Brick and mortar businesses that have long complained that internet retailers have an unfair advantage because they can skirt sales tax may have reason to celebrate. A landmark ruling by the U.S. Supreme Court Thursday gives states the go-ahead to adopt “economic nexus” as the sales tax standard, which could mean big changes for online businesses.
The 5-4 verdict overrules a 1992 precedent set by Quill v. North Dakota, which addressed mail-order businesses at the time. On petition for writ of certiorari by North Dakota, which relief was granted, the Supreme Court, per Justice Stevens, held: (i) that an out-of-state mail order seller did not need to have a physical presence in state in order to permit the state to require the business to collect use tax from its in-state customers based on its sufficient contacts with the state for due process clause purposes, but (ii) physical presence in state was required, however, for such business to have “substantial nexus” for a taxing state to impose sales tax without violating the commerce clause. The “physical presence” test was the appropriate standard in the view of the Court as a “means for limiting state burdens on interstate commerce” and established boundaries of state authority to impose a duty to collect sales and use taxes and reducing litigation concerning those taxes. The Supreme Court, therefore, found in favor of Quill Corp. and invalidated the use tax collection procedure devised by North Dakota to collect use tax from resident customers purchasing property from out-of-state retailers having no physical presence. (Source: Kostelanetz & Fink, LLP)
Quill has since been used by the e-commerce industry, which has routinely fought to exempt online purchases from sales tax so long as the seller did not have a physical operation in the state where the customer resided. In the majority opinion written by Justice Anthony Kennedy, the Supreme Court said times have changed to such a degree that online retailers no longer qualify for “an arbitrary advantage over their competitors who collect state sales taxes” by claiming they don’t have a physical presence in a state.
In the wake of Thursday’s ruling, e-commerce companies, large and small, are understandably concerned for the future. For companies like Amazon and Overstock.com, which allow third-party sellers to use their platforms, compliance may be particularly difficult. More than 50% of all Amazon sales are conducted via third-party sellers who either use Amazon for fulfillment or otherwise operate as small- to medium-sized businesses. Amazon has been collecting sales tax in all 45 states that require it by law, but it may have a substantial amount of work to do to help its Amazon Marketplace sellers stay compliant. (We don’t know yet if that burden will fall primarily on Amazon or if it will be the responsibility of the sellers.)
Executives from Etsy and eBay, among other platforms, have already released statements (here and here) calling for Congress to act to protect its partner “micro-businesses” from burdensome new tax laws that may come from this ruling.
South Dakota can be credited with kicking off the debate by implementing an economic nexus standard on May 1, 2016, with the intent of not only protecting in-state business but in presenting a challenge to mail-order and out-of-state retailers in serving up a case for Supreme Court review. Like many other states, SD 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 claimed it was losing 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’s a huge hit for South Dakota because it collects no income tax from residents; state sales tax makes up the majority of the state’s funds.
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. 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 understood that its new law would be unconstitutional unless Quill was overturned, it included a provision for expeditious judicial review if the law was challenged. South Dakota filed a declaratory judgment action in state court against Wayfair Inc., Overstock.com, and Newegg Inc., 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 was unconstitutional. After the law was declared unconstitutional by South Dakota courts, the Supreme Court granted certiorari, thereby agreeing to hear the case.
What happens next? We can’t say for sure. Note that the Supreme only overruled Quill. It did not make constitutional the South Dakota law that raised the issue. Because of this, how the ruling is clarified gets bounced back to the lower courts. Unless Congress steps in to supersede state court decisions, this case will likely be litigated for years to come.
If you think your business will be impacted, reach out immediately for assistance. We can help you prepare for changes and devise a strategy that will save you money despite the uncertainty surrounding this ruling.