Tuesday, June 26, 2018
In a landmark decision on June 21, the Supreme Court of the United States overturned existing case law by ruling that a state can collect sales tax on remote sales even when the vendor does not have a physical presence in the state.
The highly anticipated decision reverses the Supreme Court's pre-internet Quill decision of 1992, which held that states cannot force sales tax collection obligation on vendors who do not have personnel or property in the state (the "physical presence" standard).
The case, South Dakota v. Wayfair, Inc, required the court to determine when an out-of-state seller can be required to collect and remit state sales tax. In so doing, it examined the constitutionality of a South Dakota sales tax law that requires collection of the state's sales tax by internet vendors with at least 200 transactions or USD100,000 in sales to South Dakota residents.
The Supreme Court judges agreed that the South Dakota sales tax law is lawful and discussed whether an out-of-state seller can be held responsible for the payment of sales tax under the Commerce Clause of the United States Constitution, which was designed to prevent states from engaging in economic discrimination.
In its five-to-four majority decision, the court observed that physical presence "is not necessary to create a substantial nexus." It also said that it is no longer possible to defend the physical presence requirement from the point of view that its removal would create undue administrative burdens on out-of-state vendors and disrupt inter-state commerce, given the technology that makes remote online sales possible.
"The Quill majority expressed concern that without the physical presence rule 'a state tax might unduly burden interstate commerce' by subjecting retailers to tax≠ collection obligations in thousands of different taxing jurisdictions," the judgment states.
"But the administrative costs of compliance, especially in the modern economy with its internet technology, are largely unrelated to whether a company happens to have a physical presence in a state. For example, a business with one salesperson in each state must collect sales taxes in every jurisdiction in which goods are delivered; but a business with 500 salespersons in one central location and a website accessible in every state need not collect sales taxes on otherwise identical nationwide sales. In other words, under Quill, a small company with diverse physical presence might be equally or more burdened by compliance costs than a large remote seller."
The court considered that the physical presence rule "is a poor proxy for the compliance costs faced by companies that do business in multiple states," and that existing case law has provided remote sellers with an unfair tax and regulatory advantage.
"In effect, Quill has come to serve as 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 consumers – something that has become easier and more prevalent as technology has advanced," the court observed. "Worse still, the rule produces an incentive to avoid physical presence in multiple states."
The court concluded that: "The Commerce Clause must not prefer interstate commerce only to the point where a merchant physically crosses state borders. Rejecting the physical presence rule is necessary to ensure that artificial competitive advantages are not created by this court's precedents. This court should not prevent states from collecting lawful taxes through a physical presence rule that can be satisfied only if there is an employee or a building in the state."
However, the court maintained that the existing principles underpinning the legality of a tax continues to stand, including that it applies to an activity with a substantial nexus with the taxing state; is fairly apportioned; does not discriminate against interstate commerce; and is fairly related to the services the state provides.
The Court said the South Dakota tax law under examination –†S.B. 106 – satisfies these tests.
The ruling is likely to be welcomed by state governments, who have argued that the de facto sales tax exemption on items bought online deprives them of a vital source of tax revenue. Several states have already introduced laws extending their sales and use taxes to remote sales, although many have been forced to defend these measures in the courts. However, the Supreme Court's latest decision is expected to clear the way for other states to follow in South Dakota's footsteps.
The decision will also be applauded by "brick-and-mortar" retailers, who have long argued that existing sales tax rules have given online vendors an unfair and significant competitive advantage in the marketplace. It will involve substantial new tax obligations for online retailers.