tax notice and reporting statute. The AICPA urged the MTC and its member states to not adopt the draft model statute because it is contrary to good tax policy, has many costs and few benefits, and will lead to further complications and burdens on customers, sellers, marketplace facilitators, and referrers, as well as the state.

— Sally P. Schreiber (Sally.Schreiber@aicpa-cima.com) is a JofA senior editor.

Supreme Court Decides Wayfair Online Sales Tax Case

June 21, 2018

Joseph Bishop-Henchman 

The U.S. Supreme Court today handed down its anticipated decision in South Dakota v. Wayfair. The case challenges South Dakota’s application of its sales tax to internet retailers who sell into South Dakota but have no property or employees in the state. At issue is the case Quill Corp. v. North Dakota from 1992, which set the property or employees standard for sales taxes using the Court’s (debated) dormant commerce clause power to restrict state taxation of interstate commerce.

Drumroll…South Dakota won. The Court laid out why South Dakota’s law is no burden to interstate commerce but made clear that more complex or overreaching laws would be. This was not too surprising, as during oral argument the justices expressed such frustration with the issue that it’s easy to see why they wouldn’t want this to be just the first of many cases. Better to articulate the rule well here. (We had filed a brief in the case, in support of neither party, urging the Court to uphold South Dakota’s law but draw a clear line preventing more problematic laws from being held as valid.)

As Justice Kennedy’s opinion states:

That said, South Dakota’s tax system includes several features that appear designed to prevent discrimination against or undue burdens upon interstate commerce. First, the Act applies a safe harbor to those who transact only limited business in South Dakota. Second, the Act ensures that no obligation to remit the sales tax may be applied retroactively. S. B. 106, §5. Third, South Dakota is one of more than 20 States that have adopted the Streamlined Sales and Use Tax Agreement. This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state-level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the State. Sellers who choose to use such software are immune from audit liability. See App. 26–27. Any remaining claims regarding the application of the Commerce Clause in the absence of Quill and Bellas Hess may be addressed in the first instance on remand.

The majority opinion, which twice cited the Tax Foundation’s brief, was authored by Justice Anthony Kennedy, joined by Justices Clarence Thomas, Samuel Alito, Ruth Bader Ginsburg, and Neil Gorsuch. Justice Thomas concurred to write that he should have joined the Quill dissent in 1992. Justice Gorsuch concurred, joining the majority in full and adding that he questions Commerce Clause doctrine. Four justices (Chief Justice John Roberts, Justice Stephen Breyer, Justice Sonia Sotomayor, and Justice Elena Kagan) dissented, agreeing that the Court got it wrong before but arguing that Congress should fix it.

All eyes will now turn to Congress and the states. Congress has been stymied between alternate versions of federal solutions: the Remote Transactions Parity Act (RTPA) or Marketplace Fairness Act (MFA), which lets states collect if they agree to simplify their sales taxes, and a proposal from retiring Rep. Bob Goodlatte (R-VA) that would make the sales tax a business obligation rather than a consumer obligation, and have it collected based on the tax rate where the company is located but send the revenue to the jurisdiction where the customer is located. RTPA and MFA are more workable and more likely to pass, but Goodlatte controls what makes it to the House floor, so nothing has happened. Maybe today’s decision will change that.

In the states, a reminder, 31 states currently have laws taxing internet sales. Today’s decision will certainly change how states look at these laws but we may see states trying to see if their versions could survive even if they are less simplified and direct than South Dakota’s law. This ruling is not a blank check for states. The Court specifically observed that South Dakota’s law, and its tax laws generally, minimizes the burden on interstate commerce. Other states should craft their laws accordingly.

The case is South Dakota v. Wayfair, No. 17-494.